SOLUTIONS MANUAL for Accounting 28th Edition by Carl Warren, Christine Jonick & Jennifer Schneider. by StudyGuide

CHAPTER 1 INTRODUCTION TO ACCOUNTING AND BUSINESS DISCUSSION QUESTIONS 1.

Some users of accounting information include managers, employees, investors, creditors, customers, and the government.

The role of accounting is to provide information for managers to use in operating the business. In addition, accounting provides information to others to use in assessing the economic performance and condition of the business.

The corporate form allows the company to obtain large amounts of resources by issuing stock. For this reason, most companies that require large investments in property, plant, and equipment are organized as corporations.

No. The business entity concept limits the recording of economic data to transactions directly affecting the activities of the business. The payment of the interest of $4,500 is a personal transaction of Josh Reilly and should not be recorded by Dispatch Delivery Service.

The land should be recorded at its cost of $167,500 to Reliable Repair Service. This is consistent with the cost concept.

No. The offer of $2,000,000 and the increase in the assessed value should not be recognized in the accounting records because land is recorded on the cost basis.

Cash would increase by $2,125,000, land would decrease by $900,000, and owner’s equity would increase by $1,225,000.

An account receivable is a claim against a customer for goods or services sold. An account payable is an amount owed to a creditor for goods or services purchased. Therefore, an account receivable in the records of the seller is an account payable in the records of the purchaser.

(b) The business realized net income of $91,000 ($679,000 – $588,000).

(a) The business incurred a net loss of $75,000 ($640,000 – $715,000).

10.

(a) Net income or net loss (b) Owner’s equity at the end of the period (c) Cash at the end of the period

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PRACTICE EXERCISES PE 1-1A $597,000. Under the cost concept, the land should be recorded at the cost to Boulder Repair Service. PE 1-1B $369,500. Under the cost concept, the land should be recorded at the cost to Clementine Repair Service. PE 1-2A a.

A = L + OE $518,000 = $165,000 + OE OE = $353,000

A = L + OE +$86,200 = +$25,000 + OE OE = +$61,200 OE on December 31, 20Y9 = $353,000 + $61,200 = $414,200

PE 1-2B a.

A = L + OE $382,000 = $94,000 + OE OE = $288,000

A = L + OE –$63,000 = +$35,000 + OE OE = –$98,000 OE on December 31, 20Y9 = $288,000 – $98,000 = $190,000

PE 1-3A (2) Asset (Accounts Receivable) increases by $22,400; Owner’s Equity (Delivery Service Fees) increases by $22,400. (3) Liability (Accounts Payable) decreases by $4,100; Asset (Cash) decreases by $4,100. (4) Asset (Cash) increases by $14,700; Asset (Accounts Receivable) decreases by $14,700. (5) Asset (Cash) decreases by $1,600; Owner’s Equity (Terry Young, Drawing) decreases by $1,600.

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PE 1-3B (2) Owner’s Equity (Advertising Expense, increases) decreases by $6,750; Asset (Cash) decreases by $6,750. (3) Asset (Supplies) increases by $2,920; Liability (Accounts Payable) increases by $2,920. (4) Asset (Accounts Receivable) increases by $20,460; Owner’s Equity (Delivery Service Fees) increases by $20,460. (5) Asset (Cash) increases by $11,410; Asset (Accounts Receivable) decreases by $11,410.

PE 1-4A Up-in-the-Air Travel Service Income Statement For the Year Ended April 30, 20Y7 Fees earned Expenses: Wages expense Office expense Miscellaneous expense Total expenses Net income

$1,870,000 $1,115,000 343,000 21,000 1,479,000 $ 391,000

PE 1-4B Zenith Travel Service Income Statement For the Year Ended August 31, 20Y4 Fees earned Expenses: Wages expense Office expense Miscellaneous expense Total expenses Net loss

$899,600 $539,800 353,800 14,400 908,000 $ (8,400)

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PE 1-5A Up-in-the-Air Travel Service Statement of Owner’s Equity For the Year Ended April 30, 20Y7 Jerome Foley, capital, May 1, 20Y6 Additional investment by owner during year Net income for the year Withdrawals Increase in owner’s equity Jerome Foley, capital, April 30, 20Y7

$ 876,000 $ 52,000 391,000 (34,000) 409,000 $1,285,000

PE 1-5B Zenith Travel Service Statement of Owner’s Equity For the Year Ended August 31, 20Y4 Megan Cox, capital, September 1, 20Y3 Additional investment by owner during year $ 43,200 Net loss for the year (8,400) Withdrawals (21,600) Increase in owner’s equity Megan Cox, capital, August 31, 20Y4

$456,000

13,200 $469,200

PE 1-6A Up-in-the-Air Travel Service Balance Sheet April 30, 20Y7 Assets Cash Accounts receivable Supplies Land Total assets

$ 170,000 417,000 16,000 772,000 $1,375,000 Liabilities

Accounts payable

90,000

Owner’s Equity Jerome Foley, capital Total liabilities and owner’s equity

1,285,000 $1,375,000

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PE 1-6B Zenith Travel Service Balance Sheet August 31, 20Y4 Assets Cash Accounts receivable Supplies Land Total assets

$ 54,500 90,600 5,600 372,000 $522,700 Liabilities

Accounts payable

$ 53,500

Owner’s Equity Megan Cox, capital Total liabilities and owner’s equity

469,200 $522,700

PE 1-7A Up-in-the-Air Travel Service Statement of Cash Flows For the Year Ended April 30, 20Y7 Cash flows from (used for) operating activities: Cash received from customers $ 1,803,000 Cash paid for operating expenses (1,479,000) Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for purchase of land Cash flows from (used for) financing activities: Cash received from owner as investment $ 52,000 Cash withdrawals by owner (34,000) Net cash flows from financing activities Net decrease in cash Cash balance, May 1, 20Y6 Cash balance, April 30, 20Y7

$ 324,000 (347,000)

18,000 $ (5,000) 175,000 $ 170,000

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PE 1-7B Zenith Travel Service Statement of Cash Flows For the Year Ended August 31, 20Y4 Cash flows from (used for) operating activities: $ 881,000 Cash received from customers (895,000) Cash paid for operating expenses Net cash flows used for operating activities Cash flows from (used for) investing activities: Cash paid for purchase of land Cash flows from (used for) financing activities: $ 43,200 Cash received from owner as investment (21,600) Cash withdrawals by owner Net cash flows from financing activities Net decrease in cash Cash balance, September 1, 20Y3 Cash balance, August 31, 20Y4

$(14,000) (60,000)

21,600 $(52,400) 106,900 $ 54,500

PE 1-8A a.

Dec. 31, 20Y6

Dec. 31, 20Y5

$598,000 $460,000 1.30 *

$569,900 $410,000 1.39**

Dec. 31, 20Y6 Total liabilities……………………………………………… $4,042,000 Total owner’s equity………………………………………… $4,300,000 0.94 * Ratio of liabilities to owner’s equity………………………

Dec. 31, 20Y5 $3,096,000 $3,600,000 0.86**

Total liabilities……………………………………………… Total owner’s equity………………………………………… Ratio of liabilities to owner’s equity……………………… * $598,000 ÷ $460,000 ** $569,900 ÷ $410,000 b.

Decreased

PE 1-8B a.

* $4,042,000 ÷ $4,300,000 ** $3,096,000 ÷ $3,600,000 b.

Increased

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EXERCISES Ex. 1-1 a.

1. 2. 3. 4. 5.

manufacturing manufacturing manufacturing service merchandise

6. 7. 8. 9. 10.

service service service manufacturing merchandise

11. 12. 13. 14. 15.

service service manufacturing service merchandise

The accounting equation is relevant to all of the companies. It serves as the basis of the accounting information system.

Ex. 1-2 As in many ethics issues, there is no one right answer. Oftentimes, disclosing only what is legally required may not be enough. In this case, it would be best for the company’s chief executive officer to disclose both reports to the county representatives. In doing so, the chief executive officer could point out any flaws or deficiencies in the fired researcher’s report.

Ex. 1-3 a.

1. 2. 3. 4.

K G B K

5. 6. 7. 8.

B B X G

9. 10.

X B

A business transaction is an economic event or condition that directly changes an entity’s financial condition or results of operations.

Ex. 1-4 Dunkin’s stockholders’ equity: $3,457 – $4,170 = ($713) Starbucks’ stockholders’ equity: $24,156 – $22,981 = $1,175

Ex. 1-5 Dollar Tree’s stockholders’ equity: $13,501 – $7,858 = $5,643 Target’s stockholders’ equity: $41,290 – $29,993 = $11,297

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Ex. 1-6 a. b. c.

$4,474,000 ($633,000 + $3,841,000) $387,500 ($6,124,500 – $5,737,000) $1,232,900 ($1,981,800 – $748,900)

Ex. 1-7 a. b. c. d. e.

$494,000 ($659,000 – $165,000) $555,000 ($494,000 + $88,000 – $27,000) $330,000 ($494,000 – $151,000 – $13,000) $662,000 ($494,000 + $152,000 + $16,000) Net income: $92,000 ($782,000 – $196,000 – $494,000)

Ex. 1-8 a. b. c. d. e. f. g.

(1) (2) (1) (3) (1) (3) (1)

asset liability asset owner’s equity (revenue) asset owner’s equity (expense) asset

Ex. 1-9 a. b. c. d. e.

Increases assets and increases owner’s equity. Decreases assets and decreases owner’s equity. Increases assets and decreases assets. Increases assets and increases liabilities. Increases assets and increases owner’s equity.

Ex. 1-10 a.

(1) Total assets increased $183,000 ($298,000 – $115,000). (2) No change in liabilities. (3) Owner’s equity increased $183,000.

(1) Total assets decreased $80,000. (2) Total liabilities decreased $80,000. (3) No change in owner’s equity.

No. It is false that a transaction always affects at least two elements (Assets, Liabilities, or Owner’s Equity) of the accounting equation. Some transactions affect only one element of the accounting equation. For example, purchasing supplies for cash only affects assets.

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Ex. 1-11 1. 2. 3. 4.

(b) decrease (a) increase (b) decrease (a) increase

Ex. 1-12 1. 2. 3. 4. 5.

c a e e c

6. 7. 8. 9. 10.

c d a e e

Ex. 1-13 a.

(1) Provided catering services for cash, $71,800. (2) Purchase of land for cash, $15,000. (3) Payment of cash for expenses, $47,500. (4) Purchase of supplies on account, $1,100. (5) Withdrawal of cash by owner, $5,000. (6) Payment of cash to creditors, $4,000. (7) Recognition of cost of supplies used, $1,500.

b. c. d. e.

$300 ($40,300 – $40,000) $17,800 (–$5,000 + $71,800 – $49,000) $22,800 ($71,800 – $49,000) $17,800 ($22,800 – $5,000)

Ex. 1-14 No. It would be incorrect to say that the business had incurred a net loss of $8,000. The excess of the withdrawals over the net income for the period is a decrease in the amount of owner’s equity in the business.

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Ex. 1-15 Dakota Owner’s equity at end of year ($928,000 – $352,000)…………………………… Deduct owner’s equity at beginning of year ($605,000 – $237,000)………… Net income (increase in owner’s equity)………………………………………

$576,000 368,000 $208,000

Jersey Increase in owner’s equity (as determined for Dakota)……………………… Add withdrawals……………………………………………………………………… Net income (increase in owner’s equity)………………………………………

$208,000 40,000 $248,000

Carolina Increase in owner’s equity (as determined for Dakota)……………………… Deduct additional investment……………………………………………………… Net income (increase in owner’s equity)………………………………………

$208,000 66,000 $142,000

Iowa Increase in owner’s equity (as determined for Dakota)……………………… Deduct additional investment……………………………………………………… Add withdrawals……………………………………………………………………… Net income (increase in owner’s equity)………………………………………

$208,000 66,000 $142,000 40,000 $182,000

Ex. 1-16 Balance sheet items: 1, 2, 3, 4, 6, 8, 10

Ex. 1-17 Income statement items: 5, 7, 9

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Ex. 1-18 a.

Pegasus Product Company Statement of Owner’s Equity For the Month Ended April 30, 20Y7 Brian Walinsky, capital, April 1, 20Y7 Net income for April $161,000 Withdrawals (24,000) Increase in owner’s equity Brian Walinsky, capital, April 30, 20Y7

$373,000

137,000 $510,000

The statement of owner’s equity is prepared before the April 30, 20Y7, balance sheet because Brian Walinsky, Capital as of April 30, 20Y7, is needed for the balance sheet.

Ex. 1-19 Hermes Services Income Statement For the Month Ended August 31, 20Y2 Fees earned Expenses: Wages expense Rent expense Supplies expense Miscellaneous expense Total expenses Net income

$627,600 $440,800 28,100 6,800 9,300 485,000 $142,600

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Ex. 1-20 In each case, solve for a single unknown, using the following equation: Owner’s Equity (beginning) + Investments – Withdrawals + Revenues – Expenses = Owner’s Equity (ending) Freeman Owner’s equity at end of year ($1,260,000 – $330,000)……………… Owner’s equity at beginning of year ($900,000 – $360,000)………… Increase in owner’s equity………………………………………………… Deduct increase due to net income ($570,000 – $240,000)………… Increase due to additional investment less withdrawals…………… Add withdrawals………………………………………………….………… Additional investment in the business……………………………… (a)

$930,000 540,000 $390,000 330,000 $ 60,000 75,000 $135,000

Heyward Owner’s equity at end of year ($675,000 – $220,000)………………… Owner’s equity at beginning of year ($490,000 – $260,000)………… Increase in owner’s equity………………………………………………… Add withdrawals………………………………………………….………… Increase due to additional investment and net income……………… Deduct additional investment…………………………………………… Increase due to net income……………………………………………… Add expenses………………………………………………….…………… Revenue………………………………………………….…………………(b)

$455,000 230,000 $225,000 32,000 $257,000 150,000 $107,000 128,000 $235,000

Jones Owner’s equity at end of year ($100,000 – $80,000)…………………… Owner’s equity at beginning of year ($115,000 – $81,000)…………… Decrease in owner’s equity……………………………………………… Add decrease due to net loss ($115,000 – $122,500)………………… Decrease due to withdrawals less additional investment…………… Deduct additional investment…………………………………………… Withdrawals from the business……………………………………… (c)

$ 20,000 34,000 $(14,000) (7,500) $ (6,500) 10,000 $(16,500)

Ramirez Owner’s equity at end of year ($270,000 – $136,000)………………… Add decrease due to net loss ($115,000 – $128,000)………………… Add withdrawals………………………………………………….………… Beginning owner’s equity plus additional investment ……………… Deduct additional investment…………………………………………… Owner’s equity at beginning of year…………………………………… Add liabilities at beginning of year……………………………………… Assets at beginning of year…………………………………………… (d)

$134,000 (13,000) 39,000 $186,000 55,000 $131,000 120,000 $251,000

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Ex. 1-21 a. Rockwell Interiors Balance Sheet February 29, 20Y0 Assets Cash Accounts receivable Supplies Total assets

$ 290,000 720,000 30,000 $1,040,000 Liabilities

Accounts payable

$ 280,000 Owner’s Equity

David Patel, capital Total liabilities and owner’s equity

760,000 $1,040,000

Rockwell Interiors Balance Sheet March 31, 20Y0 Assets Cash Accounts receivable Supplies Total assets

$ 340,000 870,000 32,000 $1,242,000 Liabilities

Accounts payable

$ 360,000

Owner’s Equity David Patel, capital Total liabilities and owner’s equity

882,000 $1,242,000

Owner’s equity, March 31……………………………………………………… Owner’s equity, February 29…………………….…………………………… Net income……………………………………………………………………

$882,000 760,000 $122,000

Owner’s equity, March 31……………………………………………………… Owner’s equity, February 29…………………….…………………………… Increase in owner’s equity………………………………………………… Add withdrawal…………………………………………………………………… Net income……………………………………………………………………

$882,000 760,000 $122,000 50,000 $172,000

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Introduction to Accounting and Business

Ex. 1-22 a.

Balance sheet: 1, 2, 3, 4, 6, 7, 8, 9, 10, 11, 13 Income statement: 5, 12, 14, 15

Yes. An item can appear on more than one financial statement. For example, cash appears on both the balance sheet and statement of cash flows. However, the same item cannot appear on both the income statement and balance sheet.

Yes. The accounting equation is relevant to all companies, including Exxon Mobil Corporation.

Ex. 1-23 1. 2. 3. 4.

(a) operating activity (a) operating activity (b) investing activity (c) financing activity

Ex. 1-24 Ethos Consulting Group Statement of Cash Flows For the Year Ended May 31, 20Y6 Cash flows from (used for) operating activities: Cash received from customers Cash paid for operating expenses Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for purchase of land Cash flows from (used for) financing activities: Cash received from owner as investment Cash withdrawals by owner Net cash flows from financing activities Net increase in cash Cash balance, June 1, 20Y5 Cash balance, May 31, 20Y6

$ 637,500 (475,000) $162,500 (90,000) $ 62,500 (17,500) 45,000 $117,500 58,000 $175,500

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Ex. 1-25 1.

All financial statements should contain the name of the business in their heading. The statement of owner’s equity is incorrectly headed as “Omar Farah” rather than We-Sell Realty. The heading of the balance sheet needs the name of the business.

The income statement and statement of owner’s equity cover a period of time and should be labeled “For the Month Ended August 31, 20Y9.”

The year in the heading for the statement of owner’s equity should be 20Y9 rather than 20Y8.

The balance sheet should be labeled “August 31, 20Y9,” rather than “For the Month Ended August 31, 20Y9.”

In the income statement, the miscellaneous expense amount should be listed as the last expense.

In the income statement, the total expenses are incorrectly subtracted from the sales commissions, resulting in an incorrect net income amount. The correct net income should be $24,150. This also affects the statement of owner’s equity and the amount of Omar Farah, Capital, that appears on the balance sheet.

In the statement of owner’s equity, the additional investment should be added first to Omar Farah, capital, as of August 1, 20Y9. The net income should be presented next, followed by the amount of withdrawals, which is subtracted from the net income to yield the increase in owner’s equity. The increase in owner’s equity is added to Omar Farah, capital on August 1, 20Y9, to determine Omar Farah, capital on August 31, 20Y9.

Accounts payable should be listed as a liability on the balance sheet.

Accounts receivable and supplies should be listed as assets on the balance sheet.

10.

The balance sheet assets should equal the sum of the liabilities and owner’s equity.

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Ex. 1-25 (Concluded) Corrected financial statements appear as follows: We-Sell Realty Income Statement For the Month Ended August 31, 20Y9 Sales commissions Expenses: Office salaries expense Rent expense Automobile expense Supplies expense Miscellaneous expense Total expenses Net income

$140,000 $87,000 18,000 7,500 1,150 2,200 115,850 $ 24,150

We-Sell Realty Statement of Owner’s Equity For the Month Ended August 31, 20Y9 Omar Farah, capital, August 1, 20Y9 Investment on August 1, 20Y9 Net income for August Withdrawals during August Increase in owner’s equity Omar Farah, capital, August 31, 20Y9

$ 15,000 24,150 (10,000) 29,150 $29,150

We-Sell Realty Balance Sheet August 31, 20Y9 Assets Cash Accounts receivable Supplies Total assets

$ 8,900 38,600 4,000 $51,500 Liabilities

Accounts payable

$22,350

Owner’s Equity Omar Farah, capital Total liabilities and owner’s equity

29,150 $51,500

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Ex. 1-26 a.

Year 2: $43,075 ($44,529 – $1,454) Year 1: $38,633 ($42,966 – $4,333)

Year 2: 29.63 ($43,075 ÷ $1,454) Year 1: 8.92 ($38,633 ÷ $4,333)

The ratio of liabilities to stockholders’ equity increased from 8.92 to 29.63 indicating an increase in risk for creditors from Year 1 to Year 2.

Ex. 1-27 a.

Year 2: $5,873 ($35,291 – $29,418) Year 1: $6,434 ($34,408 – $27,974)

Year 2: 5.01 ($29,418 ÷ $5,873) Year 1: 4.35 ($27,974 ÷ $6,434)

The risk for creditors has increased from 4.35 in Year 1 to 5.01 in Year 2.

The Home Depot’s ratio of liabilities to stockholders’ equity (29.63 in Year 2 and 8.92 in Year 1) is more in both years than is Lowe’s ratio of liabilities to stockholders’ equity (5.01 in Year 2 and 4.35 in Year 1). Thus, the risk to creditors of The Home Depot is more than that of Lowe’s.

3,300 2,050 1,250

30,800

55,000

–

– –

13,800 13,800

49,100

18,300 30,800 49,100

18,300

18,300 18,300

Fees Earned

Rent Salaries Supplies

–

– –

8,300

8,300 8,300

–

– –

7,300

7,300 7,300

–

– –

2,050

2,050 2,050

– Expense – Expense – Expense –

–

– –

1,380

1,380 1,380

Auto Exp.

–

1-18

June’s transactions increased Pamela Schatz’s capital to $69,470 ($55,000 + $28,270 – $13,800), which is the initial capital investment of $55,000 plus June’s net income of $28,270 less Pamela Schatz’s withdrawals of $13,800.

1,010

2,290 1,010

Owner’s Equity

30,800

1,250

3,300

30,800

3,300

3,300 3,300 3,300

–

Accts. Payable

3,300

3,300 3,300

30,800 30,800

–

+ Supplies =

Pamela Schatz, Drawing

$28,270 ($49,100 – $8,300 – $7,300 – $2,050 – $1,380 – $1,800)

Accts. Rec.

Pamela Schatz, Capital

= Liabilities +

Owner’s equity is the right of owners to the assets of the business. These rights are increased by owner’s investments and revenues and decreased by owner’s withdrawals and expenses.

52,230 13,800 38,430

62,710 3,180 59,530 7,300 52,230

2,290 62,710

55,000 18,300 73,300 8,300 65,000

55,000

Cash

Assets

PROBLEMS

Introduction to Accounting and Business

(e) – Bal. (f) Bal. (g) – Bal. (h) – Bal. (i) Bal. (j) – Bal.

(a) + (b) Bal. (c) + Bal. (d) – Bal.

Prob. 1-1A

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–

– –

1,800

1,800 1,800

Misc. Exp.

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Prob. 1-2A Excalibur Travel Agency Income Statement For the Year Ended December 31, 20Y5

Fees earned Expenses: Wages expense Rent expense Utilities expense Supplies expense Miscellaneous expense Total expenses Net income 2.

$967,000 $540,400 38,100 30,200 4,300 6,800 619,800 $347,200

Excalibur Travel Agency Statement of Owner’s Equity For the Year Ended December 31, 20Y5 James Brewster, capital, January 1, 20Y5 Net income for the year $347,200 Withdrawals (44,500) Increase in owner’s equity James Brewster, capital, December 31, 20Y5

$ 710,000

302,700 $1,012,700

Excalibur Travel Agency Balance Sheet December 31, 20Y5 Assets

Cash Accounts receivable Supplies Land Total assets

$ 201,900 302,000 5,800 576,500 $1,086,200 Liabilities

Accounts payable

73,500

Owner’s Equity James Brewster, capital Total liabilities and owner’s equity 4.

1,012,700 $1,086,200

James Brewster, Capital of $1,012,700

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Prob. 1-3A Reliance Financial Services Income Statement For the Month Ended July 31, 20Y2

Fees earned Expenses: Salaries expense Rent expense Auto expense Supplies expense Miscellaneous expense Total expenses Net income 2.

$144,500 $55,000 33,000 16,000 4,500 4,800 113,300 $ 31,200

Reliance Financial Services Statement of Owner’s Equity For the Month Ended July 31, 20Y2 Seth Feye, capital, July 1, 20Y2 Investment on July 1, 20Y2 $ 50,000 Net income for July 31,200 Withdrawals (15,000) Increase in owner’s equity Seth Feye, capital, July 31, 20Y2

66,200 $66,200

Reliance Financial Services Balance Sheet July 31, 20Y2 Assets

Cash Accounts receivable Supplies Total assets

$32,600 34,500 2,500 $69,600 Liabilities

Accounts payable

$ 3,400 Owner’s Equity

Seth Feye, capital Total liabilities and owner’s equity

66,200 $69,600

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Prob. 1-3A (Concluded) 4.

(Optional)

Reliance Financial Services Statement of Cash Flows For the Month Ended July 31, 20Y2 Cash flows from (used for) operating activities: Cash received from customers Cash paid for expenses and to creditors* Net cash flows from operating activities Cash flows from (used for) investing activities Cash flows from (used for) financing activities: Cash received from owner as investment Cash withdrawal by owner Net cash flows from financing activities Net increase in cash Cash balance, July 1, 20Y2 Cash balance, July 31, 20Y2

$ 110,000 (112,400) $ (2,400) 0 $ 50,000 (15,000) 35,000 $32,600 0 $32,600

* $3,600 + $33,000 + $20,800 + $55,000; these amounts are taken from the Cash column shown in the problem.

(e) – Bal. (f) – Bal. (g) – Bal. (h) – Bal. (i) Bal.

(a) + (b) Bal. (c) – Bal. (d) + Bal.

48,050

3,600 61,700 4,000 57,700 4,650 53,050 5,000 48,050

25,000 1,200 23,800 41,500 65,300

–

650 650

1,850

1,850 900 950

+ +

25,000

–

– –

4,000

4,000 4,000

Pat Glenn, Pat Glenn, – Drawing + Capital

1-22

41,500

41,500 41,500

Sales Comm.

–

– 5,000

– 5,000 – 5,000

Salaries Exp.

–

– –

3,600

3,600 3,600

Rent Exp.

Owner’s Equity

Introduction to Accounting and Business

–

– –

3,050

3,050 3,050

Auto Exp.

650

1,850

650

1,850 1,850 1,200 650

650

–

1,850

1,850 1,850

Accts. Payable

= Liabilities +

+ Supplies =

Assets

25,000

Cash

Prob. 1-4A

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–

– –

900 900

Supplies Exp.

–

– –

1,600

1,600 1,600

Misc. Exp.

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Prob. 1-4A (Concluded) Half Moon Realty Income Statement For the Month Ended July 31, 20Y7

Sales commissions Expenses: Salaries expense Rent expense Auto expense Supplies expense Miscellaneous expense Total expenses Net income

$41,500 $5,000 3,600 3,050 900 1,600 14,150 $27,350

Half Moon Realty Statement of Owner’s Equity For the Month Ended July 31, 20Y7 Pat Glenn, capital, July 1, 20Y7 Investment on July 1, 20Y7 Net income for July Withdrawals Increase in owner’s equity Pat Glenn, capital, July 31, 20Y7

$25,000 27,350 (4,000) 48,350 $48,350

Half Moon Realty Balance Sheet July 31, 20Y7 Assets Cash Supplies Total assets

$48,050 950 $49,000 Liabilities

Accounts payable

Owner’s Equity Pat Glenn, capital Total liabilities and owner’s equity

48,350 $49,000

650

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5A 1.

Assets +

Accounts Receivable

+ Supplies +

Land

$45,000 +

$93,000

$7,000

$75,000 $220,000 $180,000

Cash

= Liabilities +

Owner’s Equity

Accounts Payable

Joel Palk, Capital

= $40,000 + Joel Palk, Capital = $40,000 + Joel Palk, Capital = Joel Palk, Capital

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5A (Continued) 2. Cash Bal. (a)

–

Bal. (d)

93,000

Bal.

7,000

93,000

7,000

–

Bal.

93,000

56,125

93,000

56,125

93,000

75,000

40,000

215,000

7,000

125,000

40,000

215,000

7,000

125,000

40,000

215,000

50,000

2,500 9,500

+ 125,000 –

93,000

(j) Bal.

(l)

9,500

125,000

19,700

215,000

19,700

215,000

177,750

9,500

125,000

33,325

177,750

9,500

125,000

49,200

215,000

177,750

9,500

125,000

49,200

215,000

9,500

125,000

49,200

215,000

125,000

49,200

215,000

Bal.

29,500

14,000 88,000

–

88,000

107,325

89,750

107,325

89,750

– –

22,800

84,750

(k) Bal.

215,000

33,325

19,325 +

2,500 42,500

Bal.

35,000

125,000

22,800 +

–

180,000 215,000

(h) (i)

40,000

Joel Palk, – Drawing

6,000

33,325

Bal.

Joel Palk, Capital

32,125

(g) Bal.

75,000

Bal.

= Payable +

40,000

50,000

(e) (f)

7,000

93,000

62,125 –

Land

Owner’s Equity

30,000 +

Accts.

+ Supplies +

35,000 80,000

Bal. (c)

Accts. Rec.

45,000 +

Bal. (b)

= Liabilities +

Assets

3,600 5,900

12,000 95,325

– 12,000 89,750

5,900

125,000

49,200

215,000

– 12,000

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5A (Continued) Owner’s Equity (Continued) Dry Cleaning + Revenue

Dry Cleaning Wages Exp. – – Exp. –

Rent Exp.

–

Supplies Exp. –

Truck Exp.

–

Utilities Exp.

–

Misc. Exp.

Bal. (a) Bal. (b) Bal. (c)

Bal.

32,125 32,125

(d)

– 6,000

Bal.

32,125

– 6,000

32,125

– 6,000

32,125

– 6,000

(e) Bal. (f) Bal. (g) Bal.

84,750 116,875

(h) Bal.

116,875

– 6,000 –

29,500

–

29,500

(i) Bal.

– 6,000 – 7,500

–

2,500

–

1,300

– 2,700

116,875

–

29,500

– 7,500

– 6,000

–

2,500

–

1,300

– 2,700

116,875

–

29,500

– 7,500

– 6,000

–

2,500

–

1,300

– 2,700

–

3,600

116,875

–

29,500

– 7,500

– 6,000

–

3,600

–

2,500

–

1,300

– 2,700

116,875

–

29,500

– 7,500

– 6,000

–

3,600

–

2,500

–

1,300

– 2,700

(j) Bal. (k) Bal. (l) Bal.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5A (Continued) D’Lite Dry Cleaners Income Statement For the Month Ended July 31, 20Y6

Dry cleaning revenue Expenses: Dry cleaning expense Wages expense Rent expense Supplies expense Truck expense Utilities expense Miscellaneous expense Total expenses Net income

$116,875 $29,500 7,500 6,000 3,600 2,500 1,300 2,700 53,100 $ 63,775

D’Lite Dry Cleaners Statement of Owner’s Equity For the Month Ended July 31, 20Y6 Joel Palk, capital, July 1, 20Y6 Additional investment during July $ 35,000 Net income for July 63,775 Withdrawals (12,000) Increase in owner’s equity Joel Palk, capital, July 31, 20Y6

$180,000

86,775 $266,775

D’Lite Dry Cleaners Balance Sheet July 31, 20Y6 Assets Cash Accounts receivable Supplies Land Total assets

$ 95,325 89,750 5,900 125,000 $315,975 Liabilities $ 49,200

Accounts payable Owner’s Equity Joel Palk, capital Total liabilities and owner’s equity

266,775 $315,975

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5A (Concluded) 4.

(Optional)

D’Lite Dry Cleaners Statement of Cash Flows For the Month Ended July 31, 20Y6 Cash flows from (used for) operating activities: Cash received from customers* Cash paid for expenses and to creditors** Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for purchase of land Cash flows from (used for) financing activities: Cash received from owner as investment Cash withdrawal by owner Net cash flows from financing activities Net increase in cash Cash balance, July 1, 20Y6 Cash balance, July 31, 20Y6

$120,125 (42,800) $ 77,325 (50,000) $ 35,000 (12,000) 23,000 $ 50,325 45,000 $ 95,325

* $32,125 + $88,000; these amounts are taken from the Cash column of the spreadsheet in Part 2. ** $6,000 + $22,800 + $14,000; these amounts are taken from the Cash column of the spreadsheet in Part 2.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-6A a.

Fees earned, $750,000 ($275,000 + $475,000)

Supplies expense, $30,000 ($475,000 – $300,000 – $100,000 – $20,000 – $25,000)

Dakota Rowe, capital, April 1, 20Y3, $0; Wolverine Realty was organized on April 1, 20Y3.

Net income for April, $275,000 from income statement

Increase in owner’s equity, $525,000 ($375,000 + $275,000 – $125,000)

Dakota Rowe, capital, April 30, 20Y3, $525,000

Total assets, $625,000 ($462,500 + $12,500 + $150,000)

Dakota Rowe, capital, $525,000 ($625,000 – $100,000)

Total liabilities and owner’s equity, $625,000 ($100,000 + $525,000); same as (g)

Cash received from customers, $750,000; this is the same as fees earned (a) since there are no accounts receivable.

Net cash flows from operating activities, $362,500 ($750,000 – $387,500)

Cash payments for acquisition of land, ($150,000)

Cash received as owner’s investment, $375,000

Cash withdrawal by owner, ($125,000)

Net cash flows from financing activities, $250,000 ($375,000 – $125,000)

Net increase in cash, $462,500 ($362,500 – $150,000 + $250,000)

April 30, 20Y3, cash balance, $462,500

1,700

50,000

Amy Austin, – Capital

– –

3,900 3,900

26,300

13,800 12,500 26,300

13,800

13,800 13,800

Fees Earned

Rent

Salaries

Supplies

–

– –

5,000

5,000 5,000

–

– –

2,500

2,500 2,500

–

– –

1,300

1,300 1,300

– Expense – Expense – Expense –

–

– –

1,150

1,150 1,150

Auto Exp.

–

– –

1-30

March’s transactions increased Amy Austin’s capital to $62,150 ($50,000 + $16,050 – $3,900), which is the initial investment of $50,000 plus the excess of March’s net income of $16,050 over Amy Austin’s withdrawals of $3,900.

2,700

12,500

1,700

2,700

1,700

4,000 1,300 2,700 1,700

1,700

4,000

1,700

4,000 4,000 2,300 1,700

1,700

–

Accts. Payable

4,000

4,000 4,000

12,500 12,500

–

+ Supplies =

Owner’s Equity

$16,050 ($26,300 – $5,000 – $2,500 – $1,300 – $1,150 – $300)

Accts. Rec.

Amy Austin, Drawing

= Liabilities +

Owner’s equity is the right of owners to the assets of the business. These rights are increased by owner’s investments and revenues and decreased by owner’s withdrawals and expenses.

52,550 3,900 48,650

52,550

5,000 56,500 1,450 55,050 2,500 52,550

50,000 2,300 47,700 13,800 61,500

50,000

Cash

Assets

Introduction to Accounting and Business

(e) – Bal. (f) – Bal. (g) – Bal. (h) Bal. (i) Bal. (j) – Bal.

(a) + (b) Bal. (c) – Bal. (d) + Bal.

Prob. 1-1B

CHAPTER 1

300

300 300

Misc. Exp.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-2B Wilderness Travel Service Income Statement For the Year Ended April 30, 20Y5

Fees earned Expenses: Wages expense Rent expense Utilities expense Supplies expense Taxes expense Miscellaneous expense Total expenses Net income 2.

$875,000 $525,000 75,000 38,000 12,000 10,000 15,000 675,000 $200,000

Wilderness Travel Service Statement of Owner’s Equity For the Year Ended April 30, 20Y5 Harper Borg, capital, May 1, 20Y4 Net income for the year $200,000 Withdrawals (40,000) Increase in owner’s equity Harper Borg, capital, April 30, 20Y5

$180,000

160,000 $340,000

Wilderness Travel Service Balance Sheet April 30, 20Y5 Assets

Cash Accounts receivable Supplies Total assets

$146,000 210,000 9,000 $365,000 Liabilities

Accounts payable

$ 25,000 Owner’s Equity

Harper Borg, capital Total liabilities and owner’s equity 4.

340,000 $365,000

Net income of $200,000

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-3B Bronco Consulting Income Statement For the Month Ended August 31, 20Y2

Fees earned Expenses: Salaries expense Rent expense Auto expense Supplies expense Miscellaneous expense Total expenses Net income 2.

$125,000 $58,000 27,000 15,500 6,100 7,500 114,100 $ 10,900

Bronco Consulting Statement of Owner’s Equity For the Month Ended August 31, 20Y2 Jose Loder, capital, August 1, 20Y2 Investment on August 1, 20Y2 $ 75,000 Net income for August 10,900 Withdrawals (15,000) Increase in owner’s equity Jose Loder, capital, August 31, 20Y2

70,900 $70,900

Bronco Consulting Balance Sheet August 31, 20Y2 Assets

Cash Accounts receivable Supplies Total assets

$38,000 33,000 2,900 $73,900 Liabilities $ 3,000

Accounts payable Owner’s Equity Jose Loder, capital Total liabilities and owner’s equity

70,900 $73,900

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-3B (Concluded) 4.

(Optional)

Bronco Consulting Statement of Cash Flows For the Month Ended August 31, 20Y2 Cash flows from (used for) operating activities: Cash received from customers $ 92,000 Cash paid for expenses and to creditors* (114,000) Net cash flows from operating activities Cash flows from (used for) investing activities Cash flows from (used for) financing activities: Cash received from owner as investment $ 75,000 Cash withdrawal by owner (15,000) Net cash flows from financing activities Net increase in cash Cash balance, August 1, 20Y2 Cash balance, August 31, 20Y2

$(22,000) 0

60,000 $ 38,000 0 $ 38,000

* $27,000 + $6,000 + $23,000 + $58,000; these amounts are taken from the Cash column shown in the problem.

(e) + Bal. (f) – Bal. (g) – Bal. (h) – Bal. (i) Bal.

(a) + (b) – Bal. (c) – Bal. (d) Bal.

18,450

31,500

19,800 38,250 750 37,500 2,500 35,000 3,500 31,500

–

+ +

– –

3,500 3,500

19,800 19,800

–

24,000

–

3,500

1-34

19,800

–

Sales Comm.

24,000

+ – –

–

Maria Adams, Drawing

24,000

Maria Adams, Capital

3,600

3,600 3,600

Rent Exp.

–

– –

2,500

2,500 2,500

Salaries Exp.

Owner’s Equity

Introduction to Accounting and Business

–

– –

1,350

1,350 1,350

Auto Exp.

450

1,200 900 300

1,200 750 450

1,200 1,200

450

–

1,200

1,200 1,200

Accts. Payable

= Liabilities +

+ Supplies =

Assets

24,000 3,600 20,400 1,950 18,450

Cash

Prob. 1-4B

CHAPTER 1

–

– –

900 900

Supplies Exp.

–

– –

600

600 600

Misc. Exp.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-4B (Concluded) Custom Realty Income Statement For the Month Ended April 30, 20Y7

Sales commissions Expenses: Rent expense Salaries expense Auto expense Supplies expense Miscellaneous expense Total expenses Net income

$19,800 $3,600 2,500 1,350 900 600 8,950 $10,850

Custom Realty Statement of Owner’s Equity For the Month Ended April 30, 20Y7 Maria Adams, capital, April 1, 20Y7 Investment on April 1, 20Y7 Net income for April Withdrawals Increase in owner’s equity Maria Adams, capital, April 30, 20Y7

$24,000 10,850 (3,500) 31,350 $31,350

Custom Realty Balance Sheet April 30, 20Y7 Assets Cash Supplies Total assets

$31,500 300 $31,800 Liabilities

Accounts payable

Owner’s Equity Maria Adams, capital Total liabilities and owner’s equity

31,350 $31,800

450

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5B 1.

= Liabilities

Assets +

Accounts Receivable

+ Supplies +

$39,000 +

$80,000

Cash

$11,000

Land

Accounts Payable

Owner’s Equity

+ Beverly Zahn, Capital

$50,000 = $31,500 + Beverly Zahn, Capital $180,000 = $31,500 + Beverly Zahn, Capital $148,500 = Beverly Zahn, Capital

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5B (Continued) 2. Cash Bal. (a)

–

80,000

Bal.

80,000

11,000

80,000

11,000

80,000

(h)

31,500

169,500

11,000

85,000

31,500

169,500

152,000

11,000

85,000

31,500

169,500

152,000

11,000

85,000

35,000

72,000

8,000

77,000 116,000

(j)

116,000

Bal.

8,000

19,000

85,000

19,500

169,500

152,000

19,000

85,000

19,500

169,500

–

19,000

85,000

19,500

169,500

77,000 75,000

+ –

169,500

152,000

(i) Bal.

20,000 11,500

38,000 39,000

Bal.

21,000

85,000

–

1,000

Bal.

–

148,500 169,500

+ +

50,000

20,000 1,000

Bal.

31,500 31,500

(f) (g)

Beverly Zahn, Drawing

4,000

21,000 –

50,000

Bal.

11,000

35,000

21,000

Bal.

Land

Owner’s Equity Beverly Zahn, Capital

25,000 –

+ Supplies +

Accts. Payable

21,000

(d) (e)

60,000

Bal. (c)

Accts. Rec.

39,000 +

Bal. (b)

= Liabilities +

Assets

29,450

75,000

19,000

85,000

48,950

169,500

75,000

19,000

85,000

48,950

169,500

29,200 86,800

(k)

–

Bal.

86,800

– (l) Bal.

5,000 81,800

7,200

75,000

11,800

85,000

48,950

169,500

75,000

11,800

85,000

48,950

169,500

–

5,000

–

5,000

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5B (Continued) Owner’s Equity (Continued) Dry Dry Cleaning Cleaning + Revenue – Exp. –

Wages Exp.

Supplies Exp. –

–

Rent Exp.

Truck Exp.

–

Utilities Misc. Exp. – Exp.

Bal. (a) Bal. (b) Bal. (c)

– 4,000

Bal. (d)

– 4,000 +

Bal.

72,000 72,000

– 4,000

72,000

– 4,000

72,000

– 4,000

(e) Bal. (f) Bal. (g) Bal.

38,000 110,000

– 4,000

110,000

– 4,000

(h) Bal.

– 29,450

(i) Bal.

110,000

– 29,450

(j) Bal.

110,000

– 29,450

– 4,000 –

24,000

–

24,000

–

2,100

–

1,800

– 1,300

– 4,000

–

2,100

–

1,800

– 1,300

–

7,200

Bal.

110,000

– 29,450

–

24,000

–

7,200

– 4,000

–

2,100

–

1,800

– 1,300

(l) Bal.

110,000

– 29,450

–

24,000

–

7,200

– 4,000

–

2,100

–

1,800

– 1,300

(k)

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5B (Continued) 3.

Bev’s Dry Cleaners Income Statement For the Month Ended November 30, 20Y6 Dry cleaning revenue Expenses: Dry cleaning expense $29,450 Wages expense 24,000 Supplies expense 7,200 Rent expense 4,000 Truck expense 2,100 Utilities expense 1,800 Miscellaneous expense 1,300 Total expenses Net income Bev’s Dry Cleaners Statement of Owner’s Equity For the Month Ended November 30, 20Y6 Beverly Zahn, capital, November 1, 20Y6 Additional investment during November $21,000 Net income for November 40,150 Withdrawals (5,000) Increase in owner’s equity Beverly Zahn, capital, November 30, 20Y6

$110,000

69,850 $ 40,150

$148,500

56,150 $204,650

Bev’s Dry Cleaners Balance Sheet November 30, 20Y6 Assets Cash Accounts receivable Supplies Land Total assets

$ 81,800 75,000 11,800 85,000 $253,600 Liabilities

Accounts payable

$ 48,950 Owner’s Equity

Beverly Zahn, capital Total liabilities and owner’s equity

204,650 $253,600

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-5B (Concluded) 4.

(Optional)

Bev’s Dry Cleaners Statement of Cash Flows For the Month Ended Novemer 30, 20Y6 Cash flows from (used for) operating activities: Cash received from customers* $115,000 Cash paid for expenses and to creditors** (53,200) Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for purchase of land Cash flows from (used for) financing activities: Cash received from owner as investment $ 21,000 Cash withdrawal by owner (5,000) Net cash flows from financing activities Net increase in cash Cash balance, November 1, 20Y6 Cash balance, November 30, 20Y6

$ 61,800 (35,000)

16,000 $ 42,800 39,000 $ 81,800

* $38,000 + $77,000; these amounts are taken from the Cash column of the spreadsheet in Part 2. ** $4,000 + $20,000 + $29,200; these amounts are taken from the Cash column of the spreadsheet in Part 2.

CHAPTER 1

Introduction to Accounting and Business

Prob. 1-6B a.

Wages expense, $203,200 ($288,000 – $48,000 – $17,600 – $14,400 – $4,800)

Net income, $112,000 ($400,000 – $288,000)

LuAnn Martin, capital, May 1, 20Y3, $0; Atlas Realty was organized on May 1, 20Y3.

Investment on May 1, 20Y3, $160,000; from statement of cash flows

Net income for May, $112,000; from (b)

Withdrawals, $64,000; from statement of cash flows

Increase in owner’s equity, $208,000 ($160,000 + $112,000 – $64,000)

LuAnn Martin, capital, May 31, 20Y3, $208,000

Land, $120,000; from statement of cash flows

Total assets, $256,000 ($123,200 + $12,800 + $120,000)

LuAnn Martin, capital, $208,000

Total liabilities and owner’s equity, $256,000 ($48,000 + $208,000)

m. Cash received from customers, $400,000; this is the same as fees earned since there are no accounts receivable. n.

Net cash flows from operating activities, $147,200 ($400,000 – $252,800)

Net cash flows from financing activities, $96,000 ($160,000 – $64,000)

Net increase in cash, $123,200 ($147,200 – $120,000 + $96,000)

May 31, 20Y3, cash balance, $123,200

CHAPTER 1

Introduction to Accounting and Business

CONTINUING PROBLEM 1. Cash June

4,000

June

3,500

Bal. June

–

– – –

Bal. –

Bal. +

Bal.

5,375

Bal. –

Bal. +

Bal. –

Bal.

5,835

Bal. –

3,500

350

4,000

3,500

350

4,000

3,500 3,500

100

350

250

4,000

350

250

4,000 +

1,000

350

250

300 3,800

4,000

1,000 4,800

500

1,000

350

250

4,000

5,300

1,000

350

250

4,000

5,300 +

900

1,000

350

250

4,000

6,200

1,000

350

250

4,000

6,200

1,000

350

250

4,000

6,200

180

1,000

170

250

4,000

6,200

1,000

170

250

4,000

6,200

1,000

170

250

4,000

6,200

1,000

170

250

4,000

1,000 4,420

June 30

4,000

415 5,420

June 30

350

1,000

– –

350

June 30 June 30

3,500

300 5,835

Bal.

4,000

400 6,135

June 30

350

900 6,535

June 30

350

240 5,635

June 30

3,500

500 5,875

June 29

4,000 350

–

+ +

3,500

300

June 22 June 25

350

5,375

Bal.

350

100 5,075

June 16

4,000

350 5,175

June 13

3,500

675 5,525

June 12

4,000

500 6,200

Fees Earned

800

6,700 6

Peyton Smith, – Drawing

Bal.

+ Supplies =

Owner’s Equity Peyton Smith, Capital +

Bal. June

Accts. Payable

6,700

Bal. June

Accts. Rec.

7,500

Bal. June

= Liabilities +

Assets

500 3,920

–

500

–

500

6,200

CHAPTER 1

Introduction to Accounting and Business

Continuing Problem (Continued) Owner’s Equity (Continued) Music Exp.

– June

June

Office Rent Exp.

–

Equip. Rent Exp.

–

Advertising Exp.

–

Wages Exp.

–

Utilities Supplies Exp. Exp. – –

Misc. Exp.

Bal. June

Bal.

–

500

–

350

–

350

–

800

–

675

–

500

–

350

–

800

–

675

–

500

–

350

–

800

–

675

–

500

–

350

–

800

–

675

–

500

–

350

–

800

–

675

–

500

–

240

–

590

–

800

–

675

–

500

–

590

–

800

–

675

–

500 –

400

–

590

–

800

–

675

–

500

–

400

–

590

–

800

–

675

–

500

–

400

–

Bal. June

675

–

300

–

300

590

–

800

–

675

–

500

–

400

–

300

–

180

–

180

Bal. June

–

Bal. June

675

800

Bal. June

– –

Bal. June

500

800

Bal. June

–

Bal. June

500

Bal. June

–

Bal. June

800

Bal. June

–

Bal. June

800

Bal. June

800

– 4

Bal. June

–

590

–

1,000

– –

–

415

–

800

–

675

–

500

–

400

–

300

–

180

–

415

1,590

–

800

–

675

–

500

–

400

–

300

–

180

–

415

1,590

–

800

–

675

–

500

–

400

–

300

–

180

–

415

CHAPTER 1

Introduction to Accounting and Business

Continuing Problem (Concluded) PS Music Income Statement For the Month Ended June 30, 20Y9

Fees earned: Expenses: Music expense Office rent expense Equipment rent expense Advertising expense Wages expense Utilities expense Supplies expense Miscellaneous expense Total expenses Net income 3.

$6,200 $1,590 800 675 500 400 300 180 415 4,860 $1,340

PS Music Statement of Owner’s Equity For the Month Ended June 30, 20Y9 Peyton Smith, capital, June 1, 20Y9 Investment on June 1, 20Y9 Net income for June Withdrawals Increase in owner’s equity Peyton Smith, capital, June 30, 20Y9

$4,000 1,340 (500) 4,840 $4,840

PS Music Balance Sheet June 30, 20Y9 Assets

Cash Accounts receivable Supplies Total assets

$3,920 1,000 170 $5,090 Liabilities

Accounts payable

$ 250 Owner’s Equity

Peyton Smith, capital Total liabilities and owner’s equity

4,840 $5,090

CHAPTER 1

Introduction to Accounting and Business

CASES & PROJECTS CP 1-1 1.

The car repair is a personal expense and is Marco’s personal responsibility. By using partnership funds to pay for the repair, Marco is behaving unethically because he is violating the business entity assumption. The business entity assumption treats the business as a separate entity from its owners. By taking money from the partnership for a personal expense, Marco is effectively stealing from his partners.

The partnership’s net income will be reduced by the $2,000 Marco has taken. This will reduce the amount of net income available to Marco’s partners.

Marco could ask his partners for a loan from the partnership. The loan could be repaid out of his salary or from his share of the partnership income.

CP 1-2 1.

Acceptable professional conduct requires that Colleen Fernandez supply First Federal Bank with all the relevant financial statements necessary for the bank to make an informed decision. Therefore, Colleen should provide the complete set of financial statements. These can be supplemented with a discussion of the net loss in the past year or other data explaining why granting the loan is a good investment for the bank.

Owners are generally willing to provide bankers with information about the operating and financial condition of the business, such as the following: ●

Operating Information: ● Description of business operations ● Results of past operations ● Preliminary results of current operations ● Plans for future operations

●

Financial Condition: ● List of assets and liabilities (balance sheet) ● Estimated current values of assets ● Owner’s personal investment in the business ● Owner’s commitment to invest additional funds in the business

Owners are normally reluctant to provide the following types of information to bankers: Proprietary Operating Information. Such information, which could hurt ● the business if it becomes known by competitors, might include special processes used by the business or future plans to expand operations into areas that are not currently served by a competitor.

CHAPTER 1

Introduction to Accounting and Business

CP 1-2 (Concluded) ● Personal Financial Information. Owners may have little choice here because banks often require owners of small businesses to pledge their personal assets as security for a business loan. Personal financial information requested by bankers often includes the owner’s net worth, salary, and other income. In addition, bankers usually request information about factors that might affect the personal financial condition of the owner. For example, a pending divorce by the owner might significantly affect the owner’s personal wealth. b.

Bankers typically want as much information as possible about the ability of the business and the owner to repay the loan with interest. Examples of such information are described above.

Both bankers and business owners share the common interest of the business doing well and being successful. If the business is successful, the bankers will receive their loan payments on time with interest and the owners will increase their personal wealth.

CP 1-3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, is as follows: 1. 2. 3. 4. 5.

Nike, Inc. Beaverton, Oregon Mark G. Parker Manufacturing Our principal business activity is the design, development, and worldwide marketing and selling of athletic footwear, apparel, equipment, accessories, and services. Income statement, statement of comprehensive income, balance sheet, statement of stockholders’ equity, statement of cash flows

Note to Instructor: The statement of comprehensive income is discussed in the appendix to Chapter 15. Since students will see this statement in a company’s annual report or 10-K, we listed it as part of the answer.

CHAPTER 1

Introduction to Accounting and Business

CP 1-4 Example Memo To: From: Date: Re:

My Teacher Ima Student January 1, 20XX Causes of Accounting Fraud

Business and accounting fraud typically result from either a failure of individual character or a culture of greed within an organization. Managers and accountants often face pressure to meet or exceed a company’s financial goals. At times, supervisors can place pressure on individuals to violate accounting standards to improve a company’s reported financial results. Individuals who give in to these pressures exhibit a failure of individual character. In other situations, the organization may expect employees to violate accounting rules as part of their job. This occurs in organizations that do not value ethical decision making or fair financial reporting and exhibit a culture of ethical indifference.

CP 1-5 The difference in the two bank balances, $55,000 ($80,000 – $25,000), may not be pure profit from an accounting perspective. To determine the accounting profit for the six-month period, the revenues for the period would need to be matched with the related expenses. The revenues minus the expenses would indicate whether the business generated net income (profit) or a net loss for the period. Using only the difference between the two bank account balances ignores such factors as amounts due from customers (receivables), liabilities (accounts payable) that need to be paid for wages or other operating expenses, additional investments that Dr. Cousins may have made in the business during the period, or withdrawals during the period that Dr. Cousins might have taken for personal reasons unrelated to the business. Some businesses that have few, if any, receivables or payables may use a “cash” basis of accounting. The cash basis of accounting ignores receivables and payables because they are assumed to be insignificant in amount. However, even with the cash basis of accounting, additional investments during the period and any withdrawals during the period must be considered in determining the net income (profit) or net loss for the period.

(a) (b) Bal. (c) Bal. (d) Bal. (e) Bal. (f) Bal. (g) Bal. (h) Bal. (i) Bal. (j) Bal. (k) Bal.

CP 1-6 1.

–

+ –

2,835 400 2,435

950 300 650 275 375 100 275 1,750 2,025 600 2,625 800 1,825 290 1,535 1,300 2,835

Cash

180

300 120 180

300

300 300

150

150 150

950

Lisa Duncan, Capital

–

– –

1-48

400 400

Lisa Duncan, Drawing

3,650

2,350 1,300 3,650

2,350

1,750 1,750 600 2,350

Fees Earned

Rent

Supplies

–

– –

800

800 800

–

– – – –

525

275 275 250 525

–

– –

120

120 120

– Expense – Expense – Expense –

Salaries

Owner’s Equity

Introduction to Accounting and Business

–

Accts. Payable +

= Liabilities +

+ Supplies =

Assets

CHAPTER 1

–

– –

290

290 290

Misc. Exp.

CHAPTER 1

Introduction to Accounting and Business

CP 1-6 (Continued) Serve-N-Volley Income Statement For the Month Ended September 30, 20Y7

Fees earned: Expenses: Salaries expense Rent expense Supplies expense Miscellaneous expense Total expenses Net income 3.

$3,650 $800 525 120 290 1,735 $1,915

Serve-N-Volley Statement of Owner’s Equity For the Month Ended September 30, 20Y7 Lisa Duncan, capital, September 1, 20Y7 Investment on September 1, 20Y7 $ 950 Net income for September 1,915 Withdrawals (400) Increase in owner’s equity Lisa Duncan, capital, September 30, 20Y7

2,465 $2,465

Serve-N-Volley Balance Sheet September 30, 20Y7 Assets

Cash Supplies Total assets

$2,435 180 $2,615 Liabilities

Accounts payable

$ 150 Owner’s Equity

Lisa Duncan, capital Total liabilities and owner’s equity

2,465 $2,615

CHAPTER 1

Introduction to Accounting and Business

CP 1-6 (Concluded) 5. a. Serve-N-Volley would provide Lisa with $715 more income per month than working as a waitress. This amount is computed as follows: Net income of Serve-N-Volley, per month………………………………… Earnings as waitress, per month: 30 hours per week × $10 per hour × 4 weeks………………………… Difference…………………………………………………………………………

$1,915 1,200 $ 715

b. Other factors that Lisa should consider before discussing a long-term arrangement with the Phoenix Tennis Club include the following: Lisa should consider whether the results of operations for September are indicative of what to expect each month. For example, Lisa should consider whether club members will continue to request lessons or use the ball machine during the fall months when interest in tennis may slacken. Lisa should evaluate whether the additional income of $715 per month from Serve-N-Volley is worth the risk being taken and the effort being expended. Lisa should also consider how much her investment in Serve-N-Volley could have earned if invested elsewhere. For example, if the initial investment of $950 had been invested to earn a rate of return of 6% per year, it would have earned $4.75 in September, or $57 for the year. Note to Instructors: Numerous other considerations could be mentioned by students, such as the ability of Lisa to withdraw cash from Serve-N-Volley for personal use. For example, some of her investment in Serve-N-Volley will be in the form of supplies (tennis balls, for example), which are readily convertible to cash. The objective of this case is not to mention all possible considerations but, rather, to encourage students to begin thinking about the use of accounting information in making business decisions.

CHAPTER 1

Introduction to Accounting and Business

CP 1-7 Note to Instructors: The purpose of this activity is to familiarize students with the certification requirements and their online availability. You might use this as an opportunity to discuss the advantages and disadvantages of careers in public accounting (CPA), management accounting (CMA), and internal auditing (CIA). The following websites provide students with useful information (such as starting salaries) on careers in accounting: American Institute of Certified Public Accountants (AICPA) https://www.aicpa.org/becomeacpa.html Institute of Certified Management Accountants (IMA) http://www.imanet.org/cma-certification/cma-certification-overview Institute of Internal Auditors (IIA) https://na.theiia.org/about-us/Pages/About-The-Institute-of-Internal-Auditors.aspx

CP 1-8

Net cash flows from (used for) operating activities Net cash flows from (used for) investing activities Net cash flows from (used for) financing activities

First Year

Second Year

Third Year

negative

positive

negative

positive

Start-up companies normally experience negative net cash flows from operating activities; however, Amazon.com was able to generate positive net cash flows from operations by its second year. Start-up companies normally have negative net cash flows from investing activities as they build up their infrastructure through purchases of property, plant, and equipment. This was the case with Amazon.com for each of its first three years. Likewise, start-up companies normally have positive net cash flows from financing activities from raising capital. This is also the case for Amazon.com.

CHAPTER 2 ANALYZING TRANSACTIONS DISCUSSION QUESTIONS 1.

An account is a form designed to record changes in a particular asset, liability, owner’s equity, revenue, or expense. A ledger is a group of related accounts.

The terms debit and credit may signify either an increase or a decrease, depending upon the nature of the account. For example, debits signify an increase in asset and expense accounts but a decrease in liability, owner’s equity, and revenue accounts.

a. b.

Assuming that no errors have occurred, the credit balance in the cash account resulted from drawing checks for $1,850 in excess of the amount of cash on deposit. The $1,850 credit balance in the cash account as of December 31 is a liability owed to the bank. It is usually referred to as an “overdraft.”

a. b.

No. Errors may have been made that had the same erroneous effect on both debits and credits, such as failing to record and/or post a transaction, recording the same transaction more than once, and posting a transaction correctly but to the wrong account.

Recording $9,800 instead of the correct amount of $8,900 is a transposition. Recording $100 instead of the correct amount of $1,000 is a slide.

a. b.

The revenue was earned in October. (1) Debit Accounts Receivable and credit Fees Earned or another appropriately titled revenue account in October. (2) Debit Cash and credit Accounts Receivable in November.

No. Because the same error occurred on both the debit side and the credit side of the trial balance, the trial balance would not be out of balance. Yes. The trial balance would not balance. The error would cause the debit total of the trial balance to exceed the credit total by $90.

a. b.

The equality of the trial balance would not be affected. On the income statement, total operating expenses (salary expense) would be overstated by $7,500, and net income would be understated by $7,500. On the statement of owner’s equity, the beginning and ending owner’s capital would be correct. The understatement of net income understates owner’s equity by $7,500, while the understatement of withdrawals overstates owner’s equity by $7,500. Thus, ending owner’s equity is correct. The balance sheet is not affected by the error.

a. b.

The equality of the trial balance would not be affected. On the income statement, revenues (fees earned) would be overstated by $300,000, and net income would be overstated by $300,000. On the statement of owner’s equity, the beginning capital would be correct. However, net income and ending capital would be overstated by $300,000. The balance sheet total assets is correct. However, liabilities (notes payable) is understated by $300,000, and owner’s equity is overstated by $300,000. The understatement of liabilities is offset by the overstatement of owner’s equity, and thus, total liabilities and owner’s equity is correct.

10.

a. b.

From the viewpoint of Surety Storage, the balance of the checking account represents an asset. From the viewpoint of Ada Savings Bank, the balance of the checking account represents a liability.

CHAPTER 2

Analyzing Transactions

PRACTICE EXERCISES PE 2-1A 1. 2. 3. 4. 5. 6.

Debit and credit entries (c), normal debit balance Credit entries only (b), normal credit balance Credit entries only (b), normal credit balance Debit entries only (a), normal debit balance Credit entries only (b), normal credit balance Debit and credit entries (c), normal credit balance

PE 2-1B 1. 2. 3. 4. 5. 6.

Debit and credit entries (c), normal credit balance Debit and credit entries (c), normal debit balance Debit entries only (a), normal debit balance Debit entries only (a), normal debit balance Debit entries only (a), normal debit balance Credit entries only (b), normal credit balance

PE 2-2A Feb.

19 Office Equipment Cash Accounts Payable

14,800

30 Office Supplies Cash Accounts Payable

1,900

3,600 11,200

PE 2-2B Sept.

600 1,300

CHAPTER 2

Analyzing Transactions

PE 2-3A Apr.

30 Accounts Receivable Fees Earned

12,980

13 Cash Fees Earned

7,480

23 Graeme Schneider, Drawing Cash

27,000

30 Claire Hope, Drawing Cash

9,500

12,980

PE 2-3B Aug.

7,480

PE 2-4A Dec.

27,000

PE 2-4B June

9,500

PE 2-5A Using the following T account, solve for the amount of cash receipts (indicated by ? below). Cash July 1 Bal. Cash receipts July 31 Bal.

42,830 ? 33,850

132,500

Cash payments

$33,850 = $42,830 + Cash receipts – $132,500 Cash receipts = $33,850 + $132,500 – $42,830 = $123,520

PE 2-5B Using the following T account, solve for the amount of supplies expense (indicated by ? below). Supplies Aug. 1 Bal. Supplies purchased Aug. 31 Bal.

1,240 3,760 1,600

Supplies expense

$1,600 = $1,240 + $3,760 – Supplies expense Supplies expense = $1,240 + $3,760 – $1,600 = $3,400

CHAPTER 2

Analyzing Transactions

PE 2-6A a.

The trial balance totals are unequal. The debit total is higher by $900 ($9,800 – $8,900).

The trial balance totals are equal because both the debit and credit entries were journalized and posted for $530.

The trial balance totals are unequal. The debit total is higher by $5,800 ($2,900 + $2,900).

PE 2-6B a.

The trial balance totals are equal because both the debit and credit entries were journalized and posted for $14,200.

The trial balance totals are unequal. The credit total is higher by $360 ($1,730 – $1,370).

The trial balance totals are unequal. The debit total is higher by $4,500 ($7,250 – $2,750).

CHAPTER 2

Analyzing Transactions

PE 2-7A a.

Journal Entry That Was Made in Error Miscellaneous Expense 3,220 Rent Expense 3,220

Journal Entry That Should Have Been Made Rent Expense 3,220 Cash

3,220

Comparison Rent Expense instead of Miscellaneous Expense should have been debited. Cash instead of Rent Expense should have been credited. The debit and credit amount of $3,220 is correct.

Correcting Journal Entries Rent Expense Miscellaneous Expense Rent Expense Cash

3,220 3,220 3,220 3,220

Journal Entry That Was Made in Error Cash 5,080 Accounts Payable 5,080

Journal Entry That Should Have Been Made Cash 5,080 Accounts Receivable

5,080

Comparison Accounts Receivable instead of Accounts Payable should have been credited.

Correcting Journal Entry Accounts Payable Accounts Receivable

5,080 5,080

CHAPTER 2

Analyzing Transactions

PE 2-7B a.

Journal Entry That Was Made in Error Accounts Receivable 10,700 Fees Earned 10,700

Journal Entry That Should Have Been Made Cash 10,700 Fees Earned 10,700

Comparison Cash instead of Accounts Receivable should have been debited.

Correcting Journal Entry Cash Accounts Receivable

10,700 10,700

Journal Entry That Was Made in Error Office Equipment 4,300 Supplies

4,300

Journal Entry That Should Have Been Made Supplies 4,300 Accounts Payable

4,300

Comparison Supplies instead of Office Equipment should have been debited. Accounts Payable instead of Supplies should have been credited. The debit and credit amount of $4,300 is correct.

Correcting Journal Entries Supplies Office Equipment Supplies Accounts Payable

4,300 4,300 4,300 4,300

CHAPTER 2

Analyzing Transactions

PE 2-8A Vaughn Company Income Statements For the Years Ended December 31

Fees earned Operating expenses Net income

20Y1

20Y0

Increase/(Decrease) Amount Percent

$716,800 557,760 $159,040

$896,000 672,000 $224,000

$(179,200) (114,240) $ (64,960)

(20%) (17%) (29%)

PE 2-8B Satterfield Company Income Statements For the Years Ended December 31

Fees earned Operating expenses Net income

20Y1

20Y0

$3,068,200 2,281,600 $ 786,600

$2,645,000 1,984,000 $ 661,000

Increase/(Decrease) Amount Percent

$423,200 297,600 $125,600

16.0% 15.0% 19.0%

CHAPTER 2

Analyzing Transactions

EXERCISES Ex. 2-1 Balance Sheet Accounts

Income Statement Accounts

Assets

Revenues

Cash Accounts Receivable Property and Equipment Fuel Inventory Parts and Supplies Prepaid Expenses

Cargo Revenue Passenger Revenue

Liabilities Accounts Payable a Air Traffic Liability Loyalty Program (Obligations)b Accrued Salaries (Obligations)

Expenses Aircraft Fuel (Expense) Aircraft Maintenance (Expense) Aircraft Rent (Expense) c Regional Carriers Expense Landing Fees (Expense)d e Passenger Commissions (Expense)

Owner’s Equity None a b c d e

Passenger ticket sales for future flights Obligations to provide frequent flyers future travel and other benefits Payments to other airlines for passenger travel under Delta tickets Fees paid to airports for landing rights Commissions paid to travel agents for passenger bookings

Ex. 2-2 Account

Account Number

Accounts Payable Accounts Receivable Cash Fees Earned Fred Biggs, Capital Fred Biggs, Drawing Land Miscellaneous Expense Supplies Expense Wages Expense

21 12 11 41 31 32 13 53 52 51

Note: Expense accounts are normally listed in order of magnitude from largest to smallest with Miscellaneous Expense always listed last. Since Wages Expense is normally larger than Supplies Expense, Wages Expense is listed as account number 51 and Supplies Expense as account number 52.

CHAPTER 2

Analyzing Transactions

Ex. 2-3 Balance Sheet Accounts 11 12 13 14 15

Income Statement Accounts

1. Assets Cash Accounts Receivable Supplies Prepaid Insurance Equipment

4. Revenue 41 Fees Earned

51 52 53 59

2. Liabilities 21 Accounts Payable 22 Unearned Rent

5. Expenses Wages Expense Rent Expense Supplies Expense Miscellaneous Expense

3. Owner’s Equity 31 Lorri Ross, Capital 32 Lorri Ross, Drawing Note: The order of some of the accounts within the major classifications is somewhat arbitrary, as in accounts 13–14, accounts 21–22, and accounts 51–53. In a new business, the order of magnitude of balances in such accounts is not determinable in advance. The magnitude may also vary from period to period.

Ex. 2-4 a. b. c. d. e. f.

debit credit debit credit credit debit

g. h. i. j. k. l.

debit credit debit credit debit debit

Ex. 2-5 1. 2. 3. 4. 5. 6. 7.

debit and credit entries (c) debit and credit entries (c) debit and credit entries (c) credit entries only (b) debit entries only (a) debit entries only (a) debit entries only (a)

CHAPTER 2

Analyzing Transactions

Ex. 2-6 a. b. c. d.

Liability—credit Asset—debit Owner’s equity (Ashley Griffin, Capital)—credit Owner’s equity (Ashley Griffin, Drawing)—debit

e. f. g. h. i. j.

Asset—debit Revenue—credit Asset—debit Expense—debit Asset—debit Expense—debit

Ex. 2-7 20Y3 Oct.

1 Rent Expense Cash

4,800

3 Advertising Expense Cash

2,500

5 Supplies Cash

1,390

6 Office Equipment Accounts Payable

10,670

10 Cash Accounts Receivable

19,730

15 Accounts Payable Cash

9,480

4,800

2,500

1,390

10,670

19,730

9,480

27 Miscellaneous Expense Cash

530

30 Utilities Expense Cash

220

530

220

31 Accounts Receivable Fees Earned

38,620

31 Utilities Expense Cash

1,540

31 Michael Short, Drawing Cash

6,700

38,620

1,540

6,700

CHAPTER 2

Analyzing Transactions

Ex. 2-8 a. JOURNAL Date

20Y4 Sept.

Post. Ref.

Description

18 Supplies Accounts Payable Purchased supplies on account.

Page

15 21

Debit

Credit

8,710 8,710

b., c., d. Account:

Supplies

Date

20Y4 Sept.

Item

1 Balance 18

Account:

20Y4 Sept. e.

Post. Ref.

Debit

 87

Credit

Item

1 Balance 18

Debit

Balance Credit

2,960 11,670

8,710

Accounts Payable

Date

Account No.

Post. Ref.

Debit

 87

Credit

Debit

Balance Credit

38,400 47,110

8,710

Yes. The rules of debit and credit apply to all companies.

Ex. 2-9 a. (1) (2) (3) (4)

Accounts Receivable Fees Earned

73,900

Supplies Accounts Payable

1,960

Cash Accounts Receivable

62,770

73,900 1,960 62,770

Accounts Payable Cash

820 820

CHAPTER 2

Analyzing Transactions

Ex. 2-9 (Concluded) b. (3)

Cash 62,770 (4)

(2)

Supplies 1,960 Accounts Receivable 73,900 (3)

(1) c.

820

(4)

Accounts Payable 820 (2)

1,960

Fees Earned (1)

73,900

62,770

No. An error may not have necessarily occurred. A credit balance in Accounts Receivable could occur if a customer overpaid his or her account. Regardless, the credit balance should be investigated to verify that an error has not occurred.

Ex. 2-10 a.

The increase of $140,000 ($515,000 – $375,000) in the cash account does not indicate net income of that amount. Net income is the excess of revenues over expenses and is normally not the same as the change in the cash account.

$60,000 ($200,000 – $140,000) or Cash X 515,000 200,000

375,000

X + $515,000 – $375,000 = $200,000 X = $200,000 – $515,000 + $375,000 X = $60,000

CHAPTER 2

Analyzing Transactions

Ex. 2-11 Accounts Payable Feb. 1 194,500 Feb. 28

X 210,400 62,500

X + $210,400 – $194,500 = $62,500 X = $62,500 + $194,500 – $210,400 X = $46,600 b. Oct.

Oct.

Accounts Receivable 121,100 X 136,800

470,500

$121,100 + X – $470,500 = $136,800 X = $136,800 + $470,500 – $121,100 X = $486,200 c. Apr.

Apr.

Cash 48,350 260,060 59,390

$48,350 + $260,060 – X = $59,390 X = $48,350 + $260,060 – $59,390 X = $249,020 Ex. 2-12 a.

Credit balance of $170,000 ($500,000 – $10,000 – $320,000).

Yes. The balance sheet prepared at December 31 will balance, with Terrace Waters, Capital, being reported in the owner’s equity section as $170,000.

CHAPTER 2

Analyzing Transactions

Ex. 2-13 a. and b. Account Debited Transaction

Type

Account Credited

Effect

Type

Effect

owner’s equity asset asset liability asset revenue asset asset asset asset

+ – – + – + – – – –

(1) (2) (3)

asset asset asset

+ + +

(4) (5) (6) (7) (8) (9)

expense asset liability asset expense drawing

+ + – + + +

Ex. 2-14 (1) Cash Mary Silva, Capital

97,000

(2) Supplies Cash

1,160

(3) Equipment Accounts Payable Cash

10,350

(4) Operating Expenses Cash

8,120

(5) Accounts Receivable Fees Earned

15,910

(6) Accounts Payable Cash

3,490

(7) Cash Accounts Receivable

10,540

97,000 1,160 8,280 2,070 8,120 15,910 3,490 10,540

(8) Operating Expenses Supplies

850

(9) Mary Silva, Drawing Cash

3,200

850 3,200

CHAPTER 2

Analyzing Transactions

Ex. 2-15 a.

Emerald Tours Co. Unadjusted Trial Balance May 31, 20Y5 Debit Balances

Cash Accounts Receivable Supplies Equipment Accounts Payable Mary Silva, Capital Mary Silva, Drawing Fees Earned Operating Expenses

Credit Balances

89,500 5,370 310 10,350 4,790 97,000 3,200 15,910 8,970 117,700

117,700

Net income, $6,940 ($15,910 – $8,970)

CHAPTER 2

Analyzing Transactions

Ex. 2-16 Hickory Furniture Company Unadjusted Trial Balance December 31, 20Y6 Debit Balances

Credit Balances

33,320* 116,900 4,275 21,600 50,000

Cash Accounts Receivable Supplies Prepaid Insurance Land Accounts Payable Unearned Rent Notes Payable Elaine Wells, Capital Elaine Wells, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Supplies Expense Insurance Expense Miscellaneous Expense

42,770 12,000 50,000 75,000 24,000 745,230 580,700 48,000 26,850 6,255 3,600 9,500 925,000

925,000

* $33,320 = $925,000 – $9,500 – $3,600 – $6,255 – $26,850 – $48,000 – $580,700 – $24,000 – $50,000 – $21,600 – $4,275 – $116,900

Ex. 2-17 Inequality of trial balance totals would be caused by errors described in (c) and (e). For (c), the debit total would exceed the credit total by $9,900 ($4,950 + $4,950). For (e), the credit total would exceed the debit total by $17,100 ($19,000 – $1,900). Errors (b), (c), (d), and (e) would require correcting entries. Although it is not a correcting entry, the entry that was not made in (a) should also be entered in the journal.

CHAPTER 2

Analyzing Transactions

Ex. 2-18 Ranger Co. Unadjusted Trial Balance August 31, 20Y7 Debit Balances

Cash Accounts Receivable Prepaid Insurance Equipment Accounts Payable Unearned Rent Carmen Meeks, Capital Carmen Meeks, Drawing Fees Earned Wages Expense Advertising Expense Miscellaneous Expense

Credit Balances

15,500 46,750 12,000 190,000 24,600 5,400 110,000 13,000 385,000 213,000 16,350 18,400 525,000

525,000

Ex. 2-19 Error

(a) Out of Balance

(b) Difference

1. 2. 3. 4. 5. 6. 7.

yes no yes yes no yes yes

$6,000 — 5,400 480 — 90 360

debit — credit debit — credit credit

CHAPTER 2

Analyzing Transactions

Ex. 2-20 1. 2. 3. 4. 5. 6.

The Debit column total is added incorrectly. The sum is $890,700 rather than $1,189,300. The trial balance should be dated “July 31, 20Y3,” not “For the Month Ending July 31, 20Y3.” The Accounts Receivable balance should be in the Debit column. The Accounts Payable balance should be in the Credit column. The Samuel Parson, Drawing, balance should be in the Debit column. The Advertising Expense balance should be in the Debit column. A corrected trial balance would be as follows: Mascot Co. Unadjusted Trial Balance July 31, 20Y3 Account No.

Cash Accounts Receivable Prepaid Insurance Equipment Accounts Payable Salaries Payable Samuel Parson, Capital Samuel Parson, Drawing Fees Earned Salary Expense Advertising Expense Miscellaneous Expense

11 12 13 14 21 22 31 32 41 51 52 59

Debit Balances

Credit Balances

36,000 112,600 18,000 375,000 53,300 7,500 297,200 17,000 682,000 396,800 73,000 11,600 1,040,000

1,040,000

CHAPTER 2

Analyzing Transactions

Ex. 2-21 a.

Journal Entry That Was Made in Error Insurance Expense 18,000 Prepaid Insurance 18,000

Journal Entry That Should Have Been Made Prepaid Insurance 18,000 Cash

18,000

Comparison Prepaid Insurance instead of Insurance Expense should have been debited. Cash instead of Prepaid Insurance should have been credited. The debit and credit amount of $18,000 is correct.

Correcting Journal Entries Prepaid Insurance Insurance Expense Prepaid Insurance Cash

18,000 18,000 18,000 18,000

Journal Entry That Was Made in Error Wages Expense 10,000 Cash 10,000

Journal Entry That Should Have Been Made Brian Phillips, Drawing 10,000 Cash

10,000

Comparison Brian Phillips, Drawing instead of Wages Expense should have been debited.

Correcting Journal Entry Brian Phillips, Drawing Wages Expense

10,000 10,000

CHAPTER 2

Analyzing Transactions

Ex. 2-22 a.

Journal Entry That Was Made in Error Fees Earned 8,800 Cash 8,800

Journal Entry That Should Have Been Made Cash 8,800 Accounts Receivable

8,800

Comparison Cash instead of Fees Earned should have been debited. Accounts Receivable instead of Cash should have been credited. The debit and credit amount of $8,800 is correct.

Correcting Journal Entries Cash Fees Earned Cash Accounts Receivable

8,800 8,800 8,800 8,800

Journal Entry That Was Made in Error Supplies Expense 1,760 Accounts Payable 1,760

Journal Entry That Should Have Been Made Supplies 1,760 Cash

1,760

Comparison Supplies instead of Supplies Expense should have been debited. Cash instead of Accounts Payable should have been credited. The debit and credit amount of $1,760 is correct.

Correcting Journal Entries Accounts Payable Supplies Expense Supplies Cash

1,760 1,760 1,760 1,760

Note: The first entry reverses the incorrect entry, and the second entry is what should have been recorded initially. These two entries could have been combined into one entry; however, preparing two entries makes it easier for someone later to understand what happened and why the entries were necessary. 2-20 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2

Analyzing Transactions

Ex. 2-23 a.

Revenue: $2,642 million increase ($75,356 – $72,714) 3.6% increase ($2,642 ÷ $72,714)

Operating expenses: $2,756 million increase ($71,246 – $68,490) 4.0% increase ($2,756 ÷ $68,490)

Operating income: $114 million decrease ($4,110 – $4,224) 2.7% decrease (–$114 ÷ $4,224)

During the recent year, revenue increased by 3.6%, while operating expenses increased by 4.0%. As a result, operating income decreased by 2.7%, from the prior year.

CHAPTER 2

Analyzing Transactions

Ex. 2-24 a.

Revenue: $12,551 million increase ($141,576 – $129,025) 9.7% increase ($12,551 ÷ $129,025)

Operating expenses: $12,182 million increase ($137,096 – $124,914) 9.8% increase ($12,182 ÷ $124,914)

Operating income: $369 million increase ($4,480 – $4,111) 9.0% increase ($369 ÷ $4,111)

During the recent year, revenue increased by 9.7%, while operating expenses increased by 9.8%. As a result, operating income increased by 9.0% from the prior year.

Because of the size differences between Target and Costco (Costco has more than 1.8 times the revenue), it is best to compare the two companies on the basis of percent changes from the prior year. Costco’s revenues increased by 9.7%, while Target’s revenue increased by 3.6%. The expenses of Costco increased by 9.8%, which is slightly more than the percentage increase in revenues. As a result, Costco’s operating income increased by 9.0%. Target’s expenses increased by 4.0%, which is less than the percentage increase in revenues. As a result, Target’s operating income decreased by 2.7%. Overall, Costco had a better operating performance than Target.

CHAPTER 2

Analyzing Transactions

PROBLEMS Prob. 2-1A 1. and 2. (a) (g)

Cash 36,000 (b) 12,200 (c) (e) (f) (h) (i) (j) (m) (n) 14,065

2,400 7,800 2,150 4,000 815 4,500 5,000 6,450 1,020

(d)

Equipment 9,000 Accounts Payable 4,500 (d) (k) Bal.

9,000 2,890 7,390

Notes Payable 5,000 (c) Bal.

25,000 20,000

(l)

Accounts Receivable 18,300

Connie Young, Capital (a)

36,000

(e)

Supplies 2,150

Professional Fees (g) (l) Bal.

12,200 18,300 30,500

(f)

Prepaid Insurance 4,000

(m)

Salary Expense 6,450

(c)

Automobiles 32,800

(k)

Blueprint Expense 2,890

(b)

Rent Expense 2,400

(n)

Automobile Expense 1,020

(h)

Miscellaneous Expense 815

Bal.

(i)

(j)

CHAPTER 2

Analyzing Transactions

Prob. 2-1A (Concluded) 3.

Connie Young, Architect Unadjusted Trial Balance October 31, 20Y4 Debit Balances

Cash Accounts Receivable Supplies Prepaid Insurance Automobiles Equipment Accounts Payable Notes Payable Connie Young, Capital Professional Fees Salary Expense Blueprint Expense Rent Expense Automobile Expense Miscellaneous Expense

Credit Balances

14,065 18,300 2,150 4,000 32,800 9,000 7,390 20,000 36,000 30,500 6,450 2,890 2,400 1,020 815 93,890

93,890

Net income, $16,925 ($30,500 – $6,450 – $2,890 – $2,400 – $1,020 – $815)

CHAPTER 2

Analyzing Transactions

Prob. 2-2A 1.

(a) (b) (c) (d) (e) (f)

(g) (h) (i)

Cash Fahad Ali, Capital

53,000

Rent Expense Cash

7,950

Supplies Accounts Payable

4,240

Accounts Payable Cash

2,320

Cash Fees Earned

24,180

Automobile Expense Miscellaneous Expense Cash

2,490 560

Office Salaries Expense Cash

6,630

Supplies Expense Supplies

1,860

Fahad Ali, Drawing Cash

2,600

53,000 7,950 4,240 2,320 24,180

3,050 6,630 1,860 2,600

CHAPTER 2

Analyzing Transactions

Prob. 2-2A (Continued) 2. 7,950 2,320 3,050 6,630 2,600

Bal.

Cash 53,000 (b) 24,180 (d) (f) (g) (i) 54,630

Supplies 4,240 (h) 2,380

1,860

(a) (e)

(d)

Accounts Payable 2,320 (c) Bal. Fahad Ali, Capital (a)

(i)

4,240 1,920

53,000

Fahad Ali, Drawing 2,600

Fees Earned (e)

(b)

Rent Expense 7,950

(g)

Office Salaries Expense 6,630

(f)

Automobile Expense 2,490

(h)

Supplies Expense 1,860

(f)

Miscellaneous Expense 560

24,180

CHAPTER 2

Analyzing Transactions

Prob. 2-2A (Concluded) 3.

Mountain Top Realty Unadjusted Trial Balance January 31, 20Y5 Debit Balances

Cash Supplies Accounts Payable Fahad Ali, Capital Fahad Ali, Drawing Fees Earned Rent Expense Office Salaries Expense Automobile Expense Supplies Expense Miscellaneous Expense

Credit Balances

54,630 2,380 1,920 53,000 2,600 24,180 7,950 6,630 2,490 1,860 560 79,100

79,100

a. $24,180 b. $19,490 ($7,950 + $6,630 + $2,490 + $1,860 + $560) c. $4,690 ($24,180 – $19,490)

There is a $2,090 increase in owner’s equity for January, which is net income of $4,690 minus withdrawals of $2,600.

CHAPTER 2

Analyzing Transactions

Prob. 2-3A 1. JOURNAL

20Y6 June

Post. Ref.

Description

Date

11 31

48,000

1 Rent Expense Cash

53 11

6,510

6 Equipment Accounts Payable

16 22

19,340

8 Van Cash Notes Payable

18 11 21

39,100

10 Supplies Cash

13 11

3,260

12 Cash Fees Earned

11 41

16,730

15 Prepaid Insurance Cash

14 11

4,940

23 Accounts Receivable Fees Earned

12 41

16,320

24 Van Expense Accounts Payable

55 22

2,060

JOURNAL

20Y6 June

Debit

1 Cash Hannah Ellis, Capital

Credit

48,000

6,510

19,340

6,200 32,900

3,260

16,730

4,940

16,320

2,060 2

Page

Post. Ref.

Description

Date

Page

Debit

29 Utilities Expense Cash

54 11

4,250

29 Miscellaneous Expense Cash

59 11

1,300

Credit

4,250

1,300

CHAPTER 2

Analyzing Transactions

Prob. 2-3A (Continued) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ 30 Cash 11 10,050 Accounts Receivable 12 10,050 30 Wages Expense Cash

51 11

6,950

30 Accounts Payable Cash

22 11

9,360

30 Hannah Ellis, Drawing Cash

32 11

2,200

6,950

9,360

2,200

2. GENERAL LEDGER Cash

Account:

Item

Date

20Y6 June

Post. Ref.

1 1 8 10 12 15 29 29 30 30 30 30

1 1 1 1 1 1 2 2 2 2 2 2

Debit

Credit

48,000 6,510 6,200 3,260 16,730 4,940 4,250 1,300 10,050 6,950 9,360 2,200

Accounts Receivable

Account:

Item

Date

20Y6 June

Account No.

23 30

Balance Debit Credit

48,000 41,490 35,290 32,030 48,760 43,820 39,570 38,270 48,320 41,370 32,010 29,810 Account No.

Post. Ref.

1 2

Debit

Balance Credit

Credit

Debit

10,050

16,320 6,270

16,320

CHAPTER 2

Analyzing Transactions

Prob. 2-3A (Continued) Supplies

Account:

Item

Date

20Y6 June

Item

Date

20Y6 June

15 Equipment

Date

Item

Date

3,260

Debit

Credit

4,940

Post. Ref.

Debit

Credit

19,340

Post. Ref.

Debit

Credit

39,100

Balance Credit

Balance Debit Credit

39,100 21

Account No.

Post. Ref.

Debit

Item

6 24 30

Debit

19,340

Credit

Debit

Balance Credit

32,900

Accounts Payable

Date

Account No.

Item

Account:

Balance Debit Credit

4,940

Notes Payable

Date

Account No.

Item

Account:

20Y6 June

Post. Ref.

20Y6 June

Credit

Van

Account:

20Y6 June

Debit

Balance Debit Credit

Account No.

Account:

20Y6 June

Post. Ref.

Prepaid Insurance

Account:

Account No.

32,900 22

Account No.

Post. Ref.

1 1 2

Debit

Credit

19,340 2,060 9,360

Balance Debit Credit

19,340 21,400 12,040

CHAPTER 2

Analyzing Transactions

Prob. 2-3A (Continued) Hannah Ellis, Capital

Account:

Date

20Y6 June

Item

Date

20Y6 June

12 23

Debit

Credit

2,200

Date

Post. Ref.

Debit

Credit

Date

Balance Credit

16,730 33,050 Account No.

Post. Ref.

Debit

Credit

6,950

Post. Ref.

Debit

6,950

Credit

6,510

Debit

4,250

Balance Debit Credit

6,510 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Item

Debit

16,730 16,320

Utilities Expense

Account:

Balance Debit Credit

Account No.

Item

2,200

Rent Expense

Account:

48,000 Account No.

1 1

Item

Balance Debit Credit

48,000

Wages Expense

Date

20Y6 June

Post. Ref.

Item

Account:

20Y6 June

Credit

Fees Earned

Date

20Y6 June

Debit

Item

Account:

20Y6 June

Post. Ref.

Hannah Ellis, Drawing

Account:

Account No.

Credit

Debit

Balance Credit

4,250

CHAPTER 2

Analyzing Transactions

Prob. 2-3A (Continued) Van Expense

Account:

Date

20Y6 June

Item

Date

20Y6 June

Post. Ref.

Balance Debit

Credit

2,060

Post. Ref.

Debit

Credit

2,060

Miscellaneous Expense

Account:

Account No.

Balance Debit

1,300

Credit

Debit

Credit

1,300

CHAPTER 2

Analyzing Transactions

Prob. 2-3A (Concluded) 3.

Whitworth Designs Unadjusted Trial Balance June 30, 20Y6 Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Equipment Van Notes Payable Accounts Payable Hannah Ellis, Capital Hannah Ellis, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Van Expense Miscellaneous Expense

11 12 13 14 16 18 21 22 31 32 41 51 53 54 55 59

Debit Balances

Credit Balances

29,810 6,270 3,260 4,940 19,340 39,100 32,900 12,040 48,000 2,200 33,050 6,950 6,510 4,250 2,060 1,300 125,990

125,990

$11,980 ($33,050 – $6,950 – $6,510 – $4,250 – $2,060 – $1,300)

Some supplies may have been used during June, but no supplies expense has been recorded. As will be discussed in Chapter 3, adjustments are necessary at the end of the accounting period to bring the accounts up to date. For example, adjustments for supplies used, insurance expired, and depreciation would probably be required by Whitworth Designs. Note to Instructors: At this point, students have not been exposed to depreciation, but some insightful students might recognize the need for recording supplies used and insurance expired. You might use this as an opportunity to discuss what is coming in Chapter 3.

CHAPTER 2

Analyzing Transactions

Prob. 2-4A 2. and 3. JOURNAL

20Y7 Apr.

Post. Ref.

Description

Date

20Y7 Apr.

Debit

1 Rent Expense Cash

52 11

6,500

2 Office Supplies Accounts Payable

14 21

2,300

5 Prepaid Insurance Cash

13 11

6,000

10 Cash Accounts Receivable

11 12

52,300

15 Land Cash Notes Payable

16 11 23

200,000

17 Accounts Payable Cash

21 11

6,450

20 Accounts Payable Office Supplies

21 14

325

23 Advertising Expense Cash

53 11

4,300

JOURNAL Date

Credit

6,500

2,300

6,000

52,300

30,000 170,000

6,450

325

4,300 19

Page

Post. Ref.

Description

Page

Debit

27 Cash Salary and Commission Expense

11 51

2,500

28 Automobile Expense Cash

54 11

1,500

29 Miscellaneous Expense Cash

59 11

1,400

Credit

2,500

1,500

1,400

CHAPTER 2

Analyzing Transactions

Prob. 2-4A (Continued) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ 30 Accounts Receivable 12 57,000 Fees Earned 41 57,000 30 Salary and Commission Expense Cash

51 11

11,900

30 Lester Wagner, Drawing Cash

32 11

4,000

30 Cash Unearned Rent

11 22

10,000

11,900

4,000

10,000

1. and 3. GENERAL LEDGER Account:

Cash Item

Date

20Y7 Apr.

1 Balance 1 5 10 15 17 23 27 28 29 30 30 30

Account:

Post. Ref.

 18 18 18 18 18 18 19 19 19 19 19 19

Debit

Credit

6,500 6,000 52,300 30,000 6,450 4,300 2,500 1,500 1,400 11,900 4,000 10,000

Accounts Receivable Item

Date

20Y7 Apr.

Account No.

1 Balance 10 30

Debit

Balance Credit

26,300 19,800 13,800 66,100 36,100 29,650 25,350 27,850 26,350 24,950 13,050 9,050 19,050 Account No.

Post. Ref.

 18 19

Debit

57,000

Balance Credit

Credit

Debit

52,300

61,500 9,200 66,200

CHAPTER 2

Analyzing Transactions

Prob. 2-4A (Continued) Prepaid Insurance

Account:

Item

Date

20Y7 Apr.

1 Balance 5

Date

20Y7 Apr.

Item

3,000 9,000

6,000

Post. Ref.

Debit

Credit

2,300 325

Post. Ref.

Debit

200,000

Credit

Item

Date

1 Balance 2 17 20

Post. Ref.

 18 18 18

Item

Date

Debit

Credit

Balance Credit

Balance Debit Credit

14,000 16,300 9,850 9,525

6,450 325

Account No.

Post. Ref.

Debit

Item

Date

Debit

2,300

Credit

Debit

Balance Credit

10,000

Notes Payable

Account:

1,800 4,100 3,775

Account No.

Unearned Rent

Account:

Balance Debit Credit

200,000

Accounts Payable

Account:

Account No.

20Y7 Apr.

Credit

Balance Debit Credit

Account No.

 18 18

Item

Date

20Y7 Apr.

Debit

Land

Account:

20Y7 Apr.

 18

1 Balance 2 20

20Y7 Apr.

Post. Ref.

Office Supplies

Account:

Account No.

10,000 23

Account No.

Post. Ref.

Debit

Credit

170,000

Balance Debit Credit

170,000

CHAPTER 2

Analyzing Transactions

Prob. 2-4A (Continued) Account:

Lester Wagner, Capital

Date

20Y7 Apr. Account:

Item

1 Balance

Account:

 19

Item

Debit

Credit

Post. Ref.

Debit

Credit

Post. Ref.

1 Balance 27 30

 19 19

Debit

Credit

2,500 11,900

Debit

Post. Ref.

 18

Debit

Credit

148,200 145,700 157,600

6,500

Balance Debit Credit

Account No.

 18

Debit

4,300

30,000 36,500

Advertising Expense Post. Ref.

Balance Credit

Account No.

1 Balance 1

1 Balance 23

240,000 297,000 Account No.

Rent Expense

Item

Balance Debit Credit

57,000

Salary and Commission Expense

Item

Balance Debit Credit

2,000 6,000

4,000

 19

Item

Account No.

1 Balance 30

Date

20Y7 Apr.

46,000

Fees Earned

Date

20Y7 Apr.

Post. Ref.

1 Balance 30

Date

20Y7 Apr.

Credit

Balance Debit Credit



Item

Date

20Y7 Apr.

Debit

Lester Wagner, Drawing

Date

20Y7 Apr.

Post. Ref.

Account No.

Credit

Balance Debit Credit

17,800 22,100

CHAPTER 2

Analyzing Transactions

Prob. 2-4A (Continued) Account:

Automobile Expense

Account:

1 Balance 28

 19

Debit

Credit

Post. Ref.

Item

1 Balance 29

 19

Balance Debit Credit

5,500 7,000

1,500

Miscellaneous Expense

Date

20Y7 Apr.

Post. Ref.

Item

Date

20Y7 Apr.

Account No.

Debit

Credit

Balance Debit Credit

3,900 5,300

1,400

4. Elite Realty Unadjusted Trial Balance April 30, 20Y7

Cash Accounts Receivable Prepaid Insurance Office Supplies Land Accounts Payable Unearned Rent Notes Payable Lester Wagner, Capital Lester Wagner, Drawing Fees Earned Salary and Commission Expense Rent Expense Advertising Expense Automobile Expense Miscellaneous Expense

Account No.

Debit Balances

11 12 13 14 16 21 22 23 31 32 41 51 52 53 54 59

19,050 66,200 9,000 3,775 200,000

Credit Balances

9,525 10,000 170,000 46,000 6,000 297,000 157,600 36,500 22,100 7,000 5,300 532,525

532,525

CHAPTER 2

Analyzing Transactions

Prob. 2-4A (Concluded) 5.

(a) The unadjusted trial balance in (4) still balances because the debits equaled the credits in the original journal entry. (b) The correcting entry for $7,200 ($19,100 – $11,900) would be as follows: JOURNAL Date

20Y7 Apr.

Post. Ref.

Description

30 Salary and Commission Expense Cash

Page

51 11

Debit

Credit

7,200 7,200

CHAPTER 2

Analyzing Transactions

Prob. 2-5A The Colby Group Unadjusted Trial Balance August 31, 20Y8

Debit Balances

Cash* Accounts Receivable Supplies** Prepaid Insurance Equipment Notes Payable Accounts Payable Terry Colby, Capital Terry Colby, Drawing Fees Earned Wages Expense Rent Expense Advertising Expense Gas, Electricity, and Water Expense Miscellaneous Expense

Credit Balances

22,400 48,000 8,750 4,300 196,000 117,600 30,800 122,150 63,000 454,450 270,000 58,100 25,200 24,150 5,100 725,000

725,000

* $17,300 + $6,000 (a) – $900 (b) ** $7,400 + $1,500 – $150 2.

No. The trial balance indicates only that the debits and credits are equal. Any errors that have the same effect on debits and credits will not affect the balancing of the trial balance.

CHAPTER 2

Analyzing Transactions

Prob. 2-1B 1. and 2. (a) (g)

Bal.

Cash 18,000 (b) 12,000 (c) (d) (f) (h) (i) (l) (m) (n) (o) 14,475

(k)

Accounts Receivable 15,650

(d)

Supplies 1,450

2,500 3,150 1,450 2,400 1,800 375 2,800 200 300 550

(n)

Notes Payable 300 (b) Bal.

17,000 16,700

Ken Jones, Capital (a)

18,000

Professional Fees (g) (k) Bal.

12,000 15,650 27,650

(c)

Rent Expense 3,150

(l)

Salary Expense 2,800

(f)

Prepaid Insurance 2,400

(j)

Blueprint Expense 2,500

(b)

Automobiles 19,500

(o)

Automobile Expense 550

(e)

Equipment 6,500

(i) (m) Bal.

Miscellaneous Expense 375 200 575

(h)

Accounts Payable 1,800 (e) (j) Bal.

6,500 2,500 7,200

CHAPTER 2

Analyzing Transactions

Prob. 2-1B (Concluded) 3.

Ken Jones, Architect Unadjusted Trial Balance April 30, 20Y4 Debit Balances

Cash Accounts Receivable Supplies Prepaid Insurance Automobiles Equipment Accounts Payable Notes Payable Ken Jones, Capital Professional Fees Rent Expense Salary Expense Blueprint Expense Automobile Expense Miscellaneous Expense

Credit Balances

14,475 15,650 1,450 2,400 19,500 6,500 7,200 16,700 18,000 27,650 3,150 2,800 2,500 550 575 69,550

69,550

Net income, $18,075 ($27,650 – $3,150 – $2,800 – $2,500 – $550 – $575)

CHAPTER 2

Analyzing Transactions

Prob. 2-2B 1.

(a) (b) (c) (d) (e) (f) (g)

(h) (i)

Cash Rafael Masey, Capital

17,500

Supplies Accounts Payable

2,300

Cash Fees Earned

13,300

Rent Expense Cash

3,000

Accounts Payable Cash

1,150

Rafael Masey, Drawing Cash

1,800

Automobile Expense Miscellaneous Expense Cash

1,500 400

Office Salaries Expense Cash

2,800

Supplies Expense Supplies

1,050

17,500 2,300 13,300 3,000 1,150 1,800

1,900 2,800 1,050

CHAPTER 2

Analyzing Transactions

Prob. 2-2B (Continued) 2. 3,000 1,150 1,800 1,900 2,800

Bal.

Cash 17,500 (d) 13,300 (e) (f) (g) (h) 20,150

(b) Bal.

Supplies 2,300 (i) 1,250

1,050

(a) (c)

(e)

Accounts Payable 1,150 (b) Bal. Rafael Masey, Capital (a)

(f)

Rafael Masey, Drawing 1,800

2,300 1,150

17,500

Fees Earned (c)

(d)

Rent Expense 3,000

(h)

Office Salaries Expense 2,800

(g)

Automobile Expense 1,500

(i)

Supplies Expense 1,050

(g)

Miscellaneous Expense 400

13,300

CHAPTER 2

Analyzing Transactions

Prob. 2-2B (Concluded) 3.

Planet Realty Unadjusted Trial Balance August 31, 20Y5 Debit Balances

Cash Supplies Accounts Payable Rafael Masey, Capital Rafael Masey, Drawing Fees Earned Rent Expense Office Salaries Expense Automobile Expense Supplies Expense Miscellaneous Expense

Credit Balances

20,150 1,250 1,150 17,500 1,800 13,300 3,000 2,800 1,500 1,050 400 31,950

31,950

a. $13,300 b. $8,750 ($3,000 + $2,800 + $1,500 + $1,050 + $400) c. $4,550 ($13,300 – $8,750)

There is a $2,750 increase in owner’s equity for August, which is net income of $4,550 minus withdrawals of $1,800.

CHAPTER 2

Analyzing Transactions

Prob. 2-3B 1. JOURNAL Date

20Y6 Oct.

Post. Ref.

Description

11 31

18,000

4 Rent Expense Cash

53 11

3,000

10 Truck Cash Notes Payable

18 11 21

23,750

13 Equipment Accounts Payable

16 22

10,500

14 Supplies Cash

13 11

2,100

15 Prepaid Insurance Cash

14 11

3,600

15 Cash Fees Earned

11 41

8,950

JOURNAL

20Y6 Oct.

Debit

1 Cash Jay Pryor, Capital

Date

Credit

18,000

3,000

3,750 20,000

10,500

2,100

3,600

8,950 2

Page

Post. Ref.

Description

Page

Debit

21 Accounts Payable Cash

22 11

2,000

24 Accounts Receivable Fees Earned

12 41

14,150

26 Truck Expense Accounts Payable

55 22

700

27 Utilities Expense Cash

54 11

2,240

Credit

2,000

14,150

700

2,240

CHAPTER 2

Analyzing Transactions

Prob. 2-3B (Continued) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ 27 Miscellaneous Expense 59 1,100 Cash 11 1,100 29 Cash Accounts Receivable

11 12

7,600

30 Wages Expense Cash

51 11

4,800

31 Jay Pryor, Drawing Cash

32 11

3,500

7,600

4,800

3,500

2. GENERAL LEDGER Cash

Account:

Date

20Y6 Oct.

Item

1 4 10 14 15 15 21 27 27 29 30 31

Post. Ref.

1 1 1 1 1 1 2 2 2 2 2 2

Debit

Credit

18,000 3,000 3,750 2,100 3,600 8,950 2,000 2,240 1,100 7,600 4,800 3,500

Accounts Receivable

Account:

Item

Date

20Y6 Oct.

Account No.

24 29

Debit

Balance Credit

18,000 15,000 11,250 9,150 5,550 14,500 12,500 10,260 9,160 16,760 11,960 8,460 Account No.

Post. Ref.

2 2

Debit

Credit

14,150 7,600

Balance Debit Credit

14,150 6,550

CHAPTER 2

Analyzing Transactions

Prob. 2-3B (Continued) Supplies

Account:

Item

Date

20Y6 Oct.

Item

15 Equipment

Date

Item

Credit

3,600

Post. Ref.

Debit

Credit

10,500

Post. Ref.

Debit

Credit

23,750

Debit

Balance Credit

Balance Debit Credit

23,750 21

Account No.

Post. Ref.

Debit

Item

13 21 26

10,500

Credit

Debit

Balance Credit

20,000

Accounts Payable

Date

Balance Debit Credit

Account No.

Item

Account:

20Y6 Oct.

Debit

Notes Payable

Date

20Y6 Oct.

Post. Ref.

Account No.

Account:

Account No.

Item

Date

Balance Debit Credit

2,100

Truck

Account:

20Y6 Oct.

Credit

2,100

Account:

20Y6 Oct.

Debit

Date

20Y6 Oct.

Post. Ref.

Prepaid Insurance

Account:

Account No.

20,000 22

Account No.

Post. Ref.

Debit

1 2 2

Credit

10,500 2,000 700

Balance Debit Credit

10,500 8,500 9,200

CHAPTER 2

Analyzing Transactions

Prob. 2-3B (Continued) Jay Pryor, Capital

Account:

Date

20Y6 Oct.

Item

31 Fees Earned

Date

Item

15 24

Date

Post. Ref.

Debit

Credit

3,500

Debit

Credit

3,500 41

Balance Debit

Credit

Debit

Credit

8,950 14,150

8,950 23,100 51

Account No.

Post. Ref.

Balance Debit

Credit

4,800

Debit

Credit

4,800 53

Account No.

Post. Ref.

Item

18,000

Balance

Balance Debit

Credit

3,000

Debit

Credit

3,000

Utilities Expense

Date

Credit

Account No.

Item

Account:

20Y6 Oct.

Post. Ref.

Rent Expense

Account:

Debit

18,000

1 2

Item

Date

20Y6 Oct.

Credit

Wages Expense

Account:

20Y6 Oct.

Debit

Account No.

Account:

20Y6 Oct.

Balance

Item

Date

20Y6 Oct.

Post. Ref.

Jay Pryor, Drawing

Account:

Account No.

Post. Ref.

Balance Debit

2,240

Credit

Debit

Credit

2,240

CHAPTER 2

Analyzing Transactions

Prob. 2-3B (Continued) Truck Expense

Account:

Date

20Y6 Oct.

Item

Post. Ref.

Debit

Credit

700

Date

Item

Balance Debit Credit

Account No.

Post. Ref.

Debit

1,100

700

Miscellaneous Expense

Account:

20Y6 Oct.

Account No.

Credit

Balance Debit Credit

1,100

CHAPTER 2

Analyzing Transactions

Prob. 2-3B (Concluded) 3.

Pioneer Designs Unadjusted Trial Balance October 31, 20Y6 Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Equipment Truck Notes Payable Accounts Payable Jay Pryor, Capital Jay Pryor, Drawing Fees Earned Wages Expense Rent Expense Utilities Expense Truck Expense Miscellaneous Expense

Debit Balances

11 12 13 14 16 18 21 22 31 32 41 51 53 54 55 59

Credit Balances

8,460 6,550 2,100 3,600 10,500 23,750 20,000 9,200 18,000 3,500 23,100 4,800 3,000 2,240 700 1,100 70,300

70,300

$11,260 ($23,100 – $4,800 – $3,000 – $2,240 – $700 – $1,100)

Some supplies may have been used during October, but no supplies expense has been recorded. As will be discussed in Chapter 3, adjustments are necessary at the end of the accounting period to bring the accounts up to date. For example, adjustments for supplies used, insurance expired, and depreciation would probably be required by Pioneer Designs. Note to Instructors: At this point, students have not been exposed to depreciation, but some insightful students might recognize the need for recording supplies used and insurance expired. You might use this as an opportunity to discuss what is coming in Chapter 3.

CHAPTER 2

Analyzing Transactions

Prob. 2-4B 2. and 3. JOURNAL

20Y7 Aug.

Post. Ref.

Description

Date

20Y7 Aug.

Debit

1 Office Supplies Accounts Payable

14 21

3,150

2 Rent Expense Cash

52 11

7,200

3 Cash Accounts Receivable

11 12

83,900

5 Prepaid Insurance Cash

13 11

12,000

9 Accounts Payable Office Supplies

21 14

400

17 Advertising Expense Cash

53 11

8,000

23 Accounts Payable Cash

21 11

13,750

JOURNAL Date

Credit

3,150

7,200

83,900

12,000

400

8,000

13,750 19

Page

Post. Ref.

Description

Page

Debit

29 Miscellaneous Expense Cash

59 11

1,700

30 Automobile Expense Cash

54 11

2,500

31 Cash Salary and Commission Expense

11 51

2,000

31 Salary and Commission Expense Cash

51 11

53,000

Credit

1,700

2,500

2,000

53,000

CHAPTER 2

Analyzing Transactions

Prob. 2-4B (Continued) ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ 31 Accounts Receivable 12 183,500 Fees Earned 41 183,500 31 Land Cash Notes Payable

16 11 23

75,000

31 Cindy Getman, Drawing Cash

32 11

1,000

31 Cash Unearned Rent

11 22

5,000

7,500 67,500

1,000

5,000

1. and 3. GENERAL LEDGER Account:

Cash Item

Date

20Y7 Aug.

Post. Ref.

1 Balance 2 3 5 17 23 29 30 31 31 31 31 31

Account:

 18 18 18 18 18 19 19 19 19 19 19 19

Debit

Credit

7,200 83,900 12,000 8,000 13,750 1,700 2,500 2,000 53,000 7,500 1,000 5,000

Accounts Receivable Item

Date

20Y7 Aug.

Account No.

1 Balance 3 31

Debit

Balance Credit

52,500 45,300 129,200 117,200 109,200 95,450 93,750 91,250 93,250 40,250 32,750 31,750 36,750 Account No.

Post. Ref.

 18 19

Debit

Credit

83,900 183,500

Balance Debit Credit

100,100 16,200 199,700

CHAPTER 2

Analyzing Transactions

Prob. 2-4B (Continued) Prepaid Insurance

Account:

Item

Date

20Y7 Aug.

1 Balance 5

Date

20Y7 Aug.

Item

12,600 24,600

12,000

Post. Ref.

Debit

Credit

3,150 400

Post. Ref.

Debit

75,000

Credit

Date

Item

1 Balance 1 9 23

Post. Ref.

 18 18 18

Item

Date

Debit

Credit

Balance Credit

Balance Debit Credit

21,000 24,150 23,750 10,000

400 13,750

Account No.

Post. Ref.

Debit

Item

Date

Debit

3,150

Credit

Debit

Balance Credit

5,000

Notes Payable

Account:

2,800 5,950 5,550

Account No.

Unearned Rent

Account:

Balance Debit Credit

75,000

Accounts Payable

Account:

Account No.

20Y7 Aug.

Credit

Balance Debit Credit

Account No.

 18 18

Item

Date

20Y7 Aug.

Debit

Land

Account:

20Y7 Aug.

 18

1 Balance 1 9

20Y7 Aug.

Post. Ref.

Office Supplies

Account:

Account No.

5,000 23

Account No.

Post. Ref.

Debit

Credit

67,500

Balance Debit Credit

67,500

CHAPTER 2

Analyzing Transactions

Prob. 2-4B (Continued) Account:

Cindy Getman, Capital

Date

20Y7 Aug.

Item

1 Balance

Account:

20Y7 Aug.

Item

20Y7 Aug.

Item

44,800 45,800

1,000

Post. Ref.

Debit

Credit

Post. Ref.

1 Balance 17

591,500 775,000

Debit

Account No.

Credit

2,000 53,000

Debit

Post. Ref.

Debit

Credit

385,000 383,000 436,000

49,000 56,200

7,200

 18

Debit

8,000

Balance Debit Credit

Account No.

Post. Ref.

Balance Credit

Account No.

 18

Item

Balance Debit Credit

183,500

Advertising Expense

Date

20Y7 Aug.

Credit

Balance Debit Credit

Account No.

 19 19

1 Balance 2

Account:

Debit

Rent Expense

Date

Account No.

 19

1 Balance 31 31

Account:

87,500

Salary and Commission Expense

Date

20Y7 Aug.

Post. Ref.

 19

1 Balance 31

Account:

Credit

Fees Earned

Date

20Y7 Aug.

Debit

Balance Debit Credit



1 Balance 31

Account:

Post. Ref.

Cindy Getman, Drawing

Date

Account No.

Credit

Balance Debit Credit

32,200 40,200

CHAPTER 2

Analyzing Transactions

Prob. 2-4B (Continued) Account:

Automobile Expense Item

Date

20Y7 Aug.

Account:

20Y7 Aug.

Post. Ref.

1 Balance 30

 19

Debit

Credit

Item

Post. Ref.

1 Balance 29

 19

Balance Debit Credit

15,750 18,250

2,500

Miscellaneous Expense

Date

Account No.

Debit

Credit

Balance Debit Credit

5,250 6,950

1,700

4. Valley Realty Unadjusted Trial Balance August 31, 20Y7

Cash Accounts Receivable Prepaid Insurance Office Supplies Land Accounts Payable Unearned Rent Notes Payable Cindy Getman, Capital Cindy Getman, Drawing Fees Earned Salary and Commission Expense Rent Expense Advertising Expense Automobile Expense Miscellaneous Expense

Account No.

Debit Balances

11 12 13 14 16 21 22 23 31 32 41 51 52 53 54 59

36,750 199,700 24,600 5,550 75,000

Credit Balances

10,000 5,000 67,500 87,500 45,800 775,000 436,000 56,200 40,200 18,250 6,950 945,000

945,000

CHAPTER 2

Analyzing Transactions

Prob. 2-4B (Concluded) 5.

(a) The unadjusted trial balance in (4) still balances because the debits equaled the credits in the original journal entry. (b) The correcting entry for $9,000 ($10,000 – $1,000) would be as follows: JOURNAL Date

20Y7 Aug.

Post. Ref.

Description

31 Cindy Getman, Drawing Cash

Page

32 11

Debit

Credit

9,000 9,000

CHAPTER 2

Analyzing Transactions

Prob. 2-5B 1.

Tech Support Services Unadjusted Trial Balance January 31, 20Y8 Debit Balances

Cash* Accounts Receivable Supplies Prepaid Insurance Equipment Notes Payable Accounts Payable Thad Engelberg, Capital Thad Engelberg, Drawing Fees Earned Wages Expense Rent Expense Advertising Expense Gas, Electricity, and Water Expense Miscellaneous Expense

Credit Balances

20,250 56,400 6,750 9,600 162,000 54,000 16,650 107,850 39,000 534,000 306,000 62,550 28,350 17,000 4,600 712,500

712,500

* $25,550 – $8,000 (a) + $2,700 (b) 2.

No. The trial balance indicates only that the debits and credits are equal. Any errors that have the same effect on debits and credits will not affect the balancing of the trial balance.

CHAPTER 2

Analyzing Transactions

CONTINUING PROBLEM 2. and 3. JOURNAL Date

20Y9 July

Post. Ref.

Description

Page

Debit

1 Cash Peyton Smith, Capital

11 31

5,000

1 Office Rent Expense Cash

51 11

1,750

1 Prepaid Insurance Cash

15 11

2,700

2 Cash Accounts Receivable

11 12

1,000

3 Cash Unearned Revenue

11 23

7,200

3 Accounts Payable Cash

21 11

250

4 Miscellaneous Expense Cash

59 11

900

5 Office Equipment Accounts Payable

17 21

7,500

8 Advertising Expense Cash

55 11

200

11 Cash Fees Earned

11 41

1,000

13 Equipment Rent Expense Cash

52 11

700

14 Wages Expense Cash

50 11

1,200

Credit

5,000

1,750

2,700

1,000

7,200

250

900

7,500

200

1,000

700

1,200

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) 2. and 3. JOURNAL Date

20Y9 July

Post. Ref.

Description

Page

Debit

16 Cash Fees Earned

11 41

2,000

18 Supplies Accounts Payable

14 21

850

21 Music Expense Cash

54 11

620

22 Advertising Expense Cash

55 11

800

23 Cash Accounts Receivable Fees Earned

11 12 41

750 1,750

27 Utilities Expense Cash

53 11

915

28 Wages Expense Cash

50 11

1,200

29 Miscellaneous Expense Cash

59 11

540

30 Cash Accounts Receivable Fees Earned

11 12 41

500 1,000

31 Cash Fees Earned

11 41

3,000

31 Music Expense Cash

54 11

1,400

31 Peyton Smith, Drawing Cash

32 11

1,250

Credit

2,000

850

620

800

2,500

915

1,200

540

1,500

3,000

1,400

1,250

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) 1. and 3. Cash

Account:

Item

Date

20Y9 July

1 1 1 1 2 3 3 4 8 11 13 14 16 21 22 23 27 28 29 30 31 31 31

Item

Date

20Y9 July

Balance

Post. Ref.

 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2

Debit

Credit

5,000 1,750 2,700 1,000 7,200 250 900 200 1,000 700 1,200 2,000 620 800 750 915 1,200 540 500 3,000 1,400 1,250

Accounts Receivable

Account:

1 2 23 30

Account No.

Balance

Balance Debit Credit

3,920 8,920 7,170 4,470 5,470 12,670 12,420 11,520 11,320 12,320 11,620 10,420 12,420 11,800 11,000 11,750 10,835 9,635 9,095 9,595 12,595 11,195 9,945 12

Account No.

Post. Ref.

 1 2 2

Debit

Credit

1,000 1,750 1,000

Balance Debit Credit

1,000 — 1,750 2,750

—

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) Supplies

Account:

Item

Date

20Y9 July

1 18

Balance

Item

Date

20Y9 July

Item

850

Debit

Credit

2,700

1 3 5 18

Post. Ref.

Debit

Credit

7,500

Post. Ref.

Debit

 1 1 2

Credit

250

250 — 7,500 8,350

—

Post. Ref.

Debit

Credit

Balance Debit Credit

7,200

Peyton Smith, Capital

1 Balance 1

Balance Debit Credit

7,500 850

Item

Account No.

Date

Balance Debit Credit

7,500

Unearned Revenue Item

Account No.

Balance

Date

Balance Debit Credit

Account No.

Item

2,700

Accounts Payable

Account:

20Y9 July

Post. Ref.

Date

Account:

170 1,020

Office Equipment

Account:

20Y9 July

Credit

Balance Debit Credit

Account No.

Date

20Y9 July

Debit

 2

Account:

20Y9 July

Post. Ref.

Prepaid Insurance

Account:

Account No.

7,200 31

Account No.

Post. Ref.

Debit

 1

Credit

5,000

Debit

Balance Credit

4,000 9,000

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) Peyton Smith, Drawing

Account:

Item

Date

20Y9 July

1 31

Date

Item

1 11 16 23 30 31

Date

Balance

Date

Item

1 1

Balance

1,250

Date

Item

1 13

Balance

Account No.

Post. Ref.

Debit

 1 2 2 2 2

Credit

Balance Debit Credit

6,200 7,200 9,200 11,700 13,200 16,200

1,000 2,000 2,500 1,500 3,000 Account No.

Post. Ref.

 1 2

Debit

Credit

Debit

Balance Credit

1,200 1,200

Account No.

Post. Ref.

 1

Debit

Post. Ref.

Credit

Balance Debit Credit

Account No.

 1

700

800 2,550

1,750

Debit

400 1,600 2,800

Equipment Rent Expense

Account:

Balance Debit Credit

500 1,750

Office Rent Expense

Account:

20Y9 July

Balance

Item

1 14 28

20Y9 July

Credit

Wages Expense

Account:

20Y9 July

 2

Debit

Fees Earned

Account:

20Y9 July

Balance

Post. Ref.

Account No.

Credit

Debit

Balance Credit

675 1,375

CHAPTER 2

Analyzing Transactions

Continuing Problem (Continued) Utilities Expense

Account:

Date

20Y9 July

Item

1 27

Date

Item

1 21 31

1 8 22

 2

Credit

Balance

Date

Item

Account:

Balance

915

 2 2

Debit

Credit

1,590 2,210 3,610

620 1,400

Account No.

Post. Ref.

Debit

 1 2

Credit

1 4 29

Debit

500 700 1,500

200 800

Debit

Credit

Debit

Miscellaneous Expense

Account No.

Balance

Debit

 1 2

900 540

Credit

Balance Credit

180

Post. Ref.

Balance Credit

Account No.

Post. Ref.

Balance Debit Credit



Item

Date

Balance Debit Credit

Account No.

Post. Ref.

300 1,215

Supplies Expense

Account:

20Y9 July

Balance

Item

Date

20Y9 July

Debit

Advertising Expense

Account:

20Y9 July

Post. Ref.

Music Expense

Account:

20Y9 July

Balance

Account No.

Balance Debit Credit

415 1,315 1,855

CHAPTER 2

Analyzing Transactions

Continuing Problem (Concluded) 4.

PS Music Unadjusted Trial Balance July 31, 20Y9 Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accounts Payable Unearned Revenue Peyton Smith, Capital Peyton Smith, Drawing Fees Earned Wages Expense Office Rent Expense Equipment Rent Expense Utilities Expense Music Expense Advertising Expense Supplies Expense Miscellaneous Expense

11 12 14 15 17 21 23 31 32 41 50 51 52 53 54 55 56 59

Debit Balances

Credit Balances

9,945 2,750 1,020 2,700 7,500 8,350 7,200 9,000 1,750 16,200 2,800 2,550 1,375 1,215 3,610 1,500 180 1,855 40,750

40,750

CHAPTER 2

Analyzing Transactions

CASES & PROJECTS CP 2-1 1.

No. For financial accounting information to be useful, it must accurately reflect an entity’s business transactions and economic activity. For this to happen, each account must reflect the increases or decreases that result from each transaction. If the trial balance does not balance, it means that a transaction has not been accurately recorded in the accounts. By knowingly submitting a trial balance that does not accurately reflect the transactions in the accounts, Buddy is demonstrating a failure of individual character and is acting unethically.

The users of the financial information who rely on this information will be affected, as the information will not be a faithful representation of the entity’s economic activity.

Buddy should have discussed the issue with his supervisor and asked for more time to find the error.

CP 2-2 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1. 2. 3. 4. 5. 6.

$22,536 million $12,724 million ($6,040 + $3,468 + $3,216) $9,812 million ($22,536 million on total assets – $12,724 million total liabilities) 3 2 The income statement reports a summary of revenues and expenses for a specific period of time, such as a month or a year. The balance sheet reports a list of assets, liabilities, and stockholders’ equity as of a specific date, usually at the close of the last day of a month or a year.

CP 2-3 1.

The rules of debit and credit must be memorized. Dot is correct in that the rules of debit and credit could be reversed as long as everyone accepted and abided by the rules. However, the important point is that everyone accepts the rules as the way in which transactions should be recorded. This generates uniformity across the accounting profession and reduces errors and confusion. Because the current rules of debit and credit have been used for centuries, Dot should adapt to the current rules of debit and credit, rather than devise her own. The primary reason that all accounts do not have the same rules for increases and decreases is for control of the recording process. The double-entry accounting system, which includes (1) the rules of debit and credit and (2) the accounting equation, guarantees that (1) debits always equal credits and (2) assets always equal liabilities plus owner’s equity. If all increases in the account were recorded by debits, then the control that debits always equal credits would be removed. In addition, the control that the normal balance of 2-66 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2

Analyzing Transactions

CP 2-3 (Concluded) assets is a debit would also be removed. The accounting equation would still hold, but the control over recording transactions would be weakened. Dot is correct that we could call the left and right sides of an account different terms, such as “LE” and “RE.” Again, centuries of tradition dictate the current terminology used. One might note, however, that in Latin, debere (debit) means “left” and credere (credit) means “right.” 2.

The accounting system may be designed to capture information about the buying habits of various customers or vendors, such as the quantity normally ordered, average amount ordered, and number of returns. Thus, in a sense, there can be other “sides” of (information about) a transaction that are recorded by the accounting system. Such information would be viewed as supplemental to the basic double-entry accounting system.

CP 2-4 Note to Instructors: The purpose of this activity is to familiarize students with the job opportunities available in accounting and allow them to demonstrate their ability to communicate the role of accounting in the context of a specific position that requires knowledge of accounting. An example of an advertisement for such a position is shown below. Individual student answers will vary depending on the specific scenario they select. ABOUT THE COMPANY Our client is looking to add a Financial Analyst. With a large and growing finance team, there is significant opportunity for growth and advancement within the department. The company boasts a team-oriented culture and provides its employees with the tools and training necessary to perform. Our client is looking to bring on more of a junior-level candidate who wants to gain experience in his or her field of study. There will be hands-on training for the role that will evolve from a data analyst into a financial analyst and will be reporting to the director of finance. Our client is in the consumer goods industry and is an international company that has multiple opportunities for growth. RESPONSIBILITIES OF THE FINANCIAL ANALYST The Financial Analyst will: • Conduct special studies to analyze complex financial actions and prepare recommendations for policy, procedure, control, or action. • Analyze financial information to determine present and future financial performance. • Evaluate complex profit plans, operating records, and financial statements. • Direct preparation of studies, reports, analyses, and recommendations in areas such as budgets, forecasts, financial plans, statistical reports, and business forecasts. • Coordinate with all levels of management to gather, analyze, summarize, and prepare recommendations regarding financial plans, trended future requirements, and operating forecasts. Source: CareerBuilder.com

CHAPTER 2

Analyzing Transactions

CP 2-5 The following general journal entry should be used to record the receipt of tuition payments received in advance of classes: Cash…………………………………………………………………… Unearned Tuition Deposits……………………………………

XXX XXX

Cash is an asset account, and Unearned Tuition Deposits is a liability account. As the classes are taught throughout the term, the unearned tuition deposits become earned revenue. The entry to record the earned portion of tuition will be: Unearned Tuition Deposits………………………………………… Earned Tuition Deposits…………………………………………

XXX XXX

CP 2-6 The journal is called the book of original entry. It provides a time-ordered history of the transactions that have occurred for the firm. This time-ordered history is very important because it allows one to trace ledger account balances back to the original transactions that created those balances. This is called an “audit trail.” If the firm recorded transactions by posting to ledgers directly, it would be nearly impossible to reconstruct actual transactions. The debits and credits would all be separated and accumulated into the ledger balances. Once the transactions become part of the ledger balances, the original transactions would be lost. That is, there would be no audit trail, and any errors that might occur in recording transactions would be almost impossible to trace. Thus, firms first record transaction debits and credits in a journal. These transactions are then posted to the ledger to update the account balances. The journal and ledger are linked using posting references. This allows an analyst to trace the transaction flow forward or backward, depending on the need.

CHAPTER 2

Analyzing Transactions

CP 2-7 a.

Although the titles and numbers of accounts may differ, depending on how expenses are classified, the following accounts would be adequate for recording transaction data for Eagle Caddy Service:

11 12 13

Balance Sheet Accounts

Income Statement Accounts

1. Assets

4. Revenue

Cash Accounts Receivable Supplies

2. Liabilities Accounts Payable

31 32

3. Owner’s Equity Cory Neece, Capital Cory Neece, Drawing

Fees Earned

51 52 53 54 55

5. Expenses Rent Expense Supplies Expense Wages Expense Utilities Expense Miscellaneous Expense

Eagle Caddy Service Income Statement For the Month Ended June 30, 20Y9 Fees earned Expenses: Rent expense Supplies expense Wages expense Utilities expense Miscellaneous expense Total expenses Net income

$11,400 $3,500 1,925 850 340 395 7,010 $ 4,390

Note to Instructors: Students may have prepared slightly different income statements, depending upon the titles of the major expense classifications chosen. Regardless of the classification of expenses, however, the total sales, total expenses, and net income should be as presented above. T accounts are not required for the preparation of the income statement of Eagle Caddy Service. The following presentation illustrates one solution using T accounts. Alternative solutions are possible if students used different accounts. In presenting the following T account solution, instructors may wish to emphasize the advantages of using T accounts (or a journal and four-column accounts) when a large number of transactions must be recorded.

CHAPTER 2

Analyzing Transactions

CP 2-7 (Continued) Cash 20Y9 June

1 15 30 30

Bal.

2,000 5,400 4,200 1,500

20Y9 June

Fees Earned

11 1 2 3 17 20 28 30 30

500 750 600 1,000 2,400 395 340 850

6,265

20Y9 June 15 25 30 Bal.

20Y9 June

Accounts Receivable 20Y9 25 1,800 June 30 300

20Y9 June

1 3

2 7 22

Bal.

20Y9 June

17 20

Supplies 20Y9 750 June 30 1,000 850 675

Accounts Payable 20Y9 1,000 June 3 2,400 7 22 Bal.

Cory Neece, Capital 20Y9 June 1

20Y9 June

1,925

20Y9 June

2,400 1,000 850 850

20Y9 June

340

Miscellaneous Expense

31 2,000

850

Utilities Expense

1,925

Wages Expense

500 3,000 3,500

Supplies Expense

12 1,500

5,400 1,800 4,200 11,400

Rent Expense

Bal.

20Y9 June Bal.

395

CHAPTER 2

Analyzing Transactions

CP 2-7 (Concluded) c.

$6,265, computed in the following manner: Cash receipts: Initial investment…………………………………………………… $2,000 Cash sales ($5,400 + $4,200)……………………………………… 9,600 Collections on accounts…………………………………………… 1,500 Total cash receipts during June………………………………

$13,100

Cash disbursements: Rent expense ($500 + $3,000)…………………………………… $3,500 Supplies purchased for cash……………………………………… 750 Wages expense……………………………………………………… 850 Payment for supplies on account……………………………… 1,000 Utilities expense…………………………………………………… 340 395 Miscellaneous expense…………………………………………… Total cash disbursements during June…………………… Cash on hand according to records*………………………………

6,835 $ 6,265

* If the student used T accounts in completing part (b), or this part, this amount ($6,265) should agree with the balance of the cash account.

d. The difference of $90 ($6,265 – $6,175) between the cash on hand according to records ($6,265) and the cash on hand according to the count ($6,175) could be due to many factors, including errors in the record keeping and withdrawals made by Cory.

CHAPTER 3 THE ADJUSTING PROCESS DISCUSSION QUESTIONS 1.

Under cash-basis accounting, revenues are reported in the period in which cash is received and expenses are reported in the period in which cash is paid.

Under accrual-basis accounting, revenues are reported in the period in which they are earned and expenses are reported in the same period as the revenues to which they relate.

The matching concept is related to the accrual basis of accounting.

Adjusting entries are needed at the end of an accounting period to bring the ledger up to date.

Adjusting entries bring the ledger up to date as a normal part of the accounting cycle. Correcting entries correct errors in the ledger.

Four different categories of adjusting entries include prepaid expenses (deferred expenses), unearned revenues (deferred revenues), accrued expenses (accrued liabilities), and accrued revenues (accrued assets).

Statement (a): Increases the balance of a revenue account.

Statement (b): Increases the balance of an expense account.

Yes, because every adjusting entry affects expenses or revenues.

The rights acquired represent an asset.

The justification for debiting Rent Expense is that when the ledger is summarized in a trial balance at the end of the month and statements are prepared, the rent will have become an expense. Hence, no adjusting entry will be necessary.

The portion of the cost of a fixed asset deducted from revenue of the period is debited to Depreciation Expense. It represents the cost of the fixed asset that has been expensed in generating revenue during the period. The reduction in the fixed asset account is recorded by a credit to Accumulated Depreciation rather than to the fixed asset account. The use of the contra asset account facilitates the presentation of original cost and accumulated depreciation on the balance sheet.

Depreciation Expense—debit balance; Accumulated Depreciation—credit balance.

No. It is not customary for the balances of the two accounts to be equal in amount.

Depreciation Expense appears on the income statement; Accumulated Depreciation appears on the balance sheet.

10.

CHAPTER 3

The Adjusting Process

PRACTICE EXERCISES PE 3-1A a. No b. No

c. d.

Yes No

e. f.

No Yes

PE 3-1B a. Yes b. No

c. d.

No Yes

e. f.

Yes Yes

PE 3-2A a. (2) Unearned revenue b. (3) Accrued revenue

c. d.

(4) Accrued expense (1) Prepaid expense

PE 3-2B a. (2) Unearned revenue b. (1) Prepaid expense

c. d.

(3) Accrued revenue (4) Accrued expense

PE 3-3A Accounts Receivable Fees Earned Accrued fees.

18,540 18,540

PE 3-3B Accounts Receivable Fees Earned Accrued fees.

27,480 27,480

PE 3-4A Salaries Expense Salaries Payable Accrued salaries [($33,300 ÷ 6 days) × 4 days].

22,200 22,200

PE 3-4B Salaries Expense Salaries Payable Accrued salaries [($16,200 ÷ 5 days) × 2 days].

6,480 6,480

CHAPTER 3

The Adjusting Process

PE 3-5A Dec. 31 Unearned Rent Rent Revenue Rent Earned [($13,200 ÷ 12 months) × 5 months].

5,500 5,500

PE 3-5B Dec. 31 Unearned Fees Fees Earned Fees Earned ($316,290 – $220,240).

96,050 96,050

PE 3-6A Insurance Expense Prepaid Insurance Insurance expired ($6,800 + $25,100 – $8,500).

23,400 23,400

PE 3-6B Supplies Expense Supplies Supplies used ($4,085 + $7,810 – $3,610).

8,285 8,285

PE 3-7A Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

14,400 14,400

PE 3-7B Depreciation Expense Accumulated Depreciation—Building Depreciation on building.

8,120 8,120

CHAPTER 3

The Adjusting Process

PE 3-8A a. b. c.

Revenues were understated by $8,000. Expenses were understated by $12,600 ($1,700 + $10,900). Net income was overstated by $4,600 ($12,600 – $8,000).

PE 3-8B a. b. c.

Revenues were understated by $64,400. Expenses were understated by $19,000 ($8,400 + $10,600). Net income was understated by $45,400 ($64,400 – $19,000).

PE 3-9A a.

The totals are equal even though the credit should have been to Wages Payable instead of Accounts Payable.

The totals are unequal. The credit total is higher by $72 ($1,591 – $1,519).

PE 3-9B a.

The totals are unequal. The debit total is higher by $1,800 ($9,700 – $7,900).

The totals are equal because the adjusting entry was omitted.

PE 3-10A a.

Upward Company Income Statements For the Years Ended December 31 20Y5 Amount

Fees earned Operating expenses Income from operations b.

Percent

$924,000 545,160 $378,840

100% 59% 41%

20Y4 Amount Percent

$784,000 478,240 $305,760

100% 61% 39%

A favorable change of decreasing operating expenses and increasing income from operations as percentages of revenue is indicated.

PE 3-10B a.

Versatile Company Income Statements For the Years Ended December 31 20Y5

Fees earned Operating expenses Income from operations b.

Amount

Percent

$1,468,000 822,080 $ 645,920

100% 56% 44%

20Y4 Amount Percent

$1,164,000 628,560 $ 535,440

100% 54% 46%

An unfavorable change of increasing operating expenses and decreasing income from operations as percentages of revenue is indicated. 3-4 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 3

The Adjusting Process

EXERCISES Ex. 3-1 1. 2. 3. 4.

Accrued expense (b) Unearned revenue (c) Accrued revenue (a) Prepaid expense (d)

5. 6. 7. 8.

Unearned revenue (c) Prepaid expense (d) Prepaid expense (d) Accrued expense (b)

Ex. 3-2 Account

Answer

Accounts Receivable…………………… Normally requires adjustment (AR). Cash………………………………………… Does not normally require adjustment. Harriet Kasun, Capital…………………… Does not normally require adjustment. Interest Expense………………………… Normally requires adjustment (AE). Interest Receivable……………………… Normally requires adjustment (AR). Land………………………………………… Does not normally require adjustment. Office Equipment………………………… Does not normally require adjustment. Prepaid Rent……………………………… Normally requires adjustment (PE). Supplies…………………………………… Normally requires adjustment (PE). Unearned Fees…………………………… Normally requires adjustment (UR). Wages Expense…………………………… Normally requires adjustment (AE).

Ex. 3-3 a.

Accounts Receivable Fees Earned Accrued fees.

59,500 59,500

No. If the cash basis of accounting is used, revenues are recognized only when the cash is received. Therefore, earned but unbilled revenues would not be recognized in the accounts, and no adjusting entry would be necessary.

Ex. 3-4 a.

Fees earned (or revenues) will be understated. Net income will be understated.

Accounts receivable (or assets) will be understated. Owner’s equity (owner’s capital account) will be understated.

CHAPTER 3

The Adjusting Process

Ex. 3-5 a.

Salaries Expense Salaries Payable Accrued salaries [($14,800 ÷ 5 days) × 3 days].

8,880

Salaries Expense Salaries Payable Accrued salaries [($14,800 ÷ 5 days) × 4 days].

11,840

8,880

11,840

Ex. 3-6 $66,075 ($73,250 – $7,175)

Ex. 3-7 a.

Salary expense (or expenses) will be understated. Net income will be overstated.

Salaries payable (or liabilities) will be understated. Owner’s equity (owner’s capital account) will be overstated.

Ex. 3-8 a.

Salary expense (or expenses) will be overstated because two days of salaries that should have been included as October expenses are being recorded in November. Net income will be understated.

The balance sheet will be correct. This is because salaries payable has been paid, and the net income errors for October and November have offset each other. Thus, owner’s equity (owner’s capital account) is correct.

Ex. 3-9 Unearned Fees Fees Earned ($23,100 – $4,620).

18,480 18,480

Ex. 3-10 a.

Rent revenue (or revenues) will be understated. Net income will be understated.

Unearned rent (liabilities) will be overstated. Owner’s equity (owner’s capital account) at the end of the period will be understated.

CHAPTER 3

The Adjusting Process

Ex. 3-11 Supplies Expense Supplies Supplies used ($10,680 – $1,940).

8,740 8,740

Ex. 3-12 $9,110 ($1,310 + $7,800) Ex. 3-13 a.

Insurance expense (or expenses) will be understated. Net income will be overstated.

Prepaid insurance (or assets) will be overstated. Owner’s equity (Owner’s Capital) will be overstated.

Ex. 3-14 a.

Insurance Expense Prepaid Insurance Insurance expired.

20,250

Insurance Expense Prepaid Insurance Insurance expired ($27,000 – $6,750).

20,250

Ex. 3-15 a.

Insurance Expense Prepaid Insurance Insurance expired ($3,000 + $32,500 – $4,800).

30,700

Insurance Expense Prepaid Insurance Insurance expired.

30,700

Ex. 3-16 a.

Unearned Fees Fees Earned Unearned fees earned during year.

39,750

Accounts Receivable Fees Earned Accrued fees earned.

24,650

39,750

24,650

CHAPTER 3

The Adjusting Process

Ex. 3-17 a.

Dec.

31 Taxes Expense Prepaid Taxes Prepaid taxes expired [($18,480 ÷ 12 months) × 8 months].

12,320

31 Taxes Expense Taxes Payable Accrued taxes.

45,000

12,320

45,000

$57,320 ($12,320 + $45,000)

Ex. 3-18 Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

8,200 8,200

Ex. 3-19 a.

$1,106,000 ($3,240,000 – $2,134,000)

No. Depreciation is an allocation of the cost of the equipment to the periods benefiting from its use. It does not necessarily relate to value or loss of value.

Ex. 3-20 a.

$29,460 million ($58,683 – $29,223)

No. Depreciation is an allocation method, not a valuation method. That is, depreciation allocates the cost of a fixed asset over its useful life. Depreciation does not attempt to measure market values, which may vary significantly from year to year.

Ex. 3-21 Income: $10,117 million ($4,442 + $5,675)

Ex. 3-22 a.

$676 million overstated

248.5% ($676 ÷ $272)

CHAPTER 3

The Adjusting Process

Ex. 3-23 Error (a) OverUnderstated stated $ 0 $34,900 0 0 0 34,900 0 0 34,900 0 0 34,900

1. Revenue for the year would be 2. Expenses for the year would be 3. Net income for the year would be 4. Assets at July 31 would be 5. Liabilities at July 31 would be 6. Owner’s equity at July 31 would be

Error (b) OverUnderstated stated $ 0 $ 0 0 12,770 12,770 0 0 0 0 12,770 12,770 0

Ex. 3-24 $218,530 ($196,400 + $34,900 – $12,770)

Ex. 3-25 a. Dec.

31 Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

13,900 13,900

(1)

Depreciation expense would be understated. Net income would be overstated.

(2)

Accumulated depreciation would be understated, and total assets would be overstated. Owner’s equity (owner’s capital account) would be overstated.

CHAPTER 3

The Adjusting Process

Ex. 3-26 1.

Accounts Receivable Fees Earned Accrued fees earned.

Supplies Expense Supplies Supplies used.

Insurance Expense Prepaid Insurance Insurance expired.

Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

Wages Expense Wages Payable Accrued wages.

CHAPTER 3

The Adjusting Process

Ex. 3-27 1.

The accountant debited Accounts Receivable for $5,000 but did not credit Laundry Revenue. This adjusting entry represents accrued laundry revenue.

The accountant debited rather than credited Laundry Supplies for $3,000.

The accountant credited the prepaid insurance account for $3,600, but debited the insurance expense account for only $600.

The accountant credited Laundry Equipment for the depreciation expense of $13,000 instead of crediting the accumulated depreciation account.

The accountant did not debit Wages Expense for $1,000.

The corrected adjusted trial balance is shown below. Eva’s Laundry Adjusted Trial Balance May 31, 20Y3 Debit Balances

Cash Accounts Receivable Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation—Laundry Equipment Accounts Payable Wages Payable Eva Baldwin, Capital Eva Baldwin, Drawing Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Expense Insurance Expense Miscellaneous Expense

Credit Balances

7,500 23,250 750 1,600 190,000 61,000 9,600 1,000 110,300 28,775 187,100 50,200 25,575 18,500 13,000 3,000 3,600 3,250 369,000

369,000

CHAPTER 3

The Adjusting Process

Ex. 3-28 a.

Amazon.com, Inc. Operating Income Statements For the Years Ended December 31 (in millions) Year 2 Amount Percent

Year 1 Amount Percent

Product sales Service sales Total sales

$141,915 90,972 $232,887

60.9% 39.1% 100.0%

$118,573 59,293 $177,866

66.7% 33.3% 100.0%

Cost of sales Fulfillment Marketing Technology and content General and administrative Other operating expense, net Total operating expenses Operating income

$139,156 34,027 13,814 28,837 4,336 296 $220,466 $ 12,421

59.8% 14.6% 5.9% 12.4% 1.9% 0.1% 94.7% 5.3%

$111,934 25,249 10,069 22,620 3,674 214 $173,760 $ 4,106

62.9% 14.2% 5.7% 12.7% 2.1% 0.1% 97.7% 2.3%

b. The vertical analysis indicates that operating income increased from 2.3% to 5.3% of total sales between the two years. Total expenses decreased from 97.7% to 94.7% of total sales. There was a sizable decrease in the cost of sales from 62.9% to 59.8% of total sales. There were also decreases in the other expenses; technology and content (12.7% to 12.4%) and general and administrative (2.1% to 1.9%) expenses. These decreases were sufficient to offset the slight increases in the other expenses; fulfillment (14.2% to 14.6%) and in marketing (5.7% to 5.9%).

CHAPTER 3

The Adjusting Process

Ex. 3-29 a. Net income: $1,933 – $4,240 = –$2,307 million

($2,307) $4,240

= –54.4%

Year 1:

$4,240 $34,350

= 12.3%

Year 2:

$1,933 $36,397

= 5.3%

Nike has a decrease in net income between the two years of $2,307 million, or 54.4%. Although Nike was able to grow sales and reduce expenses as a percent of sales between the two years, there was a substantial increase in income tax expense in the most recent year.

Ex. 3-30 a.

AT&T Revenues………………………………………………………… Cost of services (expense)…………………………………… Selling and marketing expense……………………………… Depreciation and other expenses…………………………… Operating income………………………………………………

$170,756 (79,419) (36,765) (28,476) $ 26,096

100.0% (46.5)% (21.5)% (16.7)% 15.3%

Verizon Revenues………………………………………………………… Cost of services (expense)…………………………………… Selling and marketing expense……………………………… Depreciation and other expenses…………………………… Operating income………………………………………………

$130,863 (55,508) (31,083) (21,994) $ 22,278

100.0% (42.4)% (23.8)% (16.8)% 17.0%

AT&T’s operating income is 15.3% of revenues, while Verizon’s operating income to revenues is 17.0%. Verizon appears to be more efficient in generating operating income from revenues. AT&T’s cost of services is 46.5% of revenues, while Verizon’s is over four percentage points less at 42.4% of revenues. This difference is a large contributor to Verizon’s superior operating income-to-revenues efficiency. The selling and marketing expenses are 21.5% of revenues for AT&T, while Verizon’s are slightly larger at 23.8% of revenues. Depreciation expense is close for both companies with 16.7% of revenues for AT&T and 16.8% for Verizon. In summary, it appears that Verizon is able to generate more operating income per sales dollar, mostly because of a lower cost of services per sales dollar in comparison to AT&T.

CHAPTER 3

The Adjusting Process

PROBLEMS Prob. 3-1A 1. Dec.

31 Supplies Expense Supplies Supplies used ($1,585 – $320).

1,265

31 Unearned Rent Rent Revenue Rent earned [($10,350 ÷ 5 months) × 1 month].

2,070

31 Wages Expense Wages Payable Accrued wages.

3,710

31 Accounts Receivable Fees Earned Accrued fees earned.

21,610

31 Depreciation Expense Accumulated Depreciation—Office Equipment Depreciation expense.

3,340

1,265

2,070

3,710

21,610

3,340

2. Adjusting entries are a planned part of the accounting process to update the accounts. Correcting entries are not planned but arise only when necessary to correct errors.

CHAPTER 3

The Adjusting Process

Prob. 3-2A 1. July

31 Accounts Receivable Fees Earned Accrued fees earned.

11,150

31 Supplies Expense Supplies Supplies used ($3,350 – $900).

2,450

31 Rent Expense Prepaid Rent Prepaid rent expired.

6,000

31 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

8,950

31 Unearned Fees Fees Earned Fees earned ($12,000 – $2,000).

10,000

31 Wages Expense Wages Payable Accrued wages.

4,840

11,150

2,450

6,000

8,950

10,000

4,840

2. Fees Earned would be understated by $11,150, Wages Expense would be understated by $4,840, and net income would be understated by $6,310 ($11,150 – $4,840). 3. Accounts Receivable would be understated by $11,150, total assets would be understated by $11,150, Wages Payable would be understated by $4,840, total liabilities would be understated by $4,840, owner’s equity (Owner’s Capital) would be understated by $6,310 ($11,150 – $4,840), and total liabilities and owner’s equity would be understated by $11,150 ($6,310 + $4,840). 4. There is no effect on “Net increase or decrease in cash” on the statement of cash flows because adjusting entries do not affect cash.

CHAPTER 3

The Adjusting Process

Prob. 3-3A 1. 20Y4 June

30 Accounts Receivable Fees Earned Accrued fees earned.

7,380

30 Supplies Expense Supplies Supplies used ($16,200 – $2,775).

13,425

30 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

11,000

30 Unearned Fees Fees Earned Fees earned.

16,500

30 Wages Expense Wages Payable Accrued wages.

3,880

7,380

13,425

11,000

16,500

3,880

2. Revenues…………………………… $294,750 Expenses…………………………… 226,350 ($94,500 + $72,000 + $51,750 + $8,100) Net income……………………………$ 68,400 3. Revenues…………………………… $318,630 ($294,750 + $7,380 + $16,500) Expenses…………………………… 254,655 ($226,350 + $13,425 + $11,000 + $3,880) Net income……………………………$ 63,975 4. The effect of the adjusting entries on Nancy Townes, Capital is the difference in net income in (2) and (3) of $4,425 ($68,400 – $63,975). The adjusting entries reduced net income by $4,425.

CHAPTER 3

The Adjusting Process

Prob. 3-4A 20Y5 Nov.

30 Supplies Expense Supplies Supplies used ($11,250 – $2,400).

8,850

30 Insurance Expense Prepaid Insurance Insurance expired ($14,250 – $3,850).

10,400

30 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation ($106,100 – $94,500).

11,600

30 Depreciation Expense—Automobiles Accumulated Depreciation—Automobiles Automobile depreciation ($62,050 – $54,750).

7,300

30 Utilities Expense Accounts Payable Accrued utilities expense ($26,130 – $24,930, or $14,100 – $12,900).

1,200

30 Salary Expense Salaries Payable Accrued salaries ($525,000 – $516,900).

8,100

30 Unearned Service Fees Service Fees Earned Service fees earned ($18,000 – $9,000, or $742,800 – $733,800).

9,000

8,850

10,400

11,600

7,300

1,200

8,100

9,000

CHAPTER 3

The Adjusting Process

Prob. 3-5A 1. 20Y6 Oct.

31 Insurance Expense Prepaid Insurance Insurance expired ($6,550 – $550).

6,000

31 Supplies Expense Supplies Supplies used ($1,800 – $610).

1,190

31 Depreciation Expense—Building Accumulated Depreciation—Building Building depreciation.

10,920

31 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation.

7,830

31 Unearned Rent Rent Revenue Rent revenue earned ($6,140 – $2,050).

4,090

31 Salaries and Wages Expense Salaries and Wages Payable Accrued salaries and wages.

2,550

31 Accounts Receivable Fees Earned Accrued fees earned.

9,140

6,000

1,190

10,920

7,830

4,090

2,550

9,140

CHAPTER 3

The Adjusting Process

Prob. 3-5A (Concluded) 2. Emerson Company Adjusted Trial Balance October 31, 20Y6 Debit Balances

Cash Accounts Receivable Prepaid Insurance Supplies Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment Accounts Payable Unearned Rent Salaries and Wages Payable Suzanne Emerson, Capital Suzanne Emerson, Drawing Fees Earned Rent Revenue Salaries and Wages Expense Utilities Expense Advertising Expense Repairs Expense Depreciation Expense—Building Depreciation Expense—Equipment Insurance Expense Supplies Expense Miscellaneous Expense

Credit Balances

6,820 44,080 550 610 102,400 273,200 90,580 123,110 96,960 11,060 2,050 2,550 338,000 14,000 304,460 4,090 178,500 38,560 20,750 15,700 10,920 7,830 6,000 1,190 5,530 849,750

849,750

CHAPTER 3

The Adjusting Process

Prob. 3-6A 2,750

1. Apr. 30 Supplies Expense Supplies Supplies used.

2,750

30 Accounts Receivable Fees Earned Accrued fees earned.

23,700

30 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

1,800

30 Wages Expense Wages Payable Accrued wages.

1,400

23,700

1,800

1,400

Reported amounts Corrections: Supplies used Unbilled fees earned Equipment depreciation Accrued wages Corrected amounts

Total Liabilities

Total Owner's Equity

Net Income

Total Assets

$120,000

$750,000

$300,000

$450,000

–2,750 +23,700 –1,800 –1,400 $137,750

–2,750 +23,700 –1,800 0 $769,150

0 0 0 +1,400 $301,400

–2,750 +23,700 –1,800 –1,400 $467,750

CHAPTER 3

The Adjusting Process

Prob. 3-1B 1. May

31 Accounts Receivable Fees Earned Accrued fees earned.

19,750

31 Supplies Expense Supplies Supplies used ($12,300 – $4,150).

8,150

31 Wages Expense Wages Payable Accrued wages.

2,700

31 Unearned Rent Rent Revenue Rent earned ($9,000 ÷ 3 months).

3,000

31 Depreciation Expense Accumulated Depreciation—Equipment Depreciation expense.

3,200

19,750

8,150

2,700

3,000

3,200

2. Adjusting entries are a planned part of the accounting process to update the accounts. Correcting entries are not planned but arise only when necessary to correct errors.

CHAPTER 3

The Adjusting Process

Prob. 3-2B 1. Nov.

30 Supplies Expense Supplies Supplies used ($3,170 – $550).

2,620

30 Depreciation Expense Accumulated Depreciation—Equipment Depreciation for year.

1,675

30 Rent Expense Prepaid Rent Rent expired.

8,500

30 Wages Expense Wages Payable Accrued wages.

2,000

30 Unearned Fees Fees Earned Fees earned ($10,000 – $4,000).

6,000

30 Accounts Receivable Fees Earned Accrued fees.

5,380

2,620

1,675

8,500

2,000

6,000

5,380

2. Fees Earned would be understated by $6,000, Depreciation Expense would be understated by $1,675, and net income would be understated by $4,325 ($6,000 – $1,675). 3. Accumulated Depreciation—Equipment would be understated by $1,675, total assets would be overstated by $1,675, Unearned Fees would be overstated by $6,000, total liabilities would be overstated by $6,000, owner’s equity (Owner’s Capital) would be understated by $4,325 ($6,000 – $1,675), and total liabilities and owner’s equity would be overstated by $1,675 ($6,000 – $4,325). 4. There is no effect on “Net increase or decrease in cash” on the statement of of cash flows because adjusting entries do not affect cash.

CHAPTER 3

The Adjusting Process

Prob. 3-3B 1.

20Y4 Apr.

30 Supplies Expense Supplies Supplies used ($7,200 – $1,380).

5,820

30 Accounts Receivable Fees Earned Accrued fees earned.

3,900

30 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

3,000

30 Wages Expense Wages Payable Accrued wages.

2,475

30 Unearned Fees Fees Earned Fees earned.

14,140

5,820

3,900

3,000

2,475

14,140

2. Revenues…………………………… $305,800 261,800 ($157,800 + $55,000 + $42,000 + $7,000) Expenses…………………………… Net income…………………………… $ 44,000 3. Revenues…………………………… $323,840 ($305,800 + $3,900 + $14,140) 273,095 ($261,800 + $5,820 + $3,000 + $2,475) Expenses…………………………… Net income…………………………… $ 50,745 4. The effect of the adjusting entries on John Bridger, Capital is the difference in net income in (3) and (2) of $6,745 ($50,745 – $44,000), which would increase John Bridger, Capital.

CHAPTER 3

The Adjusting Process

Prob. 3-4B 20Y5 Mar.

31 Supplies Expense Supplies Supplies used ($6,200 – $2,175).

4,025

31 Insurance Expense Prepaid Insurance Insurance expired ($9,000 – $1,150).

7,850

31 Depreciation Expense—Buildings Accumulated Depreciation—Buildings Depreciation ($61,000 – $51,500).

9,500

31 Depreciation Expense—Trucks Accumulated Depreciation—Trucks Depreciation ($17,000 – $12,000).

5,000

31 Utilities Expense Accounts Payable Accrued utilities expense ($8,750 – $6,920, or $8,030 – $6,200).

1,830

31 Salary Expense Salaries Payable Accrued salaries ($81,400 – $80,000).

1,400

31 Unearned Service Fees Service Fees Earned Service fees earned ($10,500 – $3,850, or $169,330 – $162,680).

6,650

4,025

7,850

9,500

5,000

1,830

1,400

6,650

CHAPTER 3

The Adjusting Process

Prob. 3-5B 1. 20Y6 July

31 Depreciation Expense—Building Accumulated Depreciation—Building Building depreciation.

6,400

31 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation.

2,800

31 Salaries and Wages Expense Salaries and Wages Payable Accrued salaries and wages.

6,400

2,800

900 900

31 Insurance Expense Prepaid Insurance Insurance expired ($6,000 – $1,500).

4,500

31 Accounts Receivable Fees Earned Accrued fees earned.

10,200

31 Supplies Expense Supplies Supplies used ($1,725 – $615).

1,110

31 Unearned Rent Rent Revenue Rent revenue earned ($3,600 – $300).

3,300

4,500

10,200

1,110

3,300

CHAPTER 3

The Adjusting Process

Prob. 3-5B (Concluded) 2. Reece Financial Services Co. Adjusted Trial Balance July 31, 20Y6 Debit Balances

Cash Accounts Receivable Prepaid Insurance Supplies Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment Accounts Payable Unearned Rent Salaries and Wages Payable Joni Reece, Capital Joni Reece, Drawing Fees Earned Rent Revenue Salaries and Wages Expense Utilities Expense Advertising Expense Depreciation Expense—Building Repairs Expense Insurance Expense Depreciation Expense—Equipment Supplies Expense Miscellaneous Expense

Credit Balances

10,200 44,950 1,500 615 50,000 155,750 69,250 45,000 20,450 3,750 300 900 153,550 8,000 168,800 3,300 57,750 14,100 7,500 6,400 6,100 4,500 2,800 1,110 4,025 420,300

420,300

CHAPTER 3

The Adjusting Process

Prob. 3-6B 1. Aug.

31 Accounts Receivable Fees Earned Accrued fees earned.

31,900

31 Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

7,500

31 Wages Expense Wages Payable Accrued wages.

5,200

31 Supplies Expense Supplies Supplies used.

3,000

31,900

7,500

5,200

3,000

Reported amounts Corrections: Unbilled fees earned Equipment depreciation Accrued wages Supplies used Corrected amounts

Total Liabilities

Total Owner’s Equity

Net Income

Total Assets

$112,500

$650,000

$225,000

$425,000

+31,900 –7,500 –5,200 –3,000 $128,700

+31,900 –7,500 0 –3,000 $671,400

0 0 +5,200 0 $230,200

+31,900 –7,500 –5,200 –3,000 $441,200

CHAPTER 3

The Adjusting Process

CONTINUING PROBLEM 1. JOURNAL Date

20Y9 July

Post. Ref.

Description

Page

Debit

Credit

Adjusting Entries

31 Accounts Receivable Fees Earned Accrued fees earned (115 hrs. – 80 hrs.) × $40 = $1,400.

12 41

1,400

31 Supplies Expense Supplies Supplies used ($1,020 – $275).

56 14

745

31 Insurance Expense Prepaid Insurance Insurance expired ($2,700 ÷ 12 months) = $225 per month.

57 15

225

31 Depreciation Expense Accum. Depr.—Office Equipment Office equipment depreciation.

58 18

31 Unearned Revenue Fees Earned Fees earned ($7,200 ÷ 2 months).

23 41

3,600

31 Wages Expense Wages Payable Accrued wages.

50 22

140

1,400

745

225

3,600

140

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) 2. Account:

Cash

Date

20Y9 July

Date

20Y9 July

Item

Post. Ref.

1 Balance 1 1 1 2 3 3 4 8 11 13 14 16 21 22 23 27 28 29 30 31 31 31

Account:

Account No.

 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2

Debit

Credit

5,000 1,750 2,700 1,000 7,200 250 900 200 1,000 700 1,200 2,000 620 800 750 915 1,200 540 500 3,000 1,400 1,250

Accounts Receivable Item

1 Balance 2 23 30 31 Adjusting

Balance Debit Credit

3,920 8,920 7,170 4,470 5,470 12,670 12,420 11,520 11,320 12,320 11,620 10,420 12,420 11,800 11,000 11,750 10,835 9,635 9,095 9,595 12,595 11,195 9,945 12

Account No.

Post. Ref.

 1 2 2 3

Debit

Credit

1,000 1,750 1,000 1,400

Debit

Balance Credit

1,000 — 1,750 2,750 4,150

—

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) Supplies

Account:

Item

Date

20Y9 July

1 Balance 18 31 Adjusting

Date

20Y9 July

Item

1 31 Adjusting

Item

Date

Account:

Item

1 Balance 3 5 18

Account:

Date

20Y9 July

850 745

Post. Ref.

1 3

Debit

Credit

2,700 225

Post. Ref.

Debit

Credit

7,500

Debit

Balance Credit

2,700 2,475 17

Post. Ref.

Debit

Balance Credit

7,500 18

Account No.

Credit

Balance Debit Credit

50 21

Account No.

Post. Ref.

Debit

Credit

250

Debit

Balance Credit

— 7,500 850

Wages Payable

31 Adjusting

170 1,020 275

Account No.

 1 1 2

Item

Balance Debit Credit

Account No.

Accounts Payable

Date

20Y9 July

Credit

Accumulated Depreciation—Office Equipment

31 Adjusting

Account:

 2 3

Date

20Y9 July

Debit

Office Equipment

Account:

20Y9 July

Post. Ref.

Prepaid Insurance

Account:

Account No.

250 — 7,500 8,350

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

140

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) Account:

Unearned Revenue Item

Date

20Y9 July

Account:

20Y9 July

Account:

Date

20Y9 July

1 3

Debit

Credit

Item

1 Balance 1

Post. Ref.

 2

Debit

Credit

1 Balance 11 16 23 30 31 31 Adjusting 31 Adjusting

Balance Debit Credit

4,000 9,000

5,000

Account No.

Debit

Credit

Balance Debit Credit

500 1,750

1,250

Fees Earned Item

Account No.

Peyton Smith, Drawing

1 Balance 31

7,200 3,600

3,600

 1

Item

Balance Debit Credit

7,200

Peyton Smith, Capital

Date

20Y9 July

Post. Ref.

3 31 Adjusting

Date

Account No.

Post. Ref.

Debit

 1 2 2 2 2 3 3

Credit

1,000 2,000 2,500 1,500 3,000 1,400 3,600

Balance Debit Credit

6,200 7,200 9,200 11,700 13,200 16,200 17,600 21,200

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) Account:

Wages Expense Item

Date

20Y9 July

Account:

Post. Ref.

1 Balance 14 28 31 Adjusting

 1 2 3

Item

1 Balance 1

Post. Ref.

 1

Equipment Rent Expense

Date

Post. Ref.

Account:

Item

1 Balance 13

Account:

1,200 1,200 140

Debit

Credit

1 Balance 27

Credit

Debit

Credit

Debit

Balance Credit

Account No.

Post. Ref.

 2 2

Debit

620 1,400

300 1,215

915

Music Expense

1 Balance 21 31

Balance Debit Credit

Account No.

Post. Ref.

675 1,375

700

 2

Item

Balance Debit Credit

Account No.

Debit

800 2,550

1,750

 1

Item

Date

20Y9 July

400 1,600 2,800 2,940

Utilities Expense

Date

20Y9 July

Credit

Balance Debit Credit

Account No.

Account:

20Y9 July

Debit

Office Rent Expense

Date

20Y9 July

Account No.

Credit

Balance Debit Credit

1,590 2,210 3,610

CHAPTER 3

The Adjusting Process

Continuing Problem (Continued) Account:

Advertising Expense Item

Date

20Y9 July

Account:

1 Balance 8 22

Account:

1 Balance 31 Adjusting

Account:

Item

Post. Ref.

500 700 1,500

200 800

Debit

 3

Credit

Debit

31 Adjusting

Credit

225

Debit

1 Balance 4 29

Post. Ref.

Credit

Balance Debit Credit

Debit

 1 2

900 540

Balance Credit

50 Account No.

Debit

225

Miscellaneous Expense Item

Balance Credit

Account No.

Post. Ref.

180 925

745

Depreciation Expense Item

Debit

Account No.

Post. Ref.

Balance Debit Credit

Account No.

31 Adjusting

Date

20Y9 July

Credit

Insurance Expense

Date

20Y9 July

Debit

 1 2

Item

Date

20Y9 July

Post. Ref.

Supplies Expense

Date

20Y9 July

Account No.

Credit

Balance Debit Credit

415 1,315 1,855

CHAPTER 3

The Adjusting Process

Continuing Problem (Concluded) 3.

PS Music Adjusted Trial Balance July 31, 20Y9 Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accumulated Depreciation—Office Equipment Accounts Payable Wages Payable Unearned Revenue Peyton Smith, Capital Peyton Smith, Drawing Fees Earned Wages Expense Office Rent Expense Equipment Rent Expense Utilities Expense Music Expense Advertising Expense Supplies Expense Insurance Expense Depreciation Expense Miscellaneous Expense

11 12 14 15 17 18 21 22 23 31 32 41 50 51 52 53 54 55 56 57 58 59

Debit Balances

Credit Balances

9,945 4,150 275 2,475 7,500 50 8,350 140 3,600 9,000 1,750 21,200 2,940 2,550 1,375 1,215 3,610 1,500 925 225 50 1,855 42,340

42,340

CHAPTER 3

The Adjusting Process

CASES & PROJECTS CP 3-1 1. No. The accrual basis of accounting requires that revenues be reported in the period in which they are earned. When revenue is reported before it is earned, the revenues do not accurately reflect the revenues for the period. By knowingly recording an adjusting entry for more than the amount of revenue that was earned during the period, Chris is demonstrating a failure of individual character and is acting unethically. 2. The users of the financial information who rely upon this information will be affected, as the information will not be a faithful representation of the entity’s economic activity. CP 3-2 It is acceptable for Daryl to prepare the financial statements for Squid Realty Co. on an accrual basis. The revision of the financial statements to include the accrual of the $30,000 commission as of December 28, 20Y7, would not be appropriate. Most real estate contracts include contingencies that can void the contract. Such contingencies include obtaining a loan, appraisals, environmental studies, and inspection results. In other words, Daryl can only be sure of earning the commission on January 5, 20Y8, when the attorney formally records the transfer of the property to the buyer, and Daryl may disclose the pending sale and related commission in a note to the financial statements. Indicating on the loan application to Free Spirit Bank that Squid Realty Co. has not been rejected previously for credit is unethical and unprofessional, and intentionally filing false loan documents is illegal. CP 3-3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1. Athletic footwear, apparel, and equipment 2. 3 3. $1,933 million in 2018; $4,240 million in 2017; $3,760 million in 2016 4. $36,397 million in 2018; $34,350 million in 2017; $32,376 million in 2016 5. Nike recognizes revenue when title passes and the risks and rewards of ownership have passed to the customer, based on the terms of sale. Title passes generally upon shipment or upon receipt by the customer, depending on the country of the sale and the agreement with the customer. Retail store revenues are recorded at the time of sale, and digital commerce revenues are are recorded upon delivery to the customer. 6. The company’s net income has decreased from $3,760 million in 2016 and $4,240 million in 2017 to $1,933 million in 2018. This is a significant decrease, resulting from a substantial increase in income tax expense in 2018 as a result of a revision of the U.S. tax law in December 2017.

CHAPTER 3

The Adjusting Process

CP 3-4 To: My Instructor From: Ima Student Re: Revenue Recognition of Ticket Sales at Delta Air Lines Customers of Delta Air Lines typically purchase tickets for air travel several weeks prior to their scheduled flight and pay for their tickets using a credit card such as VISA or American Express. While the credit card company will remit payment to Delta shortly after the ticket is purchased, Delta will not record revenue from the ticket until after the air travel has taken place. This is because Delta does not earn the ticket revenue until it provides the required service. When Delta receives payment from the credit card company for an airplane ticket, Delta records a liability, called Unearned Revenue. After a customer uses the ticket for a flight, Delta records an adjusting entry to remove the liability and records revenue to reflect the fact that Delta has provided the service.

CP 3-5 a.

There are several indications that adjusting entries were not recorded before the financial statements were prepared, including: 1. All expenses on the income statement are identified as “paid” items and not as “expenses.” 2. No expense is reported on the income statement for depreciation, and no accumulated depreciation is reported on the balance sheet. 3. No supplies, accounts payable, or wages payable are reported on the balance sheet.

Likely accounts requiring adjustment include: 1. 2. 3. 4. 5.

Accumulated Depreciation—Truck for depreciation expense. Supplies (paid) Expense for supplies on hand. Insurance (paid) Expense for unexpired insurance. Wages (paid) Expense for accrued wages. Utilities (paid) Expense for accrued utilities.

CHAPTER 4 COMPLETING THE ACCOUNTING CYCLE DISCUSSION QUESTIONS 1.

The end-of-period spreadsheet illustrates the flow of accounting information from the unadjusted trial balance into the adjusted trial balance and into the financial statements. In doing so, the spreadsheet illustrates the impact of the adjustments on the financial statements.

Current assets are composed of cash and other assets that may reasonably be expected to be realized in cash or sold or used up usually within one year or less, through the normal operations of the business.

Property, plant, and equipment is composed of assets that are used in the business and that are of a permanent or relatively fixed nature. The Property, Plant, and Equipment section may also be described as fixed assets or plant assets. These assets include equipment, machinery, buildings, and land.

Current liabilities are liabilities that will be due within a short time (usually one year or less) and that are to be paid out of current assets. Liabilities that will not be due for a comparatively long time (usually more than one year) are called long-term liabilities.

Revenue, expense, and drawing accounts are generally referred to as temporary accounts.

Cash, Office Equipment

Closing entries are necessary at the end of an accounting period (1) to transfer the balances in temporary accounts to permanent accounts and (2) to prepare the temporary accounts for use in recording transactions for the next accounting period.

Adjusting entries bring the accounts up to date, while closing entries reduce the revenue, expense, and drawing accounts to zero balances for use in recording transactions for the next accounting period.

a. b. c.

The purpose of the post-closing trial balance is to make sure that the ledger is in balance at the beginning of the next period.

10.

The financial statements are the most important output of the accounting cycle.

Yes. All companies have an accounting cycle that begins with analyzing and journalizing transactions and ends with a post-closing trial balance. However, companies may differ in how they implement the steps in the accounting cycle. For example, while most companies use computerized accounting systems, some companies may use manual systems.

After preparing the adjusted trial balance After preparing the financial statements Before preparing the post-closing trial balance

CHAPTER 4

Completing the Accounting Cycle

PRACTICE EXERCISES PE 4-1A 1. Balance sheet 2. Income statement 3. Statement of owner’s equity 4. Balance sheet

5. 6. 7. 8.

Income statement Income statement Balance sheet Balance sheet

PE 4-1B 1. Balance sheet 2. Balance sheet 3. Income statement 4. Income statement

5. 6. 7. 8.

Balance sheet Balance sheet Statement of owner’s equity Income statement

PE 4-2A Aquarius Advertising Services Statement of Owner’s Equity For the Year Ended December 31, 20Y3 Cyrus Bautista, capital, January 1, 20Y3 Additional investment during 20Y3 Net income Withdrawals Increase in owner’s equity Cyrus Bautista, capital, December 31, 20Y3

$471,900 $ 72,000 103,000 (17,000) 158,000 $629,900

PE 4-2B Road Runner Delivery Services Statement of Owner’s Equity For the Year Ended December 31, 20Y3 Ava Marie Rowland, capital, January 1, 20Y3 Net loss Withdrawals Decrease in owner’s equity Ava Marie Rowland, capital, December 31, 20Y3

$781,000 $(34,500) (19,000) (53,500) $727,500

CHAPTER 4

Completing the Accounting Cycle

PE 4-3A 1. Property, plant, and equipment (b) 2. Owner’s equity (e) 3. Long-term liability (d) 4. Current asset (a)

5. 6. 7. 8.

Current liability (c) Current asset (a) Current liability (c) Current liability (c)

PE 4-3B 1. Current liability (c) 2. Current asset (a) 3. Property, plant, and equipment (b) 4. Current asset (a)

5. 6. 7. 8.

Owner’s equity (e) Long-term liability (d) Current asset (a) Current liability (c)

PE 4-4A

Dec.

Closing Entries 31 Fees Earned Wages Expense Rent Expense Supplies Expense Miscellaneous Expense Ellie Liu, Capital 31 Ellie Liu, Capital Ellie Liu, Drawing

1,644,500 1,239,200 109,400 26,800 19,300 249,800 70,000 70,000

CHAPTER 4

Completing the Accounting Cycle

PE 4-4B Apr.

Closing Entries 30 Oscar Killingsworth, Capital Fees Earned Wages Expense Rent Expense Supplies Expense Miscellaneous Expense 30 Oscar Killingsworth, Capital Oscar Killingsworth, Drawing

5,500 279,100 221,600 43,800 9,000 10,200 8,200 8,200

PE 4-5A The following two steps are missing: (1) posting the transactions to the ledger and (2) preparing the financial statements. Transactions should be posted to the ledger after step (a). The financial statements should be prepared after step (f).

PE 4-5B The following two steps are missing: (1) assembling and analyzing adjustment data and (2) journalizing and posting the closing entries. The adjustment data should be assembled and analyzed after step (c). The closing entries should be journalized and posted to the ledger after step (g).

PE 4-6A a. Current assets…………… Current liabilitites……… Working capital…………

20Y9

20Y8

$2,042,400 1,380,000 $ 662,400

$1,759,500 1,150,000 $ 609,500

Current ratio……………… 1.48 ($2,042,400 ÷ $1,380,000)

1.53 ($1,759,500 ÷ $1,150,000)

b. The decrease from 1.53 to 1.48 indicates an unfavorable change.

CHAPTER 4

PE 4-6B a. Current assets……………… Current liabilitites………… Working capital…………… Current ratio…………………

Completing the Accounting Cycle

20Y9 $2,133,800 940,000 $1,193,800

20Y8 $1,613,300 730,000 $ 883,300

2.27 ($2,133,800 ÷ $940,000)

2.21 ($1,613,300 ÷ $730,000)

The increase from 2.21 to 2.27 indicates a favorable change.

CHAPTER 4

Completing the Accounting Cycle

EXERCISES Ex. 4-1 1. 2. 3.

Income statement: 5, 8, 9 Statement of owner’s equity: 4 Balance sheet: 1, 2, 3, 6, 7, 10

Ex. 4-2 a. b. c. d.

Asset: 1, 2, 5, 6, 10 Liability: 9, 11, 12 Revenue: 3, 7 Expense: 4, 8

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-3 Bamboo Consulting Income Statement For the Year Ended July 31, 20Y5 Fees earned Expenses: Salary expense Supplies expense Depreciation expense Miscellaneous expense Total expenses Net income

$348,500 $189,000 7,500 5,600 11,100 213,200 $135,300

Bamboo Consulting Statement of Owner’s Equity For the Year Ended July 31, 20Y5 Lisa Gooch, capital, August 1, 20Y4 Net income Withdrawals Increase in owner’s equity Lisa Gooch, capital, July 31, 20Y5

$516,700 $135,300 (25,000) 110,300 $627,000

Bamboo Consulting Balance Sheet July 31, 20Y5 Assets Current assets: Cash Accounts receivable Supplies Total current assets Property, plant, and equipment: Office equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Total liabilities Owner’s Equity Lisa Gooch, capital Total liabilities and owner’s equity

$ 58,000 106,200 4,400 $168,600 $515,000 33,600 481,400 $650,000

$ 20,500 2,500 $ 23,000 627,000 $650,000

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-4 Elliptical Consulting Income Statement For the Year Ended June 30, 20Y6 Fees earned Expenses: Salary expense Supplies expense Depreciation expense Miscellaneous expense Total expenses Net income

$60,000 $32,375 2,100 1,500 2,000 37,975 $22,025

Elliptical Consulting Statement of Owner’s Equity For the Year Ended June 30, 20Y6 Jayson Neese, capital, July 1, 20Y5 Net income Withdrawals Increase in owner’s equity Jayson Neese, capital, June 30, 20Y6

$ 82,200 $22,025 (2,000) 20,025 $102,225

Elliptical Consulting Balance Sheet June 30, 20Y6 Assets Current assets: Cash Accounts receivable Supplies Total current assets Property, plant, and equipment: Office equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Total liabilities Owner’s Equity Jayson Neese, capital Total liabilities and owner’s equity

$27,000 53,500 900 $ 81,400 $30,500 6,000 24,500 $105,900

$ 3,300 375 $

3,675

102,225 $105,900

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-5 Capstone Messenger Service Income Statement For the Year Ended April 30, 20Y7 Fees earned Expenses: Salaries expense Rent expense Utilities expense Depreciation expense Supplies expense Insurance expense Miscellaneous expense Total expenses Net income

$522,000 $260,900 46,500 31,900 6,700 3,200 1,200 2,800 353,200 $168,800

Ex. 4-6 Guardian Health Services Co. Income Statement For the Year Ended February 28, 20Y0 Service revenue Expenses: Wages expense Rent expense Utilities expense Depreciation expense Insurance expense Supplies expense Miscellaneous expense Total expenses Net loss

$407,900 $327,500 49,100 30,800 6,800 2,700 2,500 7,400 426,800 $ (18,900)

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-7 FedEx Corporation Income Statement For the Year Ended May 31 (in millions) Revenues Expenses: Salaries and employee benefits Purchased transportation Rentals and landing fees Depreciation expense Fuel expense Maintenance and repairs expense Provision for income taxes Other expense Total expenses Net income

$65,450 $23,207 15,101 3,361 3,095 3,374 2,622 (219) 10,337 60,878 $ 4,572

Ex. 4-8 Serenity Systems Co. Statement of Owner’s Equity For the Year Ended December 31, 20Y1 Farhan Wasti, capital, January 1, 20Y1 Net income $385,000 Withdrawals (98,000) Increase in owner’s equity Farhan Wasti, capital, December 31, 20Y1

$1,502,000

287,000 $1,789,000

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-9 Masterpiece Arts Statement of Owner’s Equity For the Year Ended April 30, 20Y2 Angelo Phelps, capital, May 1, 20Y1 Net loss Withdrawals Decrease in owner’s equity Angelo Phelps, capital, April 30, 20Y2

$537,100 $(35,200) (9,200) (44,400) $492,700

Ex. 4-10 a. b.

Current asset: 1, 3, 5, 6 Property, plant, and equipment: 2, 4

Ex. 4-11 Because current liabilities are usually due within one year, $15,000 ($1,250 × 12 months) would be reported as a current liability on the balance sheet. The remainder of $360,000 ($375,000 – $15,000) would be reported as a long-term liability on the balance sheet.

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-12 MaxFit Weight Loss Co. Balance Sheet November 30, 20Y4 Assets Current assets: Cash* Accounts receivable Supplies Prepaid insurance Prepaid rent Total current assets Property, plant, and equipment: Land Equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned fees Total liabilities Owner’s Equity Vanessa Freeman, capital Total liabilities and owner’s equity

$ 44,700 138,600 5,700 8,500 24,900 $222,400 $356,200 $563,000 221,300

341,700 697,900 $920,300

$ 44,800 10,700 21,400 $ 76,900 843,400 $920,300

* $44,700 = $920,300 – $697,900 – $24,900 – $8,500 – $5,700 – $138,600

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-13 1.

The date of the statement should be “August 31, 20Y3” and not “For the Year Ended August 31, 20Y3.”

Accounts payable should be a current liability.

Land should be classified as property, plant, and equipment.

“Accumulated depreciation” should be deducted from the related fixed asset.

An adding error was made in determining the amount of the total property, plant, and equipment.

Accounts receivable should be a current asset.

Net income should be reported on the income statement and statement of owner’s equity.

Wages payable should be a current liability.

A corrected balance sheet would be as follows:

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-13 (Concluded) Labyrinth Services Co. Balance Sheet August 31, 20Y3 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Land Building Less accumulated depreciation Equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Owner’s Equity Ruben Daniel, capital Total liabilities and owner’s equity

$ 18,500 41,400 6,500 16,600 $ 83,000 $225,000 $400,000 155,000 $ 97,000 25,000

245,000 72,000 542,000 $625,000

$ 31,300 6,500 $ 37,800 587,200 $625,000

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-14 d.

Depreciation Expense

Fees Earned

Jackie Lindsay, Drawing

Supplies Expense

Wages Expense

Ex. 4-15 $1,447,000 ($8,315,000 – $6,460,000 – $408,000) Ex. 4-16 a.

Teresa Schafer, Capital Teresa Schafer, Drawing

770,000 770,000

$1,955,000 ($1,885,000 + $3,190,000 – $2,350,000 – $770,000)

Ex. 4-17 Closing Entries July

31 Fees Earned Wages Expense Rent Expense Supplies Expense Miscellaneous Expense Violet Lozano, Capital

545,000

31 Violet Lozano, Capital Violet Lozano, Drawing

66,000

342,400 52,900 17,200 5,400 127,100

66,000

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-18 a. b. e. g. h. i. j.

Accounts Receivable Cash Doug Woods, Capital Equipment Land Salaries Payable Unearned Rent

Ex. 4-19 La Casa Services Co. Post-Closing Trial Balance March 31, 20Y6 Debit Balances

Cash Accounts Receivable Supplies Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Rent Sonya Flynn, Capital

Credit Balances

46,540 122,260 4,000 127,200

300,000

33,600 52,100 6,400 9,000 198,900 300,000

Ex. 4-20 a. c. b. d. g. f. e. i. j. h.

Transactions are analyzed and recorded in the journal (Step 1). Transactions are posted to the ledger (Step 2). An unadjusted trial balance is prepared (Step 3). Adjustment data are assembled and analyzed (Step 4). An optional end-of-period spreadsheet is prepared (Step 5). Adjusting entries are journalized and posted to the ledger (Step 6). An adjusted trial balance is prepared (Step 7). Financial statements are prepared (Step 8). Closing entries are journalized and posted to the ledger (Step 9). A post-closing trial balance is prepared (Step 10).

CHAPTER 4

Completing the Accounting Cycle

Ex. 4-21 December 31

Year 2

Year 1

Current assets…………… Current liabilitites………… Working capital……………

$2,593,628 1,315,977 $1,277,651

$2,337,679 1,060,375 $1,277,304

Current ratio………………

1.97 ($2,593,628 ÷ $1,315,977)

2.20 ($2,337,679 ÷ $1,060,375)

Under Armour’s working capital increased by $347 ($1,277,651 – $1,277,304) in Year 2. The current ratio decreased to 1.97 in Year 2. A current ratio of 1.97 still indicates a strong liquidity position. Thus, short-term creditors should not be concerned about receiving payment from Under Armour.

Ex. 4-22 a.

Year 2

Year 1

Current assets…………… Current liabilitites………… Working capital……………

$12,494,200 5,684,200 $ 6,810,000

$5,283,400 4,220,700 $1,062,700

Current ratio………………

2.20 ($12,494,200 ÷ $5,684,200)

1.25 ($5,283,400 ÷ $4,220,700)

Starbucks’ working capital increased from Year 1 to Year 2 by $5,747,300 ($6,810,000 – $1,062,700). Starbucks’ current ratio also increased from 1.25 in Year 1 to 2.20 in Year 2. The significant increase in working capital and increase in current ratio indicate Starbucks is in a strong liquidity position.

Appendix 1 Ex. 4-23 1. 2. 3. 4. 5.

i a g d c

6. 7. 8. 9. 10.

f j e h b

4-18

110 12 0 6 0 0 2 500

12 90 8 12 190 50

Debit

500

200

4 36 0 260

Credit

Unadjusted Trial Balance

10 4 3

(e)

(a)

(e)

(a)

4 10

(d)

(b) (c)

Adjustments Debit Credit

Alert Security Services Co. End-of-Period Spreadsheet (Work Sheet) For the Year Ended October 31, 20Y5

Completing the Accounting Cycle

111 12 10 6 4 3 2 517

12 103 4 2 190 50

Debit

517

213

7 36 1 260

Credit

Adjusted Trial Balance

Cash Accounts Receivable Supplies Prepaid Insurance Land Equipment Accumulated Depreciation Accounts Payable Wages Payable Brenda Schultz, Capital Brenda Schultz, Drawing Fees Earned Wages Expense Rent Expense Insurance Expense Utilities Expense Supplies Expense Depreciation Expense Miscellaneous Expense Totals

Account Title

Appendix 1 Ex. 4-24

CHAPTER 4

4-19

111 12 10 6 4 3 2 517

12 103 4 2 190 50

Debit

517

213

7 36 1 260

Credit

Adjusted Trial Balance

111 12 10 6 4 3 2 148 65 213

369 369

213

12 103 4 2 190 50

Debit

304 65 369

7 36 1 260

Credit

Balance Sheet

213

Income Statement Debit Credit

Alert Security Services Co. End-of-Period Spreadsheet (Work Sheet) For the Year Ended October 31, 20Y7

Completing the Accounting Cycle

Account Title

Appendix 1 Ex. 4-25

CHAPTER 4

Completing the Accounting Cycle

Appendix 1 Ex. 4-26 Alert Security Services Co. Income Statement For the Year Ended October 31, 20Y7 Fees earned Expenses: Wages expense Rent expense Insurance expense Utilities expense Supplies expense Depreciation expense Miscellaneous expense Total expenses Net income

$213 $111 12 10 6 4 3 2 148 $ 65

Alert Security Services Co. Statement of Owner’s Equity For the Year Ended October 31, 20Y7 Brenda Schultz, capital, November 1, 20Y6 Net income Withdrawals Increase in owner’s equity Brenda Schultz, capital, October 31, 20Y7

$260 $65 (8) 57 $317

CHAPTER 4

Completing the Accounting Cycle

Appendix 1 Ex. 4-26 (Concluded) Alert Security Services Co. Balance Sheet October 31, 20Y7 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Land Equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Owner’s Equity Brenda Schultz, capital Total liabilities and owner’s equity

$ 12 103 4 2 $121 $190 $50 7

43 233 $354

$ 36 1 $ 37 317 $354

CHAPTER 4

Completing the Accounting Cycle

Appendix 1 Ex. 4-27 20Y5 Oct.

Adjusting Entries 31 Accounts Receivable Fees Earned Accrued fees.

13 13

31 Supplies Expense Supplies Supplies used ($8 – $4).

31 Insurance Expense Prepaid Insurance Insurance expired.

31 Depreciation Expense Accumulated Depreciation Equipment depreciation.

31 Wages Expense Wages Payable Accrued wages.

Appendix 1 Ex. 4-28 20Y7 Oct.

Closing Entries 31 Fees Earned Wages Expense Rent Expense Insurance Expense Utilities Expense Supplies Expense Depreciation Expense Miscellaneous Expense Brenda Schultz, Capital

213

31 Brenda Schultz, Capital Brenda Schultz, Drawing

111 12 10 6 4 3 2 65

CHAPTER 4

Completing the Accounting Cycle

PROBLEMS Prob. 4-1A 1.

Outreach Signals Company Income Statement For the Year Ended December 31, 20Y1 Revenues: Fees earned Rent revenue Total revenues Expenses: Salaries and wages expense Advertising expense Utilities expense Depreciation expense—building Repairs expense Depreciation expense—equipment Insurance expense Supplies expense Miscellaneous expense Total expenses Net income

$631,700 2,000 $633,700 $264,520 34,200 17,900 14,200 13,930 7,100 4,700 3,540 6,850

Outreach Signals Company Statement of Owner’s Equity For the Year Ended December 31, 20Y1 Inez Villanueva, capital, January 1, 20Y1 Net income for the year $266,760 Withdrawals (16,000) Increase in owner’s equity Inez Villanueva, capital, December 31, 20Y1

366,940 $266,760

$375,000

250,760 $625,760

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-1A (Continued) 3. Outreach Signals Company Balance Sheet December 31, 20Y1 Assets Current assets: Cash Accounts receivable Prepaid insurance Supplies Total current assets Property, plant, and equipment: Land Building Less accumulated depreciation Equipment Less accumulated decpreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries and wages payable Unearned rent Total liabilities Owner’s Equity Inez Villanueva, capital Total liabilities and owner’s equity

$ 20,500 83,500 1,900 1,160 $107,060 $154,300 $787,000 416,200 $192,000 164,700

370,800 27,300 552,400 $659,460

$ 24,700 7,700 1,300 $ 33,700 625,760 $659,460

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-1A (Concluded) 4.

20Y1 Dec.

Closing Entries 31 Fees Earned Rent Revenue Salaries and Wages Expense Advertising Expense Utilities Expense Depreciation Expense—Building Repairs Expense Depreciation Expense—Equipment Insurance Expense Supplies Expense Miscellaneous Expense Inez Villanueva, Capital

631,700 2,000

31 Inez Villanueva, Capital Inez Villanueva, Drawing

16,000

264,520 34,200 17,900 14,200 13,930 7,100 4,700 3,540 6,850 266,760

16,000

Outreach Signals Company Post-Closing Trial Balance December 31, 20Y1

Cash Accounts Receivable Prepaid Insurance Supplies Land Building Accumulated Depreciation—Building Equipment Accumulated Depreciation—Equipment Accounts Payable Salaries and Wages Payable Unearned Rent Inez Villanueva, Capital

Debit Balances 20,500 83,500 1,900 1,160 154,300 787,000

Credit Balances

416,200 192,000

1,240,360

164,700 24,700 7,700 1,300 625,760 1,240,360

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-2A 1.

Finders Investigative Services Income Statement For the Year Ended June 30, 20Y3 Revenues: Service fees Rent revenue Total revenues Expenses: Salaries expense Rent expense Supplies expense Depreciation expense—building Utilities expense Repairs expense Insurance expense Miscellaneous expense Total expenses Net income

$718,000 12,000 $730,000 $522,100 48,000 10,800 8,750 7,150 3,000 2,500 6,200 608,500 $121,500

Finders Investigative Services Statement of Owner’s Equity For the Year Ended June 30, 20Y3 Stacy Tanner, capital, July 1, 20Y2 Net income for the year Withdrawals Increase in owner’s equity Stacy Tanner, capital, June 30, 20Y3

$373,800 $121,500 (12,000) 109,500 $483,300

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-2A (Continued) Finders Investigative Services Balance Sheet June 30, 20Y3 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Building Less accumulated depreciation Total property, plant, and building Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned rent Total liabilities Owner’s Equity Stacy Tanner, capital Total liabilities and owner’s equity

$28,000 69,600 4,600 2,500 $104,700 $439,500 44,200 395,300 $500,000

$11,700 3,000 2,000 $ 16,700 483,300 $500,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-2A (Concluded) 2.

20Y3 June

Closing Entries 30 Service Fees Rent Revenue Salaries Expense Rent Expense Supplies Expense Depreciation Expense—Building Utilities Expense Repairs Expense Insurance Expense Miscellaneous Expense Stacy Tanner, Capital

718,000 12,000

30 Stacy Tanner, Capital Stacy Tanner, Drawing

12,000

522,100 48,000 10,800 8,750 7,150 3,000 2,500 6,200 121,500

12,000

$(18,000) net loss ($30,000 – $12,000). The $30,000 decrease is caused by the $(12,000) withdrawals and an $(18,000) net loss.

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3A 1., 3., and 6. June

June

30 30

Bal.

Cash 11,000

Bal. Adj. Bal.

Laundry Supplies 21,500 June 30 3,600

Adj.

17,900

Adj.

5,700

June

30 30

Bal. Adj. Bal.

Prepaid Insurance 9,600 June 30 3,900

June

Bal.

Laundry Equipment 232,600 Accumulated Depreciation June 30 Bal. 30 Adj. 30 Adj. Bal.

June

Clos.

Bal.

125,400 6,500 131,900

Accounts Payable June 30

Bal.

11,800

Wages Payable June 30

Adj.

1,100

Sophie Perez, Capital 10,000 June 30 Bal. 30 Clos. 30 Bal.

105,600 10,700 106,300

Sophie Perez, Drawing 10,000 June 30 Clos.

10,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3A (Continued) June

June

30 30 30

Clos.

Laundry Revenue 232,200 June 30

Bal. Adj. Adj. Bal.

Wages Expense 125,200 June 30 1,100 126,300

Bal.

232,200

Clos.

126,300

Bal.

Rent Expense 40,000 June 30

Clos.

40,000

Bal.

Utilities Expense 19,700 June 30

Clos.

19,700

Adj.

Laundry Supplies Expense 17,900 June 30 Clos.

17,900

Adj.

Depreciation Expense 6,500 June 30 Clos.

6,500

Adj.

Insurance Expense 5,700 June 30

Clos.

5,700

Miscellaneous Expense 5,400 June 30 Clos.

5,400

Bal.

Net income

11,000 21,500 9,600 232,600

475,000

232,200

105,600

125,400 11,800

Credit

1,100

31,200

(a) 17,900 (c) 6,500 (b) 5,700

(d)

1,100

(d)

4-31

31,200

6,500

(c)

(a) 17,900 (b) 5,700

Adjustments Debit Credit

126,300 40,000 19,700 17,900 6,500 5,700 5,400 482,600

10,000

11,000 3,600 3,900 232,600

Debit

482,600

232,200

131,900 11,800 1,100 105,600

Credit

Adjusted Trial Balance

Epicenter Laundry End-of-Period Spreadsheet (Work Sheet) For the Year Ended June 30, 20Y3

Completing the Accounting Cycle

126,300 40,000 19,700 17,900 6,500 5,700 5,400 221,500 10,700 232,200

Debit

232,200

Credit

Income Statement

5,400 475,000

125,200 40,000 19,700

10,000

Debit

Account Title

Unadjusted Trial Balance

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accum. Depreciation Accounts Payable Wages Payable Sophie Perez, Capital Sophie Perez, Drawing Laundry Revenue Wages Expense Rent Expense Utilities Expense Laundry Supplies Exp. Depreciation Expense Insurance Expense Miscellaneous Expense

Optional (Appendix)

Prob. 4-3A (Continued)

CHAPTER 4

261,100

10,000

11,000 3,600 3,900 232,600

Debit

250,400 10,700 261,100

131,900 11,800 1,100 105,600

Credit

Balance Sheet

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3A (Continued) 3.

Adjusting Entries 20Y3 June

30 Laundry Supplies Expense Laundry Supplies Supplies used ($21,500 – $3,600).

17,900

30 Insurance Expense Prepaid Insurance Insurance expired.

5,700

30 Depreciation Expense Accumulated Depreciation Equipment depreciation.

6,500

30 Wages Expense Wages Payable Accrued wages.

1,100

17,900

5,700

6,500

1,100

Epicenter Laundry Adjusted Trial Balance June 30, 20Y3

Debit Balances

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation Accounts Payable Wages Payable Sophie Perez, Capital Sophie Perez, Drawing Laundry Revenue Wages Expense Rent Expense Utilities Expense Laundry Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

Credit Balances

11,000 3,600 3,900 232,600 131,900 11,800 1,100 105,600 10,000 232,200 126,300 40,000 19,700 17,900 6,500 5,700 5,400 482,600

482,600

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3A (Continued) 5.

Epicenter Laundry Income Statement For the Year Ended June 30, 20Y3 Laundry revenue Expenses: Wages expense Rent expense Utilities expense Laundry supplies expense Depreciation expense Insurance expense Miscellaneous expense Total expenses Net income

$232,200 $126,300 40,000 19,700 17,900 6,500 5,700 5,400 221,500 $ 10,700

Epicenter Laundry Statement of Owner’s Equity For the Year Ended June 30, 20Y3 Sophie Perez, capital, July 1, 20Y2 Net income for the year Withdrawals Increase in owner’s equity Sophie Perez, capital, June 30, 20Y3

$105,600 $ 10,700 (10,000) 700 $106,300

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3A (Continued) Epicenter Laundry Balance Sheet June 30, 20Y3 Assets Current assets: Cash Laundry supplies Prepaid insurance Total current assets Property, plant, and equipment: Laundry equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Owner’s Equity Sophie Perez, capital Total liabilities and owner’s equity

$ 11,000 3,600 3,900 $ 18,500 $232,600 131,900 100,700 $119,200

$ 11,800 1,100 $ 12,900 106,300 $119,200

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3A (Concluded) Closing Entries

6. 20Y3 June

30 Laundry Revenue Wages Expense Rent Expense Utilities Expense Laundry Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense Sophie Perez, Capital

232,200

30 Sophie Perez Capital Sophie Perez, Drawing

10,000

126,300 40,000 19,700 17,900 6,500 5,700 5,400 10,700

10,000

Epicenter Laundry Post-Closing Trial Balance June 30, 20Y3 Debit Balances

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation Accounts Payable Wages Payable Sophie Perez, Capital

Credit Balances

11,000 3,600 3,900 232,600

251,100

131,900 11,800 1,100 106,300 251,100

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A 1., 3., and 6. Cash

Account:

Item

Date

20Y7 Mar.

Balance

Item

Date

20Y7 Mar.

31 31

Balance Adjusting

Item

Date

31 31

Balance Adjusting

Date

Item

Balance

Date

Item

31 31

Balance Adjusting

Date

Account No.

Post. Ref.

Debit

 26

Credit

Balance Debit Credit

22,500

30,000 7,500 14

Account No.

Post. Ref.

Debit

 26

Credit

1,800

Debit

Balance Credit

3,600 1,800 16

Account No.

Post. Ref.

Debit

Credit



Post. Ref.

Balance Debit Credit

110,000

Debit

 26

Account No.

Credit

Balance Debit Credit

25,000 33,350

8,350 Account No.

Item

Balance Debit Credit

12,000

Trucks

Account:

20Y7 Mar.



Accumulated Depreciation—Equipment

Account:

20Y7 Mar.

Credit

Equipment

Account:

20Y7 Mar.

Debit

Prepaid Insurance

Account:

20Y7 Mar.

Post. Ref.

Supplies

Account:

Account No.

Balance

Post. Ref.

Debit



Credit

Balance Debit Credit

60,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A (Continued) Accumulated Depreciation—Trucks

Account:

Item

Date

20Y7 Mar.

31 31

Date

Post. Ref.

Debit

Credit

31 31 31

Balance Closing Closing

Date

Item

31 31

Balance Closing

Balance Credit

4,000 22

Account No.

Post. Ref.

Debit

Credit

Debit

Balance Credit

600

600 31

Account No.

Post. Ref.

 27 27

Debit

Credit

Post. Ref.

Debit

Balance Credit

96,000 147,150 132,150

51,150 15,000

Kaya Tarango, Drawing

Account:

Debit



Adjusting

Item

15,000 21,200

6,200

Kaya Tarango, Capital

Account:

Balance Debit Credit

Account No.

Balance

Item

Date

20Y7 Mar.

Credit

Wages Payable

Account:

20Y7 Mar.

 26

Balance Adjusting

Item

Date

20Y7 Mar.

Debit

Accounts Payable

Account:

20Y7 Mar.

Post. Ref.

Account No.

Debit

 27

Balance Credit

Credit

Debit

15,000

15,000 —

—

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A (Continued) Service Revenue

Account:

Date

20Y7 Mar.

Item

31 31

Item

Date

31 31 31

Date

Credit

160,000

Adjusting Closing

Item

Date

31 31

Balance Closing

Item

Date

31 31

Balance Closing

160,000 — 51

Account No.

Post. Ref.

Debit

 26 27

Balance Credit

Credit

Debit

45,600

45,000 45,600 —

600

— 52

Account No.

Post. Ref.

26 27

Debit

Balance Credit

Credit

Debit

22,500

22,500 —

22,500

— 53

Account No.

Post. Ref.

Debit

 27

Credit

Balance Debit Credit

10,600

10,600 —

Truck Expense

Account:

Balance Debit Credit

—

Rent Expense

Account:

20Y7 Mar.

Balance Adjusting Closing

Item

31 31

20Y7 Mar.

 27

Debit

Supplies Expense

Account:

20Y7 Mar.

Post. Ref.

Wages Expense

Account:

20Y7 Mar.

Balance Closing

Account No.

— 54

Account No.

Post. Ref.

Debit

 27

Credit

9,000

Balance Debit Credit

9,000 —

—

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A (Continued) Depreciation Expense—Equipment

Account:

Item

Date

20Y7 Mar.

31 31

Date

Item

31 31

Date

Adjusting Closing

Item

31 31

8,350 8,350

Post. Ref.

26 27

Adjusting Closing

Item

Date

31 31

Balance Closing

Balance Debit Credit

8,350 —

— 56

Account No.

Debit

Credit

6,200 6,200

Debit

Balance Credit

6,200 —

— 57

Account No.

Post. Ref.

26 27

Debit

Credit

1,800 1,800

Miscellaneous Expense

Account:

20Y7 Mar.

26 27

Credit

Insurance Expense

Account:

20Y7 Mar.

Debit

Depreciation Expense—Trucks

Account:

20Y7 Mar.

Adjusting Closing

Post. Ref.

Account No.

Post. Ref.

Balance Debit Credit

1,800 —

— 59

Account No.

Debit

 27

Credit

4,800

Debit

Balance Credit

4,800 —

—

Optional (Appendix)

Net income

Account Title Cash Supplies Prepaid Insurance Equipment Accum. Depr.—Equip. Trucks Accum. Depr.—Trucks Accounts Payable Wages Payable Kaya Tarango, Capital Kaya Tarango, Drawing Service Revenue Wages Expense Supplies Expense Rent Expense Truck Expense Depr. Exp.—Equipment Depr. Exp.—Trucks Insurance Expense Miscellaneous Expense

Prob. 4-4A (Continued)

300,000

160,000

96,000

4-40

45,600 22,500 10,600 9,000 8,350 6,200 1,800 4,800 108,850 51,150 160,000

160,000

Income Statement Debit Credit

4,800 300,000

10,600 9,000

45,000

15,000

Unadjusted Trial Balance Debit Credit 12,000 30,000 3,600 110,000 25,000 60,000 15,000 4,000

Completing the Accounting Cycle

Lakota Freight Co. End-of-Period Spreadsheet (Work Sheet) For the Year Ended March 31, 20Y7 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 12,000 (a) 22,500 7,500 (b) 1,800 1,800 110,000 (c) 8,350 33,350 60,000 (d) 6,200 21,200 4,000 (e) 600 600 96,000 15,000 160,000 (e) 600 45,600 (a) 22,500 22,500 10,600 9,000 (c) 8,350 8,350 (d) 6,200 6,200 (b) 1,800 1,800 4,800 39,450 39,450 315,150 315,150

CHAPTER 4

206,300

155,150 51,150 206,300

Balance Sheet Debit Credit 12,000 7,500 1,800 110,000 33,350 60,000 21,200 4,000 600 96,000 15,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A (Continued) 3.

JOURNAL Post. Ref.

Date

20Y7 Mar.

Adjusting Entries 31 Supplies Expense Supplies Supplies used ($30,000 – $7,500).

Page

Debit

52 13

22,500

31 Insurance Expense Prepaid Insurance Insurance expired.

57 14

1,800

31 Depreciation Expense—Equipment Accumulated Depr.—Equipment Equipment depreciation.

55 17

8,350

31 Depreciation Expense—Trucks Accumulated Depr.—Trucks Truck depreciation.

56 19

6,200

31 Wages Expense Wages Payable Accrued wages.

51 22

600

Credit

22,500

1,800

8,350

6,200

600

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A (Continued) 4.

Lakota Freight Co. Adjusted Trial Balance March 31, 20Y7 Account No.

Cash Supplies Prepaid Insurance Equipment Accumulated Depreciation—Equipment Trucks Accumulated Depreciation—Trucks Accounts Payable Wages Payable Kaya Tarango, Capital Kaya Tarango, Drawing Service Revenue Wages Expense Supplies Expense Rent Expense Truck Expense Depreciation Expense—Equipment Depreciation Expense—Trucks Insurance Expense Miscellaneous Expense

11 13 14 16 17 18 19 21 22 31 32 41 51 52 53 54 55 56 57 59

Debit Balances

Credit Balances

12,000 7,500 1,800 110,000 33,350 60,000 21,200 4,000 600 96,000 15,000 160,000 45,600 22,500 10,600 9,000 8,350 6,200 1,800 4,800 315,150

315,150

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A (Continued) 5.

Lakota Freight Co. Income Statement For the Year Ended March 31, 20Y7 Service revenue Expenses: Wages expense Supplies expense Rent expense Truck expense Depreciation expense—equipment Depreciation expense—trucks Insurance expense Miscellaneous expense Total expenses Net income

Lakota Freight Co. Statement of Owner’s Equity For the Year Ended March 31, 20Y7 Kaya Tarango, capital, April 1, 20Y6 Net income for the year Withdrawals Increase in owner’s equity Kaya Tarango, capital, March 31, 20Y7

$160,000 $45,600 22,500 10,600 9,000 8,350 6,200 1,800 4,800 108,850 $ 51,150

$ 96,000 $ 51,150 (15,000) 36,150 $132,150

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A (Continued) Lakota Freight Co. Balance Sheet March 31, 20Y7 Assets Current assets: Cash Supplies Prepaid insurance Total current assets Property, plant, and equipment: Equipment Less accumulated depreciation Trucks Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Owner’s Equity Kaya Tarango, capital Total liabilities and owner’s equity

$12,000 7,500 1,800 $ 21,300 $110,000 33,350 $ 60,000 21,200

$76,650 38,800 115,450 $136,750

$ 4,000 600 $

4,600

132,150 $136,750

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4A (Concluded) 6.

JOURNAL Post. Ref.

Date

20Y7 Mar.

Page

Debit

Closing Entries 31 Service Revenue Wages Expense Supplies Expense Rent Expense Truck Expense Depreciation Expense—Equipment Depreciation Expense—Trucks Insurance Expense Miscellaneous Expense Kaya Tarango, Capital

41 51 52 53 54 55 56 57 59 31

160,000

31 Kaya Tarango, Capital Kaya Tarango, Drawing

31 32

15,000

Account No.

Debit Balances

11 13 14 16 17 18 19 21 22 31

12,000 7,500 1,800 110,000

Credit

45,600 22,500 10,600 9,000 8,350 6,200 1,800 4,800 51,150

15,000

Lakota Freight Co. Post-Closing Trial Balance March 31, 20Y7

Cash Supplies Prepaid Insurance Equipment Accumulated Depreciation—Equipment Trucks Accumulated Depreciation—Trucks Accounts Payable Wages Payable Kaya Tarango, Capital

Credit Balances

33,350 60,000

191,300

21,200 4,000 600 132,150 191,300

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A 1. and 2. JOURNAL Post. Ref.

Date

20Y9 July

Page

Debit

1 Cash Accounts Receivable Supplies Office Equipment Samantha Hogan, Capital

11 12 14 18 31

25,700 30,200 5,100 12,100

1 Prepaid Rent Cash

15 11

8,100

2 Prepaid Insurance Cash

16 11

6,100

3 Cash Unearned Fees

11 23

10,800

5 Office Equipment Accounts Payable

18 21

6,900

6 Cash Accounts Receivable

11 12

17,300

10 Miscellaneous Expense Cash

59 11

680

12 Accounts Payable Cash

21 11

4,100

12 Accounts Receivable Fees Earned

12 41

19,200

14 Salary Expense Cash

51 11

2,000

Credit

73,100

8,100

6,100

10,800

6,900

17,300

680

4,100

19,200

2,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) JOURNAL Post. Ref.

Date

20Y9 July

Page

Debit

17 Cash Fees Earned

11 41

14,100

18 Supplies Cash

14 11

1,400

20 Accounts Receivable Fees Earned

12 41

12,200

24 Cash Fees Earned

11 41

11,500

26 Cash Accounts Receivable

11 12

16,300

27 Salary Expense Cash

51 11

2,000

29 Miscellaneous Expense Cash

59 11

440

31 Miscellaneous Expense Cash

59 11

910

31 Cash Fees Earned

11 41

9,600

31 Accounts Receivable Fees Earned

12 41

7,400

31 Samantha Hogan, Drawing Cash

32 11

27,100

Credit

14,100

1,400

12,200

11,500

16,300

2,000

440

910

9,600

7,400

27,100

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) 2., 6., and 9. Cash

Account:

Item

Date

20Y9 July

1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2

Debit

Credit

25,700 8,100 6,100 10,800 17,300 680 4,100 2,000 14,100 1,400 11,500 16,300 2,000 440 910 9,600 27,100

Accounts Receivable

Date

Item

1 6 12 20 26 31

Post. Ref.

1 1 1 2 2 2

Item

Date

1 18 31

Adjusting

Debit

Credit

30,200 17,300 19,200 12,200 16,300 7,400

25,700 17,600 11,500 22,300 39,600 38,920 34,820 32,820 46,920 45,520 57,020 73,320 71,320 70,880 69,970 79,570 52,470

1 2 3

Debit

Credit

5,100 1,400 2,600

Balance Debit Credit

30,200 12,900 32,100 44,300 28,000 35,400 Account No.

Post. Ref.

Balance Credit

Account No.

Supplies

Account:

20Y9 July

Post. Ref.

1 1 2 3 6 10 12 14 17 18 24 26 27 29 31 31 31

Account:

20Y9 July

Account No.

Balance Debit Credit

5,100 6,500 3,900

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) Prepaid Rent

Account:

Item

Date

20Y9 July

1 31

Date

Item

2 31

Date

Item

Date

8,100 2,700

Adjusting

Post. Ref.

1 3

Debit

Credit

6,100 510

Date

Item

5 12

Post. Ref.

Debit

Credit

12,100 6,900

Date

Post. Ref.

Adjusting

Debit

Balance Credit

6,100 5,590 18

Balance Debit Credit

Account No.

Debit

Credit

Debit

Balance Credit

540

540 21

Account No.

Post. Ref.

1 1

Item

12,100 19,000

Debit

Credit

Debit

Balance Credit

6,900

6,900 2,800

4,100

Salaries Payable

Account:

8,100 5,400

Account No.

Accounts Payable

Account:

Balance Debit Credit

Account No.

1 1

Item

20Y9 July

Credit

Accumulated Depreciation

Account:

20Y9 July

Adjusting

1 5

20Y9 July

1 3

Debit

Office Equipment

Account:

20Y9 July

Post. Ref.

Prepaid Insurance

Account:

20Y9 July

Adjusting

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

190

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) Unearned Fees

Account:

Item

Date

20Y9 July

3 31

Date

Item

1 31 31

Closing Closing

Item

Date

31 31

Credit

Post. Ref.

1 4 4

Closing

Post. Ref.

2 4

Date

Item

12 17 20 24 31 31 31 31

Adjusting Closing

Balance Debit Credit

10,800

10,800 4,100

6,700

Account No.

Debit

Credit

Debit

Balance Credit

73,100 68,130

73,100 141,230 114,130

27,100

Account No.

Debit

Balance Credit

Credit

Debit

27,100

27,100 —

27,100

Fees Earned

Account:

20Y9 July

1 3

Debit

Samantha Hogan, Drawing

Account:

20Y9 July

Post. Ref.

Samantha Hogan, Capital

Account:

20Y9 July

Adjusting

Account No.

— 41

Account No.

Post. Ref.

1 2 2 2 2 2 3 4

Debit

Credit

Balance Debit Credit

19,200 14,100 12,200 11,500 9,600 7,400 6,700 80,700

—

19,200 33,300 45,500 57,000 66,600 74,000 80,700 —

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) Salary Expense

Account:

Item

Date

20Y9 July

14 27 31 31

Date

20Y9 July

31 31

Credit

2,000 2,000 190 4,190

31 31

Post. Ref.

3 4

Debit

Credit

2,700 2,700

Post. Ref.

Adjusting Closing

Item

31 31

Adjusting Closing

3 4

Debit

Credit

2,600 2,600

Date

Item

31 31

Adjusting Closing

— 52

Debit

Balance Credit

2,700 —

— 53

Balance Debit Credit

2,600 —

— 54

Account No.

Post. Ref.

Debit

3 4

Credit

540 540

Insurance Expense

Account:

2,000 4,000 4,190 —

Account No.

Depreciation Expense

Date

Balance Debit Credit

Account No.

Adjusting Closing

Item

Account:

20Y9 July

Debit

Supplies Expense

Date

20Y9 July

1 2 3 4

Adjusting Closing

Item

Account:

20Y9 July

Post. Ref.

Rent Expense

Account:

Account No.

Balance Debit Credit

540 —

— 55

Account No.

Post. Ref.

Debit

3 4

Credit

510 510

Debit

Balance Credit

510 —

—

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) Miscellaneous Expense

Account:

Item

Date

20Y9 July

10 29 31 31

Closing

Post. Ref.

Account No.

Debit

1 2 2 4

Credit

680 440 910 2,030

Balance Debit Credit

680 1,120 2,030 —

—

Arborvite Consulting Unadjusted Trial Balance July 31, 20Y9

Account No.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Samantha Hogan, Capital Samantha Hogan, Drawing Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

11 12 14 15 16 18 19 21 22 23 31 32 41 51 52 53 54 55 59

Debit Balances

Credit Balances

52,470 35,400 6,500 8,100 6,100 19,000 0 2,800 0 10,800 73,100 27,100 74,000 4,000 0 0 0 0 2,030 160,700

160,700

Optional (Appendix)

Net income

Account Title Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accum. Depreciation Accounts Payable Salaries Payable Unearned Fees Samantha Hogan, Capital Samantha Hogan, Drawing Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

Prob. 4-5A (Continued)

160,700

74,000

4-53

4,190 2,700 2,600 540 510 2,030 12,570 68,130 80,700

80,700

Income Statement Debit Credit

2,030 160,700

4,000

27,100

10,800 73,100

2,800

Unadjusted Trial Balance Debit Credit 52,470 35,400 6,500 8,100 6,100 19,000

Completing the Accounting Cycle

Arborvite Consulting End-of-Period Spreadsheet (Work Sheet) For the Month Ended July 31, 20Y9 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 52,470 35,400 (b) 2,600 3,900 (e) 2,700 5,400 (a) 510 5,590 19,000 (c) 540 540 2,800 (d) 190 190 (f) 6,700 4,100 73,100 27,100 (f) 6,700 80,700 (d) 190 4,190 (e) 2,700 2,700 (b) 2,600 2,600 (c) 540 540 (a) 510 510 2,030 13,240 13,240 161,430 161,430

CHAPTER 4

148,860

80,730 68,130 148,860

Balance Sheet Debit Credit 52,470 35,400 3,900 5,400 5,590 19,000 540 2,800 190 4,100 73,100 27,100

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) 6.

JOURNAL Post. Ref.

Date

20Y9 July

Adjusting Entries 31 Insurance Expense Prepaid Insurance Insurance expired.

Page

Debit

55 16

510

31 Supplies Expense Supplies Supplies used ($6,500 – $3,900).

53 14

2,600

31 Depreciation Expense Accumulated Depreciation Equipment depreciation.

54 19

540

31 Salary Expense Salaries Payable Accrued salaries.

51 22

190

31 Rent Expense Prepaid Rent Rent expired.

52 15

2,700

31 Unearned Fees Fees Earned Unearned fees earned ($10,800 – $4,100).

23 41

6,700

Credit

510

2,600

540

190

2,700

6,700

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) Arborvite Consulting Adjusted Trial Balance July 31, 20Y9

Account No.

11 12 14 15 16 18 19 21 22 23 31 32 41 51 52 53 54 55 59

Debit Balances

Credit Balances

52,470 35,400 3,900 5,400 5,590 19,000 540 2,800 190 4,100 73,100 27,100 80,700 4,190 2,700 2,600 540 510 2,030 161,430

161,430

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) 8.

Arborvite Consulting Income Statement For the Month Ended July 31, 20Y9 Fees earned Expenses: Salary expense Rent expense Supplies expense Depreciation expense Insurance expense Miscellaneous expense Total expenses Net income

$80,700 $4,190 2,700 2,600 540 510 2,030 12,570 $68,130

Arborvite Consulting Statement of Owner’s Equity For the Month Ended July 31, 20Y9 Samantha Hogan, capital, July 1, 20Y9 Investments during month Net income Withdrawals Increase in owner’s equity Samantha Hogan, capital, July 31, 20Y9

$ 73,100 68,130 (27,100) 114,130 $114,130

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Continued) Arborvite Consulting Balance Sheet July 31, 20Y9 Assets Current assets: Cash Accounts receivable Supplies Prepaid rent Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned fees Total liabilities Owner’s Equity Samantha Hogan, capital Total liabilities and owner’s equity

$52,470 35,400 3,900 5,400 5,590 $102,760 $19,000 540 18,460 $121,220

$ 2,800 190 4,100 $

7,090

114,130 $121,220

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5A (Concluded) 9.

JOURNAL Post. Ref.

Date

20Y9 July

Page

Debit

Closing Entries 31 Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense Samantha Hogan, Capital

41 51 52 53 54 55 59 31

80,700

31 Samantha Hogan, Capital Samantha Hogan, Drawing

31 32

27,100

Credit

4,190 2,700 2,600 540 510 2,030 68,130

27,100

Arborvite Consulting Post-Closing Trial Balance July 31, 20Y9

10.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Samantha Hogan, Capital

Account No.

Debit Balances

11 12 14 15 16 18 19 21 22 23 31

52,470 35,400 3,900 5,400 5,590 19,000

121,760

Credit Balances

540 2,800 190 4,100 114,130 121,760

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-1B 1.

Last Chance Company Income Statement For the Year Ended June 30, 20Y1 Revenues: Fees earned Rent revenue Total revenues Expenses: Salaries and wages expense Advertising expense Utilities expense Travel expense Depreciation expense—equipment Depreciation expense—building Supplies expense Insurance expense Miscellaneous expense Total expenses Net loss

Last Chance Company Statement of Owner’s Equity For the Year Ended June 30, 20Y1 Tami Garrigan, capital, July 1, 20Y0 Net loss for the year Withdrawals Decrease in owner’s equity Tami Garrigan, capital, June 30, 20Y1

$283,750 3,000 $286,750 $147,000 86,800 30,000 18,750 4,550 3,000 1,500 1,300 5,875 298,775 $ (12,025)

$361,300 $(12,025) (20,000) (32,025) $329,275

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-1B (Continued) Last Chance Company Balance Sheet June 30, 20Y1

Assets Current assets: Cash Accounts receivable Prepaid insurance Supplies Total current assets Property, plant, and equipment: Land Building Less accumulated depreciation Equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries and wages payable Unearned rent Total liabilities Owner’s Equity Tami Garrigan, capital Total liabilities and owner’s equity

5,100 26,500 2,300 525 $ 34,425

$ 80,000 $340,000 193,000 $140,000 59,000

147,000 81,000 308,000 $342,425

9,750 1,900 1,500 $ 13,150 329,275 $342,425

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-1B (Concluded) 4.

20Y1 June

Closing Entries 30 Fees Earned Rent Revenue Tami Garrigan, Capital Salaries and Wages Expense Advertising Expense Utilities Expense Travel Expense Depreciation Expense—Equipment Depreciation Expense—Building Supplies Expense Insurance Expense Miscellaneous Expense

283,750 3,000 12,025

30 Tami Garrigan, Capital Tami Garrigan, Drawing

20,000

147,000 86,800 30,000 18,750 4,550 3,000 1,500 1,300 5,875

20,000

Last Chance Company Post-Closing Trial Balance June 30, 20Y1 Debit Balances

Credit Balances

5,100 26,500 2,300 525 80,000 340,000 193,000 140,000

594,425

59,000 9,750 1,900 1,500 329,275 594,425

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-2B 1. The Gorman Group Income Statement For the Year Ended October 31, 20Y3 Revenues: Service fees Rent revenue Total revenues Expenses: Salaries expense Depreciation expense—equipment Rent expense Supplies expense Utilities expense Depreciation expense—buildings Repairs expense Insurance expense Miscellaneous expense Total expenses Net income

$468,000 5,000 $473,000 $291,000 17,500 15,500 9,000 8,500 6,600 3,450 3,000 5,450 360,000 $113,000

The Gorman Group Statement of Owner’s Equity For the Year Ended October 31, 20Y3 Nicole Gorman, capital, November 1, 20Y2 Net income for the year Withdrawals Increase in owner’s equity Nicole Gorman, capital, October 31, 20Y3

$220,000 $113,000 (20,000) 93,000 $313,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-2B (Continued) The Gorman Group Balance Sheet October 31, 20Y3 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Land Buildings Less accumulated depreciation Equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned rent Total liabilities Owner’s Equity Nicole Gorman, capital Total liabilities and owner’s equity

$ 11,000 28,150 6,350 9,500 $ 55,000 $ 75,000 $250,000 117,200 $240,000 151,700

132,800 88,300 296,100 $351,100

$ 33,300 3,300 1,500 $ 38,100 313,000 $351,100

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-2B (Concluded) 2.

20Y3 Oct.

Closing Entries 31 Service Fees Rent Revenue Salaries Expense Depreciation Expense—Equipment Rent Expense Supplies Expense Utilities Expense Depreciation Expense—Buildings Repairs Expense Insurance Expense Miscellaneous Expense Nicole Gorman, Capital

468,000 5,000

31 Nicole Gorman, Capital Nicole Gorman, Drawing

20,000

291,000 17,500 15,500 9,000 8,500 6,600 3,450 3,000 5,450 113,000

20,000

$135,000 ($115,000 + $20,000) net income. The $115,000 increase is caused by the net income of $135,000 less the $20,000 withdrawals.

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3B 1., 3., and 6. Aug.

Aug.

31 31

Bal.

Cash 3,800

Bal. Adj. Bal.

Laundry Supplies 9,000 Aug. 31 2,000

Adj.

7,000

Bal. Adj. Bal.

Prepaid Insurance 6,000 Aug. 31 700

Adj.

5,300

Bal.

Laundry Equipment 180,800 Accumulated Depreciation Aug. 31 Bal. 31 Adj. 31 Adj. Bal.

Aug.

Clos.

Bal.

49,200 8,150 57,350

Accounts Payable Aug. 31

Bal.

7,800

Wages Payable Aug. 31

Adj.

2,200

Bobbi Downey, Capital 2,400 Aug. 31 Bal. 31 Clos. 31 Bal.

95,000 27,350 119,950

Bobbi Downey, Drawing 2,400 Aug. 31 Clos.

2,400

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3B (Continued) Aug.

Aug.

31 31 31

Clos.

Laundry Revenue 248,000 Aug. 31

Bal. Adj. Adj. Bal.

Wages Expense 135,800 Aug. 31 2,200 138,000

Bal.

248,000

Clos.

138,000

Bal.

Rent Expense 43,200 Aug. 31

Clos.

43,200

Utilities Expense 16,000 Aug. 31

Clos.

16,000

Aug.

Bal.

Aug.

Adj.

Depreciation Expense 8,150 Aug. 31 Clos.

8,150

Aug.

Adj.

Laundry Supplies Expense 7,000 Aug. 31 Clos.

7,000

Aug.

Adj.

Aug.

Bal.

Insurance Expense 5,300 Aug. 31

Clos.

5,300

Miscellaneous Expense 3,000 Aug. 31 Clos.

3,000

Optional (Appendix)

Net income

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accum. Depreciation Accounts Payable Wages Payable Bobbi Downey, Capital Bobbi Downey, Drawing Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Exp. Insurance Expense Miscellaneous Expense

Account Title

Prob. 4-3B (Continued)

400,000

248,000

95,000

49,200 7,800

8,150 7,000 5,300

(b) (c) (d) 22,650

2,200

(a)

2,200

(a)

4-67

22,650

8,150

7,000 5,300

(b)

Adjustments Debit Credit

138,000 43,200 16,000 8,150 7,000 5,300 3,000 410,350

2,400

3,800 2,000 700 180,800

410,350

248,000

57,350 7,800 2,200 95,000

Adjusted Trial Balance Debit Credit

138,000 43,200 16,000 8,150 7,000 5,300 3,000 220,650 27,350 248,000

248,000

Income Statement Debit Credit

3,000 400,000

135,800 43,200 16,000

2,400

3,800 9,000 6,000 180,800

Unadjusted Trial Balance Debit Credit

Completing the Accounting Cycle

La Mesa Laundry End-of-Period Spreadsheet (Work Sheet) For the Year Ended August 31, 20Y5

CHAPTER 4

189,700

2,400

3,800 2,000 700 180,800

162,350 27,350 189,700

57,350 7,800 2,200 95,000

Balance Sheet Debit Credit

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3B (Continued) 3.

Adjusting Entries 20Y5 Aug.

31 Wages Expense Wages Payable Accrued wages.

2,200

31 Depreciation Expense Accumulated Depreciation Equipment depreciation.

8,150

31 Laundry Supplies Expense Laundry Supplies Supplies used ($9,000 – $2,000).

7,000

31 Insurance Expense Prepaid Insurance Insurance expired.

5,300

2,200

8,150

7,000

5,300

La Mesa Laundry Adjusted Trial Balance August 31, 20Y5

Debit Balances

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation Accounts Payable Wages Payable Bobbi Downey, Capital Bobbi Downey, Drawing Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Expense Insurance Expense Miscellaneous Expense

Credit Balances

3,800 2,000 700 180,800 57,350 7,800 2,200 95,000 2,400 248,000 138,000 43,200 16,000 8,150 7,000 5,300 3,000 410,350

410,350

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3B (Continued) 5.

La Mesa Laundry Income Statement For the Year Ended August 31, 20Y5 Laundry revenue Expenses: Wages expense Rent expense Utilities expense Depreciation expense Laundry supplies expense Insurance expense Miscellaneous expense Total expenses Net income

$248,000 $138,000 43,200 16,000 8,150 7,000 5,300 3,000 220,650 $ 27,350

La Mesa Laundry Statement of Owner’s Equity For the Year Ended August 31, 20Y5 Bobbi Downey, capital, September 1, 20Y4 Net income for the year $27,350 Withdrawals (2,400) Increase in owner’s equity Bobbi Downey, capital, August 31, 20Y5

$ 95,000

24,950 $119,950

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3B (Continued) La Mesa Laundry Balance Sheet August 31, 20Y5 Assets Current assets: Cash Laundry supplies Prepaid insurance Total current assets Property, plant, and equipment: Laundry equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Owner’s Equity Bobbi Downey, capital Total liabilities and owner’s equity

3,800 2,000 700 $

6,500

$180,800 57,350 123,450 $129,950

7,800 2,200 $ 10,000 119,950 $129,950

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-3B (Concluded) Closing Entries

6. 20Y5 Aug.

31 Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Expense Insurance Expense Miscellaneous Expense Bobbi Downey, Capital

248,000

31 Bobbi Downey, Capital Bobbi Downey, Drawing

2,400

138,000 43,200 16,000 8,150 7,000 5,300 3,000 27,350

2,400

La Mesa Laundry Post-Closing Trial Balance August 31, 20Y5

Debit Balances

Cash Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation Accounts Payable Wages Payable Bobbi Downey, Capital

Credit Balances

3,800 2,000 700 180,800

187,300

57,350 7,800 2,200 119,950 187,300

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B 1., 3., and 6. Cash

Account:

Item

Date

20Y7 Jan.

Balance

Date

20Y7 Jan.

Item

31 31

Balance Adjusting

Date

Item

31 31

Balance Adjusting

Date

Item

Balance

Date

Item

31 31

Balance Adjusting

Date

Account No.

Post. Ref.

Debit

 26

Credit

5,150

Balance Debit Credit

8,000 2,850 14

Account No.

Post. Ref.

Debit

 26

Credit

3,150

Debit

Balance Credit

7,500 4,350 16

Account No.

Post. Ref.

Debit

Credit



Post. Ref.

Balance Debit Credit

113,000

Debit

 26

Account No.

Credit

Balance Debit Credit

12,000 17,250

5,250 Account No.

Item

Balance Debit Credit

13,100

Trucks

Account:

20Y7 Jan.



Accumulated Depreciation—Equipment

Account:

20Y7 Jan.

Credit

Equipment

Account:

20Y7 Jan.

Debit

Prepaid Insurance

Account:

20Y7 Jan.

Post. Ref.

Supplies

Account:

Account No.

Balance

Post. Ref.

Debit



Credit

Balance Debit Credit

90,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B (Continued) Accumulated Depreciation—Trucks

Account:

Item

Date

20Y7 Jan.

31 31

Date

Item

Date

Adjusting

Date

Item

31 31 31

Balance Closing Closing

Date

Item

31 31

Balance Closing

27,100 31,100 21

Account No.

Post. Ref.

Debit

Credit

Debit

Balance Credit



4,500 22

Account No.

Post. Ref.

Debit

Credit

Post. Ref.

 27 27

Post. Ref.

Debit

Balance Credit

900

900 31

Account No.

Debit

Credit

Debit

Balance Credit

126,400 172,550 169,550

46,150 3,000

Jeanne McQuay, Drawing

Account:

Balance Debit Credit

4,000

Jeanne McQuay, Capital

Account:

20Y7 Jan.

Balance

Item

20Y7 Jan.

 26

Credit

Wages Payable

Account:

20Y7 Jan.

Debit

Accounts Payable

Account:

20Y7 Jan.

Balance Adjusting

Post. Ref.

Account No.

Debit

 27

Credit

3,000

Debit

Balance Credit

3,000 —

—

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B (Continued) Service Revenue

Account:

Item

Date

20Y7 Jan.

31 31

Item

Date

31 31 31

Date

Balance Adjusting Closing

Item

31 31

Credit

155,000

Balance Closing

Item

Date

31 31

Balance Closing

Balance Debit Credit

155,000 —

—

Account No.

Post. Ref.

Debit

 26 27

Balance Credit

Credit

Debit

72,900

72,000 72,900 —

900

— 52

Account No.

Post. Ref.

Debit

 27

Credit

7,600

Truck Expense

Account:

20Y7 Jan.

 27

Debit

Rent Expense

Account:

20Y7 Jan.

Post. Ref.

Wages Expense

Account:

20Y7 Jan.

Balance Closing

Account No.

Debit

Balance Credit

7,600 —

— 53

Account No.

Post. Ref.

Debit

 27

Credit

5,350

Balance Debit Credit

5,350 —

—

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B (Continued) Depreciation Expense—Equipment

Account:

Date

20Y7 Jan.

Item

31 31

Date

Item

31 31

Date

5,250 5,250

Adjusting Closing

Date

Item

31 31

Adjusting Closing

Post. Ref.

Debit

26 27

Credit

5,150 5,150

Item

Date

31 31

Balance Closing

5,250 —

— 55

Post. Ref.

26 27

Debit

Balance Credit

5,150 —

— 56

Account No.

Debit

Credit

4,000 4,000

Balance Debit Credit

4,000 —

— 57

Account No.

Post. Ref.

26 27

Debit

Credit

3,150 3,150

Miscellaneous Expense

Account:

Balance Debit Credit

Account No.

Insurance Expense

Account:

20Y7 Jan.

Adjusting Closing

Item

31 31

20Y7 Jan.

26 27

Credit

Depreciation Expense—Trucks

Account:

20Y7 Jan.

Debit

Supplies Expense

Account:

20Y7 Jan.

Adjusting Closing

Post. Ref.

Account No.

Post. Ref.

Debit

Balance Credit

3,150 —

— 59

Account No.

Debit

 27

Credit

5,450

Balance Debit Credit

5,450 —

—

Optional (Appendix)

Net income

Account Title Cash Supplies Prepaid Insurance Equipment Accum. Depr.—Equipment Trucks Accum. Depr.—Trucks Accounts Payable Wages Payable Jeanne McQuay, Capital Jeanne McQuay, Drawing Service Revenue Wages Expense Rent Expense Truck Expense Depr. Exp.—Equipment Supplies Expense Depr. Exp.—Trucks Insurance Expense Miscellaneous Expense

Prob. 4-4B (Continued)

325,000

155,000

126,400

4-76

72,900 7,600 5,350 5,250 5,150 4,000 3,150 5,450 108,850 46,150 155,000

155,000

Income Statement Debit Credit

5,450 325,000

72,000 7,600 5,350

3,000

Unadjusted Trial Balance Debit Credit 13,100 8,000 7,500 113,000 12,000 90,000 27,100 4,500

Completing the Accounting Cycle

Recessive Interiors End-of-Period Spreadsheet (Work Sheet) For the Year Ended January 31, 20Y7 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 13,100 (a) 5,150 2,850 (b) 3,150 4,350 113,000 (c) 5,250 17,250 90,000 (d) 4,000 31,100 4,500 (e) 900 900 126,400 3,000 155,000 (e) 900 72,900 7,600 5,350 (c) 5,250 5,250 (a) 5,150 5,150 (d) 4,000 4,000 (b) 3,150 3,150 5,450 18,450 18,450 335,150 335,150

CHAPTER 4

226,300

180,150 46,150 226,300

Balance Sheet Debit Credit 13,100 2,850 4,350 113,000 17,250 90,000 31,100 4,500 900 126,400 3,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B (Continued) 3.

JOURNAL Post. Ref.

Date

20Y7 Jan.

Adjusting Entries 31 Supplies Expense Supplies Supplies used ($8,000 – $2,850).

Page

Debit

55 13

5,150

31 Insurance Expense Prepaid Insurance Insurance expired.

57 14

3,150

31 Depreciation Expense—Equipment Accumulated Depr.—Equipment Equipment depreciation.

54 17

5,250

31 Depreciation Expense—Trucks Accumulated Depr.—Trucks Truck depreciation.

56 19

4,000

31 Wages Expense Wages Payable Accrued wages.

51 22

900

Credit

5,150

3,150

5,250

4,000

900

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B (Continued) 4.

Recessive Interiors Adjusted Trial Balance January 31, 20Y7 Account No.

Cash Supplies Prepaid Insurance Equipment Accumulated Depreciation—Equipment Trucks Accumulated Depreciation—Trucks Accounts Payable Wages Payable Jeanne McQuay, Capital Jeanne McQuay, Drawing Service Revenue Wages Expense Rent Expense Truck Expense Depreciation Expense—Equipment Supplies Expense Depreciation Expense—Trucks Insurance Expense Miscellaneous Expense

11 13 14 16 17 18 19 21 22 31 32 41 51 52 53 54 55 56 57 59

Debit Balances

Credit Balances

13,100 2,850 4,350 113,000 17,250 90,000 31,100 4,500 900 126,400 3,000 155,000 72,900 7,600 5,350 5,250 5,150 4,000 3,150 5,450 335,150

335,150

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B (Continued) 5.

Recessive Interiors Income Statement For the Year Ended January 31, 20Y7 Service revenue Expenses: Wages expense Rent expense Truck expense Depreciation expense—equipment Supplies expense Depreciation expense—trucks Insurance expense Miscellaneous expense Total expenses Net income

Recessive Interiors Statement of Owner’s Equity For the Year Ended January 31, 20Y7 Jeanne McQuay, capital, February 1, 20Y6 Net income for the year Withdrawals Increase in owner’s equity Jeanne McQuay, capital, January 31, 20Y7

$155,000 $72,900 7,600 5,350 5,250 5,150 4,000 3,150 5,450 108,850 $ 46,150

$126,400 $46,150 (3,000) 43,150 $169,550

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B (Continued) Recessive Interiors Balance Sheet January 31, 20Y7 Assets Current assets: Cash Supplies Prepaid insurance Total current assets Property, plant, and equipment: Equipment Less accumulated depreciation Trucks Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Owner’s Equity Jeanne McQuay, capital Total liabilities and owner’s equity

$13,100 2,850 4,350 $ 20,300 $113,000 17,250 $ 90,000 31,100

$95,750 58,900 154,650 $174,950

$ 4,500 900 $

5,400

169,550 $174,950

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-4B (Concluded) 6.

JOURNAL Post. Ref.

Date

20Y7 Jan.

Page

Debit

Closing Entries 31 Service Revenue Wages Expense Rent Expense Truck Expense Depreciation Expense—Equipment Supplies Expense Depreciation Expense—Trucks Insurance Expense Miscellaneous Expense Jeanne McQuay, Capital

41 51 52 53 54 55 56 57 59 31

155,000

31 Jeanne McQuay, Capital Jeanne McQuay, Drawing

31 32

3,000

Credit

72,900 7,600 5,350 5,250 5,150 4,000 3,150 5,450 46,150

3,000

Recessive Interiors Post-Closing Trial Balance January 31, 20Y7

Cash Supplies Prepaid Insurance Equipment Accumulated Depreciation—Equipment Trucks Accumulated Depreciation—Trucks Accounts Payable Wages Payable Jeanne McQuay, Capital

Account No.

Debit Balances

11 13 14 16 17 18 19 21 22 31

13,100 2,850 4,350 113,000

Credit Balances

17,250 90,000

223,300

31,100 4,500 900 169,550 223,300

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B 1. and 2. JOURNAL Post. Ref.

Date

20Y9 Apr.

Page

Debit

1 Cash Accounts Receivable Supplies Office Equipment Jeff Horton, Capital

11 12 14 18 31

20,000 14,700 3,300 12,000

1 Prepaid Rent Cash

15 11

6,000

2 Prepaid Insurance Cash

16 11

4,200

4 Cash Unearned Fees

11 23

9,400

5 Office Equipment Accounts Payable

18 21

8,000

6 Cash Accounts Receivable

11 12

11,700

10 Miscellaneous Expense Cash

59 11

350

12 Accounts Payable Cash

21 11

6,400

12 Accounts Receivable Fees Earned

12 41

21,900

14 Salary Expense Cash

51 11

1,650

Credit

50,000

6,000

4,200

9,400

8,000

11,700

350

6,400

21,900

1,650

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) JOURNAL Post. Ref.

Date

20Y9 Apr.

Page

Debit

17 Cash Fees Earned

11 41

6,600

18 Supplies Cash

14 11

725

20 Accounts Receivable Fees Earned

12 41

16,800

24 Cash Fees Earned

11 41

4,450

26 Cash Accounts Receivable

11 12

26,500

27 Salary Expense Cash

51 11

1,650

29 Miscellaneous Expense Cash

59 11

540

30 Miscellaneous Expense Cash

59 11

760

30 Cash Fees Earned

11 41

5,160

30 Accounts Receivable Fees Earned

12 41

2,590

30 Jeff Horton, Drawing Cash

32 11

18,000

Credit

6,600

725

16,800

4,450

26,500

1,650

540

760

5,160

2,590

18,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) 2., 6., and 9. Cash

Account:

Item

Date

20Y9 Apr.

1 1 2 4 6 10 12 14 17 18 24 26 27 29 30 30 30

Date

1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2

Item

1 6 12 20 26 30

Debit

Credit

20,000 6,000 4,200 9,400 11,700 350 6,400 1,650 6,600 725 4,450 26,500 1,650 540 760 5,160 18,000

Post. Ref.

1 1 1 2 2 2

Debit

Credit

14,700 11,700 21,900 16,800 26,500 2,590

Date

Item

1 18 30

Adjusting

20,000 14,000 9,800 19,200 30,900 30,550 24,150 22,500 29,100 28,375 32,825 59,325 57,675 57,135 56,375 61,535 43,535

Debit

1 2 3

Debit

Credit

3,300 725 2,800

Balance Credit

14,700 3,000 24,900 41,700 15,200 17,790 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Supplies

Account:

20Y9 Apr.

Post. Ref.

Accounts Receivable

Account:

20Y9 Apr.

Account No.

Balance Debit Credit

3,300 4,025 1,225

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) Prepaid Rent

Account:

Date

20Y9 Apr.

Item

1 30

Date

Item

2 30

1 5

Date

Item

6,000 2,000

Adjusting

Date

Item

5 12

Post. Ref.

1 3

Debit

Credit

4,200 350

Date

Post. Ref.

Debit

1 1

12,000 8,000

Post. Ref.

Adjusting

Debit

Balance Credit

4,200 3,850 18

Credit

Balance Debit Credit

12,000 20,000 19

Account No.

Debit

Credit

Debit

Balance Credit

400

400 21

Account No.

Post. Ref.

1 1

Item

6,000 4,000

Account No.

Debit

Credit

Debit

Balance Credit

8,000

8,000 1,600

6,400

Salaries Payable

Account:

Balance Debit Credit

Account No.

Accounts Payable

Account:

20Y9 Apr.

Credit

Accumulated Depreciation

Account:

20Y9 Apr.

Adjusting

Item

Date

20Y9 Apr.

1 3

Debit

Office Equipment

Account:

20Y9 Apr.

Post. Ref.

Prepaid Insurance

Account:

20Y9 Apr.

Adjusting

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit

275

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) Unearned Fees

Account:

Item

Date

20Y9 Apr.

4 30

Date

Item

1 30 30

Date

Closing Closing

Item

30 30

Credit

Closing

Date

Item

12 17 20 24 30 30 30 30

Adjusting Closing

Balance Debit Credit

9,400

9,400 2,350

7,050

Account No.

Post. Ref.

1 4 4

Debit

Credit

Debit

Balance Credit

50,000 53,775

50,000 103,775 85,775

18,000

Account No.

Post. Ref.

2 4

Debit

Balance Credit

Credit

Debit

18,000

18,000 —

18,000

Fees Earned

Account:

20Y9 Apr.

1 3

Debit

Jeff Horton, Drawing

Account:

20Y9 Apr.

Post. Ref.

Jeff Horton, Capital

Account:

20Y9 Apr.

Adjusting

Account No.

— 41

Account No.

Post. Ref.

1 2 2 2 2 2 3 4

Debit

Credit

Balance Debit Credit

21,900 6,600 16,800 4,450 5,160 2,590 7,050 64,550

—

21,900 28,500 45,300 49,750 54,910 57,500 64,550 —

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) Salary Expense

Account:

Item

Date

20Y9 Apr.

14 27 30 30

Date

20Y9 Apr.

Date

Credit

1,650 1,650 275 3,575

30 30

Post. Ref.

3 4

Debit

Credit

2,800 2,800

Post. Ref.

Adjusting Closing

Item

30 30

Adjusting Closing

3 4

Debit

Credit

2,000 2,000

Date

Item

30 30

Adjusting Closing

— 52

Debit

Balance Credit

2,800 —

— 53

Balance Debit Credit

2,000 —

— 54

Account No.

Post. Ref.

Debit

3 4

Credit

400 400

Insurance Expense

Account:

1,650 3,300 3,575 —

Account No.

Depreciation Expense

Date

Balance Debit Credit

Account No.

Adjusting Closing

Item

Account:

20Y9 Apr.

Debit

Rent Expense

Account:

20Y9 Apr.

1 2 3 4

Adjusting Closing

Item

30 30

20Y9 Apr.

Post. Ref.

Supplies Expense

Account:

Account No.

Balance Debit Credit

400 —

— 55

Account No.

Post. Ref.

Debit

3 4

Credit

350 350

Debit

Balance Credit

350 —

—

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) Miscellaneous Expense

Account:

Date

20Y9 Apr.

Item

10 29 30 30

Closing

Account No.

Post. Ref.

1 2 2 4

Debit

Credit

350 540 760

Balance Debit Credit

1,650

350 890 1,650 —

Account No.

Debit Balances

11 12 14 15 16 18 19 21 22 23 31 32 41 51 52 53 54 55 59

43,535 17,790 4,025 6,000 4,200 20,000

—

Rosebud Consulting Unadjusted Trial Balance April 30, 20Y9

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Jeff Horton, Capital Jeff Horton, Drawing Fees Earned Salary Expense Supplies Expense Rent Expense Depreciation Expense Insurance Expense Miscellaneous Expense

Credit Balances

0 1,600 0 9,400 50,000 18,000 57,500 3,300 0 0 0 0 1,650 118,500

118,500

Net income

Account Title Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accum. Depreciation Accounts Payable Salaries Payable Unearned Fees Jeff Horton, Capital Jeff Horton, Drawing Fees Earned Salary Expense Supplies Expense Rent Expense Depreciation Expense Insurance Expense Miscellaneous Expense

Optional (Appendix)

Prob. 4-5B (Continued)

118,500

57,500

9,400 50,000

1,600

Credit

(d) (b) (e) (c) (a)

(f)

12,875

275 2,800 2,000 400 350

7,050

(f)

4-89

12,875

7,050

275

400

2,800 2,000 350

(b) (e) (a)

3,575 2,800 2,000 400 350 1,650 119,175

18,000

43,535 17,790 1,225 4,000 3,850 20,000

119,175

64,550

400 1,600 275 2,350 50,000

3,575 2,800 2,000 400 350 1,650 10,775 53,775 64,550

Debit

64,550

Credit

Income Statement

1,650 118,500

3,300

18,000

Debit 43,535 17,790 4,025 6,000 4,200 20,000

Unadjusted Trial Balance

Completing the Accounting Cycle

Rosebud Consulting End-of-Period Spreadsheet (Work Sheet) For the Month Ended April 30, 20Y9 Adjusted Adjustments Trial Balance Debit Credit Debit Credit

CHAPTER 4

108,400

18,000

Debit 43,535 17,790 1,225 4,000 3,850 20,000

54,625 53,775 108,400

400 1,600 275 2,350 50,000

Credit

Balance Sheet

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) 6.

JOURNAL Post. Ref.

Date

20Y9 Apr.

Adjusting Entries 30 Insurance Expense Prepaid Insurance Insurance expired.

Page

Debit

55 16

350

30 Supplies Expense Supplies Supplies used ($4,025 – $1,225).

52 14

2,800

30 Depreciation Expense Accumulated Depreciation Equipment depreciation.

54 19

400

30 Salary Expense Salaries Payable Accrued salaries.

51 22

275

30 Rent Expense Prepaid Rent Rent expired.

53 15

2,000

30 Unearned Fees Fees Earned Unearned fees earned ($9,400 – $2,350).

23 41

7,050

Credit

350

2,800

400

275

2,000

7,050

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) Rosebud Consulting Adjusted Trial Balance April 30, 20Y9

Account No.

11 12 14 15 16 18 19 21 22 23 31 32 41 51 52 53 54 55 59

Debit Balances

Credit Balances

43,535 17,790 1,225 4,000 3,850 20,000 400 1,600 275 2,350 50,000 18,000 64,550 3,575 2,800 2,000 400 350 1,650 119,175

119,175

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) 8.

Rosebud Consulting Income Statement For the Month Ended April 30, 20Y9 Fees earned Expenses: Salary expense Supplies expense Rent expense Depreciation expense Insurance expense Miscellaneous expense Total expenses Net income

$64,550 $3,575 2,800 2,000 400 350 1,650 10,775 $53,775

Rosebud Consulting Statement of Owner’s Equity For the Month Ended April 30, 20Y9 Jeff Horton, capital, April 1, 20Y9 Investment during month Net income Withdrawals Increase in owner’s equity Jeff Horton, capital, April 30, 20Y9

$ 50,000 53,775 (18,000) 85,775 $85,775

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Continued) Rosebud Consulting Balance Sheet April 30, 20Y9 Assets Current assets: Cash Accounts receivable Supplies Prepaid rent Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned fees Total liabilities Owner’s Equity Jeff Horton, capital Total liabilities and owner’s equity

$43,535 17,790 1,225 4,000 3,850 $70,400 $20,000 400 19,600 $90,000

$ 1,600 275 2,350 $ 4,225 85,775 $90,000

CHAPTER 4

Completing the Accounting Cycle

Prob. 4-5B (Concluded) 9.

JOURNAL Post. Ref.

Date

20Y9 Apr.

Page

Debit

Closing Entries 30 Fees Earned Salary Expense Supplies Expense Rent Expense Depreciation Expense Insurance Expense Miscellaneous Expense Jeff Horton, Capital

41 51 52 53 54 55 59 31

64,550

30 Jeff Horton, Capital Jeff Horton, Drawing

31 32

18,000

Credit

3,575 2,800 2,000 400 350 1,650 53,775

18,000

Rosebud Consulting Post-Closing Trial Balance April 30, 20Y9

10.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Jeff Horton, Capital

Account No.

Debit Balances

11 12 14 15 16 18 19 21 22 23 31

43,535 17,790 1,225 4,000 3,850 20,000

90,400

Credit Balances

400 1,600 275 2,350 85,775 90,400

Optional (Appendix)

Net income

Music Expense Wages Expense Office Rent Expense Advertising Expense Equip. Rent Expense Utilities Expense Supplies Expense Insurance Expense Depreciation Expense Miscellaneous Expense

Account Title Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accum. Depreciation Accounts Payable Wages Payable Unearned Revenue Peyton Smith, Capital Peyton Smith, Drawing Fees Earned

40,750

16,200

4-95

PS Music End-of-Period Spreadsheet (Work Sheet) For the Two Months Ended July 31, 20Y9 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 9,945 (a) 1,400 4,150 (b) 745 275 (c) 225 2,475 7,500 (d) 50 50 8,350 (f) 140 140 (e) 3,600 3,600 9,000 1,750 (a) 1,400 21,200 (e) 3,600 3,610 (f) 140 2,940 2,550 1,500 1,375 1,215 (b) 745 925 (c) 225 225 (d) 50 50 1,855 6,160 6,160 42,340 42,340 3,610 2,940 2,550 1,500 1,375 1,215 925 225 50 1,855 16,245 4,955 21,200

21,200

Income Statement Debit Credit

1,855 40,750

3,610 2,800 2,550 1,500 1,375 1,215 180

1,750

7,200 9,000

8,350

Unadjusted Trial Balance Debit Credit 9,945 2,750 1,020 2,700 7,500

Completing the Accounting Cycle

CONTINUING PROBLEM

CHAPTER 4

26,095

1,750

21,140 4,955 26,095

50 8,350 140 3,600 9,000

Balance Sheet Debit Credit 9,945 4,150 275 2,475 7,500

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) 2.

PS Music Income Statement For the Two Months Ended July 31, 20Y9 Fees earned Expenses: Music expense Wages expense Office rent expense Advertising expense Equipment rent expense Utilities expense Supplies expense Insurance expense Depreciation expense Miscellaneous expense Total expenses Net income

$21,200 $3,610 2,940 2,550 1,500 1,375 1,215 925 225 50 1,855 16,245 $ 4,955

PS Music Statement of Owner’s Equity For the Two Months Ended July 31, 20Y9 Peyton Smith, capital, June 1, 20Y9 Investments during the two months $ 9,000 Net income 4,955 Withdrawals (1,750) Increase in owner’s equity Peyton Smith, capital, July 31, 20Y9

12,205 $12,205

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) PS Music Balance Sheet July 31, 20Y9 Assets Current assets: Cash Accounts receivable Supplies Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Unearned revenue Total liabilities Owner’s Equity Peyton Smith, capital Total liabilities and owner’s equity

$9,945 4,150 275 2,475 $16,845 $7,500 50 7,450 $24,295

$8,350 140 3,600 $12,090 12,205 $24,295

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) JOURNAL

Post. Ref.

Date

20Y9 July

Page

Debit

Credit

Closing Entries 31 Fees Earned Wages Expense Office Rent Expense Equipment Rent Expense Utilities Expense Music Expense Advertising Expense Supplies Expense Insurance Expense Depreciation Expense Miscellaneous Expense Peyton Smith, Capital

41 50 51 52 53 54 55 56 57 58 59 31

21,200

31 Peyton Smith, Capital Peyton Smith, Drawing

31 32

1,750

2,940 2,550 1,375 1,215 3,610 1,500 925 225 50 1,855 4,955

1,750

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) Cash

Account:

Item

Date

20Y9 July

1 1 1 1 2 3 3 4 8 11 13 14 16 21 22 23 27 28 29 30 31 31 31

Item

Date

20Y9 July

Balance

Post. Ref.

 1 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 2 2 2 2 2

Debit

Credit

5,000 1,750 2,700 1,000 7,200 250 900 200 1,000 700 1,200 2,000 620 800 750 915 1,200 540 500 3,000 1,400 1,250

Accounts Receivable

Account:

1 2 23 30 31

Account No.

Balance

Adjusting

Balance Debit Credit

3,920 8,920 7,170 4,470 5,470 12,670 12,420 11,520 11,320 12,320 11,620 10,420 12,420 11,800 11,000 11,750 10,835 9,635 9,095 9,595 12,595 11,195 9,945 12

Account No.

Post. Ref.

 1 2 2 3

Debit

Credit

1,000 1,750 1,000 1,400

Balance Debit Credit

1,000 — 1,750 2,750 4,150

—

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) Supplies

Account:

Date

20Y9 July

Item

1 18 31

Date

Item

1 31

Date

 2 3

Credit

850 745

Post. Ref.

1 3

Adjusting

Debit

Credit

2,700 225

Post. Ref.

Debit

Credit

7,500

Date

Item

1 3 5 18

Balance

Balance Debit Credit

2,700 2,475 17

Post. Ref.

Debit

Balance Credit

7,500 18

Account No.

Debit

Credit

Debit

Balance Credit

Accounts Payable

Account:

170 1,020 275

Account No.

Item

Balance Debit Credit

Account No.

Accumulated Depreciation

Date

20Y9 July

Adjusting

Item

Account:

20Y9 July

Debit

Office Equipment

Account:

20Y9 July

Adjusting

Post. Ref.

Prepaid Insurance

Account:

20Y9 July

Balance

Account No.

50 21

Account No.

Post. Ref.

Debit

 1 1 2

Credit

250

Debit

— 7,500 850

Balance Credit

250 — 7,500 8,350

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) Wages Payable

Account:

Date

20Y9 July

Item

3 31

Date

Credit

1 1 31 31

140

Post. Ref.

1 3

Debit

Credit

1 31 31

 1 4 4

Closing Closing

Balance Closing

Balance Debit Credit

7,200 3,600

3,600

Account No.

Post. Ref.

Balance

Item

140

7,200

Debit

Credit

Debit

Balance Credit

4,000 9,000 13,955 12,205

5,000 4,955 1,750

Peyton Smith, Drawing

Date

Balance Debit Credit

Account No.

Adjusting

Item

Account:

20Y9 July

Debit

Peyton Smith, Capital

Account:

20Y9 July

Adjusting

Item

Date

20Y9 July

Post. Ref.

Unearned Revenue

Account:

Account No.

Post. Ref.

 2 4

Debit

Credit

1,250 1,750

Balance Debit Credit

500 1,750 —

—

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) Fees Earned

Account:

Date

20Y9 July

Item

1 11 16 23 30 31 31 31 31

Item

Date

1 14 28 31 31

 1 2 2 2 2 3 3 4

Date

Credit

Balance

Adjusting Closing

Item

1 1 31

Balance Closing

Post. Ref.

 1 2 3 4

Post. Ref.

 1 4

Date

Post. Ref.

1 13 31

Balance Closing

6,200 7,200 9,200 11,700 13,200 16,200 17,600 21,200 —

1,000 2,000 2,500 1,500 3,000 1,400 3,600 21,200

—

Debit

Credit

1,200 1,200 140 2,940

Balance Debit Credit

400 1,600 2,800 2,940 —

— 51

Account No.

Equipment Rent Expense

Item

Balance Debit Credit

Account No.

Account:

20Y9 July

Debit

Office Rent Expense

Account:

20Y9 July

Adjusting Adjusting Closing

Post. Ref.

Wages Expense

Account:

20Y9 July

Balance

Account No.

Debit

Credit

1,750 2,550

Debit

Balance Credit

800 2,550 —

— 52

Account No.

Debit

 1 4

Credit

700 1,375

Balance Debit Credit

675 1,375 —

—

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) Utilities Expense

Account:

Date

20Y9 July

Item

1 27 31

Date

Item

1 21 31 31

Date

Balance

Closing

Item

1 8 22 31

 2 4

Credit

915 1,215

Balance

Closing

Date

Item

1 31 31

Balance Adjusting Closing

Balance Debit Credit

300 1,215 —

— 54

Account No.

Post. Ref.

 2 2 4

Debit

Credit

620 1,400 3,610

Balance Debit Credit

1,590 2,210 3,610 —

— 55

Account No.

Post. Ref.

Debit

 1 2 4

Credit

200 800 1,500

Supplies Expense

Account:

20Y9 July

Debit

Advertising Expense

Account:

20Y9 July

Closing

Post. Ref.

Music Expense

Account:

20Y9 July

Balance

Account No.

Balance Debit Credit

500 700 1,500 —

— 56

Account No.

Post. Ref.

Debit

 3 4

Credit

745 925

Balance Debit Credit

180 925 —

—

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Continued) Insurance Expense

Account:

Date

20Y9 July

Item

31 31

Date

20Y9 July

Adjusting Closing

Item

31 31

Debit

3 4

Credit

225 225

Adjusting Closing

Date

Item

1 4 29 31

Balance

Closing

Balance Debit Credit

225 —

— 58

Account No.

Post. Ref.

Debit

3 4

Credit

Post. Ref.

Debit

Balance Credit

50 50

Miscellaneous Expense

Account:

20Y9 July

Post. Ref.

Depreciation Expense

Account:

Account No.

—

— 59

Account No.

Debit

 1 2 4

Credit

900 540 1,855

Balance Debit Credit

415 1,315 1,855 —

—

CHAPTER 4

Completing the Accounting Cycle

Continuing Problem (Concluded) PS Music Post-Closing Trial Balance July 31, 20Y9

Account No.

Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Wages Payable Unearned Revenue Peyton Smith, Capital

11 12 14 15 17 18 21 22 23 31

Debit Balances

Credit Balances

9,945 4,150 275 2,475 7,500

24,345

50 8,350 140 3,600 12,205 24,345

CHAPTER 4

Completing the Accounting Cycle

COMPREHENSIVE PROBLEM 1 1. and 2. JOURNAL Post. Ref.

Date

20Y5 May

Page

Debit

3 Cash Unearned Fees

11 23

4,500

5 Cash Accounts Receivable

11 12

2,450

9 Miscellaneous Expense Cash

59 11

225

13 Accounts Payable Cash

21 11

640

15 Accounts Receivable Fees Earned

12 41

9,180

16 Salary Expense Salaries Payable Cash

51 22 11

630 120

17 Cash Fees Earned

11 41

8,360

Credit

4,500

2,450

225

640

9,180

750

8,360

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) JOURNAL Post. Ref.

Date

20Y5 May

Page

Debit

20 Supplies Accounts Payable

14 21

735

21 Accounts Receivable Fees Earned

12 41

4,820

25 Cash Fees Earned

11 41

7,900

27 Cash Accounts Receivable

11 12

9,520

28 Salary Expense Cash

51 11

750

30 Miscellaneous Expense Cash

59 11

260

31 Miscellaneous Expense Cash

59 11

810

31 Cash Fees Earned

11 41

3,300

31 Accounts Receivable Fees Earned

12 41

2,650

31 Kelly Pitney, Drawing Cash

32 11

10,500

Credit

735

4,820

7,900

9,520

750

260

810

3,300

2,650

10,500

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) 2., 6., and 9. Cash

Account:

Item

Date

20Y5 May

1 3 5 9 13 16 17 25 27 28 30 31 31 31

 5 5 5 5 5 5 6 6 6 6 6 6 6

Balance

Item

Date

1 5 15 21 27 31

Debit

Credit

4,500 2,450 225 640 750 8,360 7,900 9,520 750 260 810 3,300 10,500

Balance

Post. Ref.

 5 5 6 6 6

Debit

Credit

2,450 9,180 4,820 9,520 2,650

Item

Date

1 20 31

Balance Adjusting

22,100 26,600 29,050 28,825 28,185 27,435 35,795 43,695 53,215 52,465 52,205 51,395 54,695 44,195

Debit

 6 7

Credit

735 1,370

Balance Credit

3,400 950 10,130 14,950 5,430 8,080 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Supplies

Account:

20Y5 May

Post. Ref.

Accounts Receivable

Account:

20Y5 May

Account No.

Balance Debit Credit

1,350 2,085 715

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) Prepaid Rent

Account:

Date

20Y5 May

Item

1 31

Date

Item

1 31

Date

 7

Balance Adjusting

Post. Ref.

Item

Balance

Post. Ref.

Debit

Credit

275

1 31

Balance Adjusting

Debit

Credit



Date

Item

Date

Item

1 13 20

Balance

Date

Item

1 16 31

Balance Adjusting

Debit

Balance Credit

1,500 1,225 18

Balance Debit Credit

Account No.

Debit

 7

Credit

Balance Debit Credit

330 660

330

Account No.

Post. Ref.

Debit

 5 6

Credit

Balance Debit Credit

800 160 895

640 735

Salaries Payable

Account:

14,500

Accounts Payable

Account:

3,200 1,600

Account No.

Post. Ref.

20Y5 May

1,600

 7

Accumulated Depreciation

20Y5 May

Credit

Balance Debit Credit

Account No.

Account:

20Y5 May

Debit

Office Equipment

Account:

20Y5 May

Post. Ref.

Prepaid Insurance

Account:

20Y5 May

Balance Adjusting

Account No.

Post. Ref.

Debit

 5 7

Credit

120 325

Balance Debit Credit

120 — 325

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) Unearned Fees

Account:

Item

Date

20Y5 May

1 3 31

Item

Date

1 31 31

Balance Closing Closing

Item

Date

31 31

Credit

Closing

Item

Date

15 17 21 25 31 31 31 31

Adjusting Closing

Balance Debit Credit

2,500 7,000 3,210

4,500 3,790

Account No.

Post. Ref.

 8 8

Debit

Credit

Balance Debit Credit

42,300 75,725 65,225

33,425 10,500

Account No.

Post. Ref.

6 8

Debit

Credit

Balance Debit Credit

10,500

10,500 —

10,500

Fees Earned

Account:

20Y5 May

 5 7

Debit

Kelly Pitney, Drawing

Account:

20Y5 May

Adjusting

Post. Ref.

Kelly Pitney, Capital

Account:

20Y5 May

Balance

Account No.

— 41

Account No.

Post. Ref.

5 5 6 6 6 6 7 8

Debit

Credit

Balance Debit Credit

9,180 8,360 4,820 7,900 3,300 2,650 3,790 40,000

—

9,180 17,540 22,360 30,260 33,560 36,210 40,000 —

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) Salary Expense

Account:

Item

Date

20Y5 May

16 28 31 31

Date

20Y5 May

31 31

630 750 325 1,705

31 31

Post. Ref.

7 8

Debit

Credit

1,600 1,600

Post. Ref.

Adjusting Closing

Item

31 31

Adjusting Closing

7 8

Debit

Credit

1,370 1,370

Date

Item

31 31

Adjusting Closing

— 52

Debit

Balance Credit

1,600 —

— 53

Balance Debit Credit

1,370 —

— 54

Account No.

Post. Ref.

Debit

7 8

Credit

330 330

Insurance Expense

Account:

630 1,380 1,705 —

Account No.

Depreciation Expense

Date

Balance Debit Credit

Account No.

Adjusting Closing

Item

Account:

20Y5 May

Credit

Supplies Expense

Date

20Y5 May

Debit

5 6 7 8

Adjusting Closing

Item

Account:

20Y5 May

Post. Ref.

Rent Expense

Account:

Account No.

Balance Debit Credit

330 —

— 55

Account No.

Post. Ref.

Debit

7 8

Credit

275 275

Debit

Balance Credit

275 —

—

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) Miscellaneous Expense

Account:

Item

Date

20Y5 May

9 30 31 31

Closing

Account No.

Post. Ref.

Debit

5 6 6 8

Credit

225 260 810 1,295

Balance Debit Credit

225 485 1,295 —

—

Kelly Consulting Unadjusted Trial Balance May 31, 20Y5

Account No.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Kelly Pitney, Capital Kelly Pitney, Drawing Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

11 12 14 15 16 18 19 21 22 23 31 32 41 51 52 53 54 55 59

Debit Balances

Credit Balances

44,195 8,080 2,085 3,200 1,500 14,500 330 895 0 7,000 42,300 10,500 36,210 1,380 0 0 0 0 1,295 86,735

86,735

Optional (Appendix)

Net income

Account Title Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accum. Depreciation Accounts Payable Salaries Payable Unearned Fees Kelly Pitney, Capital Kelly Pitney, Drawing Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense

Comp. Prob. 1 (Continued)

86,735

36,210

4-113

1,705 1,600 1,370 330 275 1,295 6,575 33,425 40,000

40,000

Income Statement Debit Credit

1,295 86,735

1,380

10,500

7,000 42,300

Unadjusted Trial Balance Debit Credit 44,195 8,080 2,085 3,200 1,500 14,500 330 895

Completing the Accounting Cycle

Kelly Consulting End-of-Period Spreadsheet (Work Sheet) For the Month Ended May 31, 20Y5 Adjusted Adjustments Trial Balance Debit Credit Debit Credit 44,195 8,080 (b) 1,370 715 (e) 1,600 1,600 (a) 275 1,225 14,500 (c) 330 660 895 (d) 325 325 (f) 3,790 3,210 42,300 10,500 (f) 3,790 40,000 (d) 325 1,705 (e) 1,600 1,600 (b) 1,370 1,370 (c) 330 330 (a) 275 275 1,295 7,690 7,690 87,390 87,390

CHAPTER 4

80,815

47,390 33,425 80,815

Balance Sheet Debit Credit 44,195 8,080 715 1,600 1,225 14,500 660 895 325 3,210 42,300 10,500

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) 6.

JOURNAL Post. Ref.

Date

20Y5 May

Adjusting Entries 31 Insurance Expense Prepaid Insurance Insurance expired.

Page

Debit

55 16

275

31 Supplies Expense Supplies Supplies used ($2,085 – $715).

53 14

1,370

31 Depreciation Expense Accumulated Depreciation Equipment depreciation.

54 19

330

31 Salary Expense Salaries Payable Accrued salaries.

51 22

325

31 Rent Expense Prepaid Rent Rent expired.

52 15

1,600

31 Unearned Fees Fees Earned Unearned fees ($7,000 – $3,210).

23 41

3,790

Credit

275

1,370

330

325

1,600

3,790

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) Kelly Consulting Adjusted Trial Balance May 31, 20Y5

Account No.

11 12 14 15 16 18 19 21 22 23 31 32 41 51 52 53 54 55 59

Debit Balances

Credit Balances

44,195 8,080 715 1,600 1,225 14,500 660 895 325 3,210 42,300 10,500 40,000 1,705 1,600 1,370 330 275 1,295 87,390

87,390

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) 8.

Kelly Consulting Income Statement For the Month Ended May 31, 20Y5 Fees earned Expenses: Salary expense Rent expense Supplies expense Depreciation expense Insurance expense Miscellaneous expense Total expenses Net income

$40,000 $1,705 1,600 1,370 330 275 1,295 6,575 $33,425

Kelly Consulting Statement of Owner’s Equity For the Month Ended May 31, 20Y5 Kelly Pitney, capital, May 1, 20Y5 Net income for the month Withdrawals Increase in owner’s equity Kelly Pitney, capital, May 31, 20Y5

$42,300 $ 33,425 (10,500) 22,925 $65,225

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Continued) Kelly Consulting Balance Sheet May 31, 20Y5 Assets Current assets: Cash Accounts receivable Supplies Prepaid rent Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Salaries payable Unearned fees Total liabilities Owner’s Equity Kelly Pitney, capital Total liabilities and owner’s equity

$44,195 8,080 715 1,600 1,225 $55,815 $14,500 660 13,840 $69,655

895 325 3,210 $ 4,430 65,225 $69,655

CHAPTER 4

Completing the Accounting Cycle

Comp. Prob. 1 (Concluded) 9.

JOURNAL Post. Ref.

Date

20Y5 May

Page

Debit

Closing Entries 31 Fees Earned Salary Expense Rent Expense Supplies Expense Depreciation Expense Insurance Expense Miscellaneous Expense Kelly Pitney, Capital

41 51 52 53 54 55 59 31

40,000

31 Kelly Pitney, Capital Kelly Pitney, Drawing

31 32

10,500

Credit

1,705 1,600 1,370 330 275 1,295 33,425

10,500

Kelly Consulting Post-Closing Trial Balance May 31, 20Y5

10.

Cash Accounts Receivable Supplies Prepaid Rent Prepaid Insurance Office Equipment Accumulated Depreciation Accounts Payable Salaries Payable Unearned Fees Kelly Pitney, Capital

Account No.

Debit Balances

11 12 14 15 16 18 19 21 22 23 31

44,195 8,080 715 1,600 1,225 14,500

70,315

Credit Balances

660 895 325 3,210 65,225 70,315

CHAPTER 4

Completing the Accounting Cycle

CASES & PROJECTS CP 4-1 1.

No. By knowingly recording a personal loan as a normal account receivable, Manny is reporting financial information that does not accurately reflect the company’s financial position. Specifically, the company is reporting a noncurrent asset (a loan) as a current asset (an account receivable). This may lead the bank to incorrectly expect this amount to be converted to cash in the near term, which may impact its loan decision. Manny is demonstrating a failure of individual character and is acting unethically.

The users who rely upon this financial information, such as potential investors and creditors, will be affected, because the company’s balance sheet will not be a faithful representation of the entity’s economic activity and financial position.

CP 4-2 Solutions to this activity will vary according to the companies selected by the students.

CP 4-3 To: From: Re:

Daniel Nat A+ Student Balance Sheet Presentation

The balance sheet describes the financial condition of the company as of a given date and is useful in assessing the company’s financial soundness and liquidity. For balance sheet information to be useful, it must be presented in a consistent manner and in conformity with generally accepted accounting principles (GAAP). I have reviewed the December 31, 20Y4, balance sheet of Asheville Company and have identified several presentation errors that limit its usefulness. These errors include incorrectly presenting accounts payable and Daniel Nat, capital as assets and incorrectly reporting equipment as a liability. In addition, the order of the assets and liabilities reported on the balance sheet is incorrect. The Assets section of the balance sheet should have separate sections for current assets and property, plant, and equipment, and assets should be presented in the order in which they will be converted into cash or used in operations. Cash is presented as the first item in the Current Assets section, followed by accounts receivable. Land and equipment should be presented under the subheading Property, Plant, and Equipment. The company has two liabilities that should be presented in the balance sheet as liabilities: accounts payable and wages payable. In addition, the balance sheet should include an Owner’s Equity section below liabilities. This section should include Daniel Nat, capital, $235,000. Presuming that the amounts recorded in the accounts are accurately reported, a correctly presented balance sheet follows.

CHAPTER 4

Completing the Accounting Cycle

CP 4-3 (Concluded) Asheville Company Balance Sheet For the Year Ended December 31, 20Y4 Assets Current assets: Cash Accounts receivable Total current assets Property, plant, and equipment: Land Equipment Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Wages payable Total liabilities Owner’s Equity Daniel Nat, capital Total liabilities and owner’s equity

$ 10,000 12,500 $ 22,500 $100,000 125,000 225,000 $247,500

$ 10,000 2,500 $ 12,500 235,000 $247,500

CHAPTER 4

Completing the Accounting Cycle

CP 4-4 1.

(a) With the decreasing cost of computers and related software, Main Street Co. may find it desirable to computerize its financial reporting system. In many cases, the computerization of a manual accounting system reduces the overall cost of the accounting function. (b) A computerized accounting system would allow for eliminating the end-ofperiod spreadsheet, and thus, financial statements could be prepared with “a push of a button.” However, adjustment data would still need to be recorded at the end of the accounting period before the financial statements could be prepared. (c) In designing a computerized financial reporting (accounting) system, proper accounting principles, concepts, and procedures must be followed. At a minimum, basic controls such as the use of the double-entry accounting system should be included. For example, debits must equal credits for all transactions, and assets must equal liabilities plus owner’s equity. In addition, the system should be designed to detect obvious errors, such as a credit (minus) balance for Supplies or Prepaid Insurance. In other words, to design an adequate financial reporting system, a computer programmer must have a thorough understanding of accounting and the accounting cycle. Note: Numerous accounting software packages are available. Therefore, it would probably be better for Main Street Co. to purchase existing accounting software rather than try to design its own.

Supplies cannot have a credit balance, because the supplies account is an asset account. A business cannot have a “negative” asset. Thus, the only way a credit balance could have occurred in Supplies is as the result of an error in recording one or more transactions.

CHAPTER 4

Completing the Accounting Cycle

CP 4-5 1.

A set of financial statements provides useful information concerning the economic condition of a company. For example, the balance sheet describes the financial condition of the company as of a given date and is useful in assessing the company’s financial soundness and liquidity. The income statement describes the results of operations for a period and indicates the profitability of the company. The statement of owner’s equity describes the changes in the owner’s interest in the company for a period of time. Each of these statements is useful in evaluating whether to extend credit to the company.

The following adjustments might be necessary before an accurate set of financial statements could be prepared: No supplies expense is shown. The supplies account should be adjusted for the supplies used during the year. No depreciation expense or accumulated depreciation is shown for the building or equipment accounts. An adjusting entry should be prepared for depreciation expense on each of these assets. An inquiry should be made as to whether any accrued expenses, such as wages or utilities, exist at the end of the year. An inquiry should be made as to whether any prepaid expenses, such as rent or insurance, exist at the end of the year. An inquiry should be made as to whether the owner withdrew any funds from the company during the year. No drawing account is shown in the “Statement of Accounts.” The following items should be relabeled for greater clarity: Billings Due from Others—Accounts Receivable Amounts Owed to Others—Accounts Payable Investment in Business—Joan Whalen, Capital Other Expenses—Miscellaneous Expense Note to Instructors: The preceding items are not intended to include all adjustments that might exist in the Statement of Accounts. The possible adjustments listed include only items that have been covered in Chapters 1–4. For example, uncollectible accounts expense (discussed in a later chapter) is not mentioned.

CHAPTER 4

Completing the Accounting Cycle

CP 4-5 (Concluded) 3.

In general, the decision to extend a loan is based on an assessment of the profitability and riskiness of the loan. Although the financial statements provide useful data for this purpose, other factors such as the following might also be significant: The due date and payment terms of the loan. Security for the loan. For example, whether Joan Whalen is willing to pledge personal assets (collateral) in support of the loan will affect the riskiness of the loan. The intended use of the loan. For example, if the loan is to purchase real estate (possibly for a future building site), the real estate could be used as security for the loan. The projected profitability of the company.

CHAPTER 5 ACCOUNTING SYSTEMS DISCUSSION QUESTIONS 1.

The individual accounts receivable ledger accounts provide business managers with information on the status of individual customer accounts, which is necessary for managing collections. Managers need to know which customers owe money, how much they owe, and how long the amount owed has been outstanding.

The major advantages of the use of special journals are substantial savings in record-keeping expenses and a reduction of record-keeping errors.

a. b.

400 None

a. b.

400 1

Sometime following the end of the current month, one of two things may happen: (1) an overdue notice will be received from Kelly Co., and/or (2) a letter will be received from Kelley Co., informing the buyer of the overpayment. (It is also possible that the error will be discovered at the time of making payment if the original invoice is inspected at the time the check is being written.)

The schedule of accounts payable would not agree with the balance of the accounts payable account. The error might also be discovered at the time the invoice is paid.

The creditor will call the attention of the debtor to the unpaid balance of $800.

The error will become evident during the verification process at the end of the month. The total debits in the purchases journal will be less than the total credits by $3,600.

a. b. c.

Purchases journal Cash payments journal Purchases journal

An electronic form is a software window that provides the inputs for a particular transaction. For example, a check form provides the inputs (payee, amount, date) for a cash payment transaction. An electronic invoice provides the inputs (customer, amount sold, item sold) for recording revenues earned on account.

Transactions are posted when they are entered into the computerized system. Thus, balances are updated continuously as transactions occur.

For automated systems that use electronic forms, the special journals are not used to record original transactions. Rather, electronic forms capture the original transaction detail from an invoice, for example, and automatically post the transaction details to the appropriate ledger accounts.

10.

E-commerce can be used by a business to conduct transactions directly with customers. Thus, an order can be received directly from the customer’s Internet input, and cash can be received from the credit card. Many times, the cash is received prior to actually shipping the product, resulting in a faster revenue/collection cycle. Reducing paperwork throughout the cycle also improves the efficiency of the process. For example, all of the accounting transactions can be fed automatically from the initial Internet-based inputs.

d. e.

Cash payments journal Cash payments journal

CHAPTER 5

Accounting Systems

PRACTICE EXERCISES PE 5-1A REVENUE JOURNAL Invoice No.

Date

Aug.

4 15 25

162 163 164

Account Debited

Post. Ref.

Oasis Enterprises Co. City Electric Inc. Juniper Co.

Accounts Rec. Dr. Fees Earned Cr.

320 535 170

PE 5-1B REVENUE JOURNAL Invoice No.

Date

Apr.

6 11 19

78 79 80

Account Debited

BlueBird Co. Hitchcock Inc. Fletcher Inc.

Post. Ref.

Accounts Rec. Dr. Fees Earned Cr.

1,710 3,320 550

PE 5-2A Feb.

22.

Collected cash of $200 from Central Entertainment (Invoice No. 422). Amount posted from Page 106 of the cash receipts journal.

27.

Provided $280 of services on account to Central Entertainment, itemized on Invoice No. 445. Amount posted from Page 92 of the revenue journal.

10.

Provided $890 services on account to Eclypse Products Inc., itemized on Invoice No. 119. Amount posted from Page 24 of the revenue journal.

17.

Collected cash of $720 from Eclypse Products Inc. (Invoice No. 106). Amount posted from Page 46 of the cash receipts journal.

PE 5-2B Aug.

Mar.

Date

PE 5-3B

Oct.

Date

PE 5-3A

11 14 27

6 14 26

Post. Ref.

485

310

Office Supplies Dr.

820 425 3,330

Accounts Payable Cr.

5-3

820 425

Party Supplies Dr.

Other Accounts Dr.

Office Furniture

Other Accounts Dr.

Office Equipment

PURCHASES JOURNAL

310 3,430 485

Accounts Payable Cr.

Gift Pack Supplies Inc. Fun 4 All Supplies Inc. Office Space Inc.

Account Credited

U-Save Supply Inc. Zell Computer Inc. U-Save Supply Inc.

Account Credited

Post. Ref.

Accounting Systems

PURCHASES JOURNAL

CHAPTER 5

Post. Ref.

3,330

Amount

3,430

Amount

CHAPTER 5

Accounting Systems

PE 5-4A Nov.

11.

Made purchases of $1,680 on account from Sunstar Technology (Invoice No. 85). Amount posted from Page 8 of the purchases journal.

22.

Paid $2,980 to Sunstar Technology on account (Invoice No. 43). Amount posted from Page 46 of the cash payments journal.

PE 5-4B Jan.

11.

Paid $113 to Quinlan Inc. on account (Invoice No. 122). Amount posted from Page 71 of the cash payments journal.

26.

Made purchases of $128 on account from Quinlan Inc. (Invoice No. 139). Amount posted from Page 55 of the purchases journal.

PE 5-5A Horizontal analysis:

Retail Wholesale Total revenues

20Y5

20Y4

Increase/(Decrease) Amount Percent

$145,400 173,100 $318,500

$138,500 189,300 $327,800

$ 6,900 (16,200) $ (9,300)

Amount

Percent

Amount

Percent

$145,400 173,100 $318,500

45.7% 54.3% 100.0%

$138,500 189,300 $327,800

42.3% 57.7% 100.0%

5.0% (8.6)% (2.8)%

Vertical analysis: 20Y5

Retail Wholesale Total revenues

20Y4

CHAPTER 5

Accounting Systems

PE 5-5B Horizontal analysis:

Camping Fishing Total revenues

20Y3

20Y2

Increase/(Decrease) Amount Percent

$336,900 168,500 $505,400

$288,800 192,500 $481,300

$ 48,100 (24,000) $ 24,100

Amount

Percent

Amount

Percent

$336,900 168,500 $505,400

66.7% 33.3% 100.0%

$288,800 192,500 $481,300

60.0% 40.0% 100.0%

16.7% (12.5)% 5.0%

Vertical analysis: 20Y3

Camping Fishing Total revenues

20Y2

CHAPTER 5

Accounting Systems

EXERCISES Ex. 5-1 1. 2.

General ledger accounts: (e) Subsidiary ledger accounts: (a), (b), (c), (d)

Ex. 5-2 a., b., and c. Accounts Receivable May

1 Bal.

1,080

12,900

31 Bal. 13,980 Alpha GenCorp May 20 31 Bal.

Hazmat Safety Co.

5,110 5,110

May

1 31 Bal.

Masco Co. May 10 31 Bal.

3,740 3,740 Jordan Inc.

1,790 1,790

May

1 Bal.

27 31 Bal.

1,080 2,260 3,340

d. Westside Cleaners Inc. Accounts Receivable Customer Balances May 31, 20Y3 $ 5,110 3,740 1,790 3,340 $13,980

Alpha GenCorp Hazmat Safety Co. Masco Co. Jordan Inc. Total accounts receivable

Ex. 5-3 a. b. c. d. e.

Cash receipts journal General journal Revenue journal Cash receipts journal Cash receipts journal

f. g. h. i. j.

Cash receipts journal Cash receipts journal General journal (not a revenue transaction) General journal Cash receipts journal

CHAPTER 5

Accounting Systems

Ex. 5-4 a. b. c. d. e. f.

Cash payments journal Purchases journal Purchases journal General journal General journal Purchases journal

g. h. i. j. k.

General journal Cash payments journal General journal Cash payments journal Cash payments journal

Ex. 5-5 Apr.

Provided service on account; posted from revenue journal Page 44.

Granted an invoice adjustment or corrected an error related to sale of April 3; posted from general journal Page 11. This does not represent a collection of cash, since the credit was not posted from the cash receipts journal.

24.

Received cash for balance due; posted from cash receipts journal Page 81.

Ex. 5-6 a. REVENUE JOURNAL Invoice No.

Date

Oct.

2 3 14 24 31

321 322 323 324

Account Debited

Pryor Corp. Armor Inc. Pryor Corp. Rose Co.

$5,360 $5,360

$565 ($0 + $1,625 + $565 – $1,625)

Post. Ref.

Accounts Rec. Dr. Fees Earned Cr.

1,625 850 565 2,320 5,360

Debit to Accounts Receivable [from revenue journal column total in (a)]. Credit to Fees Earned [from revenue journal column total in (a)].

CHAPTER 5

Accounting Systems

Ex. 5-7 a. and b. Aladdin Co. July

1 Bal. 18 31 Bal.

Clearmark Co.

625 950 1,575

July

4 1,890 22 3,660 31 Bal. 5,550

Life Star Inc. July

9 31 Bal.

3,410 3,410

c. Accounts Receivable July

1 Bal. 31 31 Bal.

Fees Earned

625 9,910 10,535

July 31 9,910 31 Bal. 9,910

d. Sapling Consulting Inc. Accounts Receivable Customer Balances July 31, 20Y2 Aladdin Co. Clearmark Co. Life Star Inc. Total accounts receivable

$ 1,575 5,550 3,410 $10,535

The total in the schedule above agrees with the T account balance for the accounts receivable controlling account in part (c). e.

A computerized system would likely use an electronic form specially designed for recording sales transactions, such as an electronic invoice form. The transaction details would be input into the form fields and submitted. Once submitted, the transaction would be saved and automatically posted as a debit to the individual customer account receivable and a credit to the revenue account. No control totals would be posted to a controlling account.

CHAPTER 5

Accounting Systems

Ex. 5-8 Birmingham Productions Inc. Accounts Receivable Customer Balances January 31, 20Y4 Amber Communications Inc. Clear Pointe Studios Inc. Echo Broadcasting Co. Gold Coast Media Inc. Total accounts receivable

$ 4,550 2,050 3,710 0 $10,310

Note: The balances are determined by adding the debits and subtracting the credits for each subsidiary receivable account. Accounts Receivable (Controlling) Balance, January 1, 20Y4 Total debits (from revenue journal) Total credits (from cash receipts journal) Balance, January 31, 20Y4

$ 4,720 19,520 (13,930) $ 10,310

Ex. 5-9 REVENUE JOURNAL Invoice No.

Date

20Y8 Mar.

2 8 12 20 31

512 513 514 515

Post. Ref.

Accounts Rec. Dr. Fees Earned Cr.

   

2,135 520 1,985 455 5,095

Accts. Rec. Cr.

Cash Dr.

475 1,305 2,135

475 1,305 380 2,135

3,915

195 4,490

Account Debited

Santorini Co. Gabriel Co. Yarnell Inc. Electronic Central Inc.

CASH RECEIPTS JOURNAL Date

20Y8 Mar.

Account Credited

4 19 28 29

CMI Inc. Yarnell Inc. Fees Earned Santorini Co.

31 31

Fees Earned

Post. Fees Earned Ref. Cr.

  380  195 575

CHAPTER 5

Accounting Systems

Ex. 5-10 a. REVENUE JOURNAL Invoice No.

Date

20Y5 Oct.

3 8 18 28 31

622 623 624 625

Post. Ref.

Account Debited

Accounts Rec. Dr. Fees Earned Cr.

   

Palace Corp. Sunny Style Inc. Amex Services Inc. Wayfarer Co.

2,890 1,940 2,970 900 8,700

CASH RECEIPTS JOURNAL

Account Credited

Date

20Y5 Oct.

5 12 23 30 31

Post. Ref.

Fees Earned Cr.

  

Champion Co. Wayfarer Co. Palace Corp. Fees Earned

Accts. Rec. Cr.

1,060 1,450 2,890 120 120

5,400

Cash Dr.

1,060 1,450 2,890 120 5,520

b. Lasting Summer Inc. Accounts Receivable Customer Balances October 31, 20Y5 Amex Services Inc. Sunny Style Inc. Wayfarer Co. Total accounts receivable

$2,970 1,940 900 $5,810

The total of the customer accounts on October 31, 20Y5, $5,810, equals the balance of the accounts receivable controlling account, shown as follows: Accounts Receivable Oct.

1 Bal. 31 31 Bal.

2,510 8,700 5,810

Oct. 31

5,400

CHAPTER 5

Accounting Systems

Ex. 5-10 (Concluded) c.

The accounts receivable subsidiary ledger is needed to track customer services provided on account and customer collections. Without the subsidiary ledger, Lasting Summer Inc. would not know who owes how much for services rendered. Furthermore, without the subsidiary ledger, it would be impossible to manage collections from individual customers.

Ex. 5-11 1. 2. 3.

General ledger account: (g), (h), (i), (j), (k), (l) Subsidiary ledger account: (a), (b), (c), (d), (e), (f) No posting required: (m)

Ex. 5-12 1. 2. 3.

General ledger account: (b), (c), (e), (f), (h), (i), (k), (l) Subsidiary ledger account: (a), (d), (g) No posting required: (j)

Ex. 5-13 June

Purchased services, supplies, equipment, or other commodities on account; posted from purchases journal Page 49.

14.

Received an invoice adjustment or corrected an error related to purchase of June 6; posted from general journal Page 12. (A payment would be recorded in the cash payments journal.)

16.

Paid balance owed; posted from cash payments journal Page 23.

Date

825 4,890 365 385 6,465

Accts. Payable Cr.

365 385 1,575

825

Office Supplies Dr.

5-12

Office Equipment

Other Accounts Dr.

$365 ($0 + $825 + $365 – $825)

Post. Ref.

PURCHASES JOURNAL

Accounting Systems

Credit to Accounts Payable [from purchases journal column total in (a)]. Debit to Office Supplies [from purchases journal column total in (a)].

Officemate Inc. Tek Village Inc. Officemate Inc. Paper-to-Go Inc.

$6,465 $1,575

4 9 16 19 30

Account Credited

Apr.

Ex. 5-14

CHAPTER 5

Post. Ref.

4,890

Amount

CHAPTER 5

Accounting Systems

Ex. 5-15 a. and b. Enviro-Wash Supplies Inc. Mar.

4 26 31 Bal.

Nicely Co. 690 385 1,075

Mar.

1 Bal. 15 31 Bal.

580 325 905

Office Mate Inc. Mar.

20 3,860 31 Bal. 3,860

c. Accounts Payable Mar.

1 Bal. 31 31 Bal.

Cleaning Supplies 580 5,260 5,840

Mar.

31 1,400 31 Bal. 1,400

d. Newmark Exterior Cleaners Inc. Accounts Payable Creditor Balances March 31, 20Y2 Enviro-Wash Supplies Inc. Nicely Co. Office Mate Inc. Total accounts payable

$1,075 905 3,860 $5,840

The total in the schedule above agrees with the T account balance for the accounts payable control account in (c). e.

A computerized system would likely use an electronic form specially designed for recording purchase transactions. The transaction details would be input into the form fields and submitted. Once submitted, the transaction would be saved and automatically posted as a debit to an appropriate asset account and a credit to the individual creditor accounts payable account. No control totals would be posted to a controlling account.

CHAPTER 5

Accounting Systems

Ex. 5-16 Magnolia Landscaping Accounts Payable Creditor Balances June 30, 20Y1 Augusta Sod Co. Concrete Equipment Co. Home Centers Lumber Co. Nu Lawn Fertilizer Total accounts payable

$10,380 10,790 13,570 0 $34,740

Note: The account balances are determined by subtracting the debits from the credits for each account. Accounts Payable (Controlling) Balance, June 1, 20Y1 Total credits (from purchases journal) Total debits (from cash payments journal) Balance, June 30, 20Y1

$ 3,590 44,590 (13,440) $ 34,740

20Y5 May

Date

20Y5 May

Date

Ex. 5-17

1 8 15 26 31 31

3 12 18 20 31

57 58 59 60 61

Ck. No.

   

Post. Ref.

200 360 240 110 910 (21)

 18   51

5-15

5,600 8,460

2,860

690 (21)

145 200

345

Accounts Payable Dr.

345 2,860 145 200 5,600 9,150 (11)

Cash Cr.

Electrical Service Expense

Other Accounts Dr.

Bio Safe Supplies Inc. Equipment Bowman Electrical Service Brite N’ Shine Products Inc. Salary Expense

Post. Ref.

800 (14)

200 360 240

Cleaning Supplies Dr.

Other Accounts Dr.

Accounts Payable Cr.

CASH PAYMENTS JOURNAL

Account Debited

Brite N’ Shine Products Inc. Porter Products Inc. Bio Safe Supplies Inc. Bowman Electrical Service

Account Credited

Accounting Systems

PURCHASES JOURNAL

CHAPTER 5

Post. Ref.

110 110

Amount

Date

20Y4 Sept.

Date

20Y4 Sept.

Ex. 5-18

6 18 23 30 30

4 13 19 27 30

345 346 347 348

Ck. No.

   

Post. Ref.

   54

5-16

80 80

915 (21)

320 300 295

Accounts Payable Dr.

320 300 295 80 995 (11)

Cash Cr.

Office Equipment

Other Accounts Dr.

Labradore Inc. Meow Mart Inc. Best Friend Supplies Inc. Cleaning Expense

Post. Ref.

450 1,535 (14)

295 790

Pet Supplies Dr.

Other Accounts Dr.

295 790 2,510 450 4,045 (21)

Accounts Payable Cr.

CASH PAYMENTS JOURNAL

Account Debited

Best Friend Supplies Inc. Poodle Pals Inc. Office Helper Inc. Meow Mart Inc.

Account Credited

Accounting Systems

PURCHASES JOURNAL

CHAPTER 5

Post. Ref.

2,510

Amount

CHAPTER 5

Accounting Systems

Ex. 5-18 (Concluded) b. Happy Tails Inc. Accounts Payable Creditor Balances September 30, 20Y4 $ 450 790 2,510 $3,750

Meow Mart Inc. Poodle Pals Inc. Office Helper Inc. Total accounts payable

The total of the creditor accounts on September 30, 20Y4, $3,750, equals the balance of the accounts payable controlling account, shown as follows: Accounts Payable Sept.

915

Sept.

1 Bal. 30 30 Bal.

620 4,045 3,750

Happy Tails Inc. uses a subsidiary ledger for accounts payable to track its credit purchases and payments to the individual supplier. This is needed so that it knows how much it owes to each individual supplier. Without the subsidiary ledger, Happy Tails Inc. would have difficulty accurately paying suppliers for the amount owed in a timely manner.

Ex. 5-19 a. Two errors were made in balancing the accounts in the subsidiary ledger: (1) The Carbon Supplies Inc. transaction of March 9 should have resulted in a balance of $15,300 instead of $14,000, and the account balance at March 12 should have been $15,000 instead of $13,700. The account balance at March 20 should have been $9,200 instead of $7,900. (2) The Hudson Bay Minerals Co. transaction of March 25 should have resulted in a balance of $700 instead of $1,700.

CHAPTER 5

Accounting Systems

Ex. 5-19 (Concluded) b. Bunker Hill Assay Services Inc. Accounts Payable Creditor Balances March 31, 20Y4 C. D. Greer and Son Carbon Supplies Inc. Cutler and Powell Hudson Bay Minerals Co. Valley Power Total accounts payable

$15,750 9,200 7,800 700 3,150 $36,600

Ex. 5-20 Cash receipts journal: (a) Cash payments journal: (b) Revenue journal: (c) Purchases journal: (d) General journal: (e)

Ex. 5-21 1. The Cash column is for debits (not credits). 2.

The Other Accounts column is for credits (not debits).

A better order of columns would be to place the Other Accounts Cr. column to the left of the Fees Earned Cr. column. A recommended and corrected cash receipts journal is as follows: CASH RECEIPTS JOURNAL

Date

Account Credited

Post. Ref.

Other Accounts Cr.

Fees Earned Cr.

Page

Accts. Rec. Cr.

Cash Dr.

CHAPTER 5

Accounting Systems

Ex. 5-22

In the electronic invoice form from QuickBooks shown above, typical fields for data input can be identified as follows: 1. 2. 3. 4.

Customer name and address Date and invoice number Description of item sold Amount of revenue

The customer Accounts Receivable is debited, and Fees Earned is credited. A computerized accounting system does not require posting to a separate accounts receivable control account. In this case, the total accounts receivable reported on the balance sheet is merely the sum of the balances of the individual customer account balances. That is, the accounts receivable account summarizes the customer accounts automatically.

Controlling accounts are not posted at the end of the month in a computerized accounting system. Transactions are recorded through data input into electronic forms, into electronic special journals, or for infrequent transactions, by an electronic general journal. Balances of affected accounts are automatically posted and updated from the information recorded on the form. If desired, the computer can provide a printout of the monthly transaction history for a particular account, which provides the same information as a journal. In addition, the controlling account is not posted separately. In a manual system, separate posting to the controlling account provides additional control by reconciling the controlling account balance against the sum of the individual customer account balances. However, in a computerized accounting system, there are no separate postings to a controlling account because the computer is not going to make posting or mathematical errors. Therefore, there is no need for the additional control provided by posting a journal total to a controlling account.

CHAPTER 5

Accounting Systems

Ex. 5-23 a.

iTunes is an example of a B2C, or business-to-consumer, e-commerce application. The B, or business, is Apple. The C, or consumers, would mostly be individuals who purchase digital products from the iTunes Store.

Cash Fees Earned

15 15

The cash receipts journal would be used to record debits to Cash from cash sales or collections on account.

The electronic invoice form could be used for either transactions on account, as illustrated in the chapter, or for cash sales. The invoice form used for sales on account is different from the one used for cash sales. The latter invoice form makes a debit to Cash, rather than a debit to a customer account.

Sales made on B2C e-commerce transactions are computerized transactions, so a special journal is inappropriate. On an e-commerce site, the consumer inputs the transaction information on the web page; thus, there is no need for a separate electronic form for reentering the same information to record the sale. Essentially, the e-commerce application is the form that originates the sales transaction inside the accounting system. Accounting transactions flow directly from the shopping cart information directly into the accounting system.

Ex. 5-24 a.

Amazon.com

Dell Inc.

DowDuPont Inc.

Intuit Inc.

e. f.

L.L. Bean, Inc. W.W. Grainger, Inc.

B2C and B2B. Sells books, DVDs, and other products to individual consumers. Businesses can also set up pages on Amazon for a small fee. B2C and B2B. Sells computer products to both individuals and corporations. Its site separates individual and corporate sales. ®

B2B. Specialty chemicals. DuPont Direct is its B2B web application. B2C and B2B. Arranges its site for both individuals and businesses because its products are divided this way. B2C. Consumer clothes e-retailer. B2B. Sells maintenance, repair, and operating supplies to manufacturing companies.

CHAPTER 5

Accounting Systems

Ex. 5-25 a.

Horizontal analysis:

Americas China/Asia Pacific Channel Development EMEA Other Total revenues

Recent Year (in millions)

Prior Year (in millions)

$16,732 4,474 2,297 1,048 168 $24,719

$15,620 3,240 2,257 959 311 $22,387

Increase/(Decrease) Amount Percent

$1,112 1,234 40 89 (143) $2,332

7.1% 38.1% 1.8% 9.3%* (46.0)% 10.4%*

* Difference due to rounding. b.

Vertical analysis: Recent Year Amount Percent

Americas China/Asia Pacific Channel Development EMEA Other Total revenues

$16,732 4,474 2,297 1,048 168 $24,719

67.7% 18.1% 9.3% 4.2% 0.7% 100.0%

Prior Year Amount Percent

$15,620 3,240 2,257 959 311 $22,387

69.8% 14.5% 10.1% 4.3% 1.4% 100.0%*

* Difference due to rounding. c.

The horizontal analysis indicates that the total revenues of Starbucks increased by 10.4% from the prior year to the recent year. This increase is explained by Asian continued consumer preference for Starbucks coffee and continued expansion. Revenues increased by 38.1% in China/Asia Pacific versus 7.1% in the Americas and 9.3% in EMEA. This was a noticeable difference in growth. Apparently, there are more store openings in China/Asia Pacific than in the Americas. The vertical analysis indicates that the percent of Americas’ revenues to total revenues decreased slightly by (2.1%). In this same period, the percent of China/Asia Pacific to total revenues increased by 3.6%. The EMEA, Channel Development, and Other segments show mixed results. However, it is clear that the China/Asia Pacific segment is a primary growth engine for Starbucks.

CHAPTER 5

Accounting Systems

Ex. 5-26 a. Twenty-First Century Fox, Inc. Major Product Segments

For a Recent Year (in millions) $17,946 5,162 8,747 $31,855

Cable Network Programming Television Filmed Entertainment Total revenues b.

Percent 56.3% 16.2% 27.5% 100.0%

Twenty-First Century Fox, Inc. is moderately diversified. The Cable Network Programming segment has the largest percent of revenues to total revenues at 56.3%. This segment represents more than half the revenues of the company. However, Television and Filmed Entertainment have a percent of revenues to total revenues of 16.2% and 27.5%, which suggests a degree of diversification when all three are considered together.

CHAPTER 5

Accounting Systems

Ex. 5-27 a.

Horizontal analysis:

KFC Taco Bell Pizza Hut Total revenues b.

Year 2 (in millions)

Year 1 (in millions)

$2,644 2,056 988 $5,688

$3,105 1,880 893 $5,878

Increase/(Decrease) Amount Percent

$(461) 176 95 $(190)

(14.8)% 9.4% 10.6% (3.2)%

Vertical analysis: Year 2 Amount (in millions)

KFC Taco Bell Pizza Hut Total revenues

$2,644 2,056 988 $5,688

Year 1 Percent

46.5% 36.1% 17.4% 100.0%

Amount (in millions)

$3,105 1,880 893 $5,878

Percent

52.8% 32.0% 15.2% 100.0%*

* Difference due to rounding.

The total revenues have declined by 3.2% between the two years. The largest decline occurred in the KFC (−14.8%) segment. The vertical analysis indicates that KFC represents the largest segment as a percent of revenues (46.5%), followed by Taco Bell (36.1%) and Pizza Hut (17.4%). The KFC segment dropped significantly as a percent of revenues between the two years (52.8% vs. 46.5%), while Taco Bell and Pizza Hut grew as a percent of total revenues between the two years (32.0% vs. 36.1%) and (15.2% vs. 17.4%).

CHAPTER 5

Accounting Systems

PROBLEMS Prob. 5-1A 1. and 2. REVENUE JOURNAL Invoice No.

Date

21 22 24 27 30 30 31 31

July

1 2 3 4 5 6 7

Account Debited

Post. Ref.

JOURNAL Date

July

Supplies Fees Earned

115 350 85 225 170 120 105 1,170 (12) (41) 1

Page

Post. Ref.

Description

Accounts Rec. Dr. Fees Earned Cr.

      

J. Dunlop K. Tisdale T. Quinn F. Mintz D. Chase K. Tisdale T. Quinn

Page

13 41

Debit

Credit

300

CHAPTER 5

Accounting Systems

Prob. 5-1A (Continued) ACCOUNTS RECEIVABLE SUBSIDIARY LEDGER D. Chase

Name:

Item

Date

July

Debit

Credit

Balance

170

J. Dunlop

Name:

Post. Ref.

Item

Date

July

Debit

Credit

Balance

115

F. Mintz

Name:

Date

July

Post. Ref.

Item

Debit

Credit

Balance

225

T. Quinn

Name:

July

Post. Ref.

Item

Date

24 31

R1 R1

Debit

Credit

Balance

85 105

85 190

K. Tisdale

Name:

Date

July

Post. Ref.

Item

22 30

R1 R1

Debit

Credit

Balance

350 120

350 470

CHAPTER 5

Accounting Systems

Prob. 5-1A (Concluded) GENERAL LEDGER Accounts Receivable

Account:

Item

Date

July

Date

July

Debit

Item

Credit

1,170

25 31

Account No.

Post. Ref.

Debit

Item

Date

Balance Debit Credit

1,170

Credit

300

Balance Debit Credit

300

Fees Earned

Account:

July

Post. Ref.

Supplies

Account:

Account No.

Post. Ref.

Debit

J1 R1

Credit

300 1,170

Balance Debit Credit

300 1,470

a. b.

$1,170 ($170 + $115 + $225 + $190 + $470) $1,170

The computerized system is more efficient. Each sales transaction is entered into an electronic invoice form. The postings to the accounts receivable subsidiary and fees earned ledgers are automatic. Also, all sums and totals in the subsidiary ledgers are calculated automatically. There are no separate postings to an accounts receivable control account because there is no need to verify the accuracy of account totals. There is no math or posting error. The computerized system also provides management with current customer account balance information because the postings are automatic.

CHAPTER 5

Accounting Systems

Prob. 5-2A 1. and 5. GENERAL LEDGER Cash

Account:

Date

Apr.

Item

1 30

Item

Date

Apr.

1 25 30 30

Balance

Item

Date

1 25

Credit

Post. Ref.

 J1 R40 CR36

Balance

Item

Date

30 30

Debit

Balance Credit

11,350 45,740

34,390

Account No.

Debit

Credit

3,200 23,090 21,500

Balance Debit Credit

14,830 11,630 34,720 13,220 14

Account No.

Post. Ref.

 J1

Debit

Credit

Debit

Balance Credit

6,000 9,200

3,200

Fees Earned

Account:

Apr.

 CR36

Debit

Notes Receivable

Account:

Apr.

Balance

Post. Ref.

Accounts Receivable

Account:

Account No.

Post. Ref.

Debit

R40 CR36

Credit

23,090 12,890

Balance Debit Credit

23,090 35,980

CHAPTER 5

Accounting Systems

Prob. 5-2A (Continued) 2. and 4. ACCOUNTS RECEIVABLE SUBSIDIARY LEDGER Mendez Co.

Name:

Item

Date

Apr.

1 5 22

Item

Date

2 19

Post. Ref.

R40 CR36

Item

Date

Apr.

Credit

8,710 7,470

Balance

8,710 — 7,470

Debit

Credit

4,680 4,680

Balance

4,680 —

Pinecrest Co.

Name:

1 6 15 16 20

Post. Ref.

 R40 CR36 R40 CR36

Balance

Debit

Credit

1,990 6,120 5,500 1,990

Balance

6,120 8,110 1,990 7,490 5,500

Shilo Co.

Name:

Item

Date

Apr.

 CR36 R40

Balance

Debit

Ohr Co.

Name:

Apr.

Post. Ref.

13 25

Post. Ref.

R40 J1

Debit

Credit

3,450 3,200

Balance

3,450 250

CHAPTER 5

Accounting Systems

Prob. 5-2A (Continued) 3., 4., and 5. REVENUE JOURNAL Invoice No.

Date

Apr.

2 6 13 16 22 30

793 794 795 796 797

Account Debited

Ohr Co. Pinecrest Co. Shilo Co. Pinecrest Co. Mendez Co.

CASH RECEIPTS JOURNAL

Date

Apr.

Account Credited

5 15 19 20 30 30

Post. Ref.

Fees Earned Cr.

   

Mendez Co. Pinecrest Co. Ohr Co. Pinecrest Co. Fees Earned

12,890 12,890 (41)

Apr.

Notes Receivable Accounts Receivable—Shilo Co.

Accounts Rec. Dr. Fees Earned Cr.

    

4,680 1,990 3,450 5,500 7,470 23,090 (12) (41) 36

Page

Accts. Rec. Cr.

21,500 (12)

Cash Dr.

8,710 6,120 4,680 1,990 12,890 34,390 (11) 1

Page

Post. Ref.

Description

Post. Ref.

8,710 6,120 4,680 1,990

JOURNAL Date

Page

14 12/

Debit

Credit

3,200 3,200

The subsidiary account of Shilo Co. must also be posted for a $3,000 credit. 6.

The sum of the customer balances is in agreement with the controlling account. Both have balances of $13,220 ($7,470 + $5,500 + $250).

In an automated system, individual sales transactions are posted automatically to the general ledger at the time of the original transaction. Thus, there is no need to post summary totals to the general ledger accounts. The accounts receivable account reported on the balance sheet is often merely the sum of the individual customer accounts.

CHAPTER 5

Accounting Systems

Prob. 5-3A 1. and 4. GENERAL LEDGER Field Supplies

Account:

Date

Oct.

Item

1 31

Item

Date

1 31

Date

Balance

Item

1 5

Credit

Balance

Item

Date

1 31

Balance

Debit

Balance Credit

5,920 17,850

11,930

Account No.

Post. Ref.

 P30

Debit

Credit

Balance Debit Credit

750 1,780

1,030

Account No.

Post. Ref.

 P30

Debit

Credit

Debit

Balance Credit

12,300 16,280

3,980

Accounts Payable

Account:

Oct.

 P30

Debit

Office Equipment

Account:

Oct.

Post. Ref.

Office Supplies

Account:

Oct.

Balance

Account No.

Post. Ref.

Debit

 P30

Credit

16,940

Balance Debit Credit

1,170 18,110

CHAPTER 5

Accounting Systems

Prob. 5-3A (Continued) 2. and 3. ACCOUNTS PAYABLE SUBSIDIARY LEDGER Executive Office Supply Co.

Name:

Item

Date

Oct.

1 9 29

Debit

 P30 P30

Balance

Credit

320 310

Balance

390 710 1,020

Meade Co.

Name:

Item

Date

Oct.

1 2

Post. Ref.

Debit

 P30

Balance

Credit

400

Balance

780 1,180

Omni Co.

Name:

Item

Date

Oct.

14 24 31

Post. Ref.

Debit

P30 P30 P30

Credit

2,940 3,880 1,800

Balance

2,940 6,820 8,620

Peach Computers Co.

Name:

Item

Date

Oct.

Post. Ref.

Debit

P30

Credit

3,980

Balance

3,980

Yamura Co.

Name:

Item

Date

Oct.

Post. Ref.

13 17

Post. Ref.

P30 P30

Debit

Credit

1,420 1,890

Balance

1,420 3,310

1,800 11,930 (14)

1,420 2,940 1,890 3,880

1,030 (15)

310

320

400 Office Equipment

5-32

Supply chain management e-commerce applications would be used to plan and coordinate transactions with suppliers.

400 3,980 320 1,420 2,940 1,890 3,880 310 1,800 16,940 (21)

        

$18,110 ($1,020 + $1,180 + $8,620 + $3,980 + $3,310) $18,110

Meade Co. Peach Computers Co. Executive Office Supply Co. Yamura Co. Omni Co. Yamura Co. Omni Co. Executive Office Supply Co. Omni Co.

Other Accounts Dr.

Post. Ref.

Office Supplies Dr.

Accounts Payable Cr.

Field Supplies Dr.

Page

PURCHASES JOURNAL

a. b.

2 5 9 13 14 17 24 29 31 31

Account Credited

Post. Ref.

Accounting Systems

Oct.

Date

3. and 4.

Prob. 5-3A (Concluded)

CHAPTER 5

3,980 ()

3,980

Amount

Apr.

Date

16 16 17 23 30 30 30

1., 2., and 3.

Prob. 5-4A

     

Other Accounts Dr.

5-33

5,340 21,450 510 660 7,650 6,040 41,650 (21) 7,650 1,340 14,330 (14)

5,340

1,170 (15)

510 660 Field Equipment

Field Equipment

Post. Ref.

Office Supplies Dr.

Accounts Payable Cr.

Field Supplies Dr.

Page

Hydro Supply Co. Pure Equipment Co. Best Office Supply Co. Best Office Supply Co. Hydro Supply Co. Pure Equipment Co.

Account Credited

Post. Ref.

Accounting Systems

PURCHASES JOURNAL

CHAPTER 5

4,700 26,150 ()

21,450

Amount

CHAPTER 5

Accounting Systems

Prob. 5-4A (Continued) CASH PAYMENTS JOURNAL

Ck. No.

Date

Apr.

16 19

1 2

23 24 26 30 30 30

3 4 5 6 7

Account Debited

Post. Ref.

Rent Expense Field Supplies Office Supplies Land Hydro Supply Co. Pure Equipment Co. Best Office Supply Co. Salary Expense

71 14 15 19    61

Other Accounts Dr.

Page

Accounts Payable Dr.

Cash Cr.

3,500 3,340 400 140,000 5,340 21,450 510 29,400 176,640 ()

27,300 (21)

3,500 3,340 400 140,000 5,340 21,450 510 29,400 203,940 (11)

1. and 2. JOURNAL Date

Apr.

Post. Ref.

Description

Land Field Equipment

Page

19 17

Debit

Credit

12,000 12,000

CHAPTER 5

Accounting Systems

Prob. 5-4A (Continued) 1. ACCOUNTS PAYABLE SUBSIDIARY LEDGER Best Office Supply Co.

Name:

Item

Date

Apr.

17 23 30

P1 P1 CP1

Debit

Credit

510 660 510

Balance

510 1,170 660

Hydro Supply Co.

Name:

Item

Date

Apr.

16 24 30

Post. Ref.

P1 CP1 P1

Debit

Credit

5,340 5,340 7,650

Balance

5,340 — 7,650

Pure Equipment Co.

Name:

Item

Date

Apr.

Post. Ref.

16 26 30

Post. Ref.

P1 CP1 P1

Debit

Credit

21,450 21,450 6,040

Balance

21,450 — 6,040

CHAPTER 5

Accounting Systems

Prob. 5-4A (Continued) 2. and 3. GENERAL LEDGER Cash

Account:

Date

Apr.

Item

19 30

Date

Item

19 30

Item

16 30 30

Debit

CP1 P1

3,340 14,330

23 30

203,940

Credit

Debit

Post. Ref.

Debit

3,340 17,670

Credit

400 1,170

Debit

400 1,570

Credit

21,450 4,700 12,000

Debit

CP1 J1

140,000 12,000

Credit

Balance Debit Credit

21,450 26,150 14,150 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Post. Ref.

Balance Credit

Account No.

P1 P1 J1

Item

Date

Apr.

Post. Ref.

Land

Account:

Balance Credit

Account No.

CP1 P1

Date

Debit

203,940

Field Equipment

Account:

Apr.

Credit

Office Supplies

Account:

Apr.

Debit

CP1

Date

Apr.

Post. Ref.

Field Supplies

Account:

Account No.

Balance Debit Credit

140,000 152,000

CHAPTER 5

Accounting Systems

Prob. 5-4A (Concluded) Accounts Payable

Account:

Date

Apr.

Item

30 30

Date

Apr.

Item

Debit

P1 CP1

27,300

Credit

Date

Item

Debit

Balance Credit

41,650

41,650 14,350 61

Account No.

Post. Ref.

Debit

CP1

29,400

Credit

Balance Debit Credit

29,400

Rent Expense

Account:

Apr.

Post. Ref.

Salary Expense

Account:

Account No.

Post. Ref.

CP1

Debit

Credit

3,500

Balance Debit Credit

3,500

4. AquaFresh Water Testing Service Accounts Payable Creditor Balances April 30 Best Office Supply Co. Hydro Supply Co. Pure Equipment Co. Total accounts payable*

660 7,650 6,040 $14,350

* The total of the schedule of accounts payable is equal to the balance of the accounts payable control account.

A subsidiary ledger for the field equipment would allow the company to track each piece of equipment with respect to cost, location, useful life, and other data. Such information would be useful for safeguarding equipment and determining depreciation.

CHAPTER 5

Accounting Systems

Prob. 5-5A 1., 3., and 4. GENERAL LEDGER Cash

Account:

Date

Dec.

Item

1 31 31

Date

Item

1 31 31

1 20 31

Debit

150,180

202,430 269,890 119,710

67,460

Post. Ref.

 R35 CR31

Account No.

Debit

Credit

24,060 18,380

Balance

Post. Ref.

 J1 P37

Item

Date

1 31 31

Balance

Debit

Credit

4,010 4,070

Date

Item

1 6

Balance

16,200 40,260 21,880

Debit

 CP34 P37

Credit

13,580 9,570 13,640

Debit

 P37

6,130 6,560 7,530

430 970

Debit

5,630

Balance Credit

Account No.

Post. Ref.

Balance Credit

Account No.

Post. Ref.

Balance Credit

Account No.

Office Equipment

Account:

Debit

Balance Credit

Credit

Office Supplies

Account:

Dec.

Balance

Item

Date

Dec.

 CR31 CP34

Debit

Maintenance Supplies

Account:

Dec.

Balance

Post. Ref.

Accounts Receivable

Account:

Dec.

Account No.

Credit

Balance Debit Credit

35,680 41,310

CHAPTER 5

Accounting Systems

Prob. 5-5A (Continued) Accumulated Depreciation—Office Equipment

Account:

Date

Item

Dec.

Date

Account:

Date

 P37 CP34

Debit

Credit

Account No.

Post. Ref.

Debit

Credit

Balance

18,400

Account No.

Post. Ref.

 P37 CP34

Debit

Credit

Balance Debit Credit

4,910 62,280 5,040

57,370 57,240

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit



Balance

Item

Balance Debit Credit



362,140

S. Holmes, Drawing

Date

Balance Debit Credit

Accumulated Depreciation—Vehicles

Item

Account:

Dec.

Post. Ref.

46,700 49,830

Balance

Account No.

S. Holmes, Capital

Account:

Balance Credit

120,070 166,770 216,600

Item

1 31 31

Debit

8,640

Accounts Payable

Account:

Dec.

Balance

Item

Date

Dec.

Credit



Balance

Item

1 5 16

Dec.

Debit

Vehicles

Account:

Dec.

Post. Ref.

Account No.

Post. Ref.

CP34

Account No.

Debit

3,760

Credit

Debit

Balance Credit

3,760

CHAPTER 5

Accounting Systems

Prob. 5-5A (Continued) Fees Earned

Account:

Date

Dec.

Item

16 31 31

Post. Ref.

Debit

CR31 CR31 R35 Driver Salaries Expense

Date

Post. Ref.

Debit

CP34

21,160

Dec.

Date

Item

Date

Item

Date

Credit

4,010

Date

Post. Ref.

CP34

Item

Balance Debit Credit

Debit

Credit

750

Credit

8,890

Debit

CP34

Debit

5,260

Balance Credit

8,890 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Debit

Balance Debit Credit

Account No.

Post. Ref.

4,010

Rent Expense

Account:

25,420 49,080 73,140

Account No.

Debit

CP34

Item

Balance Credit

21,160

Office Salaries Expense

Account:

Dec.

Credit

Fuel Expense

Account:

Dec.

Post. Ref.

Debit

Account No.

Maintenance Supplies Expense

Account:

Dec.

Credit

25,420 23,660 24,060

Account:

Item

Account No.

Credit

Debit

Balance Credit

5,260

CHAPTER 5

Accounting Systems

Prob. 5-5A (Continued) Advertising Expense

Account:

Date

Dec.

Item

CP34

Debit

Credit

2,230

Date

Item

Post. Ref.

Debit

CP34

630

Debit

Balance Credit

2,230

Miscellaneous Administrative Expense

Account:

Dec.

Post. Ref.

Account No.

Credit

Debit

Balance Credit

630

Dec.

Date

Dec.

Date

2. and 4.

3 10 12 16 25 31 31

5 6 18 19 23 31 46,700 5,630 2,190 2,350 500 57,370 (21)

Accounts Payable Cr.

   41  41

Post. Ref.

23,660 49,080 ()

25,420

Other Accounts Cr.

5-42

18,380 (12)

5,130

6,010 5,060 2,180

Accounts Receivable Cr.

Page

4,070 (14)

2,190 1,880

Maintenance Supplies Dr.

6,010 5,060 2,180 25,420 5,130 23,660 67,460 (11)

Cash Dr.

470 500 970 (15)

Vehicles Office Equipment

Other Accounts Dr.

Account Credited

Ryan Co. Sing Co. Clifford Co. Fees Earned Ryan Co. Fees Earned

    

Post. Ref.

Office Supplies Dr.

Accounting Systems

PURCHASES JOURNAL

CASH RECEIPTS JOURNAL

Account Credited

Platinum Motors Austin Computer Co. Essential Supply Co. McClain Co. Office To Go Inc.

Prob. 5-5A (Continued)

CHAPTER 5

18 16

Post. Ref.

Page

52,330 ()

46,700 5,630

Amount

CHAPTER 5

Accounting Systems

Prob. 5-5A (Continued) 2. and 4. REVENUE JOURNAL Invoice No.

Date

2 6 10 24 25 31

Dec.

940 941 942 943 944

Account Debited

Clifford Co. Ernesto Co. Joy Co. Sing Co. Ernesto Co.

Page Post. Ref.

Accounts Rec. Dr. Fees Earned Cr.

    

2,180 4,850 2,470 7,640 6,920 24,060 (12) (41)

CASH PAYMENTS JOURNAL Ck. No.

Date

Dec.

Account Debited

610

Rent Expense

9 10 11 11 13 16 17 20 24 26 30

611 612 613 614 615 616 617 618 619 620 621

31 31

622

Fuel Expense Office To Go Inc. Essential Supply Co. Porter Co. Platinum Motors Vehicles Misc. Admin. Expense Advertising Expense S. Holmes, Drawing Austin Computer Co. Driver Salaries Exp. Office Salaries Exp. Office Supplies

Post. Ref.

Other Accounts Dr.

Page Accounts Payable Dr.

Cash Cr.

62 53    

5,260

750

18 64 63 32 

49,830 630 2,230 3,760

51 61 15

21,160 8,890 430 92,940

57,240

750 410 3,870 630 46,700 49,830 630 2,230 3,760 5,630 21,160 8,890 430 150,180

()

(21)

(11)

410 3,870 630 46,700

5,630

CHAPTER 5

Accounting Systems

Prob. 5-5A (Concluded) 3. Date

Dec.

JOURNAL Description

20 Maintenance Supplies Expense Maintenance Supplies

Page

Post. Ref.

52 14

Debit

Credit

4,010 4,010

Fleetfoot Courier Company Unadjusted Trial Balance December 31

Cash Accounts Receivable Maintenance Supplies Office Supplies Office Equipment Accumulated Depreciation—Office Equipment Vehicles Accumulated Depreciation—Vehicles Accounts Payable S. Holmes, Capital S. Holmes, Drawing Fees Earned Driver Salaries Expense Maintenance Supplies Expense Fuel Expense Office Salaries Expense Rent Expense Advertising Expense Miscellaneous Administrative Expense

Account No.

Debit Balances

11 12 14 15 16 17 18 19 21 31 32 41 51 52 53 61 62 63 64

119,710 21,880 13,640 7,530 41,310

Credit Balances

8,640 216,600 18,400 5,040 362,140 3,760 73,140 21,160 4,010 750 8,890 5,260 2,230 630 467,360

467,360

CHAPTER 5

Accounting Systems

Prob. 5-1B 1. and 2. REVENUE JOURNAL Invoice No.

Date

Jan.

18 20 24 27 28 30 31 31

1 2 3 4 5 6 7

Account Debited

Murphy Co. Qwik-Mart Co. Hopkins Co. Carson Co. Amber Waves Co. Qwik-Mart Co. Hopkins Co.

Post. Ref.

Accounts Rec. Dr. Fees Earned Cr.

      

490 340 750 680 120 200 295 2,875 (12) (41)

JOURNAL Date

Jan.

Supplies Fees Earned

Page

Post. Ref.

Description

Page

14 41

Debit

Credit

100

CHAPTER 5

Accounting Systems

Prob. 5-1B (Continued) ACCOUNTS RECEIVABLE SUBSIDIARY LEDGER Amber Waves Co.

Name:

Item

Date

Jan.

Debit

Credit

Balance

120

Carson Co.

Name:

Date

Jan.

Post. Ref.

Item

Debit

Credit

Balance

680

Hopkins Co.

Name:

Jan.

Post. Ref.

Item

Date

24 31

R1 R1

Debit

Credit

750 295

Balance

750 1,045

Murphy Co.

Name:

Post. Ref.

Item

Date

Jan.

Debit

Credit

Balance

490

Qwik-Mart Co.

Name:

Post. Ref.

Item

Date

Jan.

Post. Ref.

20 30

R1 R1

Debit

Credit

Balance

340 200

340 540

CHAPTER 5

Accounting Systems

Prob. 5-1B (Concluded) GENERAL LEDGER Accounts Receivable

Account:

Item

Date

Jan.

Debit

Credit

2,875

Date

Item

Post. Ref.

Debit

Item

Date

Account No.

Credit

100

Balance Debit Credit

100

Fees Earned

Account:

Balance Debit Credit

2,875

Supplies

Account:

Jan.

Post. Ref.

Account No.

Post. Ref.

Debit

J1 R1

Credit

100 2,875

Debit

Balance Credit

Jan.

28 31

100 2,975

a. b.

$2,875 ($120 + $680 + $1,045 + $490 + $540) $2,875

CHAPTER 5

Accounting Systems

Prob. 5-2B 1. and 5. GENERAL LEDGER Cash

Account:

Date

June

Item

1 30

Date

June

Item

1 30 30 30

Date

Balance

Item

1 30

Credit

Post. Ref.

 J1 R40 CR36

Balance

Item

Date

30 30

Debit

Balance Credit

28,340 42,660

14,320

Account No.

Debit

Credit

2,780 9,590 7,340

Balance Debit Credit

4,090 1,310 10,900 3,560 18

Account No.

Post. Ref.

 J1

Debit

Credit

Debit

Balance Credit

53,620 56,400

2,780

Fees Earned

Account:

June

 CR36

Debit

Office Equipment

Account:

June

Balance

Post. Ref.

Accounts Receivable

Account:

Account No.

Post. Ref.

Debit

R40 CR36

Credit

9,590 6,980

Balance Debit Credit

9,590 16,570

CHAPTER 5

Accounting Systems

Prob. 5-2B (Continued) 2. and 4. ACCOUNTS RECEIVABLE SUBSIDIARY LEDGER Auto-Flex Co.

Name:

Item

Date

June

1 3 23

Item

Date

1 7 14 16 20

Post. Ref.

 R40 CR36 R40 CR36

Balance

Item

Date

10 30

2,580 1,330

Balance

2,580 — 1,330

Debit

Credit

1,040 1,510 620 1,040

Balance

1,510 2,550 1,040 1,660 620

Post. Ref.

R40 J1

Debit

Credit

4,390 2,780

Balance

4,390 1,610

Yee Co.

Name:

Item

Date

June

Credit

Ridge Communities

Name:

June

 CR36 R40

Balance

Debit

Cooper Development Co.

Name:

June

Post. Ref.

2 18

Post. Ref.

R40 CR36

Debit

Credit

2,210 2,210

Balance

2,210 —

CHAPTER 5

Accounting Systems

Prob. 5-2B (Continued) 3., 4., and 5. REVENUE JOURNAL Invoice No.

Date

June

2 7 10 16 23 30

717 718 719 720 721

Account Debited

Yee Co. Cooper Development Co. Ridge Communities Cooper Development Co. Auto-Flex Co.

CASH RECEIPTS JOURNAL

Date

June

Post. Ref.

Account Credited

3 14 18 20 30 30

Fees Earned Cr.

   

Auto-Flex Co. Cooper Development Co. Yee Co. Cooper Development Co. Fees Earned

6,980 6,980 (41)

June

30 Office Equipment Accounts Receivable—Ridge Communities

Accounts Rec. Dr. Fees Earned Cr.

    

2,210 1,040 4,390 620 1,330 9,590 (12) (41) 36

Page

Accts. Rec. Cr.

7,340 (12)

Cash Dr.

2,580 1,510 2,210 1,040 6,980 14,320 (11) 1

Page

Post. Ref.

Description

Post. Ref.

2,580 1,510 2,210 1,040

JOURNAL Date

Page

Debit

Credit

2,780

12/

2,780

The subsidiary account for Ridge Communities must also be posted for a $2,780 credit.

CHAPTER 5

Accounting Systems

Prob. 5-2B (Concluded) 6.

The sum of the customer balances is in agreement with the controlling account. Both have balances of $3,560 ($1,330 + $620 + $1,610).

CHAPTER 5

Accounting Systems

Prob. 5-3B 1. and 4. GENERAL LEDGER Field Supplies

Account:

Date

May

Item

1 31

Item

Date

1 31

Date

Balance

Item

1 19

Credit

Balance

Item

Date

1 31

Balance

Debit

Balance Credit

6,200 23,100

16,900

Account No.

Post. Ref.

 P30

Debit

Credit

Balance Debit Credit

1,490 2,595

1,105

Account No.

Post. Ref.

 P30

Debit

Credit

Debit

Balance Credit

19,400 27,550

8,150

Accounts Payable

Account:

May

 P30

Debit

Office Equipment

Account:

May

Post. Ref.

Office Supplies

Account:

May

Balance

Account No.

Post. Ref.

Debit

 P30

Credit

26,155

Balance Debit Credit

5,145 31,300

CHAPTER 5

Accounting Systems

Prob. 5-3B (Continued) 2. and 3. ACCOUNTS PAYABLE SUBSIDIARY LEDGER Accu-Vision Supply Co.

Name:

Item

Date

May

1 19

Debit

 P30

Balance

Credit

8,150

Balance

3,900 12,050

J-Mart Co.

Name:

Item

Date

May

1 15 26

Post. Ref.

Debit

 P30 P30

Balance

Credit

500 265

Balance

730 1,230 1,495

Lassiter Co.

Name:

Item

Date

May

1 3

Post. Ref.

Debit

 P30

Balance

Credit

Balance

515 855

340

Tri Cities Supplies

Name:

Item

Date

May

Post. Ref.

8 23 30

Debit

P30 P30 P30

Credit

4,500 2,450 3,040

Balance

4,500 6,950 9,990

Wendell Co.

Name:

Date

May

Post. Ref.

Item

Post. Ref.

1 12

P30 P30

Debit

Credit

3,240 3,670

Balance

3,240 6,910

3,040 16,900 (14)

2,450

4,500 3,670

3,240

1,105 (15)

265

500

340

Office Supplies Dr.

Office Equipment

Other Accounts Dr.

Page

Post. Ref.

Supply chain management e-commerce applications would be used to plan and coordinate transactions with suppliers.

3,240 340 4,500 3,670 500 8,150 2,450 265 3,040 26,155 (21)

Field Supplies Dr.

        

$31,300 ($12,050 + $1,495 + $855 + $9,990 + $6,910) $31,300

Wendell Co. Lassiter Co. Tri Cities Supplies Wendell Co. J-Mart Co. Accu-Vision Supply Co. Tri Cities Supplies J-Mart Co. Tri Cities Supplies

Accounts Payable Cr.

a. b.

1 3 8 12 15 19 23 26 30 31

Account Credited

Post. Ref.

PURCHASES JOURNAL

Accounting Systems

May

Date

3. and 4.

Prob. 5-3B (Concluded)

CHAPTER 5

8,150 ()

8,150

Amount

Oct.

Date

16 17 20 28 30 30 31

1., 2., and 3.

Prob. 5-4B

     

5-55

32,600 9,780 1,320 3,670 30,800 12,450 90,620 (21)

Accounts Payable Cr.

25,300 12,450 47,530 (14)

9,780

Field Supplies Dr.

4,990 (15)

1,320 3,670

Office Supplies Dr.

Office Equipment

Field Equipment

Other Accounts Dr.

Petro Services Inc. Midland Supply Co. A-One Office Supply Co. A-One Office Supply Co. Petro Services Inc. Midland Supply Co.

Account Credited

Post. Ref.

Accounting Systems

PURCHASES JOURNAL

CHAPTER 5

Post. Ref.

Page

38,100 ()

5,500

32,600

Amount

CHAPTER 5

Accounting Systems

Prob. 5-4B (Continued) 1. and 2. JOURNAL Date

Oct.

Page

Post. Ref.

Description

31 Prepaid Rent Field Equipment

16 17

Debit

Credit

15,000 15,000

1., 2., and 3. CASH PAYMENTS JOURNAL

Ck. No.

Date

Oct.

16 18

1 2

24 26 28 30 31 31

3 4 5 6 7

Account Debited

Post. Ref.

Rent Expense Field Supplies Office Supplies Petro Services Inc. Midland Supply Co. Land A-One Office Supply Co. Salary Expense

71 14 15   19  61

Other Accounts Dr.

Page

Accounts Payable Dr.

Cash Cr.

7,000 4,570 650 32,600 9,780 240,000 1,320 32,000 284,220 ()

43,700 (21)

7,000 4,570 650 32,600 9,780 240,000 1,320 32,000 327,920 (11)

CHAPTER 5

Accounting Systems

Prob. 5-4B (Continued) 1. ACCOUNTS PAYABLE SUBSIDIARY LEDGER A-One Office Supply Co.

Name:

Item

Date

Oct.

20 28 30

P1 P1 CP1

Debit

Credit

1,320 3,670 1,320

Balance

1,320 4,990 3,670

Midland Supply Co.

Name:

Item

Date

Oct.

17 26 30

Post. Ref.

P1 CP1 P1

Debit

Credit

9,780 9,780 12,450

Balance

9,780 — 12,450

Petro Services Inc.

Name:

Item

Date

Oct.

Post. Ref.

16 24 30

Post. Ref.

P1 CP1 P1

Debit

Credit

32,600 32,600 30,800

Balance

32,600 — 30,800

CHAPTER 5

Accounting Systems

Prob. 5-4B (Continued) 2. and 3. GENERAL LEDGER Cash

Account:

Date

Oct.

Item

18 31

Date

Item

18 31

Date

Oct.

Item

16 31

Debit

CP1 P1

4,570 47,530

Credit

Date

Debit

Post. Ref.

Debit

Credit

650 4,990

Debit

15,000

650 5,640

Credit

Debit

15,000

Credit

32,600 15,000

Debit

5,500

Credit

Balance Debit Credit

32,600 17,600 Account No.

Post. Ref.

Balance Debit Credit

Account No.

Post. Ref.

Balance Debit Credit

Account No.

Post. Ref.

Balance Credit

Account No.

P1 J1

Item

327,920

4,570 52,100

Office Equipment

Account:

Oct.

Post. Ref.

Field Equipment

Account:

Balance Credit

Account No.

CP1 P1

Item

Date

Debit

327,920

Prepaid Rent

Account:

Oct.

Credit

Office Supplies

Account:

Oct.

Debit

CP1

Item

Date

Oct.

Post. Ref.

Field Supplies

Account:

Account No.

Balance Debit Credit

5,500

CHAPTER 5

Accounting Systems

Prob. 5-4B (Concluded) Land

Account:

Date

Item

Oct.

Date

Oct.

Item

31 31

Date

Item

CP1

240,000

Credit

Date

Item

Debit

Balance Credit

240,000 21

Account No.

Post. Ref.

Debit

P1 CP1

43,700

Credit

Balance Debit Credit

90,620

90,620 46,920 61

Account No.

Post. Ref.

Debit

CP1

32,000

Credit

Balance Debit Credit

32,000

Rent Expense

Account:

Oct.

Debit

Salary Expense

Account:

Oct.

Post. Ref.

Accounts Payable

Account:

Account No.

Post. Ref.

CP1

Debit

Credit

7,000

Balance Debit Credit

7,000

4. West Texas Exploration Co. Accounts Payable Creditor Balances October 31 A-One Office Supply Co. Midland Supply Co. Petro Services Inc. Total accounts payable*

$ 3,670 12,450 30,800 $46,920

* The total of the schedule of accounts payable is equal to the balance of the accounts payable control account.

CHAPTER 5

Accounting Systems

Prob. 5-5B 1., 3., and 4. GENERAL LEDGER Cash

Account:

Date

Mar.

Item

1 31 31

Date

Item

1 31 31

1 20 31

Debit

135,365

65,200 161,250 25,885

96,050

Post. Ref.

 R35 CR31

Account No.

Debit

Credit

39,540 38,950

Balance

Post. Ref.

 J1 P37

Item

Date

1 31 31

Balance

Debit

Credit

4,400 5,070

Date

Item

1 3

Balance

31,950 71,490 32,540

Debit

 CP34 P37

Debit

Credit

7,240 2,840 7,910

Debit

 P37

3,690 4,290 6,780

600 2,490

Debit

1,570

Balance Credit

Account No.

Post. Ref.

Balance Credit

Account No.

Post. Ref.

Balance Credit

Account No.

Office Equipment

Account:

Debit

Balance Credit

Credit

Office Supplies

Account:

Mar.

Balance

Item

Date

Mar.

 CR31 CP34

Debit

Maintenance Supplies

Account:

Mar.

Balance

Post. Ref.

Accounts Receivable

Account:

Mar.

Account No.

Credit

Balance Debit Credit

17,300 18,870

CHAPTER 5

Accounting Systems

Prob. 5-5B (Continued) Accumulated Depreciation—Office Equipment

Account:

Date

Item

Mar.

Date

Item

1 2 16

Account:

Date

Post. Ref.

 P37 CP34

Debit

Credit

Date

Account No.

Balance

Item

Balance Debit Credit

Accumulated Depreciation—Vehicles

Balance

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit



17,800 21

Account No.

Post. Ref.

 P37 CP34

Debit

Credit

Balance Debit Credit

2,755 38,785 7,560

36,030 31,225

Account No.

Post. Ref.

Debit

Credit

Balance Debit Credit



162,975

J. Wu, Drawing

Account:

Mar.

4,250

26,900 28,500

Item

Balance Credit



J. Wu, Capital

Account:

Debit

62,400 89,300 117,800

Item

1 31 31

Mar.

Credit

Accounts Payable

Account:

Mar.

Balance

Item

Date

Mar.

Debit

Vehicles

Account:

Mar.

Balance

Post. Ref.

Account No.

Post. Ref.

CP34

Debit

4,000

Credit

Debit

Balance Credit

4,000

CHAPTER 5

Accounting Systems

Prob. 5-5B (Continued) Fees Earned

Account:

Date

Mar.

Item

16 31 31

Date

Mar.

Post. Ref.

Debit

CR31 CR31 R35

Item

Post. Ref.

Debit

Date

Post. Ref.

Debit

CP34

33,300

Date

Mar.

Item

Post. Ref.

Date

Item

Post. Ref.

Debit

Credit

Date

Debit

CP34

21,200

Balance Debit Credit

4,400

Credit

820

Post. Ref.

Balance Debit Credit

Account No.

Office Salaries Expense

900

33,300

4,400

Account:

Mar.

Credit

Balance Credit

Account No.

Debit

CP34

Item

Debit

Account No.

Fuel Expense

Account:

Mar.

Credit

Maintenance Supplies Expense

Account:

26,800 56,200 95,740

900

Driver Salaries Expense Item

Balance Credit

Account No.

CR31

Debit

26,800 29,400 39,540

Account:

Mar.

Credit

Rent Revenue

Account:

Account No.

Balance Debit Credit

820 Account No.

Credit

Balance Debit Credit

21,200

CHAPTER 5

Accounting Systems

Prob. 5-5B (Continued) Rent Expense

Account:

Date

Item

Mar.

Date

CP34

Item

Debit

Credit

2,450

Post. Ref.

CP34

Date

Item

Post. Ref.

CP34

Balance Debit Credit

Account No.

Debit

Credit

8,590

Debit

4,680

2,450 63

Balance Debit Credit

8,590

Miscellaneous Administrative Expense

Account:

Mar.

Post. Ref.

Advertising Expense

Account:

Mar.

Account No.

Credit

Balance Debit Credit

4,680

Mar.

Date

Mar.

Date

2. and 4.

6 10 12 16 18 25 31

2 3 18 19 21 31 26,900 1,570 2,430 4,140 990 36,030 (21)

Accounts Payable Cr.

   41 42  41

Post. Ref.

29,400 57,100 ()

26,800 900

Other Accounts Cr.

5-64

38,950 (12)

14,000

7,950 10,000 7,000

Accounts Receivable Cr.

Page

5,070 (14)

2,430 2,640

Maintenance Supplies Dr.

7,950 10,000 7,000 26,800 900 14,000 29,400 96,050 (11)

Cash Dr.

1,500 990 2,490 (15)

Vehicles Office Equipment

Other Accounts Dr.

Account Credited

Chavez Co. Sajeev Co. Ellis Co. Fees Earned Rent Revenue Chavez Co. Fees Earned

    

Post. Ref.

Office Supplies Dr.

Accounting Systems

PURCHASES JOURNAL

CASH RECEIPTS JOURNAL

Account Credited

McIntyre Sales Co. Office Mate Inc. Bastille Co. Master Supply Co. Office City

Prob. 5-5B (Continued)

CHAPTER 5

18 16

Post. Ref.

Page

28,470 ()

26,900 1,570

Amount

CHAPTER 5

Accounting Systems

Prob. 5-5B (Continued) 2. and 4. REVENUE JOURNAL Invoice No.

Date

Mar.

5 7 11 24 25 31

91 92 93 94 95

Account Debited

Ellis Co. Trent Co. Jarvis Co. Sajeev Co. Trent Co.

Page Post. Ref.

Accounts Rec. Dr. Fees Earned Cr.

    

7,000 9,840 7,200 9,200 6,300 39,540 (41) (12)

CASH PAYMENTS JOURNAL

Date

Mar.

1 9 10 10 11 13 16 17 20 26 27 30 31 31 31

Ck. No.

Post. Ref.

Account Debited

205 206 207 208 209 210 211 212 213 214 215 216 217 218

Rent Expense Fuel Expense Office City Bastille Co. Porter Co. McIntyre Sales Co. Vehicles Misc. Admin. Expense Advertising Expense Office Mate Inc. J. Wu, Drawing Driver Salaries Expense Office Salaries Expense Office Supplies

Other Accounts Dr.

62 53    

2,450 820

18 64 63 

28,500 4,680 8,590

32 51 61 15

4,000 33,300 21,200 600 104,140

Accounts Payable Dr.

Cash Cr.

31,225

2,450 820 450 1,890 415 26,900 28,500 4,680 8,590 1,570 4,000 33,300 21,200 600 135,365

(21)

(11)

450 1,890 415 26,900

1,570

()

Page

CHAPTER 5

Prob. 5-5B (Concluded) 3. Date

Mar.

Accounting Systems

JOURNAL Post. Ref.

Description

20 Maintenance Supplies Expense Maintenance Supplies

Page

52 14

Debit

Credit

4,400 4,400

AM Express Company Unadjusted Trial Balance March 31 Account No.

Cash Accounts Receivable Maintenance Supplies Office Supplies Office Equipment Accumulated Depreciation—Office Equipment Vehicles Accumulated Depreciation—Vehicles Accounts Payable J. Wu, Capital J. Wu, Drawing Fees Earned Rent Revenue Driver Salaries Expense Maintenance Supplies Expense Fuel Expense Office Salaries Expense Rent Expense Advertising Expense Miscellaneous Administrative Expense

11 12 14 15 16 17 18 19 21 31 32 41 42 51 52 53 61 62 63 64

Debit Balances

Credit Balances

25,885 32,540 7,910 6,780 18,870 4,250 117,800 17,800 7,560 162,975 4,000 95,740 900 33,300 4,400 820 21,200 2,450 8,590 4,680 289,225

289,225

CHAPTER 5

Accounting Systems

CASES & PROJECTS CP 5-1 a.

The half-price offer is a normal business practice so long as it is not the result of price collusion with other competitors or is considered “unfair pricing” according to federal statutes. Many businesses offer low initial services to entice customers to a subscription service. For example, cable and satellite companies often offer premium channels, such as HBO, for free for the first several months of service. The business objective of low initial pricing is to demonstrate the value of the service so that customers will elect to continue the service at the full subscription price. Thus, there is nothing inherently unethical about such a practice, and it is considered a fairly typical business practice.

Customer “lock-in” can be unethical if it is the result of fixing prices or acquiring competitors to achieve monopolistic concentration within an industry. However, in this case, the customer lock-in is a function and nature of the product. Namely, the data that are created by the product cannot be easily migrated to another application. Note that Netbooks is not denying the customer ownership of the data; rather, Netbooks is making it costly to switch. Such lock-in is not considered an unethical business practice. Indeed, we see such lock-in characteristics in many settings. For example: ● Razor blades are designed to be used only by the handle of the manufacturer.

Thus, customers become locked in to the razor blades of the handle manufacturer. This is such a common strategy in many arenas that it has been termed the “razor blade strategy.” ● Movie theaters prevent customers from walking in with refreshments, thus

locking theater goers in to the popcorn and refreshment stand of the theater. Theater pricing of refreshments reflects this lock-in. ® ● Sony designs video games so that they only work on its PlayStation

equipment. Therefore, the games are locked in to the consoles. This allows Sony and its licensees to limit and control competition for games. ● Many manufacturers control replacement parts for equipment by custom-

designing the parts. Customers then become locked in to the original manufacturer for replacement parts. ● Apple Inc.’s iTunes purchases can only be played using the Apple Music app.

Thus, Apple reduces competition for songs for its player and locks customers in to its music platform. Apple employs the same lock-in strategy for its Mac® operating system.

CHAPTER 5

Accounting Systems

CP 5-2 Note to Instructors: While the list of functions and services can be quite large, the key services are identified below. The purpose of these services is fairly advanced for most students. The activity asks for a listing rather than an explanation because most students have limited experience by which to provide much explanation. Use this case to demonstrate the scope and basic nature of these application tools. Selected JDA Supply Chain Management Solutions ● ● ● ● ● ● ● ● ● ● ●

Demand management Factory planning and scheduling Merchandise operations Supplier relationship management Transportation and logistics management Space and category management Visibility, collaboration, and performance management Inventory optimization Planning on demand Replenishment and fulfillment Customer order management

Selected Salesforce.com Customer Relationship Management Solutions ●

Provide the sales force with real-time information about all customer contacts with the firm to improve the effectiveness of the sales call

●

Provide real-time forecast estimation and accumulation tools

●

Support promotion plans and integrate the plans with forecasting and manufacturing

●

Provide decision tools for evaluating marketing campaign effectiveness

●

Provide tools to support call center responsiveness

CHAPTER 5

Accounting Systems

CP 5-3 MEMORANDUM To: From: Re:

Senior Management Student Cloud-based accounting software

A new approach to automating our accounting requirements is now available. It is called cloud-based accounting using a cloud computing provider. Rather than purchasing our accounting software and loading it on our own computers, cloudbased accounting software is rented and resides on the provider’s computers. Our data, along with the accounting software, stay with the provider. There are several advantages to this approach. 1.

We don’t need to administer the application or data on our own computers. This becomes the job of the service provider, thus saving us computer system personnel costs. All we need is a desktop computer and a browser to use the software.

Our people can work with our data anytime or anyplace. We don’t need to rely on our own internal computer network for accounting-related work. Instead, this product is available on the Internet. So, we can enter transactions and access our accounting data from anywhere in the world, meaning that we don’t have to be plugged into our corporate network. This also will save us network support costs.

We don’t need to purchase and load software upgrades. All upgrades are provided on the provider’s server when they are available. Thus, we are always using the latest version.

Providers promise a highly secure environment for our data.

A cloud-based accounting system should help us when data, such as orders, are passed between us and our customers and suppliers.

We also need to consider a number of disadvantages. 1.

The cost of the software is recurring. Thus, we are trading the recurring costs of maintaining our system infrastructure for the recurring cost of the service. A financial analysis should be conducted to determine whether the service is costeffective.

The Internet can be slow. During busy times, we may experience slow response times.

Our data physically reside with the service provider. Thus, we don’t control the security of our own data; the provider does. Our data are our lifeblood, so confidence in the provider’s controls is paramount.

Once we begin, we become “locked in” to the provider. It will be hard to change our mind at a later date. However, to some extent, this is also true for purchased software.

CHAPTER 5

Accounting Systems

CP 5-4 Kyle is missing some of the principal benefits of the computerized system. A computerized system has three primary advantages. First, the computerized system is more efficient and accurate at transaction processing. In the computerized system, once the transaction data have been input, the information is simultaneously recorded in the electronic journal (file) and posted to the ledger accounts. This saves a significant amount of time in recording and posting transactions. Second, the computerized environment is less prone to mathematical, posting, and recording errors. The computer does not make these types of mistakes. Thus, the computerized environment should require less time correcting errors. Third, the computerized system provides more timely information to management because account balances are kept current. Under the manual system, ledger accounts are only as current as the latest posting date, but the computerized system posts every transaction when it is journalized or recorded on a form. Thus, management has more current information with which to make decisions. As an additional note, Kyle may be reacting out of fear of the unknown. This is a common reaction to change. Thus, Kyle may be overreacting to the new computer environment because it will require significant change in the way the job is done as compared to the manual approach.

CP 5-5 a. The accounts receivable and accounts payable accounts consist of transactions with individual customers and creditors (suppliers). In both cases, the subsidiary ledger tracks what is collectible from customers or owed to suppliers. Thus, the subsidiary ledger is required for tracking the collection and payment process to individual customers and suppliers, respectively. b.

The equipment account could use a subsidiary ledger. The subsidiary ledger for equipment would track individual items of equipment, including their cost, location, and useful lives. The subsidiary ledger would be useful for determining equipment depreciation and safeguarding equipment assets.

CHAPTER 5

Accounting Systems

CP 5-6 1.

Special journals are used to reduce the processing time and expense to record transactions. A special journal is usually created when a specific type of transaction occurs frequently enough so that the use of the traditional twocolumn journal becomes cumbersome. The frequency of transactions for Omni Care would probably justify the following special journals: Purchases journal Cash payments journal Revenue journal Cash receipts journal Note to Instructors: Judgment is required in determining the number and nature of the special journals to be established for Omni Care. Differences of opinion may exist as to whether all the preceding special journals are necessary or cost-efficient. You may want to use this time to comment further on the costs of establishing special journals and the potential benefits of reducing the processing time to record transactions.

Invoice No.

Other Accounts Dr.

Post. Ref.

Accounts Rec. Dr. Fees Earned Cr.

Page

Post. Ref.

Office Supplies Dr.

Medical Supplies Dr.

Accounts Payable Cr.

REVENUE JOURNAL Account Debited

Account Credited

Post. Ref.

Page

PURCHASES JOURNAL

Accounting Systems

The business should maintain subsidiary ledgers for customer accounts receivable, supplier accounts payable, and medical equipment.

Date

CP 5-6 (Concluded)

CHAPTER 5

Amount

CHAPTER 6 ACCOUNTING FOR MERCHANDISING BUSINESSES DISCUSSION QUESTIONS 1.

Merchandising businesses acquire merchandise for resale to customers. It is the selling of merchandise, instead of providing a service, that makes the activities of a merchandising business different from the activities of a service business.

Yes. Gross profit is the excess of sales over cost of merchandise sold. A net loss arises when operating expenses exceed gross profit. Therefore, a business can earn a gross profit but incur operating expenses in excess of this gross profit and end up with a net loss.

The date of sale as shown by the date of the invoice or bill.

1% discount allowed if paid within 15 days of date of invoice; entire amount of invoice due within 60 days of date of invoice.

Payment due within 30 days of date of invoice with no discount.

Payment due by the end of the month in which the sale was made with no discount.

Sales to customers who use MasterCard or VISA cards are recorded as cash sales.

A credit memo issued by the seller of merchandise indicates the amount for which the buyer’s account is to be credited (credit to Accounts Receivable) and the reason for the sales return or allowance.

A debit memo issued by the buyer of merchandise indicates the amount for which the seller’s account is to be debited (debit to Accounts Payable) and the reason for the purchases return or allowance.

The buyer

The seller

Sales, Cost of Merchandise Sold, Merchandise Inventory

Cost of Merchandise Sold would be debited; Merchandise Inventory would be credited.

10.

Loss from Merchandise Inventory Shrinkage would be debited.

CHAPTER 6

Accounting for Merchandising Businesses

PRACTICE EXERCISES PE 6-1A a.

$771,800 ($366,100 + $1,420,000 – $1,014,300)

PE 6-1B a.

$145,600 ($21,100 + $341,700 – $217,200)

PE 6-2A a.

$23,030. Purchase of $31,458 [$32,100 – ($32,100 × 2%)] less the return of $8,428 [$8,600 – ($8,600 × 2%)]

Merchandise Inventory

PE 6-2B a.

$74,448. Purchase of $84,150 [$85,000 – ($85,000 × 1%)] less the return of $9,702 [$9,800 – ($9,800 × 1%)]

Accounts Payable

PE 6-3A a.

Accounts Receivable [$94,800 – ($94,800 × 2%)] Sales

92,904

Cost of Merchandise Sold Merchandise Inventory

56,900

Cash Accounts Receivable

92,904

56,900

92,904

Customer Refunds Payable Accounts Receivable

500 500

CHAPTER 6

Accounting for Merchandising Businesses

PE 6-3B a.

Accounts Receivable [$78,600 – ($78,600 × 1%)] Sales

77,814

Cost of Merchandise Sold Merchandise Inventory

47,200

Cash Accounts Receivable

77,814

47,200

77,814

Customer Refunds Payable Accounts Receivable

900 900

PE 6-4A a. $100,993. Purchase of $119,592 [$120,800 – ($120,800 × 1%)] less return of $19,899 [($20,100 – ($20,100 × 1%)] plus $1,300 of shipping. b. $133,574. Purchase of $144,746 [$147,700 – ($147,700 × 2%)] less return of $11,172 [($11,400 – ($11,400 × 2%)].

PE 6-4B a. $51,579. Purchase of $58,014 [$58,600 – ($58,600 × 1%)] less return of $6,435 [($6,500 – ($6,500 × 1%)]. b. $68,416. Purchase of $71,638 [$73,100 – ($73,100 × 2%)] less return of $3,822 [($3,900 – ($3,900 × 2%)] plus $600 of shipping.

CHAPTER 6

Accounting for Merchandising Businesses

PE 6-5A Sally Co. journal entries: Accounts Receivable—Buck Co. Sales [$58,900 – ($58,900 × 2%)]

57,722

Cost of Merchandise Sold Merchandise Inventory

35,200

Cash Accounts Receivable—Buck Co.

57,722

35,200

57,722

Buck Co. journal entries: Merchandise Inventory [$58,900 – ($58,900 × 2%)] Accounts Payable—Sally Co.

57,722

Accounts Payable—Sally Co. Cash

57,722

PE 6-5B Statham Co. journal entries: Accounts Receivable—Bloomingdale Co. Sales [$147,600 – ($147,600 × 2%)]

144,648

Cost of Merchandise Sold Merchandise Inventory

88,600

Accounts Receivable—Bloomingdale Co. Cash

2,400

Cash Accounts Receivable—Bloomingdale Co. ($144,648 + $2,400)

147,048

144,648

88,600

2,400

147,048

Bloomingdale Co. journal entries: Merchandise Inventory Accounts Payable—Statham Co. [$147,600 – ($147,600 × 2%)] + $2,400

147,048

Accounts Payable—Statham Co. Cash ($144,648 + $2,400)

147,048

CHAPTER 6

Accounting for Merchandising Businesses

PE 6-6A Nov. 30 Cost of Merchandise Sold Merchandise Inventory Inventory shrinkage ($755,000 – $742,000).

13,000 13,000

PE 6-6B Dec. 31 Cost of Merchandise Sold Merchandise Inventory Inventory shrinkage ($1,129,000 – $1,109,300).

19,700 19,700

PE 6-7A Sales ($3,600,000 × 0.008) Customer Refunds Payable

28,800 28,800

PE 6-7B Sales ($1,750,000 × 0.006) Customer Refunds Payable

10,500 10,500

PE 6-8A a.

20Y3 3.3 *

Asset turnover

20Y2 3.4 **

* $2,310,000 ÷ [($680,000 + $720,000) ÷ 2] ** $2,278,000 ÷ [($660,000 + $680,000) ÷ 2] b. The decrease from 3.4 to 3.3 indicates an unfavorable change in using assets to generate sales. PE 6-8B a.

20Y3 2.6 *

Asset turnover

20Y2 2.4 **

* $663,000 ÷ [($240,000 + $270,000) ÷ 2] ** $516,000 ÷ [($190,000 + $240,000) ÷ 2] b. The increase from 2.4 to 2.6 indicates a favorable change in using assets to generate sales.

CHAPTER 6

Accounting for Merchandising Businesses

EXERCISES Ex. 6-1 a.

$12,843,600 ($45,870,000 – $33,026,400)

28% ($12,843,600 ÷ $45,870,000)

No. If operating expenses are less than gross profit, there will be a net income. On the other hand, if operating expenses exceed gross profit, there will be a net loss.

Ex. 6-2 $32,918 million ($42,879 million – $9,961 million)

Ex. 6-3 Balance Sheet Accounts 100 Assets 110 Cash 112 Accounts Receivable 114 Merchandise Inventory 115 Store Supplies 116 Office Supplies 117 Prepaid Insurance 120 Land 123 Store Equipment 124 Accumulated Depreciation— Store Equipment 125 Office Equipment 126 Accumulated Depreciation— Office Equipment 200 Liabilities 210 Accounts Payable 211 Customer Refunds Payable 212 Salaries Payable 213 Notes Payable 300 Owner’s Equity 310 Kailey Garner, Capital 311 Kailey Garner, Drawing

Income Statement Accounts 400 Revenues 410 Sales 500 Expenses 510 Cost of Merchandise Sold 520 Sales Salaries Expense 521 Advertising Expense 522 Depreciation Expense— Store Equipment 523 Store Supplies Expense 524 Delivery Expense 529 Miscellaneous Selling Expense 530 Office Salaries Expense 531 Rent Expense 532 Depreciation Expense— Office Equipment 533 Insurance Expense 534 Office Supplies Expense 539 Miscellaneous Administrative Expense 600 Other Expense 610 Interest Expense

Note: The order and number of some of the accounts within subclassifications is somewhat arbitrary, as in accounts 115–117, accounts 210–213, accounts 520–524, and accounts 530–534. For example, in a new business, the order of magnitude of expense account balances often cannot be determined in advance. The magnitude may also vary from period to period.

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-4 a.

$67,320. Purchase of $83,160 [$84,000 – ($84,000 × 1%)], less return of $15,840 [$16,000 – ($16,000 × 1%)]

Merchandise Inventory

Ex. 6-5 The offer of Supplier Two is lower than the offer of Supplier One. Details are as follows: Supplier One Supplier Two $20,000 $19,500 (200) (390) $19,800 $19,110 500 $19,800 $19,610

List price Discount Price net of discount Freight Final price

Ex. 6-6 (1) Purchased merchandise on account at a cost of $39,200, which is $40,000 less the 2% discount of $800. (2) Paid freight, $450. (3) An allowance or return of merchandise was granted by the creditor, $4,900, which is a $5,000 invoice amount less the 2% discount of $100. (4) Paid the balance due within the discount period: debited Accounts Payable, $34,300, which is $39,200 less the return of $4,900.

Ex. 6-7 a.

Merchandise Inventory [$53,000 – ($53,000 × 2%)] Accounts Payable

51,940

Accounts Payable [$7,000 – ($7,000 × 2%)] Merchandise Inventory

6,860

Accounts Payable Cash

45,080

51,940

6,860

45,080

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-8 a.

Merchandise Inventory [$57,000 – ($57,000 × 2%)] Accounts Payable—Foster Co.

55,860

Accounts Payable—Foster Co. Cash

55,860

Accounts Payable*—Foster Co. [$11,000 – ($11,000 × 2%)] Merchandise Inventory

10,780

Merchandise Inventory Accounts Payable—Foster Co.

6,300

Cash Accounts Payable—Foster Co.

4,480

55,860

10,780

6,300

4,480

* Note: The debit of $10,780 to Accounts Payable in entry (c) is the amount of refund due from Foster Co. It is computed as the amount that was paid for the returned merchandise, $11,000, less the purchase discount of $220 ($11,000 × 2%). The credit to Accounts Payable of $6,300 in entry (d) reduces the debit balance in the account payable to $4,480, which is the amount of the cash refund in entry (e). The alternative entries below yield the same final results.

Accounts Receivable—Foster Co. Merchandise Inventory

10,780

Merchandise Inventory Accounts Payable—Foster Co.

6,300

Cash Accounts Payable—Foster Co. Accounts Receivable—Foster Co.

4,480 6,300

10,780

6,300

10,780

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-9 a.

Cash Sales

116,300

Cost of Merchandise Sold Merchandise Inventory

72,000

Accounts Receivable Sales

755,000

Cost of Merchandise Sold Merchandise Inventory

400,000

116,300

72,000 755,000

400,000

Cash Sales

1,950,000

Cost of Merchandise Sold Merchandise Inventory

1,250,000

1,950,000

1,250,000

Cash Sales

330,000

Cost of Merchandise Sold Merchandise Inventory

230,000

Credit Card Expense Cash

81,500

330,000

230,000 81,500

Ex. 6-10 Customer Refunds Payable Cash

3,000 3,000

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-11 (1) Sold merchandise on account for $14,850, $15,000 less discount of 1%. (2) Recorded the cost of the merchandise sold and reduced the merchandise inventory account, $8,800. (3) Issued a $450 credit memo for damaged merchandise. The customer agreed to keep the merchandise. (4) Received the balance due within the discount period of $14,400; sale of $14,850 less the credit memo of $450.

Ex. 6-12 a. b. c.

$55,370 [$56,500 – ($56,500 × 2%)] $57,470 ($55,370 + $2,100) $57,470

Ex. 6-13 a. b. c. d. e.

$15,700 ($20,500 – $4,800) $25,256 [($31,100 – $5,900) – ($25,200 × 2%) + $560] $22,473 [($24,000 – $1,300) – ($22,700 × 1%)] $9,386 [($11,000 – $1,800) – ($9,200 × 2%) + $370] $41,778 [$42,200 – ($42,200 × 1%)]

Ex. 6-14 a.

Accounts Receivable—Balboa Co. Sales

254,500

Cost of Merchandise Sold Merchandise Inventory

152,700

Customer Refunds Payable Accounts Receivable—Balboa Co.

30,000

Cash Accounts Receivable—Balboa Co.

224,500

254,500

152,700

30,000

224,500

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-15 a.

Merchandise Inventory Accounts Payable—Showcase Co.

254,500

Accounts Payable—Showcase Co. Merchandise Inventory

30,000

Accounts Payable—Showcase Co. Cash

224,500

254,500

30,000

224,500

Ex. 6-16 a. b. c. d.

At the time of sale $36,000 $38,880 [$36,000 + ($36,000 × 8%)] Sales Tax Payable

Ex. 6-17 a.

Accounts Receivable Sales Sales Tax Payable ($62,800 × 5%)

65,940

Cost of Merchandise Sold Merchandise Inventory

37,500

Sales Tax Payable Cash

39,650

62,800 3,140

37,500

39,650

Ex. 6-18 a. b. c. d. e. f.

debit credit debit debit credit credit

Ex. 6-19 Cost of Merchandise Sold Merchandise Inventory Inventory shrinkage ($2,780,000 – $2,734,800).

45,200 45,200

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-20 Sales ($51,600,000 × 1.2%) Customer Refunds Payable

619,200 619,200

Ex. 6-21 a.

20Y3 Dec. 31 Sales ($1,800,000 × 1.5%) Customer Refunds Payable 20Y4 Feb.

3 Customer Refunds Payable Cash

27,000 27,000 5,000 5,000

Ex. 6-22 a.

Gross profit: $76,550,000 ($191,350,000 – $114,800,000)

No. There could be other revenue and expense items that affect the amount of net income.

Customer Refunds Payable is a liability account with a normal credit balance.

Ex. 6-23 a. b. c.

Selling expense, (1), (2), (7), (8) Administrative expense, (3), (5), (6) Other expense, (4)

Ex. 6-24 a.

$379,900 ($463,400 – $83,500)

$687,500 ($277,500 + $410,000)

$1,020,000 ($1,295,000 – $275,000)

$1,500,000 ($900,000 + $600,000)

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-25 a.

Danns Furnishings Company Income Statement For the Year Ended March 31, 20Y4 Sales Cost of merchandise sold Gross profit Expenses: Selling expenses Administrative expenses Total expenses Income from operations Other expense: Interest expense Net income

$3,582,000 2,123,000 $1,459,000 $400,000 302,000 702,000 $ 757,000 6,000 $ 751,000

b. The major advantage of the multiple-step form of income statement is that relationships such as gross profit to sales are indicated. The major disadvantages are that it is more complex and the total revenues and expenses are not indicated, as is the case in the single-step income statement.

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-26 1.

Deducting the cost of merchandise sold from sales yields gross profit (not income from operations).

Deducting the total expenses from gross profit yields income from operations (or operating income).

Interest revenue should be reported under the caption “Other revenue” and should be added to income from operations to arrive at net income.

The final amount on the income statement should be labeled net income, not gross profit.

A corrected income statement is as follows: Curbstone Company Income Statement For the Year Ended August 31, 20Y5 Sales Cost of merchandise sold Gross profit Expenses: Selling expenses Administrative expenses Delivery expense Total expenses Income from operations Other revenue: Interest revenue Net income

$8,595,000 6,110,000 $2,485,000 $800,000 575,000 425,000 1,800,000 $ 685,000 45,000 $ 730,000

Ex. 6-27 Custom Wire & Tubing Company Income Statement For the Year Ended April 30, 20Y6 Revenues: Sales Rent revenue Total revenues Expenses: Cost of merchandise sold Selling expenses Administrative expenses Interest expense Total expenses Net income

$9,332,500 60,000 $9,392,500 $6,100,000 1,250,000 740,000 25,000 8,115,000 $1,277,500

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-28 (b) Cost of Merchandise Sold (d) (f) (h) (i) (j)

Delivery Expense Sales Supplies Expense Tim Button, Drawing Wages Expense

Ex. 6-29 20Y4 Mar.

Closing Entries 31 Sales Cost of Merchandise Sold Selling Expenses Administrative Expenses Interest Expense Kathy Melman, Capital

3,582,000

31 Kathy Melman, Capital Kathy Melman, Drawing

98,000

2,123,000 400,000 302,000 6,000 751,000

98,000

Ex. 6-30 20Y7 July

Closing Entries 31 Sales Administrative Expenses Cost of Merchandise Sold Interest Expense Selling Expenses Store Supplies Expense Peter Bronsky, Capital

1,745,000

31 Peter Bronsky, Capital Peter Bronsky, Drawing

18,000

534,000 941,000 7,000 194,000 25,500 43,500

18,000

CHAPTER 6

Accounting for Merchandising Businesses

Ex. 6-31 a.

Year 2: 2.44 {$108,203 ÷ [($44,003 + $44,529) ÷ 2]} Year 1: 2.31 {$100,904 ÷ [($44,529 + $42,966) ÷ 2]}

These analyses indicate a slight increase in the effectiveness of using the assets to generate profits. A comparison with similar companies or industry averages would be helpful in making a more definitive statement on the effectiveness of using the assets.

Ex. 6-32 a.

3.22 {$121,162 ÷ [($38,118 + $37,197) ÷ 2]}

Although Kroger and Tiffany are both retail stores, Tiffany sells jewelry using a much longer operating cycle than Kroger uses selling groceries. Thus, Kroger is able to generate $3.22 of sales for every dollar of assets. Tiffany, however, is only able to generate $0.82 in sales per dollar of assets. This difference is reasonable when one considers the sales rate for jewelry and the cost of holding jewelry inventory, relative to groceries. Fortunately, Tiffany is able to offset its longer operating cycle, relative to groceries, with higher gross profits, relative to groceries. Note to Instructors: For a recent year, Kroger’s gross profit percentage (gross profit divided by revenues) was 21.7%, while Tiffany’s gross profit percentage was 63.3%. Kroger’s ratio of net income to revenues was 2.6%, while Tiffany’s ratio of net income to revenues was 13.2%.

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 1 Ex. 6-33 a.

Accounts Receivable—Bernard Retail Inc. Sales Cost of Merchandise Sold Merchandise Inventory

15,000 15,000 8,000 8,000

Cash Sales ($15,000 × 2%) Accounts Receivable—Bernard Retail Inc.

14,700 300

Cash Accounts Receivable—Bernard Retail Inc.

15,000

Appendix 1 Ex. 6-34 Mar.

2 Accounts Receivable—Parsley Co. Sales

32,000

2 Cost of Merchandise Sold Merchandise Inventory

18,500

8 Accounts Receivable—Tabor Co. Sales

24,000

8 Cost of Merchandise Sold Merchandise Inventory

14,400

11 Cash Sales ($32,000 × 1%) Accounts Receivable—Parsley Co.

31,680 320

20 Cash Accounts Receivable—Tabor Co.

24,000

32,000

18,500

24,000

14,400

32,000

24,000

Appendix 1 Ex. 6-35 a.

20Y4 June

Sales Allowance for Sales Discounts

7,000 7,000

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 1 Ex. 6-35 (Concluded) b.

Sales would be reported as $9,993,000 ($10,000,000 − $7,000) on the income statement. Accounts receivable would be reported as a current asset on the balance sheet as follows: Accounts receivable Less allowance for sales discounts Net accounts receivable

$850,000 7,400 $842,600

Appendix 1 Ex. 6-36 20Y4 July

6 Cash Allowance for Sales Discounts ($1,500 × 2%) Accounts Receivable—Mark Bishop

1,470 30 1,500

Appendix 1 Ex. 6-37 a.

Aug.

5 Accounts Receivable—M. Quinn Sales

7,500

5 Cost of Merchandise Sold Merchandise Inventory

4,200

9 Accounts Receivable—R. Busch Sales

4,000

9 Cost of Merchandise Sold Merchandise Inventory

2,100

15 Cash Sales ($7,500 × 2%) Accounts Receivable—M. Quinn

7,350 150

20 Accounts Receivable—S. Mooney Sales

6,000

20 Cost of Merchandise Sold Merchandise Inventory

3,300

25 Cash Accounts Receivable—R. Busch

4,000

31 Cash Accounts Receivable—S. Mooney

6,000

7,500

4,200

4,000

2,100

7,500

6,000

3,300

4,000

6,000

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 1 Ex. 6-37 (Concluded) b.

Aug.

5 Accounts Receivable Sales [$7,500 – ($7,500 × 2%)]

7,350

5 Cost of Merchandise Sold Merchandise Inventory

4,200

9 Accounts Receivable Sales [$4,000 – ($4,000 × 1%)]

3,960

9 Cost of Merchandise Sold Merchandise Inventory

2,100

15 Cash Accounts Receivable

7,350

20 Accounts Receivable Sales

6,000

20 Cost of Merchandise Sold Merchandise Inventory

3,300

25 Cash Accounts Receivable Sales

4,000

31 Cash Accounts Receivable

6,000

7,350

4,200

3,960

2,100

7,350

6,000

Gross method: $17,350 ($7,500 + $4,000 − $150 + $6,000) Net method: $17,350 ($7,350 + $3,960 + $6,000 + $40)

The gross method requires an end-of-period adjusting entry.

3,300

3,960 40

6,000

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 2 Ex. 6-38 a.

Feb.

Accounts Receivable—Brewster Co. Sales [$24,000 − ($24,000) × 2%)]

23,520

Cost of Merchandise Sold Merchandise Inventory

12,200

Customer Refunds Payable Accounts Receivable—Brewster Co. [$3,000 − ($3,000) × 2%)]

2,940

Merchandise Inventory Estimated Returns Inventory

1,800

Cash Accounts Receivable—Brewster Co.

20,580

23,520

12,200

2,940

1,800

20,580

Appendix 2 Ex. 6-39 a.

Apr.

May

Accounts Receivable—Bosch Inc. Sales [$15,000 − ($15,000) × 2%)]

14,700

Cost of Merchandise Sold Merchandise Inventory

9,000

Cash Accounts Receivable—Bosch Inc.

14,700

Customer Refunds Payable Cash

2,450

Merchandise Inventory Estimated Returns Inventory

1,300

14,700

9,000

14,700

2,450

1,300

Estimated Returns Inventory is reported as a current asset, while Customer Refunds Payable is reported as a current liability.

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 2 Ex. 6-40 20Y6 Dec.

31 Sales Customer Refunds Payable ($24,000,000 × 1.1%)

264,000

31 Estimated Returns Inventory Cost of Merchandise Sold

150,000

264,000

150,000

Appendix 2 Ex. 6-41 20Y3 Dec.

31 Sales Customer Refunds Payable ($7,800,000 × 1.8%)

140,400

31 Estimated Returns Inventory Cost of Merchandise Sold

90,000

140,400

90,000

Appendix 2 Ex. 6-42 a.

20Y1 Dec.

20Y2 Feb.

31 Sales Customer Refunds Payable ($12,000,000 × 1.5%)

180,000

31 Estimated Returns Inventory Cost of Merchandise Sold

120,000

15 Customer Refunds Payable Cash

8,000

15 Merchandise Inventory Estimated Returns Inventory

5,500

180,000

120,000

8,000

5,500

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Ex. 6-43 (a) (b) (c) (d) (e) (f) (g)

credit debit debit credit debit credit credit

Appendix 3 Ex. 6-44 Jan.

2 Purchases Accounts Payable

18,200 18,200

5 Freight In Cash

190 190

6 Accounts Payable Purchases Returns and Allowances

2,750

13 Accounts Receivable [$37,300 – ($37,300 × 1%)] Sales

36,927

15 Delivery Expense Cash

2,750

36,927 215 215

17 Accounts Payable Purchases Discounts* Cash

15,450

23 Cash Accounts Receivable

36,927

309 15,141

36,927

* [($18,200 – $2,750) × 2%]

Appendix 3 Ex. 6-45 a. b. c. d.

Purchases discounts, Purchases returns and allowances Freight in Merchandise available for sale Merchandise inventory (ending)

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Ex. 6-46 a. Cost of merchandise sold: Merchandise inventory, May 1, 20Y6 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Net purchases Freight in Total cost of merchandise purchased Merchandise available for sale Merchandise inventory, April 30, 20Y7 Cost of merchandise sold

$ 380,000 $3,800,000 (150,000) (80,000) $3,570,000 16,600 3,586,600 $3,966,600 (426,600) $3,540,000

b. $2,310,000 ($5,850,000 – $3,540,000) c. No. Gross profit would be the same if the perpetual inventory system was used.

Appendix 3 Ex. 6-47 Cost of merchandise sold: Merchandise inventory, November 1 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Net purchases Freight in Total cost of merchandise purchased Merchandise available for sale Merchandise inventory, November 30 Cost of merchandise sold

$ 28,000 $475,000 (15,000) (9,000) $451,000 7,000 458,000 $486,000 (46,000) $440,000

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Ex. 6-48 Cost of merchandise sold: Merchandise inventory, July 1 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Net purchases Freight in Total cost of merchandise purchased Merchandise available for sale Merchandise inventory, July 31 Cost of merchandise sold

$ 190,850 $1,126,000 (46,000) (23,000) $1,057,000 17,500 1,074,500 $1,265,350 (195,350) $1,070,000

Appendix 3 Ex. 6-49 1.

The schedule should begin with the June 1, 20Y3, not the May 31, 20Y4, merchandise inventory.

Purchases returns and allowances and purchases discounts should be deducted from (not added to) purchases.

Freight in should be added to (not deducted from) purchases.

The merchandise inventory at May 31, 20Y4, should be deducted from merchandise available for sale to yield cost of merchandise sold.

A corrected schedule would appear as follows: Cost of merchandise sold: Merchandise inventory, June 1, 20Y3 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts Net purchases Freight in Total cost of merchandise purchased Merchandise available for sale Merchandise inventory, May 31, 20Y4 Cost of merchandise sold

91,300

$1,110,000 (55,000) (30,000) $1,025,000 22,000 1,047,000 $1,138,300 (148,300) $ 990,000

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Ex. 6-50 Dec.

Closing Entries 31 Merchandise Inventory (December 31) Sales Purchases Discounts Purchases Returns and Allowances Merchandise Inventory (January 1) Purchases Freight In Salaries Expense Advertising Expense Depreciation Expense Miscellaneous Expense Pat Kirwan, Capital 31 Pat Kirwan, Capital Pat Kirwan, Drawing

480,000 2,220,000 35,000 45,000 375,000 1,760,000 17,000 375,000 36,000 13,000 9,000 195,000 65,000 65,000

CHAPTER 6

Accounting for Merchandising Businesses

PROBLEMS Prob. 6-1A Oct.

1 Merchandise Inventory Accounts Payable—UK Imports Co.

14,448

3 Merchandise Inventory Accounts Payable—Hoagie Co. [$9,950 – ($9,950 × 2%)] + $220

9,971

4 Merchandise Inventory Accounts Payable—Taco Co. [$13,650 – ($13,650 × 2%)]

13,377

6 Accounts Payable—Taco Co. Merchandise Inventory [$4,550 – ($4,550 × 2%)]

4,459

13 Accounts Payable—Hoagie Co. Cash

9,971

14 Accounts Payable—Taco Co. Cash ($13,377 – $4,459)

8,918

19 Merchandise Inventory Accounts Payable—Veggie Co.

27,300

19 Merchandise Inventory Cash

14,448

9,971

13,377

4,459

9,971

8,918

27,300 400 400

20 Merchandise Inventory Accounts Payable—Caesar Salad Co. [$22,000 – ($22,000 × 1%)]

21,780

30 Accounts Payable—Caesar Salad Co. Cash

21,780

31 Accounts Payable—UK Imports Co. Cash

14,448

31 Accounts Payable—Veggie Co. Cash

27,300

21,780

14,448

27,300

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-2A Mar.

2 Accounts Receivable—Equinox Co. Sales [$18,900 – ($18,900 × 1%)]

18,711

2 Cost of Merchandise Sold Merchandise Inventory

13,300

3 Cash Sales Sales Tax Payable

12,031

3 Cost of Merchandise Sold Merchandise Inventory

7,000

4 Accounts Receivable—Empire Co. Sales

55,400

4 Cost of Merchandise Sold Merchandise Inventory

33,200

5 Cash Sales Sales Tax Payable

31,800

5 Cost of Merchandise Sold Merchandise Inventory

19,400

12 Cash Accounts Receivable—Equinox Co.

18,711

14 Cash Sales

13,700

14 Cost of Merchandise Sold Merchandise Inventory

8,350

16 Accounts Receivable—Targhee Co. Sales [$27,500 – ($27,500 × 1%)]

27,225

16 Cost of Merchandise Sold Merchandise Inventory

16,000

18,711

13,300

11,350 681

7,000

55,400

33,200

30,000 1,800

19,400

18,711

13,700

8,350

27,225

16,000

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-2A (Concluded) Mar.

Apr.

18 Customer Refunds Payable Accounts Receivable—Targhee Co.

1,000

19 Accounts Receivable—Vista Co. Sales [$8,250 – ($8,250 × 2%)]

8,085

19 Accounts Receivable—Vista Co. Cash

1,000

8,085

19 Cost of Merchandise Sold Merchandise Inventory

5,000

26 Cash ($27,225 – $1,000) Accounts Receivable—Targhee Co.

26,225

28 Cash ($8,085 + $75) Accounts Receivable—Vista Co.

8,160

31 Cash Accounts Receivable—Empire Co.

55,400

31 Delivery Expense Cash

5,600

5,000

26,225

8,160

55,400

5,600

3 Credit Card Expense Cash

940 940

15 Sales Tax Payable Cash

6,544 6,544

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-3A Nov.

3 Merchandise Inventory Accounts Payable—Moonlight Co. [$120,000 – ($120,000 × 25%)] = $90,000 [$90,000 – ($90,000 × 2%)]

88,200

4 Cash Sales

53,500

4 Cost of Merchandise Sold Merchandise Inventory

32,100

5 Merchandise Inventory Accounts Payable—Papoose Creek Co. [$67,400 – ($67,400 × 2%) + $1,150]

67,202

6 Accounts Payable—Moonlight Co. Merchandise Inventory [$19,200 – ($19,200 × 2%)]

18,816

8 Accounts Receivable—Quinn Co. Sales

22,100

8 Cost of Merchandise Sold Merchandise Inventory

13,000

13 Accounts Payable—Moonlight Co. Cash ($88,200 – $18,816)

69,384

14 Cash Sales

335,000

14 Cost of Merchandise Sold Merchandise Inventory

198,700

15 Accounts Payable—Papoose Creek Co. Cash

67,202

23 Cash Accounts Receivable—Quinn Co.

22,100

88,200

53,500

32,100

67,202

18,816

22,100

13,000

69,384

335,000

198,700

67,202

22,100

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-3A (Concluded) Nov.

24 Accounts Receivable—Rabel Co. Sales [$80,800 – ($80,800 × 1%)]

79,992

24 Cost of Merchandise Sold Merchandise Inventory

48,300

28 Credit Card Expense Cash

5,030

30 Customer Refunds Payable Cash

1,770

79,992

48,300

5,030

1,770

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-4A 1. Aug.

1 Accounts Receivable—Beartooth Co. Sales [$48,000 – ($48,000 × 2%)]

47,040

1 Cost of Merchandise Sold Merchandise Inventory

28,800

2 Delivery Expense Cash

1,150

5 Accounts Receivable—Beartooth Co. Sales

66,000

5 Cost of Merchandise Sold Merchandise Inventory

40,000

15 Accounts Receivable—Beartooth Co. Sales [$58,700 – ($58,700 × 1%)]

58,113

15 Accounts Receivable—Beartooth Co. Cash

1,675

15 Cost of Merchandise Sold Merchandise Inventory

35,000

16 Cash Accounts Receivable—Beartooth Co.

47,040

20 Customer Refunds Payable Cash

1,800

25 Cash ($58,113 + $1,675) Accounts Receivable—Beartooth Co.

59,788

47,040

28,800

1,150

66,000

40,000

58,113

1,675

35,000

47,040

1,800

59,788

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-4A (Concluded) 2. Aug.

1 Merchandise Inventory Accounts Payable—Summit Company

47,040

5 Merchandise Inventory Accounts Payable—Summit Company

66,000

9 Merchandise Inventory Cash

2,300

15 Merchandise Inventory Accounts Payable—Summit Company {[$58,700 – ($58,700 × 1%)] + $1,675}

59,788

16 Accounts Payable—Summit Company Cash

47,040

20 Cash Merchandise Inventory

1,800

25 Accounts Payable—Summit Company Cash

59,788

47,040

66,000

2,300

59,788

47,040

1,800

59,788

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-5A 1. Druid Hills Co. Income Statement For the Year Ended May 31, 20Y8 Sales Cost of merchandise sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Depreciation expense—store equipment Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Depreciation expense—office equipment Insurance expense Office supplies expense Miscellaneous administrative expense Total administrative expenses Total operating expenses Income from operations Other expense: Interest expense Net income

$13,746,000 9,513,000 $ 4,233,000

$1,110,100 666,500 169,700 46,100 $1,992,400 $ 787,700 113,900 60,600 58,200 34,100 17,600 1,072,100 3,064,500 $ 1,168,500 25,400 $ 1,143,100

2. Druid Hills Co. Statement of Owner’s Equity For the Year Ended May 31, 20Y8 Kristina Marble, capital, June 1, 20Y7 Net income for the year $1,143,100 Withdrawals (121,200) Increase in owner’s equity Kristina Marble, capital, May 31, 20Y8

$4,179,800

1,021,900 $5,201,700

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-5A (Concluded) 3. Druid Hills Co. Balance Sheet May 31, 20Y8 Assets Current assets: Cash Accounts receivable Merchandise inventory Office supplies Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Less accumulated depreciation Store equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Customer refunds payable Salaries payable Note payable (current portion) Total current liabilities Long-term liabilities: Note payable (final payment due in 10 years) Total liabilities Owner’s Equity Kristina Marble, capital Total liabilities and owner’s equity 4.

$ 290,800 1,170,600 2,075,300 16,400 9,700 $3,562,800 $1,005,800 666,500 $4,362,700 2,205,600

$ 339,300 2,157,100 2,496,400 $6,059,200

$ 395,100 48,500 50,300 60,600 $ 554,500 303,000 $ 857,500 5,201,700 $6,059,200

The multiple-step form of income statement contains various sections for revenues and expenses, with intermediate balances, and concludes with net income. In the single-step form, the total of all expenses is deducted from the total of all revenues. There are no intermediate balances.

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-6A 1.

Druid Hills Co. Income Statement For the Year Ended May 31, 20Y8 Sales Expenses: Cost of merchandise sold Selling expenses Administrative expenses Interest expense Total expenses Net income

$13,746,000 $9,513,000 1,992,400 1,072,100 25,400 12,602,900 $ 1,143,100

20Y8 Closing Entries May 31 Sales Cost of Merchandise Sold Sales Salaries Expense Advertising Expense Depreciation Expense—Store Equipment Miscellaneous Selling Expense Office Salaries Expense Rent Expense Depreciation Expense—Office Equipment Insurance Expense Office Supplies Expense Miscellaneous Administrative Expense Interest Expense Kristina Marble, Capital 31 Kristina Marble, Capital Kristina Marble, Drawing

13,746,000 9,513,000 1,110,100 666,500 169,700 46,100 787,700 113,900 60,600 58,200 34,100 17,600 25,400 1,143,100 121,200 121,200

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Prob. 6-7A Oct.

1 Purchases Accounts Payable—UK Imports Co.

14,448

3 Purchases Freight In Accounts Payable—Hoagie Co.

9,950 220

4 Purchases Accounts Payable—Taco Co.

13,650

6 Accounts Payable—Taco Co. Purchases Returns and Allowances

4,550

13 Accounts Payable—Hoagie Co. Cash Purchases Discounts ($9,950 × 2%)

10,170

14 Accounts Payable—Taco Co. Cash Purchases Discounts

9,100

19 Purchases Accounts Payable—Veggie Co.

27,300

14,448

10,170

13,650

4,550

9,971 199

8,918 182

19 Freight In Cash

27,300 400 400

20 Purchases Accounts Payable—Caesar Salad Co.

22,000

30 Accounts Payable—Caesar Salad Co. Cash Purchases Discounts

22,000

31 Accounts Payable—UK Imports Co. Cash

14,448

31 Accounts Payable—Veggie Co. Cash

27,300

22,000

21,780 220

14,448

27,300

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Prob. 6-8A Nov.

3 Purchases Accounts Payable—Moonlight Co. [$120,000 – ($120,000 × 25%)]

90,000

4 Cash Sales

53,500

5 Purchases Freight In Accounts Payable—Papoose Creek Co.

67,400 1,150

6 Accounts Payable—Moonlight Co. Purchases Returns and Allowances

19,200

8 Accounts Receivable—Quinn Co. Sales

22,100

13 Accounts Payable—Moonlight Co. Cash Purchases Discounts

70,800

14 Cash Sales

335,000

15 Accounts Payable—Papoose Creek Co. Cash Purchases Discounts

68,550

23 Cash Accounts Receivable—Quinn Co.

22,100

24 Accounts Receivable—Rabel Co. Sales [$80,800 – ($80,800 × 1%)]

79,992

28 Credit Card Expense Cash

5,030

30 Customer Refunds Payable Cash

1,770

90,000

53,500

68,550

19,200

22,100

69,384 1,416

335,000

67,202 1,348

22,100

79,992

5,030

1,770

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Prob. 6-9A 1.

Wyman Company uses a periodic inventory system because it maintains accounts for purchases, purchases returns and allowances, purchases discounts, and freight in.

2. Wyman Company Income Statement For the Year Ended December 31, 20Y6 $3,280,000

Sales Cost of merchandise sold: Merchandise inventory, January 1, 20Y6 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts

$ 257,000 $2,650,000 (93,000) (37,000)

Net purchases Freight in Total cost of merchandise purchased

$2,520,000 48,000 2,568,000

Merchandise available for sale Merchandise inventory, December 31, 20Y6 Cost of merchandise sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Delivery expense Depreciation expense—store equipment Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Insurance expense Office supplies expense Depreciation expense—office equipment Miscellaneous administrative expense Total administrative expenses Total operating expenses Income from operations Other revenue and expense: Rent revenue Interest expense Net income

$2,825,000 (335,000) 2,490,000 $ 790,000

$ 300,000 45,000 9,000 6,000 12,000 $ 372,000 $ 175,000 28,000 3,000 2,000 1,500 3,500 213,000 585,000 $ 205,000 $

7,000 (2,000)

5,000 $ 210,000

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Prob. 6-9A (Concluded) 3. Dec. 31

Closing Entries Merchandise Inventory (December 31) Sales Purchases Returns and Allowances Purchases Discounts Rent Revenue Merchandise Inventory (January 1) Purchases Freight In Sales Salaries Expense Advertising Expense Delivery Expense Depreciation Expense—Store Equipment Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Office Supplies Expense Depreciation Expense—Office Equipment Miscellaneous Administrative Expense Interest Expense Shirley Wyman, Capital Shirley Wyman, Capital Shirley Wyman, Drawing

335,000 3,280,000 93,000 37,000 7,000 257,000 2,650,000 48,000 300,000 45,000 9,000 6,000 12,000 175,000 28,000 3,000 2,000 1,500 3,500 2,000 210,000 25,000 25,000

4. $210,000, the same net income as under the periodic inventory system

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-1B Mar.

1 Merchandise Inventory Accounts Payable—Haas Co. [$43,250 – ($43,250 × 2%)] + $650

43,035

5 Merchandise Inventory Accounts Payable—Whitman Co.

19,175

10 Accounts Payable—Haas Co. Cash

43,035

13 Merchandise Inventory Accounts Payable—Jost Co. [$15,550 – ($15,550 × 2%)]

15,239

14 Accounts Payable—Jost Co. Merchandise Inventory [$3,750 – ($3,750 × 2%)]

3,675

18 Merchandise Inventory Accounts Payable—Fairhurst Company

13,560

43,035

19,175

43,035

15,239

3,675

18 Merchandise Inventory Cash

13,560 140 140

19 Merchandise Inventory Accounts Payable—Bickle Co. [$6,500 – ($6,500 × 2%)]

6,370

23 Accounts Payable—Jost Co. ($15,239 – $3,675) Cash

11,564

29 Accounts Payable—Bickle Co. Cash

6,370

31 Accounts Payable—Fairhurst Company Cash

13,560

31 Accounts Payable—Whitman Co. Cash

19,175

6,370

11,564

6,370

13,560

19,175

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-2B July

1 Accounts Receivable—Landscapes Co. Sales

33,450

1 Cost of Merchandise Sold Merchandise Inventory

20,000

2 Cash Sales Sales Tax Payable

92,880

2 Cost of Merchandise Sold Merchandise Inventory

51,600

5 Accounts Receivable—Peacock Company Sales [$17,500 – ($17,500 × 1%)]

17,325

5 Cost of Merchandise Sold Merchandise Inventory

10,000

8 Cash Sales Sales Tax Payable

120,960

8 Cost of Merchandise Sold Merchandise Inventory

67,200

13 Cash Sales

96,000

13 Cost of Merchandise Sold Merchandise Inventory

57,600

14 Accounts Receivable—Loeb Co. Sales [$16,000 – ($16,000 × 1%)]

15,840

14 Cost of Merchandise Sold Merchandise Inventory

9,000

15 Cash Accounts Receivable—Peacock Company

17,325

33,450

20,000

86,000 6,880

51,600

17,325

10,000

112,000 8,960

67,200

96,000

57,600

15,840

9,000

17,325

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-2B (Concluded) July

Aug.

16 Customer Refunds Payable Accounts Receivable—Loeb Co.

3,000

18 Accounts Receivable—Jennings Company Sales [$11,350 – ($11,350 × 2%)]

11,123

18 Accounts Receivable—Jennings Company Cash

475

3,000

11,123

475

18 Cost of Merchandise Sold Merchandise Inventory

6,800

24 Cash ($15,840 – $3,000) Accounts Receivable—Loeb Co.

12,840

28 Cash ($11,123 + $475) Accounts Receivable—Jennings Company

11,598

31 Delivery Expense Cash

8,550

31 Cash Accounts Receivable—Landscapes Co.

33,450

3 Credit Card Expense Cash

3,770

10 Sales Tax Payable Cash

41,260

6,800

12,840

11,598

8,550

33,450

3,770

41,260

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-3B July

3 Merchandise Inventory Accounts Payable—Hamling Co. [$72,000 – ($72,000 × 15%)] = $61,200 [$61,200 – ($61,200 × 2%)] + $1,450

61,426

5 Merchandise Inventory Accounts Payable—Kester Co. [$33,450 – ($33,450 × 2%)]

32,781

6 Accounts Receivable—Parsley Co. Sales

36,000

6 Cost of Merchandise Sold Merchandise Inventory

25,000

7 Accounts Payable—Kester Co. Merchandise Inventory [$6,850 – ($6,850 × 2%)]

6,713

13 Accounts Payable—Hamling Co. Cash

61,426

15 Accounts Payable—Kester Co. Cash ($32,781 – $6,713)

26,068

21 Cash Accounts Receivable—Parsley Co.

36,000

21 Cash Sales

108,000

21 Cost of Merchandise Sold Merchandise Inventory

64,800

22 Accounts Receivable—Tabor Co. Sales [$16,650 – ($16,650 × 2%)]

16,317

22 Cost of Merchandise Sold Merchandise Inventory

10,000

61,426

32,781

36,000

25,000

6,713

61,426

26,068

36,000

108,000

64,800

16,317

10,000

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-3B (Concluded) July

23 Cash Sales

91,200

23 Cost of Merchandise Sold Merchandise Inventory

55,000

28 Customer Refunds Payable Cash

2,500

31 Credit Card Expense Cash

1,650

91,200

55,000

2,500

1,650

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-4B 1. Apr.

2 Accounts Receivable—Bird Company Sales [$32,000 – ($32,000 × 2%)]

31,360

2 Accounts Receivable—Bird Company Cash

330

31,360

330

2 Cost of Merchandise Sold Merchandise Inventory

19,200

8 Accounts Receivable—Bird Company Sales [$49,500 – ($49,500 × 1%)]

49,005

8 Cost of Merchandise Sold Merchandise Inventory

29,700

19,200

49,005

29,700

8 Delivery Expense Cash

710 710

12 Cash ($31,360 + $330) Accounts Receivable—Bird Company

31,690

18 Customer Refunds Payable Cash

2,000

23 Cash Accounts Receivable—Bird Company

49,005

24 Accounts Receivable—Bird Company Sales

67,350

24 Cost of Merchandise Sold Merchandise Inventory

40,400

31,690

2,000

49,005

67,350

40,400

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-4B (Concluded) 2. Apr.

2 Merchandise Inventory ($31,360 + $330) Accounts Payable—Swan Company

31,690

8 Merchandise Inventory Accounts Payable—Swan Company [$49,500 – ($49,500 × 1%)]

49,005

12 Accounts Payable—Swan Company Cash

31,690

18 Cash Merchandise Inventory

2,000

23 Accounts Payable—Swan Company Cash

49,005

24 Merchandise Inventory Accounts Payable—Swan Company

67,350

31,690

49,005

31,690

2,000

26 Merchandise Inventory Cash

49,005

67,350 875 875

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-5B 1. Kanpur Co. Income Statement For the Year Ended June 30, 20Y5 Sales Cost of merchandise sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Depreciation expense—store equipment Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Insurance expense Depreciation expense—office equipment Office supplies expense Miscellaneous administrative expense Total administrative expenses Total operating expenses Income from operations Other expense: Interest expense Net income

$8,925,000 5,620,000 $3,305,000

$850,000 420,000 33,000 18,000 $1,321,000 $540,000 48,000 24,000 10,000 4,000 6,000 632,000 1,953,000 $1,352,000 12,000 $1,340,000

2. Kanpur Co. Statement of Owner’s Equity For the Year Ended June 30, 20Y5 Gerri Faber, capital, July 1, 20Y4 Net income for the year $1,340,000 Withdrawals (300,000) Increase in owner’s equity Gerri Faber, capital, June 30, 20Y5

$ 431,000

1,040,000 $1,471,000

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-5B (Concluded) 3. Kanpur Co. Balance Sheet June 30, 20Y5 Assets Current assets: Cash Accounts receivable Merchandise inventory Office supplies Prepaid insurance Total current assets Property, plant, and equipment: Office equipment Less accumulated depreciation Store equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Customer refunds payable Salaries payable Note payable (current portion) Total current liabilities Long-term liabilities: Note payable (final payment due in eight years) Total liabilities Owner’s Equity Gerri Faber, capital Total liabilities and owner’s equity 4.

$ 92,000 450,000 375,000 10,000 12,000 $ 939,000 $220,000 58,000 $650,000 87,500

$162,000 562,500 724,500 $1,663,500

$ 38,500 10,000 4,000 7,000 $

59,500

133,000 $ 192,500 1,471,000 $1,663,500

CHAPTER 6

Accounting for Merchandising Businesses

Prob. 6-6B 1.

Kanpur Co. Income Statement For the Year Ended June 30, 20Y5 Sales Expenses: Cost of merchandise sold Selling expenses Administrative expenses Interest expense Total expenses Net income

$8,925,000 $5,620,000 1,321,000 632,000 12,000 7,585,000 $1,340,000

20Y5 Closing Entries June 30 Sales Cost of Merchandise Sold Sales Salaries Expense Advertising Expense Depreciation Expense—Store Equipment Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Depreciation Expense—Office Equipment Office Supplies Expense Miscellaneous Administrative Expense Interest Expense Gerri Faber, Capital 30 Gerri Faber, Capital Gerri Faber, Drawing

8,925,000 5,620,000 850,000 420,000 33,000 18,000 540,000 48,000 24,000 10,000 4,000 6,000 12,000 1,340,000 300,000 300,000

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Prob. 6-7B Mar.

1 Purchases Freight In Accounts Payable—Haas Co.

43,250 650

5 Purchases Accounts Payable—Whitman Co.

19,175

10 Accounts Payable—Haas Co. Cash Purchases Discounts ($43,250 × 0.02)

43,900

13 Purchases Accounts Payable—Jost Co.

15,550

14 Accounts Payable—Jost Co. Purchases Returns and Allowances

3,750

18 Purchases Accounts Payable—Fairhurst Company

13,560

18 Freight In Cash

43,900

19,175

43,035 865

15,550

3,750

13,560 140 140

19 Purchases Accounts Payable—Bickle Co.

6,500

23 Accounts Payable—Jost Co. Cash Purchases Discounts

11,800

29 Accounts Payable—Bickle Co. Cash Purchases Discounts

6,500

31 Accounts Payable—Fairhurst Company Cash

13,560

31 Accounts Payable—Whitman Co. Cash

19,175

6,500

11,564 236

6,370 130

13,560

19,175

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Prob. 6-8B July

3 Purchases Freight In Accounts Payable—Hamling Co. [$72,000 – ($72,000 × 15%)]

61,200 1,450

5 Purchases Accounts Payable—Kester Co.

33,450

6 Accounts Receivable—Parsley Co. Sales

36,000

7 Accounts Payable—Kester Co. Purchases Returns and Allowances

6,850

13 Accounts Payable—Hamling Co. Cash Purchases Discounts

62,650

15 Accounts Payable—Kester Co. Cash Purchases Discounts

26,600

21 Cash Accounts Receivable—Parsley Co.

36,000

21 Cash Sales

108,000

22 Accounts Receivable—Tabor Co. Sales [$16,650 – ($16,650 × 2%)]

16,317

23 Cash Sales

91,200

28 Customer Refunds Payable Cash

2,500

31 Credit Card Expense Cash

1,650

62,650

33,450

36,000

6,850

61,426 1,224

26,068 532

36,000

108,000

16,317

91,200

2,500

1,650

Appendix 3 Prob. 6-9B 1.

Simkins Company uses a periodic inventory system because it maintains accounts for purchases, purchases returns and allowances, purchases discounts, and freight in. 6-51 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Prob. 6-9B (Continued) 2. Simkins Company Income Statement For the Year Ended June 30, 20Y9 $6,590,000

Sales Cost of merchandise sold: Merchandise inventory, July 1, 20Y8 Cost of merchandise purchased: Purchases Purchases returns and allowances Purchases discounts

$ 415,000 $4,100,000 (32,000) (13,000)

Net purchases Freight in Total cost of merchandise purchased

$4,055,000 45,000 4,100,000 $4,515,000 (541,000)

Merchandise available for sale Merchandise inventory, June 30, 20Y9 Cost of merchandise sold

3,974,000

Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Delivery expense Depreciation expense—store equipment Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Insurance expense Office supplies expense Depreciation expense—office equipment Miscellaneous administrative expense Total administrative expenses Total operating expenses Income from operations Other revenue and expense: Rent revenue Interest expense Net income

$2,616,000

$ 580,000 315,000 18,000 12,000 28,000 $ 953,000 $ 375,000 43,000 17,000 5,000 4,000 16,000 460,000 1,413,000 $1,203,000 $

32,500 (2,500)

30,000 $1,233,000

CHAPTER 6

Accounting for Merchandising Businesses

Appendix 3 Prob. 6-9B (Concluded) 3.

20Y9 June

Closing Entries Merchandise Inventory (June 30, 20Y9) Sales Purchases Returns and Allowances Purchases Discounts Rent Revenue Merchandise Inventory (July 1, 20Y8) Purchases Freight In Sales Salaries Expense Advertising Expense Delivery Expense Depreciation Expense—Store Equipment Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Office Supplies Expense Depreciation Expense—Office Equipment Interest Expense Miscellaneous Administrative Expense Amy Gant, Capital Amy Gant, Capital Amy Gant, Drawing

541,000 6,590,000 32,000 13,000 32,500 415,000 4,100,000 45,000 580,000 315,000 18,000 12,000 28,000 375,000 43,000 17,000 5,000 4,000 2,500 16,000 1,233,000 275,000 275,000

$1,233,000, the same net income as under the periodic inventory system

CHAPTER 6

Accounting for Merchandising Businesses

COMPREHENSIVE PROBLEM 2 1., 2., 6., and 9. Cash

Account:

Item

Date

20Y7 May

1 1 4 7 10 13 15 16 19 19 20 21 21 26 28 29 30 31

Balance

Post. Ref.

 20 20 20 20 20 20 20 20 20 20 21 21 21 21 21 21 21

Debit

Credit

Date

Item

1 6 7 16 20 21 21 30 30

Balance

Post. Ref.

 20 20 20 21 21 21 21 21

Debit

110

Balance Credit

83,600 5,000 600 22,300 54,000 35,280 11,000 67,130 18,700 33,450 5,000 2,300 42,900 800 85,000 2,400 111,200 82,170

Accounts Receivable

Account:

20Y7 May

Account No.

99,430 Account No.

Debit

Credit

Balance Debit Credit

233,900 67,130 22,300 67,130 108,900 2,300 42,900 77,175 111,200

112

245,875

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) Merchandise Inventory Account:

Date

20Y7 May

Item

1 3 4 6 10 19 20 21 24 30 31

Date

Item

1 31

 20 20 20 20 20 21 21 21 21 22

Debit

Credit

Balance Adjusting

Date

Item

1 29 31

Balance Adjusting

Debit

Balance Credit

652,400

41,000 32,000 18,700 70,000 87,120 4,950 47,000 13,950

599,150 585,200 Account No.

Post. Ref.

Debit

 22

 21 22

Debit

12,000

16,800 4,800

Credit

2,400 9,800

Debit

117

Balance Credit

Credit

Account No.

Post. Ref.

115

35,280 600

Store Supplies

Account:

20Y7 May

Adjusting

Post. Ref.

Prepaid Insurance

Account:

20Y7 May

Balance

Account No.

118

Balance Credit

11,400 13,800 4,000

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) Store Equipment Account:

Item

Date

20Y7 May

Account:

Date

20Y7 May

1 31

1 3 13 19 21 24 31

Credit

569,500

Accumulated Depreciation—Store Equipment

Account No.

Item

Post. Ref.

Balance Adjusting

 22

Debit

Credit

Balance

Item

Date

1 20 26 31

Balance

Adjusting

 20 20 20 21 21 21

Debit

Credit

Post. Ref.

 20 21 22

Date

Debit

Balance Credit

96,600 35,280 33,450 87,120 4,950 82,170

63,150 Account No.

Debit

Credit

Item

Adjusting

211

Balance Debit Credit

50,000 5,000 800

44,200 104,200

60,000 Account No.

Post. Ref.

210

35,280

Salaries Payable

Account:

56,700 70,700 Account No.

Post. Ref.

124

Balance Debit Credit

14,000

Customer Refunds Payable

Account:

20Y7 May

Debit

123

Balance Debit Credit



Balance

Item

Date

20Y7 May

Post. Ref.

Accounts Payable

Account:

20Y7 May

Account No.

Debit

Credit

13,600

212

Balance Debit Credit

13,600

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) Lynn Tolley, Capital Account:

Date

20Y6 June 20Y7 May

Item

Balance



31 31

Closing Closing

23 23

Item

1 31

Credit

Balance Closing

Date

706,855 135,000

1,257,155 311

Account No.

Post. Ref.

Debit

 23

Balance Credit

Credit

Debit

135,000

135,000 —

— 410

Account No.

Item

1 6 10 20 30 31 31

Balance Debit Credit

685,300

Sales

Account:

20Y7 May

Debit

Lynn Tolley, Drawing

Date

20Y7 May

Post. Ref.

Account:

310

Account No.

Balance

Adjusting Closing

Post. Ref.

 20 20 21 21 22 23

Debit

Credit

Debit

Balance Credit

5,069,000 67,130 54,000 108,900 77,175 60,000 5,316,205

—

5,376,205 5,316,205 —

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) Cost of Merchandise Sold Account:

Date

20Y7 May

Item

1 6 10 20 30 31 31

Date

1 28 31 31

Credit

Post. Ref.

 21 22 23

Balance Adjusting Closing

Item

1 15 31

Balance Closing

3,026,950

Date

31 31

Balance Credit

Debit

3,013,000 3,026,950 —

—

Account No.

520

Credit

Balance Debit Credit

727,800

664,800 720,800 727,800 —

56,000 7,000

— 521

Account No.

Post. Ref.

 20 23

Debit

Credit

Balance Debit Credit

292,000

281,000 292,000 —

11,000

Depreciation Expense

Account:

Debit

2,823,000 41,000 32,000 70,000 47,000 13,950

Advertising Expense

Date

20Y7 May

Adjusting Closing

Item

Account:

20Y7 May

 20 20 21 21 22 23

Balance

Debit

Sales Salaries Expense

Account:

20Y7 May

Post. Ref.

510

Account No.

Item

Post. Ref.

Adjusting Closing

22 23

— 522

Account No.

Debit

Credit

Balance Debit Credit

14,000

14,000 —

14,000

—

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) Store Supplies Expense Account:

Date

20Y7 May

31 31

Date

Balance Closing

Item

1 28 31 31

Credit

9,800 9,800

Post. Ref.

Debit

 23

Balance Adjusting Closing

Post. Ref.

 21 22 23

Date

Item

1 1 31

Balance Closing

Date

31 31

Balance Credit

9,800 —

— 529

Balance Credit

Credit

Debit

12,600

12,600 —

— 530

Account No.

Debit

Balance Credit

Credit

Debit

417,700

382,100 411,100 417,700 —

29,000 6,600

— 531

Account No.

Post. Ref.

 20 23

Debit

Credit

Balance Debit Credit

88,700

83,700 88,700 —

5,000

Insurance Expense

Account:

Debit

Account No.

Rent Expense

Account:

20Y7 May

22 23

Debit

Office Salaries Expense

Account:

20Y7 May

Adjusting Closing

Item

1 31

20Y7 May

Post. Ref.

Miscellaneous Selling Expense

Account:

20Y7 May

Item

523

Account No.

— 532

Account No.

Item

Post. Ref.

Adjusting Closing

22 23

Debit

Credit

Balance Debit Credit

12,000

12,000 —

12,000

—

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) Miscellaneous Administrative Expense Account:

Date

20Y7 May

Item

1 31

Balance Closing

Post. Ref.

Debit

 23

539

Account No.

Credit

7,800

Debit

Balance Credit

7,800 —

—

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) JOURNAL

1. and 2.

Post. Ref.

Date

20Y7 May

Page Debit

1 Rent Expense Cash

531 110

5,000

3 Merchandise Inventory Accounts Payable—Martin Co. [$36,000 – ($36,000 × 2%)]

115 210

35,280

4 Merchandise Inventory Cash

115 110

600

6 Accounts Receivable—Korman Co. Sales [$68,500 – ($68,500 × 2%)]

112 410

67,130

6 Cost of Merchandise Sold Merchandise Inventory

510 115

41,000

7 Cash Accounts Receivable—Halstad Co.

110 112

22,300

10 Cash Sales

110 410

54,000

10 Cost of Merchandise Sold Merchandise Inventory

510 115

32,000

13 Accounts Payable—Martin Co. Cash

210 110

35,280

15 Advertising Expense Cash

521 110

11,000

16 Cash Accounts Receivable—Korman Co.

110 112

67,130

19 Merchandise Inventory Cash

115 110

18,700

19 Accounts Payable—Buttons Co. Cash

210 110

33,450

20 Customer Refunds Payable Cash

211 110

5,000

Credit

5,000

35,280

600

67,130

41,000

22,300

54,000

32,000

35,280

11,000

67,130

18,700

33,450

5,000

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) 21

Page Post. Ref.

20Y7 May

Debit

20 Accounts Receivable—Crescent Co. Sales [$110,000 – ($110,000 × 1%)]

112 410

108,900

20 Cost of Merchandise Sold Merchandise Inventory

510 115

70,000

21 Accounts Receivable—Crescent Co. Cash

112 110

2,300

21 Cash Accounts Receivable—Gee Co.

110 112

42,900

21 Merchandise Inventory Accounts Payable—Osterman Co. [$88,000 – ($88,000 × 1%)]

115 210

87,120

24 Accounts Payable—Osterman Co. Merchandise Inventory

210 115

4,950

26 Customer Refunds Payable Cash

211 110

800

28 Sales Salaries Expense Office Salaries Expense Cash

520 530 110

56,000 29,000

29 Store Supplies Cash

118 110

2,400

30 Accounts Receivable—Turner Co. Sales [$78,750 – ($78,750 × 2%)]

112 410

77,175

30 Cost of Merchandise Sold Merchandise Inventory

510 115

47,000

30 Cash Accounts Receivable—Crescent Co.

110 112

111,200

31 Accounts Payable—Osterman Co. Cash ($87,120 – $4,950)

210 110

82,170

Credit

108,900

70,000

2,300

42,900

87,120

4,950

800

85,000

2,400

77,175

47,000

111,200

82,170

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) 3. Palisade Creek Co. Unadjusted Trial Balance May 31, 20Y7 Account No.

Cash Accounts Receivable Merchandise Inventory Prepaid Insurance Store Supplies Store Equipment Accumulated Depreciation—Store Equipment Accounts Payable Customer Refunds Payable Salaries Payable Lynn Tolley, Capital Lynn Tolley, Drawing Sales Cost of Merchandise Sold Sales Salaries Expense Advertising Expense Depreciation Expense Store Supplies Expense Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Miscellaneous Administrative Expense

110 112 115 117 118 123 124 210 211 212 310 311 410 510 520 521 522 523 529 530 531 532 539

Debit Balances

Credit Balances

99,430 245,875 599,150 16,800 13,800 569,500 56,700 63,150 44,200 — 685,300 135,000 5,376,205 3,013,000 720,800 292,000 — — 12,600 411,100 88,700 — 7,800 6,225,555

6,225,555

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) 4. and 6.

JOURNAL Post. Ref.

Date

20Y7 May

Adjusting Entries 31 Cost of Merchandise Sold Merchandise Inventory Inventory shrinkage ($599,150 – $585,200).

Page

Debit

510 115

13,950

31 Insurance Expense Prepaid Insurance Insurance expired.

532 117

12,000

31 Store Supplies Expense Store Supplies Supplies used ($13,800 – $4,000).

523 118

9,800

31 Depreciation Expense Accum. Depr.—Store Equipment Store equipment depreciation.

522 124

14,000

31 Sales Salaries Expense Office Salaries Expense Salaries Payable Accrued salaries.

520 530 212

7,000 6,600

31 Sales Customer Refunds Payable Estimated sales refunds.

410 211

60,000

Credit

13,950

12,000

9,800

14,000

13,600

60,000

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) 7.

Palisade Creek Co. Adjusted Trial Balance May 31, 20Y7 Account No.

110 112 115 117 118 123 124 210 211 212 310 311 410 510 520 521 522 523 529 530 531 532 539

Debit Balances

Credit Balances

99,430 245,875 585,200 4,800 4,000 569,500 70,700 63,150 104,200 13,600 685,300 135,000 5,316,205 3,026,950 727,800 292,000 14,000 9,800 12,600 417,700 88,700 12,000 7,800 6,253,155

6,253,155

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) 8.

Palisade Creek Co. Income Statement For the Year Ended May 31, 20Y7 Sales Cost of merchandise sold Gross profit Expenses: Selling expenses: Sales salaries expense Advertising expense Depreciation expense Store supplies expense Miscellaneous selling expense Total selling expenses Administrative expenses: Office salaries expense Rent expense Insurance expense Miscellaneous administrative expense Total administrative expenses Total expenses Net income

$5,316,205 3,026,950 $2,289,255

$727,800 292,000 14,000 9,800 12,600 $1,056,200 $417,700 88,700 12,000 7,800 526,200

Palisade Creek Co. Statement of Owner’s Equity For the Year Ended May 31, 20Y7 Lynn Tolley, capital, June 1, 20Y6 Net income for the year $ 706,855 Withdrawals (135,000) Increase in owner’s equity Lynn Tolley, capital, May 31, 20Y7

1,582,400 $ 706,855

$ 685,300

571,855 $1,257,155

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) Palisade Creek Co. Balance Sheet May 31, 20Y7 Assets Current assets: Cash Accounts receivable Merchandise inventory Prepaid insurance Store supplies Total current assets Property, plant, and equipment: Store equipment Less accumulated depreciation Total property, plant, and equipment Total assets Liabilities Current liabilities: Accounts payable Customer refunds payable Salaries payable Total liabilities Owner’s Equity Lynn Tolley, capital Total liabilities and owner’s equity

$ 99,430 245,875 585,200 4,800 4,000 $ 939,305 $569,500 70,700 498,800 $1,438,105

$ 63,150 104,200 13,600 $ 180,950 1,257,155 $1,438,105

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) JOURNAL

Post. Ref.

Date

20Y7 May

Page

Debit

Credit

Closing Entries 31 Sales Cost of Merchandise Sold Sales Salaries Expense Advertising Expense Depreciation Expense Store Supplies Expense Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Miscellaneous Administrative Expense Lynn Tolley, Capital

410 510 520 521 522 523 529 530 531 532 539 310

5,316,205

31 Lynn Tolley, Capital Lynn Tolley, Drawing

310 311

135,000

3,026,950 727,800 292,000 14,000 9,800 12,600 417,700 88,700 12,000 7,800 706,855

135,000

CHAPTER 6

Accounting for Merchandising Businesses

Comp. Prob. 2 (Continued) 10.

Palisade Creek Co. Post-Closing Trial Balance May 31, 20Y7 Account No.

110 112 115 117 118 123 124 210 211 212 310

Debit Balances 99,430 245,875 585,200 4,800 4,000 569,500

1,508,805

Credit Balances

70,700 63,150 104,200 13,600 1,257,155 1,508,805

(Optional)*

3,026,950 727,800 292,000 14,000 9,800 12,600 417,700 88,700 12,000 7,800 4,609,350 706,855 5,316,205

5,316,205

Income Statement Debit Credit

6-70

Palisade Creek Co. End-of-Period Spreadsheet (Work Sheet) For the Year Ended May 31, 20Y7 Unadjusted Adjusted Trial Balance Adjustments Trial Balance Debit Credit Debit Credit Debit Credit 99,430 99,430 245,875 245,875 599,150 (a) 13,950 585,200 16,800 (b) 12,000 4,800 13,800 (c) 9,800 4,000 569,500 569,500 56,700 (d) 14,000 70,700 63,150 63,150 44,200 (f) 60,000 104,200 (e) 13,600 13,600 685,300 685,300 135,000 135,000 5,376,205 (f) 60,000 5,316,205 3,013,000 (a) 13,950 3,026,950 720,800 (e) 7,000 727,800 292,000 292,000 (d) 14,000 14,000 (c) 9,800 9,800 12,600 12,600 411,100 (e) 6,600 417,700 88,700 88,700 (b) 12,000 12,000 7,800 7,800 6,225,555 6,225,555 123,350 123,350 6,253,155 6,253,155

Accounting for Merchandising Businesses

* This solution is applicable only if the end-of-period spreadsheet (work sheet) is used.

Net income

Account Title Cash Accounts Receivable Merchandise Inventory Prepaid Insurance Store Supplies Store Equipment Accum. Depr.—Store Equip. Accounts Payable Customer Refunds Payable Salaries Payable Lynn Tolley, Capital Lynn Tolley, Drawing Sales Cost of Merchandise Sold Sales Salaries Expense Advertising Expense Depreciation Expense Store Supplies Expense Miscellaneous Selling Expense Office Salaries Expense Rent Expense Insurance Expense Miscellaneous Admin. Expense

Comp. Prob. 2 (Concluded)

CHAPTER 6

1,643,805

936,950 706,855 1,643,805

Balance Sheet Debit Credit 99,430 245,875 585,200 4,800 4,000 569,500 70,700 63,150 104,200 13,600 685,300 135,000

CHAPTER 6

Accounting for Merchandising Businesses

CASES & PROJECTS CP 6-1 Margie has been placed in a very difficult position. Someone she trusts and respects has asked her to do something that is clearly unethical. If Margie makes the adjusting entry, her boss could very well be terminated. Yet, Margie’s primary responsibility has to be on preparing relevant and representationally faithful financial information that is useful for decision making. Margie should, therefore, make the appropriate adjusting entry. Being right, however, doesn’t always make a decision easy. Margie’s actions could result in the termination of her boss and mentor. For financial information to be representationally faithful, it must be free of bias. The company president is clearly trying to pressure the accounting department to create biased financial statements, which is inappropriate. While Margie should not bend on the issue of making the adjusting entry, she should bring this issue to the attention of the internal audit department or the board of directors.

CP 6-2 Standards of Ethical Conduct for Management Accountants requires management accountants to perform in a competent manner and to comply with relevant laws, regulations, and technical standards. If Shelby Davey intentionally subtracted the discount knowing that the discount period had expired, he would have behaved in an unprofessional manner. Such behavior could eventually jeopardize Bontanica Company’s buyer/supplier relationship with Whitetail Seed Co.

CP 6-3 A sample solution based on The Home Depot Inc.’s Form 10-K for the fiscal year ended February 3, 2019, follows: 1.

a. $37,160 million in 2018; $34,356 million in 2017; $32,313 million in 2016 b. 34.3% ($37,160 million/$108,203 million) in 2018; 34.0% ($34,356 million/$100,904 million) in 2017; 34.2% ($32,313 million/$94,595 million) in 2016 c. $15,530 ($37,160 – $21,630) million in 2018; $14,681 ($34,356 – $19,675) million in 2017; $13,427 ($32,313 – $18,886) million in 2016 d. 5.8% increase in 2018 ($849 million/$14,681 million); 9.3% increase in 2017 $1,254 million/$13,427 million) e. $11,121 million in 2018; $8,630 million in 2017; $7,957 million in 2016 f. 28.9% increase in 2018 ($2,491 million/$8,630 million); 8.5% increase in 2017 ($673 million/$7,957 million)

The company’s financial performance has improved between 2016 and 2017 and again between 2017 and 2018. A majority of the above measures have improved during this period.

CHAPTER 6

Accounting for Merchandising Businesses

CP 6-4 To:

Suzi Nomro President, Watercraft Supply Company From: A+ student Re: Proposal to Increase Net Income If the proposed changes in credit terms increase sales by 10% as expected, and if the ratio of cost of merchandise sold to sales remails at 60%, this proposal has the potential to increase net income by $64,200, from $321,000 to $385,200. This increase will be driven by a $135,000 increase in sales. Cost of merchandise sold is also expected to increase by 60% of the sales increase, or $81,000. While store supplies and miscellaneous selling expenses will increase proportionally to sales, total selling expenses will decrease by $10,200 because of the change in freight terms. By shipping goods FOB shipping point rather than FOB destination, the company will save $12,000 in freight costs. This will result in an increase in net income of $64,200. There are several potential risks associated with this type of proposal. First, the accuracy of the estimates used to project the effects of the proposed changes are not certain. If the increase in sales does not materialize, Watercraft Supply Company could incur significant costs of carrying excess inventory stocked in anticipation of increasing sales. At the same time it is incurring these additional inventory costs, cash collections from customers will be reduced by the amount of the discounts. This could create a liquidity problem for Watercraft Supply. Another potential risk arises from the proposed change in shipping terms. Watercraft Supply assumes that this change will have no effect on sales. However, customers may object to this change and seek other vendors with more favorable terms. Hence, an unanticipated decline in sales could occur because of this change. While the anticipated outcomes indicate that the company should pursue the proposal, financial projections are inherently uncertain, and there is no guarantee that the actual results will match those in the projections. Management should test the proposed changes with the company’s customer base before proceeding. As with any business decision, risks such as those mentioned above must be considered thoroughly before final action is taken. Supporting projections are provided on the following page.

CHAPTER 6

Accounting for Merchandising Businesses

CP 6-4 (Concluded) Watercraft Supply Company Projected Income Statement For the Year Ended October 31, 20Y3 Revenues: Sales Interest revenue Total revenues Expenses: Cost of merchandise sold Selling expenses Administrative expenses Interest expense Total expenses Net income

$1,485,000 15,000 $1,500,000 $891,000 129,800 90,000 4,000 1,114,800 $ 385,200

Notes: a. Projected sales [$1,350,000 + (10% × $1,350,000)]…………………………

$1,485,000

b. Projected cost of merchandise sold ($1,485,000 × 60%)……………………………………………

$ 891,000

c. Total selling expenses for year ended October 31, 20Y3… Increase in store supplies expense ($12,000 × 10%)…………………………………………… Increase in miscellaneous selling expense ($6,000 × 10%)……………………………………………… Less delivery expenses………………………………………… Projected total selling expenses………………………………

$ 140,000 $1,200 600

1,800 (12,000) $ 129,800

CHAPTER 6

Accounting for Merchandising Businesses

CP 6-5 Cam Pfeifer is correct. The accounts payable due to suppliers could be included on the balance sheet at an amount of $314,500 ($269,500 + $45,000). This is the amount that will be expected to be paid to satisfy the obligation (liability) to suppliers. However, this is proper only if Rustic Furniture Co. has a history of taking all purchases discounts, has a properly designed accounting system to identify available discounts, and has sufficient liquidity (cash) to pay the accounts payable within the discount period. In this case, Rustic Furniture Co. apparently meets these criteria, since it has a history of taking all available discounts, as indicated by Mitzi Wheeler. Thus, Rustic Furniture Co. could report total accounts payable of $314,500 on its balance sheet. Merchandise inventory would also need to be reduced by the discount of $5,500 in order to maintain consistency in approach.

CP 6-6 1.

If Mark doesn’t need the stereo immediately (by the next day), Wholesale Stereo offers the best buy, as shown below. Wholesale Stereo: List price……………………………………………………………………… Shipping and handling (not including next-day air)………………… Total……………………………………………………………………………

$1,200.00 49.99 $1,249.99

Tru-Sound Systems: List price……………………………………………………………………… Sales tax (9%).……………………………………………………………… Total……………………………………………………………………………

$1,175.00 105.75 $1,280.75

Even if the 2% cash discount offered by Tru-Sound Systems is considered, Wholesale Stereo still offers the best buy, as shown below. List price……………………………………………………………………… Less 2% cash discount.…………………………………………………… Subtotal……………………………………………………………………… Sales tax (9%).……………………………………………………………… Total……………………………………………………………………………

$1,175.00 23.50 $1,151.50 103.64 $1,255.14

If Mark needs the stereo immediately (the next day), then Tru-Sound Systems has the best price. This is because a shipping and handling charge of $89.99 would be added to the Wholesale Stereo, as shown below. Wholesale Stereo list price………………………………………………… Next-day freight charge…………………………………………………… Total……………………………………………………………………………

$1,200.00 89.99 $1,289.99

CHAPTER 6

Accounting for Merchandising Businesses

CP 6-6 (Concluded) Because both Wholesale Stereo and Tru-Sound Systems will accept Mark’s VISA, the ability to use a credit card would not affect the buying decision. Tru-Sound Systems will, however, allow Mark to pay his bill in three installments (the first due immediately). This would allow Mark to save some interest charges on his VISA for two months. If we assume that Mark would have otherwise used his VISA and that Mark’s VISA carries an interest of 1.5% per month on the unpaid balance, the potential interest savings would be calculated as follows: Tru-Sound Systems price (see previous page)………………………………… $1,280.75 426.92 Less first installment (down payment)………………………………………… Remaining balance………………………………………………………………… $ 853.83 Interest for first month at 1.5% ($853.83 × 1.5%)……………………………… $ 12.81 Remaining balance ($853.83 + $12.81)………………………………………… $ 866.64 426.92 Less second installment…………………………………………………………… Remaining balance………………………………………………………………… $ 439.72 Interest for second month at 1.5% ($439.72 × 1.5%)…………………………

6.60

The total interest savings would be $19.41 ($12.81 + $6.60). This interest savings still would not be enough to offset the price advantage of Wholesale Stereo, as shown below. Tru-Sound Systems price (see above)……………………………………… $1,280.75 19.41 Less interest savings…………………………………………………………… $1,261.34 Total………………………………………………………………………………… 2.

Other considerations in buying the stereo include the ability to have the stereo repaired locally. In addition, Tru-Sound Systems’ employees would presumably be available to answer questions on the operation and installation of the stereo. Also, if Mark purchased the stereo from Tru-Sound Systems, he would have the stereo the same day rather than the next day, which is the earliest Wholesale Stereo could deliver the stereo.

CHAPTER 7 INVENTORIES DISCUSSION QUESTIONS 1.

The receiving report should be reconciled to the initial purchase order and the vendor’s invoice before inventory purchases are recorded and paid. This procedure will verify that the inventory received matches the type and quantity of inventory ordered. It also verifies that the vendor’s invoice is charging the company for the actual quantity of inventory received at the agreedupon price.

A physical inventory should be taken periodically to test the accuracy of the perpetual records. In addition, a physical inventory will identify inventory shortages or shrinkage.

No. They are not techniques for determining physical quantities. The terms refer to cost flow assumptions, which affect the determination of the cost prices assigned to items in the inventory.

a. b.

FIFO.

LIFO. In periods of rising prices, the use of LIFO will result in the lowest net income and thus the lowest income tax expense.

The merchandise should be valued using the lower of its cost of $1,350 or its market (net realizable) value of $1,295 ($1,475 – $180). Thus, the merchandise should be valued at its market value of $1,295.

Gross profit for the year was understated by $14,750.

Merchandise inventory and owner’s equity were understated by $14,750.

LIFO FIFO

c. d.

LIFO FIFO

Bibbins Company. Since the merchandise was shipped FOB shipping point, title passed to Bibbins Company when it was shipped and should be reported in Bibbins Company’s financial statements at May 31, the end of the fiscal year.

10.

Manufacturer’s. The manufacturer retains title until the goods are sold. Thus, any unsold merchandise at the end of the year is part of the manufacturer’s (consignor’s) inventory, even though the merchandise is in the hands of the retailer (consignee).

CHAPTER 7

Inventories

PRACTICE EXERCISES PE 7-1A

a. First-in, first-out (FIFO) b. Last-in, first-out (LIFO) c. Weighted average cost

Gross Profit April

Ending Inventory April 30

$56 ($132 – $76) $49 ($132 – $83) $52 ($132 – $80)

$164 ($81 + $83) $157 ($76 + $81) $160 ($80 × 2)

Gross Profit June

Ending Inventory June 30

$130 ($270 – $140) $112 ($270 – $158) $120 ($270 – $150)

$310 ($152 + $158) $292 ($140 + $152) $300 ($150 × 2)

PE 7-1B

a. First-in, first-out (FIFO) b. Last-in, first-out (LIFO) c. Weighted average cost

PE 7-2A a.

Cost of merchandise sold (March 25): 60 units @ $7 280 units @ $8 340

$ 420 2,240 $2,660

b. Inventory, March 31: $1,040 = 130 units × $8

PE 7-2B a.

Cost of merchandise sold (July 24): 11 units @ $21 59 units @ $24 70

$ 231 1,416 $1,647

b. Inventory, July 31: $2,424 = 101 units × $24

CHAPTER 7

Inventories

PE 7-3A a. Cost of merchandise sold (September 27): $27,300 = (105 units × $260) b. Inventory, September 30: 15 units @ $255 5 units @ $260

$3,825 1,300

$5,125

PE 7-3B a. Cost of merchandise sold (March 27): $8,450 = (325 units × $26) b. Inventory, March 31: 60 units @ $24 185 units @ $26

$1,440 4,810

245

$6,250

PE 7-4A a. Weighted average unit cost: $132 Inventory total cost after purchase on July 23: 90 units @ $120 360 units @ $135

$10,800 48,600

450

$59,400

Weighted average unit cost = $132 ($59,400 ÷ 450 units) b. Cost of merchandise sold (July 26): $43,560 (330 units @ $132) c.

Inventory, July 31: $15,840 (120 units @ $132)

PE 7-4B a. Weighted average unit cost: $15.50 Inventory total cost after purchase on October 22: 200 units @ $14 600 units @ $16

$ 2,800 9,600

800

$12,400

Weighted average unit cost = $15.50 ($12,400 ÷ 800 units) b. Cost of merchandise sold (October 29): $6,975 (450 units @ $15.50) c.

Inventory, October 31: $5,425 (350 units @ $15.50)

CHAPTER 7

Inventories

PE 7-5A a. First-in, first-out (FIFO) method: $86,700 = 17 units × $5,100 b. Last-in, first-out (LIFO) method: $69,200 = [(15 units × $4,000) + (2 units × $4,600)] c. Weighted average cost method: $78,200 (17 units × $4,600), where average cost = $4,600 = $248,400 ÷ 54 units

PE 7-5B a. First-in, first-out (FIFO) method: $32,851 = (50 units × $456) + (23 units × $437) b. Last-in, first-out (LIFO) method: $32,591 = (30 units × $460) + (43 units × $437) c. Weighted average cost method: $32,193 (73 units × $441), where average cost = $441 = $180,810 ÷ 410 units

PE 7-6A Total

Market

Inventory Quantity

per Unit

Value per Unit (Net Realizable Value)

1,700 9,200

$163 24

$159 30

Cost Item Raven 10 Dove 23 Total

Cost

Market

LCM

$277,100 220,800 $497,900

$270,300 276,000 $546,300

$270,300 220,800 $491,100

PE 7-6B Total

Market

Inventory Quantity

per Unit

Value per Unit (Net Realizable Value)

5,750 1,040

$ 9 27

$10 24

Cost Item

JFW1 SAW9 Total

Cost

Market

LCM

$51,750 28,080 $79,830

$57,500 24,960 $82,460

$51,750 24,960 $76,710

CHAPTER 7

Inventories

PE 7-7A Amount of Misstatement Overstatement (Understatement)

Balance Sheet: Merchandise inventory understated*………………… Current assets understated……………………………… Total assets understated………………………………… Owner’s equity understated……………………………

$(17,200) (17,200) (17,200) (17,200)

Income Statement: Cost of merchandise sold overstated………………… Gross profit understated………………………………… Net income understated…………………………………

$ 17,200 (17,200) (17,200)

* $560,700 – $543,500 = $17,200

PE 7-7B Amount of Misstatement Overstatement (Understatement)

Balance Sheet: Merchandise inventory overstated*…………………… Current assets overstated……………………………… Total assets overstated………………………………… Owner’s equity overstated………………………………

$ 3,400 3,400 3,400 3,400

Income Statement: Cost of merchandise sold understated……………… Gross profit overstated………………………………… Net income overstated……………………………………

$(3,400) 3,400 3,400

* $274,100 – $270,700 = $3,400

CHAPTER 7

Inventories

PE 7-8A a.

Inventory Turnover

20Y4

20Y3

Cost of merchandise sold Inventories: Beginning of year End of year Average inventory

$3,598,900

$3,015,630

$593,000 $648,000 $620,500

$589,600 $593,000 $591,300

[($593,000 + $648,000) ÷ 2]

[($589,600 + $593,000) ÷ 2]

5.8

5.1

($3,598,900 ÷ $620,500)

($3,015,630 ÷ $591,300)

Days’ Sales in Inventory

20Y4

20Y3

Cost of merchandise sold Average daily cost of merchandise sold

$3,598,900

$3,015,630

Inventory turnover

Average inventory

Days’ sales in inventory

$9,860

$8,262

($3,598,900 ÷ 365 days)

($3,015,630 ÷ 365 days)

$620,500

$591,300

[($593,000 + $648,000) ÷ 2]

[($589,600 + $593,000) ÷ 2]

62.9

71.6

($620,500 ÷ $9,860)

($591,300 ÷ $8,262)

c. The increase in the inventory turnover from 5.1 to 5.8 and the decrease in the days’ sales in inventory from 71.6 days to 62.9 days indicate favorable changes in managing inventory.

CHAPTER 7

Inventories

PE 7-8B a.

Inventory Turnover

20Y7

20Y6

Cost of merchandise sold Inventories: Beginning of year End of year Average inventory

$2,912,700

$3,009,790

$489,000 $533,000 $511,000

$481,900 $489,000 $485,450

[($489,000 + $533,000) ÷ 2]

[($481,900 + $489,000) ÷ 2]

5.7

6.2

($2,912,700 ÷ $511,000)

($3,009,790 ÷ $485,450)

Days’ Sales in Inventory

20Y7

20Y6

Cost of merchandise sold Average daily cost of merchandise sold

$2,912,700

$3,009,790

$7,980

$8,246

($2,912,700 ÷ 365 days)

($3,009,790 ÷ 365 days)

Inventory turnover

Average inventory

Days’ sales in inventory c.

$511,000

$485,450

[($489,000 + $533,000) ÷ 2]

[($481,900 + $489,000) ÷ 2]

64.0 days

58.9 days

($511,000 ÷ $7,980)

($485,450 ÷ $8,246)

The decrease in the inventory turnover from 6.2 to 5.7 and the increase in the days’ sales in inventory from 58.9 days to 64.0 days indicate unfavorable changes in managing inventory.

CHAPTER 7

Inventories

EXERCISES Ex. 7-1 Switching to a perpetual inventory system will strengthen Triple Creek Hardware’s internal controls over inventory because the store managers will be able to keep track of how much of each item is on hand. This should minimize shortages of good-selling items and excess inventories of poor-selling items. On the other hand, switching to a perpetual inventory system will not eliminate the need to take a physical inventory count. A physical inventory must be taken to verify the accuracy of the inventory records in a perpetual inventory system. In addition, a physical inventory count is needed to detect shortages of inventory due to damage or theft.

Ex. 7-2 a.

Appropriate. The inventory tags will protect the inventory from customer theft.

b. Inappropriate. The control of using security measures to protect the inventory is violated if the stockroom is not locked. c.

Inappropriate. Good controls include a receiving report, prepared after all inventory items received have been counted and inspected. Inventory purchased should be recorded and paid for only after reconciling the receiving report, the initial purchase order, and the vendor’s invoice.

Date

Balances

240

210

11,040

8,820 40 130 60

140

Quantity

40 42 42

Unit Cost

15,180

1,600 5,460 2,520

5,600

Total Cost

Cost of Merchandise Sold

Unit Cost

Total Cost

Purchases

Inventories

20 20 240

180 40 40 210 80

Quantity

7-9

Note to Instructors: Exercise 7-4 shows that the inventory is $11,840 under LIFO.

Because the prices rose from $40 for the April 1 inventory to $46 for the purchase on April 30, we would expect that under last-in, first-out, the inventory would be lower.

24 30

1 10 15

Quantity

Portable Game Players

Apr.

Ex. 7-3

CHAPTER 7

Unit Cost

42 42 46

40 40 40 42 42

Inventory

840 840 11,040 11,880

7,200 1,600 1,600 8,820 3,360

Total Cost

Date

11,040

7-10

42 40

15,220

1,680 800

7,140

5,600

20 240

180 40 40 210 40 40 20

Quantity

Balances

240

140

40 20

8,820

42 170

210

Quantity

Unit Cost

Total Cost

Cost of Merchandise Sold

Unit Cost

Total Cost

Purchases

Inventories

1 10 15

Quantity

Portable Game Players

Apr.

Ex. 7-4

CHAPTER 7

Unit Cost

40 46

40 40 40 42 40 42 40

Inventory

800 11,040 11,840

7,200 1,600 1,600 8,820 1,600 1,680 800

Total Cost

Date

Balances

1,200

720

57,600

32,400

1,000

720 480 830

Quantity

45 44 44

Unit Cost

138,040

48,000

32,400 21,120 36,520

Total Cost

Cost of Merchandise Sold

Unit Cost

Total Cost

Purchases

Inventories

240 240 1,200 240 200

1,550 1,550 720 1,070

Quantity

7-11

Note to Instructors: Exercise 7-6 shows that the inventory is $21,120 under FIFO.

Because the prices rose from $44 for the May 1 inventory to $48 for the purchase on May 20, we would expect that under first-in, first-out, the inventory would be higher.

14 20

1 10

Quantity

Prepaid Cell Phones

May

Ex. 7-5

CHAPTER 7

Unit Cost

44 44 48 44 48

44 44 45 44

Inventory

10,560 10,560 57,600 10,560 9,600 20,160

68,200 68,200 32,400 47,080

Total Cost

Date

57,600

7-12

240 760

45 48

44 45

10,800 36,480 137,080

15,400 21,600

52,800

440

240 240 1,200

1,550 1,550 720 350 720

Quantity

Balances

1,200

350 480

32,400

45 1,200

720

Quantity

Unit Cost

Total Cost

Cost of Merchandise Sold

Unit Cost

Total Cost

Purchases

Inventories

1 10

Quantity

Prepaid Cell Phones

May

Ex. 7-6

CHAPTER 7

Unit Cost

45 45 48

44 44 45 44 45

Inventory

21,120 21,120

10,800 10,800 57,600

68,200 68,200 32,400 15,400 32,400

Total Cost

Inventories

25,000

25.00

61.80

60.00

4,500

2,500

7-13

23.20

20.00

Inventory

Quantity Unit Cost 4,000 20.00 50,000 1,500 20.00 7,500 23.20 104,400 3,000 23.20 4,000 23.65 154,400 4,000 23.65

Cost of Merchandise Sold Unit Total Quantity Cost Cost

22,500

12,000

Inventory

Quantity Unit Cost 15,000 60.00 720,000 3,000 60.00 30,000 61.80 1,390,500 7,500 61.80 18,000 63.20 2,110,500 18,000 63.20

Cost of Merchandise Sold Unit Total Quantity Cost Cost

Total Cost 80,000 30,000 174,000 69,600 94,600 94,600

Total Cost 900,000 180,000 1,854,000 463,500 1,137,600 1,137,600

144,000

24.00

Total Cost

674,100

64.20

Purchases Unit Quantity Cost

Date Jan. 1 Apr. 19 June 30 6,000 Sept. 2 Nov. 15 1,000 Dec. 31 Balances

Ex. 7-9

1,674,000

Total Cost

62.00

Purchases Unit Quantity Cost

Date Jan. 1 Mar. 18 May 2 27,000 Aug. 9 Oct. 20 10,500 Dec. 31 Balances

Ex. 7-8

a. $823,680 ($26.40 × 31,200 units) b. $763,200 [($20.00 × 7,200 units) + ($25.20 × 12,000 units) + ($26.40 × 12,000 units)] = $144,000 + $302,400 + $316,800

Ex. 7-7

CHAPTER 7

15 31

Nov.

Dec.

Balances

1,000

6,000

Total Cost

25.00

25,000

24.00 144,000

Purchases Unit Quantity Cost

20.00 24.00

20.00

7-14

1,500 3,000

2,500

Inventory

Quantity Unit Cost 4,000 20.00 50,000 1,500 20.00 1,500 20.00 6,000 24.00 30,000 3,000 24.00 72,000 3,000 24.00 1,000 25.00 152,000

Cost of Merchandise Sold Unit Total Quantity Cost Cost

Inventories

Sept.

Date Jan. 1 Apr. 19 June 30

Ex. 7-10

CHAPTER 7

72,000 25,000 97,000

Total Cost 80,000 30,000 30,000 144,000 72,000

Nov.

Dec.

$120,000 176,000 204,000 157,500 $657,500

7-15

Cost of merchandise available for sale: 1,000 units @ $120……………………………………………… 1,375 units @ $128……………………………………………… 1,500 units @ $136……………………………………………… 1,125 units @ $140……………………………………………… 5,000 units (at an average cost of $131.50)…………………

$157,800 (1,200 units at $131.50)

24.00

20.00

$145,600 (1,000 units at $120 plus 200 units at $128) = $120,000 + $25,600

25,000

4,500

2,500

Inventory

Quantity Unit Cost 4,000 20.00 50,000 1,500 20.00 1,500 20.00 6,000 24.00 108,000 1,500 20.00 1,500 24.00 1,500 20.00 1,500 24.00 1,000 25.00 158,000

25.00

24.00 144,000

Total Cost

Cost of Merchandise Sold Unit Total Quantity Cost Cost

$167,700 (1,125 units at $140 plus 75 units at $136) = $157,500 + $10,200

Balances

1,000

6,000

Purchases Unit Quantity Cost

Inventories

Ex. 7-12

Sept.

Date 1 Jan. 19 Apr. 30 June

Ex. 7-11

CHAPTER 7

Total Cost 80,000 30,000 30,000 144,000 30,000 36,000 30,000 36,000 25,000 91,000

CHAPTER 7

Inventories

Ex. 7-13 Cost Inventory Method

a. b. c.

FIFO LIFO Weighted average cost

Merchandise Inventory

Merchandise Sold

$59,960 54,100 56,750

$167,040 172,900 170,250

Cost of merchandise available for sale: 900 units at $54……………………………………………………...……… 1,120 units at $55………………………………………………...…………… 1,000 units at $58………………………………………………………..…… 980 units at $60………………………………………………….…………… 4,000 units (at an average cost of $56.75)………………………………… a.

$ 48,600 61,600 58,000 58,800 $227,000

First-in, first-out: Merchandise inventory: 980 units at $60…………………………………………………..………… 20 units at $58………………………………………...…………………… 1,000 units……………………………………………………..………………

$58,800 1,160 $59,960

Merchandise sold: $227,000 – $59,960…………………………………….…………………………

$167,040

b. Last-in, first-out:

Merchandise inventory: 900 units at $54……………………………………………...……………… 100 units at $55………………………………………….…………………… 1,000 units…………………………………………………………...…………

$48,600 5,500 $54,100

Merchandise sold: $227,000 – $54,100……………………………………………..………………

$172,900

Weighted average cost: Merchandise inventory: 1,000 units at $56.75 ($227,000 ÷ 4,000 units)………………………………

$56,750

Merchandise sold: $227,000 – $56,750…………………………………...…………………………

$170,250

CHAPTER 7

Inventories

Ex. 7-14 a.

1. 2. 3. 4.

FIFO inventory FIFO cost of merchandise sold FIFO net income FIFO income taxes

> (greater than) < (less than) > (greater than) > (greater than)

LIFO inventory LIFO cost of merchandise sold LIFO net income LIFO income taxes

b. In periods of rising prices, the income shown on the company’s tax return would be lower if LIFO rather than FIFO were used; thus, there is a tax advantage of using LIFO. Note to Instructors: The federal tax laws require that if LIFO is used for tax purposes, LIFO must also be used for financial reporting purposes. This is known as the LIFO conformity rule. Thus, selecting LIFO for tax purposes means that the company’s reported income will also be lower than if FIFO had been used. Companies using LIFO believe the tax advantages from using LIFO outweigh any negative impact of reporting a lower income to shareholders. Ex. 7-15 Total

Market

Inventory Item

Inventory Quantity

per Unit

Value per Unit (Net Realizable Value)

Birch Cypress Mountain Ash Spruce Willow Total

120 90 200 160 70

$150 120 110 90 130

$140 130 100 100 120

Cost

Market

LCM

$18,000 10,800 22,000 14,400 9,100 $74,300

$16,800 11,700 20,000 16,000 8,400 $72,900

$16,800 10,800 20,000 14,400 8,400 $70,400

Ex. 7-16 The merchandise inventory would appear in the Current Assets section, as follows: Merchandise inventory—at lower of cost (FIFO) or market…………………… $70,400 Alternatively, the details of the method of determining cost and the method of valuation could be presented in a note.

CHAPTER 7

Inventories

Ex. 7-17 a.

Balance Sheet

Merchandise inventory*………………………………………… Current assets…………………………………………………… Total assets……………………………………………………… Owner’s equity……………………………………………………

$5,200 understated $5,200 understated $5,200 understated $5,200 understated

* $5,200 = $238,600 – $233,400 b.

Income Statement

Cost of merchandise sold……………………………………… Gross profit……………………………………………………… Net income………………………………………………………… c.

$5,200 overstated $5,200 understated $5,200 understated Income Statement

Cost of merchandise sold……………………………………… Gross profit……………………………………………………… Net income…………………………………………………………

$5,200 understated $5,200 overstated $5,200 overstated

d. The December 31, 20Y3, balance sheet would be correct, since the 20Y2 inventory error reverses itself in 20Y3.

Ex. 7-18 a.

Balance Sheet

$8,650 overstated $8,650 overstated $8,650 overstated $8,650 overstated

* $8,650 = $337,500 – $328,850 b.

Income Statement

$8,650 understated $8,650 overstated $8,650 overstated Income Statement

$8,650 overstated $8,650 understated $8,650 understated

d. The December 31, 20Y9, balance sheet would be correct, since the 20Y8 inventory error reverses itself in 20Y9.

CHAPTER 7

Inventories

Ex. 7-19 When an error is discovered affecting the prior period, it should be corrected. In this case, the merchandise inventory account should be debited and the owner’s capital account credited for $42,750. Failure to correct the error for 20Y4 and purposely misstating the inventory and the cost of merchandise sold in 20Y5 would cause the income statements for the two years not to be comparable. The balance sheet at the end of 20Y5 would be correct, however, because the 20Y4 inventory error reverses itself in 20Y5.

Ex. 7-20 a.

Apple: 37.2 {$163,756 ÷ [($3,956 + $4,855) ÷ 2]} Mattel: 4.7 {$2,716 ÷ [($543 + $601) ÷ 2]}

b. Lower. Although Mattel’s business is seasonal, with most of its revenue generated during the major holidays, much of its nonholiday inventory may turn over very slowly. Apple, on the other hand, turns its inventory over very fast because it maintains a low inventory, which allows it to respond quickly to customer needs. In addition, Apple’s computer products can become obsolete quickly, so it cannot risk building large inventories.

CHAPTER 7

Inventories

Ex. 7-21 a.

Inventory Turnover

Cost of Merchandise Sold Average Inventory

Kroger:

$94,894 ($8,123 + $7,781) ÷ 2

= 11.93

Sprouts:

$3,460 ($264 + $230) ÷ 2

= 14.01

Ingles:

$3,113 ($372 + $349) ÷ 2

= 8.64

b. Days’ Sales in Inventory

Average Inventory Cost of Merchandise Sold ÷ 365

Kroger:

($8,123 + $7,781) ÷ 2 $94,894 ÷ 365

$7,952.0 $260.0

= 30.6 days

Sprouts:

($264 + $230) ÷ 2 $3,460 ÷ 365

$247.0 $9.5

= 26.0 days

Ingles:

($372 + $349) ÷ 2 $3,113 ÷ 365

$360.5 $8.5

= 42.4 days

Alternatively, the day’s sales in inventory could be computed by dividing 365 days by the inventory turnover as follows: Kroger: Sprouts: Ingles:

30.6 days (365 ÷ 11.93) 26.1 days* (365 ÷ 14.01) 42.2 days* (365 ÷ 8.64)

* Difference is due to rounding.

The inventory turnover ratios and days’ sales in inventory are similar for Kroger and Sprouts. Ingles has a lower inventory turnover and a higher days’ sales in inventory than Kroger and Sprouts. These results suggest that Kroger and Sprouts are more efficient than Ingles in managing inventory.

d. If Ingles matched Kroger’s days’ sales in inventory, then its hypothetical ending inventory would be determined as follows: Days’ Sales in Inventory = 30.6 days =

Average Inventory Cost of Merchandise Sold ÷ 365 X ($3,113 ÷ 365)

X = 30.6 × ($3,113 ÷ 365) = 30.6 × $8.5 X = $260.1

CHAPTER 7

Inventories

Ex. 7-21 (Concluded) Thus, the additional cash flow that would have been generated is the difference between the actual average inventory and the hypothetical average inventory, as follows: Actual average inventory……………………………………… Hypothetical average inventory……………………………… Positive cash flow potential…………………………………

$361 million 260 million $101 million

That is, a lower average inventory amount would have required less cash than actually was required. Appendix Ex. 7-22 $666,900 ($1,235,000 × 54%) Appendix Ex. 7-23 $241,804 ($396,400 × 61%) Appendix Ex. 7-24 $511,500 ($775,000 × 66%) Appendix Ex. 7-25 Cost

Merchandise inventory, June 1 Purchases in June (net) Merchandise available for sale Ratio of cost to retail price:

$ 165,000 2,361,500 $2,526,500 $2,526,500 $4,075,000

Retail

$ 275,000 3,800,000 $4,075,000

= 62%

Sales for June Merchandise inventory, June 30, at retail price Merchandise inventory, June 30, at estimated cost ($525,000 × 62%)

3,550,000 $ 525,000 $ 325,500

Appendix Ex. 7-26 a.

Merchandise inventory, January 1 Purchases (net), January 1–December 31 Merchandise available for sale Sales, January 1–December 31 Less estimated gross profit ($4,440,000 × 35%) Estimated cost of merchandise sold Estimated merchandise inventory, December 31

$ 350,000 2,950,000 $3,300,000 $4,440,000 1,554,000 2,886,000 $ 414,000

CHAPTER 7

Inventories

Appendix Ex. 7-26 (Concluded) b. The gross profit method is useful for estimating inventories for monthly or quarterly financial statements. It is also useful in estimating the cost of merchandise destroyed by fire or other disasters.

Appendix Ex. 7-27 Merchandise available for sale………………………………………………… Less cost of merchandise sold [$9,250,000 × (100% – 36%)]……………… Estimated ending merchandise inventory……………………………………

$6,125,000 5,920,000 $ 205,000

Appendix Ex. 7-28 Merchandise available for sale………………………………………………… Less cost of merchandise sold [$1,450,000 × (100% – 42%)]……………… Estimated ending merchandise inventory……………………………………

$960,000 841,000 $119,000

Mar.

Feb.

Jan.

Date

Prob. 7-1A

28 5

30 5 10

1 10

90.00

89.50

87.50

85.00

675,000

4,027,500

4,725,000

1,912,500

7-23

26,250

15,000 15,000

13,500 13,500 25,500

7,500 3,750 3,750 1,500

89.50

87.50 89.50

85.00 87.50 87.50

75.00 85.00 85.00 85.00

10,891,875

2,349,375

1,312,500 1,342,500

1,147,500 1,181,250 2,231,250

562,500 318,750 318,750 127,500

Total Cost

Unit Cost

Quantity

Unit Cost

Total Cost

Cost of Merchandise Sold

Purchases

30,000 30,000 7,500 3,750 7,500

40,500 15,000 15,000 45,000

18,750 15,000 13,500 13,500 54,000

7,500 7,500 22,500

Quantity

Balances

7,500

45,000

54,000

22,500

Quantity

Inventories

PROBLEMS

CHAPTER 7

89.50 89.50 90.00 89.50 90.00

87.50 87.50 87.50 89.50

85.00 85.00 85.00 85.00 87.50

75.00 75.00 85.00

Unit Cost

Inventory

2,685,000 2,685,000 675,000 335,625 675,000 1,010,625

3,543,750 1,312,500 1,312,500 4,027,500

1,593,750 1,275,000 1,147,500 1,147,500 4,725,000

562,500 562,500 1,912,500

Total Cost

CHAPTER 7

Inventories

Prob. 7-1A (Concluded) 2.

Accounts Receivable Sales

19,875,000

Cost of Merchandise Sold Merchandise Inventory

10,891,875

19,875,000*

10,891,875

* $19,875,000 = $1,687,500 + $562,500 + $225,000 + $4,320,000 + $4,080,000 + $4,800,000 + $4,200,000

$8,983,125 ($19,875,000 – $10,891,875)

$1,010,625 ($335,625 + $675,000)

Because the prices rose from $75 for the January 1 inventory to $90 for the purchase on March 25, we would expect that under the last-in, first-out method, the inventory would be lower. Note to Instructors: Problem 7-2A shows that the inventory is $881,250 under LIFO.

CHAPTER 7

Inventories

Prob. 7-2A 1.

Purchases Date

Jan. 1 10

Quantity

22,500

Cost of Merchandise Sold

Unit

Total

Cost

Quantity

Unit

Total

Cost

85.00 1,912,500

11,250

85.00

956,250

3,750

85.00

318,750

Feb. 5

1,500

85.00

127,500

27,000

87.50 2,362,500

25,500

87.50 2,231,250

30,000

89.50 2,685,000

7,500 15,000 1,500 2,250

90.00 675,000 89.50 1,342,500 87.50 131,250 85.00 191,250 11,021,250

Mar. 5

54,000

45,000

87.50 4,725,000

89.50 4,027,500

7,500

90.00

675,000

31 Balances

Inventory Unit

Total

Quantity

Cost

7,500 7,500 22,500 7,500 11,250 7,500 7,500 7,500 6,000 7,500 6,000 54,000 7,500 6,000 27,000 7,500 6,000 1,500 7,500 6,000 1,500 45,000 7,500 6,000 1,500 15,000 7,500 6,000 1,500 15,000 7,500 7,500 3,750

75.00 562,500 75.00 562,500 85.00 1,912,500 75.00 562,500 85.00 956,250 75.00 562,500 85.00 637,500 75.00 562,500 85.00 510,000 75.00 562,500 85.00 510,000 87.50 4,725,000 75.00 562,500 85.00 510,000 87.50 2,362,500 75.00 562,500 85.00 510,000 87.50 131,250 75.00 562,500 85.00 510,000 87.50 131,250 89.50 4,027,500 75.00 562,500 85.00 510,000 87.50 131,250 89.50 1,342,500 75.00 562,500 85.00 510,000 87.50 131,250 89.50 1,342,500 90.00 675,000 75.00 562,500 85.00 318,750

881,250

CHAPTER 7

Inventories

Prob. 7-2A (Concluded) 2.

Total sales………………………………………………………………………… $19,875,000 * Total cost of merchandise sold………………………………………………… 11,021,250 Gross profit………………………………………………………………………… $ 8,853,750 * Total Sales = $19,875,000 = $1,687,500 + $562,500 + $225,000 + $4,320,000 + $4,080,000 + $4,800,000 + $4,200,000

$881,250 = [(7,500 units × $75) + (3,750 units × $85)] = $562,500 + $318,750

87.50

89.50 90.00

54,000

45,000 7,500

Balances

85.00

22,500

Purchases Unit Quantity Cost

675,000

4,027,500

4,725,000

1,912,500

Total Cost

26,250

30,000

27,000 25,500

11,250 3,750 1,500

89.00

88.75

86.50 86.50

82.50 82.50 82.50

2,336,250 10,901,250

2,662,500

2,335,500 2,205,750

928,125 309,375 123,750

Cost of Merchandise Sold Total Quantity Unit Cost Cost

Inventories

7,500 30,000 18,750 15,000 13,500 67,500 40,500 15,000 60,000 30,000 37,500 11,250

Quantity

75.00 82.50 82.50 82.50 82.50 86.50 86.50 86.50 88.75 88.75 89.00 89.00

Unit Cost

Inventory

7-27

$1,001,250 (11,250 × $89.00)

* Total sales = $1,687,500 + $562,500 + $225,000 + $4,320,000 + $4,080,000 + $4,800,000 + $4,200,000 = $19,875,000

Total sales………………………………………………………………… $19,875,000 * Total cost of merchandise sold………………………………………… 10,901,250 Gross profit………………………………………………………………… $ 8,973,750

1 10 28 30 Feb. 5 10 16 28 Mar. 5 14 25 30 31

Jan.

Date

Prob. 7-3A

CHAPTER 7

562,500 2,475,000 1,546,875 1,237,500 1,113,750 5,838,750 3,503,250 1,297,500 5,325,000 2,662,500 3,337,500 1,001,250 1,001,250

Total Cost

CHAPTER 7

Inventories

Prob. 7-4A 1.

First-In, First-Out Method Merchandise inventory, March 31………………………………………… $ 1,010,625 Cost of merchandise sold………………………………………..………… 10,891,875 Supporting computations Inventory: Units in beginning inventory and purchased…………………………… Units sold……………………………………………..……………………… Units in ending inventory…………………………………………………..

136,500 125,250 11,250

7,500 units @ $90.00…………………………………………………… $ 675,000 335,625 3,750 units @ $89.50…………………………………………………… 11,250 units………………………………………………………..……… $1,010,625 Cost of merchandise sold: Beginning inventory, January 1…………………………………………… $ 562,500 Purchases………………………………………………………...…………… 11,340,000 * Merchandise available for sale…………………………………………… $11,902,500 Ending inventory, March 31………………………………………………… 1,010,625 Cost of merchandise sold……………………………………………..…… $10,891,875 * $1,912,500 + $4,725,000 + $4,027,500 + $675,000

Last-In, First-Out Method Inventory, March 31………………………………………...………………… $ 881,250 Cost of merchandise sold……………………………………………..…… 11,021,250 Supporting computations Inventory: 7,500 units @ $75.00…………………………………………………… 3,750 units @ $85.00…………………………………………………… 11,250 units…………………………………………………….…………

$562,500 318,750 $881,250

Cost of merchandise sold: Beginning inventory, January 1…………………………………………… $ 562,500 Purchases……………………………………………………………………… 11,340,000 Merchandise available for sale…………………………………………… $11,902,500 Ending inventory, March 31…………………………………………...…… 881,250 Cost of merchandise sold…………………………………………………… $11,021,250

CHAPTER 7

Inventories

Prob. 7-4A (Concluded) 3. Weighted Average Cost Method Inventory, March 31………………………………………………………… $ 981,000 Cost of merchandise sold…………………………………………………… 10,921,500 Supporting computations Total Cost of Merchandise Available for Sale Units Available for Sale

Weighted Average Unit Cost = =

$11,902,500 = $87.20 per unit (rounded) 136,500 units

Inventory: 11,250 units × $87.20 = $981,000 Cost of merchandise sold: Beginning inventory, January 1............................................................ Purchases............................................................................................... Merchandise available for sale............................................................. Ending inventory, March 31.................................................................. Cost of merchandise sold..................................................................... 4.

562,500 11,340,000 $11,902,500 981,000 $10,921,500

Sales Cost of merchandise sold Gross profit

FIFO $19,875,000 * 10,891,875 $ 8,983,125

LIFO $19,875,000 11,021,250 $ 8,853,750

Weighted Average $19,875,000 10,921,500 $ 8,953,500

Inventory, March 31

$ 1,010,625

881,250

981,000

* ($1,687,500 + $562,500 + $225,000 + $4,320,000 + $4,080,000 + $4,800,000 + $4,200,000)

CHAPTER 7

Inventories

Prob. 7-5A 1.

First-In, First-Out Method Model

A10 B15 E60 G83 J34 M90 Q70

Quantity

Unit Cost

4 2 6 2 5 9 15 3 2 7 1

$ 76 70 184 170 70 259 270 130 128 180 175

Quantity

Unit Cost

Total Cost

4 2 8 3 2 7 2 12 3 2 2 1 5 3

$ 64 70 176 75 65 242 250 240 246 108 110 128 160 170

$ 256 140 1,408 225 130 1,694 500 2,880 738 216 220 128 800 510 $9,845

Total 2.

Total Cost

304 140 1,104 340 350 2,331 4,050 390 256 1,260 175 $10,700

Last-In, First-Out Method Model

A10 B15 E60 G83 J34 M90

Q70 Total

CHAPTER 7

Inventories

Prob. 7-5A (Concluded) 3.

Weighted Average Cost Method Model

A10 B15 E60 G83 J34 M90 Q70 Total

Quantity

Unit Cost*

6 8 5 9 15 5 8

$ 70 174 69 253 258 121 172

Total Cost

420 1,392 345 2,277 3,870 605 1,376 $10,285

* Computations of unit costs: A10: $70 = [(4 × $64) + (4 × $70) + (4 × $76)] ÷ (4 + 4 + 4) B15: $174 = [(8 × $176) + (4 × $158) + (3 × $170) + (6 × $184)] ÷ (8 + 4 + 3 + 6) E60: $69 = [(3 × $75) + (3 × $65) + (15 × $68) + (9 × $70)] ÷ (3 + 3 + 15 + 9) G83: $253 = [(7 × $242) + (6 × $250) + (5 × $260) + (10 × $259)] ÷ (7 + 6 + 5 + 10) J34: $258 = [(12 × $240) + (10 × $246) + (16 × $267) + (16 × $270)] ÷ (12 + 10 + 16 + 16) M90: $121 = [(2 × $108) + (2 × $110) + (3 × $128) + (3 × $130)] ÷ (2 + 2 + 3 + 3) Q70: $172 = [(5 × $160) + (4 × $170) + (4 × $175) + (7 × $180)] ÷ (5 + 4 + 4 + 7)

During periods of rising prices, the LIFO method will result in a lower cost of inventory, a greater amount of cost of merchandise sold, and less net income than the other two methods. For Dymac Appliances, the LIFO method would be preferred for the current year because it would result in less income tax.

b. During periods of declining prices, the FIFO method will result in less net income and would be preferred for income tax purposes.

CHAPTER 7

Inventories

Prob. 7-6A Inventory Sheet December 31 Total

Market Cost per Unit

Value per Unit (Net Realizable Value)

30 8

$ 60 59

$ 57 57

20 13

178 128 129

180 126 126

Inventory Item

Inventory Quantity

B12

E41 G19

18 33

L88

N94 P24

R66

400 90

10 8

80 10 5 3

563 560 8 22 21 248 260

550 550 7 18 18 250 250

T33

140

100 40

21 19

20 20

Z16

10 5

750 745

752 752

Total

Cost

Market

$ 1,800 472 2,272 3,204 2,560 1,677 4,237 5,630 4,480 10,110 3,200 1,760 210 1,970 1,240 780 2,020 2,100 760 2,860 7,500 3,725 11,225 $41,098

$ 1,710 456 2,166 3,240 2,520 1,638 4,158 5,500 4,400 9,900 2,800 1,440 180 1,620 1,250 750 2,000 2,000 800 2,800 7,520 3,760 11,280 $39,964

LCM

$ 2,166 3,204

4,158

9,900 2,800

1,620

2,000

2,800

11,225 $39,873

CHAPTER 7

Inventories

Appendix Prob. 7-7A 1. Celebrity Tan Co. Cost

Merchandise inventory, August 1 Net purchases Merchandise available for sale Ratio of cost to retail price:

$ 300,000 2,149,000 $2,449,000

$2,449,000 $3,950,000

Retail

$ 575,000 3,375,000 $3,950,000

= 62%

Sales Merchandise inventory, August 31, at retail Merchandise inventory, at estimated cost ($780,000 × 62%)

3,170,000 $ 780,000 $ 483,600

2. Ranchworks Co. Cost

Merchandise inventory, March 1 Net purchases Merchandise available for sale Sales Less estimated gross profit ($15,800,000 × 38%) Estimated cost of merchandise sold Estimated merchandise inventory, November 30 Estimated merchandise inventory, November 30 Physical inventory count, November 30 Estimated loss due to theft or damage, March 1–November 30

880,000 9,500,000 $10,380,000 $15,800,000 6,004,000 9,796,000 $ 584,000 $

584,000 369,750

214,250

June

May

Apr.

Date

Prob. 7-1B

16 21

19 28

30 8

3 8

712

707

700

690

128,160

84,840

70,000

82,800

7-34

60 130

40 20 40

50 30 30

40 20 50

Quantity

707 712

700 707 707

690 700 700

670 690 690

42,420 92,560 357,000

28,000 14,140 28,280

34,500 21,000 21,000

26,800 13,800 34,500

100 60 60 180

70 40 40 120

100 50 50 100

40 40 120

Quantity

Balances

180

120

100

120

Quantity

Unit Cost

Total Cost

Cost of Merchandise Sold

Unit Cost

Inventories

Purchases Total Cost

CHAPTER 7

712

707 707 707 712

700 700 700 707

690 690 690 700

670 670 690

Unit Cost

Inventory

35,600 35,600

70,700 42,420 42,420 128,160

49,000 28,000 28,000 84,840

69,000 34,500 34,500 70,000

26,800 26,800 82,800

Total Cost

CHAPTER 7

Inventories

Prob. 7-1B (Concluded) 2.

Accounts Receivable Sales

611,800

Cost of Merchandise Sold Merchandise Inventory

357,000

611,800*

357,000

* $611,800 = $67,200 + $56,000 + $89,600 + $33,600 + $75,600 + $50,400 + $239,400

$254,800 ($611,800 – $357,000)

$35,600 (50 units × $712)

Because the prices rose from $670 for the April 3 inventory to $712 for the purchase on June 21, we would expect that under last-in, first-out, the inventory would be lower. Note to Instructors: Problem 7-2B shows that the inventory is $33,870 under LIFO.

June

May

Apr.

Date

Prob. 7-2B

712

128,160

7-36

180 10

712 707

707

700 690

700

690

128,160 7,070 358,730

28,280

42,420

14,000 6,900

56,000

34,500

41,400

40 40 120 40 60 40 20 40 20 180 40 10

40 40 120 40 60 40 10 40 10 100 40 10 20

Quantity

Balances

180

84,840

707 60

120

20 10

70,000

700

100

82,800

690 60

120

Quantity

3 8

Quantity

Unit Cost

Total Cost

Cost of Merchandise Sold

Unit Cost

Inventories

Purchases Total Cost

CHAPTER 7

670 670 707 670 707 670 707 670 707 712 670 707

670 670 690 670 690 670 690 670 690 700 670 690 700

Unit Cost

Inventory

26,800 26,800 84,840 26,800 42,420 26,800 14,140 26,800 14,140 128,160 26,800 7,070 33,870

26,800 26,800 82,800 26,800 41,400 26,800 6,900 26,800 6,900 70,000 26,800 6,900 14,000

Total Cost

CHAPTER 7

Inventories

Prob. 7-2B (Concluded) 2.

Total sales………………………………………………………………………… Total cost of merchandise sold……………………………………………… Gross profit………………………………………………………………………

$611,800 * 358,730 $253,070

* $611,800 = $67,200 + $56,000 + $89,600 + $33,600 + $75,600 + $50,400 + $239,400

$33,870 = [(40 units × $670) + (10 units × $707)] = $26,800 + $7,070

700

707

712

100

120

180 Balances

690

120

Quantity

Unit Cost

Purchases

128,160

84,840

70,000

82,800

Total Cost

190

60 40

80 30

60 50

710

704 704

695 695

685 685

Quantity Unit Cost

134,900 357,100

42,240 28,160

55,600 20,850

41,100 34,250

Total Cost

Cost of Merchandise Sold

Inventories

7-38

40 160 100 50 150 70 40 160 100 60 240 50

Quantity

670 685 685 685 695 695 695 704 704 704 710 710

Unit Cost

Inventory

$35,500 (50 units × $710)

* $611,800 = $67,200 + $56,000 + $89,600 + $33,600 + $75,600 + $50,400 + $239,400

Total sales……………………………………………………………… $611,800 * 357,100 Total cost of merchandise sold…………………………………… Gross profit…………………………………………………………… $254,700

3 8 11 30 May 8 10 19 28 June 5 16 21 28 30

Apr.

Date

Prob. 7-3B

CHAPTER 7

26,800 109,600 68,500 34,250 104,250 48,650 27,800 112,640 70,400 42,240 170,400 35,500 35,500

Total Cost

CHAPTER 7

Inventories

Prob. 7-4B 1.

First-In, First-Out Method Merchandise inventory, June 30……………………………………….… Cost of merchandise sold………………………………………..…………

$ 35,600 357,000

Supporting computations Merchandise inventory: 50 units @ $712……………………………………………...…………

$ 35,600

Cost of merchandise sold:

Beginning inventory, April 1………………………………………….…… Purchases……………………………………………………………….…… Merchandise available for sale……………………………………….…… Less ending inventory, June 30………………………………………...… Cost of merchandise sold…………………………………………………

$ 26,800 365,800 $392,600 35,600 $357,000

Last-In, First-Out Method Merchandise inventory, June 30………………………………………… Cost of merchandise sold…………………………………….……………

$ 33,700 358,900

Supporting computations Merchandise inventory: 40 units @ $670………………………………………………………… 10 unit @ $690………………………………………………………… 50 units…………………………………………………………………

$26,800 6,900 $33,700

Cost of merchandise sold: Beginning inventory, April 1……………………………………………… Purchases…………………………………………………………………...… Merchandise available for sale…………………………………………… Less ending inventory, June 30……………………………………….… Cost of merchandise sold…………………………………………………

$ 26,800 365,800 $392,600 33,700 $358,900

CHAPTER 7

Inventories

Prob. 7-4B (Continued) 3. Weighted Average Cost Method Merchandise inventory, June 30………………………………… $ 35,050 Cost of merchandise sold………………………………………… 357,550 Supporting computations Weighted Average Unit Cost = =

Total Cost of Merchandise Available for Sale Units Available for Sale $392,600 560 units

= $701 per unit (rounded)

Merchandise inventory: 50 units × $701 = $35,050 (rounded) Cost of merchandise sold: Beginning inventory, April 1……………………………………… $ 26,800 Purchases…………………………………………………………… 365,800 Merchandise available for sale…………………………………… $392,600 Less ending inventory, June 30………………………………… 35,050 Cost of merchandise sold………………………………………… $357,550 4. Sales Cost of merchandise sold Gross profit

FIFO $611,800 357,000 $254,800

LIFO $611,800 358,900 $252,900

Weighted Average $611,800 357,550 $254,250

Inventory, June 30

$ 35,600

$ 33,700

$ 35,050

CHAPTER 7

Inventories

Prob. 7-5B 1.

First-In, First-Out Method Model

C55 D11 F32 H29 K47 S33 X74 Total 2.

Quantity

Unit Cost

Total Cost

3 1 6 5 1 1 4 6 2 2 7

$1,070 1,060 675 666 280 260 317 542 549 232 39

$ 3,210 1,060 4,050 3,330 280 260 1,268 3,252 1,098 464 273 $18,545

Quantity

Unit Cost

Total Cost

3 1 9 2 2 4 6 2 2 4 3

$1,040 1,054 639 645 240 305 520 531 222 35 36

$ 3,120 1,054 5,751 1,290 480 1,220 3,120 1,062 444 140 108 $17,789

Last-In, First-Out Method Model

C55 D11 F32 H29 K47 S33 X74 Total

CHAPTER 7

Inventories

Prob. 7-5B (Concluded) 3.

Weighted Average Cost Method Model

C55 D11 F32 H29 K47 S33 X74 Total

Quantity

Unit Cost*

Total Cost

4 11 2 4 8 2 7

$1,056 654 252 311 534 227 37

$ 4,224 7,194 504 1,244 4,272 454 259 $18,151

* Computations of unit costs: C55: $1,056 = [(3 × $1,040) + (3 × $1,054) + (3 × $1,060) + (3 × $1,070)] ÷ (3 + 3 + 3 + 3) D11: $654 = [(9 × $639) + (7 × $645) + (6 × $666) + (6 × $675)] ÷ (9 + 7 + 6 + 6) F32: $252 = [(5 × $240) + (3 × $260) + (1 × $260) + (1 × $280)] ÷ (5 + 3 + 1 + 1) H29: $311 = [(6 × $305) + (3 × $310) + (3 × $316) + (4 × $317)] ÷ (6 + 3 + 3 + 4) K47: $534 = [(6 × $520) + (8 × $531) + (4 × $549) + (6 × $542)] ÷ (6 + 8 + 4 + 6) S33: $227 = [(4 × $222) + (4 × $232)] ÷ (4 + 4) X74: $37 = [(4 × $35) + (6 × $36) + (8 × $37) + (7 × $39)] ÷ (4 + 6 + 8 + 7)

During periods of rising prices, the LIFO method will result in a lower cost of inventory, a greater amount of cost of merchandise sold, and less net income than the other two methods. For Pappa’s Appliances, the LIFO method would be preferred for the current year because it would result in less income tax.

b. During periods of declining prices, the FIFO method will result in less net income and would be preferred for income tax purposes.

CHAPTER 7

Inventories

Prob. 7-6B Inventory Sheet December 31 Total

Market Cost per Unit

Value per Unit (Net Realizable Value)

30 7

$ 60 58

$ 56 56

20 10

174 130 128

178 132 132

Inventory Item

Inventory Quantity

A54

C77 F66

24 30

H83

K12 Q58

S36

375 90

6 15

75 15 5 3

547 540 6 25 26 256 260

545 545 5 18 18 235 235

V97

140

100 40

17 16

20 20

Y88

10 7

750 740

744 744

Total

Cost

Market

$ 1,800 406 2,206 4,176 2,600 1,280 3,880 3,282 8,100 11,382 2,250 1,875 390 2,265 1,280 780 2,060 1,700 640 2,340 7,500 5,180 12,680 $43,239

$ 1,680 392 2,072 4,272 2,640 1,320 3,960 3,270 8,175 11,445 1,875 1,350 270 1,620 1,175 705 1,880 2,000 800 2,800 7,440 5,208 12,648 $42,572

LCM

$ 2,072 4,176

3,880

11,382 1,875

1,620

1,880

2,340

12,648 $41,873

CHAPTER 7

Inventories

Appendix Prob. 7-7B 1. Jaffe Co. Cost

Merchandise inventory, February 1 Net purchases Merchandise available for sale Ratio of cost to retail price:

$ 400,000 4,055,000 $4,455,000

$4,455,000 $5,940,000

Retail

$ 615,000 5,325,000 $5,940,000

= 75%

Sales Merchandise inventory, February 28, at retail Merchandise inventory, at estimated cost ($840,000 × 75%)

5,100,000 $ 840,000 $ 630,000

2. Coronado Co. Cost

Merchandise inventory, May 1 Net purchases Merchandise available for sale Sales Less estimated gross profit ($4,750,000 × 35%) Estimated cost of merchandise sold Estimated merchandise inventory, October 31 Estimated merchandise inventory, October 31 Physical inventory count, October 31 Estimated loss due to theft or damage, May 1–October 31

$ 400,000 3,150,000 $3,550,000 $4,750,000 1,662,500 3,087,500 $ 462,500 $ 462,500 366,500 $

96,000

CHAPTER 7

Inventories

CASES & PROJECTS CP 7-1 1.

In the short run, Sizemo Electroniks may benefit slightly from the inflated inventory values and higher earnings. However, at some point in the future, the inventory will be sold at a significantly reduced price or a lower-of-cost-or-market adjustment will be made. Tina benefits from avoiding a possible altercation with the CEO, board members, and stockholders who might be unsettled by a decline in earnings. However, these benefits are only temporary, as the loss will ultimately be recorded in later periods.

The users of Sizemo’s financial statements are harmed by this decision, as it does not result in financial statements that fairly present the company’s financial results. Investors may use the information to make investment decisions. Creditors may use the information as a basis for making loans to the company. Both investors and creditors may rely on the inflated values of the 537X semiconductors to predict future earnings, which could expose them to future financial losses.

No. Tina is acting unethically by instructing Jay to ignore a lower-of-cost-or-market adjustment intentionally. As Jay’s supervisor, Tina has a responsibility to ensure her employees behave ethically and apply GAAP correctly. Jay is behaving unethically by knowingly applying GAAP incorrectly. He should have reported the incident to Tina’s supervisor.

CP 7-2 Because the title to merchandise shipped FOB shipping point passes to the buyer when the merchandise is shipped, the shipments made before midnight, October 31, should be recorded properly as sales for the fiscal year ending October 31. Hence, Ryan Frazier is behaving in a professional manner. However, Ryan should realize that recording these sales in the current year precludes them from being recognized as sales in the next year. Thus, accelerating the shipment of orders to increase sales of one period will have the effect of decreasing sales of the next period.

CHAPTER 7

Inventories

CP 7-3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1. a. Inventory costs consist primarily of product cost from the company’s suppliers, as well as inbound freight, import duties, taxes, insurance and logistics, and other handling fees. b. Inventories are stated at lower of cost and net realizable value, and valued on either an average or specific identification cost basis. c. $5,261 million (from balance sheet) d. 34.8% ($5,261 ÷ $15,134) in 2018; 31.5% ($5,055 ÷ $16,061) in 2017. Inventory as a percentage of total current assets has increased slightly. e. $20,441 2.

The company’s inventory turnover has improved between 2017 and 2018. 2018 Cost of merchandise sold…………………………… $20,441 Beginning inventory…………………………………… 5,055 Ending inventory……………………………………… 5,261 Average inventory………………………………… 5,158 Inventory turnover……………………………………… 4.0

2017 $19,038 4,838 5,055 4,947 3.8

CHAPTER 7

Inventories

CP 7-4 Memo To: From: Re:

Ms. Connie Kilmer President, Golden Eagle Company A+ Student Comparison of LIFO and FIFO inventory methods

LIFO and FIFO are alternative methods of applying unit cost to the units that are sold during the year and those units that remain in ending inventory at the end of the year. The LIFO method is often viewed as the best basis for reflecting income from operations. This is because the LIFO method matches the most current cost of merchandise purchases against current sales. The matching of current costs with current sales results in a gross profit amount that best reflects the results of current operations. For Golden Eagle Company, the gross profit of $3,025,600 reflects the matching of the most current costs of the product of $6,974,400 against the current period sales of $10,000,000. This matching of current costs with current sales also tends to minimize the effects of price trends on the results of operations. During periods of rising prices, such as for Golden Eagle Company, the LIFO method will also result in less net income than FIFO. Because taxes are levied as a percentage of net income, Golden Eagle Company would pay a lower income tax under the LIFO method. While the LIFO method is often viewed as the best method for matching revenues and expenses, the FIFO method is often consistent with the physical movement of merchandise in a business, since most businesses tend to dispose of commodities in the order of their acquisition. To the extent that this is the case, the FIFO method approximates the results that will be attained by a specific identification of costs. The FIFO method also provides the best reflection of the replacement cost of the ending inventory for the balance sheet. This is because the amount reported on the balance sheet for inventory will be assigned costs from the most recent purchases. These costs reflect purchases made near the end of the period. For Golden Eagle Company, the ending inventory on December 31 is assigned costs totaling $1,436,400 under the FIFO method. These costs represent purchases made during the period of August through December. This FIFO inventory amount of $1,436,400 more closely approximates the replacement cost of the ending inventory than the $1,173,600 LIFO amount.

CHAPTER 7

Inventories

CP 7-4 (Concluded) Supporting computations: The cost of ending inventory under the last-in, first-out and first-in, first-out methods is as follows: Last-in, first-out method: 31,000 units at $36.60………………………………………………… 1,000 units at $39.00…………………………………………………

$1,134,600 39,000

32,000 units……………………………………………………………

$1,173,600

First-in, first-out method: 8,000 units at $48.00………………………………………………… 8,000 units at $44.85………………………………………………… 12,800 units at $43.50………………………………………………… 3,200 units at $42.75…………………………………………………

$ 384,000 358,800 556,800 136,800

32,000 units……………………………………………………………

$1,436,400

The cost of merchandise sold and gross profit under each method are as follows: FIFO

LIFO

$10,000,000 6,974,400 $ 3,025,600

$10,000,000 6,711,600 $ 3,288,400

Ending inventory………………………………………………..……

$8,148,000 1,173,600

$8,148,000 1,436,400

Cost of merchandise sold…………………………………………

$6,974,400

$6,711,600

Sales…………………………………………………………. Cost of merchandise sold (see below)………………… Gross profit………………………………………………… Cost of merchandise sold calculation: Cost of merchandise available for sale…………………………

CHAPTER 7

Inventories

CP 7-5 In developing a response to Paula’s concerns, you should probably emphasize the practical need for an assumption concerning the flow of cost of merchandise purchased and sold. That is, when identical goods are frequently purchased, it may not be practical to specifically identify each item of inventory. If all the identical goods were purchased at the same price, it wouldn’t make any difference for financial reporting purposes which goods Musick Foods assumed were sold first, second, etc. However, in most cases, goods are purchased over time at different prices, and hence, a need arises to determine which goods are sold so that the price (cost) of those goods can be matched against the revenues to determine operating income. Next, you should emphasize that accounting principles allow for the fact that the physical flow of the goods may differ from the flow of costs. Specifically, accounting principles allow for three cost flow assumptions: first-in, first-out; last-in, first-out; and weighted average. Each of these methods has advantages and disadvantages. One primary advantage of the last-in, first-out method is that it better matches current costs (the cost of merchandise purchased last) with current revenues. Therefore, the reported operating income is more reflective of current operations and what might be expected in the future. Another reason the last-in, first-out method is often used is that it tends to minimize taxes during periods of price increases. Because for most businesses prices tend to increase, the LIFO method will generate lower taxes than will the alternative cost flow methods. The preceding explanation should help Paula better understand LIFO and its impact on the financial statements and taxes.

CHAPTER 7

Inventories

CP 7-6 a. Target Corp. Inventory Turnover = =

Cost of Merchandise Sold Average Inventory $53,299 ($9,497 + $8,597) ÷ 2

= 5.89

Amazon.com Inventory Turnover = =

Cost of Merchandise Sold Average Inventory $139,156 ($17,174 + $16,047) ÷ 2

= 8.38

b. Target Corp. Days’ Sales in Inventory

Average Inventory Cost of Merchandise Sold ÷ 365

($9,497 + $8,597) ÷ 2 $53,299 ÷ 365

Average Inventory Cost of Merchandise Sold ÷ 365

($17,174 + $16,047) ÷ 2 $139,156 ÷ 365

= 62.0 days

Amazon.com Days’ Sales in Inventory

= 43.6 days

Note to Instructors: Days’ sales in inventory could also be computed by dividing 365 days by the inventory turnover as follows: Target Corp. Amazon.com

62.0 days (365 days ÷ 5.89) 43.6 days (365 days ÷ 8.38)

c. Amazon.com has a smaller investment in inventory for its volume than does Target. Amazon.com’s inventory turnover is faster (larger), and the days’ sales in inventory is shorter (smaller). This is because Amazon.com uses a different business model than Target does. That is, Amazon.com sells through the Internet, while Target uses the more traditional retail store model, which requires it to stock more inventory.

CHAPTER 7

Inventories

CP 7-7 a. Cost of merchandise sold............................

Costco $123,152

Wal-Mart $385,301

JCPenney $7,870

Merchandise inventory, beginning.............. Merchandise inventory, ending................... Total...........................................................

$ 9,834 11,040 $20,874

$43,783 44,269 $88,052

$2,803 2,437 $5,240

Average merchandise inventory.................. Inventory turnover.........................................

$10,437 11.80

$44,026 8.75

$2,620 3.00

Costco

Wal-Mart

JCPenney

Average merchandise inventory [from part (a)].............................................. Cost of merchandise sold............................

$10,437 $123,152

$44,026 $385,301

$2,620 $7,870

Average daily cost of merchandise sold..... Days’ sales in inventory...............................

$337.4 30.9

$1,055.6 41.7

$21.6 121.3

Both the inventory turnover ratio and the days’ sales in inventory reflect the merchandising approaches of the three companies. Costco is a club warehouse. Its approach is to hold only mass appeal items that are sold quickly off the shelf. Most items are sold in bulk quantities at very attractive prices. Costco couples thin margins with very fast inventory turnover. Wal-Mart has a traditional discounter approach. It has attractive pricing, but the inventory moves slower than would be the case at a club warehouse. For example, many purchases made at Wal-Mart would not be packaged in the same bulk as would be the case at Costco. JCPenney is a traditional department store with a wider assortment of goods that will not necessarily appeal to the mass market. That is, some of the merchandise items will be more specialized and unique. As such, its inventory moves slower but at a higher price (and margin). JCPenney is having difficulty implementing a competitive strategy against retailers such as Costco and Wal-Mart.

CHAPTER 8 INTERNAL CONTROL AND CASH DISCUSSION QUESTIONS 1.

The five elements of internal control are the control environment, risk assessment, control procedures, monitoring, and information and communication. The control environment is the overall attitude of management and employees about the importance of controls. Risk assessment includes evaluating various risks facing the business, including competitive threats, regulatory changes, and changes in economic factors. Control procedures are established to provide reasonable assurance that business goals will be achieved. Monitoring is the evaluation of the internal control system. Information and communication provide management with feedback about internal control.

No. One element of internal control is not more important than another element. All five elements are necessary for effective internal control.

To reduce the possibility of errors and embezzlement, the functions of operations and accounting should be separated. Thus, one employee should not be responsible for handling cash receipts (operations) and maintaining the accounts receivable records (accounting).

The control procedure requiring that responsibility for a sequence of related operations be divided among different persons is violated in this situation. This weakness in the internal control may permit irregularities. For example, the ticket seller, while acting as ticket taker, could admit friends without a ticket.

The responsibility for maintaining the accounting records should be separated from the responsibility for operations so that the accounting records can serve as an independent check on operations.

Controls that could have prevented or detected the fraud include (1) requiring supporting documentation such as receiving reports and purchase orders of all payments, (2) requiring approval by an independent party, and (3) allowing payments only to vendors who have been previously approved by upper management.

The three documents supporting the liability are the vendor’s invoice, the purchase order, and the receiving report. The invoice should be compared with the receiving report to determine that the items billed have been received and with the purchase order to verify quantities, prices, and terms.

The cash balance and the bank statement balance are likely to differ because of (1) a delay by the bank or company in recording transactions or (2) errors by the bank or company in recording transactions.

The purpose of a bank reconciliation is to determine the reasons for the difference between the balance according to the company’s records and the balance according to the bank statement and to correct those items representing errors in recording that may have been made by the bank or the company.

CHAPTER 8

Internal Control and Cash

DISCUSSION QUESTIONS (Continued) 9.

10.

Yes. Even though the petty cash fund is only $750, if the fund is replenished frequently, a significant amount of cash could be stolen. For example, if the fund is replenished weekly, $39,000 ($750 × 52 weeks) could be subject to theft.

Controls for petty cash include (1) designating one person who is responsible for the fund, (2) maintaining a written record of all payments, (3) requiring support (receipts) for payments from the fund, and (4) having an independent person periodically review the funds on hand and the payments.

Cash and cash equivalents are usually reported as one amount in the Current Assets section of the balance sheet.

Examples of cash equivalents include certificates of deposit, U.S. government securities, corporate notes and bonds, and commercial paper.

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Internal Control and Cash

PRACTICE EXERCISES PE 8-1A 1. 2. 3.

PE 8-1B 1. 2. 3.

(a) the control environment (c) information and communication (b) control procedures

PE 8-2A

Item No.

Appears on the Bank Statement as a Debit or Credit Memo

Increases or Decreases the Balance of the Company’s Bank Account

1 2 3 4

credit memo credit memo credit memo debit memo

increases increases increases decreases

Item No.

Appears on the Bank Statement as a Debit or Credit Memo

Increases or Decreases the Balance of the Company’s Bank Account

1 2 3 4

credit memo debit memo credit memo debit memo

increases decreases increases decreases

PE 8-2B

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Internal Control and Cash

PE 8-3A a.

$9,660, determined as follows: Bank section of reconciliation: $14,385 + $2,125 – $6,850 = $9,660 Company section of reconciliation: $11,200 – $60 – $1,480 = $9,660

Accounts Receivable Miscellaneous Expense Cash

1,480 60 1,540

PE 8-3B a.

$21,390, determined as follows: Bank section of reconciliation: $28,240 + $6,500 – $13,350 = $21,390 Company section of reconciliation: $10,280 + $11,170 – $60 = $21,390

Miscellaneous Expense Cash

60 60

Cash Notes Receivable Interest Revenue

11,170 10,640 530

PE 8-4A a.

Petty Cash Cash

1,410 1,410

Repairs Expense Miscellaneous Selling Expense Cash Short and Over Cash

850 80 40 970

PE 8-4B a.

Petty Cash Cash

1,270 1,270

Store Supplies Miscellaneous Selling Expense Cash Short and Over Cash

780 280 50 1,110

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Internal Control and Cash

PE 8-5A a.

Monthly Cash Expenses =

= Ratio of Cash to = Monthly Cash Expenses =

Negative Cash Flow from Operations 12 months $97,200 = $8,100 per month 12 months Cash as of Year-End Monthly Cash Expenses $54,270 $8,100 per month

= 6.7 months

b. The preceding computations indicate that Abrams Company has 6.7 months of cash remaining as of December 31. Abrams Company will need to generate positive cash flow from operations or raise additional financing from its owners or by issuing debt.

PE 8-5B a.

Monthly Cash Expenses =

= Ratio of Cash to = Monthly Cash Expenses =

Negative Cash Flow from Operations 12 months $308,400 = $25,700 per month 12 months Cash as of Year-End Monthly Cash Expenses $138,780 $25,700 per month

= 5.4 months

b. The preceding computations indicate that McMasters Company has 5.4 months of cash remaining as of December 31. McMasters Company will need to generate positive cash flow from operations or raise additional financing from its owners or by issuing debt.

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Internal Control and Cash

EXERCISES Ex. 8-1 Section 404 requires management’s internal control report to: (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the issuer’s fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. The complete AICPA summary of Section 404 of Sarbanes-Oxley is as follows: Section 404: Management Assessment of Internal Controls. Requires each annual report of an issuer to contain an “internal control report,” which shall: (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2) contain an assessment, as of the end of the issuer’s fiscal year, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. Each issuer’s auditor shall attest to, and report on, the assessment made by the management of the issuer. An attestation made under this section shall be in accordance with standards for attestation engagements issued or adopted by the Board. An attestation engagement shall not be the subject of a separate engagement. The language in the report of the Committee that accompanies the bill to explain the legislative intent states, “. . . the Committee does not intend that the auditor’s evaluation be the subject of a separate engagement or the basis for increased charges or fees.” Directs the SEC to require each issuer to disclose whether it has adopted a code of ethics for its senior financial officers and the contents of that code. Directs the SEC to revise its regulations concerning prompt disclosure on Form 8-K to require immediate disclosure “of any change in, or waiver of,” an issuer’s code of ethics.

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Internal Control and Cash

Ex. 8-2 a. Agree. Jimmy has made one employee responsible for the cash drawer in accordance with the internal control principle of assignment of responsibility. In addition, Jimmy has segregated the operations (preparing the orders) from the accounting (taking orders and payments). b.

Disagree. It is commendable that Jimmy has given the employee a specific responsibility and is holding that employee accountable for it. However, after the cashier has counted the cash, another employee (or perhaps Jimmy) should remove the cash register tape and compare the amount on the tape to the cash in the drawer. Also, Jimmy’s standard of no mistakes may encourage the cashiers to overcharge a few customers in order to cover any possible shortages in the cash drawer.

Disagree. Stealing is a serious issue. An employee who can justify taking a box of tea bags can probably justify “borrowing” cash from the cash register.

Ex. 8-3 a.

The salesclerks could steal money by writing phony refunds and pocketing the cash supposedly refunded to these fictitious customers.

Ramona’s Clothing suffers from inadequate separation of responsibilities for related operations because the clerks issue refunds and restock all merchandise. In addition, there is a lack of proofs and security measures because the supervisors authorize returns two hours after they are issued.

A store credit for any merchandise returned without a receipt would reduce the possibility of theft of cash. In this case, a clerk could only issue a phony store credit rather than taking money from the cash register. A store credit is not as tempting as cash. In addition, salesclerks could only use a few store credits to purchase merchandise for themselves without management getting suspicious. An advantage of issuing a store credit for returns without a receipt is that the possibility of stealing cash is reduced. The store will also lose less revenue if customers must choose other store merchandise instead of receiving a cash refund. The overall level of returns/exchanges may be reduced because customers will not return an acceptable gift simply because they need cash more than the gift. The policy will also reduce the “cash drain” during the weeks immediately following the holidays, allowing Ramona’s Clothing to keep more of its money earning interest or use that cash to purchase spring merchandise or pay creditors.

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Internal Control and Cash

Ex. 8-3 (Concluded) A disadvantage of issuing a store credit for returns without a receipt is that preholiday sales might drop as gift-givers realize that the return policy has tightened. After the holidays, customers wanting to return items for cash refunds may be frustrated when they learn the store policy has changed. The ill will may reduce future sales. It may take longer to explain the new policy and fill out the paperwork for a store credit, lengthening lines at the return counter after the holidays. Salesclerks will need to be trained to apply the new policy and write up a store credit. Salesclerks also will need to be trained to handle the redemption of the store credit on future merchandise purchases. d.

The potential for abuse in the cash refund system could be eliminated if clerks were required to get a supervisor’s authorization for a refund before giving the customer the cash. The supervisor should authorize the refund only after seeing both the customer and the merchandise that is being returned. An alternative would be to use security measures that detect a salesclerk attempting to ring up a refund and remove cash when a customer is not present at the sales desk. These security measures could include cameras or additional security personnel discreetly monitoring the sales desk. Finally, an employee on the following work shift could be assigned the responsibility of restocking returned merchandise and reconciling the returns to a refund list for the department.

Ex. 8-4 As an internal auditor, you would probably disagree with the change in policy. Pacific Bank has some normal business risk associated with default on bank loans. One way to help minimize this is to evaluate loan applications carefully. Large loans present greater risk in the event of default than do smaller loans. Thus, it is reasonable to have more than one person involved in making the decision to grant a large loan. In addition, loans should be granted on their merits, not on the basis of favoritism or mere association with the bank president. Allowing the bank president to have sole authority to grant large loans can lead to the president granting loans to friends and business associates without the required due diligence. This can result in a bank becoming exposed to very poor credit risks. Indeed, this scenario is one of the causes of the savings and loan failures of the past.

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Internal Control and Cash

Ex. 8-5 The Societe Generale trading losses show how small lapses in internal control can have large consequences. When the losses became so large that they could no longer be hidden, it was too late. The loss could have been avoided using a number of internal controls. First, the separation of duties control was overcome by the trader’s intimate knowledge of the monitoring software. This knowledge of the monitoring system allowed the trader to hide trades effectively. The design of the monitoring software would need to be improved and access prohibited by traders. If traders have access to the monitoring software, the separation of duties control is violated. Second, the trader should be under managerial oversight. For example, trades that exceed a certain amount of exposure should require management approval. In this way, a trader would be forced to slow down or stop once trades reached a certain limit. This would avoid the trader’s tendency to try to “make up” losses with even larger bets. Finally, if the trader had had to take required vacation time, managers may have been alerted then to the hidden losses once the trader was unable to attend to the trading positions.

Ex. 8-6 This is an example of a fraud perpetrated with multiple parties in different positions of control, which makes detecting fraud more difficult. In this case, the fraud began with an employee responsible for authorizing claim payments. This is a sensitive position because his decisions would initiate payments. However, claims would need to be authorized and verified before payment would be made. Knowing this, the employee made sure each claim had a phony “victim.” Thus, there was a verifiable story behind each claim. Only by tracking physical evidence of the accident could it be discovered that the claim was fictitious. However, the very nature of the process was to resolve small claims quickly without excessive control. Finally, corrupt lawyers were brought into the fraud to act as attorneys for the claimants. This gave the claims even more credibility. In actuality, the lawyers had done legitimate business with the trucking company, so all appeared normal. This fraud was discovered when the fraudulent employee’s bank noticed irregularities in his bank account and notified authorities. As the saying goes, “Follow the money!”

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Internal Control and Cash

Ex. 8-7 All-Around Sound Co. should not have relied on the unusual nature of the vendors and frequency of deliveries to uncover this fraud. The purchase and payment cycle is one of the most critical business cycles to control because the potential for abuse is so great. Purchases should be initiated by a requisition document. This document should be countersigned by a superior so that two people agree as to what is being purchased. The requisition should initiate a purchase order to a vendor for goods or services. The vendor responds to the purchase order by delivering the goods. The goods should be formally received using a receiving document. An accounts payable clerk matches the requisition, purchase order, and invoice before any payment is made. Such “triple matching” prevents unauthorized requests and payments. In this case, the requests were unauthorized, suggesting that the employee has sole authority to make a request. Another issue is that this employee had access to the invoices. This access allowed the employee to change critical characteristics of the invoice to hide the true nature of the goods being received. The invoice should have been delivered directly to the accounts payable clerk to avoid corrupting the document. There apparently was no receiving document (common for smaller companies); thus, only the invoice provided proof of what was received and needed to be paid. If there had been a receiving report, the invoice could not have been doctored and gone undetected because it would not have matched the receiving report. Note to Instructors: This exercise is based on an actual fraud.

Ex. 8-8 a.

The most difficult frauds to detect are those that involve the senior managers of a company who are in a conspiracy to commit the fraud. The senior managers have the power to access many parts of the accounting system, while the normal separation of duties is subverted by involving many people in the fraud. In addition, the authorization control is subverted because most of the authorization power resides in senior management.

Overall, this type of fraud can be stopped if there is a strong oversight of senior management, such as an audit committee of the board of directors. Individual whistle-blowers in the company can make their concerns known to the independent or internal auditors who, in turn, can inform the audit committee. The audit committee should be independent of management and have the power to monitor the actions of management.

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Internal Control and Cash

Ex. 8-9 a.

The salesclerks should not have access to the cash register tapes.

The cash register tapes should be locked in the cash register and the key retained by the cashier. An employee of the cashier’s office should remove the cash register tape, record the total on the memo form, and note discrepancies.

Ex. 8-10 Big & Bad Burgers suffers from a failure to separate responsibilities for related operations. Big & Bad Burgers could stop this theft by limiting the drive-through clerk to taking customer orders, entering them on the cash register, accepting the customers’ payments, returning customers’ change, and handing customers their orders that another employee has assembled. By making another employee responsible for assembling orders, the drive-through clerk must enter the orders on the cash register. This will produce a printed receipt or an entry on a computer screen at the food bin area, specifying the items that must be assembled to fill each order. Once the drive-through clerk has entered the sale on the cash register, the clerk cannot steal the customer’s payment because the clerk’s cash drawer will not balance at the end of the shift. This change also makes the drive-through more efficient and could reduce the time it takes to service a drive-through customer. If another employee cannot be added, the weakness in internal control could be improved with more thorough supervision. The restaurant manager should be directed to keep a watchful eye on the drive-through area in order to detect when a clerk takes an order without ringing up the sale. Another option is for Big & Bad Burgers to implement a policy that any customer who does not receive a receipt is entitled to a free burger and advertise this policy at the cash register and drive-through window. This approach uses the customer as an internal control.

Ex. 8-11 a.

The remittance advices should not be sent to the cashier.

The mailroom employees should send the remittance advices directly to the Accounting Department.

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Internal Control and Cash

Ex. 8-12 Cash Cash Short and Over Sales

25,538 132 25,670

Ex. 8-13 Cash Sales Cash Short and Over

66,670 66,341 329

Ex. 8-14 The use of the voucher system is appropriate, the essentials of which are outlined below. (Although invoices could be used instead of vouchers, vouchers more satisfactorily provide for account distribution, signatures, and other significant data.) 1.

Each voucher should be approved for payment by a designated official only after completion of the following verifications: (a) that prices, quantities, terms, etc., on the invoice are in accordance with the provisions of the purchase order; (b) that all quantities billed have been received in good condition, as indicated on a receiving report; and (c) that all arithmetic details are correct.

The file for unpaid vouchers should be composed of 31 compartments, one for each day of the month. Each voucher should be filed in the compartment representing the last day of the discount period or the due date if the invoice is not subject to a cash discount.

Each day, the vouchers should be removed from the appropriate section of the file and checks issued by the disbursing official. If the bank balance is insufficient to pay all of the vouchers, those that remain unpaid should be refiled according to the date when payment should next be considered.

At the time of payment, all vouchers and supporting documents should be stamped or perforated “Paid” to prevent their resubmission for payment. They should then be filed in numerical sequence for future reference. The implementation and use of a computerized system would also reduce the chance that any available cash discounts are missed. For example, when invoices are received and approved for payment, they are automatically scheduled for payment within the discount period. However, even in a computerized system, the use of an approval process that requires supporting documents and indicating “paid” on these supporting documents is an important control for avoiding duplicate payments.

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Internal Control and Cash

Ex. 8-15 To prevent the fraud scheme described, Paragon Tech must separate responsibilities for related operations. As in the past, all service requisitions should be submitted to the Purchasing Department. After receiving the service request, Purchasing should complete a Service Verification form stating the service that has been ordered and the name of the company that will provide the service. This form should be delivered via intercompany mail to the person responsible for verifying that the service was performed. This person should have firsthand knowledge of whether the service was performed. This person, who must be someone other than the manager requesting the service, should fill in the date and time the service was received and sign the form. In addition, the vendor providing the service should sign the form before leaving the premises. When completed, the Service Verification form should be forwarded to the Accounting Department. Accounting will authorize payment of the vendor’s invoice after the Service Verification form has been compared with the invoice.

Ex. 8-16 a. b. c. d.

Addition to the balance per bank: (5) Deduction from the balance per bank: (4), (6) Addition to the balance per company’s records: (7) Deduction from the balance per company’s records: (1), (2), (3)

Ex. 8-17 (1), (2), (3), (7) The preceding additions and deductions to the cash balance according to the company’s records require journal entries in the company’s records. Additions and deductions to the cash balance according to the bank’s records do not require the company to record journal entries.

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Internal Control and Cash

Ex. 8-18 a. Nakajima Co. Bank Reconciliation July 31 Cash balance according to bank statement Add deposit in transit, not recorded by bank Deduct outstanding checks Adjusted balance

$48,250 6,450 (4,460) $50,240

Cash balance according to company’s records Add error in recording check as $950 instead of $590 Deduct bank service charge Adjusted balance

$49,910 360 (30) $50,240

$50,240; the adjusted balance from the bank reconciliation should be reported on the July 31 balance sheet for Nakajima Co.

Yes. The bank reconciliation must always balance (reconcile) to an adjusted balance.

Ex. 8-19 July

Cash Accounts Payable

360

Miscellaneous Expense Cash

360

Ex. 8-20 Cash Notes Receivable Interest Revenue

15,120 14,000 1,120

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Internal Control and Cash

Ex. 8-21 a. Chesner Co. Bank Reconciliation August 31 Cash balance according to bank statement Add deposit in transit on August 31 Deduct outstanding checks Adjusted balance Cash balance according to company’s records Add: Error in recording Check No. 1056 as $950 instead of $590 Note for $12,000 collected by bank, including interest Deduct bank service charges Adjusted balance b.

$20,300 7,200 (3,585) $23,915 $11,100 $

360

12,480

12,840 (25) $23,915

$23,915

Ex. 8-22 a.

The heading should be “June 30,” and not “For the Month Ended June 30.”

The outstanding checks should be deducted from the balance per bank.

The deposit of June 30, not recorded by the bank, should be added to the balance per bank.

Service charges should be deducted from the balance per company’s records.

The error in recording the June 17 deposit of $7,150 as $1,750 should be added to the balance per company’s records.

The adjusted balances ($12,590 and $9,010) are not equal.

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Internal Control and Cash

Ex. 8-22 (Concluded) b.

A correct bank reconciliation would be as follows:

Poway Co. Bank Reconciliation June 30 Cash balance according to bank statement Add deposit of June 30, not recorded by bank Deduct outstanding checks: No. 1067 1106 1110 1113 Adjusted balance Cash balance according to company’s records Add: Note and interest collected by bank Error in recording June 17 deposit as $1,750 instead of $7,150 Deduct: Check returned because of insufficient funds Service charges Adjusted balance

$16,185 6,600 $ 575 470 1,050 910

(3,005) $19,780 $ 8,985

$6,300 5,400 $ 890 15

11,700 (905) $19,780

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Internal Control and Cash

Ex. 8-23 a.

The amount of cash receipts stolen by the salesclerk can be determined by attempting to reconcile the bank account. The bank reconciliation will not reconcile by the amount of cash receipts stolen. The amount stolen by the salesclerk is $4,135, determined as follows:

Alaska Impressions Co. Bank Reconciliation October 31 Cash balance according to bank statement Deduct outstanding checks Adjusted balance

$13,275 (3,670) $ 9,605

Cash balance according to company’s records Add note and interest collected by bank Deduct bank service charges Adjusted balance

$11,680 2,100 (40) $13,740

Amount stolen: $4,135 ($13,740 – $9,605) b.

The theft of the cash receipts might have been prevented by having more than one person make the daily deposit. Two individuals would then have been necessary to steal cash receipts. In addition, two employees making the daily cash deposits would tend to discourage theft of the cash receipts from the employees on the way to the bank. Daily reconciliation of the amount of cash receipts—comparing the cash register tapes to a receipt from the bank as to the amount deposited (a duplicate deposit ticket)—would also discourage theft of the cash receipts. In this latter case, if the reconciliation were prepared by an employee independent of the cash function, any theft of cash receipts from the daily deposit would be discovered immediately. That is, the daily deposit would not reconcile against the daily cash receipts.

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Internal Control and Cash

Ex. 8-24 a.

Petty Cash Cash

1,290 1,290

Office Supplies Miscellaneous Selling Expense Miscellaneous Administrative Expense Cash Short and Over Cash

427 365 165 30 987

Ex. 8-25 Toy manufacturers and retailers experience a seasonal trend in cash flows from operating activities. Hasbro, Inc., experiences negative cash flows during the periods when merchandise is ordered and produced for the holiday season. Hasbro, Inc., generates large positive cash flows during the holiday season, November–December. As a result, it reports overall positive net cash flows from operating activities for the year.

Ex. 8-26 a.

8.4 months ($1,415,400 ÷ $168,500)

At the current rate of operations, El Dorado has 8.4 months of cash remaining. El Dorado should either restructure its operations or plan on raising additional financing in order to continue in business.

Ex. 8-27 a.

$720.1 thousand ($8,641 ÷ 12)

20.0 months ($14,408 ÷ $720.1)

Capstone Turbine has cash to continue its operations for approximately 20.0 months. Note to Instructors: Capstone has credit agreements with banks that it uses (draws on) for short-term cash needs. Thus, it appears that Capstone will be able to continue operating for the foreseeable future. However, in the long run, Capstone Turbine will have to generate postive cash flows from operations in order to survive.

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Internal Control and Cash

Ex. 8-28 a. (in thousands) Year 3: $24,996.3 per month ($299,955 ÷ 12) Year 2: $17,807.9 per month ($213,695 ÷ 12) Year 1: $12,512.3 per month ($150,147 ÷ 12) b.

Year 3: 3.2 months ($79,749 ÷ $24,996.3) Year 2: 2.8 months ($49,060 ÷ $17,807.9) Year 1: 14.9 months ($187,026 ÷ $12,512.3)

At the end of Year 1, Amicus Therapeutics had 14.9 months of cash and cash equivalents remaining to use in operations. At the end of Year 2, Amicus had 2.8 months of cash and cash equivalents to use in operations. However, during Year 2, Amicus issued over $243 million of additional stock and at the end of Year 2, had short-term investments of $309 million. If the short-term investments of $309 million are included as being available to convert to cash, Amicus has 20.1 months of available cash to use in operations at the end of Year 2. At the end of Year 3, Amicus had 3.2 months of cash and cash equivalents to use in operations. However, during Year 3, Amicus issued over $294 million of additional stock and at the end of Year 3 had short-term investments of $424 million. If the short-term investments of $424 million are included as being available to convert to cash, Amicus has 20.2 months of available cash to use in operations at the end of Year 3. Overall, Amicus has been able to support its operations by issuing additional stock. However, its negative cash flows have increased from $(150,147) in Year 1 to $(299,955) in Year 3. Unless Amicus generates positive cash flows from operations, its ability to continue raising funds from issuing stock or debt will be limited. Thus, in the long run, Amicus must generate positive cash flows from operations to survive.

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Internal Control and Cash

PROBLEMS Prob. 8-1A Strengths: a, b, e, and f Weaknesses: c.

Employees should not be allowed to use the petty cash fund to cash personal checks. In any case, postdated checks should not be accepted. In effect, postdated checks represent a receivable from the employees.

Requiring cash register clerks to make up any cash shortages from their own funds gives the clerks an incentive to shortchange customers. That is, the clerks will want to make sure they don’t have a shortage at the end of the day. In addition, one might also assume that the clerks can keep any overages. This would again encourage clerks to shortchange customers. The shortchanging of customers will create customer complaints as well as other issues. The best policy is to report any cash shortages or overages at the end of each day. If a clerk is consistently short or over, then corrective action (e.g., training or removal) could be taken.

The mail clerk should prepare an initial listing of cash remittances before forwarding the cash receipts to the cashier. This establishes initial accountability for the cash receipts. The mail clerk should forward a copy of the listing of remittances to the accounts receivable clerk for recording in the accounts.

The bank reconciliation should be prepared by someone not involved with the handling or recording of cash.

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Internal Control and Cash

Prob. 8-2A Jan.

1 Petty Cash Cash

900 900

12 Cash Cash Short and Over Sales

6,180 32 6,148

31 Store Supplies Delivery Expense Office Supplies Miscellaneous Administrative Expense Cash Short and Over Cash 31 Cash Cash Short and Over Sales

470 140 110 90 15 825 4,536 14 4,550

31 Cash Petty Cash

200 200

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Internal Control and Cash

Prob. 8-3A 1. Norwegian Medical Co. Bank Reconciliation April 30 Cash balance according to bank statement Add: Deposit of April 30, not recorded by bank Bank error in charging check as $860 instead of $680 Deduct outstanding checks Adjusted balance Cash balance according to company’s records Add note and interest collected by bank Deduct: Error in recording check Bank service charges Adjusted balance

$468,460 $51,230 180

51,410 (73,870) $446,000 $403,784 50,630

$ 8,244 170

(8,414) $446,000

2. Apr.

Cash Notes Receivable Interest Revenue

50,630

Accounts Payable—Universal Supply Co. Miscellaneous Expense Cash

8,244 170

48,220 2,410

8,414

3. $446,000; the adjusted balance from the bank reconciliation should be reported as cash on the April 30 balance sheet for Norwegian Medical Co.

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Internal Control and Cash

Prob. 8-4A 1. Brentwood Bike Co. Bank Reconciliation May 31 Cash balance according to bank statement Add: Deposit of May 31, not recorded by bank Bank error in charging check as $930 instead of $390 Deduct outstanding checks Adjusted balance Cash balance according to company’s records* Add note and interest collected by bank Deduct: Check returned because of insufficient funds Bank service charges Error in recording check Adjusted balance * Cash balance, May 1………………………………………………………………… Plus cash deposited in May………………………………………………………… Less checks written in May………………………………………………………… Balance per company’s books, May 31…………………………………………

$43,525 $1,850 540

2,390 (6,440) $39,475 $35,670 5,250

$1,325 30 90

(1,445) $39,475

$ 34,250 140,300 (138,880) $ 35,670

2. May

Cash Notes Receivable Interest Revenue

5,250

Accounts Payable—Adkins Co. Accounts Receivable—Jennings Co. Miscellaneous Expense Cash

90 1,325 30

5,000 250

1,445

3. $39,475; the adjusted balance from the bank reconciliation should be reported as cash on the May 31 balance sheet for Brentwood Bike Co.

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Internal Control and Cash

Prob. 8-5A 1. Beeler Furniture Company Bank Reconciliation June 30, 20Y2 Cash balance according to bank statement Add deposit of June 30, not recorded by bank Deduct outstanding checks: No. 738 756 758 759 Adjusted balance Cash balance according to company’s records* Add: Note and interest collected by bank Error in recording Check No. 743 Deduct: Check returned because of insufficient funds Error in recording June 10 deposit Error in recording June 24 deposit Bank service charges Adjusted balance

$13,624.71 1,117.74 $ 251.40 113.95 259.60 901.50

(1,526.45) $13,216.00 $10,145.50

$3,710.00 90.00 $ 550.00 100.00 4.50 75.00

3,800.00

(729.50) $13,216.00

* Balance per cash in bank account, June 1………………… $ 9,317.40 Add June receipts……………………………………………… Deduct June disbursements………………………………… Balance per cash in bank account, June 30………………

9,223.76 (8,395.66) $10,145.50

2. 20Y2 June

Cash Notes Receivable Interest Revenue Accounts Payable

3,800.00

Sales ($100.00 + $4.50) Accounts Receivable Miscellaneous Expense Cash

104.50 550.00 75.00

3,500.00 210.00 90.00

729.50

$13,216.00

The error of $540 ($930 – $390) in the canceled check should be added to the “balance according to bank statement” on the bank reconciliation. The canceled check should be presented to the bank with a request that the bank balance be corrected.

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Internal Control and Cash

Prob. 8-1B Strengths: a, b, e, and f Weaknesses: c.

An independent person (e.g., a supervisor) should count the cash in each cashier’s cash register, unlock the record, and compare the amount of cash with the amount on the record to determine cash shortages or overages.

Cash receipts should not be handled by the accounts receivable clerk. This violates the segregation of duties between the handling of cash receipts and the recording of cash receipts.

The bank reconciliation should be prepared by someone not involved with the handling or recording of cash.

Prob. 8-2B June

1 Petty Cash Cash

1,000

12 Cash Cash Short and Over Sales

9,506

1,000

66 9,440

30 Store Supplies Merchandise Inventory Office Supplies Miscellaneous Administrative Expense Cash Short and Over Cash 30 Cash Cash Short and Over Sales

375 215 208 134 22 954 13,350 40 13,390

30 Petty Cash Cash

200 200

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Internal Control and Cash

Prob. 8-3B 1. Stone Systems Bank Reconciliation July 31 Cash balance according to bank statement Add deposit of July 31, not recorded by bank Deduct: Outstanding checks Bank error in charging check as $1,180 instead of $1,810 Adjusted balance Cash balance according to company’s records Add: Note and interest collected by bank Error in recording check Deduct bank service charges Adjusted balance

$ 33,650 9,150 $17,865 630

(18,495) $ 24,305 $ 17,750

$ 6,095 540

6,635 (80) $ 24,305

2. July

Cash Notes Receivable Interest Revenue Accounts Payable—Holland Co. Miscellaneous Expense Cash

6,635 5,750 345 540 80 80

3. $24,305; the adjusted balance from the bank reconciliation should be reported as cash on the July 31 balance sheet for Stone Systems.

CHAPTER 8

Internal Control and Cash

Prob. 8-4B 1. Collegiate Sports Co. Bank Reconciliation November 30 Cash balance according to bank statement Add deposit of November 30, not recorded by bank Deduct: Outstanding checks Bank error in charging check as $2,750 instead of $7,250 Adjusted balance Cash balance according to company’s records* Add: Note and interest collected by bank Error in recording check as $7,600 instead of $760 Deduct: Check returned because of insufficient funds Bank service charges Adjusted balance

$112,675 12,200 $41,840 4,500

(46,340) $ 78,535 $ 66,935

$ 7,385 6,840 $ 2,500 125

14,225 (2,625) $ 78,535

* Cash balance, November 1…………………………………………… $ 81,145 Plus cash deposited in November………………………………… 293,150 Less checks written in November…………………………………… (307,360) Balance per company’s records, November 30…………………… $ 66,935

2. Nov.

Cash Notes Receivable Interest Revenue Accounts Payable—Ramirez Co.

14,225

Accounts Receivable—Hallen Academy Miscellaneous Expense Cash

2,500 125

7,000 385 6,840

2,625

3. $78,535; the adjusted balance from the bank reconciliation should be reported as cash on the November 30 balance sheet for Collegiate Sports Co.

CHAPTER 8

Internal Control and Cash

Prob. 8-5B 1. Sunshine Interiors Bank Reconciliation July 31, 20Y5 Cash balance according to bank statement Add deposit of July 31, not recorded by bank Deduct outstanding checks: No. 613 628 633 Adjusted balance Cash balance according to company’s records* Add: Note and interest collected by bank Error in recording July 23 deposit Error in recording Check No. 627 Deduct: Check returned because of insufficient funds Bank service charges Adjusted balance

$11,601.41 1,177.87 $ 137.50 837.70 310.08

(1,285.28) $11,494.00 $ 7,664.00

$4,160.00 18.00 63.00 $ 375.00 36.00

4,241.00 (411.00) $11,494.00

* Balance per cash in bank account, July 1………………… $ 9,578.00 Add July receipts……………………………………………… Deduct July disbursements………………………………… Balance per cash in bank account, July 31………………

6,465.42 (8,379.42) $ 7,664.00

2. 20Y5 July

Cash Notes Receivable Interest Revenue Sales Accounts Payable

4,241.00

Accounts Receivable Miscellaneous Expense Cash

375.00 36.00

4,000.00 160.00 18.00 63.00

411.00

$11,494.00

The error of $1,620 ($1,800 – $180) in the canceled check should be added to the “balance according to bank statement” on the bank reconciliation. The canceled check should be presented to the bank, with a request that the bank balance be corrected.

CHAPTER 8

Internal Control and Cash

CASES & PROJECTS CP 8-1 Both Tehra and her supervisor are acting in an unethical manner. While Tehra’s disappointment at not receiving a raise may be justified, it is not appropriate for Tehra to submit personal expenses for reimbursement. By knowingly submitting false expense reimbursements, Tehra is effectively stealing from the company and exhibiting a failure of individual character. By allowing this behavior to happen and continue, Tehra’s supervisor is creating a culture of ethical indifference in the organization. This will likely lead to larger and more frequent incidents, potentially impacting the company’s financial results.

CP 8-2 Acceptable business and professional conduct requires Joel Knolls to notify the bank of the error. Note to Instructors: Individuals may be criminally prosecuted for knowingly using funds that are erroneously credited to their bank accounts.

CP 8-3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1. a. b.

$4,249 million (from balance sheet) 28.1% ($4,249 ÷ $15,134) in 2018; 23.7% ($3,808 ÷ $16,061) in 2017. Cash as a percentage of total current assets has increased.

2. Management’s Annual Report on Internal Control Over Financial Reporting is included in the annual report immediately before the financial statements. a.

Management

Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the financial statements for external purposes in accordance with generally accepted accounting principles in the United States of America. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets of the Company; (ii) provide reasonable assurance the transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipt and expenditures of the Company are being made only in accordance with authorizations of our management and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets of the Company that could have a material effect on the financial statements.

CHAPTER 8

Internal Control and Cash

CP 8-4 Note to Instructors: The purpose of this activity is to familiarize students with the internal controls used by specific businesses. For example, when you order food at a McDonald’s drive-through lane, your order is processed as follows: 1.

The order is taken at a remote location by speaking with the cashier who rings up the order and indicates the amount you owe.

The order is simultaneously shown on a computer screen in the food preparation area.

You then drive up and pay the cashier the amount owed and are handed a receipt.

You drive farther to where your order is delivered by an employee other than the cashier.

The preceding procedures separate the handling of cash from the delivery of the food order. If the cashier also delivered your order, the cashier could pocket your cash, not ring up your order, and deliver your food without anyone knowing.

CP 8-5 MEMO To: From: Re:

My Instructor A+ Student Control Procedures for Self-Checkout Lanes

Wholesome and Happy Foods could incorporate several features into the kiosks that would increase the likelihood of customers scanning all of the items in their carts for purchase. First, the scanning system should be set up so that an audible beep is heard each time an item is scanned and a sale recorded. This will alert the attendant that the item has been scanned properly. If the attendant does not hear a beep for each item, the attendant should be trained to investigate to ensure that all items have been scanned properly. Second, the kiosk should include a built-in scale that measures changes in the total weight as items are placed in the bagging area. If the weight increases without an item being scanned, the attendant should be alerted by the system. Finally, the kiosk should remind customers to check their cart’s bottom rack for any items they may have forgotten to scan.

CHAPTER 8

Internal Control and Cash

CP 8-6 Several control procedures could be implemented to prevent or detect the theft of cash from fictitious returns. One procedure would be to establish a policy of “no cash refunds.” That is, returns could only be exchanged for other merchandise. However, such a policy might not be popular with customers, and Turpin Meadows Electronics might lose sales from customers who would shop at other stores with a more liberal return policy. Another procedure would be to allow returns only through a centralized location, such as a customer service desk. The customer service desk clerk would issue an approved refund slip, which the customer could then take to a cash register to receive a cash refund. Because the customer service clerk does not have access to cash, the customer service clerk could not steal cash through fictitious returns. Yet another procedure would be to allow returns at the individual cash registers but require that all returns be approved by a supervisor. In this way, cash could be stolen through fictitious returns only through the supervisor and the cash register clerk agreeing to steal.

CP 8-7 Several possible procedures for preventing or detecting the theft of grocery items by failing to scan their prices include the following: a.

Most scanning systems are designed so that an audible beep is heard each time an item is rung up on the cash register. This is intended to alert the cashier that the item has been rung up properly. Thus, observing whether a cashier is ringing up all merchandise can be accomplished by standing near the cash register and listening for the beeps. Such observations might be done on a periodic, surprise basis by supervisors.

Some grocery stores have their cash registers networked so that a monitor in a centralized office, usually high above the floor, can monitor any cash register’s activity. In this way, a supervisor could monitor cash register activity on a periodic basis.

CHAPTER 8

Internal Control and Cash

CP 8-8 1.

Several methods could be used to determine how much the cashier stole. The method described here is based on preparing a bank reconciliation as illustrated in the chapter. Because of the theft of the undeposited receipts, the bank reconciliation adjusted balances will not agree. The difference between the adjusted balances is the estimate of the amount stolen by the cashier.

Parker Company Bank Reconciliation July 31 Balance according to bank statement Add undeposited cash receipts on hand Deduct outstanding checks: No. 2670 3679 3690 5148 5149 5151 Adjusted balance

$10,575 1,500 $1,050 675 1,650 225 750 800

(5,150) $ 6,925

Balance according to company’s records Add note and interest collected by bank Adjusted balance

$10,400 2,400 $12,800

Adjusted balance according to company’s records Adjusted balance according to bank statement Amount stolen by cashier

$12,800 6,925 $ 5,875

Note to Instructors: The amount stolen by the cashier could also be computed directly from the cashier-prepared bank reconciliation as follows: Outstanding checks omitted from the bank reconciliation prepared by the cashier: No. 2670……………………………………………………… 3679……………………………………………………… 3690……………………………………………………… Unrecorded note plus interest incorrectly recorded on the bank reconciliation prepared by the cashier…………… Addition error in the total of the outstanding checks in the bank reconciliation prepared by the cashier*……………

$1,050 675 1,650

$3,375 2,400 100 $5,875

* Note: The cashier has altered the adding machine tape so that the total is not correct.

CHAPTER 8

Internal Control and Cash

CP 8-8 (Concluded) 2.

The cashier attempted to conceal the theft by preparing an incorrect bank reconciliation. Specifically, the cashier (1) omitted outstanding checks on July 31 totaling $3,375, (2) added the list of outstanding checks shown on the bank reconciliation incorrectly so that the total is misstated by $100, and (3) incorrectly handled the treatment of the note and interest collected by the the bank.

Two major weaknesses in internal controls that allowed the cashier to steal the undeposited cash receipts are as follows: ●

Large amounts of undeposited cash receipts were kept on hand during the month. For example, cash receipts for July 30 and 31 had yet to be deposited as of July 31. The large amount of undeposited cash receipts allowed the cashier to steal the cash without arousing suspicion that any cash was missing.

●

The cashier prepared the bank reconciliation. This allowed the cashier to conceal the theft temporarily.

Two recommendations that would improve internal controls so that similar types of thefts of undeposited cash receipts can be prevented are as follows: ●

All cash receipts should be deposited daily. This would reduce the risk of significant cash losses. In addition, any missing cash would be more easily detected.

●

The bank reconciliation should be prepared by an independent individual who does not handle cash or the accounting records. One possibility would be for the owner of Parker Company to prepare the reconciliation.

Note to Instructors: In addition to the above recommendations, Parker Company should be counseled that it is standard practice for any disgruntled employees, fired employees, or employees who have announced quitting dates to be removed from sensitive positions (such as the cashier position) so that company assets or records will not be jeopardized. Finally, checks that have been outstanding for long periods of time (such as Nos. 2670, 3679, and 3690) should be voided (with stop payment instructions given to the bank) and reentered in the cash records. This establishes control over these items and prevents their misuse.

CHAPTER 8

Internal Control and Cash

CP 8-9 1. (in thousands) Year 3: $804.7 per month ($9,656 ÷ 12) Year 2: $1,043.0 per month ($12,516 ÷ 12) Year 1: $1,975.3 per month ($23,703 ÷ 12) 2. Year 3: 9.0 months ($7,272 ÷ $804.7) Year 2: 14.8 months ($15,471 ÷ $1,043.0) Year 1: 7.0 months ($13,838 ÷ $1,975.3) 3. At the end of Year 1, TearLab had 7.0 months of cash remaining. During Year 2, the monthly cash expenses decreased from $1,975.3 to $1,043.0. At the end of Year 2, less than 15 months (14.8) of cash remained. In Year 3, TearLab decreased its monthly cash expenses from $1,043.0 to $804.7. At the end of Year 3, 9 months (9.0) of cash remained. Unless TearLab changes its operations or raises additional financing, it will run out of cash within a year. In the long term, unless the company improves its cash flows, it may have difficulty raising sufficient cash from investors or creditors to continue operations.

CHAPTER 9 RECEIVABLES DISCUSSION QUESTIONS 1.

Receivables are normally classified as (1) accounts receivable, (2) notes receivable, or (3) other receivables.

Dan’s Hardware should use the direct write-off method because it is a small business that has a relatively small number and volume of accounts receivable.

Contra asset, credit balance.

The accounts receivable and allowance for doubtful accounts may be reported at a net amount of $661,500 ($673,400 – $11,900) in the Current Assets section of the balance sheet. In this case, the amount of the allowance for doubtful accounts should be shown separately in a note to the financial statements or in parentheses on the balance sheet. Alternatively, the accounts receivable may be shown at the gross amount of $673,400 less the amount of the allowance for doubtful accounts of $11,900, thus yielding net accounts receivable of $661,500.

(1) The percentage rate used is excessive in relation to the accounts written off as uncollectible; hence, the balance in the allowance is excessive. (2) A substantial volume of old uncollectible accounts is still being carried in the accounts receivable account.

An estimate based on analysis of receivables provides the most accurate estimate of the current net realizable value.

a. b.

The interest will amount to $5,100 ($85,000 × 6%) only if the note is payable one year from the date it was created. The usual practice is to state the interest rate in terms of an annual rate rather than in terms of the period covered by the note.

Debit Accounts Receivable for $243,600 Credit Notes Receivable for $240,000 Credit Interest Revenue for $3,600

10.

Sailfish Company Notes Receivable

Cash Accounts Receivable [$240,000 + ($240,000 × 6% × 90 ÷ 360)] Interest Revenue ($243,600 × 9% × 30 ÷ 360)

245,427 243,600 1,827

CHAPTER 9

Receivables

PRACTICE EXERCISES PE 9-1A Apr.

Aug.

15 Cash Bad Debt Expense Accounts Receivable—Joe Brown

1,800 2,700

7 Accounts Receivable—Joe Brown Bad Debt Expense

2,700

7 Cash Accounts Receivable—Joe Brown

2,700

2 Cash Bad Debt Expense Accounts Receivable—Elita Ramirez

1,140 2,570

20 Accounts Receivable—Elita Ramirez Bad Debt Expense

2,570

20 Cash Accounts Receivable—Elita Ramirez

2,570

15 Cash Allowance for Doubtful Accounts Accounts Receivable—Joe Brown

1,800 2,700

7 Accounts Receivable—Joe Brown Allowance for Doubtful Accounts

2,700

7 Cash Accounts Receivable—Joe Brown

2,700

4,500

2,700

PE 9-1B Oct.

Dec.

3,710

2,570

PE 9-2A Apr.

Aug.

4,500

2,700

CHAPTER 9

Receivables

PE 9-2B Oct.

Dec.

2 Cash Allowance for Doubtful Accounts Accounts Receivable—Elita Ramirez

1,140 2,570

20 Accounts Receivable—Elita Ramirez Allowance for Doubtful Accounts

2,570

20 Cash Accounts Receivable—Elita Ramirez

2,570

3,710

2,570

PE 9-3A a.

$158,000 ($31,600,000 × 0.005)

Adjusted Balance Debit (Credit) Accounts Receivable……………………………………………… Allowance for Doubtful Accounts ($14,860 + $158,000)…… Bad Debt Expense…………………………………………………

$2,450,000 (172,860) 158,000

Net realizable value ($2,450,000 – $172,860)……………………

$2,277,140

PE 9-3B a.

$478,500 ($63,800,000 × 0.0075)

Adjusted Balance Debit (Credit) Accounts Receivable……………………………………………… Allowance for Doubtful Accounts ($478,500 – $17,230)…… Bad Debt Expense…………………………………………………

$4,770,000 (461,270) 478,500

Net realizable value ($4,770,000 – $461,270)……………………

$4,308,730

CHAPTER 9

Receivables

PE 9-4A a. $235,140 ($250,000 – $14,860) Adjusted Balance Debit (Credit)

b. Accounts Receivable……………………………………………… Allowance for Doubtful Accounts……………………………… Bad Debt Expense…………………………………………………

$2,450,000 (250,000) 235,140

c. Net realizable value ($2,450,000 – $250,000)……………………

$2,200,000

PE 9-4B a. $397,230 ($380,000 + $17,230) Adjusted Balance Debit (Credit)

$4,770,000 (380,000) 397,230

c. Net realizable value ($4,770,000 – $380,000)……………………

$4,390,000

PE 9-5A a. The due date for the note is September 21, determined as follows: July …………………………………………………………….……… August …………………………………………………………….… September …………………………………………………………… Total……………………………………………………………………

8 days (31 – 23) 31 days 21 60 days

b. $56,840 [$56,000 + ($56,000 × 9% × 60 ÷ 360)] c. Sept.

21 Cash Notes Receivable Interest Revenue

56,840 56,000 840

CHAPTER 9

Receivables

PE 9-5B a.

The due date for the note is October 10, determined as follows: June…………………………………………………………………… July…………………………………………………………………… August……………………………………………………………… September…………………………………………………………… October………………………………………………………….…… Total……………………………………………………………………

$428,400 [$420,000 + ($420,000 × 6% × 120 ÷ 360)]

Oct.

10 Cash Notes Receivable Interest Revenue

18 days (30 – 12) 31 days 31 days 30 days 10 days 120 days

428,400 420,000 8,400

PE 9-6A a.

Turnover Sales……………………………… Accounts receivable: Beginning of year…………… End of year…………………… Average accts. receivable……

20Y2

20Y1

$1,848,000

$1,881,000

$ 195,300 $ 224,700 $ 210,000

$ 184,700 $ 195,300 $ 190,000

[($195,300 + $224,700) ÷ 2]

[($184,700 + $195,300) ÷ 2]

8.8

9.9

($1,848,000 ÷ $210,000)

($1,881,000 ÷ $190,000)

20Y2

20Y1

$1,848,000 $ 5,063.0

$1,881,000 $ 5,153.4

($1,848,000 ÷ 365 days)

($1,881,000 ÷ 365 days)

$ 210,000

$ 190,000

[($195,300 + $224,700) ÷ 2]

[($184,700 + $195,300) ÷ 2]

41.5

36.9

($210,000 ÷ $5,063.0)

($190,000 ÷ $5,153.4)

Accts. receivable turnover……

Days’ Sales in Receivables Sales……………………………… Average daily sales…………… Average accts. receivable…… Days’ sales in receivables……

The decrease in the accounts receivable turnover from 9.9 to 8.8 and the increase in the days’ sales in receivables from 36.9 days to 41.5 days indicate unfavorable changes in the efficiency of collecting receivables.

CHAPTER 9

Receivables

PE 9-6B a.

Accounts Receivable Turnover

20Y9

20Y8

$9,525,000

$7,616,000

$ 715,000 $ 785,000 $ 750,000

$ 645,000 $ 715,000 $ 680,000

[($715,000 + $785,000) ÷ 2]

[($645,000 + $715,000) ÷ 2]

Sales…………………………………… Accounts receivable: Beginning of year……………… End of year……………………… Average accts. receivable…………

12.7

11.2

($9,525,000 ÷ $750,000)

($7,616,000 ÷ $680,000)

20Y9

20Y8

$9,525,000 $ 26,095.9

$7,616,000 $ 20,865.8

($9,525,000 ÷ 365 days)

($7,616,000 ÷ 365 days)

Accts. receivable turnover…………

Days’ Sales in Receivables Sales…………………………………… Average daily sales…………………

$ 750,000

$ 680,000

[($715,000 + $785,000) ÷ 2]

[($645,000 + $715,000) ÷ 2]

Average accts. receivable…………

28.7

32.6

($750,000 ÷ $26,095.9)

($680,000 ÷ $20,865.8)

Days’ sales in receivables…………

The increase in the accounts receivable turnover from 11.2 to 12.7 and the decrease in the days’ sales in receivables from 32.6 days to 28.7 days indicate favorable changes in the efficiency of collecting receivables.

CHAPTER 9

Receivables

EXERCISES Ex. 9-1 Accounts receivable from the U.S. government are significantly different from receivables from commercial aircraft carriers such as Delta and United. In its filing with the Securities and Exchange Commission, Boeing reports the receivables together on the balance sheet but discloses each receivable separately in a note to the financial statements.

Ex. 9-2 a.

MGM Resorts International: 12.1% ($90,775,000 ÷ $747,981,000)

Johnson & Johnson: 1.7% ($248,000,000 ÷ $14,346,000,000)

Casino operations experience greater bad debt risk because it is difficult to control the creditworthiness of customers entering the casino. In addition, individuals who may have adequate creditworthiness could overextend themselves and lose more than they can afford if they get caught up in the excitement of gambling. In contrast, Johnson & Johnson’s customers are primarily other businesses such as grocery store chains.

Note to Instructors: Approximately one-half of MGM’s receivables are related to its casino operations.

Ex. 9-3 Jan.

July

Nov.

19 Accounts Receivable—Dr. Sinclair Welby Sales

77,000

19 Cost of Merchandise Sold Merchandise Inventory

52,600

7 Cash Bad Debt Expense Accounts Receivable—Dr. Sinclair Welby

30,800 46,200

2 Accounts Receivable—Dr. Sinclair Welby Bad Debt Expense

46,200

2 Cash Accounts Receivable—Dr. Sinclair Welby

46,200

77,000

52,600

77,000

46,200

CHAPTER 9

Receivables

Ex. 9-4 May

Aug.

Dec.

1 Accounts Receivable—Taiwan Palace Co. Sales

25,800

1 Cost of Merchandise Sold Merchandise Inventory

15,300

30 Cash Allowance for Doubtful Accounts Accounts Receivable—Taiwan Palace Co.

10,900 14,900

8 Accounts Receivable—Taiwan Palace Co. Allowance for Doubtful Accounts

14,900

8 Cash Accounts Receivable—Taiwan Palace Co.

14,900

25,800

15,300

25,800

14,900

Ex. 9-5 a.

Bad Debt Expense Accounts Receivable—Philadelphia Inc.

45,800

Allowance for Doubtful Accounts Accounts Receivable—Philadelphia Inc.

45,800

Ex. 9-6 a. b.

$162,000 ($32,400,000 × 0.0050) $155,100 ($128,000 + $27,100)

c. d.

$243,000 ($32,400,000 × 0.0075) $261,100 ($279,000 – $17,900)

Ex. 9-7 Account

Avalanche Auto Bales Auto Derby Auto Repair Lucky’s Auto Repair Pit Stop Auto Reliable Auto Repair Trident Auto Valley Repair & Tow

Due Date

August 8 October 11 June 23 September 2 September 19 July 15 August 24 May 17

Number of Days Past Due

84 (23 + 30 + 31) 20 (31 – 11) 130 (7 + 31 + 31 + 30 + 31) 59 (28 + 31) 42 (11 + 31) 108 (16 + 31 + 30 + 31) 68 (7 + 30 + 31) 167 (14 + 30 + 31 + 31 + 30 + 31)

CHAPTER 9

Receivables

Ex. 9-8 a. Customer

Conover Industries Keystone Company Moxie Creek Inc. Rainbow Company Swanson Company

Due Date

Number of Days Past Due

March 22 July 1 July 25 September 10 August 3

162 days (9 + 30 + 31 + 30 + 31 + 31) 61 days (30 + 31) 37 days (6 + 31) Not past due 28 days (31 – 3)

b. Aging of Receivables Schedule August 31 Days Past Due Customer

Balance

Academy Industries Inc. Ascent Company

3,000 4,500

Zoot Company

5,000

Subtotals Conover Industries Keystone Company Moxie Creek Inc. Rainbow Company Swanson Company Totals

1,050,000 30,000 18,000 9,000 26,400 46,600 1,180,000

Not Past Due

1–30

31–60

61–90

Over 90

3,000 4,500 5,000 600,000

220,000

115,000

85,000

30,000 30,000

18,000 9,000 26,400 626,400

46,600 266,600

124,000

103,000

60,000

Ex. 9-9 Days Past Due Not Past Due

1–30

31–60

61–90

Over 90

1,180,000

626,400 2%

266,600 4%

124,000 18%

103,000 40%

60,000 75%

131,712

12,528

10,664

22,320

41,200

45,000

Balance Total receivables Percentage uncollectible Allowance for doubtful accounts

CHAPTER 9

Receivables

Ex. 9-10 Aug.

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($131,712 – $10,112).

121,600 121,600

Ex. 9-11

Age Interval

Balance

Not past due 1–30 days past due 31–60 days past due 61–90 days past due 91–180 days past due Over 180 days past due Total

$3,250,000 1,050,000 780,000 320,000 240,000 150,000 $5,790,000

Estimated Uncollectible Accounts Percent Amount

0.8% 2.4% 7.0% 18.0% 34.0% 85.0%

$ 26,000 25,200 54,600 57,600 81,600 127,500 $372,500

Ex. 9-12 Dec.

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($372,500 + $28,400).

400,900 400,900

CHAPTER 9

Receivables

Ex. 9-13 a.

Apr.

May

July

Dec.

13 Bad Debt Expense Accounts Receivable—Dean Sheppard

8,450

15 Cash Bad Debt Expense Accounts Receivable—Dan Pyle

500 6,600

27 Accounts Receivable—Dean Sheppard Bad Debt Expense

8,450

27 Cash Accounts Receivable—Dean Sheppard

8,450

31 Bad Debt Expense Accounts Receivable—Paul Chapman Accounts Receivable—Duane DeRosa Accounts Receivable—Teresa Galloway Accounts Receivable—Ernie Klatt Accounts Receivable—Marty Richey

13,510

8,450

7,100

8,450

2,225 3,550 4,770 1,275 1,690

31 No entry

CHAPTER 9

Receivables

Ex. 9-13 (Concluded) b.

Apr.

May

July

Dec.

13 Allowance for Doubtful Accounts Accounts Receivable—Dean Sheppard

8,450

15 Cash Allowance for Doubtful Accounts Accounts Receivable—Dan Pyle

500 6,600

27 Accounts Receivable—Dean Sheppard Allowance for Doubtful Accounts

8,450

27 Cash Accounts Receivable—Dean Sheppard

8,450

31 Allowance for Doubtful Accounts Accounts Receivable—Paul Chapman Accounts Receivable—Duane DeRosa Accounts Receivable—Teresa Galloway Accounts Receivable—Ernie Klatt Accounts Receivable—Marty Richey

13,510

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($3,778,000 × 0.75% = $28,335).

28,335

8,450

7,100

8,450

2,225 3,550 4,770 1,275 1,690

28,335

Bad debt expense under: Allowance method………………………...…………………………………… Direct write-off method ($8,450 + $6,600 – $8,450 + $13,510)…………… Difference ($28,335 – $20,110)…………………………………………………

$28,335 20,110 $ 8,225

Shipway Company’s income would have been $8,225 higher under the direct write-off method than under the allowance method.

CHAPTER 9

Receivables

Ex. 9-14 a.

June

Aug.

Oct.

Dec.

8 Bad Debt Expense Accounts Receivable—Kathy Quantel

8,440

14 Cash Bad Debt Expense Accounts Receivable—Rosalie Oakes

3,000 9,500

16 Accounts Receivable—Kathy Quantel Bad Debt Expense

8,440

16 Cash Accounts Receivable—Kathy Quantel

8,440

31 Bad Debt Expense Accounts Receivable—Wade Dolan Accounts Receivable—Greg Gagne Accounts Receivable—Amber Kisko Accounts Receivable—Shannon Poole Accounts Receivable—Niki Spence

24,955

8,440

12,500

8,440

4,600 3,600 7,150 2,975 6,630

31 No entry

CHAPTER 9

Receivables

Ex. 9-14 (Continued) b.

June

Aug.

Oct.

Dec.

8 Allowance for Doubtful Accounts Accounts Receivable—Kathy Quantel

8,440

14 Cash Allowance for Doubtful Accounts Accounts Receivable—Rosalie Oakes

3,000 9,500

16 Accounts Receivable—Kathy Quantel Allowance for Doubtful Accounts

8,440

16 Cash Accounts Receivable—Kathy Quantel

8,440

31 Allowance for Doubtful Accounts Accounts Receivable—Wade Dolan Accounts Receivable—Greg Gagne Accounts Receivable—Amber Kisko Accounts Receivable—Shannon Poole Accounts Receivable—Niki Spence

24,955

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($47,090 – $1,545).

45,545

8,440

12,500

8,440

4,600 3,600 7,150 2,975 6,630

45,545

Computations: Aging Class (Number of Days Past Due) 0–30 days 31–60 days 61–90 days 91–120 days More than 120 days Total receivables

Receivables Balance on December 31

$320,000 110,000 24,000 18,000 43,000 $515,000

Estimated Doubtful Accounts Percent Amount

1% 3% 10% 33% 75%

$ 3,200 3,300 2,400 5,940 32,250 $47,090

Estimated balance of allowance account from aging schedule………………… Unadjusted credit balance of allowance account………………………………… Adjustment…………………………………………………………………………………

$47,090 1,545 * $45,545

* $36,000 – $8,440 – $9,500 + $8,440 – $24,955 = $1,545

CHAPTER 9

Receivables

Ex. 9-14 (Concluded) c.

Bad debt expense under: Allowance method……………………………………………………………… Direct write-off method ($8,440 + $9,500 – $8,440 + $24,955)…………… Difference…………………………………………………………………………

$45,545 34,455 $11,090

Rustic Tables’ income would have been $11,090 higher under the direct write-off method than under the allowance method.

Ex. 9-15 $482,800, computed as follows: Net income under direct method……………………………………… Bad debt expense under direct method……………………………… Bad debt expense under allowance method ($3,250,000 × 1%)……………………………………………………… Less increase in bad debt expense under allowance method…… Net income under allowance method…………………………………

$487,500 $27,800 32,500 4,700 $482,800

Ex. 9-16 $593,000, computed as follows: a. Net income under direct method………………………………… Bad debt expense under direct method………………………… Bad debt expense under allowance method ($4,100,000 × 1%)………………………………………………… Less increase in bad debt expense under allowance method………………………………………………… Net income under allowance method…………………………… b.

$600,000 $34,000 41,000 7,000 $593,000

$11,700, as shown in the following T account: Allowance for Doubtful Accounts Year 1 Write-offs 27,800 Year 1 Adj. Entry

32,500

Bal. Year 2 Adj. Entry

4,700 41,000

Bal.

11,700

Year 2 Write-offs

34,000

Ex. 9-17 a.

Bad Debt Expense Accounts Receivable—Shawn Brooke Accounts Receivable—Eve Denton Accounts Receivable—Art Malloy Accounts Receivable—Cassie Yost

30,000 4,650 5,180 11,050 9,120

CHAPTER 9

Receivables

Ex. 9-17 (Concluded) b.

Allowance for Doubtful Accounts Accounts Receivable—Shawn Brooke Accounts Receivable—Eve Denton Accounts Receivable—Art Malloy Accounts Receivable—Cassie Yost

30,000

Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($5,250,000 × 0.75% = $39,375).

39,375

4,650 5,180 11,050 9,120

39,375

Net income would have been $9,375 higher under the direct write-off method because bad debt expense would have been $9,375 lower under the direct method ($39,375 expense under the allowance method versus $30,000 expense under the direct write-off method).

Ex. 9-18 a.

Bad Debt Expense Accounts Receivable—Kim Abel Accounts Receivable—Lee Drake Accounts Receivable—Jenny Green Accounts Receivable—Mike Lamb

102,500

Allowance for Doubtful Accounts Accounts Receivable—Kim Abel Accounts Receivable—Lee Drake Accounts Receivable—Jenny Green Accounts Receivable—Mike Lamb

102,500

Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($109,650 + $7,500).

117,150

21,550 33,925 27,565 19,460

117,150

Computations: Aging Class (Number of Days Past Due) 0–30 days 31–60 days 61–90 days 91–120 days More than 120 days Total receivables

Receivables Balance on December 31

$ 715,000 310,000 102,000 76,000 97,000 $1,300,000

Estimated Doubtful Accounts Percent Amount

1% 2% 15% 30% 60%

7,150 6,200 15,300 22,800 58,200 $109,650

CHAPTER 9

Receivables

Ex. 9-18 (Concluded) Unadjusted debit balance of Allowance for Doubtful Accounts ($102,500 – $95,000)……………………………………………………………………… $ 7,500 Estimated balance of Allowance for Doubtful Accounts 109,650 from aging schedule…………………………………………………………………… Adjustment………………………………………………………………………………… $117,150 c.

Net income would have been $14,650 lower under the allowance method because bad debt expense would have been $14,650 higher under the allowance method ($117,150 expense under the allowance method versus $102,500 expense under the direct write-off method).

Ex. 9-19 a. b. c. d. e.

Due Date

Interest

Apr. 10 Sept. 15 July 5 Dec. 7 Jan. 19

$500 720 525 270 180

[$40,000 × 0.05 × (90 ÷ 360)] [$18,000 × 0.08 × (180 ÷ 360)] [$90,000 × 0.07 × (30 ÷ 360)] [$36,000 × 0.03 × (90 ÷ 360)] [$27,000 × 0.04 × (60 ÷ 360)]

Ex. 9-20 a.

August 11 (17 + 31 + 30 + 31 + 11)

$94,550 [($93,000 × 5% × 120 ÷ 360) + $93,000]

(1)

(2)

Apr.

Aug.

13 Notes Receivable Accounts Rec.—Autumn Designs & Decorators

93,000

11 Cash Notes Receivable Interest Revenue

94,550

93,000

93,000 1,550

Ex. 9-21 a.

Sale on account.

Cost of goods sold for the sale on account.

Note received from customer on account.

Note dishonored and charged face value of note plus interest to customer’s account receivable.

Payment received from customer for dishonored note plus interest earned after due date.

CHAPTER 9

Receivables

Ex. 9-22 20Y3 Nov.

Dec.

20Y4 Jan.

21 Notes Receivable Accounts Receivable—McKenna Outer Wear Co.

96,000

31 Interest Receivable Interest Revenue Accrued interest ($96,000 × 0.03 × 40 ÷ 360).

320

96,000

320

20 Cash Notes Receivable Interest Receivable Interest Revenue ($96,000 × 0.03 × 20 ÷ 360)

96,480

23 Notes Receivable Accounts Receivable—Radon Express Co.

48,000

21 Accounts Receivable—Radon Express Co. Notes Receivable Interest Revenue ($48,000 × 0.08 × 90 ÷ 360).

48,960

21 Cash Accounts Receivable—Radon Express Co. Interest Revenue ($48,960 × 0.10 × 30 ÷ 360).

49,368

96,000 320 160

Ex. 9-23 June

Sept.

Oct.

48,000

48,000 960

48,960 408

CHAPTER 9

Receivables

Ex. 9-24 Apr.

May

June

Aug.

Oct.

18 Notes Receivable Accounts Receivable—Glenn Cross

60,000

30 Notes Receivable Accounts Receivable—Rhoni Melville

42,000

18 Accounts Receivable—Glenn Cross Notes Receivable Interest Revenue ($60,000 × 7% × 30 ÷ 360).

60,350

29 Accounts Receivable—Rhoni Melville Notes Receivable Interest Revenue ($42,000 × 8% × 60 ÷ 360).

42,560

16 Cash Accounts Receivable—Glenn Cross Interest Revenue ($60,350 × 8% × 90 ÷ 360).

61,557

22 Allowance for Doubtful Accounts Accounts Receivable—Rhoni Melville

42,560

60,000

42,000

60,000 350

42,000 560

60,350 1,207

42,560

Ex. 9-25 1.

The interest receivable should be reported separately as a current asset. It should not be deducted from notes receivable.

The allowance for doubtful accounts should be deducted from accounts receivable. A corrected partial balance sheet would be as follows: Napa Vino Company Balance Sheet December 31, 20Y9 Assets

Current assets: Cash Notes receivable Accounts receivable Less allowance for doubtful accounts Interest receivable

$ $1,200,000 11,500

78,500 300,000 1,188,500 4,500

CHAPTER 9

Receivables

Ex. 9-26 a. and b. Sales……………………………… Accounts receivable…………… Average accts. receivable……

Year 2

Year 1

$6,182,300 $ 643,600 $ 654,100

$6,652,800 $ 664,600 $ 717,650

[($643,600 + $664,600) ÷ 2]

[($664,600 + $770,700) ÷ 2]

9.45

9.27

($6,182,300 ÷ $654,100)

($6,652,800 ÷ $717,650)

Accts. receivable turnover…… Average daily sales……………

$ 16,937.8

$ 18,226.8

($6,182,300 ÷ 365)

($6,652,800 ÷ 365)

38.6

39.4

($654,100 ÷ $16,937.8)

($717,650 ÷ $18,226.8)

Days’ sales in receivables……

The days’ sales in receivables could also be computed by dividing 365 days by the accounts receivable turnover as follows: Year 2: 38.6 (365 days ÷ 9.45) Year 1: 39.4 (365 days ÷ 9.27) c.

The accounts receivable turnover indicates a slight increase in the efficiency of collecting accounts receivable by increasing from 9.27 to 9.45, a favorable change. The days’ sales in receivables also indicates an increase in the efficiency of collecting accounts receivable by decreasing from 39.4 to 38.6, which is a favorable change. However, before reaching a final conclusion, the ratios should be compared with industry averages and similar firms.

Ex. 9-27 a. and b. Sales……………………………… Accounts receivable…………… Average accts. receivable…… Accts. receivable turnover…… Average daily sales……………

Year 2

Year 1

$8,685 $ 805 $710.5

$7,890 $ 616 $627.0

[($805 + $616) ÷ 2]

[($616 + $638) ÷ 2]

12.22

12.58

($8,685 ÷ $710.5)

($7,890 ÷ $627.0)

$23.79

$21.62

($8,685 ÷ 365)

($7,890 ÷ 365)

29.9

29.0

($710.5 ÷ $23.79)

($627.0 ÷ $21.62)

Days’ sales in receivables……

The days’ sales in receivables could also be computed by dividing 365 days by the accounts receivable turnover as follows: Year 2: 29.9 (365 days ÷ 12.22) Year 1: 29.0 (365 days ÷ 12.58)

CHAPTER 9

Receivables

Ex. 9-27 (Concluded) c. The accounts receivable turnover indicates a decrease in the efficiency of collecting accounts receivable by decreasing from 12.58 to 12.22, an unfavorable change. The number of days’ sales in receivables increased from 29.0 to 29.9 days, also indicating an unfavorable change in collections of receivables. However, before a final conclusion can be reached, both ratios should be compared with those of past years, industry averages, and similar firms.

Ex. 9-28 a. and b. Sales……………………………… Accounts receivable……………… Average accts. receivable………

Year 2

Year 1

$4,036 $ 93 $ 85.5

$3,796 $ 78 $ 82.5

[($93 + $78) ÷ 2]

[($78 + $87) ÷ 2]

47.20

46.01

($4,036 ÷ $85.5)

($3,796 ÷ $82.5)

Accts. receivable turnover……… Average daily sales………………

$ 11.1

$ 10.4

($4,036 ÷ 365)

($3,796 ÷ 365)

7.7

7.9

($85.5 ÷ $11.1)

($82.5 ÷ $10.4)

Days’ sales in receivables………

The days’ sales in receivables could also be computed by dividing 365 days by the accounts receivable turnover as follows: Year 2: 7.7 (365 days ÷ 47.20) Year 1: 7.9 (365 days ÷ 46.01) c. The accounts receivable turnover indicates an increase in the efficiency of collecting accounts receivable by increasing from 46.01 to 47.20, a favorable change. The days’ sales in receivables indicates an increase in the efficiency of collecting accounts receivable by decreasing from 7.9 to 7.7, also indicating a favorable change. Before a conclusion can be reached, however, the ratios should be compared with industry averages and similar firms.

CHAPTER 9

Receivables

Ex. 9-29 a.

The average accounts receivable turnover ratios are as follows: Campbell Soup: 12.40 [(12.22 + 12.58) ÷ 2] American Eagle Outfitters: 46.61 [(47.20 + 46.01) ÷ 2] Note: For computations of the individual ratios, see Ex. 9-27 and Ex. 9-28.

American Eagle Outfitters has the higher average accounts receivable turnover ratio.

American Eagle Outfitters operates a specialty retail chain of stores that sells directly to individual consumers. Many of these consumers (retail customers) pay using MasterCard or VISA, which is recorded as cash sales. In contrast, Campbell Soup manufactures foods that are sold to food wholesalers, grocery store chains, and other food distributors that eventually sell Campbell’s products to individual consumers. Accordingly, because of the extended distribution chain, we would expect Campbell Soup to have more accounts receivable than American Eagle. In addition, we would expect Campbell’s business customers to take a longer period to pay their receivables. Thus, we would expect Campbell’s average accounts receivable turnover ratio to be lower than American Eagle, as shown in (a).

CHAPTER 9

Receivables

PROBLEMS Prob. 9-1A 1. and 2. Allowance for Doubtful Accounts Jan. Aug. Dec.

29 9 31 31

10,200 22,380 98,530 Unadjusted Balance

7,950

Jan. 1 Apr. 18 Nov. 7 Dec. 31 31

Balance

Adjusting Entry

102,380 7,560 13,220 121,280

Adj. Balance

113,330

Bad Debt Expense Dec.

Adjusting Entry

121,280

$2,626,670 ($2,740,000 – $113,330)

a. b. c.

$124,500 ($24,900,000 × 0.005) $116,550 ($124,500 – $7,950) $2,623,450 ($2,740,000 – $116,550)

CHAPTER 9

Receivables

Prob. 9-1A (Concluded) 2.

Jan.

Apr.

Aug.

Nov.

Dec.

29 Cash Allowance for Doubtful Accounts Accounts Receivable—Jankovich Co.

6,800 10,200

18 Accounts Receivable—Vince Karm Allowance for Doubtful Accounts

7,560

18 Cash Accounts Receivable—Vince Karm

7,560

9 Allowance for Doubtful Accounts Accounts Receivable—Golden Stallion Co.

22,380

7 Accounts Receivable—Wiley Co. Allowance for Doubtful Accounts

13,220

7 Cash Accounts Receivable—Wiley Co.

13,220

31 Allowance for Doubtful Accounts Accounts Receivable—Claire Moon Inc. Accounts Receivable—Jet Set Co. Accounts Receivable—Randall Distributors Accounts Receivable—Harmonic Audio

98,530

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($113,330 + $7,950).

121,280

17,000

7,560

22,380

13,220

22,860 15,320 41,460 18,890

121,280

Prob. 9-2A 1. Customer Adams Sports & Flies Blue Dun Flies Cicada Fish Co. Deschutes Sports Green River Sports Smith River Co. Western Trout Company Wolfe Sports

Due Date

Number of Days Past Due

May 22, 20Y6 Oct. 10, 20Y6 Sept. 29, 20Y6 Oct. 20, 20Y6 Nov. 7, 20Y6 Nov. 28, 20Y6 Dec. 7, 20Y6 Jan. 20, 20Y7

223 days (9 + 30 + 31 + 31 + 30 + 31 + 30 + 31) 82 days (21 + 30 + 31) 93 days (1 + 31 + 30 + 31) 72 days (11 + 30 + 31) 54 days (23 + 31) 33 days (2 + 31) 24 days Not past due

CHAPTER 9

Receivables

Prob. 9-2A (Concluded) 2. and 3. Aging of Receivables Schedule December 31, 20Y6 Not Customer

Balance

AAA Outfitters

20,000

Brown Trout Fly Shop

7,500

Zigs Fish Adventures Subtotals Adams Sports & Flies

Days Past Due

Past Due

1–30

Over 120

40,000

20,000

80,000

4,000 750,000

290,000

120,000

5,000

4,900

Cicada Fish Co.

8,400

Deschutes Sports

7,000

Green River Sports

3,500

Smith River Co.

2,400

Western Trout Company

6,800

Totals

91–120

7,500

Blue Dun Flies

Wolfe Sports

61–90

20,000

4,000 1,300,000

31–60

4,900 8,400 7,000

6,800

4,400

1,342,400

754,400

296,800

125,900

51,900

28,400

85,000

10%

30%

40%

80%

7,544

5,936

12,590

15,570

11,360

68,000

Percentage uncollectible Estimate of uncollectible accounts

121,000

Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($121,000 + $3,600).

124,600 124,600

On the balance sheet, assets would be overstated by $124,600 because the allowance for doubtful accounts would be understated by $124,600. In addition, the owner’s capital account would be overstated by $124,600 because bad debt expense would be understated and net income overstated by $124,600 on the income statement.

CHAPTER 9

Receivables

Prob. 9-3A 1.

Bad Debt Expense

Year

Expense Actually Reported

Expense Based on Estimate

Increase (Decrease) in Amount of Expense

1st 2nd 3rd 4th

$ 4,500 9,600 12,800 16,550

$ 9,000 12,500 15,000 22,000

$4,500 2,900 2,200 5,450

Balance of Allowance Account, End of Year

$ 4,500 7,400 9,600 15,050

Yes. The actual write-offs of accounts originating in the first two years are reasonably close to the expense that would have been charged to those years on the basis of 1% of sales. The total write-off of receivables originating in the first year amounted to $8,500 ($4,500 + $3,000 + $1,000), as compared to bad debt expense, based on the percentage of sales, of $9,000 ($900,000 × 1%). For the second year, the comparable amounts were write-offs of $11,800 ($6,600 + $3,700 + $1,500) and bad debt expense of $12,500 ($1,250,000 × 1%).

CHAPTER 9

Receivables

Prob. 9-4A (a)

(b)

Note

Due Date

Interest Due at Maturity

1. 2. 3. 4. 5. 6.

Apr. 20 June 22 Nov. 17 Dec. 5 Jan. 28 Jan. 29

Nov.

17 Accounts Receivable Notes Receivable Interest Revenue

Dec.

$500 360 840 945 270 300

($80,000 × 5% × 45 ÷ 360) ($24,000 × 9% × 60 ÷ 360) ($42,000 × 6% × 120 ÷ 360) ($54,000 × 7% × 90 ÷ 360) ($27,000 × 6% × 60 ÷ 360) ($72,000 × 5% × 30 ÷ 360) 42,840 42,000 840

31 Interest Receivable Interest Revenue Accrued interest. $27,000 × 6% × 32 ÷ 360 $72,000 × 5% × 1 ÷ 360 Total

Jan.

154 154 = $144 10 = $154

28 Cash Notes Receivable Interest Receivable Interest Revenue ($27,000 × 6% × 28 ÷ 360).

27,270

29 Cash Notes Receivable Interest Receivable Interest Revenue ($72,000 × 5% × 29 ÷ 360).

72,300

27,000 144 126

72,000 10 290

CHAPTER 9

Receivables

Prob. 9-5A Apr.

May

June

Aug.

Sept.

Oct.

Nov.

Dec.

10 Notes Receivable Accounts Receivable

144,000

15 Notes Receivable Accounts Receivable

270,000

9 Cash Notes Receivable Interest Revenue

145,200

22 Notes Receivable Accounts Receivable

150,000

12 Cash Notes Receivable Interest Revenue

276,300

30 Notes Receivable Accounts Receivable

210,000

6 Cash Notes Receivable Interest Revenue

150,750

18 Notes Receivable Accounts Receivable

120,000

29 Cash Notes Receivable Interest Revenue

212,800

17 Cash Notes Receivable Interest Revenue

121,000

144,000

270,000

144,000 1,200

150,000

270,000 6,300

210,000

150,000 750

120,000

210,000 2,800

120,000 1,000

CHAPTER 9

Receivables

Prob. 9-6A Jan.

Feb.

Mar.

Apr.

May

July

3 Notes Receivable Cash

18,000

10 Accounts Receivable—Bradford & Co. Sales

24,000

10 Cost of Merchandise Sold Merchandise Inventory

14,400

13 Accounts Receivable—Dry Creek Co. Sales

60,000

13 Cost of Merchandise Sold Merchandise Inventory

54,000

12 Notes Receivable Accounts Receivable—Bradford & Co.

24,000

14 Notes Receivable Accounts Receivable—Dry Creek Co.

60,000

3 Notes Receivable Cash Notes Receivable Interest Revenue ($18,000 × 8% × 90 ÷ 360).

18,000 360

11 Cash Notes Receivable Interest Revenue ($24,000 × 7% × 60 ÷ 360).

24,280

13 Accounts Receivable—Dry Creek Co. Notes Receivable Interest Revenue ($60,000 × 9% × 60 ÷ 360).

60,900

12 Cash Accounts Receivable—Dry Creek Co. Interest Revenue ($60,900 × 12% × 60 ÷ 360).

62,118

18,000

24,000

14,400

60,000

54,000

24,000

60,000

18,000 360

24,000 280

60,000 900

60,900 1,218

CHAPTER 9

Receivables

Prob. 9-6A (Concluded) Aug.

Oct.

1 Cash Notes Receivable Interest Revenue ($18,000 × 9% × 120 ÷ 360).

18,540

5 Accounts Receivable—Halloran Co. Sales

13,500

5 Cost of Merchandise Sold Merchandise Inventory

8,100

15 Cash Accounts Receivable—Halloran Co.

13,500

18,000 540

13,500

8,100

13,500

Prob. 9-1B 1. and 2. Allowance for Doubtful Accounts Apr. July Dec.

3 16 31

12,750 16,500 24,000

Jan.

Balance

Nov.

1 19 23

50,000 2,660 4,000

Dec.

Unadjusted Balance

3,410

Adjusting Entry

56,590

Adjusted Balance

60,000

Bad Debt Expense Dec.

Adjusting Entry

56,590

$2,290,000 ($2,350,000 – $60,000)

a. b. c.

$79,000 ($15,800,000 × 0.005) $82,410 ($79,000 + $3,410) $2,267,590 ($2,350,000 – $82,410)

CHAPTER 9

Receivables

Prob. 9-1B (Concluded) 2.

Jan.

Apr.

July

Nov.

Dec.

19 Accounts Receivable—Arlene Gurley Allowance for Doubtful Accounts

2,660

19 Cash Accounts Receivable—Arlene Gurley

2,660

3 Allowance for Doubtful Accounts Accounts Receivable—Premier GS Co.

12,750

16 Cash Allowance for Doubtful Accounts Accounts Receivable—Hayden Co.

5,500 16,500

23 Accounts Receivable—Harry Carr Allowance for Doubtful Accounts

4,000

23 Cash Accounts Receivable—Harry Carr

4,000

31 Allowance for Doubtful Accounts Accounts Receivable—Cavey Co. Accounts Receivable—Fogle Co. Accounts Receivable—Lake Furniture Accounts Receivable—Melinda Shryer

24,000

31 Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($60,000 – $3,410).

56,590

2,660

12,750

22,000

4,000

3,300 8,100 11,400 1,200

56,590

CHAPTER 9

Receivables

Prob. 9-2B 1. Customer Arcade Beauty Creative Images Excel Hair Products First Class Hair Care Golden Images Oh That Hair One Stop Hair Designs Visions Hair & Nail

Due Date

Number of Days Past Due

Aug. 17, 20Y1 Oct. 30, 20Y1 July 3, 20Y1 Sept. 8, 20Y1 Nov. 23, 20Y1 Nov. 29, 20Y1 Dec. 7, 20Y1 Jan. 11, 20Y2

136 days (14 + 30 + 31 + 30 + 31) 62 days (1 + 30 + 31) 181 days (28 + 31 + 30 + 31 + 30 + 31) 114 days (22 + 31 + 30 + 31) 38 days (7 + 31) 32 days (1 + 31) 24 days Not past due

2. and 3. Aging of Receivables Schedule December 31, 20Y1 Not Customer

Balance

ABC Beauty

15,000

Angel Wigs

8,000

Zodiac Beauty

875,000

Arcade Beauty

10,000

Creative Images

8,500

Excel Hair Products

7,500

First Class Hair Care

6,600

Golden Images

3,600

Oh That Hair

1,400

One Stop Hair Designs

4,000

Totals

1–30

31–60

61–90

91–120

Over 120

55,000

18,000

65,000

15,000 8,000

3,000

Subtotals

Visions Hair & Nail

Days Past Due

Past Due

3,000 415,000

210,000

112,000

10,000 8,500 7,500 6,600 3,600 1,400 4,000

9,000

925,600

424,000

214,000

117,000

63,500

24,600

82,500

16%

25%

40%

80%

4,240

8,560

18,720

15,875

9,840

66,000

Percentage uncollectible Estimate of uncollectible accounts

123,235

CHAPTER 9

Receivables

Prob. 9-2B (Concluded) 4.

Bad Debt Expense Allowance for Doubtful Accounts Uncollectible accounts estimate ($123,235 – $7,375).

115,860 115,860

On the balance sheet, assets would be overstated by $115,860 because the allowance for doubtful accounts would be understated by $115,860. In addition, the owner’s capital account would be overstated by $115,860 because bad debt expense would be understated and net income overstated by $115,860 on the income statement.

Prob. 9-3B 1.

Bad Debt Expense

Year

Expense Actually Reported

Expense Based on Estimate

Increase (Decrease) in Amount of Expense

Balance of Allowance Account, End of Year

1st 2nd 3rd 4th

$18,000 30,200 39,900 52,600

$31,250 37,000 45,000 60,000

$13,250 6,800 5,100 7,400

$13,250 20,050 25,150 32,550

Yes. The actual write-offs of accounts originating in the first two years are reasonably close to the expense that would have been charged to those years on the basis of 1/4% of sales. The total write-off of receivables originating in the first year amounted to $30,600 ($18,000 + $9,000 + $3,600), as compared to bad debt expense, based on the percentage of sales of $31,250 ($12,500,000 × 0.0025). For the second year, the comparable amounts were write-offs of $35,600 ($21,200 + $9,300 + $5,100) and bad debt expense of $37,000 ($14,800,000 × 0.0025).

CHAPTER 9

Receivables

Prob. 9-4B (a)

(b)

Note

Due Date

Interest Due at Maturity

1. 2. 3. 4. 5. 6.

Feb. 13 Apr. 23 Oct. 10 Nov. 6 Jan. 14 Feb. 8

Oct.

10 Accounts Receivable Notes Receivable Interest Revenue

Dec.

$110 525 600 200 480 240

($33,000 × 4% × 30 ÷ 360) ($60,000 × 7% × 45 ÷ 360) ($48,000 × 5% × 90 ÷ 360) ($16,000 × 6% × 75 ÷ 360) ($36,000 × 8% × 60 ÷ 360) ($24,000 × 6% × 60 ÷ 360) 48,600 48,000 600

31 Interest Receivable Interest Revenue Accrued interest. $36,000 × 8% × 46 ÷ 360 $24,000 × 6% × 21 ÷ 360 Total

Jan.

Feb.

452 452 = $368 84 = $452

14 Cash Notes Receivable Interest Receivable Interest Revenue ($36,000 × 8% × 14 ÷ 360).

36,480

8 Cash Notes Receivable Interest Receivable Interest Revenue ($24,000 × 6% × 39 ÷ 360).

24,240

36,000 368 112

24,000 84 156

CHAPTER 9

Receivables

Prob. 9-5B Mar.

May

June

July

Aug.

Dec.

8 Notes Receivable Accounts Receivable

33,000

31 Notes Receivable Accounts Receivable

80,000

7 Cash Notes Receivable Interest Revenue

33,275

16 Notes Receivable Accounts Receivable

72,000

11 Notes Receivable Accounts Receivable

36,000

29 Cash Notes Receivable Interest Revenue

81,400

26 Cash Notes Receivable Interest Revenue

36,270

4 Notes Receivable Accounts Receivable

48,000

14 Cash Notes Receivable Interest Revenue

73,260

2 Cash Notes Receivable Interest Revenue

49,440

33,000

80,000

33,000 275

72,000

36,000

80,000 1,400

36,000 270

48,000

72,000 1,260

48,000 1,440

CHAPTER 9

Receivables

Prob. 9-6B Jan.

Mar.

May

June

July

Sept.

21 Accounts Receivable—Black Tie Co. Sales

28,000

21 Cost of Merchandise Sold Merchandise Inventory

16,800

18 Notes Receivable Accounts Receivable—Black Tie Co.

28,000

17 Cash Notes Receivable Interest Revenue ($28,000 × 6% × 60 ÷ 360).

28,280

15 Accounts Receivable—Pioneer Co. Sales

17,700

15 Cost of Merchandise Sold Merchandise Inventory

10,600

21 Notes Receivable Cash

18,000

25 Cash Accounts Receivable—Pioneer Co.

17,700

21 Notes Receivable Cash Notes Receivable Interest Revenue ($18,000 × 8% × 30 ÷ 360).

18,000 120

19 Cash Notes Receivable Interest Revenue ($18,000 × 9% × 60 ÷ 360).

18,270

22 Accounts Receivable—Wycoff Co. Sales

20,000

28,000

16,800

28,000

28,000 280

17,700

10,600

18,000

17,700

18,000 120

18,000 270

20,000

CHAPTER 9

Receivables

Prob. 9-6B (Concluded) Sept.

Oct.

Nov.

Dec.

22 Cost of Merchandise Sold Merchandise Inventory

12,000

14 Notes Receivable Accounts Receivable—Wycoff Co.

20,000

13 Accounts Receivable—Wycoff Co. Notes Receivable Interest Revenue ($20,000 × 6% × 30 ÷ 360).

20,100

28 Cash Accounts Receivable—Wycoff Co. Interest Revenue ($20,100 × 8% × 45 ÷ 360).

20,301

12,000

20,000

20,000 100

20,100 201

CHAPTER 9

Receivables

CASES & PROJECTS CP 9-1 Estimates of uncollectible accounts receivable create a unique financial reporting challenge. Because the company does not know with certainty the amount of accounts receivable that will be uncollectible, there is no “correct” estimate. The company must use its judgment along with historical data to develop an estimate that fairly presents the portion of credit sales that will become uncollectible. These estimates are required under GAAP and should be representationally faithful and accurately match bad debt expense to revenues generated from credit sales. In this case, both Tim and Gowen appear to be acting unethically. The historical data indicate that a higher estimate is needed, and they have both knowingly ignored this data in order to improve the company’s reported earnings. Tim and Gowen have used the subjectivity in these estimates inappropriately. The result is a bad debt expense amount that does not faithfully represent the potential losses associated with uncollectible accounts receivable.

CP 9-2 By computing interest using a 365-day year for depository accounts (liabilities), Bev is minimizing interest expense to the bank. By computing interest using a 360-day year for loans (assets), Bev is maximizing interest revenue to the bank. However, federal legislation (Truth in Lending Act) requires banks to compute interest on a 365-day year. Hence, Bev is behaving in an unprofessional manner.

CP 9-3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1.

a. b. c. d.

$3,498 million (from balance sheet) $30 million (Note 1) 23.1% ($3,498 ÷ $15,134) in 2018; 22.9% ($3,677 ÷ $16,061) in 2017. Accounts receivable as a percentage of total current assets has increased. The amount for Nike is so small that it is not reported in the financial statements.

The company’s receivables turnover has improved from 9.9 in 2017 to 10.1 in 2018, as shown below. Sales……………………………………………………… Beginning accounts receivable……………………… Ending accounts receivable………………………… Average accounts receivable………………………… Accounts receivable turnover………………………

2018 $ 36,397

2017 $ 34,350

$ 3,677 3,498

$ 3,241 3,677

$3,587.5

$3,459.0

10.1

9.9

CHAPTER 9

Receivables

CP 9-4 To: From: Re:

Todd Hurley, CEO A+ Student Allowance Method for Uncollectible Accounts

Accounts receivable result from the sale of goods to customers on account. Because payment is received from customers after goods are delivered, there is a risk that customers will default on their accounts. While the company does not know which customers will default, it does have historical information on the portion of accounts receivable that has become uncollectible in the past. The allowance method uses this information to estimate the amount of accounts receivable that will be uncollectible at the end of the accounting period. Based on this estimate, an adjusting entry is used to record bad debt expense. However, because the company does not know which customer accounts will be uncollectible, the specific customer accounts cannot be removed. Instead, a contra asset account, Allowance for Doubtful Accounts, is credited for the estimated bad debts in the adjusting journal entry: Bad Debt Expense Allowance for Doubtful Accounts

XXX XXX

This adjusting entry affects both the income statement and balance sheet. On the income statement, bad debt expense is matched against the revenues generated by the accounts receivable. On the balance sheet, the accounts receivable balance is reduced by the allowance for doubtful accounts, which is the portion of the accounts receivable that the company does not expect to collect. This resulting number is the amount of accounts receivable that the company expects to collect, called the net realizable value of the receivables. When a specific customer’s account is identified as uncollectible, it is written off against the allowance account. This requires the company to remove the specific account receivable from the accounts receivable ledger and an equal amount from the allowance account. Because the adjusting entry for bad debt expense is an estimate and the write-off of accounts receivable is based on actual defaults, the allowance account will rarely have a zero balance at the beginning or end of a period.

CHAPTER 9

Receivables

CP 9-5 1.

Year

a. Addition to Allowance for Doubtful Accounts

20Y4 20Y5 20Y6 20Y7

$20,000 22,000 24,000 25,500

b. Accounts Written Off During Year $15,000 ($20,000 – $5,000) 18,750 ($5,000 + $22,000 – $8,250) 22,050 ($8,250 + $24,000 – $10,200) 21,300 ($10,200 + $25,500 – $14,400)

The estimate of 1/2 of 1% of credit sales may be too large because the allowance for doubtful accounts has steadily increased each year. The increasing balance of the allowance for doubtful accounts may also be due to the failure to write off a large number of uncollectible accounts. These possibilities could be evaluated by examining the accounts in the accounts receivable subsidiary ledger for collectibility and comparing the result with the balance in the allowance for doubtful accounts.

Note to Instructors: Because the allowance for doubtful accounts increased by 188% [($14,400 – $5,000) ÷ $5,000] while sales increased by 27.5% [($5,100,000 – $4,000,000) ÷ $4,000,000], the increase cannot be explained by an expanding volume of sales. b.

The balance of Allowance for Doubtful Accounts that should exist at December 31, 20Y7, can only be determined after all attempts have been made to collect the receivables on hand at December 31, 20Y7. However, the account balances at December 31, 20Y7, could be analyzed, perhaps using an aging schedule, to determine a reasonable amount of allowance and to determine accounts that should be written off. Also, past write-offs of uncollectible accounts could be analyzed in depth in order to develop a reasonable percentage for future adjusting entries, based on past history. Caution, however, must be exercised in using historical percentages. Specifically, inquiries should be made to determine whether any significant changes between prior years and the current year may have occurred, which might reduce the accuracy of the historical data. For example, a recent change in credit-granting policies or changes in the general economy (entering a recessionary period, for example) could reduce the usefulness of analyzing historical data. Based on the preceding analyses, a recommendation to decrease the annual rate charged as an expense may be in order (perhaps Xtreme Co. is experiencing a lower rate of uncollectibles than is the industry average), or perhaps a change to the “estimate based on analysis of receivables” method may be appropriate.

CHAPTER 9

Receivables

CP 9-6 1. and 2. Year 2

Year 1

$42,879 $ 1,032

$42,151 $ 1,198

[($1,015 + $1,049) ÷ 2]

[($1,049 + $1,347) ÷ 2]

Sales………………………………… Average accts. receivable…………

41.55

35.18

($42,879 ÷ $1,032)

($42,151 ÷ $1,198)

$ 117.5

$ 115.5

($42,879 ÷ 365)

($42,151 ÷ 365)

Accts. receivable turnover………… Average daily sales…………………

8.8

10.4

($1,032 ÷ $117.5)

($1,198 ÷ $115.5)

Days’ sales in receivables…………

The days’ sales in receivables could also be computed by dividing 365 days by the accounts receivable turnover as follows: Year 2: 8.8 (365 days ÷ 41.55) Year 1: 10.4 (365 days ÷ 35.18) 3.

The accounts receivable turnover indicates an increase in the efficiency of collecting accounts receivable by increasing from 35.18 to 41.55, a favorable change. The days’ sales in receivables decreased from 10.4 days to 8.8, a favorable change. Thus, based on (1) and (2), Best Buy has increased its efficiency in the collection of receivables.

We assumed that the percentage of credit sales to total sales remains constant from one period to the next and no major changes in operations occurred between years. For example, if the percentage of credit sales to total sales is not similar or if the percentage changes between years, then the ratios would be distorted and, thus, not comparable. Also, any major changes in operations could distort the comparison between years.

CHAPTER 9

Receivables

CP 9-7 1. and 2. Year 2 $265,595 $ 20,530

Year 1 $229,234 $ 16,814

[($23,186 + $17,874) ÷ 2]

[($17,874 + $15,754) ÷ 2]

Sales………………………………… Average accts. receivable…………

12.94

13.63

($23,186 ÷ $20,530)

($229,234 ÷ $16,814)

Accts. receivable turnover………… Average daily sales…………………

727.7

628.0

($265,595 ÷ 365)

($229,234 ÷ 365)

28.2

26.8

($20,530 ÷ $727.7)

($16,814 ÷ $628.0)

Days’ sales in receivables…………

The days’ sales in receivables could also be computed by dividing 365 days by the accounts receivable turnover as follows: Year 2: 28.2 (365 days ÷ 12.94) Year 1: 26.8 (365 days ÷ 13.63) 3.

The accounts receivable turnover indicates a decline in the efficiency of collecting accounts receivable by decreasing from 13.63 to 12.94, an unfavorable change. The days’ sales in receivables increased from 26.8 days to 28.2, an unfavorable change. Before a more definitive conclusion can be reached, the ratios should be compared with industry averages and similar firms.

CHAPTER 9

Receivables

CP 9-8 1. and 2. Year 2

Year 1

$138,434 $ 1,550.5

$126,172 $ 1,342.0

[($1,669 + $1,432) ÷ 2]

[($1,432 + $1,252) ÷ 2]

Sales………………………………… Average accts. receivable…………

89.28

94.02

($138,434 ÷ $1,550.5)

($126,172 ÷ $1,342.0)

Accts. receivable turnover………… Average daily sales…………………

379.3

($138,434 ÷ 365)

345.7

($126,172 ÷ 365)

4.1

3.9

($1,550.5 ÷ $379.3)

($1,342.0 ÷ $345.7)

Days’ sales in receivables…………

The days’ sales in receivables could also be computed by dividing 365 days by the accounts receivable turnover as follows: Year 2: 4.1 (365 days ÷ 89.28) Year 1: 3.9 (365 days ÷ 94.02) 3.

The accounts receivable turnover indicates a slight decrease in the efficiency of collecting accounts receivable by decreasing from 94.02 to 89.28, an unfavorable change. The days’ sales in receivables increased from 3.9 days to 4.1 days, an unfavorable change. Before a more definitive conclusion can be reached, the ratios should be compared with industry averages and similar firms.

Costco’s accounts receivable turnover would normally be higher than that of a typical manufacturing company such as the Campbell Soup Company. This is because many of Costco’s customers charge their purchases to credit cards or pay with checks or cash. In contrast, the customers of the Campbell Soup Company are other businesses that pay their accounts receivable on a less timely basis. For a recent year, the accounts receivable turnover ratio for Campbell Soup was 12.22 (see Ex. 9-27).

CHAPTER 9

Receivables

CP 9-9 1.

Note to Instructors: The turnover ratios will vary over time. Recently, the various turnover ratios (rounded to one decimal place) were as follows: Alcoa Corp. …………………………… 12.2 AutoZone, Inc. ………………………… 40.6 Barnes & Noble, Inc. ………………… 55.8 Caterpillar ……………………………… 6.7 The Coca-Cola Company …………… 8.3 Delta Air Lines ………………………… 17.3 The Home Depot ……………………… 50.5 IBM ……………………………………… 9.8 Kroger …………………………………… 79.6 Procter & Gamble …………………… 13.8 Wal-Mart ………………………………… 95.1 Whirlpool Corporation ……………… 8.5 Based on the above ratios, the companies can be categorized as follows: Accounts Receivable Turnover Ratio Below 15 Above 15 Alcoa Inc. Caterpillar The Coca-Cola Company IBM Procter & Gamble Whirlpool Corporation

AutoZone, Inc. Barnes & Noble, Inc. Delta Air Lines The Home Depot Kroger Wal-Mart

The companies with accounts receivable turnover ratios above 15 are all companies selling primarily to individual consumers. In contrast, companies with turnover ratios below 15 are companies selling primarily to other businesses. Generally, we would expect companies selling to individual consumers to have higher turnover ratios, since many customers will charge their purchases on credit cards. In contrast, companies selling to other businesses normally allow a credit period of at least 30 days or longer.

CHAPTER 10 LONG-TERM ASSETS: FIXED AND INTANGIBLE DISCUSSION QUESTIONS 1.

a. b.

Property, plant, and equipment or fixed assets Current assets (inventory)

Undeveloped land acquired for future resale rather than operations is classified and reported as an investment, below the Current Assets section.

$1,100,000

12 years

No. A business may use different depreciation methods for different classes of assets.

The straight-line depreciation method is most appropriate when the revenues generated by the asset are about the same from period to period.

The units-of-activity depreciation method is most appropriate when the asset’s use (and revenues) vary from period to period.

The double-declining-balance depreciation method is most appropriate when the revenues generated by the asset are greater in the early periods of use rather than in later periods.

Capital expenditures include the cost of acquiring fixed assets and the cost of improving an asset. These costs are recorded by increasing (debiting) a fixed asset account. Capital expenditures also include the costs of extraordinary repairs, which are recorded by decreasing (debiting) the asset’s accumulated depreciation account. Revenue expenditures are recorded as expenses and are costs that benefit only the current period and are incurred for normal maintenance and repairs of fixed assets.

Capital expenditure

No. The accumulated depreciation for an asset cannot exceed the cost of the asset. To do so would allocate more to depreciation expense than was paid for the asset, which would create a negative book value.

The cost and accumulated depreciation should be removed from the accounts when the asset is no longer useful and is removed from service. Presumably, the asset will then be sold, traded in, or discarded.

10. a. b. c.

The cost of a patent should be amortized over the shorter of its legal life or years of usefulness. Research and development costs should be expensed as incurred. Goodwill should not be amortized but written down when impaired.

CHAPTER 10

Long-Term Assets: Fixed and Intangible

PRACTICE EXERCISES PE 10-1A a. $1,290,000 ($1,630,000 – $340,000) b. 10% (100% ÷ 10) c. $129,000 ($1,290,000 × 10%) or ($1,290,000 ÷ 10 years)

PE 10-1B a. b. c.

$408,000 ($470,000 – $62,000) 20% (100% ÷ 5) $81,600 ($408,000 × 20%) or ($408,000 ÷ 5 years)

PE 10-2A a. b. c.

$184,800 ($202,800 – $18,000) $0.42 per mile ($184,800 ÷ 440,000 miles) $47,460 (113,000 miles × $0.42)

PE 10-2B a. b. c.

$630,000 ($678,000 – $48,000) $14.00 per hour ($630,000 ÷ 45,000 hours) $46,620 (3,330 hours × $14.00)

PE 10-3A a. b.

5% [(100% ÷ 40) × 2] $59,650 ($1,193,000 × 5%)

PE 10-3B a. b.

20% [(100% ÷ 10) × 2] $108,000 ($540,000 × 20%)

PE 10-4A a. b. c.

$16,400 [($304,000 – $41,600) ÷ 16] $140,000 [$304,000 – ($16,400 × 10)] $15,400 [($140,000 – $16,800) ÷ 8]

PE 10-4B a. b. c.

$8,250 [($123,000 − $24,000) ÷ 12] $65,250 [$123,000 − ($8,250 × 7)] $10,050 [($65,250 − $15,000) ÷ 5] 10-2 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 10

Long-Term Assets: Fixed and Intangible

PE 10-5A Feb.

14 Accumulated Depreciation—Delivery Van Cash 14 Delivery Van Cash

4,700 4,700 920 920

PE 10-5B Aug.

7 Delivery Truck Cash

2,800 2,800

7 Repairs and Maintenance Expense Cash

70 70

PE 10-6A a.

$35,000 = $280,000 × [(100% ÷ 16) × 2] = $280,000 × 12.5%

$16,025 gain, computed as follows: Cost…………………………………………… $280,000 First-year depreciation………………… (35,000) (30,625) [($280,000 – $35,000) × 12.5%] Second-year depreciation……………… $214,375 Book value at end of second year………… Gain on sale ($230,400 – $214,375) = $16,025

Cash Accumulated Depreciation—Equipment Equipment Gain on Sale of Equipment

230,400 65,625 280,000 16,025

PE 10-6B a. $28,900 [($287,100 – $27,000) ÷ 9] b.

$3,900 loss {$138,700 – [$287,100 – ($28,900 × 5)]}

Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

138,700 144,500 3,900 287,100

CHAPTER 10

Long-Term Assets: Fixed and Intangible

PE 10-7A a. $1.12 per ton = $342,720,000 ÷ 306,000,000 tons b.

$62,272,000 = 55,600,000 tons × $1.12 per ton

Dec.

31 Depletion Expense Accumulated Depletion Depletion of mineral deposit.

62,272,000 62,272,000

PE 10-7B a.

$0.35 per ton = $195,650,000 ÷ 559,000,000 tons

$8,015,000 = 22,900,000 tons × $0.35 per ton

Dec.

31 Depletion Expense Accumulated Depletion Depletion of mineral deposit.

8,015,000

31 Loss from Impaired Goodwill Goodwill Impaired goodwill.

4,700,000

8,015,000

PE 10-8A a.

Dec.

31 Amortization Expense—Patents Patents Amortized patent rights [($1,260,000 ÷ 12) × (9 ÷ 12)].

4,700,000 78,750 78,750

PE 10-8B a.

Dec.

31 Loss from Impaired Goodwill Goodwill Impaired goodwill. 31 Amortization Expense—Patents Patents Amortized patent rights [($594,000 ÷ 15) × (5 ÷ 12)].

1,600,000 1,600,000 16,500 16,500

CHAPTER 10

Long-Term Assets: Fixed and Intangible

PE 10-9A a. Fixed Asset Turnover: Year 2 $4,521,000

Year 1 $3,960,000

$1,140,000 $1,600,000 $1,370,000

$1,060,000 $1,140,000 $1,100,000

[($1,140,000 + $1,600,000) ÷ 2]

[($1,060,000 + $1,140,000) ÷ 2]

Sales……………………………… Fixed assets: Beginning of year…………… End of year…………………… Average fixed assets……………

3.3

3.6

($4,521,000 ÷ $1,370,000)

($3,960,000 ÷ $1,100,000)

Fixed asset turnover…………… b.

The decrease in the fixed asset turnover ratio from 3.6 to 3.3 indicates an unfavorable change in the efficiency of using fixed assets to generate sales.

PE 10-9B a.

Fixed Asset Turnover: Sales…………………………… Fixed assets: Beginning of year………… End of year………………… Average fixed assets…………

Year 2

Year 1

$1,560,000

$1,026,000

$580,000 $620,000 $600,000

$500,000 $580,000 $540,000

[($580,000 + $620,000) ÷ 2]

[($500,000 + $580,000) ÷ 2]

2.6

1.9

($1,560,000 ÷ $600,000)

($1,026,000 ÷ $540,000)

Fixed asset turnover………… b.

The increase in the fixed asset turnover ratio from 1.9 to 2.6 indicates a favorable change in the efficiency of using fixed assets to generate sales.

CHAPTER 10

Long-Term Assets: Fixed and Intangible

EXERCISES Ex. 10-1 a. b.

New printing press: 1, 2, 3, 5, 6 Used printing press: 7, 8, 9, 11

Ex. 10-2 a.

Yes. All expenditures incurred for the purpose of making the land suitable for its intended use should be debited to the land account.

No. Land is not depreciated.

Ex. 10-3 Initial cost of land ($90,000 + $50,000)……………………… Legal fees……………………………………………………… Delinquent taxes……………………………………………… Demolition of building……………………………………… Total costs to acquire and prepare land for use…………… Less salvage of materials……………………………………… Cost of land to be reported on the balance sheet…………

$140,000 $ 1,750 25,000 9,000

35,750 $175,750 1,000 $174,750

Ex. 10-4 a.

No. The $44,500,000 represents the original cost of the equipment. Its replacement cost, which may be more or less than $44,500,000, is not reported in the financial statements.

No. The $29,800,000 is the accumulation of the past depreciation charges on the equipment. The recognition of depreciation expense has no relationship to the cash account or accumulation of cash funds.

Ex. 10-5 (a) 10% (100% ÷ 10), (b) 12.5% (100% ÷ 8), (c) 4% (100% ÷ 25), (d) 2.5% (100% ÷ 40), (e) 20% (100% ÷ 5), (f) 25% (100% ÷ 4), (g) 5% (100% ÷ 20) Ex. 10-6 $4,400 [($66,700 – $5,100) ÷ 14] Ex. 10-7 $136,700 – $14,500 18,800 hours

= $6.50 depreciation per hour

CHAPTER 10

Long-Term Assets: Fixed and Intangible

Ex. 10-8 a. Depreciation Rate per Mile: Truck 1 ($80,000 – $15,000) ÷ 250,000 = $0.26 Truck 2 ($54,000 – $6,000) ÷ 300,000 = $0.16 Truck 3 ($72,900 – $10,900) ÷ 200,000 = $0.31 Truck 4 ($90,000 – $22,800) ÷ 240,000 = $0.28 Credit to Accumulated Rate per Mile Depreciation Miles Operated Truck No. $ 5,460 21,000 1 $0.26 5,360 2 0.16 33,500 1,860 8,000 3 0.31 6,300 4 22,500 0.28 $18,980 Total……………………………………………………………… Note: Mileage depreciation of $2,480 (31 cents × 8,000) is limited to $1,860 for Truck 3, which reduces the book value of the truck to $10,900, its residual value. b.

Dec. 31 Depreciation Expense—Trucks Accumulated Depreciation—Trucks Truck depreciation.

18,980 18,980

Ex. 10-9 First Year

Second Year

20% of $35,000 = $7,000 or $35,000 ÷ 5 = $7,000

40% of $35,000 = $14,000

40% of ($35,000 – $14,000) = $8,400

Ex. 10-10 a.

5% of ($61,000 – $9,000) = $2,600 or [($61,000 – $9,000) ÷ 20]

Year 1: 10% of $61,000 = $6,100 Year 2: 10% of ($61,000 – $6,100) = $5,490

CHAPTER 10

Long-Term Assets: Fixed and Intangible

Ex. 10-11 a.

Year 1: ($105,000 – $12,000) ÷ 10 = $9,300; $9,300 × (8 ÷ 12) = $6,200 Year 2: ($105,000 – $12,000) ÷ 10 = $9,300

Year 1: 8 ÷ 12 × 20% of $105,000 = $14,000 Year 2: 20% of ($105,000 – $14,000) = $18,200

Ex. 10-12 a.

$23,750 [($1,200,000 – $250,000) ÷ 40] or [($1,200,000 – $250,000) × 2.5%]

$535,000 [$1,200,000 – ($23,750 × 28 yrs.)]

$35,500 [($535,000 – $180,000) ÷ 10 yrs.]

Ex. 10-13 Capital expenditures: 1, 3, 5, 7, 8, 9, 10 Revenue expenditures: 2, 4, 6

Ex. 10-14 Capital expenditures: 2, 3, 4, 8, 9, 10 Revenue expenditures: 1, 5, 6, 7

Ex. 10-15 Mar.

June

Nov.

20 Accumulated Depreciation—Delivery Truck Cash

1,890

11 Delivery Truck Cash

1,350

1,890

1,350

30 Repairs and Maintenance Expense Cash

CHAPTER 10

Long-Term Assets: Fixed and Intangible

Ex. 10-16 a. b.

Apr. Dec.

30 Carpet Cash

18,000 18,000

31 Depreciation Expense—Carpet Accumulated Depreciation—Carpet Carpet depreciation [($18,000 ÷ 15 years) × (8 ÷ 12)].

800 800

Ex. 10-17 a. Cost of equipment…………………………………………………………………… $168,000 Less accumulated depreciation at end of fourth year, December 31 34,000 (4 years at $8,500 per year)……………………………………………………… Book value at end of fourth year, December 31………………………………… $134,000 Yearly depreciation = ($168,000 – $15,000) ÷ 18 = $8,500

Apr.

1 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation ($8,500 × 3 ÷ 12).

2,125

1 Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

125,000 36,125* 6,875

2,125

168,000

* Accumulated Depreciation—Equipment = $34,000 + $2,125 = $36,125

CHAPTER 10

Long-Term Assets: Fixed and Intangible

Ex. 10-18 a.

Year 1 depreciation expense: $20,900 [($401,300 – $25,100) ÷ 18] Year 2 depreciation expense: $20,900 Year 3 depreciation expense: $20,900

$338,600 [$401,300 – ($20,900 × 3)]

Year 4 Jan.

3 Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

315,000 62,700 23,600

3 Cash Accumulated Depreciation—Equipment Equipment Gain on Sale of Equipment

342,000 62,700

401,300

401,300 3,400

Ex. 10-19 a.

$53,200,000 ÷ 19,000,000 tons = $2.80 depletion per ton 2,500,000 tons × $2.80 = $7,000,000 depletion expense

Dec.

31 Depletion Expense Accumulated Depletion Depletion of mineral deposit.

7,000,000 7,000,000

Ex. 10-20 a.

($2,800,000 ÷ 8) + ($38,000 ÷ 5) = $357,600 total patent amortization expense

Dec.

31 Amortization Expense—Patents Patents Amortized patent rights ($350,000 + $7,600).

357,600 357,600

CHAPTER 10

Long-Term Assets: Fixed and Intangible

Ex. 10-21 a.

Property, Plant, and Equipment (in millions): Current Year Land and buildings………………………………………………… $16,216 Machinery, equipment, and internal-use software…………… 65,982 8,205 Other fixed assets …………………………………………………

Preceding Year $13,587 54,210 7,279

Total fixed assets…………………………………………………… $90,403 Less accumulated depreciation and amortization…………… 49,099 Book value…………………………………………………………… $41,304

$75,076 41,293 $33,783

A comparison of the book values of the current and preceding years indicates that the book value increased. A comparison of the total cost and accumulated depreciation reveals that Apple purchased $15,327 million ($90,403 – $75,076) of additional fixed assets, which was offset by the additional depreciation expense of $7,806 million ($49,099 – $41,293) taken during the current year. b.

We would expect Apple’s book value of fixed assets to increase during the year as its sales increase. Although additional depreciation expense will reduce the book value, most companies, such as Apple, invest in new assets in an amount that is at least equal to the depreciation expense. However, during periods of economic downturn, companies purchase fewer fixed assets, and the book value of their fixed assets may decline.

Ex. 10-22 1.

Fixed assets should be reported at cost and not replacement cost.

Land does not depreciate.

Patents and goodwill are intangible assets that should be listed in a separate section following the Fixed Assets section. Patents should be reported at their net book values (cost less amortization to date). Goodwill should not be amortized but should be written down only upon impairment.

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Long-Term Assets: Fixed and Intangible

Ex. 10-23 a. Fixed Asset Turnover Ratio = Amazon:

$232,887 $55,332

= 4.2

Netflix:

$15,794 $369

= 42.8

Sales Average Book Value of Fixed Assets

b. Netflix is more efficient than Amazon in generating revenue from fixed assets. Netflix’s fixed asset turnover ratio is 42.8, which means it is able to generate $42.80 of revenue for every dollar of fixed assets. Amazon’s fixed asset turnover ratio is 4.2, which is only $4.20 of revenue for every dollar of fixed assets. Netflix’s fixed asset turnover ratio is more than 10 times larger than Amazon’s (42.8 ÷ 4.2). c. The difference in their fixed asset turnover ratios reflects the difference in their core businesses. Netflix is mostly an Internet streaming and DVD rental company. These services do not require significant fixed assets. The most significant fixed assets of Netflix are its information technology assets, followed by its headquarters and DVD mailing operations. Amazon also provides streaming services, media downloads, and other electronic products. In addition, Amazon sells a wide ® assortment of merchandise and markets Kindle products. This broader assortment of activities requires more extensive use of fixed assets beyond information technology, including warehouses and equipment. These additional fixed assets are the cause of Amazon’s lower fixed asset turnover ratio.

Ex. 10-24 a. Fixed Asset Turnover Ratio = Verizon:

Sales Average Book Value of Fixed Assets

$130,863 ($89,286 + $88,568) ÷ 2

= 1.5

b. Verizon earns $1.50 revenue for every dollar of fixed assets. Telecommunications requires a significant investment in the network in order to generate revenues. The industry average fixed asset turnover ratio is just over 1.0. Thus, Verizon is using its fixed assets more efficiently in generating revenues than the industry as a whole. The reason would require further analysis into the nature of Verizon’s fixed assets and revenues, but is likely related to having high data volume on its network.

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Long-Term Assets: Fixed and Intangible

Ex. 10-25 a.

Fixed Asset Turnover Ratio = FedEx:

$65,450 $27,068

= 2.4

UPS:

$71,861 $24,347

= 3.0

Sales Average Book Value of Fixed Assets

b. The ratios show that UPS is 25% more efficient at using its fixed assets than FedEx [(3.0 – 2.4) ÷ 2.4]. c. The fixed asset turnover is a measure of how efficiently revenue is generated from underlying fixed assets. In the case of UPS, the fixed assets represent all fixed assets necessary to deliver packages from one location to another. These include aircraft, trucks, sorting and handling facilities, and information technology. For every dollar of these fixed assets, UPS is able to generate $3.00 in sales. The fixed asset turnover ratio will be influenced by the degree these assets are utilized to their optimal capacity. So, for example, optimally filled planes, trucks, and sorting centers will cause the fixed asset turnover ratio to improve.

Ex. 10-26 a.

Fixed Asset Turnover Ratio =

Sales Average Book Value of Fixed Assets

Alphabet (Google) Inc.:

$136,819 $51,051

= 2.7

Comcast:

$94,507 $41,454

= 2.3

Walmart:

$510,329 $113,107

= 4.5

b. Comcast’s fixed asset turnover is less than the other two companies. This means Comcast is less efficient at generating sales from fixed assets than the other two companies. This can be explained by the nature of Comcast’s business. Comcast must build a complete cable network in order to earn revenues. This includes underground cable through cities, neighborhoods, and individual residences. In addition, Comcast must provide the additional technology to carry broadband over this network. As a result, Comcast has a significant investment in fixed assets in order to earn revenues. Alphabet (Google) has a significant investment in servers; however, these servers are able to generate advertising revenue more efficiently than Comcast is able to earn subscription revenues over its cable network. Walmart’s

CHAPTER 10

Long-Term Assets: Fixed and Intangible

Ex. 10-26 (Concluded) major fixed assets are its stores. However, Walmart’s other major asset is merchandise inventory, which is not included in the fixed asset turnover ratio. Thus, Walmart’s higher asset efficiency is only partially explained by the fixed asset turnover ratio. The inventory turnover ratio would also need to be analyzed to fully appreciate Walmart’s efficiency in using its total assets. The other two companies do not have merchandise inventory, so the fixed asset turnover ratio is a more complete measure of their total asset efficiency relative to Walmart’s.

Appendix Ex. 10-27 a. Price (fair market value) of new equipment…………………… Less trade-in allowance of old equipment……………………… Cash paid on the date of exchange………………………………

$275,000 90,000 $185,000

b. Fair market value (trade-in allowance) of old equipment…… Less book value of old equipment……………………………… Gain on exchange of equipment…………………………………

$ 90,000 68,000 $ 22,000

or Price (fair market value) of new equipment…………………… Assets given up in exchange: Book value of old equipment………………………………… $ 68,000 185,000 Cash paid on the exchange…………………………………… Gain on exchange of equipment…………………………………

$275,000

253,000 $ 22,000

Appendix Ex. 10-28 a. Price (fair market value) of new equipment…………………… Less trade-in allowance of old equipment……………………… Cash paid on the date of exchange………………………………

$275,000 90,000 $185,000

b. Fair market value (trade-in allowance) of old equipment…… Less book value of old equipment……………………………… Loss on exchange of equipment…………………………………

$ 90,000 108,500 $ (18,500)

or Price (fair market value) of new equipment…………………… Assets given up in exchange: Book value of old equipment………………………………… $108,500 185,000 Cash paid on the exchange…………………………………… Loss on exchange of equipment…………………………………

$275,000

293,500 $ (18,500)

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Long-Term Assets: Fixed and Intangible

Appendix Ex. 10-29 a.

July

1 Depreciation Expense—Equipment Accumulated Depreciation—Equipment Equipment depreciation ($12,000 × 6 ÷ 12). 1 Accumulated Depreciation—Equipment Equipment Loss on Exchange of Equipment Equipment Cash

6,000 6,000 126,000 220,000 9,000 180,000 175,000

Appendix Ex. 10-30 a.

Oct.

1 Depreciation Expense—Trucks Accumulated Depreciation—Trucks Truck depreciation ($7,000 × 9 ÷ 12).

5,250

1 Accumulated Depreciation—Trucks Trucks Trucks Cash Gain on Exchange of Trucks

40,250 75,000

5,250

56,000 51,000 8,250

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Long-Term Assets: Fixed and Intangible

PROBLEMS Prob. 10-1A 1. Item a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s.

Land $

Building

Other Accounts

2,500 340,000 15,500 5,000 (4,000)* 29,000 $ 60,000 6,000 12,000 $(900,000) * 5,500 $32,000 11,000 2,000 2,500 (7,500)*

$400,000

Land Improvements

$45,000

800,000 34,500 (500)* $900,000

* Received cash. 3.

Land used as a plant site does not lose its ability to provide services; thus, it is not depreciated. However, land improvements do lose their ability to provide services as time passes and are, therefore, depreciated.

Because land improvements are depreciated, depreciation expense of $1,200 [$12,000 × (100% ÷ 20) × 2] would be overstated and net income would be understated by $1,200 on the income statement. On the balance sheet, Land would be understated by $12,000, Land Improvements would be overstated by $10,800 ($12,000 – $1,200), and Retained Earnings would be understated by $1,200.

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Prob. 10-2A 1.

Long-Term Assets: Fixed and Intangible

Depreciation Expense a. Straightb. Units-ofLine Activity Method Method

Year Year 1 Year 2 Year 3 Total

$22,500 22,500 22,500 $67,500

c. DoubleDeclining-Balance Method

$28,500 22,500 16,500 $67,500

$48,000 16,000 3,500 $67,500

Calculations: Straight-line method: ($72,000 – $4,500) ÷ 3 = $22,500 each year Units-of-activity method: ($72,000 – $4,500) ÷ 18,000 hours = $3.75 per hour Year 1: Year 2: Year 3:

7,600 hours × $3.75 = $28,500 6,000 hours × $3.75 = $22,500 4,400 hours × $3.75 = $16,500

Double-declining-balance method: Year 1: Year 2: Year 3:

$72,000 × (2 ÷ 3) = $48,000 ($72,000 – $48,000) × (2 ÷ 3) = $16,000 ($72,000 – $48,000 – $16,000 – $4,500) = $3,500

Note: Book value should not be reduced below the residual value of $4,500. 2.

The double-declining-balance method yields the most depreciation expense in Year 1 of $48,000.

Over the three-year life of the equipment, all three depreciation methods yield the same total depreciation, $67,500, which is the cost of the equipment of $72,000 less the residual value of $4,500.

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Long-Term Assets: Fixed and Intangible

Prob. 10-3A a. Straight-line method: Year 1: Year 2: Year 3: Year 4: b.

Units-of-activity method: Activity rate = ($270,000 – $9,000) ÷ 18,000 hours = $14.50 per hour Year 1: Year 2: Year 3: Year 4:

($270,000 – $9,000) ÷ 3 × 9 ÷ 12……………………………………… $65,250 ($270,000 – $9,000) ÷ 3………………………………………………… 87,000 ($270,000 – $9,000) ÷ 3………………………………………………… 87,000 ($270,000 – $9,000) ÷ 3 × 3 ÷ 12……………………………………… 21,750

7,500 hours × $14.50………………………………………………… 5,500 hours × $14.50………………………………………………… 4,000 hours × $14.50………………………………………………… 1,000 hours × $14.50…………………………………………………

$108,750 79,750 58,000 14,500

Double-declining-balance method: Year 1: Year 2: Year 3: Year 4:

$270,000 × 2 ÷ 3 × 9 ÷ 12…………...………………………………… $135,000 ($270,000 – $135,000) × 2 ÷ 3………………………………………… 90,000 ($270,000 – $135,000 – $90,000) × 2 ÷ 3…………………………… 30,000 ($270,000 – $135,000 – $90,000 – $30,000 – $9,000)……………… 6,000

Note: Book value should not be reduced below $9,000, the residual value.

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Long-Term Assets: Fixed and Intangible

Prob. 10-4A 1. Year

Depreciation Expense

1………………………………………………$142,000 2……………………………………………… 142,000 3……………………………………………… 142,000 4……………………………………………… 142,000 5……………………………………………… 142,000

Accumulated Depreciation, End of Year

Book Value, End of Year

$142,000 284,000 426,000 568,000 710,000

$658,000 516,000 374,000 232,000 90,000

$320,000 512,000 627,200 696,320 710,000

$480,000 288,000 172,800 103,680 90,000

Yearly depreciation = [($800,000 – $90,000) ÷ 5] = $142,000

1 2 3 4 5

[$800,000 × (100% ÷ 5) × 2]……… $320,000 [$480,000 × (100% ÷ 5) × 2]……… 192,000 [$288,000 × (100% ÷ 5) × 2]……… 115,200 [$172,800 × (100% ÷ 5) × 2]……… 69,120 ($800,000 – $696,320 – $90,000)… 13,680

Note: Book value should not be reduced below $90,000, the residual value. 2.

Mar.

4 Cash Accumulated Depreciation—Equipment Equipment Gain on Sale of Equipment

135,000 696,320 800,000 31,320

Gain on sale of equipment = $135,000 – ($800,000 – $696,320) = $31,320

Mar.

4 Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

88,750 696,320 14,930 800,000

Loss on sale of equipment = $88,750 – ($800,000 – $696,320) = –$14,930

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Long-Term Assets: Fixed and Intangible

Prob. 10-5A Year 1 Jan.

Nov.

Dec.

Year 2 Jan.

Apr.

June

Dec.

4 Delivery Truck Cash

28,000 28,000

2 Truck Repair Expense Cash

675 675

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$28,000 × (100% ÷ 4) × 2].

14,000

6 Delivery Truck Cash

48,000

1 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [($28,000 – $14,000) × (100% ÷ 4) × 2 × (3 ÷ 12)].

1,750

1 Accum. Depreciation—Delivery Truck Cash Delivery Truck Gain on Sale of Delivery Truck

15,750 15,000

14,000

48,000

11 Truck Repair Expense Cash

1,750

28,000 2,750 450 450

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$48,000 × (100% ÷ 5) × 2].

19,200 19,200

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Long-Term Assets: Fixed and Intangible

Prob. 10-5A (Concluded) Year 3 July

Oct.

Dec.

1 Delivery Truck Cash

54,000

2 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [($48,000 – $19,200) × (100% ÷ 5) × 2 × (9 ÷ 12)]. 2 Cash Accum. Depreciation—Delivery Truck Loss on Sale of Delivery Truck Delivery Truck

8,640

54,000

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$54,000 × (100% ÷ 8) × 2 × (1 ÷ 2)].

8,640

16,750 27,840 3,410 48,000 6,750 6,750

Prob. 10-6A 1. a.

$1,600,000 ÷ 5,000,000 board feet = $0.32 per board foot; 1,100,000 board feet × $0.32 per board foot = $352,000

Loss from impaired goodwill, $3,750,000

$6,600,000 ÷ 12 years = $550,000; 3/4 of $550,000 = $412,500

2. a.

Dec.

31 Depletion Expense Accumulated Depletion Depletion of timber rights.

352,000 352,000

31 Loss from Impaired Goodwill Goodwill Impaired goodwill.

3,750,000

31 Amortization Expense—Patents Patents Patent amortization.

412,500

3,750,000

412,500

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Long-Term Assets: Fixed and Intangible

Prob. 10-1B 1. Item a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s.

Land 3,600 780,000 23,400 15,000

Building

Other Accounts

$ 75,000 10,000 (3,400) * 18,000 8,400 $(800,000) * 13,400 3,000 2,000 $14,000 21,600 40,000 (4,500) *

$860,000

Land Improvements

$35,600

800,000 (1,400)* $922,000

* Received cash. 3.

Because land improvements are depreciated, depreciation expense of $4,320 [$21,600 × (100% ÷ 10) × 2] would be understated and net income would be overstated by $4,320 on the income statement. On the balance sheet, Land would be overstated by $21,600, Land Improvements would be understated by $17,280 ($21,600 – $4,320), and Retained Earnings would be overstated by $4,320.

CHAPTER 10

Prob. 10-2B 1.

Long-Term Assets: Fixed and Intangible

Year

Depreciation Expense a. Straightb. Units-ofLine Activity Method Method

Year 1 Year 2 Year 3 Year 4 Total

$ 71,250 71,250 71,250 71,250 $285,000

c. DoubleDeclining-Balance Method

$102,600 91,200 62,700 28,500 $285,000

$160,000 80,000 40,000 5,000 $285,000

Calculations: Straight-line method: ($320,000 – $35,000) ÷ 4 = $71,250 each year Units-of-activity method: ($320,000 – $35,000) ÷ 20,000 hours = $14.25 per hour Year 1: Year 2: Year 3: Year 4:

7,200 hours × $14.25 = $102,600 6,400 hours × $14.25 = $91,200 4,400 hours × $14.25 = $62,700 2,000 hours × $14.25 = $28,500

Double-declining-balance method: Year 1: Year 2: Year 3: Year 4:

$320,000 × [(1 ÷ 4) × 2] = $160,000 ($320,000 – $160,000) × [(1 ÷ 4) × 2] = $80,000 ($320,000 – $160,000 – $80,000) × [(1 ÷ 4) × 2] = $40,000 ($320,000 – $160,000 – $80,000 – $40,000 – $35,000) = $5,000

Note: Book value should not be reduced below the residual value of $35,000. 2.

The double-declining-balance method yields the most depreciation expense in Year 1 of $160,000.

Over the four-year life of the equipment, all three depreciation methods yield the same total depreciation, $285,000, which is the cost of the equipment of $320,000 less the residual value of $35,000.

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Long-Term Assets: Fixed and Intangible

Prob. 10-3B a. Straight-line method: Year 1: [($162,000 – $3,600) ÷ 3] × 8 ÷ 12………………………………… [($162,000 – $3,600) ÷ 3]…………………………………………… Year 2: [($162,000 – $3,600) ÷ 3]…………………………………………… Year 3: [($162,000 – $3,600) ÷ 3] × 4 ÷ 12………………………………… Year 4: b.

Units-of-activity method: Activity rate = ($162,000 – $3,600) ÷ 12,000 hours = $13.20 per hour Year 1: Year 2: Year 3: Year 4:

$35,200 52,800 52,800 17,600

2,400 hours × $13.20……………………………………………… 3,900 hours × $13.20……………………………………………… 4,050 hours × $13.20……………………………………………… 1,650 hours × $13.20………………………………………………

$31,680 51,480 53,460 21,780

Double-declining-balance method: Year 1: Year 2: Year 3: Year 4:

$162,000 × 2 ÷ 3 × 8 ÷ 12…………...……………………………… $72,000 ($162,000 – $72,000) × 2 ÷ 3……………………………………… 60,000 ($162,000 – $72,000 – $60,000) × 2 ÷ 3…………………………… 20,000 ($162,000 – $72,000 – $60,000 – $20,000 – $3,600)…………… 6,400

Note: Book value should not be reduced below $3,600, the residual value.

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Long-Term Assets: Fixed and Intangible

Prob. 10-4B 1.

Accumulated Depreciation Depreciation, Expense End of Year

Year a.

1………………………………………………… $25,625 2………………………………………………… 25,625 3………………………………………………… 25,625 4………………………………………………… 25,625

Book Value, End of Year

$ 25,625 51,250 76,875 102,500

$84,375 58,750 33,125 7,500

$ 55,000 82,500 96,250 102,500

$55,000 27,500 13,750 7,500

Yearly depreciation = [($110,000 – $7,500) ÷ 4] = $25,625

1 2 3 4

[$110,000 × (100% ÷ 4) × 2]………… $55,000 [$55,000 × (100% ÷ 4) × 2]…………… 27,500 [$27,500 × (100% ÷ 4) × 2]…………… 13,750 ($110,000 – $96,250 – $7,500)……… 6,250

Note: Book value should not be reduced below $7,500, the residual value. 2.

Sept.

6 Cash Accumulated Depreciation—Equipment Equipment Gain on Sale of Equipment

18,000 96,250 110,000 4,250

Gain on sale of equipment = $18,000 – ($110,000 – $96,250) = $4,250

Sept.

6 Cash Accumulated Depreciation—Equipment Loss on Sale of Equipment Equipment

10,500 96,250 3,250 110,000

Loss on sale of equipment = $10,500 – ($110,000 – $96,250) = –$3,250

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Long-Term Assets: Fixed and Intangible

Prob. 10-5B Year 1 Jan.

Mar.

Dec.

Year 2 Jan.

Feb.

Apr.

Dec.

8 Delivery Truck Cash

24,000 24,000

7 Truck Repair Expense Cash

900 900

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$24,000 × (100% ÷ 4) × 2].

12,000

9 Delivery Truck Cash

50,000

12,000

50,000

28 Truck Repair Expense Cash

250 250

30 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [($24,000 – $12,000) × (100% ÷ 4) × 2 × (4 ÷ 12)].

2,000

30 Accum. Depreciation—Delivery Truck Cash Loss on Sale of Delivery Truck Delivery Truck

14,000 9,500 500

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$50,000 × (100% ÷ 8) × 2].

12,500

2,000

24,000

12,500

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Long-Term Assets: Fixed and Intangible

Prob. 10-5B (Concluded) Year 3 Sept.

Dec.

1 Delivery Truck Cash

58,500

4 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [($50,000 – $12,500) × (100% ÷ 8) × 2 × (8 ÷ 12)].

6,250

4 Cash Accum. Depreciation—Delivery Truck Delivery Truck Gain on Sale of Delivery Truck

36,000 18,750

31 Depreciation Expense—Delivery Truck Accum. Depreciation—Delivery Truck Delivery truck depreciation [$58,500 × (100% ÷ 10) × 2 × (4 ÷ 12)].

3,900

58,500

6,250

50,000 4,750

3,900

Prob. 10-6B 1. a.

Loss from impaired goodwill, $3,400,000

$4,800,000 ÷ 8 years = $600,000; 1/4 of $600,000 = $150,000

$2,975,000 ÷ 12,500,000 board feet = $0.238 per board foot; 4,150,000 board feet × $0.238 per board foot = $987,700

2. a.

Dec.

31 Loss from Impaired Goodwill Goodwill Impaired goodwill.

3,400,000

31 Amortization Expense—Patents Patents Patent amortization.

150,000

31 Depletion Expense Accumulated Depletion Depletion of timber rights.

987,700

3,400,000

150,000

987,700

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Long-Term Assets: Fixed and Intangible

CASES & PROJECTS CP 10-1 1. Estimates of the factors determining depreciation expense create a unique financial reporting challenge. Because the useful life and residual value are estimates, there is no “correct” amount. The company must use judgment along with historical data to develop estimates that fairly reflect these items. These estimates are required under GAAP and should be representationally faithful. By subjectively changing these estimates, Mike and James are manipulating financial statement information to meet earnings targets. If this manipulation goes undetected, they will likely meet the owner’s earnings targets and save their jobs. Financial statement users, however, will be harmed by this action because they will be relying on financial statement information that is not a fair representation of the company’s underlying economics. 2. In this case, both Mike and James appear to be acting unethically. The original useful life and residual value estimates were based on good faith estimates. By changing these estimates in order to meet an earnings goal, they have both knowingly manipulated financial statement estimates to improve the company’s reported earnings. Mike and James have used the subjectivity in these estimates inappropriately. The result is a depreciation expense amount that does not faithfully represent the depreciation associated with the equipment. CP 10-2 It is considered unprofessional for employees to use company assets for personal reasons because such use reduces the useful life of the assets for normal business purposes. Thus, it is unethical for Dave Elliott to use Lyric Consulting Co.’s computers and laser printers to service his part-time accounting business, even on an after-hours basis. In addition, it is improper for Dave’s clients to call him during regular working hours. Such calls may interrupt or interfere with Dave’s ability to carry out his assigned duties for Lyric Consulting Co.

CP 10-3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1. a.

c. d.

Depreciation is determined on a straight-line basis for buildings and leasehold improvements over 2 to 40 years and for machinery and equipment over 2 to 15 years. The company does not report depreciation expense separately on the face of the income statement. However, the amount of depreciation can be obtained from footnotes to the financial statements and is reported at $747 million. $8,891 million (Note 3) $4,454 (Note 3 and balance sheet)

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Long-Term Assets: Fixed and Intangible

CP 10-3 (Concluded) e.

Identifiable intangible assets consist of indefinite-lived trademarks, which are not subject to amortization, and acquired trademarks and other intangible assets, which are subject to amortization. At May 31, 2018 and 2017, indefinite-lived trademarks were $281 million. Acquired trademarks and other intangible assets at May 31, 2018 and 2017, were $4 million and $2 million, respectively. Goodwill was $154 million at May 31, 2018.

2. No. Book value is the difference between the fixed asset account and its related accumulated depreciation account. Depreciation does not measure a decline in the market value of a fixed asset. Instead, depreciation is an allocation of a fixed asset’s cost to expense over the asset’s useful life. Thus, the book value of a fixed asset (cost less accumulated depreciation) normally does not agree with the asset’s market value.

CP 10-4 Note to Instructors: The purpose of this activity is to familiarize students with the procedures involved in acquiring a patent, a copyright, and a trademark. You may wish to divide the class into three groups to report back on patents, copyrights, and trademarks separately. The following is some information on patents, copyrights, and trademarks that you may find helpful in your discussions. Patent A patent is requested by filing a written application at the relevant patent office. The person or company filing the application is referred to as “the applicant.” The applicant may be the inventor or its assignee. The application contains a description of how to make and use the invention that must provide sufficient detail for a person skilled in the art (i.e., the relevant area of technology) to make and use the invention. In some countries, there are requirements for providing specific information such as the usefulness of the invention, the best mode of performing the invention known to the inventor, or the technical problem or problems solved by the invention. Drawings illustrating the invention may also be provided. The application also includes one or more claims, although it is not always a requirement to submit these when first filing the application. The claims set out what the applicant is seeking to protect in that they define what the patent owner has a right to exclude others from making, using, or selling, as the case may be. In other words, the claims define what a patent covers or the “scope of protection.” After filing, an application is often referred to as “patent pending.” While this term does not confer legal protection, and a patent cannot be enforced until granted, it serves to provide warning to potential infringers that if the patent is issued, they may be liable for damages. Source: http://en.wikipedia.org/wiki/Patent#Application_and_prosecution. 10-29 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

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Long-Term Assets: Fixed and Intangible

CP 10-4 (Concluded) Copyright While copyright in the United States automatically attaches upon the creation of an original work of authorship, registration with the Copyright Office puts a copyright holder in a better position if litigation arises over the copyright. A copyright holder wanting to register his or her copyright should do the following: 1.

Obtain and complete appropriate form.

Prepare clear rendition of material being submitted for copyright.

Send both documents to the U.S. Copyright Office in Washington, D.C.

Source: http://en.wikipedia.org/wiki/United_States_copyright_law#Procedural_issues.

Trademark The law considers a trademark to be a form of property. Proprietary rights in relation to a trademark may be established through actual use in the marketplace or through registration of the mark with the trademarks office (or “trademarks registry”) of a particular jurisdiction. In some jurisdictions, trademark rights can be established through either or both means. Certain jurisdictions generally do not recognize trademark rights arising through use. In the United States, the only way to qualify for a federally registered trademark is to first use the trademark in commerce. If trademark owners do not hold registrations for their marks in such jurisdictions, the extent to which they will be able to enforce their rights through trademark infringement proceedings will be limited. In cases of dispute, this disparity of rights is often referred to as “first to file” as opposed to “first to use.” Other countries such as Germany offer a limited amount of common law rights for unregistered marks where, to gain protection, the goods or services must occupy a highly significant position in the marketplace—where this could be 40% or more market share for sales in the particular class of goods or services. Source: http://en.wikipedia.org/wiki/Trademark#Maintaining_rights.

CP 10-5 To: From: Re:

CFO, Godwin Co. IMA Student Financial Statement Effects of Modifications to Trucks 1 and 2

The modification to Truck 1 is an example of an asset improvement. After this truck was placed into service, a hydraulic lift was added to the truck. This change increased the capabilities of the truck. As a result, the cost of the hydraulic lift is added to the cost of the truck and depreciated over the truck’s remaining useful life. Because the cost of the delivery truck will be increased, depreciation expense for the truck will also increase. Truck 2 is an example of an extraordinary repair. The overhaul of the engine extends the truck’s useful life, allowing it to operate for a longer period than originally estimated. As a result, the cost of the engine overhaul is recorded as a decrease in the truck’s accumulated depreciation. The truck’s remaining book value is depreciated over the extended useful life of the truck. 10-30 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 10

Long-Term Assets: Fixed and Intangible

CP 10-6 You should explain to Nolan and Stacy that it is acceptable to maintain two sets of records for tax and financial reporting purposes. This can happen when a company uses one method for financial statement purposes, such as straight-line depreciation, and another method for tax purposes, such as MACRS depreciation. This should not be surprising because the methods for taxes and financial statements are established by two different groups with different objectives. That is, tax laws and related accounting methods are established by Congress. The Internal Revenue Service then applies the laws and, in some cases, issues interpretations of the law and congressional intent. The primary objective of the tax laws is to generate revenue in an equitable manner for government use. Generally accepted accounting principles, on the other hand, are established primarily by the Financial Accounting Standards Board. The objective of generally accepted accounting principles is the preparation and reporting of true economic conditions and results of operations of business entities. You might note, however, that companies are required in their tax returns to reconcile differences in accounting methods. For example, income reported on the company’s financial statements must be reconciled with taxable income. Finally, you might also indicate to Nolan and Stacy that even generally accepted accounting principles allow for alternative methods of accounting for the same transactions or economic events. For example, a company could use straight-line depreciation for some assets and double-declining-balance depreciation for other assets.

CHAPTER 11 CURRENT LIABILITIES AND PAYROLL DISCUSSION QUESTIONS 1.

No. A discounted note payable has no stated interest rate, but provides interest by discounting the note proceeds. The discount, which is the difference between the proceeds and the face of the note, is the interest and is accounted for as such.

Employee’s federal income taxes, social security, and Medicare

Employees Federal Income Tax Payable, Social Security Tax Payable, and Medicare Tax Payable

The deductions from employees’ earnings are for amounts owed (liabilities) to others for such items as federal taxes, state and local income taxes, and contributions to pension plans.

1. 2. 3. 4. 5.

An advantage of using a separate payroll bank account is that reconciling the bank statements is simplified. In addition, a payroll bank account establishes control over payroll and, thus, prevents their theft or misuse.

a c c b b

Constants are data that remain unchanged from payroll to payroll. These include employee names, social security numbers, marital status, number of income tax withholding allowances, rates of pay, tax rates, and withholding tables. Variables are data that change from payroll to payroll. These include number of hours or days worked for each employee, accrued days of sick leave, vacation credits, total earnings to date, and total taxes withheld.

The vacation pay expense should be recorded during the period in which the vacation privilege is earned.

In a defined contribution pension plan, the company invests contributions on behalf of the employee during the employee’s working years. Normally, the employee and employer contribute to the plan. The employee’s pension depends on the total contributions and the investment returns earned on those contributions.

To match revenues and expenses properly, the expense and liability for product warranties should be recorded in the period during which the sale of the product is recorded.

10.

When the defective product is repaired, the repair costs would be recorded by debiting Product Warranty Payable and crediting Cash, Supplies, or another appropriate account.

CHAPTER 11

Current Liabilities and Payroll

PRACTICE EXERCISES PE 11-1A a.

$180,000

$176,400 [$180,000 – ($180,000 × 8% × 90 ÷ 360)]

PE 11-1B a.

$324,000

$319,950 [$324,000 – ($324,000 × 10% × 45 ÷ 360)]

PE 11-2A Total wage payment……………………………………………………… One allowance …………………………………………………………… Multiplied by allowances claimed on Form W-4…………………… Amount subject to withholding………………………………………

$2,400.00 $81.00 2 ×

Initial withholding from wage bracket in Exhibit 2………………… Plus additional withholding: 24% of excess over $1,692*……… Federal income tax withholding………………………………………

162.00 $2,238.00 $ 276.54 131.04 $ 407.58

* ($2,238 – $1,692) × 24%

PE 11-2B Total wage payment……………………………………………………… One allowance …………………………………………………………… Multiplied by allowances claimed on Form W-4…………………… Amount subject to withholding……………………………………… Initial withholding from wage bracket in Exhibit 2………………… Plus additional withholding: 22% of excess over $832*………… Federal income tax withholding………………………………………

$1,370.00 $81.00 1 ×

81.00 $1,289.00 $

87.34 100.54 $ 187.88

* ($1,289 – $832) × 22%

CHAPTER 11

Current Liabilities and Payroll

PE 11-3A Total wage payment………………………………………… Less: Federal income tax withholding………………… Social security tax ($2,400 × 6%)………………… Medicare tax ($2,400 × 1.5%)…………………… Net pay…………………………………………………………

$2,400.00 $407.58 144.00 36.00

587.58 $1,812.42

PE 11-3B Total wage payment………………………………………… Less: Federal income tax withholding………………… Social security tax ($1,370 × 6%)………………… Medicare tax ($1,370 × 1.5%)…………………… Net pay…………………………………………………………

$1,370.00 $187.88 82.20 20.55

290.63 $1,079.37

PE 11-4A Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Salaries Payable

189,000 11,340 2,835 37,420 137,405

PE 11-4B Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Retirement Savings Deductions Payable Salaries Payable

54,000 3,240 810 10,690 3,500 35,760

CHAPTER 11

Current Liabilities and Payroll

PE 11-5A Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable* Federal Unemployment Tax Payable**

15,315 11,340 2,835 1,026 114

* $19,000 × 5.4% ** $19,000 × 0.6%

PE 11-5B Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable* Federal Unemployment Tax Payable**

4,350 3,240 810 270 30

* $5,000 × 5.4% ** $5,000 × 0.6%

PE 11-6A a.

Vacation Pay Expense Vacation Pay Payable Vacation pay accrued for the period.

25,500

Pension Expense Cash To record pension contribution (6% × $340,000).

20,400

25,500

20,400

PE 11-6B a.

Vacation Pay Expense Vacation Pay Payable Vacation pay accrued for the period.

62,000

Pension Expense Cash Unfunded Pension Liability To record pension cost and funding.

342,920

62,000

298,000 44,920

CHAPTER 11

Current Liabilities and Payroll

PE 11-7A a.

Jan.

Aug.

31 Product Warranty Expense Product Warranty Payable To record warranty expense for January (3% × $391,000). 15 Product Warranty Payable Supplies Wages Payable Replaced defective part under warranty.

11,730 11,730

165 110 55

PE 11-7B a.

July

Nov.

31 Product Warranty Expense Product Warranty Payable To record warranty expense for July (4.5% × $436,000). 11 Product Warranty Payable Cash Refunded product cost under warranty.

19,620 19,620

480 480

PE 11-8A a.

December 31, current year: Quick Ratio = Quick Assets ÷ Current Liabilities = ($2,070 + $4,780 + $2,160) ÷ $5,300 = 1.7 December 31, previous year: Quick Ratio = Quick Assets ÷ Current Liabilities = ($2,230 + $5,030 + $2,420) ÷ $4,400 = 2.2

The quick ratio of Basted Company has declined from 2.2 in the previous year to 1.7 in the current year. This decrease is the result of an increase in accounts payable compared to decreases in the three types of quick assets (cash, temporary investments, and accounts receivable).

CHAPTER 11

Current Liabilities and Payroll

PE 11-8B a.

December 31, current year: Quick Ratio = Quick Assets ÷ Current Liabilities = ($1,760 + $2,130 + $1,430) ÷ $2,800 = 1.9 December 31, previous year: Quick Ratio = Quick Assets ÷ Current Liabilities = ($1,680 + $2,090 + $1,330) ÷ $3,400 = 1.5

The quick ratio of Aloha Company has improved from 1.5 in the previous year to 1.9 in the current year. This increase is the result of an increase in the three types of quick assets (cash, temporary investments, and accounts receivable) as well as a decrease in the current liability, accounts payable.

CHAPTER 11

Current Liabilities and Payroll

EXERCISES Ex. 11-1 Current liabilities: Federal income taxes payable*………………………………………………… $ 336,000 1,593,750 Advances on magazine subscriptions**……………………………………… Total current liabilities………………………………………………………… $1,929,750 * $840,000 × 40% ** 25,000 × $85 × 9/12 = $1,593,750 The nine months of unfilled subscriptions are a current liability because Bon Nebo received payment prior to providing the magazines.

Ex. 11-2 a.

Merchandise Inventory Notes Payable

130,000

Notes Payable Interest Expense* Cash

130,000 975

Notes Receivable Sales

130,000

Cash Notes Receivable Interest Revenue*

130,975

130,000

130,975

130,000

130,000 975

* $130,000 × 6% × 45 ÷ 360

Ex. 11-3 a.

2. b.

Merchandise Inventory Interest Expense* Notes Payable

793,000 7,000

Notes Payable Cash

800,000

Notes Receivable Sales Interest Revenue*

800,000

Cash Notes Receivable

800,000

800,000 800,000 793,000 7,000 800,000

* $800,000 × 7% × 45 ÷ 360

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-4 a.

$360,000 × 5% × 60 ÷ 360 = $3,000 for each alternative.

(1) $360,000 simple-interest note: $360,000 proceeds (2) $360,000 discounted note: $360,000 – $3,000 interest = $357,000 proceeds

Alternative (1) is more favorable to the borrower. This can be verified by comparing the effective interest rates for each loan as follows: Situation (1): 5% effective interest rate ($3,000 × 360 ÷ 60) ÷ $360,000 = 5% Situation (2): 5.04% effective interest rate ($3,000 × 360 ÷ 60) ÷ $357,000 = 5.04% The effective interest rate is higher for the discounted note because the creditor lent only $357,000 in return for $3,000 interest over 60 days. In the undiscounted note, the creditor must lend $360,000 for 60 days to earn the same $3,000 interest.

Ex. 11-5 a.

Accounts Payable Notes Payable

210,000

Notes Payable Interest Expense* Cash

210,000 1,575

210,000

211,575

* $210,000 × 6% × 45 ÷ 360

Ex. 11-6 a.

Accounts Payable Interest Expense* Notes Payable

79,500 500

Notes Payable Cash

80,000

* $80,000 × 5% × 45 ÷ 360

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-7 a.

Accounts Payable Notes Payable

100,000

Notes Payable Interest Expense* Cash

100,000 875

Accounts Payable Notes Payable

100,000

Notes Payable Interest Expense** Cash

100,000 1,750

100,000

100,875

100,000

101,750

* $100,000 × 7% × 45 ÷ 360 ** $100,000 × 7% × 90 ÷ 360

Ex. 11-8 a.

$3,953 is the amount disclosed as the current portion of long-term debt.

The current liabilities decreased by $67 ($3,953 – $4,020).

$28,295 ($32,248 – $3,953)

Ex. 11-9 a.

Regular pay (40 hrs. × $22)…………………………………… Overtime pay (10 hrs. × $44)…………………………………… Gross pay…………………………………………………………

$ 880.00 440.00 $1,320.00

Gross pay………………………………………………………… Less: Social security tax (6% × $1,320)…………………… Medicare tax (1.5% × $1,320)………………………… Federal withholding…………………………………… Net pay……………………………………………………………

$1,320.00 $ 79.20 19.80 177.10

276.10 $1,043.90

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-10 Consultant

Computer Programmer

Administrator

Regular earnings…………………………… $5,000.00 Overtime earnings………………………… Gross pay…………………………………… $5,000.00

$3,200.00 720.00 $3,920.00

$2,000.00 1,000.00 $3,000.00

$ 300.001 75.00 4 1,190.70 $1,565.70 $3,434.30

$ 235.20 2 58.80 5 845.82 $1,139.82 $2,780.18

$ 180.00 45.00 6 551.58 $ 776.58 $2,223.42

Consultant

Computer Programmer

Administrator

Gross weekly pay…………………………

$5,000.00

$3,920.00

$3,000.00

Number of withholding allowances…… Multiplied by: Value of one allowance… Amount to be deducted…………………… Amount subject to withholding………… Initial withholding from wage bracket in Exhibit 2………………………………… Plus: Bracket percentage over bracket excess…………………………… Amount withheld……………………………

2 × $81.00 $ 162.00 $4,838.00

1 × $81.00 $ 81.00 $3,839.00

2 × $81.00 $ 162.00 $2,838.00

$ 896.70

$ 629.82

$ 276.54

294.00 7 $1,190.70

216.00 8 $ 845.82

275.049 $ 551.58

Less: Social security tax………………… Medicare tax……………………… Federal income tax withheld…… Net pay……………………………………… 1 2 3 4 5 6

6.0% × $5,000.00 = $300.00 6.0% × $3,920.00 = $235.20 6.0% × $3,000.00 = $180.00 1.5% × $5,000.00 = $75.00 1.5% × $3,920.00 = $58.80 1.5% × $3,000.00 = $45.00

Withholding supporting calculations:

7 8 9

35% × ($4,838 – $3,998) 32% × ($3,839 – $3,164) 24% × ($2,838 – $1,692)

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-11 a.

Summary: (1) $460,000; (3) $540,000; (8) $6,750; (12) $135,000 $338,850 201,150

Net amount paid……………………………………………… Total deductions……………………………………………… (3) Total earnings………………………………………………… Overtime……………………………………………………… (1) Regular…………………………………………………………

$540,000 80,000 $460,000

Total deductions……………………………………………… Social security tax…………………………………………… $ 32,400 Medicare tax…………………………………………………… 8,100 Income tax withheld………………………………………… 135,000 18,900 Medical insurance…………………………………………… (8) Union dues…………………………………………………… Total earnings………………………………………………… Factory wages………………………………………………… $285,000 Office salaries………………………………………………… 120,000 (12) Sales salaries………………………………………………… b.

Factory Wages Expense Sales Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Medical Insurance Payable Union Dues Payable Salaries Payable

285,000 135,000 120,000

Salaries Payable Cash

338,850

$201,150

194,400 $ 6,750 $540,000 405,000 $135,000

32,400 8,100 135,000 18,900 6,750 338,850

338,850

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-12 a.

Social security tax (6% × $560,000)…………………………………………… Medicare tax (1.5% × $560,000)………………………………………………… State unemployment tax (5.4% × $60,000)…………………………………… Federal unemployment (0.6% × $60,000)………………………………………

Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

$33,600 8,400 3,240 360 $45,600

45,600 33,600 8,400 3,240 360

Ex. 11-13 a.

Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Salaries Payable

1,380,000

Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable* Federal Unemployment Tax Payable**

118,200

82,800 20,700 276,000 1,000,500

82,800 20,700 13,230 1,470

* 5.4% × $245,000 ** 0.6% × $245,000

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-14 a.

Wages Expense Social Security Tax Payable* Medicare Tax Payable** Employees Federal Income Tax Payable Wages Payable

320,000 19,200 4,800 75,200 220,800

* 6.0% × $320,000 ** 1.5% × $320,000 b.

Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable* Federal Unemployment Tax Payable**

26,400 19,200 4,800 2,160 240

* 5.4% × $40,000 ** 0.6% × $40,000

Ex. 11-15 Big Howie’s Hot Dog Stand does have an internal control procedure that should detect the payroll error. Before funds are transferred from the regular bank account to the payroll account, the owner authorizes the total amount of the week’s payroll. The owner should catch the error, since the extra 60 hours will cause the weekly payroll to be substantially higher than usual. The owner should sign the paychecks, thereby restricting access to cash by employees who are responsible for record keeping.

Ex. 11-16 a.

Appropriate. All changes to the payroll system, including wage rate increases, should be authorized by someone outside the Payroll Department.

Inappropriate. Each employee should record his or her own time out for lunch. Under the current procedures, one employee could clock in several employees who are still out to lunch. The company would be paying employees for more time than they actually worked.

Inappropriate. Payroll should be informed when any employee is fired. A supervisor or another individual could continue to clock in and out for the terminated employee and collect the extra paycheck.

Inappropriate. Access to the check-signing machine should be restricted.

Appropriate. The use of a special payroll account assists in preventing fraud and makes it easier to reconcile the company’s bank accounts.

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-17 a.

Vacation Pay Expense Vacation Pay Payable Vacation pay accrued for January ($138,000 ÷ 12 ).

11,500 11,500

Vacation pay is reported as a current liability on the balance sheet. If employees are allowed to accumulate their vacation pay, then the estimated vacation pay that will not be taken in the current year will be reported as a long-term liability. When employees take vacations, the liability for vacation pay is decreased.

Ex. 11-18 a.

Dec.

Jan.

31 Pension Expense Unfunded Pension Liability To record quarterly pension cost.

365,000

15 Unfunded Pension Liability Cash To record pension funding.

365,000

In a defined contribution plan, the company invests contributions on behalf of the employee during the employee’s working years. Normally, the employee and employer contribute to the plan. The employee’s pension depends on the total contributions and the investment return on those contributions. In a defined benefit plan, the company pays the employee a fixed annual amount based on a formula. The employer is obligated to pay for (fund) the employee’s future pension benefits.

Ex. 11-19 The $4,391 million unfunded pension liability is the approximate amount of the pension obligation that exceeds the value of the net assets of the pension plan. Apparently, Procter & Gamble has underfunded its plan relative to the obligation that has accrued over time. This can occur when the company contributes less to the plan than the annual pension cost. The obligation grows yearly by the amount of the periodic pension cost. Thus, the $208 million periodic pension cost is a measure of the amount of pension earned by employees during the year. The annual pension cost is determined by making assumptions about employee life expectancies, employee turnover, expected compensation levels, and interest.

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-20 a.

Product Warranty Expense Product Warranty Payable To record warranty expense for January (2.5% × $398,000).

9,950

Product Warranty Payable Supplies Wages Payable Replaced defective parts under warranty.

660

9,950

410 250

Ex. 11-21 a.

The warranty liability represents estimated outstanding automobile warranty claims. Of these claims, $2,994 million is estimated to be due during Year 2, while the remainder ($5,338 million) is expected to be paid after Year 2. The distinction between short- and long-term liabilities is important to creditors in order to accurately evaluate the near-term cash demands on the business relative to the quick current assets and other longer-term demands. Product Warranty Expense Product Warranty Payable

2,258,000,000 2,258,000,000

$8,332 + X – $3,000 = $7,590 X = $7,590 – $8,332 + $3,000 X = $2,258 million c.

In order for a product warranty to be reported as a liability on the financial statements, it must qualify as a contingent liability. A contingent liability is reported as a liability on the balance sheet only if it is probable that the liability will occur and the amount of the liability is reasonably estimable.

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-22 a.

Damage Awards and Fines EPA Fines Payable Litigation Claims Payable

365,000 240,000 125,000

Note to Instructors: The “damage awards and fines” would be disclosed on the income statement under “Other expenses.” b.

The company experienced a hazardous materials spill at one of its plants during the previous period. This spill has resulted in a number of lawsuits to which the company is a party. The Environmental Protection Agency (EPA) has fined the company $240,000, which the company is contesting in court. Although the company does not admit fault, legal counsel believes that the fine payment is probable. In addition, an employee has sued the company. A $125,000 out-of-court settlement has been reached with the employee. The EPA fine and out-of-court settlement have been recognized as an expense for the period. There is one other outstanding lawsuit related to this incident. Counsel does not believe that the lawsuit has merit. Other lawsuits and unknown liabilities may arise from this incident.

Ex. 11-23 a.

Quick Ratio =

Quick Assets Current Liabilities

Previous year:

$500,000 + $200,000 $500,000

= 1.4

Current year:

$486,000 + $210,000 $580,000

= 1.2

The quick ratio decreased between the two balance sheet dates. The major reason is a significant increase in inventory that likely drove the increase in accounts payable. Cash also declined, possibly to purchase the inventory. As a result, quick assets actually declined, while the current liabilities increased. The quick ratio for the current year is not yet at an alarming level. However, the trend suggests that the firm’s current asset (working capital) management should be watched closely.

CHAPTER 11

Current Liabilities and Payroll

Ex. 11-24 a.

Quick Ratio =

Quick Assets Current Liabilities

Apple Inc. (in millions):

$25,913 + $40,388 + $48,995 $116,866

1.0

HP, Inc. (in millions):

$5,166 + $0 + $5,133 $25,131

0.4

It is clear that Apple Inc.’s short-term liquidity is stronger than HP’s. Apple’s quick ratio is 150% [(1.0 – 0.4) ÷ 0.4] higher. Apple has a much stronger relative short-term investment position than does HP. Apple’s cash, accounts receivable, and short-term investments are 88% of total current assets (and almost 100% of current liabilities), compared to HP’s 48% of total current assets (41% of current liabilities). A quick ratio of 1.0 for Apple suggests ample flexibility to make strategic investments with its excess cash, while a quick ratio of 0.4 for HP indicates a tight quick asset management policy.

CHAPTER 11

Current Liabilities and Payroll

PROBLEMS Prob. 11-1A 1.

Jan.

Feb.

Mar.

May

June

July

Dec.

10 Merchandise Inventory Accounts Payable—Beckham Co.

420,000

9 Accounts Payable—Beckham Co. Notes Payable

420,000

11 Notes Payable Interest Expense ($420,000 × 6% × 30 ÷ 360) Cash

420,000 2,100

1 Cash Notes Payable

240,000

1 Tools Interest Expense ($312,000 × 5% × 60 ÷ 360) Notes Payable

309,400 2,600

15 Notes Payable Interest Expense ($240,000 × 5% × 45 ÷ 360) Notes Payable Cash

240,000 1,500

30 Notes Payable Interest Expense ($240,000 × 7% × 45 ÷ 360) Cash

240,000 2,100

30 Notes Payable Cash

312,000

1 Office Equipment Notes Payable Cash

700,500

15 Litigation Loss Litigation Claims Payable

144,200

31 Notes Payable Interest Expense ($54,000 × 5% × 30 ÷ 360) Cash

54,000 225

420,000

422,100

240,000

312,000

240,000 1,500

242,100

312,000

540,000 160,500

144,200

54,225

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-1A (Concluded) 2.

Product Warranty Expense Product Warranty Payable

19,500

Interest Expense* Interest Payable

2,025

19,500

2,025

* ($540,000 – $54,000) × 5% × 30 ÷ 360, or $54,000 × 9 × 5% × 30 ÷ 360

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-2A 1. a.

Dec.

1 2

2. a.

30 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable3 4 Federal Unemployment Tax Payable

60,675 46,620 11,655 2,160 240

$40,000 × 5.4% $40,000 × 0.6%

30 Sales Salaries Expense Warehouse Salaries Expense Office Salaries Expense Employees Federal Income Tax Payable Social Security Tax Payable1 Medicare Tax Payable2 Retirement Savings Payable Group Insurance Payable Salaries Payable

402,000 210,000 165,000 135,975 46,620 11,655 17,094 13,986 551,670

$777,000 × 6% $777,000 × 1.5%

Jan.

135,975 46,620 11,655 17,094 13,986 551,670

$777,000 × 1.5%

Dec.

402,000 210,000 165,000

$777,000 × 6%

Dec.

30 Sales Salaries Expense Warehouse Salaries Expense Office Salaries Expense Employees Federal Income Tax Payable Social Security Tax Payable1 2 Medicare Tax Payable Retirement Savings Payable Group Insurance Payable Salaries Payable

5 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable3 Federal Unemployment Tax Payable4

104,895 46,620 11,655 41,958 4,662

$777,000 × 5.4% $777,000 × 0.6%

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-3A 1. Employee Arnett…………… Cruz……………… Edwards………… Harvin…………… Nicks…………… Shiancoe……… Ward……………

Gross Earnings* $ 8,250.00 57,600.00 24,000.00 6,000.00 110,000.00 116,000.00 7,830.00

Federal Income Tax Withheld $ 1,416.00 9,996.00 4,776.00 1,070.00 25,850.00 26,000.00 1,314.00

Social Security Tax Withheld $ 495.00 3,456.00 1,440.00 360.00 6,600.00 6,960.00 469.80 $19,780.80

Medicare Tax Withheld $ 123.75 864.00 360.00 90.00 1,650.00 1,740.00 117.45 $4,945.20

* The gross earnings are determined by multiplying the monthly earnings by the number of months of employment based on the date of hire.

2. a. Social security tax paid by employer…………………………………… $19,780.80 b. Medicare tax paid by employer……………………………………………

4,945.20

c. Earnings subject to unemployment compensation tax, $10,000 for all employees except Arnett, Harvin, and Ward. Thus, total earnings subject to SUTA and FUTA are $62,080 [(4 × $10,000) + $8,250 + $6,000 + $7,830]. State unemployment compensation tax: $62,080 × 5.4%……………

3,352.32

d. Federal unemployment compensation tax: $62,080 × 0.6%…………

372.48

e. Total payroll tax expense……………………………………………………$28,450.80

2,720.00 2,480.00 2,800.00 1,960.00 2,480.00 1,944.00

2,480.00 16,864.00

Regular

46 41 48 35 45

Total Hours

186.00 2,196.00

465.00

612.00 93.00 840.00

Overtime

EARNINGS

3,332.00 2,573.00 3,640.00 1,960.00 2,945.00 1,800.00 1,944.00 2,000.00 2,666.00 22,860.00

Total

19,060.00 3,800.00

199.92 154.38 218.40 117.60 176.70 108.00 116.64 120.00 159.96 1,371.60

Social Security Tax

11-22

1,371.60 342.91 4,836.37 885.00 15,424.12

49.98 38.60 54.60 29.40 44.18 27.00 29.16 30.00 39.99 342.91

Medicare Tax

December 9, 20Y8

750.20 537.68 832.64 366.04 641.84 342.45 382.56 398.24 584.72 4,836.37 130.00 120.00 130.00 125.00 50.00 885.00

100.00 110.00 120.00

DEDUCTIONS Federal Income Retirement Tax Savings

PAYROLL FOR WEEK ENDING

Current Liabilities and Payroll

1,100.10 840.66 1,225.64 513.04 992.72 597.45 658.36 673.24 834.67 7,435.88

Total

Net Pay

PAID

2,231.90 1,732.34 2,414.36 1,446.96 1,952.28 1,202.55 1,285.64 1,326.76 1,831.33 15,424.12

Sales Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Retirement Savings Deductions Payable Salaries Payable

Aaron Cobb Clemente DiMaggio Griffey, Jr. Mantle Robinson Williams Vaughn

Employee

Prob. 11-4A 1.

CHAPTER 11

901 902 903 904 905 906 907 908 909

Ck. No.

2,666.00 19,060.00

1,944.00

3,332.00 2,573.00 3,640.00 1,960.00 2,945.00

3,800.00

2,000.00

1,800.00

ACCOUNTS DEBITED Sales Office Salaries Salaries Expense Expense

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-5A 1.

Dec.

2 Retirement Savings Deductions Payable Cash

3,400

2 Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Cash

9,273 2,318 15,455

13 Operations Salaries Expense Officers Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Employees State Income Tax Payable Retirement Savings Deductions Payable Medical Insurance Payable Salaries Payable

43,200 27,200 6,800

13 Salaries Payable Cash

46,296

13 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

6,265

16 Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Cash

9,264 2,316 15,440

19 Medical Insurance Payable Cash

31,500

3,400

27,046

4,632 1,158 15,440 3,474 1,700 4,500 46,296

46,296

4,632 1,158 350 125

27,020

31,500

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-5A (Concluded) Dec.

2. a.

Dec.

27 Operations Salaries Expense Officers Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Employees State Income Tax Payable Retirement Savings Deductions Payable Salaries Payable

42,800 28,000 7,000

27 Salaries Payable Cash

51,360

27 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

6,135

27 Employees State Income Tax Payable Cash

20,884

31 Retirement Savings Deductions Payable Cash

3,400

31 Pension Expense Cash Unfunded Pension Liability

60,000

31 Operations Salaries Expense Officers Salaries Expense Office Salaries Expense Salaries Payable

8,560 5,600 1,400

31 Vacation Pay Expense Vacation Pay Payable

15,000

4,668 1,167 15,404 3,501 1,700 51,360

51,360

4,668 1,167 225 75

20,884

3,400

45,000 15,000

15,560

15,000

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-1B 1.

Apr.

May

July

Aug.

Sept.

Oct.

Nov.

Dec.

15 Cash Notes Payable

225,000

1 Equipment Interest Expense ($320,000 × 6% × 180 ÷ 360) Notes Payable

310,400 9,600

15 Notes Payable Interest Expense ($225,000 × 6% × 30 ÷ 360) Notes Payable Cash

225,000 1,125

14 Notes Payable Interest Expense ($225,000 × 8% × 60 ÷ 360) Cash

225,000 3,000

16 Merchandise Inventory Accounts Payable—Exige Co.

90,000

15 Accounts Payable—Exige Co. Notes Payable

90,000

28 Notes Payable Cash

320,000

30 Notes Payable Interest Expense ($90,000 × 6% × 45 ÷ 360) Cash

90,000 675

16 Store Equipment Notes Payable Cash

450,000

16 Notes Payable Interest Expense ($20,000 × 9% × 30 ÷ 360) Cash

20,000 150

28 Litigation Loss Litigation Claims Payable

87,500

225,000

320,000

225,000 1,125

228,000

90,000

320,000

90,675

400,000 50,000

20,150

87,500

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-1B (Concluded) 2.

Product Warranty Expense Product Warranty Payable

26,800

Interest Expense* Interest Payable

4,275

26,800

4,275

* $20,000 × 9% × 45 ÷ 360 × 19

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-2B 1. a.

Dec.

625,000 240,000 320,000 232,260 71,100 17,775 35,500 53,325 775,040

$1,185,000 × 6%

2 $1,185,000 × 1.5%

Dec.

30 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable3 4 Federal Unemployment Tax Payable

$30,000 × 5.4%

$30,000 × 0.6%

2. a.

Dec.

$1,185,000 × 6%

$1,185,000 × 1.5%

Jan.

4 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable3 4 Federal Unemployment Tax Payable

$1,185,000 × 5.4%

$1,185,000 × 0.6%

90,675 71,100 17,775 1,620 180

625,000 240,000 320,000 232,260 71,100 17,775 35,500 53,325 775,040

159,975 71,100 17,775 63,990 7,110

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-3B 1.

Gross Earnings* Employee Addai………………… $44,880 Kasay………………… 25,200 McGahee…………… 67,410 Moss………………… 55,200 Stewart……………… 4,500 Tolbert……………… 4,875 Wells………………… 84,000

Federal Income Tax Withheld $ 9,372 3,731 12,999 9,396 758 669 18,872

Social Security Tax Withheld $ 2,692.80 1,512.00 4,044.60 3,312.00 270.00 292.50 5,040.00 $17,163.90

Medicare Tax Withheld $ 673.20 378.00 1,011.15 828.00 67.50 73.13 1,260.00 $4,290.98

* The gross earnings are determined by multiplying the monthly earnings by the number of months of employment based on the date of hire.

Social security tax paid by employer………………………………… $17,163.90

Medicare tax paid by employer………………………………………

4,290.98

Earnings subject to unemployment compensation tax, $10,000 for all employees except Stewart and Tolbert. Thus, total earnings subject to SUTA and FUTA are $59,375 [(5 × $10,000) + $4,500 + $4,875]. State unemployment compensation tax: $59,375 × 5.4%…………

3,206.25

Federal unemployment compensation tax: $59,375 × 0.6%……

356.25

Total payroll tax expense……………………………………………… $25,017.38

2,000.00 1,872.00 2,320.00 1,665.00

2,080.00 2,000.00 2,160.00 14,097.00

36 45 37

46 48 43

Regular

Total Hours

468.00 600.00 243.00 2,646.00

435.00

900.00

Overtime

EARNINGS

2,900.00 4,000.00 1,872.00 2,755.00 1,665.00 3,200.00 2,548.00 2,600.00 2,403.00 23,943.00

Total

16,743.00 7,200.00

174.00 240.00 112.32 165.30 99.90 192.00 152.88 156.00 144.18 1,436.58

Social Security Tax

11-29

1,436.58 359.16 5,013.68 541.00 16,592.58

43.50 60.00 28.08 41.33 24.98 48.00 38.22 39.00 36.05 359.16

Medicare Tax

December 9, 20Y8

667.00 860.00 355.68 578.55 349.65 768.00 382.20 572.00 480.60 5,013.68 75.00 80.00 541.00

44.00 62.00 120.00

60.00 100.00

DEDUCTIONS Federal Income Retirement Tax Savings

PAYROLL FOR WEEK ENDING

Current Liabilities and Payroll

944.50 1,260.00 496.08 829.18 536.53 1,128.00 573.30 842.00 740.83 7,350.42

Total

Net Pay

PAID

1,955.50 2,740.00 1,375.92 1,925.82 1,128.47 2,072.00 1,974.70 1,758.00 1,662.17 16,592.58

Sales Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Retirement Savings Deductions Payable Salaries Payable

Carlton Grove Johnson Koufax Maddux Seaver Spahn Winn Young

Employee

Prob. 11-4B 1.

CHAPTER 11

328 329 330 331 332 333 334 335 336

Ck. No.

2,548.00 2,600.00 2,403.00 16,743.00

1,872.00 2,755.00 1,665.00

2,900.00

7,200.00

3,200.00

4,000.00

ACCOUNTS DEBITED Sales Office Salaries Salaries Expense Expense

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-5B 1.

Dec.

1 Medical Insurance Payable Cash

2,520

1 Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Cash

2,913 728 4,490

2 Retirement Savings Deductions Payable Cash

2,300

12 Sales Salaries Expense Officers Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Employees State Income Tax Payable Retirement Savings Deductions Payable Medical Insurance Payable Salaries Payable

14,500 7,100 2,600

12 Salaries Payable Cash

15,418

12 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

2,220

15 Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Cash

2,904 726 4,308

2,520

8,131

2,300

1,452 363 4,308 1,089 1,150 420 15,418

15,418

1,452 363 315 90

7,938

CHAPTER 11

Current Liabilities and Payroll

Prob. 11-5B (Concluded) Dec.

2. a.

Dec.

26 Sales Salaries Expense Officers Salaries Expense Office Salaries Expense Social Security Tax Payable Medicare Tax Payable Employees Federal Income Tax Payable Employees State Income Tax Payable Retirement Savings Deductions Payable Salaries Payable

14,250 7,250 2,750

26 Salaries Payable Cash

15,873

26 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable Federal Unemployment Tax Payable

2,009

30 Employees State Income Tax Payable Cash

6,258

30 Retirement Savings Deductions Payable Cash

2,300

31 Pension Expense Cash Unfunded Pension Liability

65,500

31 Sales Salaries Expense Officers Salaries Expense Office Salaries Expense Salaries Payable

4,275 2,175 825

31 Vacation Pay Expense Vacation Pay Payable

13,350

1,455 364 4,317 1,091 1,150 15,873

15,873

1,455 364 150 40

6,258

2,300

55,400 10,100

7,275

13,350

CHAPTER 11

Current Liabilities and Payroll

COMPREHENSIVE PROBLEM 3 1.

Jan.

Feb.

Apr.

May

June

Aug.

Sept.

3 Petty Cash Cash

4,500

26 Office Supplies Miscellaneous Selling Expense Miscellaneous Administrative Expense Cash

1,680 570 880

14 Merchandise Inventory Accounts Payable

31,300

13 Accounts Payable Cash

31,300

17 Cash Cash Short and Over Sales

21,200 40

2 Notes Receivable Accounts Receivable—Ryanair

180,000

1 Cash Notes Receivable Interest Revenue ($180,000 × 8% × 60 ÷ 360).

182,400

24 Cash Allowance for Doubtful Accounts Accounts Receivable—Finley

7,600 1,400

15 Accounts Receivable—Finley Allowance for Doubtful Accounts

1,400

Cash Accounts Receivable—Finley

1,400

4,500

3,130

31,300

21,240

180,000

180,000 2,400

9,000

1,400

CHAPTER 11

Current Liabilities and Payroll

Comp. Prob. 3 (Continued) Sept.

Oct.

Nov.

15 Land Interest Expense Notes Payable ($670,000 × 90 ÷ 360 × 9%).

654,925 15,075

17 Cash Notes Receivable Accumulated Depreciation—Office Equipment Loss on Sale of Office Equipment Office Equipment

135,000 100,000 64,000 21,000

30 Sales Salaries Expense Office Salaries Expense Employees Federal Income Tax Payable Social Security Tax Payable Medicare Tax Payable Salaries Payable

135,000 77,250

30 Payroll Tax Expense Social Security Tax Payable Medicare Tax Payable State Unemployment Tax Payable* Federal Unemployment Tax Payable**

16,219

670,000

320,000

39,266 12,735 3,184 157,065

12,735 3,184 270 30

* $5,000 × 5.4% ** $5,000 × 0.6%

Dec.

14 Notes Payable Cash

670,000

31 Pension Expense Cash Unfunded Pension Liability Pension cost of $190,400 funded at $139,700.

190,400

670,000

139,700 50,700

CHAPTER 11

Current Liabilities and Payroll

Comp. Prob. 3 (Continued) 2.

Kornett Company Bank Reconciliation December 31, 20Y8 Cash balance according to bank statement Add deposit in transit, not recorded by bank Deduct outstanding checks Adjusted balance Cash balance according to company’s records Deduct: Bank service charges Error in recording check Adjusted balance

Miscellaneous Expense Accounts Payable Cash

4. a.

$283,000 29,500 (68,540) $243,960 $245,410 $750 700

(1,450) $243,960

750 700 1,450

Bad Debt Expense Allowance for Doubtful Accounts ($16,000 + $2,000).

18,000

Cost of Merchandise Sold Merchandise Inventory

3,300

Insurance Expense Prepaid Insurance

22,820

Office Supplies Expense Office Supplies

3,920

18,000

3,300

22,820

3,920

CHAPTER 11

Current Liabilities and Payroll

Comp. Prob. 3 (Continued) e.

Depreciation Expense—Buildings Depreciation Expense—Office Equipment Depreciation Expense—Store Equipment Accumulated Depreciation—Buildings Accumulated Depreciation—Office Equipment Accumulated Depreciation—Store Equipment

36,000 44,000 5,000 36,000 44,000 5,000

Computations: Buildings ($900,000 × 4%)…………………… $36,000 Office Equipment [20% × ($246,000 – $26,000)]……………… 44,000 Store Equipment [1/2 × 10% × ($112,000 – $12,000)]………… 5,000 f.

Amortization Expense—Patents Patents ($48,000 ÷ 8 years).

6,000

Depletion Expense Accumulated Depletion [($546,000 ÷ 910,000 tons) × 50,000 tons].

30,000

Vacation Pay Expense Vacation Pay Payable

10,500

Product Warranty Expense Product Warranty Payable ($1,900,000 × 4%).

76,000

Interest Receivable Interest Revenue ($100,000 × 9% × 75 ÷ 360).

1,875

6,000

30,000

10,500

76,000

1,875

CHAPTER 11

Current Liabilities and Payroll

Comp. Prob. 3 (Continued) 5.

Kornett Company Balance Sheet December 31, 20Y8 Assets

Current assets: Petty cash Cash Notes receivable Accounts receivable Less allowance for doubtful accounts Merchandise inventory—at cost Interest receivable Prepaid insurance Office supplies Total current assets Property, plant, and equipment: Land Buildings Less accumulated depreciation Office equipment Less accumulated depreciation Store equipment Less accumulated depreciation Mineral rights Less accumulated depletion Total property, plant, and equipment Intangible assets: Patents Total assets

$ 4,500 243,960 100,000 $470,000 16,000

454,000 320,000 1,875 45,640 13,390 $1,183,365 $654,925

$900,000 36,000 $246,000 44,000 $112,000 5,000 $546,000 30,000

864,000 202,000 107,000 516,000 2,343,925 42,000 $3,569,290

CHAPTER 11

Current Liabilities and Payroll

Comp. Prob. 3 (Concluded) Liabilities

Current liabilities: Social security tax payable Medicare tax payable Employees federal income tax payable State unemployment tax payable Federal unemployment tax payable Salaries payable Accounts payable Interest payable Product warranty payable Vacation pay payable (current portion) Notes payable (current portion) Total current liabilities Long-term liabilities: Vacation pay payable Unfunded pension liability Notes payable Total long-term liabilities Total liabilities

$ 25,470 4,710 40,000 270 30 157,000 131,600 28,000 76,000 7,140 70,000 $ 540,220 $

3,360 50,700 630,000 684,060 $1,224,280

Owner’s Equity

J. Kornett, capital Total liabilities and owner’s equity

2,345,010 $3,569,290

CHAPTER 11

Current Liabilities and Payroll

CASES & PROJECTS CP 11-1 1.

Cannally and Kennedy is not obligated to pay a bonus to its employees under any circumstances. The decision to pay a bonus is discretionary. Companies frequently decide to discontinue or suspend annual bonuses for a variety of reasons, including deteriorating economic conditions, poor company or divisional performance, and alternative cash needs within the business. Even though the firm paid a two-week bonus for 10 straight years, it is not obligated to pay a bonus in Year 11. Thus, the firm is not behaving unethically for reducing the bonus.

Tonya Latirno, on the other hand, is behaving unethically. Believing that she is being cheated, Tonya is attempting to replace the bonus by working overtime that is not required. This behavior is fraudulent if the overtime is unnecessary, even though Tonya is present on the job during the overtime hours. Tonya is incorrect in thinking that her behavior is justified because she did not receive the full two-week bonus. In fact, this behavior would not be justified even if she had a legitimate claim against the company. If she had a claim or grievance against the firm, then it should be handled through proper human resource or legal means.

CP 11-2 1.

The so-called “underground economy” hides transactions from IRS scrutiny by conducting business with cash (not check or credit card, which leaves an audit trail). The intent in many such transactions is to evade income tax illegally. However, just because a transaction is in cash does not exempt it from taxation. Tina Song also appears to perform construction services on a cash basis to evade reporting income while paying employees with cash to avoid paying social security and Medicare payroll taxes. The IRS reports that nearly 86% of the persons convicted of evading employment taxes were sentenced to an average of 17 months in prison and ordered to make restitution to the government for the taxes evaded plus interest and penalties.

Marvin should respond that he would rather receive a payroll check as a normal employee does. As an employee, receiving cash rather than a payroll check subverts the U.S. tax system. That is, such cash payments do not include deductions for payroll taxes, as required by law. That is why, for example, cash tips must be formally reported to the IRS and subjected to payroll tax deductions by the employer. In addition, if Marvin followed Tina’s advice, Marvin not only would be avoiding payroll deductions but also would be underreporting income. This would subject Marvin to potential fines and possible criminal prosecution for underreporting income.

CHAPTER 11

Current Liabilities and Payroll

CP 11-3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1.

$6,040 million. The company’s current liabilities include accounts payable, notes payable, current portion of long-term debt, accrued liabilities, and income taxes payable.

The company’s current liabilities have increased by $566 million, from $5,474 million to $6,040 million.

Contingent liabilities are discussed in Note 15 and include leases, letters of credit, guarantees of indebtedness, and lawsuits.

$6 million (balance sheet)

CP 11-4 The purpose of this activity is to familiarize students with retrieving and using IRS forms. Students should be able to find the three required forms without much difficulty. Encourage students to retrieve the forms from the IRS website because this is a useful source for any IRS form or publication they might need. IRS website forms come in .pdf format, which means Adobe Acrobat Reader or similar software is necessary to open and print the files. PDF reader software is available as free plug-ins for most Internet browsers. However, some students may need to download a free full version in order to open the forms. This is also a useful exercise because many sophisticated forms on the web require a PDF reader. The W-2 form is the Annual Wage and Tax Statement transmitted by the employer to the IRS. The IRS uses this information to reconcile the taxpayer’s reported income and withholding taxes with the taxpayer’s tax return. Copies of the W-2 are provided for the employee’s own records and for submission with state and federal tax returns. Form 940 is the Employer’s Annual Federal Unemployment Tax Return. The FUTA tax is reported annually, while the 941 payroll taxes are reported quarterly to the IRS. Form 941 is the Employer’s Quarterly Federal Tax Return. This return is used to report federal withholding payroll taxes collected from employees and FICA taxes (both employee and employer portions) for the quarter.

CHAPTER 11

Current Liabilities and Payroll

CP 11-5 Memo To: From: Re:

U. D. Mach III A+ Student Financial Reporting of Series 3 Shock Absorber Lawsuit

The customer lawsuit filed against WBM Motorworks arising from cracks in Series 3 motorcycle front shock absorbers creates a potential liability for the company. The way in which this potential liability is reported on the financial statements depends on two factors: what the likelihood is of losing the lawsuit and whether the amount of the loss can be measured. If the likelihood that the lawsuit will be lost is probable and the amount of the loss can be reasonably measured, then both a loss and a liability should be recorded in the accounts. If the likelihood that a loss will occur is only reasonably possible, then the potential liability should be disclosed in the notes to the financial statements but should not be recorded in the accounts. Based on the information that exists at this time, it appears that a loss should be recorded on the income statement and a liability should be recorded on the balance sheet. The discovery of a manufacturing defect and the associated recall significantly increases the likelihood that the company will lose the lawsuit if it is taken to trial. While a direct link has not been made between the manufacturing defect and the shock absorber failure, the voluntary recall would make it difficult for a jury to disconnect the manufacturing defect from the product failure. As a result, I believe it is probable that the lawsuit will be lost if the case goes to trial. In addition, the amount of the loss is reasonably estimable. Similar lawsuits against other manufacturers have been settled for $2,000,000, which indicates that the amount can be estimated with reasonable accuracy. Since the potential loss is both probable and reasonably estimable, the company should record a loss on the income statement and a liability on the balance sheet. An alternative argument could be made that the uncertainty surrounding the connection between the manufacturing defect and the cracked shock absorber is too uncertain to classify the likelihood of losing the lawsuit as probable. Rather, the likelihood of losing the lawsuit would be classified as reasonably possible. In this case, the lawsuit would be disclosed in the notes to the financial statements, but no loss or liability would be reported on the financial statements. It should be noted that considerable judgment is necessary in distinguishing between classes of contingent liabilities. This is especially true when distinguishing between probable and reasonably possible contingent liabilities, as is the case in this scenario.

CHAPTER 11

Current Liabilities and Payroll

CP 11-6 Sumana’s interpretation of the pension issue is correct. The employee earns the pension during the working years. The pension is part of the employee’s compensation that is deferred until retirement. Thus, Felton should record an expense equal to the amount of pension benefit earned by the employee for the period. This gives rise to the rather complex issue of estimating the amount of the pension expense. Francie indicates that the complexity of this calculation makes determining the annual pension expense impossible. This is not so. There are a number of mathematical and statistical approaches (termed “actuarial” approaches) that can reliably estimate the amount of benefits earned by the workforce for a given year. As a side note, Francie’s perspective can be summarized as “pay as you go.” In her interpretation, there is no expense until a pension is paid to the retiree. Failing to account for pension promises when they are earned is not considered sound accounting.

CP 11-7 This activity does not require students to research the contingency notes for Philip Morris International Inc. (PMI). The contingency disclosure is extensive and complicated. Rather, the student should identify PMI’s main business and from this information determine the likely cause of the contingency disclosures. 1.

PMI is a holding company for a number of businesses. Thus, PMI’s primary business is in the manufacture and distribution of tobacco products.

The health concerns surrounding tobacco products give rise to numerous lawsuits and legal actions against PMI. The notes to the financial statements include an extensive section describing the scope and status of these actions. As of February 4, 2019, PMI had more than 90 cases pending, including 11 class actions and 16 health care recovery actions. PMI’s Form 10-K provides a section describing some of these actions.

CHAPTER 12 ACCOUNTING FOR PARTNERSHIPS AND LIMITED LIABILITY COMPANIES DISCUSSION QUESTIONS 1. The main advantages for: a. Proprietorship: Ease of formation and nontaxable entity. b. Partnership: Expanded owner expertise and capital, nontaxable entity, and moderate complexity of formation. c. Limited liability company: Limited liability to owners, expanded access to capital, nontaxable entity, and moderate complexity of formation. 2. The disadvantages of a partnership are that its life is limited, each partner has unlimited liability, one partner can bind the partnership to contracts, and raising large amounts of capital is more difficult for a partnership than a limited liability company. 3. Yes. A partnership may incur losses in excess of the total investment of all partners. The division of losses among the partners is made according to their agreement. In addition, because of the unlimited liability of each partner for partnership debts, a particular partner may lose a greater amount than his or her capital balance. 4. The partnership agreement (partnership) or operating agreement (LLC) establishes the incomesharing ratio among the partners (members), amounts to be invested, and admission and withdrawal of partners (members). In addition, for an LLC, the operating agreement specifies whether the LLC is owner-managed or manager-managed. 5. No. Maholic would have to bear his share of losses. In the absence of any agreement as to division of net income or net loss, his share would be one-third. In addition, because of the unlimited liability of each partner, Maholic may have to bear more than one-third of the losses if one partner is unable to absorb his or her share of the losses. 6. Yes. Partnership net income is divided according to the income-sharing ratio, regardless of the amount of the withdrawals by the partners. Therefore, it is very likely that the partners’ monthly withdrawals from a partnership will not equal their shares of net income exactly. 7. a. Debit the partner’s drawing account and credit Cash. b. No. Payments to partners and the division of net income are separate. The amount of one does not affect the amount of the other. c. Debit the revenue accounts, credit the expense accounts, and credit the partners’ capital accounts for their respective shares of the net income. 8. a. By purchase of an interest, the capital interest of the new partner is obtained from the old partner, and neither the total assets nor the total equity of the partnership is affected. b. By investment, both the total assets and the total equity of the partnership are increased.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

DISCUSSION QUESTIONS (Continued) 9. It is important to state all partnership assets in terms of current prices at the time of the admission of a new partner because failure to do so might result in participation by the new partner in gains or losses attributable to the period prior to admission to the partnership. To illustrate, assume that A and B share net income and net loss equally and operate a partnership that owns land recorded at and costing $20,000. C is admitted to the partnership, and the three partners share in income equally. The day after C is admitted to the partnership, the land is sold for $35,000, and because the land was not revalued, C receives a one-third distribution of the $15,000 gain. In this case, C participates in the gain attributable to the period prior to admission to the partnership. 10. A new partner who is expected to improve the fortunes (income) of the partnership through such things as reputation or skill might be given equity in excess of the amount invested to join the partnership.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

PRACTICE EXERCISES PE 12-1A 15,000 35,000 71,000

Cash Accounts Receivable Patent Accounts Payable Allowance for Doubtful Accounts Melissa Shallowford, Capital

11,000 2,000 108,000

PE 12-1B Cash Inventory Land Notes Payable Xi Lin, Capital

38,600 45,100 187,400 37,600 233,500

PE 12-2A Distributed to Gonzalez and Van Horne: Annual salary allowance…………………………… Interest allowance…………………………………… Total………………………………………………… Remaining income…………………………………… Net income………….….……………………………… 1 2 3 4

Gonzalez

Van Horne

Total

$25,000 6,300 1

0 9,450 2

$ 25,000 15,750

$31,300 49,500 3 $80,800

$ 9,450 24,750 4 $34,200

$ 40,750 74,250 $115,000

$126,000 × 5% $189,000 × 5% ($115,000 – $40,750) × 2/3 ($115,000 – $40,750) × 1/3

Gonzalez: $80,800 Van Horne: $34,200

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

PE 12-2B Distributed to Delew and Comatof: Annual salary……………………………………… Interest……………………………………………… Total……………………………………………… Deduct excess of allowances over income..................................................... Net income………………………………………… 1 2 3

Delew $18,000 1 2,160

Comatof $51,000 5,460 2

Total $69,000 7,620

$20,160

$56,460

$76,620

10,810 $ 9,350

10,810 3 $45,650

21,620 $55,000

$36,000 × 6% $91,000 × 6% ($55,000 – $76,620) × 50%

Delew: $9,350 Comatof: $45,650

PE 12-3A a.

Land Adam Freidman, Capital Ian Hamilton, Capital [($189,200 − $116,400) × 50%].

72,800

Ian Hamilton, Capital Greg Thomas, Capital [($52,400 + $36,400) × 50%].

44,400

36,400 36,400

44,400

PE 12-3B a.

Equipment Daniel Trenton, Capital [($77,400 – $57,300) × 2/3] Ann Marie Rainwater, Capital

20,100

Cash Marquis Westbury, Capital

119,100

13,400 6,700

119,100

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

PE 12-4A $ 310,000 490,000

Equity of Patel……………………………………………………………………… Killingsworth’s contribution……………………………………………………… Total equity after admitting Killingsworth……………………………………… Killingsworth’s equity interest…………………………………………………… Killingsworth’s equity after admission…………………………………………

$ 800,000 60 % × $ 480,000

Killingsworth’s contribution……………………………………………………… Killingsworth’s equity after admission………………………………………… Bonus paid to Patel…………………………………………………………………

$ 490,000 (480,000) $ 10,000

PE 12-4B Equity of Todd……………………………………………………………………… Zanetti’s contribution……………………………………………………………… Total equity after admitting Zanetti……………………………………………… Zanetti’s equity interest………………………………………………………...… Zanetti’s equity after admission………………………………………………… Zanetti’s contribution……………………………………………………………… Bonus paid to Zanetti………………………………………………………………

$170,600 45,500 $216,100 40 % × $ 86,440 (45,500) $ 40,940

PE 12-5A Cameron’s equity prior to liquidation………………………… Realization of asset sales……………………………………… $ 166,000 Book value of assets (liabilities + owner’s equity) ($9,000 + $44,000 + $92,000)………………………………… (145,000) Gain on liquidation………………………………………………… $ 21,000 Cameron’s share of gain (50% × $21,000)…………………… Cameron’s cash distribution……………………………………

$44,000

10,500 $54,500

PE 12-5B Kim’s equity prior to liquidation………………………………… Realization of asset sales……………………………………… $ 520,000 Book value of assets (liabilities + owner’s equity) ($106,000 + $304,000 + $190,000)…………………………… (600,000) Loss on liquidation……………………………………………… $ (80,000) Kim’s share of loss [50% × ($80,000)]………………………… Kim’s cash distribution……………………………………………

$304,000

(40,000) $264,000

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

PE 12-6A a. Warren’s equity prior to liquidation…………………………… Realization of asset sales………………………………………… Book value of assets (sum of capital accounts)*…………… Loss on liquidation………………………………………………… Warren’s share of loss [50% × ($146,000)]…………………… Warren’s deficiency………………………………………………

$ 67,000 $ 49,000 (195,000) $(146,000) (73,000) $ (6,000)

* $128,000 + $67,000 b. $49,000 ($128,000 − $73,000 share of loss − $6,000 Warren’s deficiency; also equals the amount realized from asset sales) PE 12-6B a. Jacobs’s equity prior to liquidation…………………………… Realization of asset sales………………………………………… Book value of assets (sum of capital accounts)*…………… Loss on liquidation………………………………………………… Jacobs’s share of loss [50% × ($692,000)]…………………… Jacobs’s deficiency………………………………………………

$ 320,000 $ 52,000 (744,000) $(692,000) (346,000) $ (26,000)

* $320,000 + $424,000 b. $52,000 ($424,000 – $346,000 share of loss – $26,000 Jacobs’s deficiency; also equals the amount realized from asset sales) PE 12-7A a. 20Y4:

$9,338,000 = $203,000 per employee 46 employees

20Y5:

$11,825,000 = $215,000 per employee 55 employees

b. Schwartz and Beer, CPAs grew revenues by $2,487,000 ($11,825,000 – $9,338,000), or 26.6% ($2,487,000 ÷ $9,338,000). The number of employees expanded by 9, or 19.6% (9 ÷ 46). The growth in revenue was more than the growth in the number of employees; thus, the revenue per employee improved between the two years. The firm is more efficient in generating revenues from its staff resources between the two years.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

PE 12-7B a. 20Y1:

$4,400,000 = $110,000 per employee 40 employees

20Y2:

$3,894,000 = $118,000 per employee 33 employees

b. Makeman Architects reduced revenues by $506,000 ($4,400,000 – $3,894,000), or 11.5% ($506,000 ÷ $4,400,000). The number of employees declined by 7, or 17.5% (7 ÷ 40). The decline in revenue was less than the decline in the number of employees; thus, the revenue per employee improved between the two years. The firm is more efficient in generating revenues from its staff resources between the two years.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

EXERCISES Ex. 12-1 Cash Accounts Receivable* Merchandise Inventory Equipment Allowance for Doubtful Accounts Vanessa Kaiser, Capital

25,800 181,600 131,400 104,900 5,700 438,000

* $187,600 – $6,000

Ex. 12-2 Cash Accounts Receivable Land Equipment Allowance for Doubtful Accounts Accounts Payable Notes Payable Hannah Freeman, Capital

65,000 125,000 320,000 34,800 9,500 24,800 76,000 434,500

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-3 a. ……………………………………………………………………… b. ……………………………………………………………………… c. ……………………………………………………………………… d. ……………………………………………………………………… e. ………………………………………………………………………

Dawson

McDonald

$190,000 285,000 158,440 184,000 188,600

$190,000 95,000 221,560 196,000 191,400

Details: a. Net income (1:1)………………………………

Dawson $190,000

McDonald $190,000

Total $380,000

b. Net income (3:1)………………………………

$285,000

$ 95,000

$380,000

c. Interest allowance…………………………… Remaining income (2:3)……………………… Net income………………………………………

$ 13,8001 144,640 $158,440

4,600 2 216,960 $221,560

$ 18,400 361,600 $380,000

d. Salary allowance……………………………… Remaining income (1:1)……………………… Net income………………………………………

$ 47,000 137,000 $184,000

$ 59,000 137,000 $196,000

$106,000 274,000 $380,000

e. Interest allowance…………………………… Salary allowance……………………………… Remaining income (1:1)……………………… Net income………………………………………

$ 13,800 47,000 127,800 $188,600

4,600 2 59,000 127,800 $191,400

$ 18,400 106,000 255,600 $380,000

1 2

$276,000 × 5% $92,000 × 5%

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-4 a. ……………………………………………………………………… b. ……………………………………………………………………… c. ……………………………………………………………………… d. ……………………………………………………………………… e. ………………………………………………………………………

Dawson

McDonald

$ 68,000 102,000 60,840 62,000 66,600

$68,000 34,000 75,160 74,000 69,400

Details: a. Net income (1:1)………………………………

Dawson $68,000

McDonald $68,000

Total $136,000

b. Net income (3:1)………………………………

$102,000

$34,000

$136,000

c. Interest allowance…………………………… Remaining income (2:3)……………………… Net income………………………………………

$13,8001 47,040 $60,840

$ 4,600 2 70,560 $75,160

$ 18,400 117,600 $136,000

d. Salary allowance……………………………… Remaining income (1:1)……………………… Net income………………………………………

$47,000 15,000 $62,000

$59,000 15,000 $74,000

$106,000 30,000 $136,000

$13,800 47,000 5,800 $66,600

$ 4,600 2 59,000 5,800 $69,400

$ 18,400 106,000 11,600 $136,000

Lynn Carpenter

Matthew Fredrick

Total

Salary allowances………………………………… Remainder (net loss, $33,000, plus $99,000 salary allowances) divided equally…………

$ 58,000

$ 41,000

$ 99,000

(66,000)

(132,000)

Net loss……………………………………………

$ (8,000)

$(25,000)

$ (33,000)

1 2

$276,000 × 5% $92,000 × 5%

Ex. 12-5

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-6 a. The partners can divide net income in any ratio they wish. However, in the absence of an agreement, net income is divided equally between the partners. Therefore, Wanda’s conclusion was correct but for the wrong reasons. In addition, note that the monthly drawings have no impact on the division of income. These drawings are not the same as a salary allowance, which is part of a formal incomesharing agreement. b. An income-sharing agreement could be designed to credit each partner’s capital account for her respective share of income. For example, an income-sharing agreement could be designed to credit Wanda for interest on her capital contribution, whereas a salary allowance could be designed to credit Ava for the greater effort she puts into the partnership. After deducting for these items, the remaining income could be divided equally. Ex. 12-7 a. Net income: $148,000 Farley Salary allowance………………… Remaining income………………

$40,000 46,800 Net income………………………… $86,800

Clark

Total

$30,000 31,200 $61,200

$ 70,000 78,000 $148,000

Farley’s remaining income: ($148,000 – $70,000) × 3/5 Clark’s remaining income: ($148,000 – $70,000) × 2/5 b. (1)

(2)

Revenues Expenses Martin Farley, Member Equity Ashley Clark, Member Equity

668,000

Martin Farley, Member Equity Ashley Clark, Member Equity Martin Farley, Drawing Ashley Clark, Drawing

40,000 30,000

520,000 86,800 61,200

40,000 30,000

Note: The reduction in members’ equity from withdrawals would be disclosed on the statement of members’ equity. c. If the net income of the LLC was less than the sum of the salary allowances, both members would still be credited with their salary allowances. From this amount, each partner would deduct his or her share of the excess of the total salary allowance over the net income. Thus, the difference between the net income and total salary allowances would be allocated to each partner as a deduction, according to the income-sharing ratio.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-8 a. WACS Partners

Elyse O’Reilly

Encounter Newspaper, LLC

Salary allowance……………… Interest allowance…………… $ 27,500 1 Remaining income (4:3:3)…… 145,200

$ 76,000 5,500 2 108,900

$ 22,000 108,900

Net income……………………… $172,700

$190,400

$130,900

Total $ 76,000 55,000 363,000 $494,000

10% × $275,000 10% × $55,000 3 10% × $220,000 2

20Y2 Dec.

31 Revenues Expenses WACS Partners, Member Equity Elyse O’Reilly, Member Equity Encounter Newspaper, LLC, Member Equity

1,730,000

31 WACS Partners, Member Equity Elyse O’Reilly, Member Equity* Encounter Newspaper, LLC, Member Equity WACS Partners, Drawing Elyse O’Reilly, Drawing Encounter Newspaper, LLC, Drawing

27,500 81,500

1,236,000 172,700 190,400 130,900

22,000 27,500 81,500 22,000

* $76,000 + $5,500

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-8 (Concluded) c.

Exploit Media, LLC Statement of Members’ Equity For the Year Ended December 31, 20Y2

Balances, January 1, 20Y2 Capital additions Net income for the year Member withdrawals Balances, December 31, 20Y2

WACS Partners

Elyse O’Reilly

Encounter Newspaper, LLC

$275,000 69,000 172,700 (27,500)

$ 55,000

$220,000

190,400 (81,500)

130,900 (22,000)

$ 550,000 69,000 494,000 (131,000)

$489,200

$163,900

$328,900

$ 982,000

Total LLC Capital

d. An income-sharing agreement provides flexibility and fairness. Without an incomesharing agreement, each member would be credited with an equal proportion of the total earnings, or one-third each. However, the members provide different capital and effort to the LLC. WACS is a large contributor of capital (funds), while Elyse O’Reilly is providing ongoing effort and expertise. These separate contributions should be acknowledged in the income-sharing formula. Thus, the agreement credits member equity for both interest on capital and a salary allowance for O’Reilly. Any remaining income is credited to capital according to a negotiated allocation, which in this case is not an equal amount to each member.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-9 a. and b. Myles Etter, Capital Lonnie Davis, Capital $210,000 × 1/3.

70,000 70,000

Note: The sale to Davis is not a transaction of the partnership, so the sales price is not considered in this journal entry.

Ex. 12-10 a. (1)

(2)

Trent Henry, Capital (1/5 × $160,000) Tim Chou, Capital (1/4 × $100,000) LeAnne Gilbert, Capital

32,000 25,000

Cash Becky Clarke, Capital

90,000

57,000

90,000

b. Trent Henry, Capital ($160,000 – $32,000)……………… $128,000 Tim Chou, Capital ($100,000 – $25,000)………………… 75,000 LeAnne Gilbert, Capital…………………………………… 57,000 Becky Clarke, Capital……………………………………… 90,000 The purchase price paid for each interest by Gilbert is not a partnership transaction, but a transaction between partners. Thus, those amounts are not shown in the partnership accounts.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-11 a.

Cash Grayson Jackson, Capital Harry Barge, Capital Lewan Gorman, Capital

43,300 3,600 3,600 50,500

b. Grayson Jackson, Capital ($64,900 – $3,600)……………… Harry Barge, Capital ($86,500 – $3,600)……………………… Lewan Gorman, Capital…………………………………………

$61,300 82,900 50,500

c. Tangible assets should be adjusted to current market prices so that the new partner does not share in any gains or losses from changes in market prices prior to being admitted. For example, if the market price of land doubled prior to admitting a new partner, the existing partners should realize the increase in the value of the land in their capital accounts prior to the new partner’s admission. Otherwise, the new partner would share in the increase in the market value of the land.

Ex. 12-12 a. Bonus received by Solano: Cody Jenkins, capital…………………………………………… $ 78,000 Lacey Tanner, capital…………………………………………… 46,000 32,000 Solano’s contribution…………………………………………… Total partners’ capital after admitting Solano……………… $156,000 30 % Solano’s equity interest after admission…………………… × Valeria Solano, capital…………………………………………… $ 46,800 (32,000) Solano’s contribution…………………………………………… $ 14,800 Bonus paid to Solano…………………………………………… b.

Cash Cody Jenkins, Capital Lacey Tanner, Capital Valeria Solano, Capital

32,000 7,400 7,400 46,800

c. Apparently, Jenkins and Tanner value the expertise offered by Solano. Solano is able to use the computer to design and render landscape designs. This type of skill is likely to be very useful for both selling and implementing landscape ideas. Her skills can help the partnership sell ideas to clients by providing computer renderings of the designs. In this way, a client can see the design on the computer before agreeing to the work. In addition, the computer-aided landscapes provide materials plans, labor estimates, and other cost estimates for a particular design. Thus, the partners may be better able to control their costs by using Solano’s skills. Overall, they value her skills sufficiently to provide a partner bonus upon her admittance to the partnership.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-13 a.

Medical Equipment Abrams, Member Equity* Lipscomb, Member Equity**

40,000 16,000 24,000

* $40,000 × 2/5 = $16,000 ** $40,000 × 3/5 = $24,000 b.

(1)

Cash Abrams, Member Equity* Lipscomb, Member Equity** Lin, Member Equity

228,000 15,600 23,400 189,000

* $39,000 × 2/5 = $15,600 ** $39,000 × 3/5 = $23,400 Supporting calculations for the bonus: Abrams, member equity ($154,000 + $16,000)……… $ 170,000 Lipscomb, member equity ($208,000 + $24,000)…… 232,000 Contribution by Lin……………………………………… 228,000 Total equity after admitting Lin……………………… $ 630,000 30 % Lin’s equity interest after admission………………… × $ 189,000 Lin, member equity……………………………………… Contribution by Lin……………………………………… $ 228,000 Lin’s equity interest after admission………………… (189,000) Bonus paid to Abrams and Lipscomb……………… $ 39,000 (2)

Cash Abrams, Member Equity* Lipscomb, Member Equity** Lin, Member Equity

124,000 3,000 4,500 131,500

* $7,500 × 2/5 = $3,000 ** $7,500 × 3/5 = $4,500 Supporting calculations for the bonus: Abrams, member equity……………………………… $ 170,000 Lipscomb, member equity…………………………… 232,000 Contribution by Lin……………………………………… 124,000 Total equity after admitting Lin……………………… $ 526,000 25 % Lin’s equity interest after admission………………… × Lin, member equity……………………………………… $ 131,500 Contribution by Lin……………………………………… (124,000) Bonus paid to Lin……………………………………… $ 7,500

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-14 a.

L. Bowers, Capital V. Lipscomb, Capital Equipment

b. (1)

4,000 4,000 8,000

Cash L. Bowers, Capital* V. Lipscomb, Capital M. Ortiz, Capital

20,000 4,800 4,800 29,600

* $9,600 × 1/2 Supporting calculations for the bonus: L. Bowers, capital ($96,000 – $4,000)…………………… V. Lipscomb, capital ($40,000 – $4,000)……………… Contribution by Ortiz……………………………………… Total equity after admitting Ortiz……………………… Ortiz’s equity interest after admission………………… M. Ortiz, capital…………………………………………… Contribution by Ortiz……………………………………… Bonus paid to Ortiz………………………………………… (2)

Cash L. Bowers, Capital* V. Lipscomb, Capital M. Ortiz, Capital

$ 92,000 36,000 20,000 $148,000 20 % × $ 29,600 (20,000) $ 9,600 60,000 1,800 1,800 56,400

* $3,600 × 1/2 Supporting calculations for the bonus: L. Bowers, capital………………………………………… V. Lipscomb, capital……………………………………… Contribution by Ortiz……………………………………… Total equity after admitting Otiz………………………… Ortiz’s equity interest after admission………………… M. Ortiz, capital……………………………………………

$ 92,000 36,000 60,000 $188,000 30 % × $ 56,400

Contribution by Ortiz……………………………………… M. Ortiz, capital…………………………………………… Bonus paid to Bowers and Lipscomb…………………

$ 60,000 (56,400) $ 3,600

The bonus to Bowers and Lipscomb is credited equally between Bowers’ and Lipscomb’s capital accounts.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-15 Angel Investor Associates Statement of Partnership Equity For the Year Ended December 31, 20Y5

Balances, January 1, 20Y5 Admission of Randy Campbell Salary allowance Remaining income Partner withdrawals Balances, December 31, 20Y5

Dennis Overton, Capital

Ben Testerman, Capital

Randy Campbell, Capital

$180,000 — 40,000 52,800 (46,400)1

$120,000 —

$ 75,000

$226,400

$137,600

35,200 (17,600) 2

Total Partnership Capital

22,000 (11,000)3

$300,000 75,000 40,000 110,000 (75,000)

$ 86,000

$450,000

1 ($52,800 + $40,000) ÷ 2 2 $35,200 ÷ 2 3 $22,000 ÷ 2

Admission of Randy Campbell

Equity of initial partners prior to admission……………………… Contribution by Campbell…………………………………………… Total……………………………………………………………………… Campbell’s equity interest after admission……………………… Campbell’s equity after admission………………………………… Contribution by Campbell…………………………………………… Bonus…………………………………………………………………… Net income distribution

$300,000 75,000 $375,000 20% × $ 75,000 (75,000) $ 0

The income-sharing ratio is equal to the proportion of the capital balances after admitting Campbell according to the partnership agreement: Dennis Overton:

$180,000 $375,000

= 48%

Ben Testerman:

$120,000 $375,000

= 32%

Randy Campbell:

$75,000 $375,000

= 20%

These ratios can be multiplied by the $110,000 remaining income after the salary allowance to Overton ($150,000 – $40,000). These amounts are credited to the respective partner capital accounts. For example, Dennis Overton: $52,800 = $110,000 × 48%.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-15 (Concluded) Withdrawals: Half of the remaining income is distributed to the three partners. Overton need not take the salary allowance as a withdrawal but may allow it to accumulate in the member equity account. He is taking half of the allowance as a withdrawal.

Ex. 12-16 a.

Merchandise Inventory Allowance for Doubtful Accounts Lane Stevens, Capital* Cherrie Ford, Capital** LaMarcus Rollins, Capital**

22,300 1,300 9,000 6,000 6,000

* ($22,300 – $1,300) × 3/7 ** ($22,300 – $1,300) × 2/7 b.

Lane Stevens, Capital* Cash Notes Payable

159,000 59,000 100,000

* $150,000 + $9,000

Ex. 12-17 a. The income-sharing ratio is determined by dividing the net income for each member by the total net income. Thus, in 20Y3, the income-sharing ratio is as follows: Idaho Properties, LLC:

$57,000 $190,000

= 30%

Silver Streams, LLC:

$133,000 $190,000

= 70%

Or a 3:7 ratio

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-17 (Concluded) b. Following the same procedure as in a.: Idaho Properties, LLC:

$62,500 $250,000

= 25%

Silver Streams, LLC:

$137,500 $250,000

= 55%

Thomas Dunn:

$50,000 $250,000

= 20%

c. Thomas Dunn provided a $230,000 cash contribution to the business. The amount credited to his member equity account is this amount less a $10,000 bonus paid to the other two members, or $220,000. d. The positive entries to Idaho Properties and Silver Streams are the result of a bonus paid by Thomas Dunn. e. Thomas Dunn acquired a 22% interest in the business on January 1, 20Y4, computed as follows: Thomas Dunn, member equity………………………… Idaho Properties, LLC, member equity……………… Silver Streams, LLC, member equity………………… Total…………………………………………………………

$ 220,000 333,000 447,000 $1,000,000

Thomas’s ownership interest after admission ($220,000 ÷ $1,000,000)…………………………………

22%

f. Withdrawals need not be the same as the income credited to the members’ equity accounts. Withdrawals will be less than the amounts credited when the members want to retain capital in the business to support business growth or otherwise strengthen the business.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-18 a. Cash balance………………………………………………… $ 35,000 Sum of capital accounts…………………………………… (46,000) Loss on realization………………………………………… $ 11,000 Hewitt Capital balances before realization……………………… $ 28,000 (5,500) b. Division of loss on realization*…………………………… Balances……………………………………………………… $ 22,500 (22,500) c. Cash distributed to partners……………………………… 0 Final balances………………………………………………… $

Patel $ 18,000 (5,500) $ 12,500 (12,500) $ 0

* ($11,000) ÷ 2

Ex. 12-19 Oliver Capital balances before realization………… $ 28,000 Division of gain on realization 2,000 [($67,000 – $63,000) ÷ 2]…………………… Capital balances after realization…………… $ 30,000 Cash distributed to partners………………… (30,000) 0 Final balances…………………………………… $

Ansari

Total

$ 35,000

$63,000

2,000 $ 37,000 (37,000) $ 0

Ex. 12-20 a. Deficiency b. $97,500 ($73,500 + $41,000 – $17,000) c.

Cash Fowler, Capital

17,000 17,000

Support for entry:

Lewis

Zapata

Fowler

Capital balances after realization………… $73,500 Receipt of partner deficiency…………… Capital balances after eliminating deficiency…………………………………… $73,500

$41,000

$(17,000) Dr. 17,000

$41,000

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-21 a. $975 [$1,500 – ($225 + $300)] b. Cash should be distributed as indicated in the following tabulation: Capital invested…………… Net income…………………… Capital balances and cash distribution…………

Bray

Lincoln

Mapes

Total

$225 325

$300 325

$ — 325

$ 525 975 *

$550

$625

$325

$1,500

* $1,500 – $225 – $300 c. Mapes has a capital deficiency of $75, as indicated in the following tabulation: Capital invested…………… Net loss……………………… Capital balances……………

Bray

Lincoln

$225 (75) $150

$300 (75) $225

Mapes $ — (75) $(75) Dr.

Total $ 525 (225) * $ 300

* $300 – $525

Ex. 12-22 Nettles Capital balances after realization…………… $(15,000) Distribution of partner deficiency…………… 15,000 Capital balances after deficiency 0 distribution…………………………………… $

King

Tanaka

$ 46,000 (10,000)*

$71,000 (5,000) **

$ 36,000

$66,000

* $15,000 × 2/3 ** $15,000 × 1/3

$ 72,500 116,400 $ 188,900 (41,300) $ 147,600 (147,600) $ 0

Cash

12-23

$ 124,200 (124,200) $ 0 — $ 0 — $ 0

Noncash Assets =

$ 41,300 — $ 41,300 (41,300) $ 0 — $ 0

Liabilities

Silver, Carillo, and Tingley Statement of Partnership Liquidation For Period July 1–29

$ 77,700 (3,900) $ 73,800 — $ 73,800 (73,800) $ 0

Silver (3/6)

Accounting for Partnerships and Limited Liability Companies

$ 51,800 (2,600) $ 49,200 — $ 49,200 (49,200) $ 0

Carillo (2/6)

Capital

Balances before realization Sale of assets and division of loss Balances after realization Payment of liabilities Balances after payment of liabilities Cash distributed to partners Final balances

Ex. 12-23

CHAPTER 12

$ 25,900 (1,300) $ 24,600 — $ 24,600 (24,600) $ 0

Tingley (1/6)

Lester, Member Equity Torres, Member Equity Hearst, Member Equity Cash

Balances before realization Sale of assets and division of gain Balances after realization Payment of liabilities Balances after payment of liabilities Cash distributed to members Final balances $ 26,000 158,000 $ 184,000 (35,000) $ 149,000 (149,000) $ 0

Cash

53,800 65,800 29,400

$ 146,000 (146,000) $ 0 — $ 0 — $ 0

Noncash Assets

149,000

$ 35,000 — $ 35,000 (35,000) $ 0 — $ 0

= Liabilities +

Arcadia Sales, LLC Statement of LLC Liquidation For Period August 1–31

$ 49,000 4,800 $ 53,800 — $ 53,800 (53,800) $ 0

Lester (2/5)

$ 61,000 4,800 $ 65,800 — $ 65,800 (65,800) $ 0

Member Equity Torres + + (2/5)

Accounting for Partnerships and Limited Liability Companies

12-24

c. The income- and loss-sharing ratio is only used to distribute the gain or loss on the realization of asset sales. It is not used for the final distribution. The final distribution is based upon the credit balances in the member equity accounts after all gains and losses on realization have been divided and any partner deficiencies have been paid or allocated.

Ex. 12-24

CHAPTER 12

$ 27,000 2,400 $ 29,400 — $ 29,400 (29,400) $ 0

Hearst (1/5)

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-25 a. (1)

(2)

Revenues Expenses Lorraine Grecco, Capital Carrie Rosenfeld, Capital

654,000

Lorraine Grecco, Capital Carrie Rosenfeld, Capital Lorraine Grecco, Drawing Carrie Rosenfeld, Drawing

43,000 53,000

570,000 42,000 42,000

43,000 53,000

b. Grecco and Rosenfeld Statement of Partnership Equity For the Year Ended December 31, 20Y4

Balances, January 1, 20Y4 Additional investment during the year Net income for the year Withdrawals during the year Balances, December 31, 20Y4

Lorraine Grecco

Carrie Rosenfeld

Total

$ 64,000 11,000 42,000 (43,000) $ 74,000

$ 99,000 — 42,000 (53,000) $ 88,000

$163,000 11,000 84,000 (96,000) $162,000

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Ex. 12-26 a. Revenue per professional staff, current year: Revenue per professional staff, previous year:

$19,900,000,000 79,347

= $250,797

$18,600,000,000 71,212

= $261,192

b. The revenues increased between the two years from $18.6 billion to $19.9 billion, or 7.0% [($19.9 – $18.6) ÷ $18.6]. However, the number of employees has increased even more, from 71,212 to 79,347, or 11.4% [(79,347 – 71,212) ÷ 71,212]. As a result, the revenue per professional staff employee has declined by approximately $10,395, from $261,192 to $250,797. Thus, there is a slight decline in efficiency in the current year.

Ex. 12-27 a. Revenue per employee, 20Y9:

$27,270,000 135

= $202,000

Revenue per employee, 20Y8:

$31,140,000 180

= $173,000

b. Revenues decreased between the two years; however, the number of employees has decreased at a faster rate. Thus, the revenue per employee increased from $173,000 in 20Y8 to $202,000 in 20Y9. This indicates that the efficiency of the firm has increased in the two years even though revenues declined. This is likely the result of the termination of the two contracts. That is, the large decrease in the employment base is the likely result of the reduction in business. Thus, the business was able to reduce the workforce faster than the revenue base. This suggests that the contracts were not very efficient from a revenue-per-employee perspective and thus were likely good candidates for termination.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

PROBLEMS Prob. 12-1A 1. Mar. 1 Cash Merchandise Inventory Eric Keene, Capital

23,400 62,600 86,000

1 Cash Accounts Receivable Equipment Allowance for Doubtful Accounts Accounts Payable Notes Payable Renee Wallace, Capital

39,000 19,500 55,400 1,400 15,000 37,500 60,000

Keene and Wallace Balance Sheet March 1, 20Y8

Assets Current assets: Cash Accounts receivable Less allowance for doubtful accounts Merchandise inventory Total current assets Property, plant, and equipment: Equipment Total assets Liabilities Current liabilities: Accounts payable Notes payable Total liabilities Partners’ Equity Eric Keene, capital Renee Wallace, capital Total partners’ equity Total liabilities and partners’ equity

$62,400* $19,500 1,400

18,100 62,600 $143,100 55,400 $198,500

$15,000 37,500 $ 52,500 $86,000 60,000 146,000 $198,500

* $23,400 + $39,000

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-1A (Concluded) 3. Feb.

28 Revenues Expenses Eric Keene, Capital* Renee Wallace, Capital*

300,000

28 Eric Keene, Capital Renee Wallace, Capital Eric Keene, Drawing Renee Wallace, Drawing

19,000 24,000

230,000 33,800 36,200

19,000 24,000

* Computations: Keene Interest allowance…………………………… Salary allowance……………………………… Remaining income (1:1)……………………… Net income……………………………………… 1

Wallace 1

$ 8,600 19,000 6,200 3 $33,800

6,000 2

24,000 6,200 3 $36,200

Total $14,600 43,000 12,400 $70,000

10% × $86,000

2 10% × $60,000 3 ($70,000 – $14,600 – $43,000) × 1/2

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-2A (1) $276,000 Black Shannon

Plan

a. ……………………………………… $138,000 b. ……………………………………… 207,000 c. ……………………………………… 92,000 d. ……………………………………… 145,200 e. ……………………………………… 109,200 f. ……………………………………… 108,000

$138,000 69,000 184,000 130,800 166,800 168,000

(2) $480,000 Black Shannon $240,000 360,000 160,000 247,200 211,200 189,600

$240,000 120,000 320,000 232,800 268,800 290,400

Details: $276,000 Black Shannon

$480,000 Black Shannon

a. Net income (1:1)………………… $138,000

$138,000

$240,000

b. Net income (3:1)………………… $207,000

$69,000

$360,000

$120,000

$92,000

$184,000

$160,000

$320,000

d. Interest allowance……………… $ 21,600 Remaining income (1:1)………… 123,600 Net income……………………… $145,200

7,200 123,600 $130,800

$ 21,600 225,600 $247,200

e. Interest allowance……………… $ 21,600 Salary allowance………………… 96,000 Excess of allowances over 2 income (1:1)…………………… (8,400) Remaining income (1:1)………… Net income……………………… $109,200

$ 21,600 96,000

93,600 $211,200

93,600 $268,800

f. Interest allowance……………… $ 21,600 Salary allowance………………… 96,000 Bonus allowance………………… Excess of allowances over income (1:1)…………………… (9,600) Remaining income (1:1)………… Net income……………………… $108,000

$ 21,600 96,000

72,000 $189,600

72,000 $290,400

c. Net income (1:2)…………………

7,200 168,000

7,200 225,600 $232,800 7,200 168,000

(8,400) $166,800 7,200 168,000 2,4003

7,200 168,000 4 43,200

(9,600) $168,000

1 $360,000 × 6% 2 ($276,000 – $28,800 – $264,000)/2 3

20% × [$276,000 – ($96,000 + $168,000)]

20% × [$480,000 – ($96,000 + $168,000)]

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-3A Lambert and Yost Income Statement For the Year Ended December 31, 20Y3

$395,300

Professional fees Operating expenses: Salary expense Depreciation expense—building Property tax expense Heating and lighting expense Supplies expense Depreciation expense—office equipment Miscellaneous expense Total operating expenses Net income

$154,500 15,700 12,000 8,500 6,000 5,000 3,600 205,300 $190,000

Division of net income: Tyler Lambert Salary allowance……………………………… $45,000 Interest allowance……………………………… 13,500 * 34,500 Remaining income (1:1)……………………… $93,000 Net income………………………………………

Jayla Yost $54,700 7,800 ** 34,500 $97,000

Total $ 99,700 21,300 69,000 $190,000

* $135,000 × 10% ** ($88,000 – $10,000) × 10% 2.

Lambert and Yost Statement of Partnership Equity For the Year Ended December 31, 20Y3 Tyler Lambert

$135,000 — 93,000 (50,000) $178,000

Balances, January 1, 20Y3 Capital additions Net income for the year Partner withdrawals Balances, December 31, 20Y3

Jayla Yost

Total

$ 78,000 10,000 97,000 (60,000) $125,000

$ 213,000 10,000 190,000 (110,000) $ 303,000

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-3A (Concluded) 3.

Lambert and Yost Balance Sheet December 31, 20Y3 Assets Current assets: Cash Accounts receivable Supplies Total current assets Property, plant, and equipment: Land Building Less accumulated depreciation Office equipment Less accumulated depreciation Total property, plant, and equip. Total assets Liabilities Current liabilities: Accounts payable Salaries payable Total liabilities Partners’ Equity Tyler Lambert, capital Jayla Yost, capital Total partners’ equity Total liabilities and partners’ equity

$ 34,000 47,800 2,000 $ 83,800 $120,000 $157,500 67,200 $ 63,600 21,700

90,300 41,900 252,200 $336,000

$ 27,900 5,100 $ 33,000 $178,000 125,000 303,000 $336,000

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-4A 1. June

2. July

30 Asset Revaluations Accounts Receivable Allowance for Doubtful Accounts [($42,500 – $2,500) × 5%] – $1,600.

2,900

30 Merchandise Inventory Asset Revaluations $76,600 – $72,000.

4,600

30 Accumulated Depreciation—Equipment Equipment Asset Revaluations $155,700 – $180,500.

43,100

30 Asset Revaluations Musa Moshref, Capital Shaniqua Hollins, Capital

20,000*

1 Shaniqua Hollins, Capital Taylor Anderson, Capital

70,000

1 Cash Taylor Anderson, Capital

45,000

2,500 400

4,600

24,800 18,300

10,000 10,000

70,000

45,000

* The asset revaluations account has a credit balance of ($2,900 – $4,600 – $18,300), which is allocated to Moshref’s and Hollins’ capital accounts equally.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-4A (Concluded) 3.

Moshref, Hollins, and Anderson Balance Sheet July 1, 20Y7 Assets Current assets: Cash1 Accounts receivable Less allowance for doubtful accounts Merchandise inventory Prepaid insurance Total current assets Property, plant, and equipment: Equipment Total assets Liabilities Current liabilities: Accounts payable Notes payable Total liabilities Partners’ Equity Musa Moshref, capital2 Shaniqua Hollins, capital3 Taylor Anderson, capital Total partners’ equity Total liabilities and partners’ equity

$ 53,000 $40,000 2,000

38,000 76,600 3,000 $170,600 155,700 $326,300

$ 21,300 35,000 $ 56,300 $130,000 25,000 115,000 270,000 $326,300

1 $8,000 + $45,000 2 $120,000 + $10,000 3 $85,000 + $10,000 – $70,000

Balances before realization a. Sale of assets and division of loss Balances after realization b. Payment of liabilities Balances after payment of liabilities c. Receipt of deficiency Balances d. Cash distributed to partners Final balances $ 5,200 34,300 $ 39,500 (15,000) $ 24,500 900 $ 25,400 (25,400) $ 0

Cash

600 300

$ 55,900 (55,900) $ 0 — $ 0 — $ 0 — $ 0

Noncash Assets

900

$ 15,000 — $ 15,000 (15,000) $ 0 — $ 0 — $ 0

= Liabilities +

Gerloff, Chu, and Jewett Statement of Partnership Liquidation For Period February 3–28

$ 19,300 (10,800) $ 8,500 — $ 8,500 — $ 8,500 (8,500) $ 0

Gerloff (2/4) +

Accounting for Partnerships and Limited Liability Companies

$ 4,500 (5,400) $ (900) — $ (900) 900 $ 0 — $ 0

Capital Chu (1/4) +

$ 22,300 (5,400) $ 16,900 — $ 16,900 — $ 16,900 (16,900) $ 0

Jewett (1/4)

* $8,500 – $600 ** $16,900 – $300

12-34

7,900 16,600 24,500

b. William Gerloff, Capital* Courtney Jewett, Capital** Cash

The $900 deficiency of Chu would be divided between the other partners, Gerloff and Jewett, in their income-sharing ratio (2:1, respectively). Therefore, Gerloff would absorb two-thirds of the $900 deficiency, or $600, and Jewett would absorb one-third of the $900 deficiency, or $300.

2. a. William Gerloff, Capital Courtney Jewett, Capital Joshua Chu, Capital

Prob. 12-5A

CHAPTER 12

1. a.

$ 38,000 185,000 $ 223,000 (24,000) $ 199,000 (199,000) $ 0

Cash

12-35

$ 152,000 (152,000) $ 0 — $ 0 — $ 0

Noncash Assets

$ 24,000 — $ 24,000 (24,000) $ 0 — $ 0

= Liabilities +

Bowes, Simmons, and Ahmed Statement of Partnership Liquidation For Period November 1–30

$ 69,000 13,200 $ 82,200 — $ 82,200 (82,200) $ 0

Bowes (2/5)

Accounting for Partnerships and Limited Liability Companies

$ 85,000 13,200 $ 98,200 — $ 98,200 (98,200) $ 0

Capital Simmons + + (2/5)

Balances before realization Sale of assets and division of gain Balances after realization Payment of liabilities Balances after payment of liabilities Cash distributed to partners Final balances

Prob. 12-6A

CHAPTER 12

$ 12,000 6,600 $ 18,600 — $ 18,600 (18,600) $ 0

Ahmed (1/5)

Balances before realization Sale of assets and division of loss Balances after realization Payment of liabilities Balances after payment of liabilities Receipt of deficiency Balances Cash distributed to partners Final balances $ 38,000 65,000 $103,000 (24,000) $ 79,000 5,400 $ 84,400 (84,400) $ 0

Cash

2,700 2,700

$ 152,000 (152,000) $ 0 — $ 0 — $ 0 — $ 0

Noncash Assets

5,400

$ 24,000 — $ 24,000 (24,000) $ 0 — $ 0 — $ 0

= Liabilities +

Bowes, Simmons, and Ahmed Statement of Partnership Liquidation For Period November 1–30

$ 69,000 (34,800) $ 34,200 — $ 34,200 — $ 34,200 (34,200) $ 0

Bowes (2/5)

Accounting for Partnerships and Limited Liability Companies

$ 85,000 (34,800) $ 50,200 — $ 50,200 — $ 50,200 (50,200) $ 0

Capital Simmons + + (2/5)

$ 12,000 (17,400) $ (5,400) — $ (5,400) 5,400 $ 0 — $ 0

Ahmed (1/5)

12-36

31,500 47,500 79,000

** $50,200 – $2,700

* $34,200 – $2,700

b. Bowes, Capital* Simmons, Capital** Cash

The $5,400 deficiency of Ahmed would be divided between the other partners, Bowes and Simmons, in their incomesharing ratio (1:1, respectively). Therefore, Bowes would absorb one-half of the $5,400 deficiency, or $2,700, and Simmons would absorb one-half of the $5,400 deficiency, or $2,700.

2. a. Bowes, Capital Simmons, Capital Ahmed, Capital

1. b.

Prob. 12-6A (Concluded)

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-1B 1. Apr.

1 Cash Merchandise Inventory Whitney Lang, Capital

18,000 50,000

1 Cash Accounts Receivable Merchandise Inventory Equipment Allowance for Doubtful Accounts Accounts Payable Notes Payable Eli Capri, Capital

26,200 43,400 28,900 63,400

68,000

3,500 23,400 15,000 120,000

Lang and Capri Balance Sheet April 1, 20Y1

Assets Current assets: Cash Accounts receivable Less allowance for doubtful accounts Merchandise inventory Total current assets Property, plant, and equipment: Equipment Total assets Liabilities Current liabilities: Accounts payable Notes payable Total liabilities Partners’ Equity Whitney Lang, capital Eli Capri, capital Total partners’ equity Total liabilities and partners’ equity

$ 44,200 * $43,400 3,500

39,900 78,900** $163,000 63,400 $226,400

$ 23,400 15,000 $ 38,400 $ 68,000 120,000 188,000 $226,400

* $18,000 + $26,200 ** $28,900 + $50,000

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-1B (Concluded) 3. Mar.

31 Revenues Expenses Whitney Lang, Capital* Eli Capri, Capital*

598,000

31 Whitney Lang, Capital Eli Capri, Capital Whitney Lang, Drawing Eli Capri, Drawing

40,000 30,000

480,000 63,400 54,600

40,000 30,000

* Computations: Interest allowance…………………………… Salary allowance……………………………… Remaining income (1:1)…………………… Net income…………………………………… 1

Lang

Capri

Total

6,8001

$12,000 2

36,000 20,600 3 $63,400

22,000 20,600 3 $54,600

$ 18,800 58,000 41,200 $118,000

10% × $68,000

2 10% × $120,000 3

($118,000 – $18,800 – $58,000) × 1/2

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-2B

Plan

(1) $420,000 Howell Nickles

(2) $150,000 Howell Nickles

a. …………………………………… b. …………………………………… c. …………………………………… d. …………………………………… e. …………………………………… f. ……………………………………

$210,000 168,000 280,000 249,500 218,250 254,550

$ 75,000 60,000 100,000 87,500 83,250 92,550

$210,000 252,000 140,000 170,500 201,750 165,450

$75,000 90,000 50,000 62,500 66,750 57,450

Details: $420,000 Howell Nickles

$150,000 Howell Nickles

a. Net income (1:1)………………

$210,000

$ 75,000

$75,000

b. Net income (2:3)………………

$168,000

$252,000

$ 60,000

$90,000

c. Net income (2:1)………………

$280,000

$140,000

$100,000

$50,000

d. Interest allowance…………… Remaining income (3:2)……… Net income………………………

5,0001 244,500 $249,500

7,500 163,000 $170,500

5,000 82,500 $ 87,500

$ 7,500 55,000 $62,500

e. Interest allowance…………… Salary allowance……………… Remaining income (1:1)……… Net income………………………

5,000 38,000 175,250 $218,250

7,500 19,000 175,250 $201,750

5,000 38,000 40,250 $ 83,250

$ 7,500 19,000 40,250 $66,750

f. Interest allowance…………… Salary allowance……………… Bonus allowance……………… Remaining income (1:1)……… Net income………………………

$ 7,500 19,000

$50,000 × 10%

20% × [$420,000 – ($38,000 + $19,000)]

20% × [$150,000 – ($38,000 + $19,000)]

5,000 38,000 72,600 2 138,950 $254,550

7,500 19,000

138,950 $165,450

5,000 38,000 18,600 3 30,950 $ 92,550

30,950 $57,450

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-3B 1.

Ramirez and Xue Income Statement For the Year Ended December 31, 20Y2 Professional fees Operating expenses: Salary expense Depreciation expense—building Heating and lighting expense Depreciation expense—office equipment Property tax expense Supplies expense Miscellaneous expense Total operating expenses Net income

$555,300 $384,900 12,900 10,500 6,300 3,200 3,000 2,500 423,300 $132,000

Division of net income: Camila Ramirez Salary allowance…………………………… $50,000 Interest allowance………………………… 15,000 * (7,100) Remaining income (loss) (1:1)…………… Net income…………………………………… $57,900 * $125,000 × 12% ** ($155,000 – $20,000) × 12% 2.

Ping Xue $65,000 16,200 ** (7,100) $74,100

Total $115,000 31,200 (14,200) $132,000

Ramirez and Xue Statement of Partnership Equity For the Year Ended December 31, 20Y2 Camila Ping Ramirez Xue Balances, January 1, 20Y2 $125,000 $135,000 — 20,000 Capital additions 57,900 74,100 Net income for the year (35,000) Partner withdrawals (50,000) $147,900 Balances, December 31, 20Y2 $179,100

Total $260,000 20,000 132,000 (85,000) $327,000

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-3B (Concluded) 3.

Ramirez and Xue Balance Sheet December 31, 20Y2 Assets Current assets: Cash Accounts receivable Supplies Total current assets Property, plant, and equipment: Land Building Less accumulated depreciation Office equipment Less accumulated depreciation Total property, plant, and equip. Total assets Liabilities Current liabilities: Accounts payable Salaries payable Total liabilities Partners’ Equity Camila Ramirez, capital Ping Xue, capital Total partners’ equity Total liabilities and partners’ equity

$ 70,300 33,600 5,800 $109,700 $128,000 $175,000 80,000 $ 42,000 25,300

95,000 16,700 239,700 $349,400

$ 12,400 10,000 $ 22,400 $147,900 179,100 327,000 $349,400

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-4B 1. Aug.

2. Sept.

31 Asset Revaluations Accounts Receivable Allowance for Doubtful Accounts [($19,500 – $1,500) × 5%] – $600.

1,800

31 Merchandise Inventory Asset Revaluations $46,800 – $42,500.

4,300

31 Accumulated Depreciation—Equipment Equipment Asset Revaluations $64,500 – $67,500.

15,500

31 Asset Revaluations Brian Caldwell, Capital Adriana Estrada, Capital

15,000*

1 Adriana Estrada, Capital Kris Mays, Capital

26,000

1 Cash Kris Mays, Capital

32,000

1,500 300

4,300

3,000 12,500

7,500 7,500

26,000

32,000

* The asset revaluations account has a credit balance of $15,000 ($1,800 – $4,300 – $12,500), which is allocated to Caldwell’s and Mays’ capital accounts equally.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

Prob. 12-4B (Concluded) 3.

Caldwell, Estrada, and Mays Balance Sheet September 1, 20Y9 Assets Current assets: Cash1 Accounts receivable Less allowance for doubtful accounts Merchandise inventory Prepaid insurance Total current assets Property, plant, and equipment: Equipment Total assets Liabilities Current liabilities: Accounts payable Notes payable Total liabilities Partners’ Equity Brian Caldwell, capital2 Adriana Estrada, capital3 4

Kris Mays, capital Total partners’ equity Total liabilities and partners’ equity

$44,300 $18,000 900

17,100 46,800 1,200 $109,400 64,500 $173,900

$ 8,900 15,000 $ 23,900 $62,500 29,500 58,000 150,000 $173,900

1 $12,300 + $32,000 2 $55,000 + $7,500 3 $48,000 + $7,500 – $26,000 4 $26,000 + $32,000

500 1,000

$ 84,500 (84,500) $ 0 — $ 0 — $ 0 — $ 0

1,500

$ 22,000 — $ 22,000 (22,000) $ 0 — $ 0 — $ 0 $ 42,000 (9,000) $ 33,000 — $ 33,000 — $ 33,000 (33,000) $ 0

$ 7,500 (9,000) $(1,500) — $(1,500) 1,500 $ 0 — $ 0

Capital Lowes (1/4) +

$ 36,500 (18,000) $ 18,500 — $ 18,500 — $ 18,500 (18,500) $ 0

Howard (2/4)

12-44

32,500 17,500 50,000

* $33,000 – $500 ** $18,500 – $1,000

b. Zach Fairchild, Capital* Amber Howard, Capital** Cash

The $1,500 deficiency of Lowes would be divided between the other partners, Fairchild and Howard, in their incomesharing ratio (1:2, respectively). Therefore, Fairchild would absorb one-third of the $1,500 deficiency, or $500, and Howard would absorb two-thirds of the $1,500 deficiency, or $1,000.

$ 23,500 48,500 $ 72,000 (22,000) $ 50,000 1,500 $ 51,500 (51,500) $ 0

Cash

Noncash Fairchild + Assets = Liabilities + + (1/4)

Fairchild, Lowes, and Howard Statement of Partnership Liquidation For Period April 10–30

Accounting for Partnerships and Limited Liability Companies

2. a. Zach Fairchild, Capital Amber Howard, Capital Austin Lowes, Capital

Prob. 12-5B

CHAPTER 12

1. a.

$ 65,000 217,000 $ 282,000 (30,000) $ 252,000 (252,000) $ 0

Cash

12-45

$ 167,000 (167,000) $ 0 — $ 0 — $ 0

Noncash Assets

$ 30,000 — $ 30,000 (30,000) $ 0 — $ 0

= Liabilities +

Chapelle, Rock, and Pryor Statement of Partnership Liquidation For Period August 3–29

$ 14,000 10,000 $ 24,000 — $ 24,000 (24,000) $ 0

Chapelle (1/5)

Accounting for Partnerships and Limited Liability Companies

Capital Rock (2/5)

$ 102,000 20,000 $ 122,000 — $ 122,000 (122,000) $ 0

Balances before realization Sale of assets and division of gain Balances after realization Payment of liabilities Balances after payment of liabilities Cash distributed to partners Final balances

Prob. 12-6B

CHAPTER 12

$ 86,000 20,000 $ 106,000 — $ 106,000 (106,000) $ 0

Pryor (2/5)

$ 65,000 72,000 $ 137,000 (30,000) $ 107,000 5,000 $ 112,000 (112,000) $ 0

Cash

2,500 2,500

$ 167,000 (167,000) $ 0 — $ 0 — $ 0 — $ 0

Noncash Assets

5,000

$ 30,000 — $ 30,000 (30,000) $ 0 — $ 0 — $ 0

$ 14,000 (19,000) $ (5,000) — $ (5,000) 5,000 $ 0 — $ 0

Chapelle = Liabilities + + (1/5)

Chapelle, Rock, and Pryor Statement of Partnership Liquidation For Period August 3–29

Accounting for Partnerships and Limited Liability Companies

$102,000 (38,000) $ 64,000 — $ 64,000 — $ 64,000 (64,000) $ 0

Capital Rock (2/5) +

$ 86,000 (38,000) $ 48,000 — $ 48,000 — $ 48,000 (48,000) $ 0

Pryor (2/5)

12-46

61,500 45,500 107,000

* $64,000 – $2,500 ** $48,000 – $2,500

b. Rock, Capital* Pryor, Capital** Cash

The $5,000 deficiency of Chapelle would be divided between the other partners, Rock and Pryor, in their incomesharing ratio (1:1, respectively). Therefore, Rock would absorb one-half of the $5,000 deficiency, or $2,500, and Pryor would absorb one-half of the $5,000 deficiency, or $2,500.

2. a. Rock, Capital Pryor, Capital Chapelle, Capital

1. b.

Prob. 12-6B (Concluded)

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

CASES & PROJECTS CP 12-1 This scenario highlights one of the problems that arises in partnerships: attempting to align contribution with income division. Often, disagreements are based on honest differences of opinion. However, in this scenario, there is evidence that Robbins was acting unethically. Robbins apparently made no mention of his plans to “scale back” once the partnership was consummated. As a result, Barrow agreed to an equal division of income based on the assumption that Robbins’s past efforts would project into the future, while in fact, Robbins had no intention of this. As a result, Barrow is now providing more effort while receiving the same income as Robbins. This is clearly not sustainable in the long term. Robbins does not appear to be concerned about this inequity. Thus, the evidence points to some duplicity on Robbins’s part. Essentially, he knows that he is riding on Barrow’s effort and had planned it that way. Barrow could respond to this situation by either withdrawing from the partnership or changing the partnership agreement. One possible change would be to provide a partner salary based on the amount of patient billings. This salary would be highly associated with the amount of revenue brought into the partnership, thus avoiding disputes associated with unequal contributions to the firm.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

CP 12-2 a. and b. This table is from the 2018 “Accounting Today Top 100 Firms.” Total Revenues (in millions) Deloitte & Touche………………… PwC…………………………………… Ernst & Young……………………… KPMG…………………………………

$18,551 15,620 13,000 8,960

Total Partners

Revenues per Partner*

3,135 3,327 3,200 2,178

$5,917,384 4,694,920 4,062,500 4,113,866

* Revenue per partner is determined by dividing the total revenue by the number of partners for each firm, adjusting the revenues for the fact that they are expressed in millions in the table. For example, revenue per partner is determined for Deloitte & Touche as follows: Deloitte & Touche revenue per partner:

$18,551 3,135

× 1,000,000

= $5,917,384

c. Revenue per Partner

Percent of Deloitte & Touche

Deloitte & Touche…………………… $5,917,384 PwC…………………………………… 4,694,920 KPMG…………………………………… 4,113,866 Ernst & Young………………………… 4,062,500

100% 79%* 70% 69%

* $4,694,920 ÷ $5,917,384 d. As can be seen, Deloitte & Touche has the highest revenue per partner relative to the other three firms, while Ernst & Young has the lowest. Ernst & Young’s revenue per partner is 69% of Deloitte & Touche’s. These data suggest that Deloitte & Touche has a somewhat smaller relative partner base supporting its revenues than do the other three firms. This result may be from the advantage of relative size (in revenues) compared to the other two firms.

CHAPTER 12

Accounting for Partnerships and Limited Liability Companies

CP 12-3 When developing an LLC (or partnership), the operating (or partnership) agreement is a critical part of establishing a business. Each party must consider the various incentives of each individual in the LLC. For example, in this case, one party, Lindsey Wilson, is providing all of the funding, while the other two parties are providing expertise and talent. This type of arrangement can create some natural conflicts because the interests of an investor might not be the same as those operating the LLC. Specifically, you would want to advise Wilson that not all matters should be settled by majority vote. Such a provision would allow the two noninvesting members to vote as a block to the detriment of Wilson. For example, the salaries for the two working members could be set by their vote so that little profit would be left to be distributed. This would essentially keep Wilson’s return limited to the 10% preferred return. Wilson should insist that salary allowances require unanimous approval of all members. A second issue is the division of partnership income. The suggested agreement is for all the partners to share the remaining income, after the 10% preferred return, equally. Wilson should be counseled to consider all aspects of the LLC contribution to determine whether this division is equitable. There are many considerations, including the amount of investment, risk of the venture, degree of expertise of noninvesting partners, and degree of exclusivity of noninvesting members’ effort contribution (unique skills or business connections, for example). Often, the simple assumption of equal division is not appropriate. In addition, it is sometimes best to require working members to have an investment in the LLC, even if it is small, so that they are sensitive to the perspective of financial loss.

CP 12-4 A good solution to this problem would be to divide income into three steps: 1. Provide interest on each partner’s capital balance. 2. Provide a monthly salary for each partner. 3. Divide the remainder according to a partnership formula. With this approach, the return on capital and effort will be calculated separately in the income division formula before applying the percentage formula. Thus, Willard will receive a large interest distribution based on the large capital balance, while Hill should receive a large salary distribution based on the larger service contribution. The return on capital and salary allowances should be based on prevailing market rates. If both partners are pleased with their return on capital and effort, then the remaining income could be divided equally between them.

CHAPTER 13 CORPORATIONS: ORGANIZATION, STOCK TRANSACTIONS, AND DIVIDENDS DISCUSSION QUESTIONS 1.

No. Common stock with a higher par is not necessarily a better investment than common stock with a lower par because par is an amount assigned to the shares.

The broker is not correct. Corporations are not legally liable to pay dividends until the dividends are declared. If the company that issued the preferred stock has operating losses, it could omit dividends first on its common stock and later on its preferred stock.

The company may not have had enough cash on hand to pay a dividend on the common stock, or resources may be needed for plant expansion, replacement of facilities, payment of liabilities, etc.

a. b.

There is no change. Total equity is the same.

a. b.

Current liability Stockholders’ equity

The primary purpose of a stock split is to bring about a reduction in the market price per share and thus to encourage more investors to buy the company’s shares.

a. b.

It has no effect on revenue or expense. It reduces stockholders’ equity by $3,000,000.

a. b.

It has no effect on revenue. It increases stockholders’ equity by $3,750,000.

The three classifications of restrictions on retained earnings are legal, contractual, and discretionary. Restrictions are normally reported in the notes to the financial statements.

10.

Such prior period adjustments should be reported as an adjustment to the beginning balance of retained earnings.

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

PRACTICE EXERCISES PE 13-1A Year 1 Amount distributed…………………………… $ 45,000 Preferred dividend (50,000 shares)………… (45,000) 0 Common dividend (100,000 shares)……… $

Year 2

Year 3

$ 123,000 (105,000) * $ 18,000

$130,000 (75,000) $ 55,000

* Year 1 dividends in arrears of $30,000 ($75,000** – $45,000) plus Year 2 dividends of $75,000 ** $75 par × 50,000 shares × 2% = $75,000 Dividend per share: Preferred stock…………………………… Common stock………………………………

$0.90 None

$2.10 $0.18

$1.50 $0.55

Year 1

Year 2

Year 3

$ 6,300 (6,300) $ 0

$ 80,500 (30,100)** $ 50,400

PE 13-1B Amount distributed…………………………… $ 35,000 Preferred dividend (14,000 shares)………… (18,200) * Common dividend (70,000 shares)………… $ 16,800

* $130 par × 14,000 shares × 1% = $18,200 ** Year 2 dividends of $30,100 includes dividends in arrears of $11,900 ($18,200** – $6,300) plus Year 3 dividends of $18,200

Dividend per share: Preferred stock…………………………… Common stock………………………………

$1.30 $0.24

$0.45 None

$2.15 $0.72

PE 13-2A May

23 Cash (45,000 shares × $16) Common Stock (45,000 shares × $4) Paid-In Capital in Excess of Stated Value— Common Stock [45,000 shares × ($16 – $4)

720,000

6 Cash Preferred Stock (12,000 shares × $75)

900,000

Sept. 15 Cash (20,000 shares × $22) Common Stock (20,000 shares × $4) Paid-In Capital in Excess of Stated Value— Common Stock [20,000 shares × ($22 – $4)

440,000

July

180,000 540,000

900,000

80,000 360,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

PE 13-2B Jan.

Feb.

Aug.

22 Cash Common Stock (125,000 shares × $6)

750,000

14 Cash Preferred Stock (32,000 shares × $80)

2,560,000

30 Cash (7,000 shares × $94) Preferred Stock (7,000 shares × $80) Paid-In Capital in Excess of Par— Preferred Stock [7,000 shares × ($94 – $80)]

750,000

2,560,000 658,000 560,000 98,000

PE 13-3A Feb.

28 Cash Dividends Cash Dividends Payable

Apr.

1 No entry required.

May

15 Cash Dividends Payable Cash

428,000 428,000

PE 13-3B Feb.

1 Cash Dividends Cash Dividends Payable

Mar.

18 No entry required.

May

1 Cash Dividends Payable Cash

195,000 195,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

PE 13-4A Sept.

2 Stock Dividends (900,000 shares × 3% × $44) Stock Dividends Distributable (27,000 shares × $26) Paid-In Capital in Excess of Par— Common Stock [$27,000 shares × ($44 – $26)]

Oct.

3 No entry required.

Nov.

30 Stock Dividends Distributable Common Stock

1,188,000 702,000 486,000

702,000 702,000

PE 13-4B June

8 Stock Dividends (370,000 shares × 5% × $51) Stock Dividends Distributable (18,500 shares × $27) Paid-In Capital in Excess of Par— Common Stock [18,500 shares × ($51 – $27)]

July

13 No entry required.

Aug.

12 Stock Dividends Distributable Common Stock

943,500 499,500 444,000

499,500 499,500

PE 13-5A Jan.

Apr.

Oct.

31 Treasury Stock (18,700 shares × $45) Cash

841,500

20 Cash (10,600 shares × $52) Treasury Stock (10,600 shares × $45) Paid-In Capital from Sale of Treasury Stock [10,600 shares × ($52 – $45)]

551,200

4 Cash (8,100 shares × $37) Paid-In Capital from Sale of Treasury Stock [8,100 shares × ($45 – $37)] Treasury Stock (8,100 shares × $45)

299,700

841,500

477,000 74,200

64,800 364,500

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

PE 13-5B May

Aug.

Nov.

27 Treasury Stock (64,000 shares × $12) Cash

768,000

3 Cash (41,000 shares × $17) Treasury Stock (41,000 shares × $12) Paid-In Capital from Sale of Treasury Stock [41,000 shares × ($17 – $12)]

697,000

14 Cash (23,000 shares × $9) Paid-In Capital from Sale of Treasury Stock [23,000 shares × ($12 – $9)] Treasury Stock (23,000 shares × $12)

207,000

768,000

492,000 205,000

69,000 276,000

PE 13-6A Stockholders’ Equity Paid-in capital: Common stock, $3 par (200,000 shares authorized, 90,000 shares issued) Excess over par

$ 270,000 1,196,000

Paid-in capital, common stock From sale of treasury stock

$1,466,000 62,000

Total paid-in capital Retained earnings Treasury stock (5,000 shares at cost) Total stockholders’ equity

$1,528,000 7,430,000 (230,000) $8,728,000

PE 13-6B Stockholders’ Equity Paid-in capital: Common stock, $120 par (500,000 shares authorized, 212,500 shares issued) Excess over par

$25,500,000 7,230,000

Paid-in capital, common stock From sale of treasury stock

$32,730,000 4,074,000

Total paid-in capital Retained earnings Treasury stock (35,000 shares at cost) Total stockholders’ equity

$36,804,000 47,101,000 (3,920,000) $79,985,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

PE 13-7A Seismic Inc. Retained Earnings Statement For the Year Ended June 30, 20Y5 Retained earnings, July 1, 20Y4 $311,000 Net income (66,000) Dividends declared Increase in retained earnings Retained earnings, June 30, 20Y5

$1,700,000

245,000 $1,945,000

PE 13-7B Haggen Cruises Inc. Retained Earnings Statement For the Year Ended October 31, 20Y9 Retained earnings, November 1, 20Y8 $2,232,000 Net income (451,000) Dividends declared Increase in retained earnings Retained earnings, October 31, 20Y9

$11,775,000

1,781,000 $13,556,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

PE 13-8A a.

20Y3: Earnings per Share =

Net Income – Preferred Dividends Avg. Number of Common Shares Outstanding

$775,000 – $35,000 80,000 shares

$740,000 80,000 shares

20Y2: Earnings per Share =

= $9.25

Net Income – Preferred Dividends Avg. Number of Common Shares Outstanding

$966,000 – $35,000 95,000 shares

$931,000 95,000 shares

= $9.80

b. The decrease in the earnings per share from $9.80 to $9.25 indicates an unfavorable change in the company’s profitability.

PE 13-8B a.

20Y6: Earnings per Share =

Net Income – Preferred Dividends Avg. Number of Common Shares Outstanding

$4,243,200 – $64,000 128,000 shares

$4,179,200 128,000 shares

20Y5: Earnings per Share =

= $32.65

Net Income – Preferred Dividends Avg. Number of Common Shares Outstanding

$2,855,360 – $64,000 104,000 shares

$2,791,360 104,000 shares

= $26.84

b. The increase in the earnings per share from $26.84 to $32.65 indicates a favorable change in the company’s profitability.

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

EXERCISES Ex. 13-1 1st Year

2nd Year

3rd Year

4th Year

Amount distributed………………

$49,000

$132,000

$146,000

$160,000

Preferred dividend (current)……

$49,000

$ 84,000 *

$ 84,000

Preferred dividend in arrears……

—

35,000 **

—

Total preferred dividends………

$49,000

$119,000

$ 84,000

Preferred shares outstanding…

÷ 70,000

Preferred dividend per share……

0.70

1.70

1.20

* $60 par × 70,000 shares × 2% = $84,000 ** $84,000 − $49,000 = $35,000

—

$ 13,000 ÷100,000 $ 0.13

$ 62,000 ÷100,000 $ 0.62

$ 76,000 ÷100,000 $ 0.76

1st Year

2nd Year

3rd Year

4th Year

Amount distributed………………

$36,000

$58,000

$75,000

$124,000

Preferred dividend (current)…… Preferred dividend in arrears……

$36,000 —

$44,000 * 14,000 **

$50,000 6,000

$ 50,000 —

Total preferred dividends……… Preferred shares outstanding… Preferred dividend per share……

$36,000 ÷40,000 $ 0.90

$58,000 ÷40,000 $ 1.45

$56,000 ÷40,000 $ 1.40

$ 50,000 ÷ 40,000 $ 1.25

$ 19,000

$ 74,000 ÷100,000 $ 0.74

Common dividend………………… Common shares outstanding…… Common dividend per share……

Ex. 13-2

* Pay dividend in arrears first; $44,000 = $58,000 – $14,000 ** $125 par × 40,000 shares × 1% = $50,000; $50,000 − $36,000 = $14,000

Common dividend………………… Common shares outstanding…… Common dividend per share……

—

÷100,000 $ 0.19

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-3 a. Oct.

Nov.

31 Cash (320,000 shares × $12) Common Stock (320,000 shares × $5) Paid-In Capital in Excess of Par—Common Stock [320,000 shares × ($12 – $5)]

3,840,000

19 Cash (45,000 shares × $72) Preferred Stock (45,000 shares × $60) Paid-In Capital in Excess of Par—Preferred Stock [45,000 shares × ($72 – $60)]

3,240,000

1,600,000 2,240,000

2,700,000 540,000

b. $7,080,000 ($1,600,000 + $2,240,000 + $2,700,000 + $540,000)

Ex. 13-4 a. Feb.

Aug.

12 Cash (1,000,000 shares × $1.20) Common Stock (1,000,000 shares × $0.25) Paid-In Capital in Excess of Stated Value— Common Stock [1,000,000 shares × ($1.20 – $0.25)]

1,200,000

3 Cash (10,000 shares × $21) Preferred Stock (10,000 shares × $15) Paid-In Capital in Excess of Par—Preferred Stock [10,000 shares × ($21 – $15)]

210,000

250,000

950,000

150,000 60,000

b. $1,410,000 ($250,000 + $950,000 + $150,000 + $60,000)

Ex. 13-5 Apr.

5 Land (30,000 shares × $112) Common Stock (30,000 shares × $80) Paid-In Capital in Excess of Par— Common Stock [30,000 shares × ($112 – $80)]

3,360,000 2,400,000 960,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-6 a.

Cash Common Stock (100,000 shares × $1)

100,000

Organizational Expenses Common Stock (3,000 shares × $1)

3,000

Cash Common Stock (45,000 shares × $1)

45,000

Land Building Interest Payable Mortgage Note Payable Common Stock (99,800 shares × $1)

60,000 225,000

100,000

3,000

45,000

5,200 180,000 99,800

Ex. 13-7 Oct.

Oct.

Cash (120,000 shares × $31.50) Common Stock (120,000 shares × $30.00) Paid-In Capital in Excess of Par—Common Stock [120,000 shares × ($31.50 – $30.00)]

3,780,000

Buildings Land Preferred Stock (35,000 shares × $80) Paid-In Capital in Excess of Par—Preferred Stock [35,000 shares × ($92 – $80)]

2,380,000 840,000

3,600,000 180,000

2,800,000 420,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-8 July

1 Cash Common Stock (260,000 shares × $11)

2,860,000

1 Organizational Expenses Common Stock (2,000 shares × $11)

22,000

7 Land Buildings Equipment Common Stock (60,000 shares × $11) Paid-In Capital in Excess of Par—Common Stock [60,000 shares × ($16 – $11)]

320,000 550,000 90,000

Sept. 20 Cash (30,000 shares × $74) Preferred Stock (30,000 shares × $70) Paid-In Capital in Excess of Par—Preferred Stock [30,000 shares × ($74 – $70)]

2,220,000

Aug.

2,860,000

22,000

660,000 300,000

2,100,000 120,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-9 Jan.

12 Cash Dividends Cash Dividends Payable

Mar.

13 No entry required.

Apr.

12 Cash Dividends Payable Cash

135,000 135,000

Ex. 13-10 a. (1)

(2)

Stock Dividends [(400,000 shares × 2%) × $19] Stock Dividends Distributable (8,000 shares × $8) Paid-In Capital in Excess of Par— Common Stock [8,000 shares × ($19 – $8)]

152,000

Stock Dividends Distributable Common Stock

64,000

64,000 88,000

64,000

b. (1) $4,000,000 ($3,200,000 + $800,000) (2) $25,600,000 (3) $29,600,000 ($4,000,000 + $25,600,000) c. (1) $4,152,000 ($3,200,000 + $800,000 + $64,000 + $88,000) (2) $25,448,000 ($25,600,000 – $152,000) (3) $29,600,000 ($4,152,000 + $25,448,000)

Ex. 13-11 a. 105,000 shares (35,000 × 3) b. $90 per share ($270 ÷ 3)

Ex. 13-12

(1) Authorizing and issuing stock certificates in a stock split (2) Declaring a stock dividend (3) Issuing stock certificates for the stock dividend declared in (2) (4) Declaring a cash dividend (5) Paying the cash dividend declared in (4)

Assets

Liabilities

Stockholders’ Equity

0 0

0 +

0 –

–

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-13 Jan.

8 No entry required. The stockholders’ ledger would be revised to record the increased number of shares held by each stockholder.

Apr.

30 Cash Dividends [(18,000 shares × $0.75) + (150,000 shares × $0.28) = $13,500 + $42,000 = $55,500] Cash Dividends Payable

July

1 Cash Dividends Payable Cash

Oct.

55,500 55,500 55,500

31 Cash Dividends [(18,000 shares × $0.75) + (150,000 shares × $0.14) = $13,500 + $21,000 = $34,500] Cash Dividends Payable 31 Stock Dividends (150,000 shares × 5% × $52 = $390,000) Stock Dividends Distributable (7,500 shares × $40) Paid-In Capital in Excess of Par—Common Stock [7,500 shares × ($52 – $40)]

Dec.

55,500

34,500 34,500

390,000 300,000 90,000

31 Cash Dividends Payable Cash

34,500

31 Stock Dividends Distributable Common Stock

300,000

34,500

300,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-14 a.

Feb.

Apr.

Aug.

11 Treasury Stock (180,000 shares × $17) Cash

3,060,000

30 Cash (90,000 shares × $20) Treasury Stock (90,000 shares × $17) Paid-In Capital from Sale of Treasury Stock [90,000 shares × ($20 – $17)]

1,800,000

22 Cash (30,000 shares × $15) Paid-In Capital from Sale of Treasury Stock [30,000 shares × ($17 – $15)] Treasury Stock (30,000 shares × $17)

450,000

3,060,000

1,530,000 270,000

60,000 510,000

$210,000 ($270,000 – $60,000) credit

Lava Lake may have purchased the stock to support the market price of the stock, to provide shares for resale to employees, or to reissue to employees as a bonus according to stock purchase agreements.

Ex. 13-15 a.

Jan.

June

Nov.

31 Treasury Stock (42,000 shares × $36) Cash

1,512,000 1,512,000

14 Cash (19,000 shares × $43) Treasury Stock (19,000 shares × $36) Paid-In Capital from Sale of Treasury Stock [19,000 shares × ($43 – $36)]

817,000

23 Cash (16,000 shares × $39) Treasury Stock (16,000 shares × $36) Paid-In Capital from Sale of Treasury Stock [16,000 shares × ($39 – $36)]

624,000

684,000 133,000

576,000 48,000

$181,000 ($133,000 + $48,000) credit

$252,000 [(42,000 shares − 19,000 shares − 16,000 shares) × $36]

The balance in the treasury stock account is reported as a deduction from the total of the paid-in capital and retained earnings.

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-16 a.

May

Sept.

Nov.

14 Treasury Stock (23,500 shares × $75) Cash

1,762,500

6 Cash (14,000 shares × $81) Treasury Stock (14,000 shares × $75) Paid-In Capital from Sale of Treasury Stock [14,000 shares × ($81 – $75)]

1,134,000

30 Cash (9,500 shares × $72) Paid-In Capital from Sale of Treasury Stock [9,500 shares × ($75 – $72)] Treasury Stock (9,500 shares × $75)

684,000

1,762,500

1,050,000 84,000

28,500 712,500

$55,500 ($84,000 – $28,500) credit

Stockholders’ Equity section

Biscayne Bay Water Inc. may have purchased the stock to support the market price of the stock, to provide shares for resale to employees, or to reissue to employees as a bonus according to stock purchase agreements.

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-17 Stockholders’ Equity

Paid-in capital: Preferred 2% stock, $110 par (100,000 shares authorized, 55,000 shares issued) Excess over par Paid-in capital, preferred stock Common stock, no par, $22 stated value (300,000 shares authorized, 250,000 shares issued) Excess over stated value Paid-in capital, common stock From sale of treasury stock Total paid-in capital

$6,050,000 165,000 $6,215,000

$5,500,000 380,000 5,880,000 35,000 $12,130,000

Ex. 13-18 Stockholders’ Equity

Paid-in capital: Common stock, $45 par (80,000 shares authorized, 68,000 shares issued) Excess over par Paid-in capital, common stock From sale of treasury stock Total paid-in capital Retained earnings Treasury stock (9,000 shares at cost) Total stockholders’ equity

$3,060,000 272,000 $3,332,000 115,000 $ 3,447,000 20,553,000 (324,000) $23,676,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-19 Stockholders’ Equity

Paid-in capital: Preferred 1% stock, $150 par (50,000 shares authorized, 48,000 shares issued) Excess over par Paid-in capital, preferred stock Common stock, $36 par (300,000 shares authorized, 280,000 shares issued) Excess over par Paid-in capital, common stock From sale of treasury stock Total paid-in capital Retained earnings Treasury common stock (24,000 shares at cost) Total stockholders’ equity

$ 7,200,000 384,000 $ 7,584,000

$10,080,000 420,000 10,500,000 340,000 $18,424,000 71,684,000 (1,008,000) $89,100,000

Ex. 13-20 Pressure Pumps Corporation Retained Earnings Statement For the Year Ended January 31, 20Y2 Retained earnings, February 1, 20Y1 Net income $ 4,082,000 Dividends declared (1,801,000) Increase in retained earnings Retained earnings, January 31, 20Y2

$29,842,000

2,281,000 $32,123,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-21 a.

Retained earnings is not part of paid-in capital.

The cost of treasury stock should be deducted from the total stockholders’ equity.

Dividends payable should be included as part of current liabilities and not as part of stockholders’ equity.

Common stock should be included as part of paid-in capital.

The amount of shares of common stock issued of 619,000 times the par value per share of $10 should be extended as $6,190,000, not $6,623,000. The difference, $433,000, probably represents paid-in capital in excess of par.

Organizing costs should be expensed as Organizational Expenses when incurred and not included as a part of stockholders’ equity.

A corrected Stockholders’ Equity section of the balance sheet using Method 1 of Exhibit 8 is as follows: Stockholders’ Equity

Paid-in capital: Preferred 2% stock, $60 par (94,000 shares authorized and issued) Excess over par Paid-in capital, preferred stock Common stock, $10 par (750,000 shares authorized, 619,000 shares issued) Excess over par Paid-in capital, common stock Total paid-in capital Retained earnings* Treasury stock (56,000 shares at cost) Total stockholders’ equity

$5,640,000 375,000 $6,015,000

$6,190,000 433,000 6,623,000 $12,638,000 72,300,000 (868,000) $84,070,000

* $72,525,000 – $225,000. Since the organizing costs should have been expensed, the retained earnings should be $225,000 less.

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-22 I-Cards Inc. Statement of Stockholders’ Equity For the Year Ended December 31, 20Y9

Balance, Jan. 1, 20Y9

Common Stock, $40 par

Paid-In Capital in Excess of Par

Treasury Stock

$4,800,000

$ 960,000

—

1,200,000

300,000

Retained Earnings

Total

$11,375,000

$17,135,000

Issued 30,000 shares of common stock

1,500,000

Purchased 12,000 shares (552,000)

$(552,000)

as treasury stock Net income

3,780,000

Dividends

(276,000)

$14,879,000

$21,587,000

$6,000,000

Balance, Dec. 31, 20Y9

$1,260,000

$(552,000)

Ex. 13-23 Earnings per Share

Net Income – Preferred Dividends Avg. Number of Common Shares Outstanding

$565,300 – ($2.10 × 23,000 shares) 55,000 shares

$565,300 – $48,300 55,000 shares

$517,000 55,000 shares

= $9.40

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-24 a.

Earnings per Share = Year 3 Earnings per Share =

Net Income – Preferred Dividends Avg. Number of Common Shares Outstanding $(6,837) – $14 517 shares

= $(13.25) Year 2 Earnings per Share =

$1,660 – $14 512 shares

= $3.21 Year 1 Earnings per Share =

$1,407 – $14 499 shares

= $2.79 b.

Year 3

Year 2

Year 1

Earnings per share…………………………………… $(13.25)* Growth as a percent of Year 1 (base year)……… (575)%

$3.21 15%

$2.79 100%

Net income (loss)……………………………………… $(6,837)* Growth as a percent of Year 1 (base year)……… (586)%

$1,660 18%

$1,407 100%

Earnings per share and net income varied significantly over the three-year period. Earnings per share grew 15% [($3.21 – $2.79) ÷ $2.79] in Year 2 from Year 1, but declined in Year 3 by 575% [(–$13.25 – $2.79) ÷ $2.79] of Year 1’s earnings per share. Net income increased in Year 2 to 18% [($1,660 – $1,407) ÷ $1,407] of Year 1’s net income. However, net income in Year 3 decreased significantly by 586% [(–$6,837 – $1,407) ÷ $1,407] of Year 1’s net income. Thus, the changes in earnings per share and net income were similar. The variability of earnings per share and net income is partially explained by the unpredictable nature of Pacific Gas and Electric’s regulatory environment. For example, Pacific Gas and Electric is regulated by the California Public Utilities Commission (CPUC). The CPUC has jurisdiction over the rates, terms, and conditions of service for the company’s electricity and natural gas distribution operations, electricity generation, and natural gas transmission and storage services. The CPUC also has jurisdiction over the company’s issuances of securities, dispositions of utility assets and facilities, energy purchases on behalf of the company’s electricity and natural gas retail customers, rates of return, rates of depreciation, oversight of nuclear decommissioning, and aspects of the siting of facilities used in providing electric and natural gas service. The CPUC has the right to conduct investigations and issue penalties against the company. * The significant net loss in Year 3 is due to hundreds of millions of dollars of California wildfirerelated claims.

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Ex. 13-25 a. Caterpillar Inc. Earnings per Share = Year 2: Earnings per Share =

Net Income Avg. Number of Common Shares Outstanding $6,147 591 shares

= $10.40 Year 1: Earnings per Share =

$754 592 shares

= $1.27 Deere & Company Earnings per Share = Year 2: Earnings per Share =

Net Income Avg. Number of Common Shares Outstanding $2,368 323 shares

= $7.33 Year 1: Earnings per Share =

$2,159 320 shares

= $6.75

Caterpillar Deere b.

Earnings per Share Year 2 Year 1 $10.40 * $1.27 $7.33 $6.75

Deere’s earnings per share for Year 1 is higher than Caterpillar’s. However, from Year 1 to Year 2, the earnings per share for both companies increased. Caterpillar’s earnings per share increased by 719% [$10.40 − $1.27) ÷ $1.27], while Deere’s earnings per share increased by 9% [$7.33 − $6.75) ÷ $6.75]. Overall, Caterpillar appears to be the more profitable company. * The significant increase in Caterpillar’s Year 2 income was due to increased sales volumes and a reduction of costs related to the restructuring of operations, including the closure of its Belgium facility.

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

PROBLEMS Prob. 13-1A 1. Year

Total Dividends

Preferred Dividends Per Total Share

Common Dividends Per Total Share

Year 1……… Year 2……… Year 3……… Year 4……… Year 5……… Year 6………

$ 80,000 90,000 150,000 150,000 160,000 180,000

$ 80,000 90,000 130,000* 100,000 100,000 100,000

$0.32 0.36 0.52 0.40 0.40 0.40

0 0 20,000 50,000 60,000 80,000

$2.40

$0.00 0.00 0.04 0.10 0.12 0.16 $0.42

* $130,000 = (Year 1 dividends in arrears of $20,000) + (Year 2 dividends in arrears of $10,000) + (Year 3 current dividend of $100,000)

Average annual dividend for preferred: $0.40 per share ($2.40 ÷ 6) Average annual dividend for common: $0.07 per share ($0.42 ÷ 6)

a. 1.6% ($0.40 ÷ $25.00) b. 0.4% ($0.07 ÷ $17.50)

Prob. 13-2A May

11 Building Land Common Stock (125,000 shares × $35) Paid-In Capital in Excess of Par— Common Stock [125,000 shares × ($39 – $35)]

3,375,000 1,500,000

20 Cash (40,000 shares × $52) Preferred Stock (40,000 shares × $50) Paid-In Capital in Excess of Par— Preferred Stock [40,000 shares × ($52 – $50)]

2,080,000

31 Cash Mortgage Note Payable

4,000,000

4,375,000

500,000

2,000,000

80,000

4,000,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-3A a.

Cash (220,000 × $15) Common Stock (220,000 × $12) Paid-In Capital in Excess of Par—Common Stock [220,000 × ($15 – $12)]

3,300,000

Cash (6,000 × $94) Preferred Stock (6,000 × $80) Paid-In Capital in Excess of Par—Preferred Stock [6,000 × ($94 – $80)]

564,000

2,640,000 660,000

480,000 84,000

Treasury Stock (130,000 × $19) Cash

2,470,000

Cash (70,000 × $23) Treasury Stock (70,000 × $19) Paid-In Capital from Sale of Treasury Stock [70,000 × ($23 – $19)]

1,610,000

Cash (40,000 × $17) Paid-In Capital from Sale of Treasury Stock [40,000 × ($19 – $17)] Treasury Stock (40,000 × $19)

680,000

Cash Dividends Cash Dividends Payable

337,600*

Cash Dividends Payable Cash

337,600

* Calculation of cash dividends: Beginning of year (a) (b) (c) (d) (e) Cash dividends per share Dividends paid in (f)

2,470,000

1,330,000 280,000

80,000 760,000

337,600

337,600 Outstanding Shares of Stock Preferred Stock Common Stock 65,000 shares 1,400,000 shares 220,000 6,000 (130,000) 70,000 40,000 71,000 shares 1,600,000 shares 0.14 × $1.60 × $113,600 $224,000

Total dividends paid $337,600 ($113,600 + $224,000)

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-4A 1. and 2. Common Stock Jan. 1 Apr. 10 Aug. 15 Dec. 31

Bal.

7,500,000 1,500,000 360,000 9,360,000

Paid-In Capital in Excess of Stated Value—Common Stock Jan. 1 Bal. 825,000 Apr. 10 300,000 July 5 90,000 Dec. 31 Bal. 1,215,000

Dec.

Jan. Nov. Dec.

Retained Earnings 493,800 Jan. 1 Dec. 31 Dec. 31

1 23 31

Bal. Bal.

Treasury Stock 450,000 June 6 570,000 570,000

33,600,000 1,125,000 34,231,200

450,000

Paid-In Capital from Sale of Treasury Stock June 6

200,000

360,000

Aug.

Stock Dividends Distributable 360,000 July 5

July

Stock Dividends 450,000 Dec. 31

450,000

Dec.

Cash Dividends 43,800 Dec. 31

43,800

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-4A (Continued) 2. Jan.

22 Cash Dividends Payable [(375,000 shares – 25,000 shares) × $0.08] Cash

Apr.

June

July

Nov.

Dec.

28,000

10 Cash Common Stock (75,000 shares × $20) Paid-In Capital in Excess of Stated Value— Common Stock [75,000 shares × ($24 – $20)]

1,800,000

6 Cash (25,000 shares × $26) Treasury Stock (25,000 shares × $18) Paid-In Capital from Sale of Treasury Stock [25,000 shares × ($26 – $18)]

650,000

5 Stock Dividends [(375,000 shares + 75,000 shares) × 4% × $25] Stock Dividends Distributable (18,000 shares × $20) Paid-In Capital in Excess of Stated Value— Common Stock [18,000 shares × ($25 – $20)]

Aug.

28,000

1,500,000 300,000

450,000 200,000

450,000 360,000 90,000

15 Stock Dividends Distributable Common Stock

360,000

23 Treasury Stock (30,000 shares × $19) Cash

570,000

360,000

28 Cash Dividends [(375,000 shares + 75,000 shares + 18,000 shares – 30,000 shares) × $0.10] Cash Dividends Payable 31 Retained Earnings Stock Dividends Cash Dividends

570,000

43,800 43,800 493,800 450,000 43,800

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-4A (Concluded) 3. Morrow Enterprises Inc. Retained Earnings Statement For the Year Ended December 31, 20Y5 Retained earnings, January 1, 20Y5 Net income $1,125,000 Dividends: Cash dividends (43,800) Stock dividends (450,000) Increase in retained earnings Retained earnings, December 31, 20Y5

$33,600,000

631,200 $34,231,200

4. Stockholders’ Equity

Paid-in capital: Common stock, $20 stated value (500,000 shares authorized, 468,000 shares issued) Excess over stated value Paid-in capital, common stock From sale of treasury stock Total paid-in capital Retained earnings Treasury stock (30,000 shares at cost) Total stockholders’ equity

$9,360,000 1,215,000 $10,575,000 200,000 $10,775,000 34,231,200 (570,000) $44,436,200

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-5A Jan.

5 No entry required. The stockholders’ ledger would be revised to record the increased number of shares held by each stockholder and the new par value.

Mar.

10 Treasury Stock (100,000 shares × $30) Cash

Apr.

30 Cash Dividends {(30,000 shares × $0.25) + [(4,000,000 shares – 100,000 shares) × $0.08]} Cash Dividends Payable

June 15 Cash Dividends Payable Cash

319,500 319,500

319,500

15 Cash Dividends {(30,000 shares × $0.25) + [(4,000,000 shares – 40,000 shares) × $0.08]} Cash Dividends Payable 15 Stock Dividends (39,600 shares × $35) Stock Dividends Distributable (39,600 shares × $5) Paid-In Capital in Excess of Par— Common Stock (39,600 shares × $30)

Dec.

3,000,000

319,500

Aug. 20 Cash (60,000 shares × $40) Treasury Stock (60,000 shares × $30) Paid-In Capital from Sale of Treasury Stock [60,000 shares × ($40 – $30)] Oct.

3,000,000

2,400,000 1,800,000 600,000

324,300 324,300 1,386,000 198,000 1,188,000

19 Cash Dividends Payable Cash

324,300

19 Stock Dividends Distributable Common Stock

198,000

324,300

198,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-1B 1. Year

Total Dividends

Year 1………… $ 42,500 Year 2………… 18,000 Year 3………… 223,500 Year 4………… 178,000 Year 5………… 222,000 Year 6………… 222,000

Preferred Dividends Per Total Share $ 42,500 18,000 179,500* 80,000 80,000 80,000

$0.85 0.36 3.59 1.60 1.60 1.60 $9.60

Common Dividends Per Total Share $ 0 $0.00 0 0.00 44,000 0.44 98,000 0.98 142,000 1.42 1.42 142,000 $4.26

* $179,500 = Year 1 dividends in arrears of $37,500 + Year 2 dividends in arrears of $62,000 + Year 3 current dividend of $80,000

Average annual dividend for preferred: $1.60 per share ($9.60 ÷ 6) Average annual dividend for common: $0.71 per share ($4.26 ÷ 6)

a. 1.6% ($1.60 ÷ $100) b. 14.2% ($0.71 ÷ $5)

Prob. 13-2B Oct.

9 Cash Mortgage Note Payable

1,500,000

17 Cash (20,000 shares × $126) Preferred Stock (20,000 shares × $120) Paid-In Capital in Excess of Par— Preferred Stock [20,000 shares × ($126 – $120)]

2,520,000

28 Building Land Common Stock (300,000 shares × $15) Paid-In Capital in Excess of Par— Preferred Stock [300,000 shares × ($16.50 – $15.00)]

4,150,000 800,000

1,500,000

2,400,000

120,000

4,500,000

450,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-3B a.

Treasury Stock (87,500 shares × $8) Cash

700,000

Cash (55,000 shares × $11) Treasury Stock (55,000 shares × $8) Paid-In Capital from Sale of Treasury Stock [55,000 shares × ($11 – $8)]

605,000

Cash (20,000 shares × $84) Preferred Stock (20,000 shares × $80) Paid-In Capital in Excess of Par—Preferred Stock [20,000 shares × ($84 – $80)]

1,680,000

Cash (400,000 shares × $13) Common Stock (400,000 shares × $9) Paid-In Capital in Excess of Par—Common Stock [400,000 shares × ($13 – $9)]

5,200,000

Cash (18,000 shares × $7.50) Paid-In Capital from Sale of Treasury Stock [18,000 shares × ($8.00 – $7.50)] Treasury Stock (18,000 shares × $8)

135,000

Cash Dividends Cash Dividends Payable

234,775 *

Cash Dividends Payable Cash

234,775

* Calculation of cash dividends: Beginning of year (a) (b) (c) (d) (e) Cash dividends per share Dividends paid in (f)

700,000

440,000 165,000

1,600,000 80,000

3,600,000 1,600,000

9,000 144,000

234,775

234,775 Outstanding Shares of Stock Preferred Stock Common Stock 60,000 shares 1,750,000 shares (87,500) 55,000 20,000 400,000 18,000 80,000 shares 2,135,500 shares × $1.60 × $0.05 $128,000 $106,775

Total dividends paid $234,775 ($128,000 + $106,775)

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-4B 1. and 2. Common Stock Jan. 1 Apr. 13 July 16 Dec. 31

Bal.

3,100,000 1,000,000 123,000 4,223,000

Paid-In Capital in Excess of Stated Value—Common Stock Jan. 1 Bal. 1,240,000 Apr. 13 600,000 June 14 61,500 Dec. 31 Bal. 1,901,500

Dec.

Jan. Oct. Dec.

Retained Earnings 248,068 Jan. 1 Dec. 31 Dec. 31

1 30 31

Bal. Bal.

Treasury Stock 288,000 Mar. 15 300,000 300,000

4,875,000 775,000 5,401,932

288,000

Paid-In Capital from Sale of Treasury Stock Mar. 15

36,000

123,000

July

Stock Dividends Distributable 123,000 June 14

June

Stock Dividends 184,500 Dec. 31

184,500

Dec.

Cash Dividends 63,568 Dec. 31

63,568

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-4B (Continued) 2. Jan.

Mar.

Apr.

June

July

Oct.

Dec.

15 Cash Dividends Payable [(620,000 shares – 48,000 shares) × $0.06] Cash

34,320 34,320

15 Cash (48,000 shares × $6.75) Treasury Stock (48,000 shares × $6.00) Paid-In Capital from Sale of Treasury Stock [48,000 shares × ($6.75 – $6.00)]

324,000

13 Cash (200,000 shares × $8) Common Stock (200,000 shares × $5) Paid-In Capital in Excess of Stated Value— Common Stock [200,000 shares × ($8 – $5)]

1,600,000

14 Stock Dividends [(620,000 shares + 200,000 shares) × 3% × $7.50] Stock Dividends Distributable (24,600 shares × $5) Paid-In Capital in Excess of Stated Value— Common Stock [24,600 shares × ($7.50 – $5.00)]

288,000 36,000

1,000,000 600,000

184,500 123,000

61,500

16 Stock Dividends Distributable Common Stock

123,000

30 Treasury Stock (50,000 shares × $6) Cash

300,000

30 Cash Dividends [(620,000 shares + 200,000 shares + 24,600 shares – 50,000 shares) × $0.08] Cash Dividends Payable 31 Retained Earnings Stock Dividends Cash Dividends

123,000

300,000

63,568 63,568 248,068 184,500 63,568

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-4B (Concluded) 3. Nav-Go Enterprises Inc. Retained Earnings Statement For the Year Ended December 31, 20Y3 Retained earnings, January 1, 20Y3 Net income $ 775,000 Dividends: Cash dividends (63,568) Stock dividends (184,500) Increase in retained earnings Retained earnings, December 31, 20Y3

$4,875,000

526,932 $5,401,932

4. Stockholders’ Equity

Paid-in capital: Common stock, $5 stated value (900,000 shares authorized, 844,600 shares issued) Excess over stated value Paid-in capital, common stock From sale of treasury stock Total paid-in capital Retained earnings Treasury stock (50,000 shares at cost) Total stockholders’ equity

$4,223,000 1,901,500 $6,124,500 36,000 $ 6,160,500 5,401,932 (300,000) $11,262,432

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

Prob. 13-5B Jan.

15 No entry required. The stockholders’ ledger would be revised to record the increased number of shares held by each stockholder and the new par value.

Mar.

1 Cash Dividends [(100,000 shares × $0.25) + (800,000 shares × $0.07)] Cash Dividends Payable

Apr.

30 Cash Dividends Payable Cash

May

81,000

Aug. 17 Cash (40,000 shares × $38) Treasury Stock (40,000 shares × $32) Paid-In Capital from Sale of Treasury Stock [40,000 shares × ($38 – $32)] 1 Cash Dividends {(100,000 shares × $0.25) + [(800,000 shares – 60,000 shares + 40,000 shares) × $0.09]} Cash Dividends Payable 1 Stock Dividends [(800,000 shares – 60,000 shares + 40,000 shares) × 1% × $40] Stock Dividends Distributable (7,800 shares × $30) Paid-In Capital in Excess of Par— Common Stock [7,800 shares × ($40 – $30)] Oct.

81,000 81,000

31 Treasury Stock (60,000 shares × $32) Cash

Sept.

81,000

1,920,000 1,920,000 1,520,000 1,280,000 240,000

95,200 95,200

312,000 234,000 78,000

31 Cash Dividends Payable Cash

95,200

31 Stock Dividends Distributable Common Stock

234,000

95,200

234,000

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

CASES & PROJECTS CP 13-1 Tommy is clearly acting unethically for several reasons. First, he is violating the company’s policy on stock purchases. This policy was established to ensure the fair and timely dissemination of information that gives all potential investors the same chance to participate in the stock price increases. The fact that he is purchasing the stock in partnership with his father does not get around the company policy. Second, Tommy has “inside information” that is not available to other potential investors. Purchasing the stock with knowledge of information that is not available to other investors is unethical. Ethical managers and accountants are honest and fair, which means that they do not attempt to profit from “inside information” that is not available publicly. Doing so would give them an unfair advantage to benefit from stock price increases. Trading on “inside information” is also a violation of federal securities laws, which is a crime punishable by fine and/or imprisonment.

CP 13-2 Lou and Shirley are behaving in a professional manner as long as full and complete information is provided to potential investors in accordance with federal regulations for the sale of securities to the public. If such information is provided, the marketplace will determine the fair value of the company’s stock.

CP 13-3 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1. Nike, Inc. 2. Oregon 3. Our principal business activity is the design, development, and worldwide marketing and selling of athletic footwear, apparel, equipment, accessories, and services. 4. $22,536 million 5. $12,724 million 6. $9,812 million ($22,536 million total assets – $12,724 million total liabilities) 7. $36,397 million 8. $1,933 million 9. Class A Common, 400 million authorized; Class B, 2,400 million authorized. Class A issued and outstanding, 329 million; Class B issued and outstanding, 1,272 million 10. Class A and Class B: No par 11. Basic earnings per share: $1.19 Diluted earnings per share: $1.17 12. $0.78 dividends per share

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

CP 13-4 Memo To: From: Re:

Matt Cengage A+ Student Fourth Quarter 20Y8 Cash Dividend

In order to declare a dividend prudently for the fourth quarter, the company must have a sufficient Retained Earnings balance from which to declare the dividend. On December 31, 20Y8, Motion Designs has a $4,630,000 balance in Retained Earnings. This balance is more than enough to cover the $90,000 declaration of the normal quarterly cash dividend of $0.50 per share. In addition, the company must have enough cash on hand to pay the dividend while meeting the remaining cash needs of the business. The company has a December 31, 20Y8, cash balance of $250,000, of which $100,000 is committed as the compensating balance under the loan agreement. This leaves only $150,000 to pay the dividend of $90,000 and finance normal operations. Unless the cash balance can be expected to increase significantly in early 20Y9, it is questionable whether the company’s cash balance is large enough to both pay the cash dividend and provide for the company’s near-term operating needs. Before declaring a dividend, the company should also consider its working capital and the effect of plant expansion on the current ratio requirement of the loan. On December 31, 20Y8, the company has working capital of $5,000,000 ($7,000,000 – $2,000,000), resulting in a current ratio of 3.5. However, after deducting the $3,000,000 committed to store modernization and product-line expansion, the ratio drops to 2 ($4,000,000 ÷ $2,000,000). If a cash dividend is declared and paid, the current ratio will further drop to 1.955 ($3,910,000 ÷ $2,000,000), which would violate the loan agreement. In addition, working capital commitments and potential near-term capital expenditures could further deplete the company’s working capital. As a result, I advise the company to forgo the declaration of a cash dividend in the fourth quarter of 20Y8, as this would likely result in the company violating the terms of the loan.

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

CP 13-5 At the time of this decision, the WorldCom board had come under intense scrutiny. This was the largest loan by a company to its CEO in history. The SEC began an investigation into this loan, and Bernie Ebbers was eventually terminated as the CEO, with this loan being cited as part of the reason. The board indicated that the decision to lend Ebbers this money was to keep him from selling his stock and depressing the share price. Thus, it claimed that it was actually helping shareholders by keeping these shares from being sold. However, this argument wasn’t well received, given that the share price dropped from around $15 per share at the time of the loan to about $2.50 per share when Ebbers was terminated. In addition, critics were scornful of the low “sweetheart” interest rate given to Ebbers for this loan. In addition, many critics viewed the loan as risky, given that it was not supported by any personal assets. WorldCom later entered bankruptcy, Ebbers went to prison, and the Ebbers loan went uncollected. Some press comments: 1.

When he borrowed money personally, he used his WorldCom stock as collateral. As these loans came due, he was unwilling to sell at “depressed prices” of $10 to $15 (it’s now around $2.50). So WorldCom lent him the money to consolidate his loans, to the tune of $366 million. How a board of directors, representing you and me at the table, allowed this to happen is beyond comprehension. They should resign with Bernie. (Source: Andy Kessler, “Bernie Bites the Dust,” Wall Street Journal, May 1, 2002, p. A18.)

It was astonishing to read the other day that the board of directors of the United States’ second-largest telecommunications company claims to have had its shareholders’ interests in mind when it agreed to grant more than $430 million in low-interest loans to the company’s CEO, mainly to meet margin calls on his stock. Yet that’s the level to which fiduciary responsibility seems to have sunk on the board of Clinton, Mississippi-based WorldCom, the deeply troubled telecom giant, as it sought to bail Bernard Ebbers out of the folly of speculating in shares of WorldCom itself. Sadly, WorldCom is hardly alone. “The very essence of why Mr. Ebbers was granted a loan was to protect shareholder value,” said a WorldCom spokesman in mid-March, just as the U.S. Securities & Exchange Commission was unfurling a probe of the loan and 23 other matters related to WorldCom’s finances. Yes, folks, you read that right. On March 14, 2002, a spokesman for a publicly traded, $20 billion company actually stood up and declared that of all the uses to which the company could have put almost half-a-billion dollars, the

CHAPTER 13

Corporations: Organization, Stock Transactions, and Dividends

CP 13-5 (Concluded) best one by far—at least from the point of view of the shareholders—was to spend it on some sort of stock-parking scheme in order to keep the CEO out of bankruptcy court . (Source: Christopher Byron, “Bernie’s Bad Idea,” Red Herring , April 16, 2002.) Note to Instructors: Bernie Ebbers is currently serving a 25-year prison sentence for conspiracy and securities fraud and for making false statements to securities regulators. CP 13-6 1.

This case involves a transaction in which a security has been issued that has characteristics of both stock and debt. The primary argument for classifying the issuance of the common stock as debt is that the investors have a legal right to an amount equal to the purchase price (face value) of the security. This is similar to a note payable or a bond payable. The additional $120 payment could be argued to be equivalent to an interest payment, whose payment has been deferred until a later date. Arguments against classifying the security as debt include the fact that the investors will not receive fixed “annual” interest payments. In fact, if Epstein Engineering Inc. does not generate any sales, the investors do not have a right to receive any payments. One could argue that the payments of 5% of sales are, in substance, a method of redeeming the stock. As indicated in the case, the stockholders must surrender their stock for $120 per share after the $25 million payment has been made. Overall, the arguments would seem to favor classifying the security as common stock.

In practice, the $25 million stock issuance would probably be classified as common stock. However, full disclosure should be made of the 5% of sales and $120 per share payment obligations in the notes to the financial statements. In addition, as Epstein Engineering Inc. generates sales, a current liability should be recorded for the payment to stockholders. Such payments would be classified as dividend payments rather than interest payments. Dan Fisher should also investigate whether such payments might violate any loan agreements with the banks. Banks often restrict dividend payments in loan agreements. If such an agreement has been violated, Epstein Engineering Inc. should notify the bank immediately and request a waiver of the violation.

CHAPTER 14 LONG-TERM LIABILITIES: BONDS AND NOTES DISCUSSION QUESTIONS 1.

Two distinct obligations are incurred by a corporation when issuing bonds: (1) To pay the face (maturity) amount of the bonds at a specified date. (2) To pay periodic interest at a specified percentage of the face amount.

Convertible bonds are bonds that may be exchanged for shares of stock under specified conditions.

Callable bonds give the issuing corporation the right to redeem the bonds before the the maturity date.

More than face amount. Because comparable bonds provide a market interest rate (11%) that is less than the rate on the bond being issued (12%), the bond will sell for more than its face amount (a premium) as the market’s means of equalizing the two interest rates.

Greater than $26,000,000

1. 2. 3. 4.

$26,000,000 7% 9% $26,000,000

Greater than the contract rate

Premium

$125,000 Premium

Premium on Bonds Payable

A loss of $50,000 [($5,000,000 × 0.98) – ($5,000,000 – $150,000)]

A mortgage note is an installment note that is secured by a pledge of the borrower’s assets. If the borrower fails to pay the note, the lender has the right to take possession of the pledged asset and sell it to pay off the debt.

A bond is an interest-bearing note that requires periodic interest payments and repayment of the face amount of the bonds at maturity. Bonds consist of two different components: (1) interest payments made periodically over the life of the bond and (2) the face amount that must be repaid at maturity. The periodic payments consist entirely of interest, and the final payment at maturity consists entirely of principal. Installment notes, on the other hand, have periodic payments that consist partially of interest and partially of principal. Each payment reduces the principal on the note so that at maturity the entire amount borrowed will have been repaid.

10.

As a current liability on the balance sheet

As a long-term liability on the balance sheet

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

PRACTICE EXERCISES PE 14-1A Plan 1

Plan 2

Earnings before bond interest and income tax…………

$ 400,000

Interest on bonds…………………………………………… Income before income tax………………………………… Income tax…………………………………………………… Net income…………………………………………………… Dividends on preferred stock……………………………… Available for dividends on common stock……………… Shares of common stock outstanding…………………… Earnings per share on common stock……………………

(150,000)1

(50,000)

$ 250,000 2 (100,000)

$ 350,000 (140,000) 4

$ 150,000 —

$ 210,000 (150,000) 5

$ 150,000 ÷ 300,0006

$ 60,000 ÷ 200,000 7

1 2 3 4 5 6 7

0.50

0.30

$3,000,000 × 5% $250,000 × 40% $1,000,000 × 5% $350,000 × 40% ($3,000,000 ÷ $20) × $1.00 ($3,000,000 ÷ $10 par) ($2,000,000 ÷ $10 par)

PE 14-1B Earnings before bond interest and income tax………… Interest on bonds…………………………………………… Income before income tax………………………………… Income tax…………………………………………………… Net income…………………………………………………… Dividends on preferred stock……………………………… Available for dividends on common stock……………… Shares of common stock outstanding…………………… Earnings per share on common stock…………………… 1 2 3 4 5 6 7

Plan 1

Plan 2

$3,000,000 (600,000)1

$ 3,000,000 (375,000) 3

$2,400,000 (960,000)2

$ 2,625,000 (1,050,000) 4

$1,440,000 —

$ 1,575,000 (450,000) 5

$1,440,000 ÷ 300,0006

$ 1,125,000 ÷ 187,500 7

4.80

6.00

$6,000,000 × 10% $2,400,000 × 40% $3,750,000 × 10% $2,625,000 × 40% ($4,500,000 ÷ $25) × $2.50 ($6,000,000 ÷ $20) ($3,750,000 ÷ $20)

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

PE 14-2A a. Cash Bonds Payable

3,500,000

b. Interest Expense Cash

87,500

c. Bonds Payable Cash

3,500,000

87,500

3,500,000

PE 14-2B a. Cash Bonds Payable

700,000

b. Interest Expense Cash

21,000

c. Bonds Payable Cash

700,000

21,000

700,000

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

PE 14-3A Cash Discount on Bonds Payable Bonds Payable

1,725,151 74,849 1,800,000

PE 14-3B Cash Discount on Bonds Payable Bonds Payable

4,041,710 158,290 4,200,000

PE 14-4A Interest Expense Discount on Bonds Payable* Cash

61,485 7,485 54,000

* $74,849 ÷ 10 semiannual payments

PE 14-4B Interest Expense Discount on Bonds Payable* Cash

225,829 15,829 210,000

* $158,290 ÷ 10 semiannual payments

PE 14-5A Cash Premium on Bonds Payable Bonds Payable

8,932,035 332,035 8,600,000

PE 14-5B Cash Premium on Bonds Payable Bonds Payable

5,520,390 220,390 5,300,000

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

PE 14-6A Interest Expense Premium on Bonds Payable* Cash * $332,035 ÷ 10 semiannual payments

439,796 33,204 473,000

PE 14-6B Interest Expense Premium on Bonds Payable* Cash * $220,390 ÷ 10 semiannual payments

189,961 22,039 212,000

PE 14-7A Bonds Payable Loss on Redemption of Bonds Discount on Bonds Payable Cash

2,300,000 38,500 107,500 2,231,000

PE 14-7B Bonds Payable Premium on Bonds Payable Gain on Redemption of Bonds Cash

1,900,000 101,264 22,264 1,979,000

PE 14-8A a.

Cash Notes Payable Issued installment notes for cash.

89,000

Interest Expense Notes Payable Cash Paid principal and interest on installment notes.

5,340 15,788

89,000

21,128

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

PE 14-8B a.

Cash Notes Payable Issued installment notes for cash.

35,000

Interest Expense Notes Payable Cash Paid principal and interest on installment notes.

1,750 3,665

35,000

5,415

PE 14-9A a.

Current Year: Times interest earned:

$5,610,000 + $510,000 $510,000

= 12.0

$6,720,000 + $480,000 $480,000

= 15.0

Prior Year: Times interest earned: b.

The times interest earned ratio has decreased from 15.0 in the prior year to 12.0 currently. Although the company has adequate earnings to pay interest, the decline in this ratio may cause concern among debtholders.

PE 14-9B a.

Current Year: Times interest earned:

$4,212,000 + $270,000 $270,000

= 16.6

$3,450,000 + $250,000 $250,000

= 14.8

Prior Year: Times interest earned: b.

The times interest earned ratio has increased from 14.8 in the prior year to 16.6 currently. The increase in this ratio increases debtholders’ confidence in the company’s ability to make its interest payments.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

EXERCISES Ex. 14-1 Domanico Co. a.

Earnings before bond interest and income tax………………………… Bond interest………………………………………………………………… Balance………………………………………………………………………… Income tax…………………………………………………………………… Net income…………………………………………………………………… Dividends on preferred stock……………………………………………… Earnings available for common stock…………………………………… Shares of common stock outstanding…………………………………… Earnings per share on common stock…………………………………… Earnings before bond interest and income tax………………………… Bond interest………………………………………………………………… Balance………………………………………………………………………… Income tax…………………………………………………………………… Net income…………………………………………………………………… Dividends on preferred stock……………………………………………… Earnings available for common stock…………………………………… Shares of common stock outstanding…………………………………… Earnings per share on common stock…………………………………… Earnings before bond interest and income tax………………………… Bond interest………………………………………………………………… Balance………………………………………………………………………… Income tax…………………………………………………………………… Net income…………………………………………………………………… Dividends on preferred stock……………………………………………… Earnings available for common stock…………………………………… Shares of common stock outstanding…………………………………… Earnings per share on common stock……………………………………

$ 900,000 (300,000)* $ 600,000 (240,000) $ 360,000 (60,000)** $ 300,000 ÷ 200,000*** $

1.50

$1,100,000 (300,000)* $ 800,000 (320,000) $ 480,000 (60,000)** $ 420,000 ÷ 200,000 *** $ 2.10 $1,500,000 (300,000)* $1,200,000 (480,000) $ 720,000 (60,000)** $ 660,000 ÷ 200,000 *** $ 3.30

* $6,000,000 bonds payable × 5% interest ** ($3,000,000 preferred stock ÷ $100 par value) × $2 preferred dividend per share *** $5,000,000 common stock ÷ $25 par value

Ex. 14-2 Factors other than earnings per share that should be considered in evaluating financing plans include: bonds represent a fixed annual interest requirement, while dividends on stock do not; bonds require the repayment of principal, while stock does not; and common stock represents a voting interest in the ownership of the corporation, while bonds do not.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Ex. 14-3 Nike’s major source of financing is common stock. Nike has long-term debt; however, the amount is less than 40% of stockholders’ equity.

Ex. 14-4 The bonds were selling at a discount. This is indicated by the selling price of 77.00, which is stated as a percentage of the face amount and is less than par (100%). The market rate of interest for similar quality bonds was higher than 7.5%, and this is why the bonds were selling at a discount.

Ex. 14-5 May

Nov.

Dec.

1 Cash Bonds Payable

700,000

1 Interest Expense* Cash

31,500

31 Interest Expense** Interest Payable

10,500

700,000

31,500

10,500

* $700,000 × 9% × 6/12 ** $700,000 × 9% × 2/12

Ex. 14-6 a.

Cash Discount on Bonds Payable Bonds Payable

6,194,985 305,015 6,500,000

Interest Expense Discount on Bonds Payable* Cash**

252,918

Interest Expense Discount on Bonds Payable Cash

252,918

25,418 227,500

* $305,015 ÷ 12 semiannual payments ** $6,500,000 × 7% × 1/2

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Ex. 14-6 (Concluded) $455,000 50,836 $505,836

Annual interest paid ($6,500,000 × 7%)……………………………… Discount amortized ($25,418 × 2)……………………………………… Interest expense for first year…………………………………………

The bonds sell for less than their face amount because the market rate of interest is greater than the contract rate of interest. Investors are not willing to pay the full face amount for bonds that pay a lower contract rate of interest than the rate they could earn on similar bonds (market rate).

Ex. 14-7 a.

Apr.

Oct.

Cash Premium on Bonds Payable Bonds Payable

36,492,785

Interest Expense Premium on Bonds Payable* Cash**

1,075,721 149,279

1,492,785 35,000,000

1,225,000

* $1,492,785 ÷ 10 semiannual payments ** $35,000,000 × 7% × 1/2 c.

The bonds sell for more than their face amount because the market rate of interest is less than the contract rate of interest. Investors are willing to pay more for bonds that pay a higher rate of interest (contract rate) than the rate they could earn on similar bonds (market rate).

Ex. 14-8 20Y1 Mar.

Sept.

20Y5 Sept.

1 Cash Bonds Payable

11,000,000

1 Interest Expense* Cash

495,000

11,000,000

495,000

1 Bonds Payable Loss on Redemption of Bonds Cash**

11,000,000 110,000 11,110,000

* $11,000,000 × 9% × 1/2 ** $11,000,000 × 1.01

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Ex. 14-9 20Y1 May

Nov.

20Y5 Nov.

1 Cash Bonds Payable

15,000,000

1 Interest Expense* Cash

675,000

15,000,000

675,000

1 Bonds Payable Gain on Redemption of Bonds Cash**

15,000,000 600,000 14,400,000

* $15,000,000 × 9% × 1/2 ** $15,000,000 × 0.96

Ex. 14-10 a.

Cash Notes Payable

85,000

Interest Expense* Notes Payable Cash

5,950 9,822

85,000

15,772

* $85,000 × 7% b.

Notes payable are reported as liabilities on the balance sheet. The portion of the note payable that is due within one year is reported as a current liability. The remaining portion of the note payable that is not due within one year is reported as a long-term liability. For this company, the current and noncurrent portions of the note payable would be reported as follows:

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Ex. 14-10 (Concluded) Current liabilities: Notes payable*…………………………………………………………………………… $10,510 * The principal repayment portion of the next installment payment. See computation below.

Noncurrent liabilities: Notes payable**………………………………………………………………………… ** Original note payable…………………………………………………………………… Principal repayment from Year 1……………………………………………………… Note payable balance at the end of Year 1…………………………………………

$85,000 9,822

Annual payment on note……………………………………………………………… Second-year interest payment ($75,178 × 0.07)…………………………………… Principal repayment portion of next installment……………………………………

$15,772 5,262 $10,510

Note payable balance at the end of Year 1………………………………………… Current portion of note payable (due within one year)…………………………… Noncurrent portion of note payable…………………………………………………

$75,178 10,510

$64,668

$75,178

$64,668

Ex. 14-11 Year 1 Jan.

Dec.

Year 4 Dec.

1 Cash Notes Payable

170,000

31 Interest Expense Notes Payable Cash

13,600 28,978

31 Interest Expense Notes Payable* Cash

6,074 36,504

170,000

42,578

* $42,578 – $6,074

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Ex. 14-12 a.

Amortization of Installment Notes A Year Ending December 31 Year 1 Year 2 Year 3 Year 4

January 1 Note Carrying Payment Amount (Cash Paid)

Interest Expense (7% of January 1 Note Carrying Amount)

D Decrease in Notes Payable (B – C)

$147,750 114,473 78,866 40,767

$ 43,620 43,620 43,620 43,620

$10,343 (7% of $147,750) 8,013 (7% of $114,473) 5,521 (7% of $78,866) 2,853 *

$ 33,277 35,607 38,099 40,767

$174,480

$26,730

$147,750

E Dec. 31 Carrying Amount (A – D) $114,473 78,866 40,767 —

* Forced amount to bring carrying value to zero ($43,620 − $40,767). b.

Year 1 Jan.

Dec.

Year 2 Dec.

Year 3 Dec.

Year 4 Dec.

1 Cash Notes Payable

147,750

31 Interest Expense Notes Payable Cash

10,343 33,277

31 Interest Expense Notes Payable Cash

8,013 35,607

31 Interest Expense Notes Payable Cash

5,521 38,099

31 Interest Expense Notes Payable Cash

2,853 40,767

147,750

43,620

c. Interest expense of $10,343 would be reported on the income statement.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Ex. 14-13 1.

The significant loss on redemption of the Simmons Industries bonds should be reported in the Other Income and Expense section of the income statement, rather than as cost of merchandise sold.

The Hunter Corporation bonds outstanding at the end of the current year should be reported as a current liability on the balance sheet because they mature within one year.

Ex. 14-14 a.

Current Year: Times interest earned:

$3,164,000,000 + $131,000,000 = 25.2 $131,000,000

Prior Year: Times interest earned: b.

$3,265,000,000 + $114,000,000 = 29.6 $114,000,000

The times interest earned ratio has decreased from 29.6 in the prior year to 25.2 in the current year. Although Southwest Airlines had enough earnings to pay interest in both years, the decline in this ratio in the current year may cause some concern for debtholders.

Ex. 14-15 a.

Current Year: Times interest earned:

$310,500,000 + $13,500,000 = 24.0 $13,500,000

Prior Year: Times interest earned: b.

$432,000,000 + $16,000,000 = 28.0 $16,000,000

The times interest earned ratio has decreased from 28.0 in the prior year to 24.0 in the current year. Although Loomis has adequate earnings to pay interest, the decline in this ratio may cause concern among debtholders.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Ex. 14-16 a.

Current Year: Times interest earned ratio:

$3,500,000 + $5,000,000 $5,000,000

= 1.7

$6,000,000 + $5,000,000 $5,000,000

= 2.2

Prior Year: Times interest earned ratio: b.

The times interest earned ratio has decreased from 2.2 in the prior year to 1.7 in the current year. Although the company has enough earnings to pay interest in the current year, the decline is a concern to debtholders.

Appendix 1 Ex. 14-17 a.

$1,000,000 × 0.75131 = $751,310

Cash on hand today can be invested to earn interest income. If $751,310 is invested at 10%, it will be worth $1,000,000 at the end of three years.

Appendix 1 Ex. 14-18 a.

First Year: Second Year: Third Year: Fourth Year: Total present value

$200,000 × 3.38721 = $677,442*

$200,000 × 0.93458 = $186,916 $200,000 × 0.87344 = 174,688 $200,000 × 0.81630 = 163,260 $200,000 × 0.76290 = 152,580 $677,444

* $2 difference between a. and b. is due to rounding.

Cash on hand today can be invested to earn interest income. If each of the $200,000 receipts is invested at 7%, it will be worth $677,444 at the end of four years.

Appendix 1 Ex. 14-19 $6,000,000 × 7.36009 = $44,160,540

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Appendix 1 Ex. 14-20 No. The present value of your winnings using an interest rate of 10% is $36,867,420 ($6,000,000 × 6.14457), which is less than the present value of your winnings using an interest rate of 6% ($44,160,540; see Ex. 14-19). This is because the winnings are affected by the higher interest rate.

Appendix 1 Ex. 14-21 Present value of $1 for 10 semiannual periods at 4.5% semiannual rate………………………… Face amount of bonds……………………………………… Present value of an annuity of $1 for 10 periods at 4.5%……………………………………… Semiannual interest payment……………………………… Total present value (proceeds)……………………………

0.64393 $25,000,000 × 7.91272 * $875,000 ×

$16,098,250

6,923,630 $23,021,880

* $25,000,000 × 3.5%

Appendix 1 Ex. 14-22 Present value of $1 for 10 semiannual periods at 4.5% semiannual rate………………………… Face amount of bonds……………………………………… Present value of an annuity of $1 for 10 semiannual periods at 4.5% semiannual rate… Semiannual interest payment……………………………… Total present value (proceeds)……………………………

0.64393 $42,000,000 × 7.91272 * $2,310,000 ×

$27,045,060

18,278,383 $45,323,443

* $42,000,000 × 5.5%

Appendix 2 Ex. 14-23 a. 1.

Cash Discount on Bonds Payable Bonds Payable

43,495,895 6,504,105

Interest Expense* Discount on Bonds Payable Cash**

1,957,315

50,000,000

207,315 1,750,000

* $43,495,895 × 4.5% ** $50,000,000 × 3.5%

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Appendix 2 Ex. 14-23 (Concluded) 3.

Interest Expense* Discount on Bonds Payable Cash

1,966,644 216,644 1,750,000

* ($43,495,895 + $207,315) × 4.5% Note: The following data in support of the proceeds of the bond issue stated in the exercise are presented for the instructor’s information. Students are not required to make the computations. Present value of $1 for 20 semiannual periods at 4.5% semiannual rate…………………… Face amount of bonds………………………………… Present value of annuity of $1 for 20 semiannual periods at 4.5% semiannual rate………………………………………… Semiannual interest payment………………………… Total present value (proceeds)…………………………

0.41464 × $50,000,000

13.00794 × $1,750,000*

$20,732,000

22,763,895 $43,495,895

* $50,000,000 × 3.5% b.

Annual interest paid…………………………………………………………… Discount amortized*…………………………………………………………… Interest expense for first year………………………………………………

$3,500,000 423,959 $3,923,959

* $207,315 + $216,644 c.

Appendix 2 Ex. 14-24 a.

Cash Premium on Bonds Payable Bonds Payable

23,829,684 1,829,684 22,000,000

Interest Expense* Premium on Bonds Payable Cash**

834,039 155,961 990,000

* $23,829,684 × 3.5% ** $22,000,000 × 4.5% 3.

Interest Expense* Premium on Bonds Payable Cash

828,580 161,420 990,000

* ($23,829,684 – $155,961) × 3.5%

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Appendix 2 Ex. 14-24 (Concluded) b.

Annual interest paid……………………………………………………………… $1,980,000 (317,381) Premium amortized*……………………………………………………………… $1,662,619 Interest expense for first year………………………………………………… * $155,961 + $161,420

Appendix 1 and Appendix 2 Ex. 14-25 a.

Present value of $1 for 10 semiannual periods at 5% semiannual rate……………………… 0.61391 $35,000,000 Face amount of bonds…………………………………… ×

$21,486,850

Present value of an annuity of $1 for 10 semiannual periods at 5% semiannual rate………… 7.72173 $2,100,000 16,215,633 Semiannual interest payment…………………………… × Proceeds of bond sale…………………………………………………………… $37,702,483 b.

First semiannual interest payment…………………………………………… $ 2,100,000 (1,885,124) 5% of carrying amount of $37,702,483……………………………………… Premium amortized……………………………………………………………… $ 214,876

Second semiannual interest payment………………………………………… $ 2,100,000 (1,874,380) 5% of carrying amount of $37,487,607*……………………………………… Premium amortized……………………………………………………………… $ 225,620 * $37,702,483 – $214,876

Annual interest paid……………………………………………………………… $4,200,000 (440,496) Premium amortized*……………………………………………………………… $3,759,504 Interest expense for first year………………………………………………… * $214,876 + $225,620

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Appendix 1 and Appendix 2 Ex. 14-26 a.

Present value of $1 for 10 semiannual periods at 6.0% semiannual rate……………………… 0.55839 Face amount of bonds……………………………………… × $80,000,000

$44,671,200

Present value of an annuity of $1 for 10 semiannual periods at 6.0% semiannual rate……………………… 7.36009 26,496,324 Semiannual interest payment…………………………… × $3,600,000 * Proceeds of bond sale…………………………………………………………… $71,167,524 * $80,000,000 × 4.5% b.

6.0% of carrying amount of $71,167,524……………………………………… $ 4,270,051 First semiannual interest payment…………………………………………… (3,600,000) Discount amortized……………………………………………………………… $ 670,051

6.0% of carrying amount of $71,837,575*…………………………………… $ 4,310,255 Second semiannual interest payment………………………………………… (3,600,000) Discount amortized……………………………………………………………… $ 710,255 * $71,167,524 + $670,051

Annual interest paid……………………………………………………………… $7,200,000 Discount amortized*……………………………………………………………… 1,380,306 Interest expense for first year………………………………………………… $8,580,306 * $670,051 + $710,255

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

PROBLEMS Prob. 14-1A 1. Earnings before interest and income tax…… Interest on bonds……………………………… Income before income tax……………………… Income tax………………………………………… Net income……………………………………… Dividends on preferred stock………………… Available for dividends on common stock… Shares of common stock outstanding……… Earnings per share on common stock……… 2. Earnings before interest and income tax…… Interest on bonds……………………………… Income before income tax……………………… Income tax………………………………………… Net income……………………………………… Dividends on preferred stock………………… Available for dividends on common stock… Shares of common stock outstanding……… Earnings per share on common stock………

Plan 1

Plan 2

Plan 3

$2,100,000 —

$2,100,000 (720,000)1

$2,100,000 (840,000)

$1,380,000 (552,000)

$1,260,000 —

$1,260,000 (360,000)

$ 828,000 (180,000)

$1,260,000 ÷1,800,000 2 $ 0.70

$ 900,000 ÷ 900,0003 $ 1.00

$ 648,000 ÷ 450,000 4 $ 1.44

Plan 1

Plan 2

Plan 3

$1,050,000 —

$1,050,000 (720,000)1

$1,050,000 (420,000)

$ 330,000 (132,000)

$ 630,000 —

$ 630,000 (360,000)

$ 198,000 (180,000)

$ 630,000 ÷1,800,0002 $ 0.35

$ 270,000 ÷ 900,0003 $ 0.30

$ 18,000 ÷ 450,0004 $ 0.04

1 $9,000,000 × 8% 2 $18,000,000 ÷ $10 par 3 $9,000,000 ÷ $10 par 4 $4,500,000 ÷ $10 par

3. The principal advantage of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal, and a payment of preferred dividends is not required. It is also more attractive to common shareholders than is Plan 2 or 3 if earnings before interest and income tax is $1,050,000. In this case, it has the largest EPS ($0.35). The principal disadvantage of Plan 1 is that, if earnings before interest and income tax is $2,100,000, it offers the lowest EPS ($0.70) on common stock. The principal advantage of Plan 3 is that less investment would need to be made by common shareholders. Also, it offers the largest EPS ($1.44) if earnings before interest and income tax is $2,100,000. Its principal disadvantage is that the bonds carry a fixed annual interest charge and require the payment of principal. It also requires a dividend payment to preferred stockholders before a common dividend can be paid. Finally, Plan 3 provides the lowest EPS ($0.04) if earnings before interest and income tax is $1,050,000. Plan 2 provides a middle ground in terms of the advantages and disadvantages described in the preceding paragraphs for Plans 1 and 3. 14-19 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-2A 1.

Year 1 July

1 Cash Discount on Bonds Payable Bonds Payable

Year 1 Dec.

31 Interest Expense Discount on Bonds Payable* Cash**

16,661,102 1,338,898 18,000,000

516,945 66,945 450,000

* $1,338,898 ÷ 20 semiannual payments ** $18,000,000 × 5% × 1/2 b.

Year 2 June

30 Interest Expense Discount on Bonds Payable* Cash

516,945 66,945 450,000

* $1,338,898 ÷ 20 semiannual payments 3.

$516,945 = $450,000 + $66,945

Yes. Investors will not be willing to pay the face amount of the bonds when the interest payments they will receive from the bonds are less than the amount of interest that they could receive from investing in other bonds of a similar risk.

Present value of $1 for 20 semiannual 0.55368 periods at 3.0% semiannual rate……………………… Face amount of bonds…………………………………… × $18,000,000

$ 9,966,240

Present value of annuity of $1 for 20 semiannual periods at 3.0% semiannual rate……… Semiannual interest payment…………………………… Proceeds of bond issue……………………………………

6,694,862 $16,661,102

14.87747 × $450,000

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-3A 1.

Year 1 July

1 Cash Premium on Bonds Payable Bonds Payable

Year 1 Dec. 31 Interest Expense Premium on Bonds Payable* Cash**

33,546,022 1,546,022 32,000,000

1,151,165 128,835 1,280,000

* $1,546,022 ÷ 12 seminannual payments ** $32,000,000 × 8% × 1/2

Year 2 June 30 Interest Expense Premium on Bonds Payable* Cash

1,151,165 128,835 1,280,000

* $1,546,022 ÷ 12 semiannual payments 3.

$1,151,165 = $1,280,000 – $128,835

Yes. Investors will be willing to pay more than the face amount of the bonds when the interest payments they will receive from the bonds exceed the amount of interest that they could receive from investing in other bonds of a similar risk.

Present value of $1 for 12 semiannual periods at 3.5% semiannual rate…………………… 0.66178 Face amount of bonds…………………………………… × $32,000,000

$21,176,960

Present value of annuity of $1 for 12 semiannual periods at 3.5% semiannual rate… Semiannual interest payment………………………… Proceeds of bond issue…………………………………

12,369,062 $33,546,022

9.66333 × $1,280,000

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-4A 1.

Year 1 July

Oct.

Dec.

Year 2 June

Sept.

Dec.

Year 3 June

1 Cash Discount on Bonds Payable Bonds Payable

63,532,267 10,467,733 74,000,000

1 Cash Notes Payable

200,000

31 Interest Expense Interest Payable

3,000

200,000

3,000

31 Interest Expense Discount on Bonds Payable Cash

4,331,693

30 Interest Expense Discount on Bonds Payable Cash

4,331,693

261,693 * 4,070,000

261,693 * 4,070,000 **

30 Interest Expense Interest Payable Notes Payable Cash

9,000 3,000 28,673

31 Interest Expense Interest Payable

2,570

40,673

2,570

31 Interest Expense Discount on Bonds Payable Cash

4,331,693

30 Bonds Payable Loss on Redemption of Bonds Discount on Bonds Payable Cash***

74,000,000 7,940,961

261,693 * 4,070,000 **

9,420,961 72,520,000

* $10,467,733/40 ** $74,000,000 × 11% × 1/2 *** $74,000,000 × 0.98

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-4A (Concluded) Year 3 Sept.

30 Interest Expense Interest Payable Notes Payable Cash

7,710 2,570 30,393 40,673

a. b.

Year 1: $4,334,693 ($3,000 + $4,331,693) Year 2: $8,674,956 ($4,331,693 + $9,000 + $2,570 + $4,331,693)

Initial carrying amount of bonds…………………………………………… $63,532,267 Discount amortized on December 31, Year 1……………………………… 261,693 Discount amortized on June 30, Year 2…………………………………… 261,693 261,693 Discount amortized on December 31, Year 2……………………………… Carrying amount of bonds, December 31, Year 2………………………… $64,317,346

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Appendix 1 and Appendix 2 Prob. 14-5A 1.

Year 1 July

1 Cash Discount on Bonds Payable Bonds Payable

Year 1 Dec.

31 Interest Expense* Discount on Bonds Payable Cash

16,661,102 1,338,898 18,000,000

499,833 49,833 450,000

* $16,661,102 × 3.0%

Year 2 June

30 Interest Expense* Discount on Bonds Payable Cash

501,328 51,328 450,000

* ($16,661,102 + $49,833) × 3.0%

$499,833

Appendix 1 and Appendix 2 Prob. 14-6A 1.

Year 1 July

1 Cash Premium on Bonds Payable Bonds Payable

Year 1 Dec.

31 Interest Expense* Premium on Bonds Payable Cash

33,546,022 1,546,022 32,000,000

1,174,111 105,889 1,280,000

* $33,546,022 × 3.5%

Year 2 June

30 Interest Expense* Premium on Bonds Payable Cash

1,170,405 109,595 1,280,000

* ($33,546,022 – $105,889) × 3.5%

$1,174,111

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-1B 1.

Plan 1

Plan 2

Plan 3

Earnings before interest and income tax……… $10,000,000 — Interest on bonds………………………………

$10,000,000 —

$10,000,000 1 (3,600,000)

Income before income tax………………………… $10,000,000 Income tax……………………………………… (4,000,000)

$10,000,000 (4,000,000)

$ 6,400,000 (2,560,000)

Net income…………………………………………… $ 6,000,000 — Dividends on preferred stock…………………… Available for dividends on common stock…… $ 6,000,000 2 Shares of common stock outstanding………… ÷ 4,000,000

$ 6,000,000 (2,000,000)

$ 3,840,000 (1,000,000)

$ 4,000,000 ÷ 2,000,0003

$ 2,840,000 ÷ 1,000,000 4

Earnings per share on common stock………… $

1.50 Plan 1

2.00

2.84

Plan 2

Plan 3

Earnings before interest and income tax……… $ 6,000,000 — Interest on bonds………………………………

$ 6,000,000 —

$ 6,000,000 (3,600,000)1

Income before income tax………………………… $ 6,000,000 Income tax……………………………………… (2,400,000)

$ 6,000,000 (2,400,000)

$ 2,400,000 (960,000)

Net income…………………………………………… $ 3,600,000 — Dividends on preferred stock…………………… Available for dividends on common stock…… $ 3,600,000 2 Shares of common stock outstanding………… ÷ 4,000,000

$ 3,600,000 (2,000,000)

$ 1,440,000 (1,000,000)

$ 1,600,000 ÷ 2,000,000 3

$ 440,000 ÷ 1,000,000 4

Earnings per share on common stock…………

0.90

0.80

0.44

1 $40,000,000 × 9% 2 $80,000,000 ÷ 20 par 3 $40,000,000 ÷ $20 par 4 $20,000,000 ÷ $20 par

3. The principal advantage of Plan 1 is that it involves only the issuance of common stock, which does not require a periodic interest payment or return of principal, and a payment of preferred dividends is not required. It is also more attractive to common shareholders than is Plan 2 or 3 if earnings before interest and income tax is $6,000,000. In this case, it has the largest EPS ($0.90). The principal disadvantage of Plan 1 is that, if earnings before interest and income tax is $10,000,000, it offers the lowest EPS ($1.50) on common stock. The principal advantage of Plan 3 is that less investment would need to be made by common shareholders. Also, it offers the largest EPS ($2.84) if earnings before interest and income tax is $10,000,000. Its principal disadvantage is that the bonds carry a fixed annual interest charge and require the payment of principal. It also requires a dividend payment to preferred stockholders before a common dividend can be paid. Finally, Plan 3 provides the lowest EPS ($0.44) if earnings before interest and income tax is $6,000,000. Plan 2 provides a middle ground in terms of the advantages and disadvantages described in the preceding paragraphs for Plans 1 and 3.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-2B 1.

Year 1 July

1 Cash Discount on Bonds Payable Bonds Payable

Year 1 Dec.

31 Interest Expense Discount on Bonds Payable* Cash**

42,309,236 3,690,764 46,000,000

2,392,269 92,269 2,300,000

* $3,690,764 ÷ 40 semiannual payments ** $46,000,000 × 10% × 1/2

Year 2 June

30 Interest Expense Discount on Bonds Payable* Cash

2,392,269 92,269 2,300,000

* $3,690,764 ÷ 40 semiannual payments

$2,392,269 = $2,300,000 + $92,269

Present value of $1 for 40 semiannual 0.11746 periods at 5.5% semiannual rate……………………… Face amount of bonds…………………………………… × $46,000,000

$ 5,403,160

Present value of an annuity of $1 for 40 semiannual periods at 5.5% semiannual rate……… Semiannual interest payment…………………………… Proceeds of bond issue…………………………………

36,906,076 $42,309,236

16.04612 × $2,300,000

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-3B 1.

Year 1 July

Year 1 Dec.

Cash Premium on Bonds Payable Bonds Payable

73,100,469

3,494,977 405,023

Interest Expense Premium on Bonds Payable* Cash**

8,100,469 65,000,000

3,900,000

* $8,100,469 ÷ 20 semiannual periods ** $65,000,000 × 12% × 1/2

Year 2 June

Interest Expense Premium on Bonds Payable* Cash

3,494,977 405,023 3,900,000

* $8,100,469 ÷ 20 semiannual periods 3.

$3,494,977 = $3,900,000 – $405,023

Present value of $1 for 20 semiannual 0.37689 periods at 5% semiannual rate……………………… Face amount of bonds………………………………… × $65,000,000

$24,497,850

Present value of an annuity of $1 for 20 semiannual periods at 5% semiannual rate……… Semiannual interest payment………………………… Proceeds of bond issue………………………………

48,602,619 $73,100,469

12.46221 × $3,900,000

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-4B 1.

Year 1 July

Oct.

Dec.

Year 2 June

Sept.

Dec.

Year 3 June

1 2 3 4

1 Cash Premium on Bonds Payable Bonds Payable

85,659,600 10,659,600 75,000,000

1 Cash Notes Payable

270,000

31 Interest Expense Interest Payable

5,400

270,000

5,400

31 Interest Expense Premium on Bonds Payable Cash

2,842,020 532,9801

30 Interest Expense Premium on Bonds Payable Cash

2,842,020 532,980

3,375,000 2

3,375,000

30 Interest Expense Interest Payable Notes Payable Cash

16,200 5,400 36,805

31 Interest Expense Interest Payable

4,664

58,405

4,664

31 Interest Expense Premium on Bonds Payable Cash

2,842,020 532,980

30 Bonds Payable Premium on Bonds Payable Gain on Redemption of Bonds Cash

75,000,000 8,527,680

3,375,000

6,277,680 3 77,250,000 4

$10,659,600 ÷ 20 $75,000,000 × 9% × 1/2 $75,000,000 + $8,527,680 – $77,250,000 $75,000,000 × 1.03

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Prob. 14-4B (Concluded) Year 3 Sept.

30 Interest Expense Interest Payable Notes Payable Cash

13,992 4,664 39,749 58,405

a. b.

Year 1: $2,847,420 ($5,400 + $2,842,020) Year 2: $5,704,904 ($2,842,020 + $16,200 + $4,664 + $2,842,020)

Initial carrying amount of bonds…………………………………………… $85,659,600 Premium amortized on December 31, Year 1…………………………… (532,980) (532,980) Premium amortized on June 30, Year 2…………………………………… (532,980) Premium amortized on December 31, Year 2…………………………… Carrying amount of bonds, December 31, Year 2……………………… $84,060,660

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

Appendix 1 and Appendix 2 Prob. 14-5B 1.

Year 1 July

1 Cash Discount on Bonds Payable Bonds Payable

Year 1 Dec.

31 Interest Expense* Discount on Bonds Payable Cash

42,309,236 3,690,764 46,000,000

2,327,008 27,008 2,300,000

* $42,309,236 × 5.5%

Year 2 June

30 Interest Expense* Discount on Bonds Payable Cash

2,328,493 28,493 2,300,000

* ($42,309,236 + $27,008) × 5.5%

$2,327,008

Appendix 1 and Appendix 2 Prob. 14-6B 1.

Year 1 July

1 Cash Premium on Bonds Payable Bonds Payable

Year 1 Dec.

31 Interest Expense* Premium on Bonds Payable Cash

73,100,469 8,100,469 65,000,000

3,655,023 244,977 3,900,000

* $73,100,469 × 5%

Year 2 June

30 Interest Expense* Premium on Bonds Payable Cash

3,642,775 257,225 3,900,000

* ($73,100,469 – $244,977) × 5%

$3,655,023

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

CASES & PROJECTS CP 14-1 CEG’s actions were technically legal, and did not violate any laws. However, this action could damage the company’s reputation. If investors perceive that the company is not acting fairly in its dealings with investors, the company may find it difficult to issue additional debt in the future. This case is based on a real-world situation, where GE Capital, a division of General Electric, announced a follow-up long-term bond issue within days of an initial debt issue. The company’s actions created a significant public relations problem for the company. Here are some of the reactions from investors: “A lot of people feel like they have been sorely used,” said one bond fund manager. “There was nothing illegal about it, but it was nasty.” “But then to find out two days later that they had filed a $50 billion shelf?” he said. “People buy GE because it’s like buying Treasuries, not because they want to get jerked around.” “An example of a lack of candor. It was the most recent and most egregious example of how bondholders are mistreated.” In response to the criticisms, GE Capital released the following public statement: “With the $11 billion bond issuance of March 13, GE Capital exhausted its existing debt shelf registration; consequently, on March 20, GE Capital filed a $50 billion shelf registration.” The release went on to indicate that the shelf filing was not an offering and that it would be used in part to roll over $31 billion in maturing long-term debt. In retrospect, GE Capital could have been a little more forthcoming about its financing plans prior to selling the $11 billion of bonds, but there was nothing unethical or illegal about its actions.

CP 14-2 A sample solution based on Nike Inc.’s Form 10-K for the fiscal year ended May 31, 2018, follows: 1. a. $3,468 million (balance sheet) b. Yes. See table below. (Dollar amounts are in millions.) In addition to these five bonds, the company reports Japanese yen notes that are not included in the table. (1)

Due Date

(2) Contract Rate

(3) Face Amount

(4) Book Value

5/1/2023 11/1/2026 5/1/2043 11/1/2045 11/1/2046

2.25% 2.38% 3.63% 3.88% 3.38%

$ 500 1,000 500 1,000 500

$498 994 495 982 490

The company has very little long-term debt relative to total assets and net income. 14-31 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

CP 14-3 To: From: Re:

Liz Nolan A+ Student Bond redemption

I have reviewed the proposed redemption of the company’s 7% bonds and the subsequent issuance of new 5% bonds and have concluded that this is a good financial decision for the company. My assessment is based on a comparison of the redemption price to the proceeds from the new bond issuance and the interest savings from the new bond issue. The proceeds from the new 5% bond issue will be $30,000 less than what is needed to redeem the existing 7% bonds. The company will receive $1,000,000 from issuing the new 7% bonds at face amount, but will have to pay $1,030,000 ($1,000,000 × 103) to redeem the outstanding bonds. Thus, it will cost the company $30,000 to replace the existing 7% bonds with new 5% bonds. However, the new 5% bonds will pay less interest semiannually than the existing 7% bonds, resulting in interest savings of $100,000 over the next five years. These savings were calculated as follows:

Face amount…………………………………… × Contract rate of interest…………………… × Term…………………………………………… Semiannual interest payment………………

7% Bonds $1,000,000 7.0% 0.5

5% Bonds $1,000,000 5.0% 0.5

35,000

25,000

× Number of interest periods remaining…………………………………………… Total interest savings……………………………………………………………………

Interest Savings

$ 10,000 10 × $100,000

The interest savings of $100,000 are significantly larger than the $30,000 redemption premium, resulting in a $70,000 savings to the company. However, the company must also consider the impact of the time value of money on these savings. The $70,000 in interest savings occurs over the next five years, with the company saving $10,000 on every semiannual interest payment. Because these savings are in the future, they must be discounted back to today to determine their present value. Using the market rate of interest of 5%, the present value of these savings is calculated as follows: Semiannual interest savings………………………………………………………… Present value factor of an annuity of $1 at compound interest (n = 10, i = 5%)………………………………………………………………………… Present value of interest savings……………………………………………………

$10,000.00 × 7.72173

$77,217.30

On a present value basis, the company is saving $77,217.30 in interest costs, while paying a $30,000 redemption premium to repurchase the bonds. This results in a $47,217.30 savings to the company. The company should proceed with the plan.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

CP 14-4 Receive $100,000,000 today: Present value of $100,000,000 today = $100,000,000 Receive $25,000,000 today, plus $9,000,000 per year for 8 years: Present value of $25,000,000 today = $25,000,000 Present value of annual payments = $9,000,000 × 5.97130 (Present value of an annuity of $1 for 8 periods at 7%) = $53,741,700 Total value = Present value of $25,000,000 + Present value of annual payments Total value = $25,000,000 + $53,741,700 = $78,741,700 Receive $15,000,000 per year for 10 years: Present value of annual payments = $15,000,000 × 7.02358 (Present value of an annuity of $1 for 10 periods at 7%) = $105,353,700 The option that has the highest value in terms of present value is to receive $15,000,000 a year for 10 years.

CP 14-5 The primary advantage of issuing preferred stock rather than bonds is that the preferred stock does not obligate Xentec to pay dividends, while interest on bonds must be paid. The issuance of bonds will require annual interest payments, necessitating a periodic (probably semiannual) cash outflow. Given Sweeping Bluff Golf Course’s volatility of operating cash flows, the required interest payments might strain Xentec’s liquidity. In the extreme, this could even lead to a bankruptcy of Xentec. The issuance of bonds has the advantage of providing a tax deduction for interest expense. This would tend to reduce the net (after-tax) cost of the bonds. Probably the safest alternative is for Xentec to issue preferred stock. Of course, another alternative might be to issue a combination of preferred stock and bonds.

CHAPTER 14

Long-Term Liabilities: Bonds and Notes

CP 14-6 1.

Plan 1 400,000

Plan 2 950,000

Earnings before bond interest and income tax……… Interest on bonds………………………………………… Income before income tax……………………………… Income tax………………………………………………… Net income…………………………………………………

$5,000,000 2,080,000

$5,000,000 1,200,000

$2,920,000 1,168,000 $1,752,000

$3,800,000 1,520,000 $2,280,000

Earnings per share on common stock…………………

Shares of common stock…………………………………

4.38 *

2.40 **

* $1,752,000 ÷ 400,000 shares ** $2,280,000 ÷ 950,000 shares 2.

Factors to be considered in addition to earnings per share: 1.

There is a definite legal obligation to pay interest on bonds, but there is no definite commitment to pay dividends on common stock. Therefore, if net income should drop substantially, bonds would be less desirable than common stock.

If the bonds are issued, there is a definite commitment to repay the principal in 20 years. In case of liquidation, the claims of the bondholders would rank ahead of the claims of the common stockholders.

Present stockholders must purchase the new stock if they are to retain their proportionate control and financial interest in the corporation.

Because the net income has been relatively stable in the past and anticipated earnings under Plan 1 offer earnings per share of $4.38 for each share of common stock, Plan 1 appears to be somewhat more advantageous for stockholders.

CP 14-7 1.

Year 3: 2.3 =

$121,000 + $158,000 $121,000

Year 2: 5.8 =

$62,000 + $299,000 $62,000

Year 1: 6.7 =

$80,000 + $459,000 $80,000

The times interest earned ratio has decreased from Year 1 to Year 3. This was due to the company’s increasing interest expense and decreasing earnings during this period.

CHAPTER 15 INVESTMENTS DISCUSSION QUESTIONS 1.

A company may temporarily have excess cash that is not needed for use in its current operations. Instead of letting excess cash remain idle, most companies invest their excess cash in temporary investments. The primary objective of investing in temporary investments is as follows: a. Earn interest revenue b. Receive dividends c. Realize gains from increases in the market price of the securities

The equity method is used for equity investments representing more than 20% and less than 50% of the outstanding shares of the investee.

A dividend received for an equity investment of less than 20% ownership is recorded as dividend revenue. Under the equity method used for equity investments of between 20%–50% ownership, a dividend received is not recorded as dividend revenue but is recorded as a reduction in the book value of the investment.

An investment greater than 50% of the investee is considered to be an investment that has control over the investee (subsidiary). Thus, the financial statements of the investee (subsidiary) are consolidated (combined) with that of the investor (parent company).

A gain or loss can occur when the selling price of the bond differs from the book value of the bond. The price of bond investments can change due to changes in the market rate of interest. If the proceeds from the sale exceed the book value of the bonds, a gain is recorded.

Both portfolios are reported at fair value. However, changes in the fair value of trading securities during a period are reported as an unrealized gain or loss on the income statement. For available-forsale securities, changes in the fair value of the securities are reported in stockholders’ equity and, thus, are not recognized as part of net income.

A credit balance in Valuation Allowance for Trading Investments is subtracted from Trading Investments (at cost). The net amount is the trading investments at fair value.

A debit balance in Valuation Allowance for Available-for-Sale Investments is added to Availablefor-Sale Investments (at cost). The net reported amount is the available-for-sale securities at fair value.

A debit balance in Unrealized Gain (Loss) on Available-for-Sale Investments would be reported as a reduction in the Stockholders’ Equity section of the balance sheet, after Retained Earnings.

10.

When an asset is reported at its fair value, any difference between the asset’s original cost or prior period’s fair value must be recorded. A valuation allowance for investments account is used to record fair value for trading and available-for-sale securities. For available-for-sale securities, the unrealized gain or loss on changes in fair values is reported as part of stockholders’ equity. For trading securities, the unrealized gain or loss is reported as part of income.

CHAPTER 15

Investments

PRACTICE EXERCISES PE 15-1A Jan.

23 Investments—Aurora Company Stock Cash

375,150 * 375,150

* (15,000 shares × $25 per share) + $150

7,500 *

12 Cash Dividend Revenue

Apr.

7,500

* $0.50 per share × 15,000 shares

June

10 Cash Gain on Sale of Investments Investments—Aurora Company Stock

185,900 * 35,840 150,060**

* (6,000 shares × $31) – $100 ** 6,000 shares × ($375,150 ÷ 15,000 shares)

31 Valuation Allowance for Equity Investments Unrealized Gain on Equity Investments

Dec.

44,910 * 44,910

* (9,000 shares × $30) – ($375,150 – $150,060)

PE 15-1B Sept.

12 Investments—Denver Company Stock Cash

120,300 * 120,300

* (3,000 shares × $40 per share) + $300

Oct.

2,400 *

15 Cash Dividend Revenue

2,400

* $0.80 per share × 3,000 shares

Nov.

10 Cash Loss on Sale of Investments Investments—Denver Company Stock

57,450 * 6,710 64,160 **

* (1,600 shares × $36) – $150 ** 1,600 shares × ($120,300 ÷ 3,000 shares)

Dec.

31 Unrealized Loss on Equity Investments Valuation Allowance for Equity Investments

7,140 * 7,140

* ($120,300 – $64,160) – (1,400 shares × $35)

CHAPTER 15

Investments

PE 15-2A 20Y7 Jan.

Dec.

2 Investment in Violet Company Stock Cash

720,000

31 Investment in Violet Company Stock Income of Violet Company Recorded 30% of Violet Company income (30% × $190,000).

57,000

31 Cash Investment in Violet Company Stock

12,000*

720,000

57,000

12,000

* 30% × $40,000

20Y8 Jan.

31 Cash Gain on Sale of Violet Company Stock Investment in Violet Company Stock

770,000 5,000 765,000*

* $720,000 + $57,000 – $12,000

PE 15-2B 20Y4 Jan.

Dec.

2 Investment in Aloof Company Stock Cash

340,000

31 Investment in Aloof Company Stock Income of Aloof Company Recorded 40% of Aloof Company income, 40% × $180,000.

72,000

31 Cash Investment in Aloof Company Stock

4,000 *

340,000

72,000

4,000

* 40% × $10,000

20Y5 Jan.

31 Cash Loss on Sale of Aloof Company Stock Investment in Aloof Company Stock

405,000 3,000 408,000*

* $340,000 + $72,000 – $4,000

CHAPTER 15

Investments

PE 15-3A a.

Investments—Vasquez City Bonds Interest Receivable Cash

420,000 6,300

Cash Interest Receivable Interest Revenue

12,600 *

426,300

6,300 6,300

* $420,000 × 6% × 1/2

Cash Loss on Sale of Investments Interest Revenue Investments—Vasquez City Bonds

208,950 * 2,100 1,050 210,000

* Sales proceeds ($210,000 × 99%)…………………………

$207,900 1,050 Accrued interest……………………………………………… $208,950 Total proceeds from sale……………………………………

Cash Investments—Vasquez City Bonds

210,000 210,000

PE 15-3B a.

Investments—Hotline Inc. Bonds Interest Receivable Cash

180,000 1,500 181,500 4,500 *

Cash Interest Receivable Interest Revenue

1,500 3,000

* $180,000 × 5% × 1/2

92,550 *

Cash Interest Revenue Gain on Sale of Investments Investments—Hotline Inc. Bonds

750 1,800 90,000

* Sales proceeds ($90,000 × 102%)…………………………$91,800 750 Accrued interest……………………………………………… Total proceeds from sale……………………………………$92,550

Cash Investments—Hotline Inc. Bonds

90,000 90,000

CHAPTER 15

Investments

PE 15-4A 20Y3 Dec.

31 Unrealized Loss on Trading Investments Valuation Allowance for Trading Investments To record decrease in fair value of trading investments.

* Trading investments at fair value, December 31 …………………………… Less trading investments at cost, December 31 …………………………… Unrealized loss on trading investments………………………………………

37,000 * 37,000

$309,000 346,000 $ (37,000)

PE 15-4B 20Y9 Dec.

31 Valuation Allowance for Trading Investments Unrealized Gain on Trading Investments To record increase in fair value of trading investments.

* Trading investments at fair value, December 31 …………………………… Less trading investments at cost, December 31 …………………………… Unrealized gain on trading investments………………………………………

6,500 * 6,500

$79,100 72,600 $ 6,500

PE 15-5A 20Y5 Dec.

31 Unrealized Loss on Available-for-Sale Investments Valuation Allowance for Available-for-Sale Investments To record decrease in fair value of available-for-sale securities.

* Available-for-sale investments at fair value, December 31 ………………… Less available-for-sale investments at cost, December 31 ………………… Unrealized loss on available-for-sale investments……………………………

4,170 * 4,170

$39,120 43,290 $ (4,170)

PE 15-5B 20Y7 Dec.

31 Valuation Allowance for Available-for-Sale Investments Unrealized Gain on Available-for-Sale Investments To record increase in fair value of available-for-sale securities.

3,830 * 3,830

* Available-for-sale investments at fair value, December 31 ………………… $22,870 Less available-for-sale investments at cost, December 31 ………………… 19,040 Unrealized gain on available-for-sale investments………………………… $ 3,830

CHAPTER 15

Investments

PE 15-6A Dividend Yield = =

Dividends per Share of Common Stock Market Price per Share of Common Stock $8.00 $100.00

= 0.08, or 8%

PE 15-6B Dividend Yield =

Dividends per Share of Common Stock Market Price per Share of Common Stock $0.90 $60.00

= 0.015, or 1.5%

CHAPTER 15

Investments

EXERCISES Ex. 15-1 a.

Feb.

22 Investments—Jupiter Co. Stock Cash

850,680* 850,680

* (34,000 shares × $25) + $680

June

57,800*

1 Cash Dividend Revenue

57,800

* $1.70 × 34,000 shares

Nov.

12 Cash Gain on Sale of Investments Investments—Jupiter Co. Stock

216,900 * 41,760 175,140 **

* (7,000 shares × $31) – $100 ** ($850,680 ÷ 34,000 shares) × 7,000 shares

Dec.

31 Valuation Allowance for Equity Investments Unrealized Gain on Equity Investments

13,500 * 13,500

* 27,000 shares × ($25.52 – $25.02) $850,680 ÷ 34,000 shares = $25.02 per share

Ex. 15-2 Apr.

10 Investments—Delew Company Stock Cash

660,220* 660,220

* (11,000 shares × $60) + $220

July

9,350 *

8 Cash Dividend Revenue

9,350

* $0.85 per share × 11,000 shares

Sept.

10 Cash Loss on Sale of Investments Investments—Delew Company Stock

161,910 * 18,150 180,060**

* (3,000 shares × $54) – $90 ** 3,000 shares × ($660,220 ÷ 11,000 shares)

Dec.

31 Unrealized Loss on Equity Investments Valuation Allowance for Equity Investments

960* 960

* 8,000 shares × ($59.90 – $60.02) $660,220 ÷ 11,000 shares = $60.02 per share

CHAPTER 15

Investments

Ex. 15-3 Feb.

2 Investments—Celeste Inc. Stock Cash

99,324 * 99,324

* (3,100 shares × $32) + $124

Mar.

1,395*

6 Cash Dividend Revenue

1,395

* 3,100 shares × $0.45

June

7 Investments—Celeste Inc. Stock Cash

53,256* 53,256

* (1,400 shares × $38) + $56

July

26 Cash Gain on Sale of Investments Investments—Celeste Inc. Stock

163,900* 30,340 133,560**

* (4,000 shares × $41) – $100 ** 3,100 shares purchased……………………………………………………… 900 shares × ($53,256 ÷ 1,400 shares)……………………………………… Total cost…………………………………………………………………………

Sept.

$ 99,324 34,236 $133,560

310 *

25 Cash Dividend Revenue

310

* 500 shares × $0.62

Dec.

31 Valuation Allowance for Equity Investments Unrealized Gain on Equity Investments

1,700 * 1,700

* $20,720 – (500 shares × $38.04) $53,256 ÷ 1,400 shares = $38.04 per share

CHAPTER 15

Investments

Ex. 15-4 Feb.

85,150 *

24 Investments—Tett Co. Stock Cash

85,150

* (1,000 shares × $85) + $150

May

16 Investments—Issacson Co. Stock Cash

90,100 * 90,100

* (2,500 shares × $36) + $100

July

14 Cash Gain on Sale of Investments Investments—Tett Co. Stock

39,925* 5,865 34,060**

* (400 shares × $100) – $75 ** 400 shares × ($85,150 ÷ 1,000 shares)

Aug.

12 Cash Loss on Sale of Investments Investments—Issacson Co. Stock

24,295* 2,735 27,030**

* (750 shares × $32.50) – $80 ** 750 shares × ($90,100 ÷ 2,500 shares)

Oct.

240*

31 Cash Dividend Revenue

240

* (1,000 shares – 400 shares) × $0.40

Dec.

31 Valuation Allowance for Equity Investments Unrealized Gain on Equity Investments

120* 120

* 600 shares × ($85.35 – $85.15) $85,150 ÷ 1,000 shares = $85.15 per share

Ex. 15-5 a.

Investment in Tran Corp. Stock Income of Tran Corp. To record 35% share of Tran Corp. net income [$600,000 × (280,000 shares ÷ 800,000 shares)].

210,000

Cash Investment in Tran Corp. Stock

140,000 *

210,000

140,000

* 280,000 shares × $0.50

Herrera’s investment in Tran Corp. represents 35% of the outstanding shares of Tran Corp. An investment amount between 20% and 50% of the outstanding common stock of the investee is presumed to represent significant influence. The equity method is appropriate when the investor can exercise significant influence over the investee. 15-9 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 15

Investments

Ex. 15-6 a.

20Y4 Jan.

4 Investment in Silva Company Stock Cash

14,400,000 * 14,400,000

* 480,000 shares × $30 per share

July

2 Cash Investment in Silva Company Stock

300,000* 300,000

* $750,000 × (480,000 ÷ 1,200,000 shares)

Dec.

31 Investment in Silva Company Stock Income of Silva Company To record 40% share of Silva Company net income [$2,000,000 × (480,000 shares ÷ 1,200,000 shares)].

800,000 800,000

Initial acquisition cost…………………………………………………………… $14,400,000 800,000 Equity earnings for 20Y4………………………………………………………… (300,000) Cash dividends received………………………………………………………… Investment in Silva Company Stock balance, December 31, 20Y4……………………………………….…………………… $14,900,000

Ex. 15-7 a.

20Y8 Jan.

June

6 Investment in Gator Co. Stock Cash 30 Cash Investment in Gator Co. Stock

212,000 212,000 8,160* 8,160

* $24,000 × 34%

Dec.

31 Loss of Gator Co. Investment in Gator Co. Stock To record 34% share of Gator Co. net loss ($56,000 × 34%).

19,040

Initial acquisition cost…………………………………………………………… Equity loss for 20Y8……………………………………………………………… Cash dividends received………………………………………………………… Investment in Gator Co. Stock balance, December 31, 20Y8………………

19,040

$212,000 (19,040) (8,160) $184,800

CHAPTER 15

Investments

Ex. 15-7 (Concluded) c.

Under the equity method, the investor will record its proportionate share of the net increase (or decrease) of the book value of the investee resulting from earnings and dividend distributions. The fair value method uses market price information to value the investment in the investee. These two methods result in different valuations because the equity method is based on book accounting while the fair value approach uses market information. The two methods need not be related to each other over time. While changes in book value can influence market prices, many other variables can influence the market price of a stock.

Ex. 15-8 (in millions) Investment in Raven Company stock, December 31, 20Y5……………………… Plus equity earnings in Raven Company…………………………………………… Less dividends received*……………………………………………………………… Investment in Raven Company stock, December 31, 20Y6………………………

$264 25 (8) $281

* The Raven Company investment is accounted for under the equity method. Because there were no purchases or sales of Raven Company stock, a dividend must have been received. This would explain how the ending balance of the investment account went from $264 to $281, with $25 million in equity earnings. Because the investment is accounted for under the equity method, the fair value is not used for valuation purposes.

CHAPTER 15

Investments

Ex. 15-9 a.

May

Nov.

1 Investments—Marimar Co. Bonds Cash

150,000 150,000

1 Cash Interest Revenue $150,000 × 6% × 6/12.

4,500

1 Cash Loss on Sale of Investments Investments—Marimar Co. Bonds

53,900 * 1,100

4,500

55,000

* $55,000 × 98%

Dec.

950*

31 Interest Receivable Interest Revenue Accrued interest.

950

* ($150,000 – $55,000) × 6% × 2/12

Ex. 15-10 a.

20Y1 Oct.

20Y1 Dec.

20Y2 Apr.

1 Investments—Effenstein Corp. Bonds Cash

240,000

31 Interest Receivable Interest Revenue Accrued interest ($240,000 × 8% × 3/12).

4,800

1 Cash Interest Receivable Interest Revenue

9,600

240,000

4,800

4,800 4,800*

* $240,000 × 8% × 3/12

20Y2 Apr.

1 Cash Gain on Sale of Investments Investments—Effenstein Corp. Bonds

91,800 * 1,800 90,000

* $90,000 × 102%

20Y8 Oct.

1 Cash Investments—Effenstein Corp. Bonds

150,000 150,000

CHAPTER 15

Investments

Ex. 15-11 a.

Year 1 May

11 Investments—Lumpkin County Bonds Interest Receivable Cash

360,000 2,400 * 362,400

* $360,000 × 6% × 40 ÷ 360

Oct.

10,800 *

1 Cash Interest Receivable Interest Revenue

2,400 8,400

* $360,000 × 6% × 1/2

Oct.

31 Cash Loss on Sale of Investments Interest Revenue Investments—Lumpkin County Bonds

* Bond sale ($90,000 × 0.98)………………………………… Accrued interest ($90,000 × 6% × 30 ÷ 360)……………… Less brokerage commission……………………………… Total proceeds…………………………………………………

Dec.

88,450* 2,000 450 90,000

$88,200 450 (200) $88,450

4,095*

31 Interest Receivable Interest Revenue

4,095

* $270,000 × 6% × 91 ÷ 360

Year 20 Apr.

1 Cash Investments—Lumpkin County Bonds

270,000 270,000

CHAPTER 15

Investments

Ex. 15-12 Jan.

31 Investments—Government Bonds Interest Receivable Cash

75,000 375 * 75,375

* $75,000 × 6% × 30 ÷ 360

July

2,250 *

1 Cash Interest Receivable Interest Revenue

375 1,875

* $75,000 × 6% × 1/2

Aug.

30 Cash Loss on Sale of Investments Interest Revenue Investments—Government Bonds

34,650 * 700 350 35,000

* Bond sale ($35,000 × 98%)………………………………… $34,300 350 Accrued interest ($35,000 × 6% × 60/360)……………… Total proceeds from sale…………………………………… $34,650

Dec.

July

31 Interest Receivable Interest Revenue Accrued interest ($40,000 × 6% × 1/2).

1,200

1 Cash Investments—Government Bonds

40,000

1,200

40,000

Ex. 15-13 $2,500 Interest earned (February 1 to July 1)1…………………………………………… 2 500 Interest earned on sold bonds (July 1 to October 1) …………………………… 3 2,000 Interest earned on remaining bonds (July 1 to December 31) ……………… Total interest earned during the year……………………………………………… $5,000 1 2 3

$120,000 × 5% × 5/12 $40,000 × 5% × 3/12 $80,000 × 5% × 6/12

CHAPTER 15

Investments

Ex. 15-14 a. b. c. d. e. f. g. h. i.

$6,000 $29,000 $35,000 $132,000 $39,000 $185,000 $6,000 $211,000 $273,000

{$35,000 [from (c)] – $29,000 [from (b)]} [$17,000 – $(12,000)] ($245,000 – $210,000) ($144,000 – $12,000) ($28,000 + $11,000) ($168,000 + $17,000) ($17,000 – $11,000) ($205,000 + $6,000) ($245,000 + $28,000)

Ex. 15-15 a.

20Y7 Feb.

Dec.

24 Trading Investments—Raiders Inc. Cash 31 Valuation Allowance for Trading Investments Unrealized Gain on Trading Investments To record increase in fair value of trading investments ($609,000 – $551,000).

551,000 551,000

58,000 58,000

The unrealized gain or unrealized loss on trading investments is reported on the income statement as Other Revenue (or a separate item if significant). Unrealized losses would be deducted in determining net income, while unrealized gains would be added in determining net income.

The unrealized gain on available-for-sale investments of $58,000 would be reported as an addition to stockholders’ equity on the balance sheet. The debit balance of Valuation Allowance for Available-for-Sale Investments of $58,000 would be added to the balance of the investments account of $551,000 to report the fair value of $609,000 on the balance sheet.

Ex. 15-16 a.

20Y3 Dec.

31 Unrealized Loss on Trading Investments Valuation Allowance for Trading Investments To record decrease in fair value of trading investments ($115,550 – $117,500).

1,950 1,950

CHAPTER 15

Investments

Ex. 15-16 (Concluded) b.

20Y4 May

20Y4 Dec.

10 Trading Investments—Carroll Inc. Cash

31 Valuation Allowance for Trading Investments Unrealized Gain on Trading Investments To record the increase in fair value of trading investments ($175,000 – $117,500 – $34,900 + $1,950*).

34,900 34,900

24,550 24,550

* Since the Valuation Allowance for Trading Investments has an “unadjusted” credit balance of $1,950 on December 31, 20Y4, $1,950 must be added to arrive at an “adjusted” balance of $22,600 ($175,000 – $117,500 – $34,900) on December 31, 20Y4.

$175,000; the fair value of the trading investments, which is the sum of the trading investments account of $152,400 and the valuation account of $22,600.

Ex. 15-17 a.

20Y5 Dec.

31 Valuation Allowance for Available-forSale Investments Unrealized Gain on Availablefor-Sale Investments

17,500 * 17,500

* $337,500 – $320,000, as determined from the following schedule: Issuing Company Arden Enterprises Inc. ……………………………………………………… French Broad Industries Inc. ………………………………………………… Pisgah Construction Inc. …………………………………………………… Total…………………………………………………………………………

Cost

Fair Value Dec. 31, 20Y5

$150,000 66,000 104,000

$170,000 71,500 96,000

$320,000

$337,500

There would be no adjusting entry for December 31, 20Y6, if the fair value of the portfolio of securities is unchanged from December 31, 20Y5. This is because the unrealized gain from the difference between the cost and market has already been recognized on December 31, 20Y5. Only changes in market prices would be recognized subsequent to December 31, 20Y5.

CHAPTER 15

Investments

Ex. 15-17 (Concluded) c.

20Y6 Dec.

31 Valuation Allowance for Available-forSale Investments Unrealized Gain on Availablefor-Sale Investments To record the increase in fair value of available-for-sale investments ($340,000 – $337,500).

20Y6 Dec.

31 Unrealized Loss on Available-for-Sale Investments Valuation Allowance for Availablefor-Sale Investments To record the decrease in fair value of available-for-sale investments ($337,500 – $330,000).

2,500 2,500

7,500 7,500

Ex. 15-18 Dividend Yield =

Cash Dividends per Share of Common Stock Market Price per Share of Common Stock $4.19 $198.01

= 2.1%

Ex. 15-19 a.

Current: Previous:

Dividend Yield = $1.68 ÷ $101.57 = 1.65% Dividend Yield = $1.56 ÷ $85.95 = 1.82%

Dividends per share increased in the current year from the previous year. The dividend yield, however, decreased from 1.82% in the previous year to 1.65% in the current year. This decrease is a result of a decrease in the dividend relative to stock price. Microsoft provides a small return to the shareholder in terms of a dividend yield and an additional return in terms of price appreciation of the stock.

Ex. 15-20 Investors would receive a return on the investment through share price appreciation as internally generated funds are used to fund growth and earnings opportunities. Thus, investors in Booking Holdings would likely approve of this policy because the company is able to earn superior returns with internally generated earnings beyond what investors could likely earn on their own by investing dividend distributions. 15-17 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 15

Investments

Appendix Ex. 15-21 Valur Co. For the Year Ended December 31, 20Y8 Net income Other comprehensive income (loss): Unrealized gain (loss) on available-for-sale investments Comprehensive income

$210,000 15,000 * $225,000

* $200,000 – $185,000

CHAPTER 15

Investments

PROBLEMS Prob. 15-1A 1. 20Y2 Feb.

1 Investments—Caldwell Inc. Stock Cash

375,075* 375,075

* (7,500 shares × $50 per share) + $75

May

July

1 Trading Investments—Holland Inc. Cash

126,000

1 Cash Loss on Sale of Investments Investments—Caldwell Inc. Stock

206,890* 18,155

126,000

225,045**

* (4,500 shares × $46 per share) – $110 ** 4,500 shares × ($375,075 ÷ 7,500 shares)

1,500 *

31 Cash Dividend Revenue

1,500

* (7,500 shares – 4,500 shares) × $0.50

Nov.

15 Cash Gain on Sale of Investments Investments—Caldwell Inc. Stock

152,910 * 2,880 150,030**

* (3,000 shares × $51 per share) – $90 ** 3,000 shares × ($375,075 ÷ 7,500 shares)

Dec.

31 Unrealized Loss on Trading Investments Valuation Allowance for Trading Investments

6,000 6,000 *

* $126,000 – $120,000

CHAPTER 15

Investments

Prob. 15-1A (Concluded) 20Y3 Apr.

Oct.

Dec.

1 Trading Investments—Fuller Inc. Cash

125,000

14 Cash Gain on Sale of Investments Trading Investments—Fuller Inc.

30,000

31 Valuation Allowance for Trading Investments Unrealized Gain on Trading Investments

28,100 *

125,000

5,000 25,000

28,100

* $248,100 – $226,000 + $6,000

Rios Co. Balance Sheet (selected items) December 31, 20Y3 Current assets: Trading investments (at cost) Valuation allowance for trading investments Trading investments (at fair value)

$226,000* 22,100** $248,100

* $126,000 + $100,000 ** $(6,000) (from 20Y2) + $28,100 (from 20Y3)

Unrealized gains or losses are reported on the income statement, often as “Other Revenue (Losses).” For 20Y2, Rios Co. would have reported an unrealized loss of $6,000 as “Other Losses.” For 20Y3, Rios Co. would have reported an unrealized gain of $28,100 as “Other Revenue.” If unrealized gains and losses were significant for Rios Co., then they would be disclosed separately on the income statement.

CHAPTER 15

Investments

Prob. 15-2A 1.

20Y6 Jan.

Dec.

10 Investment in Imboden Inc. Stock Cash

720,000

31 Cash Investment in Imboden Inc. Stock

57,600

31 Investment in Imboden Inc. Stock Income of Imboden Inc. To record 32% of Imboden Inc. income $450,000 × (96,000 shares ÷ 300,000 shares).

144,000

720,000

57,600

144,000

No. Since Forte Inc. owns 32% (96,000 shares ÷ 300,000 shares) of the outstanding stock of Imboden Inc., Forte’s investment in Imboden Inc.’s stock is accounted for under the equity method. Equity investments, which include investments of between 20%–50% ownership, are not reported at fair value.

CHAPTER 15

Investments

Prob. 15-3A 1.

20Y3 Apr.

June

Sept.

1 Investments—Welch Co. Bonds Interest Receivable Cash

100,000 500

1 Investments—Bailey Bonds Interest Receivable Cash

210,000 700

100,500

210,700 3,000*

1 Cash Interest Receivable Interest Revenue

500 2,500

* $100,000 × 6% × 1/2

30 Cash Loss on Sale of Investments Interest Revenue Investments—Welch Co. Bonds

39,000 * 1,200 200 40,000

* ($40,000 × 0.97) + $200

Nov.

4,200*

1 Cash Interest Receivable Interest Revenue

700 3,500

* $210,000 × 4% × 1/2

Dec.

1,210*

31 Interest Receivable Interest Revenue

1,210

* $60,000 × 6% × 121 ÷ 360

1,400*

31 Interest Receivable Interest Revenue

1,400

* $210,000 × 4% × 2 ÷ 12

CHAPTER 15

Investments

Prob. 15-3A (Concluded) 20Y4 Mar.

1,800 *

1 Cash Interest Receivable Interest Revenue

1,210 590

* $60,000 × 6% × 1/2

May

4,200*

1 Cash Interest Receivable Interest Revenue

1,400 2,800

* $210,000 × 4% × 1/2

If the bonds are classified as available-for-sale securities, then the portfolio of bonds would be adjusted to fair value. This would be accomplished by using a valuation allowance account and an unrealized gain (loss) account as part of stockholders’ equity. If the fair value were greater than the cost of the bond portfolio, the two accounts would be added to investments and stockholders’ equity, respectively. If the fair value were less than the cost of the bond portfolio, the two accounts would be subtracted from investments and stockholders’ equity, respectively.

CHAPTER 15

Investments

Prob. 15-4A a. b. c.

$238,170 $(7,800) $230,370

(from table) ($230,370 – $238,170, from table) ($238,170 – $7,800)

Issuing Company Bernard Co. ………………………………………………… Chadwick Co. .……………………………………………… Gozar Inc. …………………………………………………… Nightline Co. ………………………………………………… d. e. f. g. h. i.

$600 $98,100 $813,600 $457,000 $(7,800) $813,600

Cost

Fair Value

$ 38,250 65,520 94,400 40,000 $238,170

$ 34,650 57,960 98,560 39,200 $230,370

($40,000 × 6% × 3/12) [$77,000 + ($112,000 × 30%) – $12,500] [same as (i)] ($308,770 + $148,230) [same as (b)] ($69,400 + $70,000 + $225,000 + $457,000 – $7,800)

CHAPTER 15

Investments

Prob. 15-4A (Concluded) The partial balance sheets with the missing amounts are as follows: O’Brien Industries Inc. Partial Balance Sheets December 31 20Y5

20Y4

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Available-for-sale investments (at cost) $238,170 $103,770 Valuation allowance for available-for-sale investments (7,800) (2,500) Available-for-sale investments (fair value) $230,370 $101,270 Interest receivable Investment in Jolly Roger Co. stock Office equipment (net) Total assets

600 98,100 115,000 $813,600

— $ 77,000 130,000 $666,270

Accounts payable Common stock Excess of issue price over par Retained earnings Unrealized gain (loss) on available-for-sale investments Total liabilities and stockholders’ equity

$ 69,400 70,000 225,000 457,000

$ 65,000 70,000 225,000 308,770

(7,800) $813,600

(2,500) $666,270

CHAPTER 15

Investments

Prob. 15-1B 1. 20Y8 Feb.

14 Investments—Apollo Inc. Stock Cash

124,992 * 124,992

* (4,800 shares × $26 per share) + $192

Apr.

June

1 Trading Investments—Ares Inc. Cash

45,000

1 Cash Gain on Sale of Investments Investments—Apollo Inc. Stock

19,100*

45,000

3,476 15,624**

* (600 shares × $32 per share) – $100 ** 600 shares × ($124,992 ÷ 4,800 shares)

840*

27 Cash Dividend Revenue

840

* (4,800 shares – 600 shares) × $0.20

Oct.

15 Cash Loss on Sale of Investments Investments—Apollo Inc. Stock

106,800* 2,568 109,368**

* (4,200 shares × $25.50 per share) – $300 ** 4,200 shares × ($124,992 ÷ 4,800 shares)

Dec.

31 Valuation Allowance for Trading Investments Unrealized Gain on Trading Investments

6,300* 6,300

* $51,300 – $45,000

CHAPTER 15

Investments

Prob. 15-1B (Concluded) 20Y9 Mar.

July

Dec.

14 Trading Investments—Athena Inc. Cash

78,000

30 Cash Loss on Sale of Investments Trading Investments—Athena Inc.

25,000 3,000

31 Valuation Allowance for Trading Investments Unrealized Gain on Trading Investments

13,200*

78,000

28,000

13,200

* $114,500 – $95,000 – $6,300

Zeus Inc. Balance Sheet (selected items) December 31, 20Y9 Current assets: Trading investments (at cost) Valuation allowance for trading investments Trading investments (at fair value)

$95,000* 19,500** $114,500

* $45,000 + $50,000 ** $6,300 (from 20Y8) + $13,200 (from 20Y9)

Unrealized gains or losses are reported on the income statement, often as “Other Revenue (Losses).” For 20Y8, Zeus Inc. would have reported an unrealized gain of $6,300 as “Other Revenue.” For 20Y9, Zeus Inc. would have reported an unrealized gain of $13,200 as “Other Revenue.” If unrealized gains and losses were significant for Zeus Inc., then they would be disclosed separately on the income statement.

CHAPTER 15

Investments

Prob. 15-2B 1.

20Y3 Jan.

Dec.

25 Investment in Helsi Co. Stock Cash

800,000

31 Cash Investment in Helsi Co. Stock

38,000

31 Investment in Helsi Co. Stock Income of Helsi Co. To record 30% of Helsi Co. income [$170,000 × (75,000 shares ÷ 250,000 shares)].

51,000

800,000

38,000

51,000

No. Since Glacier Products Inc. owns 30% (75,000 shares ÷ 250,000 shares) of the outstanding stock of Helsi Co., Glacier Product Inc.’s investment in Helsi Co.’s stock is accounted for under the equity method. Equity investments, which include investments of between 20%–50% ownership, are not reported at fair value.

CHAPTER 15

Investments

Prob. 15-3B 1.

20Y5 Apr.

May

Aug.

1 Investments—Smoke Bay Bonds Interest Receivable Cash

90,000 900

16 Investments—Geotherma Co. Bonds Interest Receivable Cash

42,000 70

1 Cash Interest Receivable Interest Revenue

2,700 *

90,900

42,070

900 1,800

* $90,000 × 6% × 1/2

Sept.

1 Cash Interest Revenue Gain on Sale of Investments Investments—Smoke Bay Bonds

12,180* 60 120 12,000

* ($12,000 × 1.01) + $60

Nov.

840 *

1 Cash Interest Receivable Interest Revenue

70 770

* $42,000 × 4% × 1/2

Dec.

1,950*

31 Interest Receivable Interest Revenue Accrued interest.

1,950

* $78,000 × 6% × 5 ÷ 12

280 *

31 Interest Receivable Interest Revenue Accrued interest.

280

* $42,000 × 4% × 2 ÷ 12

CHAPTER 15

Investments

Prob. 15-3B (Concluded) 20Y6 Feb.

2,340*

1 Cash Interest Receivable Interest Revenue

1,950 390

* $78,000 × 6% × 1/2

May

840 *

1 Cash Interest Receivable Interest Revenue

280 560

* $42,000 × 4% × 1/2

If the bonds are classified as available-for-sale securities, then the portfolio of bonds would need to be adjusted to fair value. This would be recorded by using a valuation allowance account and an unrealized gain (loss) account. If the fair value were greater than the cost of the bond portfolio, the two accounts would be added to investments and stockholders’ equity, respectively. If the fair value were less than the cost of the bond portfolio, the two accounts would be subtracted from investments and stockholders’ equity, respectively.

CHAPTER 15

Investments

Prob. 15-4B a. b. c.

$147,200 $4,680 $151,880

(from table) ($151,880 – $147,200, from table) (from table)

Issuing Company Alvarez Inc. ........................................................................... Hirsch Inc. ............................................................................ Richter Inc. ........................................................................... Toon Co. ............................................................................... d. e. f. g. h.

$240 $81,200 $604,320 $178,640 $4,680

Cost

Fair Value

$ 36,480 54,720 32,000 24,000 $147,200

$ 39,840 49,400 38,400 24,240 $151,880

($24,000 × 4% × 3/12) [$69,200 + ($80,000 × 30%) – $12,000] (same as total liabilities and stockholders’ equity) ($127,400 + $51,240) [same as (b)]

CHAPTER 15

Investments

Prob. 15-4B (Concluded) The partial balance sheets with the missing amounts are as follows: Teasdale Inc. Partial Balance Sheets December 31 20Y8

20Y7

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Available-for-sale investments (at cost) Valuation allowance for available-for-sale investments Available-for-sale investments (fair value)

$147,200

$ 91,200

4,680 $151,880

8,776 $ 99,976

Interest receivable Investment in Wright Co. stock Office equipment (net) Total assets

240 81,200 96,000 $604,320

— 69,200 105,000 $538,176

Accounts payable Common stock Excess of issue price over par Retained earnings Unrealized gain (loss) on available-for-sale investments Total liabilities and stockholders’ equity

$ 91,000 80,000 250,000 178,640

$ 72,000 80,000 250,000 127,400

4,680 $604,320

8,776 $538,176

CHAPTER 15

Investments

COMPREHENSIVE PROBLEM 4 1.

Cash Common Stock Paid-In Capital in Excess of Par— Common Stock

450,000

Cash Preferred Stock Paid-In Capital in Excess of Par— Preferred Stock

400,000

Cash Bonds Payable Premium on Bonds Payable

520,000 *

300,000 150,000

320,000 80,000

500,000 20,000

* $500,000 × 1.04

50,000*

Cash Dividends Cash Dividends Payable

50,000

* 100,000 shares × $0.50 per share

20,000*

Cash Dividends Cash Dividends Payable

20,000

* 20,000 shares × $1.00 per share

Cash Dividends Payable Cash

70,000 70,000

Available-for-Sale Investments—Solstice Corp. Bonds Cash

300,150 300,150 264,000*

Treasury Stock Cash

264,000

* 8,000 shares × $33 per share

Investment in Pinkberry Co. Stock Cash

960,000 * 960,000

* 40,000 shares × $24 per share

CHAPTER 15

Investments

Comp. Prob. 4 (Continued) i.

Cash Dividends Cash Dividends Payable

20,000

Cash Dividends Payable Cash

20,000

Cash Investment in Pinkberry Co. Stock

27,500

Investments—Dream Inc. Bonds Interest Receivable Cash

90,000 375

Cash Treasury Stock Paid-In Capital from Sale of Treasury Stock * 2,600 shares × $38 per share ** 2,600 shares × $33 per share

98,800*

Cash Interest Revenue * $300,000 × 4% × 1/2

6,000*

Cash Gain on Sale of Investments Available-for-Sale Investments— Solstice Corp. Bonds * $45,000 – $4,980

45,000

20,000

27,500

90,375

85,800** 13,000

6,000

4,980 40,020*

CHAPTER 15

Investments

Comp. Prob. 4 (Continued) p.

Interest Expense Premium on Bonds Payable Cash

11,500 1,000 12,500

Computation: Semiannual interest payment ($500,000 × 5% × 1/2)……………… $12,500 1,000 Less amortization premium [($20,000 ÷ 10 years) × 1/2]………… Interest expense………………………………………………………… $11,500 q.

Interest Receivable Interest Revenue Interest accrued for 3 months.

1,125 * 1,125

* $90,000 × 5% × 3/12

Investment in Pinkberry Co. Stock Income from Pinkberry Co. Recorded 32% share of Pinkberry Co. net income. * $240,000 × 32%, 32% = 40,000 shares ÷ 125,000 shares Unrealized Loss on Available-for-Sale Investments Valuation Allowance for Available-for-Sale Investments * $300,150 – $40,020 – $253,630

76,800* 76,800

6,500* 6,500

CHAPTER 15

Investments

Comp. Prob. 4 (Continued) 2.

a. Equinox Products Inc. Income Statement For the Year Ended December 31, 20Y5 $5,254,000 3,700,000 $1,554,000

Sales Cost of merchandise sold Gross profit Operating expenses: Selling expenses: Sales salaries expense Sales commissions expense Advertising expense Depreciation expense—store buildings and equipment Delivery expense Store supplies expense Miscellaneous selling expense Administrative expenses: Office salaries expense Office rent expense Depreciation expense—office buildings and equipment Office supplies expense Miscellaneous administrative expense Total operating expenses Income from operations

$385,000 185,000 150,000 100,000 30,000 21,000 14,000

$885,000

$170,000 50,000 30,000 10,000 7,500

267,500 1,152,500 $ 401,500

Other revenue and expense: Interest revenue Income from Pinkberry Co. investment Gain on sale of investments Interest expense Income before income tax Income tax Net income Earnings per common share: Net income

8,720 76,800 4,980 (21,000)

69,500 $ 471,000 142,000 $ 329,000

$2.29 *

* ($329,000 – $100,000 preferred dividends) ÷ 100,000 common shares

CHAPTER 15

Investments

Comp. Prob. 4 (Continued) b.

Equinox Products Inc. Retained Earnings Statement For the Year Ended December 31, 20Y5 $9,319,725

Retained earnings, January 1, 20Y5 Net income for year Dividends: Common Preferred Increase in retained earnings Retained earnings, December 31, 20Y5

$ 329,000 (155,120) (100,000) 73,880 $9,393,605

Equinox Products Inc. Balance Sheet December 31, 20Y5 Assets Current assets: Cash Available-for-sale investments Less valuation allowance for available-for-sale investments Accounts receivable Less allowance for doubtful accounts Merchandise inventory, at lower of cost (FIFO) or market Interest receivable Prepaid expenses Total current assets Investments: Investment in Pinkberry Co. stock Investment in Dream Inc. bonds Property, plant, and equipment: Store buildings and equipment Less accumulated depreciation Office buildings and equipment Less accumulated depreciation Total property, plant, and equipment Intangible assets: Goodwill Total assets

$ 246,000 $

260,130 253,630

6,500 545,000 8,450

536,550 778,000 1,125 27,400 $ 1,842,705 1,009,300 90,000

$12,560,000 4,126,000 $ 4,320,000 1,580,000

$8,434,000 2,740,000 11,174,000 500,000 $14,616,005

CHAPTER 15

Investments

Comp. Prob. 4 (Concluded) Equinox Products Inc. Balance Sheet December 31, 20Y5 Liabilities Current liabilities: Accounts payable Income tax payable Total current liabilities Long-term liabilities: Bonds payable Add premium on bonds payable Total liabilities Stockholders’ Equity

Paid-in capital: Preferred $1 stock, $80 par (30,000 shares authorized; 20,000 shares issued) Excess of issue price over par Common stock, $20 par (400,000 shares authorized; 100,000 shares issued, 94,600 shares oustanding) Excess of issue price over par From sale of treasury stock Total paid-in capital Retained earnings Unrealized gain (loss) on availablefor-sale investments Total Treasury common stock (5,400 shares at cost) Total stockholders’ equity Total liabilities and stockholders’ equity

$1,600,000 150,000

$2,000,000 886,800

194,300 44,000 $

238,300

519,000 757,300

500,000 19,000

$ 1,750,000

2,886,800 13,000 $ 4,649,800 9,393,605 (6,500) $14,036,905 (178,200) 13,858,705 $14,616,005

CHAPTER 15

Investments

CASES & PROJECTS CP 15-1 Because many complex and exotic investment vehicles do not have ready market values, management must value these investments using mathematical models, subjective inputs, and risk assessments. These mathematically determined valuations are subject to wide variation, depending on the assumptions. Therein lies the ethical challenge. Because the valuation is subjective, it is possible for managers to over- or underestimate fair values to meet their personal objectives. Moreover, the ability for auditors to verify these values independently is difficult because there is a lack of agreed-upon objectivity.

Investments

3,942 246 2,513 2,058 109,862 5,182 3,868 6,947 271 1,220 558 $136,667

15-40

$ — — — — 62 1 4 21 37 95 — $220

Unrealized Gains

— — — — (1,167) (10) (13) (56) (1) (10) — $(1,257)

Unrealized Losses

3,942 246 2,513 2,058 108,757 5,173 3,859 6,912 307 1,305 558 $135,630

Recorded Basis

— — — $11,946

—

$ 3,942 246 2,215 1,865 3,678

Cash and Cash Equivalents

June 30 Cash Mutual funds Commercial paper Certificates of deposit U.S. Government and Agency securities Foreign government bonds Mortgage-backed securities Corporate notes and bonds Municipal securities Common and preferred stock Other investments Total

(In millions)

Cost Basis

Investment Components, Including Associated Derivatives

NOTE 4 INVESTMENTS

The following are portions of Notes 3 and 4 from the financial statements dated June 30, of a recent year, for Microsoft.

CP 15-2

CHAPTER 15

— — 298 193 105,079 5,173 3,859 6,912 307 — 1 $121,822

Short-Term Investments

— — — — — — — — — 1,305 557 $1,862

Equity and Other Investments

CHAPTER 15

Investments

CP 15-2 (Concluded) NOTE 3 OTHER INCOME (EXPENSE) The components of other income (expense) were as follows: (In millions) Year Ended June 30, Dividends and interest income Interest expense Net recognized gains (losses) on investments Net gains (losses) on derivatives Net gains (losses) on foreign currency remeasurements Other Total

Y3 $ 2,214 (2,733) 2,399 (187)

Y2 $ 1,387 (2,222) 2,583 (510)

Y1 $ 903 (1,243) 668 (443)

(218) (59) $ 1,416

(111) (251) $ 876

(129) (195) $ (439)

Note to Instructors: This solution is provided as a guide. Students may have different numbers, depending on the date of the financial statements. Answers in millions. 1.

$136,667

$135,630 (termed “recorded basis” by Microsoft)

$220

$(1,257)

a. b. c.

$2,214

$2,399

$11,946 ÷ $135,630 = 8.8% $121,822 ÷ $135,630 = 89.8% $1,862 ÷ $135,630 = 1.4%

CP 15-3 Memo To: From: Re:

My Instructor Ima Student Look-through earnings

Look-through earnings is a concept originally developed by Mr. Warren Buffett that adjusts GAAP net income for the equity earnings (the “forgotten-but-not gone” earnings) in investments where less than 20% of the outstanding shares are owned. Thus, look-through earnings would be significantly greater than GAAP net income for a company that held a large portfolio of these types of investments (which Berkshire does). These are supplemental disclosures that Buffet provides his shareholders in addition to GAAP disclosures. Essentially, he is treating these investments as if they were being accounted for under the equity method. 15-41 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 15

Investments

CP 15-3 (Concluded) Buffett makes the case that there is no reason for the equity method to be used only for 20%–50% investees, but that the rationale for the equity method applies equally well for investments of less than 20%. Thus, Berkshire Hathaway provides an additional non-GAAP disclosure to its investors, which essentially adds the after-tax equity earnings of its less than 20% investees to its net income. In so doing, Buffett argues that the earning power of all of his investments is properly disclosed in look-through earnings. He believes that the dividends he receives from his less than 20%-owned investees do not reflect the earning power of his investment, even though that is what is required by GAAP.

CP 15-4 1.

Under generally accepted accounting principles, the land would be reported at $350,000 for Wyatt Corp. and $2,000,000 for TexoPete Inc. These valuations reflect their historical costs.

The historical cost valuation reduces the ability to compare the two companies. In this scenario, both companies have nearly identical land holdings. Wyatt Corp. purchased its land in 20Y1; thus, the land is valued according to a 20Y1 valuation. TexoPete Inc. purchased its land in 20Y9, reflecting a more current valuation. Thus, both companies have a similar asset; however, the balance sheet reports very different valuations (Wyatt’s valuation is approximately 17.5% of TexoPete’s). Therefore, comparability is reduced. If the land were valued at fair value, then both companies would report the land at nearly identical valuations, which is a better reflection of reality.

CP 15-5 The accounting treatment for increases in fair value for property, plant, and equipment under International Accounting Standards is similar to the treatment for unrealized gains and losses from available-for-sale investments. Increases in fair value bypass the income statement and are reported directly in stockholders’ equity. Thus, increases in property, plant, and equipment fair values would not be reported in earnings. Decreases in fair value are reported on the income statement as an expense. Income statement treatment is similar to the treatment for unrealized gains and losses from trading securities. If the property, plant, and equipment fair value declines, the income statement impact of this decline is fully disclosed.

CHAPTER 16 STATEMENT OF CASH FLOWS DISCUSSION QUESTIONS 1.

The primary advantage of the direct method is that it directly reports cash receipts and cash payments in the statement of cash flows. Its primary disadvantage is that these data may not be readily available in the accounting records. Thus, the direct method is normally more costly to prepare and, as a result, is used infrequently in practice.

The indirect method focuses on the differences between net income and cash flows from operating activities, and the data needed are generally more readily available and less costly to obtain than is the case for the direct method.

The transaction would be reported in a separate schedule of noncash investing and financing activities accompanying the statement of cash flows. This section usually appears at the bottom of the statement.

The $30,000 increase must be added to net income because the amount of cash paid to merchandise creditors was $30,000 less than the amount of purchases included in the cost of merchandise sold.

The $25,000 decrease in salaries payable should be deducted from net income. The effect of the decrease in the amount of salaries owed was to pay $25,000 more cash during the year than had been recorded as an expense.

Cash flows from investing activities—Cash received from the disposal of fixed assets, $15,000 The $15,000 gain on asset disposal should be deducted from net income in determining net cash flows from (used for) operating activities under the indirect method.

No effect

$100,000 gain

Cash inflow of $600,000

The gain of $100,000 would be deducted from net income in determining net cash flows from (used for) operating activities; $600,000 would be reported as a cash inflow under investing activities.

Cash flows from (used for) financing activities—issuance of bonds, $1,960,000 ($2,000,000 × 98%)

The same. The total amount reported as the net cash flows from operating activities is not affected by the use of the direct or indirect method.

10.

Cash received from customers, cash payments for merchandise, cash payments for operating expenses, cash payments for interest, and cash payments for income taxes.

CHAPTER 16

Statement of Cash Flows

PRACTICE EXERCISES PE 16-1A a. b. c.

Financing Operating Operating

d. e. f.

Financing Operating Investing

d. e. f.

Operating Operating Financing

PE 16-1B a. b. c.

Financing Investing Operating

PE 16-2A Net income…………………………………………………………………………… $343,700 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation……………………………………...…………………………… 17,720 Amortization of patents………………………………...…………………… 3,800 5,200 Loss from sale of land…………………………..…………………………… Net cash flows from operating activities………………………..……………… $370,420

PE 16-2B Net income……………………………………………………………………...…… $126,300 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation……………………………………………………..…………… 6,320 Amortization of patents…………………………………..………………… 2,450 (13,510) Gain from sale of investments…………………………….……………… Net cash flows from operating activities……………………..………………… $121,560

CHAPTER 16

Statement of Cash Flows

PE 16-3A Net income…………………………….…………………………………………………… $185,000 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Changes in current operating assets and liabilities: Decrease in accounts receivable………………………………...…………… 2,700 Increase in inventory…………………………………..……………………… (2,300) 1,500 Increase in accounts payable……………………………….………………… Net cash flows from operating activities…………………………..………………… $186,900 Note: The change in dividends payable impacts the cash paid for dividends, which is disclosed under financing activities.

PE 16-3B Net income…………………………………..……………………………………………… $351,000 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Changes in current operating assets and liabilities: Increase in accounts receivable………………………………...…………… (7,900) Increase in inventory…………………………….……………………………… (11,190) 15,340 Increase in accounts payable………………………….……………………… Net cash flows from operating activities………………….…………………………

$347,250

Note: The change in dividends payable impacts the cash paid for dividends, which is disclosed under financing activities.

PE 16-4A Cash flows from (used for) operating activities: Net income……………………………………….…………………… Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation…………………………………………...………… Gain on disposal of equipment……………………………… Changes in current operating assets and liabilities: Decrease in accounts receivable……………………..… Decrease in accounts payable…………………………… Net cash flows from operating activities……………………..…

$296,000

113,100 (58,200) 71,300 (27,100) $395,100

CHAPTER 16

Statement of Cash Flows

PE 16-4B Cash flows from (used for) operating activities: Net income…………………………………….………………………… $170,000 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation………………………………...…………………… 29,000 Loss on disposal of equipment……………………………..… 11,850 Changes in current operating assets and liabilities: Increase in accounts receivable…………………………… (10,490) 5,430 Increase in accounts payable……………………….……… Net cash flows from operating activities……………………...……

$205,790

PE 16-5A The loss on the sale of land is added to net income in the Operating Activities section. Loss on sale of land……………………………………….………………………… $ 33,000 The purchase and sale of land are reported as part of cash flows from (used for) investing activities as shown below. Cash received from sale of land…………………...……………………………… $ 81,000 Cash paid for purchase of land……………………………...……………………… (310,000)

PE 16-5B The gain on the sale of land is subtracted from net income in the Operating Activities section. Gain on sale of land………………………….……………………………………… $ (29,000) The purchase and sale of land are reported as part of cash flows from (used for) investing activities as shown below. Cash received from sale of land…………………..………………………………… $ 177,000 Cash paid for purchase of land………………………..…………………………… (295,000)

CHAPTER 16

Statement of Cash Flows

PE 16-6A Cash flows from (used for) financing activities: Cash received from issuing common stock*……………………… Cash dividends**…………………...………………………………… Net cash flows from financing activities……………………...……

$12,000 (2,000) $10,000

* Increase in common stock of $5,000 plus increase in paid-in capital in excess of par— common stock of $7,000.

** Dividends declared of $4,000 less increase in dividends payable of $2,000.

PE 16-6B Cash flows from (used for) financing activities: Cash received from issuing common stock*…………………..… $ 156,000 Cash paid to retire bonds payable………………………..………… (160,000) (11,000) Cash dividends**…………………...………………………………… Net cash flows used for financing activities……………………..

$(15,000)

* Increase in common stock of $60,000 plus increase in paid-in capital in excess of par— common stock of $96,000.

** Dividends declared of $15,000 less increase in dividends payable of $4,000.

CHAPTER 16

Statement of Cash Flows

PE 16-7A a.

Net cash flows from operating activities…………… Less investments in fixed assets to replace existing capacity……………………………………… Free cash flow……………………………………………

Year 2 $385,000

Year 1 $367,000

205,100 * $179,900

231,000 ** $136,000

* 70% × $293,000 ** 70% × $330,000

The increase in free cash flow from $136,000 to $179,900 represents an improvement.

PE 16-7B a.

Year 2 $623,000

Year 1 $596,000

447,200 *

396,000 **

$175,800

$200,000

* 80% × $559,000 ** 80% × $495,000

The decrease in free cash flow from $200,000 to $175,800 represents a decline.

CHAPTER 16

Statement of Cash Flows

EXERCISES Ex. 16-1 There were net additions of $3,161 ($1,063 + $2,098) to the net loss $1,063 reported on the income statement to convert the net loss to the net cash flows from operating activities. For example, depreciation and amortization are expenses in determining net income, but they do not result in cash 'outflows. Thus, depreciation and amortization are added back to the net loss in order to determine net cash flows from operations. Other items that are added to the net loss are losses from disposals of fixed assets, decreases in noncash current assets, and increases in current liabilities. Conversely, gains on disposals of fixed assets, increases in noncash currrent assets, and decreases in current liabilities are deducted from the net loss. The following cash flows from operating activities for Tesla, Inc. (in millions) is provided for class discussion: Cash flows from (used for) operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash flows from (used for) operating activities: Depreciation and amortization Stock-based compensation Amortization of debt discounts and issuance costs Inventory write-downs Loss on disposals of fixed assets Foreign currency transaction (gains) losses Interest expense, noncash, and other operating activities Changes in certain assets and liabilities: Decrease (increase) in accounts receivable Decrease (increase) in inventory Decrease (increase) in operating lease vehicles Decrease (increase) in other assets Increase (decrease) in accounts payable Increase (decrease) in deferred revenue Increase (decrease) in customer deposits Increase (decrease) in resale value guarantee Increase (decrease) in other liabilities Net cash flows from operating activities

$(1,063)

1,901 749 159 85 161 (1) 49 (497) (1,023) (215) (289) 1,723 407 (97) (111) 160 $ 2,098

CHAPTER 16

Statement of Cash Flows

Ex. 16-2 a. b. c. d.

Cash payment, $303,000 Cash receipt, $720,000 Cash receipt, $31,500 Cash payment, $290,000

e. f. g. h.

Cash payment, $40,000 Cash receipt, $588,000 Cash payment, $675,000 Cash payment, $1,065,000*

* 710,000 shares outstanding × $1.50 710,000 shares outstanding = 800,000 shares issued – 90,000 treasury stock shares

Ex. 16-3 a. b. c. d. e. f.

financing financing financing operating investing financing

g. h. i. j. k.

investing investing investing financing financing

g. h. i. j. k.

added deducted added added added

Ex. 16-4 a. b. c. d. e. f.

deducted deducted added deducted added added

CHAPTER 16

Statement of Cash Flows

Ex. 16-5 a.

Cash flows from (used for) operating activities: Net income………………………………………………………… Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation………………………………………………… Changes in current operating assets and liabilities: Increase in accounts receivable……………………… Decrease in merchandise inventory………………… Decrease in prepaid expenses………………………… Increase in accounts payable………………………… Decrease in wages payable…………………………… Net cash flows from operating activities………………………

$73,600

27,400 (8,000) 4,500 2,250 5,000 (900) $103,850

Cash flows from operating activities show the cash inflow or outflow from a company’s day-to-day operations. Net income reports the excess of revenues over expenses for a company using the accrual basis of accounting. Revenues are recorded when they are earned, not necessarily when cash is received. Expenses are recorded when they are incurred and matched against revenue, not necessarily when cash is paid. As a result, the cash flows from operating activities differ from net income because the accrual basis of accounting is not used.

Ex. 16-6 a.

Cash flows from (used for) operating activities: Net income………………………………………………………… $290,000 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation………………………………………………… 150,500 Changes in current operating assets and liabilities: Decrease in accounts receivable……………………… 8,600 Increase in inventories………………………………… (17,600) Decrease in prepaid expenses………………………… 1,500 Decrease in accounts payable………………………… (29,000) 5,000 Increase in salaries payable…………………………… Net cash flows from operating activities………………………

$409,000

Yes. The amount of net cash flows from operating activities reported on the statement of cash flows is not affected by the method of reporting such flows. The net amount of all three sections—operating, investing, and financing—will be the same regardless of which method is used.

CHAPTER 16

Statement of Cash Flows

Ex. 16-7 a.

Cash flows from (used for) operating activities: Net income…………………………………………………………… $542,000 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation…………………………………………………… 57,000 Gain on disposal of equipment……………………………… (24,000) Changes in current operating assets and liabilities: Increase in accounts receivable………………………… (9,800) Decrease in inventory……………………………………… 5,550 Decrease in prepaid insurance………………………… 1,000 Decrease in accounts payable…………………………… (3,700) 1,440 Increase in income taxes payable……………………… Net cash flows from operating activities…………………………

$569,490

Note: The change in dividends payable would be used to adjust the dividends declared in obtaining the cash paid for dividends in the Financing Activities section of the statement of cash flows. b.

Cash flows from operating activities reports the cash inflow or outflow from a company’s day-to-day operations. Net income reports the excess of revenues over expenses for a company using the accrual basis of accounting. Revenues are recorded when they are earned, not necessarily when cash is received. Expenses are recorded when they are incurred and matched against revenue, not necessarily when cash is paid. As a result, the cash flows from operating activities differs from net income because it does not use the accrual basis of accounting.

Ex. 16-8 a.

Net cash flows from operating activities…………………………… Add:

Increase in accounts receivable…………………………… $ 14,300 Increase in prepaid expenses……………………………… 2,970 Decrease in income taxes payable………………………… 7,700 Gain on sale of investments………………………………… 13,200

Deduct: Depreciation………………………………………………… $(29,480) Decrease in inventories…………………………………… (19,140) (5,280) Increase in accounts payable…………………………… Net income, per income statement……………………………………

$357,500

38,170

(53,900) $341,770

Note to Instructors: The net income must be determined by working backward through the Cash Flows from (used for) Operating Activities section of the statement of cash flows. Hence, those items that were added (deducted) to determine net cash flow from operating activities must be deducted (added) to determine net income.

CHAPTER 16

Statement of Cash Flows

Ex. 16-8 (Concluded) b.

Curwen’s net income differed from net cash flows from operating activities because of the following: ● $29,480 of depreciation expense, which has no effect on cash flows from operating activities. ● A $13,200 gain on the sale of investments. The proceeds from this sale, which include the gain, are reported in the Investing Activities section of the statement of cash flows. ● Changes in current operating assets and liabilities that are added or deducted, depending on their effect on cash flows: Increase in accounts receivable, $14,300 Increase in prepaid expenses, $2,970 Decrease in income taxes payable, $7,700 Decrease in inventories, $19,140 Increase in accounts payable, $5,280

Ex. 16-9 a.

Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Loss on disposal of property Other items involving noncash expense Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventory Increase in prepaid expenses Increase in accounts payable and other current liabilities Net cash flows from operating activities

$149,774

13,226 149 837

(13,041) (7,565) (10,548) 17,464 $150,296

National Beverage is doing well financially. The company has positive earnings and positive net cash flow from operating activities. The increases in accounts receivable and inventory are reasonable variations and not concerning. The increase in accounts payable might be due to timing of payments. Given the overall increase in cash for the year, these changes are acceptable. Note: Company’s actual statement of cash flows does not reconcile exactly to its prepaid expense and current liabilities amounts from its balance sheet.

CHAPTER 16

Statement of Cash Flows

Ex. 16-10 Cash flows from (used for) investing activities: Cash received from sale of equipment…………………………………………

$101,250

The loss on the sale, $16,875 ($101,250 proceeds from sale less $118,125* book value), would be added to net income in determining the net cash flows from operating activities if the indirect method of reporting cash flows from operations was used. * $202,500 – $84,375

Ex. 16-11 Cash flows from (used for) investing activities: Cash received from sale of equipment…………………………………………

$132,500

The loss on the sale, $7,500 ($132,500 proceeds from sale less $140,000* book value), would be added to net income in determining the net cash flows from operating activities if the indirect method of reporting cash flows from operations was used. * $200,000 – $60,000

Ex. 16-12 Cash flows from (used for) investing activities: Cash received from sale of land…………………...……………………………… $ 95,550 Cash paid for purchase of land…………………………………………………… (104,300) The gain on the sale of land, $31,710*, would be deducted from net income in determining the net cash flows from operating activities if the indirect method of reporting cash flows from operations was used. * $63,840 Cost of land – $95,550

Ex. 16-13 Cash flows from (used for) investing activities: Cash paid for purchase of land……………………………………………………

$(246,000)

A separate schedule of noncash investing and financing activities would report the purchase of $324,000 land with a long-term mortgage note, as follows: Purchase of land by issuing long-term mortgage note…………………………

$324,000

Ex. 16-14 Dividends declared……………………………………………………………………… Decrease in dividends payable……………………………………………………… Dividends paid to stockholders during the year…………………………………

$585,000 21,375 * $606,375

CHAPTER 16

Statement of Cash Flows

Ex. 16-15 Cash flows from (used for) financing activities: Cash received from issuing common stock…………………………………… $1,920,000 * Cash dividends……………………………………………………………………… (463,200) * $1,200,000 + $720,000 A stock dividend does not involve the receipt or payment of cash. Note: It could be disclosed in a note since it involves the issuance of additional stock.

Ex. 16-16 Cash flows from (used for) financing activities: Cash received from issuing bonds payable…………………………………… Cash paid to redeem bonds payable……………………………………………

$420,000 * 138,000

Note: The noncash discount amortization of $2,625 would be shown as an adjusting item (increase) in the Cash Flows from (used for) Operating Activities section under the indirect method. * $450,000 – $30,000

CHAPTER 16

Statement of Cash Flows

Ex. 16-17 a.

Hirayama Industries Inc. Statement of Cash Flows For the Year Ended December 31, 20Y2 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Gain on sale of land Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of land Cash paid for purchase of equipment Net cash flows from investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock Cash dividends* Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y2 Cash balance, December 31, 20Y2

$ 79

33 (51)

(7) (23) 18 $ 49 $153 (38) 115 $ 77 (25) 52 $216 18 $234

* $31 – $6 = $25 b.

Hirayama Industries Inc.’s net income was more than the net cash flows from operating activities because of the following: ● $33 of depreciation expense, which has no effect on cash. ● A $51 gain on the sale of land. The proceeds from this sale of $153, which include the gain, are reported in the Investing Activities section of the statement of cash flows. ● Changes in current operating assets and liabilities that are added or deducted, depending on their effect on cash flows: Increase in accounts receivable, $7 deducted Increase in inventories, $23 deducted Increase in accounts payable, $18 added

CHAPTER 16

Statement of Cash Flows

Ex. 16-18 a.

The increase in accounts receivable should be deducted from net income in the Cash Flows from (used for) Operating Activities section.

The gain on the sale of investments should be deducted from net income in the Cash Flows from (used for) Operating Activities section.

The increase in accounts payable should be added to net income in the Cash Flows from (used for) Operating Activities section.

The correct amount of cash at the beginning of the year, $240,000, should be added to the net increase in cash.

The final amount should be the amount of cash at the end of the year, $350,160.

The final amount of net cash flows from operating activities is $381,360.

The amounts of cash received and paid under investing activities net to $(451,200 rather than $(415,200), a transposition error.

CHAPTER 16

Statement of Cash Flows

Ex. 16-18 (Concluded) b. A corrected statement of cash flows would be as follows: Shasta Inc. Statement of Cash Flows For the Year Ended December 31, 20Y9 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Gain on sale of investments Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable Decrease in accrued expenses payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock Cash dividends Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y9 Cash balance, December 31, 20Y9

$ 360,000

100,800 (17,280)

(27,360) (36,000) 3,600 (2,400) $ 381,360 $ 240,000 (259,200) (432,000) (451,200) $ 312,000 (132,000) 180,000 $ 110,160 240,000 $ 350,160

CHAPTER 16

Statement of Cash Flows

Ex. 16-19 a. Cash flows used for investments in PPE………………………………… Replacement percentage…………………………………………………… Cash paid for maintaining property, plant, and equipment…………… Net cash flows from operating activities………………………………… Less cash paid for maintaining property, plant, and equipment…… Free cash flow………………………………………………………………… b.

$210,000 75 % $157,500 $539,000 157,500 $381,500

Free cash flow is often used to measure the financial strength of a business. The more free cash flow that a business has, the easier it will be for the company to pay the interest on the loan and repay the loan principal. Sweeter’s free cash flow is $381,500, which is very strong.

Ex. 16-20 a. Recent Fiscal Year-End (all numbers in thousands)*

Cash flows used for investments in PPE…………………… Replacement percentage………………………………………… Cash paid for maintaining PPE…………………………………

$1,028 90 %

Net cash flows from operating activities…………………… Less cash paid for maintaining PPE………………………… Free cash flow……………………………………………………

$4,955 925 $4,030

$ 925

* Rounded

Free cash flow is often used to measure the financial strength of a business. The more free cash flow that a business has, the easier it will be for the company to pay the interest on a loan and repay the loan principal.

Yes. Nike’s free cash flow is extremely strong and is well in excess of the capital expenditures necessary to maintain capacity.

Ex. 16-21 Cash flows used for investments in PPE……………………………………… Replacement percentage………………………………………………………… Cash paid for maintaining PPE…………………………………………………

$440,000 85%

Net cash flows from operating activities……………………………………… Less investments in fixed assets to maintain current production……… Free cash flow………………………………………………………………………

$720,000 374,000 $346,000

$374,000

CHAPTER 16

Statement of Cash Flows

Appendix 2 Ex. 16-22 a.

Sales………………………………………………………………………………… Decrease in accounts receivable balance…………………………………… Cash received from customers…………………………………………………

$753,500 48,400 $801,900

Income tax expense……………………………………………………………… Decrease in income tax payable……………………………………………… Cash paid for income taxes……………………………………………………

$50,600 5,500 $56,100

Because the customers paid more than the amount of sales for the period, cash received from customers exceeded sales made on account by $48,400 during the current year.

Appendix 2 Ex. 16-23 Cost of merchandise sold*…………………………………………………………… Decrease in merchandise inventories…………………………………………… Decrease in accounts payable……………………………………………………… Cash paid for merchandise…………………………………………………………

$12,199 (67) 84 $12,216

* In millions

Appendix 2 Ex. 16-24 a.

Cost of merchandise sold……………………………………………………… $1,031,550 9,660 Decrease in accounts payable………………………………………………… (15,410) Decrease in inventories………………………………………………………… Cash paid for merchandise…………………………………………………… $1,025,800

Operating expenses other than depreciation……………………………… Decrease in accrued expenses payable……………………………………… Cash paid for operating expenses……………………………………………

$179,400 1,380 $180,780

CHAPTER 16

Statement of Cash Flows

Appendix 2 Ex. 16-25 a.

Cash flows from (used for) operating activities: Cash received from customers…………………………… Cash paid for merchandise……………………………… Cash paid for operating expenses……………………… Cash paid for income taxes……………………………… Net cash flows from operating activities………………

$ 522,7601 (302,400) 2 (99,960) 3 (24,360) 4 $ 96,040

Computations:

Sales……………………………………………………………..……………… Decrease in accounts receivable………………………………………… Cash received from customers……………………………………………

$511,000 11,760 $522,760

Cost of merchandise sold…………………………………………………… Increase in inventories……………………………………………………… Decrease in accounts payable……………………………………………… Cash paid for merchandise…………………………………………………

$290,500 3,920 7,980 $302,400

Operating expenses other than depreciation…………………………… Decrease in prepaid expenses…………………………………………… Increase in accrued expenses payable…………………………………… Cash paid for operating expenses…………………………………………

$105,000 (3,780) (1,260) $ 99,960

Income tax expense………………………………………………………… Decrease in income tax payable…………………………………………… Cash paid for income taxes…………………………………………………

$21,700 2,660 $24,360

The direct method directly reports cash receipts and payments. The cash received less the cash paid is the net cash flows from operating activities. Individual cash receipts and payments are reported in the Cash Flows from (used for) Operating Activities section. The indirect method adjusts accrual basis net income for revenues and expenses that do not involve the receipt or payment of cash to arrive at net cash flows from operating activities.

CHAPTER 16

Statement of Cash Flows

Appendix 2 Ex. 16-26 Cash flows from (used for) operating activities: Cash received from customers……………………………… Cash paid for merchandise…………………………………… Cash paid for operating expenses………………………… Cash paid for income taxes………………………………… Net cash flows from operating activities…………………

$ 370,250 1 (135,600) 2 (97,310) 3 (33,290) $104,050

Computations: 1.

Sales………………………………………………………………………………… Increase in accounts receivable………………………………………………… Cash received from customers…………………………………………………

$374,500 (4,250) $370,250

Cost of merchandise sold………………………………………………………… Increase in inventories…………………………………………………………… Increase in accounts payable…………………………………………………… Cash paid for merchandise………………………………………………………

$129,500 10,170 (4,070) $135,600

Operating expenses other than depreciation………………………………… Decrease in accrued expenses payable……………………………………… Decrease in prepaid expenses………………………………………………… Cash paid for operating expenses………………………………………………

$96,910 1,510 (1,110) $97,310

CHAPTER 16

Statement of Cash Flows

PROBLEMS Prob. 16-1A Iglesias Inc. Statement of Cash Flows For the Year Ended December 31, 20Y3 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation* Gain on sale of investments Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable Decrease in accrued expenses payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock Cash dividends** Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y3 Cash balance, December 31, 20Y3

$ 600,000

120,000 (90,000)

(60,000) (24,000) 48,000 (6,000) $ 588,000 $ 210,000 (600,000) (240,000) (630,000) $ 150,000 (102,000) 48,000 6,000 180,000 $ 186,000 $

* Accumulated Depreciation: $720,000 – $600,000 ** $108,000 + $30,000 – $36,000 = $102,000

CHAPTER 16

Statement of Cash Flows

Prob. 16-1A (Concluded) Appendix 1 (Optional) Iglesias Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y3 Transactions

Balance, Account Title

Cash Accounts receivable (net) Inventories Investments Land Equipment Accum. depr.—equipment Accounts payable Accrued expenses payable Dividends payable Common stock, $4 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net income Depreciation Gain on sale of investments Increase in accounts receivable Increase in inventories Increase in accounts payable Decrease in accrued expenses payable Investing activities: Purchase of equipment Purchase of land Sale of investments Financing activities: Declaration of cash dividends Issuance of common stock Increase in dividends payable Net increase in cash Totals

Debit

Dec. 31, 20Y2

180,000 (m) 480,000 (l) 900,000 (k) 120,000 — (i) 1,440,000 (h) (600,000) (360,000) (60,000) (e) (30,000) (720,000) (210,000) (1,140,000) (b) 0 (a) (g)

(f)

Balance,

Credit

6,000 60,000 24,000

Dec. 31, 20Y3

(j)

120,000

(g) (f)

120,000 48,000

(d) (c)

6,000 120,000

186,000 540,000 924,000 — 600,000 1,680,000 (720,000) (408,000) (54,000) (36,000) (840,000)

(240,000) (1,632,000) 0

600,000 240,000

6,000

600,000 120,000 (j)

90,000

(l) (k)

60,000 24,000

(e)

6,000

(h) (i)

240,000 600,000

(b)

108,000

(m)

6,000 1,134,000

48,000

(j)

210,000

150,000 6,000 1,134,000

The letters in the Debit and Credit columns are included for reference purposes. They do not correspond to the letters in the additional data section of this problem.

CHAPTER 16

Statement of Cash Flows

Prob. 16-2A Orange Angel Enterprises Inc. Statement of Cash Flows For the Year Ended December 31, 20Y8 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Changes in current operating assets and liabilities: Decrease in accounts receivable Increase in merchandise inventory Increase in prepaid expenses Increase in accounts payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock* Cash dividends Cash paid to retire mortgage note payable Net cash flows from financing activities Net decrease in cash Cash balance, January 1, 20Y8 Cash balance, December 31, 20Y8

$ 359,000

218,000

47,000 (209,000) (9,000) 19,000 $ 425,000 $ (750,000) (750,000) $1,140,000 (95,000) (759,000) 286,000 $ (39,000) 190,000 $ 151,000

* 76,000 shares × $15 = $1,140,000 Note to Instructors: The disposal of fully depreciated equipment is not included in the cash flow statement because there is no associated cash flow. This transaction strictly involves the removal of $142,000 from the equipment and accumulated depreciation—equipment accounts.

CHAPTER 16

Statement of Cash Flows

Prob. 16-2A (Concluded) Appendix 1 (Optional) Orange Angel Enterprises Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y8 Transactions

Balance, Account Title

Cash Accounts receivable (net) Merchandise inventory Prepaid expenses Equipment Accum. depr.—equipment Accounts payable Mortgage note payable Common stock, $10 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net income Depreciation Decrease in accts. receivable Increase in merchandise inventory Increase in prepaid expenses Increase in accounts payable Investing activities: Purchase of equipment Financing activities: Payment of cash dividends Issuance of common stock Payment of mortgage note payable Net decrease in cash Totals

Debit

Dec. 31, 20Y7

190,000 569,000 759,000 (j) 19,000 (i) 1,424,000 (h) (304,000) (g) (171,000) (759,000) (d) (380,000) (190,000) (1,157,000) (b) 0 (a) (f) (k)

(e)

(c)

(l)

Balance,

Credit

(l) (k)

39,000 47,000

209,000 9,000 750,000 (g) 142,000 (f) (e) 759,000 (c)

142,000 218,000 19,000

Dec. 31, 20Y8

760,000

151,000 522,000 968,000 28,000 2,032,000 (380,000) (190,000) — (1,140,000)

(570,000) (1,421,000) 0

359,000 218,000 47,000 (j) (i)

209,000 9,000

(h)

750,000

(b)

95,000

(d)

759,000

19,000

1,140,000

39,000 1,822,000

1,822,000

The letters in the Debit and Credit columns are included for reference purposes. They do not correspond to the letters in the additional data section of this problem.

CHAPTER 16

Statement of Cash Flows

Prob. 16-3A Whitman Co. Statement of Cash Flows For the Year Ended December 31, 20Y2 Cash flows from (used for) operating activities: Net loss Adjustments to reconcile net loss to net cash flows from (used for) operating activities: Depreciation* Loss on sale of land** Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Net cash flows used for operating activities*** Cash flows from (used for) investing activities: Cash received from sale of land Cash paid for acquisition of building Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing bonds payable Cash received from issuing common stock Cash dividends Net cash flows from financing activities Net decrease in cash Cash balance, January 1, 20Y2 Cash balance, December 31, 20Y2

$ (35,320)

55,620 12,600

(66,960) (105,480) 5,760 (35,820) $(169,600) $ 151,200 (561,600) (104,400) (514,800) $ 270,000 400,000 (32,400) 637,600 $ (46,800) 964,800 $ 918,000

* $26,280 + $29,340 ** $151,200 – $163,800 *** When a company has negative cash flow from operations, the total is described as net cash used for operating activities.

CHAPTER 16

Statement of Cash Flows

Prob. 16-3A (Concluded) Appendix 1 (Optional) Whitman Co. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y2 Transactions

Balance, Account Title

Cash Accounts receivable Inventories Prepaid expenses Land Buildings Accum. depr.—buildings Equipment Accum. depr.—equipment Accounts payable Bonds payable Common stock, $25 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net loss Depreciation—equipment Depreciation—buildings Loss on sale of land Increase in accts. receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Investing activities: Purchase of equipment Acquisition of building Sale of land Financing activities: Payment of cash dividends Issuance of bonds payable Issuance of common stock Net decrease in cash Totals

Debit

Dec. 31, 20Y1

964,800 761,940 (g) 1,162,980 (h) 35,100 479,700 900,900 (k) (382,320) 454,680 (i) (158,760) (j) (958,320) (c) 0 (117,000) (558,000) (2,585,700) (a) (b) 0

(d) (e) (l)

(f)

Balance,

Credit

Dec. 31, 20Y2

(o)

46,800

(f) (l)

5,760 163,800

(e) 104,400 (j) 46,800 (d) 35,820 (m) (n)

26,280 46,800 29,340 270,000 200,000

(n)

200,000

(758,000) (2,517,980)

988,780

66,960 105,480

561,600

35,320 32,400 988,780 (a)

35,320

(g) (h)

66,960 105,480

(c)

35,820

(i) (k)

104,400 561,600

(b)

32,400

918,000 828,900 1,268,460 29,340 315,900 1,462,500 (408,600) 512,280 (141,300) (922,500) (270,000) (317,000)

29,340 26,280 12,600

5,760

(l)

151,200

(m) (n) (o)

270,000 400,000 46,800 941,980

941,980

CHAPTER 16

Statement of Cash Flows

Appendix 2 Prob. 16-4A Canace Products Inc. Statement of Cash Flows For the Year Ended December 31, 20Y6 Cash flows from (used for) operating activities: Cash received from customers1 Cash paid for merchandise2 Cash paid for operating expenses3 Cash paid for income taxes Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock Cash dividends* Net cash flows from financing activities

$ 5,960,600 (2,456,800) (3,107,400) (102,800) $ 293,600 $

176,000 (520,000) (200,000) (544,000)

240,000 (25,600)

Net decrease in cash Cash balance, January 1, 20Y6 Cash balance, December 31, 20Y6

214,400 $ (36,000) 679,400 $ 643,400

Schedule Reconciling Net Income with Net Cash Flows from Operating Activities: Cash flows from (used for) operating activities: Net income…………………………………………………………………… Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation…………………………………………………………… Loss on sale of investments……………………………………… Changes in current operating assets and liabilities: Increase in accounts receivable……………………………… Increase in inventories…………………………………………… Increase in accounts payable…………………………………… Decrease in accrued expenses payable……………………… Net cash flows from operating activities………………………………

$217,200

44,000 64,000 (19,400) (28,200) 23,400 (7,400) $293,600

* Dividends paid: $28,000 + $6,400 – $8,800 = $25,600

CHAPTER 16

Statement of Cash Flows

Appendix 2 Prob. 16-4A (Concluded) Computations: 1.

Sales………………………………………………………………………………… $5,980,000 (19,400) Increase in accounts receivable………………………………………………… Cash received from customers………………………………………………… $5,960,600

Cost of merchandise sold………………………………………………………… $2,452,000 Increase in inventories…………………………………………………………… 28,200 (23,400) Increase in accounts payable…………………………………………………… Cash paid for merchandise……………………………………………………… $2,456,800

Operating expenses other than depreciation………………………………… $3,100,000 7,400 Decrease in accrued expenses payable……………………………………… Cash paid for operating expenses……………………………………………… $3,107,400

CHAPTER 16

Statement of Cash Flows

Appendix 2 Prob. 16-5A Iglesias Inc. Statement of Cash Flows For the Year Ended December 31, 20Y3 Cash flows from (used for) operating activities: Cash received from customers1 Cash paid for merchandise2 Cash paid for operating expenses3 Cash paid for income taxes Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock 4

Cash dividends Net cash flows from financing activities

$ 3,540,000 (1,656,000) (1,146,000) (150,000) $ 588,000 $

210,000 (600,000) (240,000) (630,000)

150,000 (102,000)

Net increase in cash Cash balance, January 1, 20Y3 Cash balance, December 31, 20Y3

48,000 $

6,000 180,000 $ 186,000

Schedule Reconciling Net Income with Net Cash Flows from Operating Activities: Cash flows from (used for) operating activities: Net income………………………………………………………………… Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation…………………………………………………………… Gain on sale of investments……………………………………… Changes in current operating assets and liabilities: Increase in accounts receivable……………………………… Increase in inventories………………………………………… Increase in accounts payable………………………………… Decrease in accrued expenses payable……………………… Net cash flows from operating activities………………………………

$600,000

120,000 (90,000) (60,000) (24,000) 48,000 (6,000) $588,000

CHAPTER 16

Statement of Cash Flows

Appendix 2 Prob. 16-5A (Concluded) Computations: 1.

Sales……………………………………………………………………………… Increase in accounts receivable……………………………………………… Cash received from customers………………………………………………

$3,600,000 (60,000) $3,540,000

Cost of merchandise sold……………………………………………………… $1,680,000 Increase in inventories………………………………………………………… 24,000 (48,000) Increase in accounts payable………………………………………………… Cash paid for merchandise…………………………………………………… $1,656,000

Operating expenses other than depreciation……………………………… Decrease in accrued expenses payable…………………………………… Cash paid for operating expenses……………………………………………

$1,140,000 6,000 $1,146,000

Cash dividends declared……………………………………………………… Deduct increase in dividends payable……………………………………… Cash paid for dividends…………………………………………………………

$108,000 (6,000) $102,000

CHAPTER 16

Statement of Cash Flows

Prob. 16-1B Merrick Equipment Co. Statement of Cash Flows For the Year Ended December 31, 20Y9 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Loss on sale of investments* Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable Increase in accrued expenses payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock Cash dividends** Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y9 Cash balance, December 31, 20Y9

$ 141,680

14,790 10,200

(19,040) (8,670) 11,560 3,740 $ 154,260 $ 91,800 (295,800) (80,580) (284,580) $ 250,000 (96,900) 153,100 $ 22,780 47,940 $ 70,720

* $91,800 – $102,000 = $10,200 loss on sale of investment ** $102,000 + $20,400 – $25,500 = $96,900

CHAPTER 16

Statement of Cash Flows

Prob. 16-1B (Concluded) Appendix 1 (Optional) Merrick Equipment Co. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y9 Transactions

Balance, Account Title

Cash Accounts receivable (net) Inventories Investments Land Equipment Accum. depr.—equipment Accounts payable Accrued expenses payable Dividends payable Common stock, $1 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net income Depreciation Loss on sale of investments Increase in accounts receivable Increase in inventories Increase in accounts payable Increase in accrued expenses payable Investing activities: Purchase of equipment Purchase of land Sale of investments Financing activities: Declaration of cash dividends Issuance of common stock Increase in dividends payable Net increase in cash Totals

Debit

Dec. 31, 20Y8

47,940 (m) 188,190 (l) 289,850 (k) 102,000 — (i) 358,020 (h) (84,320) (194,140) (26,860) (20,400) (102,000) (204,000) (354,280) (b) 0 (a) (g) (j)

Balance,

Credit

22,780 19,040 8,670

Dec. 31, 20Y9

(j)

102,000

(g) (f) (e) (d) (c)

14,790 11,560 3,740 5,100 100,000

70,720 207,230 298,520 — 295,800 438,600 (99,110) (205,700) (30,600) (25,500) (202,000)

150,000 141,680 528,870

(354,000) (393,960) 0

295,800 80,580

141,680 14,790 10,200

(f)

11,560

(e)

3,740

(j)

91,800

250,000 5,100 528,870

(l) (k)

19,040 8,670

(h) (i)

80,580 295,800

(b)

102,000

(m)

22,780 528,870

The letters in the Debit and Credit columns are included for reference purposes. They do not correspond to the letters in the additional data section of this problem.

CHAPTER 16

Statement of Cash Flows

Prob. 16-2B Harris Industries Inc. Statement of Cash Flows For the Year Ended December 31, 20Y4 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Patent amortization Changes in current operating assets and liabilities: Increase in accounts receivable Decrease in inventories Increase in prepaid expenses Decrease in accounts payable Decrease in salaries payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash paid for construction of building Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing mortgage note Cash dividends* Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y4 Cash balance, December 31, 20Y4 Schedule of Noncash Financing and Investing Activities: Issued common stock to retire bonds

$ 524,580

74,340 5,040 (73,080) 134,680 (6,440) (89,600) (8,120) $ 561,400 $(579,600) (579,600) $ 224,000 (123,480) 100,520 $ 82,320 360,920 $ 443,240

$ 390,000

* $131,040 + $25,200 – $32,760 = $123,480

CHAPTER 16

Statement of Cash Flows

Prob. 16-2B (Continued) Appendix 1 (Optional) Harris Industries Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y4 Balance, Account Title

Cash Accounts receivable (net) Inventories Prepaid expenses Land Buildings Accum. depr.—buildings Machinery and equipment Accum. depr.—machinery and equipment Patents Accounts payable Dividends payable Salaries payable Mortgage note payable Bonds payable Common stock, $5 par Paid-in capital in excess of par—common stock Retained earnings Totals

Dec. 31, 20Y3

360,920 (p) 592,200 (o) 1,022,560 25,200 (m) 302,400 1,134,000 (l) (414,540) 781,200

Transactions Debit

Balance,

Credit

82,320 73,080

Dec. 31, 20Y4

443,240 665,280 887,880 31,640 302,400 1,713,600 (466,200) 781,200

(n)

134,680

(k)

51,660

(j) (i)

22,680 5,040

(g)

7,560

(e)

224,000

(c)

150,000

(214,200) 106,960 (837,480) (32,760) (78,960) (224,000) — (200,400)

(126,000) (c) (2,118,660) (b) 131,040 (a) 0 1,360,200

240,000 524,580 1,360,200

(366,000) (2,512,200) 0

(191,520) 112,000 (927,080) (h) (25,200) (87,080) (f) — (390,000) (d) (50,400)

6,440 579,600

89,600 8,120 390,000

The letters in the Debit and Credit columns are included for reference purposes. They do not correspond to the letters in the additional data section of this problem.

CHAPTER 16

Statement of Cash Flows

Prob. 16-2B (Concluded) Appendix 1 (Optional) Harris Industries Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y4 Transactions

Balance, Account Title

Debit

Dec. 31, 20Y3

Operating activities: Net income Depreciation—buildings Depreciation—machinery and equipment Amortization of patents Increase in accounts receivable Decrease in inventories Increase in prepaid expenses Decrease in accounts payable Decrease in salaries payable Investing activities: Construction of building Financial activities: Declaration of cash dividends Issuance of mortgage note payable Increase in dividends payable Schedule of noncash investing and financing activities: Issuance of common stock to retire bonds Net increase in cash Totals

(a) (k)

524,580 51,660

(j) (i)

22,680 5,040

(n)

134,680

(e) (g)

(c)

Balance,

Credit

(o)

73,080

(m) (h) (f)

6,440 89,600 8,120

(l)

579,600

(b)

131,040

Dec. 31, 20Y4

224,000 7,560

390,000 (d) 390,000 (p) 82,320 1,360,200 1,360,200

CHAPTER 16

Statement of Cash Flows

Prob. 16-3B Coulson, Inc. Statement of Cash Flows For the Year Ended December 31, 20Y2 Cash flows from (used for) operating activities: Net income Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation Gain on sale of land Changes in current operating assets and liabilities: Increase in accounts receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Increase in income taxes payable Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of land Cash paid for acquisition of building Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing bonds payable Cash received from issuing common stock Cash dividends Net cash flows from financing activities Net decrease in cash Cash balance, January 1, 20Y2 Cash balance, December 31, 20Y2

$ 326,600

68,400 (60,000)

(94,800) (52,800) 7,800 (37,200) 4,800 $ 162,800 $ 456,000 (990,000) (196,800) (730,800) $ 330,000 280,000 (79,200) 530,800 $ (37,200) 337,800 $ 300,600

CHAPTER 16

Statement of Cash Flows

Prob. 16-3B (Concluded) Appendix 1 (Optional) Coulson, Inc. Spreadsheet (Work Sheet) for Statement of Cash Flows For the Year Ended December 31, 20Y2 Transactions

Balance, Account Title

Cash Accounts receivable (net) Inventories Prepaid expenses Land Buildings Accum. depr.—buildings Equipment Accum. depr.—equipment Accounts payable Income taxes payable Bonds payable Common stock, $20 par Paid-in capital in excess of par—common stock Retained earnings Totals Operating activities: Net income Depreciation—equipment Depreciation—buildings Gain on sale of land Increase in accts. receivable Increase in inventories Decrease in prepaid expenses Decrease in accounts payable Increase in income taxes payable Investing activities: Purchase of equipment Acquisition of building Sale of land Financing activities: Payment of cash dividends Issuance of bonds payable Issuance of common stock Net decrease in cash Totals

Debit

Dec. 31, 20Y1

337,800 609,600 (i) 865,800 (h) 26,400 1,386,000 990,000 (l) (366,000) 529,800 (j) (162,000) (k) (631,200) (d) (21,600) — (180,000) (810,000) (2,574,600) (b) 0 (a) (e) (f)

(p)

37,200

(g) (m)

7,800 396,000

(f) 196,800 (k) 66,000 (e) 37,200 (c) (n) (o)

31,200 66,000 37,200

(c)

Dec. 31, 20Y2

4,800 330,000 140,000

300,600 704,400 918,600 18,600 990,000 1,980,000 (397,200) 660,600 (133,200) (594,000) (26,400) (330,000) (320,000)

(o) 140,000 79,200 (a) 326,600 1,516,800 1,516,800

(950,000) (2,822,000) 0

94,800 52,800

990,000

326,600 37,200 31,200 (m) (i)

(g)

Balance,

Credit

(h)

60,000 94,800 52,800

(d)

37,200

(j) (l)

196,800 990,000

(b)

79,200

7,800

4,800

(m)

456,000

(n) (o) (p)

330,000 280,000 37,200 1,510,800

1,510,800

CHAPTER 16

Statement of Cash Flows

Appendix 2 Prob. 16-4B Suffridge Inc. Statement of Cash Flows For the Year Ended December 31, 20Y4 Cash flows from (used for) operating activities: Cash received from customers1 Cash paid for merchandise2 Cash paid for operating expenses3 Cash paid for taxes Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for land Cash paid for equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock Cash dividends* Net cash flows from financing activities Net decrease in cash Cash balance, January 1, 20Y4 Cash balance, December 31, 20Y4

$ 5,293,500 (2,709,300) (1,619,310) (357,100) $ 607,790 $

702,000 (1,146,100) (286,500) (730,600)

716,300 (619,000) 97,300 $ (25,510) 815,600 $ 790,090

Schedule Reconciling Net Income with Net Cash Flows from Operating Activities: Cash flows from (used for) operating activities: Net income……………………………………………………………………… $ 667,290 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation expense…………………………………………………… 135,000 Gain on sale of investments…………………………………………… (186,200) Changes in current operating assets and liabilities: Increase in accounts receivable………………………………… (93,400) Increase in inventories……………………………………………… (36,600) Increase in accounts payable……………………………………… 135,400 (13,700) Decrease in accrued expenses payable………………………… $ 607,790 Net cash flows from operating activities………………………………… * Dividends paid: $108,900 + $630,400 – $120,300 = $619,000

CHAPTER 16

Statement of Cash Flows

Appendix 2 Prob. 16-4B (Concluded) Computations: 1.

Sales………………………………………………………………………… Increase in accounts receivable………………………………………… Cash received from customers…………………………………………

$5,386,900 (93,400) $5,293,500

Cost of merchandise sold………………………………………………… Increase in inventories…………………………………………………… Increase in accounts payable…………………………………………… Cash paid for merchandise………………………………………………

$2,808,100 36,600 (135,400) $2,709,300

Operating expenses other than depreciation………………………… Decrease in accrued expenses payable………………………………… Cash paid for operating expenses………………………………………

$1,605,610 13,700 $1,619,310

CHAPTER 16

Statement of Cash Flows

Appendix 2 Prob. 16-5B Merrick Equipment Co. Statement of Cash Flows For the Year Ended December 31, 20Y9 Cash flows from (used for) operating activities: Cash received from customers1 Cash paid for merchandise2 Cash paid for operating expenses3 Cash paid for taxes Net cash flows from operating activities Cash flows from (used for) investing activities: Cash received from sale of investments Cash paid for purchase of land Cash paid for purchase of equipment Net cash flows used for investing activities Cash flows from (used for) financing activities: Cash received from issuing common stock Cash dividends* Net cash flows from financing activities Net increase in cash Cash balance, January 1, 20Y9 Cash balance, December 31, 20Y9

$ 2,004,858 (1,242,586) (513,559) (94,453) $ 154,260 $

91,800 (295,800) (80,580) (284,580)

250,000 (96,900) 153,100 $ 22,780 47,940 $ 70,720

Schedule Reconciling Net Income with Net Cash Flows from Operating Activities: Cash flows from (used for) operating activities: Net income……………………………………………………………………… $141,680 Adjustments to reconcile net income to net cash flows from (used for) operating activities: Depreciation……………………………………………………………… 14,790 Loss on sale of investments………………………………………… 10,200 Changes in current operating assets and liabilities: Increase in accounts receivable………………………………… (19,040) Increase in inventories……………………………………………… (8,670) Increase in accounts payable……………………………………… 11,560 3,740 Increase in accrued expenses payable………………………… Net cash flows from operating activities………………………………… $154,260 * Dividends paid: $102,000 + $20,400 – $25,500 = $96,900

CHAPTER 16

Statement of Cash Flows

Appendix 2 Prob. 16-5B (Concluded) Computations: 1.

Sales……………………………………………………………………………… Increase in accounts receivable…………………………………………… Cash received from customers………………………………………………

$2,023,898 (19,040) $2,004,858

Cost of merchandise sold…………………………………………………… Increase in inventories………………………………………………………… Increase in accounts payable………………………………………………… Cash paid for merchandise……………………………………………………

$1,245,476 8,670 (11,560) $1,242,586

Operating expenses other than depreciation……………………………… Increase in accrued expenses payable…………………………………… Cash paid for operating expenses……………………………………………

$517,299 (3,740) $513,559

CHAPTER 16

Statement of Cash Flows

CASES & PROJECTS CP 16-1 Although this situation might seem harmless at first, it is, in fact, a violation of generally accepted accounting principles. The operating cash flow per share figure should not be shown on the face of the income statement. The income statement is constructed under accrual accounting concepts, and operating cash flow “undoes” the accounting accruals. Thus, unlike Lucas’s assertion that this information would be useful, more likely the information would be confusing to users. Some users might not be able to distinguish between earnings and operating cash flow per share—or how to interpret the difference. By agreeing with Lucas, John has breached his professional ethics because the disclosure would violate generally accepted accounting principles. On a more subtle note, Lucas is being somewhat disingenuous. Apparently, Lucas is not pleased with this year’s operating performance and would like to cover the earnings “bad news” with some cash flow “good news” disclosures. An interesting question is whether Lucas would be as interested in the dual per share disclosures in the opposite scenario—with earnings per share improving and cash flow per share deteriorating. Probably not.

CP 16-2 A sample solution based on Nike Inc.'s Form 10-K for the fiscal year ended May 31, 2018, follows: 1.

a. b. c. d.

$4,955 million $276 million $(4,835) million $441 million*

* In addition to the net cash flows from operating, investing, and financing activities, Nike Inc. reported net cash flows from foreign currency exchange rate changes of $45 million. Thus, the net increase in cash for the year was $441 million ($4,955 + $276 + $(4,835) + $45).

The company has a very strong cash position, generating considerably more cash flows from operations than it requires for investing or financing activities.

CHAPTER 16

Statement of Cash Flows

CP 16-3 Memo To: From: Re:

My Instructor A+ Student Tidewater Inc. Financial Condition

Tidewater Inc. is a retailer that has been unprofitable in recent years. While the company has returned to profitability, there are several “red flags” indicating that the company’s future prospects are highly uncertain. These red flags are discussed below. • The company has initiated a new marketing campaign that significantly increased the number of customers who are purchasing merchandise on credit using the company’s branded credit card. This campaign significantly increased revenue and has helped the company return to profitability. However, it appears that the company has done a poor job of screening the creditworthiness of its new credit card customers. Increases in credit card purchases have resulted in a large accounts receivable balance. It is unlikely that the company will be able to collect a large portion of these accounts receivable, which will likely lead to a cash crisis. • The purchases of deeply discounted merchandise appear to be backfiring. The company has received some “good deals” on price. However, the merchandise is only a “good deal” if the company can resell the merchandise at a profit. The large increase in inventory indicates that this is not the case. It appears that the merchandise has little customer appeal, and it is questionable whether the company will be able to sell the merchandise. • The company has not been able to pay off its accounts payable in a timely manner, resulting in significant overdue accounts payable balances. While the company reports that most of the past-due payables have been paid, it is concerning that the company became overdue on its accounts payable. A retailer cannot afford a poor payment history, or it will be denied future merchandise shipments. This is a signal of a severe cash flow problem. These red flags suggest that the company is having severe operating cash flow difficulties, and the company’s future prospects are highly uncertain.

CHAPTER 16

Statement of Cash Flows

CP 16-4 Start-up companies are unique in that they frequently have negative retained earnings and operating cash flows. The negative retained earnings are often due to losses from high start-up expenses. The negative operating cash flows are typical because growth requires cash. Growth must be financed with cash before the cash returns. For example, a company must expend cash to provide the service in Period 1 before selling it and receiving cash in Period 2. The start-up company constantly faces the problem of spending cash today for the next period’s growth. For Giraffe Inc., the money spent on salaries to develop the business is a cash outflow that must occur before the service provides revenues. In addition, the company must use cash to market its service to potential customers. In this situation, the only way the company stays in business is from the capital provided by the owners. This owner-supplied capital is the lifeblood of a start-up company. Banks will not likely lend money on this type of venture (except with assets as security). Giraffe Inc. could be a good investment. It all depends on whether the new service has promise. The financial figures will not reveal this in a straightforward manner. Only actual sales will reveal whether the service is a hit. Until such a time, the company is at risk. If the service is not popular, the company will have no cash to fall back on—it will likely go bankrupt. If, however, the service is successful, then Giraffe Inc. should become self-sustaining and provide a good return for the shareholders.

CP 16-5 a.

Normal practice for determining net cash flows from operating activities during the year is to begin with the reported net income. This net income must ordinarily be adjusted upward or downward to determine the amount of cash flows. Although many operating expenses decrease cash, depreciation does not. The amount of net income understates the amount of cash flows provided by operations to the extent that depreciation expense is deducted from revenue. The associated cash outflow occurs when the asset is purchased and is reported as a cash outflow from investing activities. Accordingly, the depreciation expense for the year must be added back to the reported net income in arriving at net cash flows from operating activities.

Generally accepted accounting principles require that significant transactions affecting future cash flows be reported in a separate schedule to the statement even though they do not affect cash. Accordingly, even though the issuance of the common stock for land does not affect cash, the transaction affects future cash flows and must be reported.

The $180,000 cash received from the sale of the investments is reported in the Cash Flows from (used for) Investing Activities section. Because the net income included a gain of $30,000, the gain is deducted from net income to avoid double reporting this amount and to remove it from the determination of net cash flows from operating activities.

CHAPTER 16

Statement of Cash Flows

CP 16-5 (Concluded) 4.

The balance sheets for the last two years will indicate the increase in cash but will not indicate the firm’s activities in meeting its financial obligations, paying dividends, and maintaining and expanding operating capacity. Such information, as provided by the statement of cash flows, assists creditors in assessing the firm’s solvency and profitability—two very important factors impacting the evaluation of a potential loan.

The statement of cash flows indicates a strong liquidity position for Argon Inc. The increase in cash of $291,000 for the past year is more than adequate to cover the $150,000 of new building and store equipment costs that will not be provided by the loan. Thus, the statement of cash flows most likely will enhance the company’s chances of receiving a loan. However, other information, such as a projection of future earnings, a description of collateral pledged to support the loan, and an independent credit report, would normally be considered before a decision is made on a final loan.

CP 16-6 a. and b. Recent statements of cash flows for Johnson & Johnson and JetBlue Airways Corp. are shown on the following pages. The actual analysis may be different due to updated information. However, this answer shows the structure for a possible response. Johnson & Johnson Johnson & Johnson (J&J) is a powerful generator of cash flows from operating activities, with almost $22.2 billion in net cash flows from operating activities. This is enough to support almost $3.2 billion in investing activities, with cash left over to pay a sizable dividend and repurchase shares of common stock. Overall, the statement of cash flows indicates very favorable cash flows for J&J. J&J’s free cash flow is approximately $18.5 billion for the year ($22.2 – $3.7). JetBlue Airways Corp. JetBlue is weaker than J&J. JetBlue had net cash flows from operating activities of around $1.2 billion. In addition, JetBlue had net cash flows used for investing activities of $1.2 billion. The net cash flows from financing activities was $113 million and was primarily from the issuance of long-term debt. JetBlue generated slightly more cash flow from operations than it needed to maintain the necessary investment in its fixed assets. Free cash flow is approximately $300 million ($1.2 – $0.9). JetBlue is in a much weaker cash flow position than Johnson & Johnson.

CHAPTER 16

Statement of Cash Flows

CP 16-6 (Continued) Johnson & Johnson Statement of Cash Flows For Period Ended December 31, 2018 (in millions) Cash flows from operating activities: Net earnings Adjustments to reconcile net earnings to cash flows from operating activities: Depreciation and amortization of property and intangibles Stock-based compensation Asset write-downs Gain on sale of assets/businesses Deferred tax provision Accounts receivable allowances Changes in assets and liabilities: Increase in accounts receivable Increase in inventories Increase in accounts payable and accrued liabilities Increase in other current and noncurrent assets Decrease in other current and noncurrent liabilities Net cash flows from operating activities Cash flows from investing activities: Additions to property, plant, and equipment Proceeds from the disposal of assets Acquisitions, net of cash acquired Purchases of investments Sales of investments Other (primarily intangibles) Net cash used by investing activities Cash flows from financing activities: Dividends to shareholders Repurchase of common stock Proceeds from short-term debt Retirement of short-term debt Proceeds from long-term debt Retirement of long-term debt Proceeds from the exercise of stock options Other Net cash used by financing activities Effect of exchange rate changes on cash and cash equivalents Increase (decrease) in cash and cash equivalents Cash and cash equivalents, beginning of year Cash and cash equivalents, end of year

$ 15,297

6,929 978 1,258 (1,217) (1,016) (31) (1,185) (644) 3,951 (275) (1,844) $ 22,201 $ (3,670) 3,203 (899) (5,626) 4,289 (464) $ (3,167) $ (9,494) (5,868) 80 (2,479) 5 (1,555) 949 (148) $(18,510) $ (241) $ 283 17,824 $ 18,107

CHAPTER 16

Statement of Cash Flows

CP 16-6 (Concluded) JetBlue Airways Corp. Consolidated Statement of Cash Flows For Period Ended December 31, 2018 (in millions) Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation Amortization Stock-based compensation Impairment of long-lived assets Deferred income taxes Changes in certain operating assets and liabilities: Decrease (increase) in receivables Increase (decrease) in inventories, prepaid and other Increase (decrease) in air traffic liability Increase (decrease) in accounts payable and other accrued liabilities Other, net Net cash provided by operating activities

46 (174) 131 96 2 $ 1,217

Cash flows from investing activities: Capital expenditures Predelivery deposits for flight equipment Purchase of held-to-maturity investments Proceeds from maturity of held-to-maturity investments Purchase of available-for-sale securities Proceeds from sale of available-for-sale securities Other, net Net cash used in investing activities

$ (908) (206) (429) 505 (979) 875 (14) $(1,156)

Cash flows from financing activities: Proceeds from: Issuance of common stock Issuance of long-term debt Repayment of long-term debt and capital lease obligations Acquisition of treasury stock Other, net Net cash provided by financing activities Increase (decrease) in cash Cash at beginning of year Cash at end of year

$ 188

423 68 28 319 90

48 687 (222) (382) (18) $ 113 $ 174 359 $ 533

CHAPTER 17 FINANCIAL STATEMENT ANALYSIS DISCUSSION QUESTIONS 1.

Liquidity is the ability of a company to convert assets into cash. Short-term creditors such as banks and financial institutions are most concerned with liquidity. Solvency is the ability of a company to pay its debts. Long-term creditors such as bondholders are concerned primarily with a company’s solvency. Profitability is the ability of a company to generate earnings. Investors such as stockholders are concerned primarily with profitability because it determines whether the company’s stock price will increase.

Comparative statements provide information as to changes between dates or periods. Trends indicated by comparisons may be far more significant than the data for a single date or period.

Before this question can be answered, the increase in net income should be compared with changes in sales, expenses, and assets devoted to the business for the current year. The return on assets for both periods should also be compared. If these comparisons indicate favorable trends, the operating performance has improved; if not, the apparent favorable increase in net income may be offset by unfavorable trends in other areas.

Generally, the two ratios would be very close because most service businesses sell services and hold very little inventory.

A high inventory turnover minimizes the amount invested in inventories, thus freeing funds for more advantageous use. Storage costs, administrative expenses, and losses caused by obsolescence and adverse changes in prices are also kept to a minimum.

Yes. The inventory turnover relates to the “turnover” of inventory during the year, while the number of days’ sales in inventory relates to the amount of inventory on hand at the beginning and end of the year. Therefore, a business could have a high inventory turnover during the year yet have a high number of days’ sales in inventory based on the beginning and end-of-year inventory amounts.

The ratio of fixed assets to long-term liabilities increased from 3.4 ($1,360,000 ÷ $400,000) for the preceding year to 4.2 ($1,260,000 ÷ $300,000) for the current year, indicating that the company is in a stronger position now than in the preceding year to borrow additional funds on a long-term basis.

The return on total assets adds interest expense to the net income, which is divided by average total assets. It measures the profitability of the total assets without regard for how the assets are financed. The return on stockholders’ equity divides net income by the average total stockholders’ equity. It measures the profitability of the stockholders’ investment.

The return on stockholders’ equity is normally higher than the return on total assets. This is because of leverage, which compensates stockholders for the higher risk of their investments.

CHAPTER 17

Financial Statement Analysis

DISCUSSION QUESTIONS (Continued) 8. The price-earnings ratio measures the market’s expectations of a company’s future earnings prospects. Kroger’s low price-earnings ratio compared to the industry average suggests that the market has low expectations about the company’s future earnings. 9. The dividend yield measures the rate of return common stockholders receive from a cash dividend. The high dividend yield for Suburban Propane indicates that a significant portion of the return to its shareholders comes in the form of a cash dividend. The lack of a dividend yield for Alphabet indicates that the return to shareholders comes solely from stock appreciation. 10. One report is the Report on Internal Control, which verifies management’s conclusions on internal control. Another report is the Report of Independent Registered Public Accounting Firm, where the Certified Public Accounting (CPA) firm that conducts the audit renders an opinion on the fairness of the statements.

CHAPTER 17

Financial Statement Analysis

PRACTICE EXERCISES PE 17-1A Temporary investments……… $6,000 increase ($36,000 – $30,000), or 20% ($6,000 ÷ $30,000) Merchandise inventory……… $3,000 decrease ($72,000 – $75,000), or (4)% ($3,000 ÷ $75,000) PE 17-1B Accounts payable…………… Long-term debt………………

$24,000 decrease ($176,000 – $200,000), or (12)% ($24,000 ÷ $200,000) $13,950 increase ($168,950 – $155,000), or 9% ($13,950 ÷ $155,000)

PE 17-2A Sales…………………………… Cost of merchandise sold…… Gross profit……………………

Amount

Percentage

$200,000 140,000 $ 60,000

100% 70% 30%

Amount

Percentage

$1,400,000 812,000

100% 58%

$ 588,000

42%

($200,000 ÷ $200,000) ($140,000 ÷ $200,000) ($60,000 ÷ $200,000)

PE 17-2B Sales…………………………… Cost of merchandise sold…… Gross profit……………………

($1,400,000 ÷ $1,400,000) ($812,000 ÷ $1,400,000) ($588,000 ÷ $1,400,000)

PE 17-3A a.

Current Ratio = Current Assets ÷ Current Liabilities = ($120,000 + $40,000 + $50,000 + $90,000) ÷ $150,000 = 2.0

Quick Ratio = Quick Assets ÷ Current Liabilities = ($120,000 + $40,000 + $50,000) ÷ $150,000 = 1.4

CHAPTER 17

Financial Statement Analysis

PE 17-3B a. Current Ratio = Current Assets ÷ Current Liabilities = ($320,000 + $170,000 + $140,000 + $450,000) ÷ $300,000 = 3.6 b.

Quick Ratio = Quick Assets ÷ Current Liabilities = ($320,000 + $170,000 + $140,000) ÷ $300,000 = 2.1

PE 17-4A Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable

= $1,460,000 ÷ $100,000 = 14.6 b.

Number of Days’ Sales in Receivables =

Average Accounts Receivable Average Daily Sales

= $100,000 ÷ ($1,460,000 ÷ 365) = $100,000 ÷ $4,000 = 25.0 days

PE 17-4B a.

Accounts Receivable Turnover = Sales ÷ Average Accounts Receivable = $6,862,000 ÷ $365,000 = 18.8 Number of Days’ Sales in Receivables =

Average Accounts Receivable Average Daily Sales

= $365,000 ÷ ($6,862,000 ÷ 365) = $365,000 ÷ $18,800 = 19.4 days

CHAPTER 17

Financial Statement Analysis

PE 17-5A a.

Inventory Turnover = Cost of Merchandise Sold ÷ Average Merchandise Inventory = $558,000 ÷ $45,000 = 12.4

Number of Days’ Sales in Inventory =

Average Merchandise Inventory Average Daily Cost of Merchandise Sold

= $45,000 ÷ ($558,000 ÷ 365) = $45,000 ÷ $1,529 = 29.4 days

PE 17-5B a.

Inventory Turnover = Cost of Merchandise Sold ÷ Average Merchandise Inventory = $680,400 ÷ $94,500 = 7.2

Number of Days’ Sales in Inventory =

Average Merchandise Inventory Average Daily Cost of Merchandise Sold

= $94,500 ÷ ($680,400 ÷ 365) = $94,500 ÷ $1,864 = 50.7 days

CHAPTER 17

Financial Statement Analysis

PE 17-6A a.

Fixed Assets Long-Term Liabilities

Ratio of Fixed Assets to Long-Term Liabilities =

= $774,000 ÷ $430,000 = 1.8 b.

Ratio of Liabilities to Stockholders’ Equity =

Total Liabilities Total Stockholders’ Equity

= $1,218,000 ÷ $580,000 = 2.1 PE 17-6B a.

Fixed Assets Long-Term Liabilities

Ratio of Fixed Assets to Long-Term Liabilities =

= $630,000 ÷ $140,000 = 4.5 b.

Ratio of Liabilities to Stockholders’ Equity =

Total Liabilities Total Stockholders’ Equity

= $957,000 ÷ $290,000 = 3.3 PE 17-7A Times Interest Earned =

Income Before Income Tax + Interest Expense Interest Expense $6,000,000 + $300,000 $300,000

= = 21.0

PE 17-7B Times Interest Earned = =

Income Before Income Tax + Interest Expense Interest Expense $4,300,000 + $600,000 $600,000

= 8.2

CHAPTER 17

Financial Statement Analysis

PE 17-8A Asset Turnover = Sales ÷ Average Total Assets = $6,480,000 ÷ $2,400,000 = 2.7

PE 17-8B Asset Turnover = Sales ÷ Average Total Assets = $5,580,000 ÷ $3,100,000 = 1.8

PE 17-9A Return on Total Assets =

Net Income + Interest Expense Average Total Assets

$110,000 + $77,000 $1,700,000

$187,000 $1,700,000

= 11.0%

PE 17-9B Return on Total Assets =

Net Income + Interest Expense Average Total Assets

$502,100 + $113,500 $3,800,000

$615,600 $3,800,000

= 16.2%

CHAPTER 17

Financial Statement Analysis

PE 17-10A a.

Net Income Average Stockholders’ Equity

Return on Stockholders’ Equity =

= $750,000 ÷ $5,000,000 = 15.0% b.

Return on Common = Stockholders’ Equity =

Net Income – Preferred Dividends Average Common Stockholders’ Equity $750,000 – $150,000 $3,750,000

= 16.0%

PE 17-10B a.

Net Income Average Stockholders’ Equity

Return on Stockholders’ Equity =

= $500,000 ÷ $3,125,000 = 16.0% b.

Return on Common = Stockholders’ Equity =

Net Income – Preferred Dividends Average Common Stockholders’ Equity $500,000 – $25,000 $1,900,000

= 25.0%

CHAPTER 17

Financial Statement Analysis

PE 17-11A a.

Earnings per Share = on Common Stock

Net Income – Preferred Dividends Shares of Common Stock Outstanding

= ($460,000 – $40,000) ÷ 150,000 = $2.80 b.

Price-Earnings Ratio =

Market Price per Share of Common Stock Earnings per Share on Common Stock

= $40.60 ÷ $2.80 = 14.5

PE 17-11B a.

Earnings per Share = on Common Stock

Net Income – Preferred Dividends Shares of Common Stock Outstanding

= ($640,000 – $82,000) ÷ 60,000 = $9.30 b.

Price-Earnings Ratio =

Market Price per Share of Common Stock Earnings per Share on Common Stock

= $120.90 ÷ $9.30 = 13.0

CHAPTER 17

Financial Statement Analysis

EXERCISES Ex. 17-1 a.

Innovation Quarter Inc. Comparative Income Statement For the Years Ended December 31

Sales Cost of merchandise sold Gross profit Selling expenses Administrative expenses Total operating expenses Income from operations Income tax expense Net income b.

Current Year Amount Percent

Prior Year Amount Percent

$4,000,000 2,280,000 $1,720,000 $ 600,000 520,000 $1,120,000 $ 600,000 240,000 $ 360,000

$3,600,000 1,872,000 $1,728,000 $ 648,000 360,000 $1,008,000 $ 720,000 216,000 $ 504,000

100% 57% 43% 15% 13% 28% 15% 6% 9%

100% 52% 48% 18% 10% 28% 20% 6% 14%

The vertical analysis indicates that the cost of merchandise sold as a percent of sales increased by 5 percentage points (57% – 52%), selling expenses decreased by 3 percentage points (15% – 18%), and administrative expenses increased by 3% (13% – 10%). Thus, net income as a percent of sales dropped by 5% (9% – 14%).

CHAPTER 17

Financial Statement Analysis

Ex. 17-2 a.

Speedway Motorsports, Inc. Comparative Income Statement (in thousands of dollars) For the Years Ended December 31

Revenues: Admissions Event-related revenue NASCAR broadcasting revenue Other operating revenue Total revenues Expenses and other: Direct expense of events NASCAR event management fees Other direct operating expenses General and administrative Total expenses and other Income from continuing operations

Current Year Amount Percent

Prior Year Amount Percent

$ 78,332 140,210

17.0% 30.4%

$ 86,949 133,632

19.0% 29.2%

216,592 26,780 $461,914

46.9% 5.8% 100.0%*

209,155 28,622 $458,358

45.6% 6.2% 100.0%

$101,876

22.1%

$ 98,973

21.6%

123,212 18,502 164,949 $408,539

26.7% 4.0% 35.7% 88.4%*

119,101 18,782 177,132 $413,988

26.0% 4.1% 38.6% 90.3%

$ 53,375

11.6%

$ 44,370

9.7%

* Totals may differ because of rounding.

Overall revenue increased some between the two years, accompanied by a slight change in the overall mix of revenue sources. The NASCAR broadcasting revenue increased by 1.3% (46.9% – 45.6%) of total revenues, and event-related revenue increased by 1.2% (30.4% – 29.2%) of total revenues. One of the major expense categories, NASCAR event management fees, increased by 0.7% (26.7% – 26.0%) of total revenues. The direct expense of events and other direct operating expenses remained relatively constant during the two-year period. General and administrative expenses, however, decreased by over 2.9% (35.7% – 38.6%) of total revenues. This cost reduction was the driving factor behind the increase in income from continuing operations, increasing from 9.7% to 11.6% of total revenues. It appears that aggressive cost cutting has helped the company significantly improve its income from continuing operations.

CHAPTER 17

Financial Statement Analysis

Ex. 17-3 a.

Tannenhill Company Common-Sized Income Statement For the Year Ended December 31 Tannenhill Company Amount Percent

Sales Cost of merchandise sold Gross profit Selling expenses Administrative expenses Total operating expenses Income from operations Other revenue and expense: Other revenue Other expense Income before income tax expense Income tax expense Net income b.

Electronics Industry Average

$4,000,000 2,120,000 $1,880,000 $1,080,000 640,000 $1,720,000 $ 160,000

100% 53% 47% 27% 16% 43% 4%

100% 60% 40% 24% 14% 38% 2%

120,000 (80,000) $ 200,000 80,000 $ 120,000

3% 2% 5% 2% 3%

3% 2% 3% 2% 1%

The cost of merchandise sold is 7% (60% – 53%) lower than the industry average, but the selling expenses and administrative expenses are 3% and 2% higher than the industry average, respectively. The combined impact causes net income as a percent of sales to be 2% better than the industry average. Apparently, the company is managing the cost of manufacturing product better than the industry is but has slightly higher selling and administrative expenses relative to the industry. The cause of the higher selling and administrative expenses as a percent of sales, relative to the industry, can be investigated further.

CHAPTER 17

Financial Statement Analysis

Ex. 17-4 Kwan Company Comparative Balance Sheet For the Years Ended December 31 Current Year Amount Percent

Prior Year Amount Percent

Current assets Property, plant, and equipment Intangible assets Total assets

$2,352,000 4,536,000 1,512,000 $8,400,000

28.0% 54.0% 18.0% 100.0%

$1,900,000 4,712,000 988,000 $7,600,000

25.0% 62.0% 13.0% 100.0%

Current liabilities Long-term liabilities Common stock Retained earnings Total liabilities and stockholders’ equity

$1,848,000 2,520,000 1,260,000 2,772,000

22.0% 30.0% 15.0% 33.0%

$1,444,000 2,888,000 836,000 2,432,000

19.0% 38.0% 11.0% 32.0%

$8,400,000

100.0%

$7,600,000

100.0%

Ex. 17-5 a.

Winthrop Company Comparative Income Statement For the Years Ended December 31

Sales Cost of merchandise sold Gross profit Selling expenses Administrative expenses Total operating expenses Income before income tax expense Income tax expense Net income b.

Current Year Amount

Prior Year Amount

Increase (Decrease) Amount Percent

$2,280,000 1,960,000 $ 320,000 $ 156,500 122,000 $ 278,500

$2,000,000 1,750,000 $ 250,000 $ 125,000 100,000 $ 225,000

$280,000 210,000 $ 70,000 $ 31,500 22,000 $ 53,500

14.0% 12.0% 28.0% 25.2% 22.0% 23.8%

$ 16,500 6,600 $ 9,900

66.0% 66.0% 66.0%

41,500 16,600 24,900

25,000 10,000 15,000

The net income for Winthrop Company increased by 66% between years. This increase was the combined result of an increase in sales of 14% and a lower percentage increase in cost of merchandise sold. As a result, the percentage increase in gross profit exceeded the percentage increase in sales.

CHAPTER 17

Financial Statement Analysis

Ex. 17-6 a. (1) Working Capital = Current Assets – Current Liabilities Current year: $1,120,000 = $1,820,000 – $700,000 Prior year: $720,000 = $1,320,000 – $600,000 (2)

Current Ratio = Current Year:

(3)

$1,820,000 $700,000

Quick Ratio = Current Year:

Current Assets Current Liabilities = 2.6

Prior Year:

$1,320,000 $600,000

= 2.2

Prior Year:

$1,020,000 $600,000

= 1.7

Quick Assets Current Liabilities

$1,330,000 $700,000

= 1.9

b. The liquidity of Albertini has improved from the preceding year to the current year. The working capital, current ratio, and quick ratio have all increased. Most of these changes are the result of an increase in current assets relative to current liabilities.

Ex. 17-7 a. (1)

(2)

Current Ratio =

Current Assets Current Liabilities

Current Year:

$21,893 $22,138

Quick Ratio = Current Year:

= 1.0

Prior Year:

$31,027 $20,502

= 1.5

Prior Year:

$26,534 $20,502

= 1.3

Quick Assets Current Liabilities $16,135 $22,138

= 0.7

b. The liquidity of PepsiCo has decreased over this time period. The current ratio has decreased from 1.5 to 1.0, and the quick ratio has decreased from 1.3 to 0.7.

CHAPTER 17

Financial Statement Analysis

Ex. 17-8 a.

The working capital, current ratio, and quick ratio are calculated incorrectly. The working capital and current ratio incorrectly include intangible assets and property, plant, and equipment as a part of current assets. Both are noncurrent. The quick ratio has an incorrect numerator and denominator. The numerator of the quick ratio is incorrectly calculated as the sum of merchandise inventory; prepaid expenses; and property, plant, and equipment ($36,000 + $24,000 + $55,200). The denominator is also incorrect, as it does not include accrued liabilities. The denominator of the quick ratio should be total current liabilities. The correct calculations are as follows: Working Capital = Current Assets – Current Liabilities $30,000 = $330,000 – $300,000 Current Ratio = = Quick Ratio = =

Current Assets Current Liabilities $330,000 $300,000

1.1

Quick Assets Current Liabilities $102,000 + $48,000 + $120,000 $300,000

= 0.9

Unfortunately, the working capital, current ratio, and quick ratio are below the minimum threshold required by the bond indenture. This may require the company to renegotiate the bond contract, including a possible unfavorable change in the interest rate.

CHAPTER 17

Financial Statement Analysis

Ex. 17-9 a.

(1)

Sales Average Accounts Receivable

Accounts Receivable Turnover = 20Y3:

$4,125,280 $448,400 *

= 9.2

20Y2:

* $448,400 = ($476,800 + $420,000) ÷ 2

(2)

Average Accounts Receivable Average Daily Sales

20Y3: 1 2 3 4

$11,302 2

= 8.4

** $398,500 = ($420,000 + $377,000) ÷ 2

Number of Days’ Sales in Receivables = $448,400

$3,347,400 $398,500**

= 39.7 days

20Y2:

$398,500 $9,171 4

= 43.5 days

Average accounts receivable = $448,400 = ($476,800 + $420,000) ÷ 2 Average daily sales = $11,302 = $4,125,280 ÷ 365 days Average accounts receivable = $398,500 = ($420,000 + $377,000) ÷ 2 Average daily sales = $9,171 = $3,347,400 ÷ 365 days

The collection of accounts receivable has improved. This can be seen in both the increase in accounts receivable turnover and the reduction in the collection period. The credit terms require payment in 45 days. In both the current and the prior years, the collection period is within the credit terms of the company. The results indicate the company became more aggressive in collecting accounts receivable or more restrictive in granting credit to customers.

CHAPTER 17

Financial Statement Analysis

Ex. 17-10 a.

(1)

(2)

Accounts Receivable Turnover =

Sales Average Accounts Receivable

Xavier:

$8,500,000 ($820,000 + $880,000) ÷ 2

= 10.0

Lestrade:

$4,585,000 ($600,000 + $710,000) ÷ 2

= 7.0

Number of Days’ Sales in Receivables =

Average Accounts Receivable Average Daily Sales

Xavier:

($820,000 + $880,000) ÷ 2 $23,287.7 *

= 36.5 days

Lestrade:

($600,000 + $710,000) ÷ 2 $12,561.6**

= 52.1 days

* Average daily sales = $23,287.7 = $8,500,000 ÷ 365 days ** Average daily sales = $12,561.6 = $4,585,000 ÷ 365 days b.

Xavier’s accounts receivable turnover is much higher than Lestrade’s (10.0 for Xavier vs. 7.0 for Lestrade). The number of days’ sales in receivables is lower for Xavier than for Lestrade (36.5 days for Xavier vs. 52.1 days for Lestrade). These differences indicate that Xavier is able to turn over its receivables more quickly than Lestrade. As a result, Xavier takes less time to collect its receivables.

CHAPTER 17

Financial Statement Analysis

Ex. 17-11 a.

(1)

(2)

Inventory Turnover =

Cost of Merchandise Sold Average Merchandise Inventory

Current Year:

$8,964,000 ($900,000 + $760,000) ÷ 2

= 10.8

Prior Year:

$9,782,000 ($760,000 + $700,000) ÷ 2

= 13.4

Number of Days’ = Sales in Inventory

Average Merchandise Inventory Average Daily Cost of Merchandise Sold

Current Year:

($900,000 + $760,000) ÷ 2 $24,559 *

= 33.8 days

Prior Year:

($760,000 + $700,000) ÷ 2 $26,800**

= 27.2 days

* Average daily cost of merchandise sold = $24,559 = $8,964,000 ÷ 365 days ** Average daily cost of merchandise sold = $26,800 = $9,782,000 ÷ 365 days b.

The inventory position of the business has deteriorated. The inventory turnover has decreased, while the number of days’ sales in inventory has increased. The sales volume appears to have declined faster than the inventory, resulting in a deteriorating inventory position.

CHAPTER 17

Financial Statement Analysis

Ex. 17-12 a.

(1) Inventory Turnover =

(2)

Cost of Merchandise Sold Average Merchandise Inventory

QT:

$44,754 ($1,382 + $1,404) ÷ 2

= 32.1

Elppa:

$92,385 ($6,317 + $7,490) ÷ 2

= 13.4

Number of Days’ = Sales in Inventory QT:

Elppa:

Average Merchandise Inventory Average Daily Cost of Merchandise Sold ($1,382 + $1,404) ÷ 2 $122.6 * ($6,317 + $7,490) ÷ 2 $253.1 **

= 11.4 days

= 27.3 days

* Average daily cost of merchandise sold = $122.6 = $44,754 ÷ 365 days ** Average daily cost of merchandise sold = $253.1 = $92,385 ÷ 365 days b.

QT has a much higher inventory turnover ratio than does Elppa (32.1 vs. 13.4). Likewise, QT has a much smaller number of days’ sales in inventory (11.4 days vs. 27.3 days). These significant differences are a result of QT’s make-to-order strategy whereby QT has successfully developed a manufacturing process that fills a customer order quickly. As a result, QT does not prebuild many computers for inventory. Elppa, in contrast, prebuilds computers to be sold to retail stores and other retail channels. In this industry, there is great obsolescence risk in holding computers in inventory. New technology can make an inventory of computers difficult to sell; therefore, inventory is costly and risky.

CHAPTER 17

Financial Statement Analysis

Ex. 17-13 a.

Ratio of Liabilities to Stockholders’ Equity = Current Year:

$2,124,000 $2,360,000

= 0.9

Prior Year:

$2,200,000 $2,000,000

= 1.1

Times Interest Earned = Current Year: Prior Year:

Total Liabilities Total Stockholders’ Equity

Income Before Income Tax + Interest Expense Interest Expense

$480,000 + $120,000 * $120,000

= 5.0

$420,000 + $140,000 ** = 4.0 $140,000

* Interest expense = ($1,000,000 + $200,000) × 10% = $120,000 ** Interest expense = ($1,200,000 + $200,000) × 10% = $140,000 c.

Both the ratio of liabilities to stockholders’ equity and the times interest earned ratio have improved from the previous year. These results are the combined result of a larger income before income taxes and lower interest expense in the current year compared to the previous year.

CHAPTER 17

Financial Statement Analysis

Ex. 17-14 a.

Ratio of Liabilities to Stockholders’ Equity =

Hasbro:

$3,508,502 $1,754,486

= 2.0

Mattel:

$4,574,000 $669,465

= 6.8

Times Interest Earned =

Total Liabilities Total Stockholders’ Equity

Income Before Income Tax + Interest Expense Interest Expense

Hasbro:

$270,402 + $90,826 $90,826

= 4.0

Mattel:

$(419,261) + $181,886 $181,886

= (1.3)

Hasbro carries a smaller proportion of debt to the stockholders’ equity than Mattel does (2.0 and 6.8 times stockholders’ equity, respectively). Hasbro has fairly strong interest coverage. Since Mattel has a net loss, the computation of times interest earned is not meaningful. As a result, Mattel may not be able to pay its interest in the future. Unlike Mattel, Hasbro’s ratio indicates that it provides creditors with a sound margin of safety, and earnings are more than enough to make interest payments.

CHAPTER 17

Financial Statement Analysis

Ex. 17-15 a.

Ratio of Liabilities to Stockholders’ Equity =

Total Liabilities Total Stockholders’ Equity

Mondelez:

$16,737,000 + $12,532,000 + $7,747,000 $25,713,000

= 1.4

Hershey:

$2,418,566 + $3,254,280 + $622,908 $1,407,266

= 4.5

Ratio of Fixed Assets to Long-Term Liabilities =

Fixed Assets (net) Long-Term Liabilities

Mondelez:

$8,482,000 $12,532,000 + $7,747,000

$8,482,000 $20,279,000

= 0.4

Hershey:

$2,130,294 $3,254,280 + $622,908

$2,130,294 $3,877,188

= 0.5

Hershey uses more debt than Mondelez does. As a result, Hershey’s total liabilities to stockholders’ equity ratio is higher than Mondelez’s (4.5 vs. 1.4). Mondelez has a lower ratio of fixed assets to long-term liabilities than Hershey does. This ratio divides the property, plant, and equipment (net) by the long-term debt. The ratio for Mondelez is aggressive, with fixed assets covering only 40% of the long-term debt. That is, the creditors of Mondelez have 40 cents of property, plant, and equipment covering every dollar of long-term debt. The same ratio for Hershey shows fixed assets covering 50% of the long-term debt. That is, Hershey’s creditors have 50 cents of property, plant, and equipment covering every dollar of long-term debt. This suggests that Hershey has slightly stronger creditor protection and borrowing capacity than Mondelez does.

CHAPTER 17

Financial Statement Analysis

Ex. 17-16 a.

Asset Turnover =

Sales Average Total Assets

YRC:

$5,092,000 $1,601,300

= 3.2

Union Pacific:

$22,832,000 $58,476,500

= 0.4

C.H. Robinson:

$16,631,172 $4,331,623

= 3.8

The asset turnover ratio measures the number of sales dollars earned for each dollar of assets. The greater the number of sales dollars earned for every dollar of assets, the more efficient a firm is in using assets. Thus, the ratio is a measure of each company’s asset efficiency. Union Pacific earns only 40 cents for every dollar of assets. This is because railroads are very asset-intensive. The company must invest in locomotives, railcars, terminals, tracks, right-of-way, and information systems in order to earn revenues. These investments are significant. YRC has a higher asset turnover ratio and is able to earn $3.20 for every dollar of assets. This is because the motor carrier invests in trucks, trailers, and terminals, which require less investment per dollar of revenue than the railroad does. Moreover, the motor carrier does not invest in the highway system because the government owns the highway system. Thus, the motor carrier has no investment in the transportation network, unlike the railroad. C.H. Robinson, the transportation arranger, hires transportation services from motor carriers and railroads but does not own these assets. The transportation arranger’s assets are in the form of accounts receivable and information systems. However, the company does not require transportation assets; thus, it is able to earn the highest revenue per dollar of assets of $3.80. Note to Instructors: Students may wonder how asset-intensive companies overcome their asset efficiency disadvantages to competitors with better asset efficiencies, as in the case between railroads and motor carriers. Asset efficiency is part of the financial equation; the other part is the profit margin made on each dollar of sales. Thus, companies with high asset efficiency often operate on thinner margins than do companies with lower asset efficiency. For example, the motor carrier must pay highway taxes, which lowers its operating margins when compared to railroads that own their right-of-way and thus do not have the tax expense of the highway. While not required in this exercise, the railroad has the highest profit margins, the motor carrier is in the middle, and the transportation arranger operates on very thin margins.

CHAPTER 17

Financial Statement Analysis

Ex. 17-17 a.

Net Income + Interest Expense Average Total Assets

Return on Total Assets = 20Y7:

$411,000 + $150,000 1 $5,100,000 2

= 11.0%

20Y6:

$462,500 + $150,000 3 $4,900,000 4

= 12.5%

Interest expense = $2,500,000 × 6%

Average total assets = ($5,200,000 + $5,000,000) ÷ 2

Interest expense = $2,500,000 × 6%

Average total assets = ($5,000,000 + $4,800,000) ÷ 2

Return on Stockholders’ Equity =

Net Income Average Total Stockholders’ Equity

20Y7:

$411,000 $2,148,000 *

= 19.1%

20Y6:

$462,500 $1,736,000 **

= 26.6%

* Average total stockholders’ equity = ($2,324,000 + $1,972,000) ÷ 2 ** Average total stockholders’ equity = ($1,972,000 + $1,500,000) ÷ 2 Return on Common = Stockholders’ Equity

Net Income – Preferred Dividends Average Common Stockholders’ Equity

20Y7:

$411,000 – $12,500 1 $1,648,000 2

= 24.2%

20Y6:

$462,500 – $12,500 3 $1,236,000 4

= 36.4%

Preferred dividends = $500,000 × 2.5%

Average common stockholders’ equity = ($1,824,000 + $1,472,000) ÷ 2

Preferred dividends = $500,000 × 2.5%

Average common stockholders’ equity = ($1,472,000 + $1,000,000) ÷ 2

The profitability ratios indicate that the company’s profitability has deteriorated. Most of this change is from net income falling from $462,500 in 20Y6 to $411,000 in 20Y7. Because the return on common stockholders’ equity exceeds the return on total assets in both years, there is positive leverage from the use of debt. However, this leverage is greater in 20Y6 because the return on common stockholders’ equity exceeds the return on total assets by a greater amount in 20Y6.

CHAPTER 17

Financial Statement Analysis

Ex. 17-18 a.

Return on Total Assets =

Net Income + Interest Expense Average Total Assets

Fiscal Year 3:

$162,800 + $18,200 ($6,143,300 + $5,652,000) ÷ 2

= 3.1%

Fiscal Year 2:

$(99,300) + $12,400 ($5,652,000 + $6,213,100) ÷ 2

= (1.5)%

b. Return on Stockholders’ Equity =

Net Income Average Total Stockholders’ Equity

Fiscal Year 3:

$162,800 ($3,457,400 + $3,299,600) ÷ 2

= 4.8%

Fiscal Year 2:

$(99,300) ($3,299,600 + $3,743,500) ÷ 2

= (2.8)%

Both the return on total assets and the return on stockholders’ equity have increased over the two-year period. The return on total assets increased from (1.5)% to 3.1%, and the return on stockholders’ equity increased from (2.8)% to 4.8%. The return on stockholders’ equity exceeds the return on total assets due to the positive use of leverage.

CHAPTER 17

Financial Statement Analysis

Ex. 17-19 a.

Ratio of Fixed Assets to = Long-Term Liabilities =

Ratio of Liabilities to = Stockholders’ Equity =

Asset Turnover = =

Return on Total Assets = =

Fixed Assets (net) Long-Term Liabilities $3,040,000 $1,600,000

= 1.9

Total Liabilities Total Stockholders’ Equity $2,800,000 $4,000,000

= 0.7

Sales Average Total Assets $17,920,000 = 2.8 $6,400,000 ** Net Income + Interest Expense Average Total Assets $928,000 + $96,000* $6,400,000**

= 16.0%

* Interest expense = $1,600,000 × 6% ** Average total assets = ($6,000,000 + $6,800,000***) ÷ 2 *** The total assets at the end of the year is the sum of the total liabilities ($2,800,000) and total stockholders’ equity ($4,000,000) at the end of the year. Total assets ($6,800,000) = Total liabilities ($2,800,000) + Total stockholders’ equity ($4,000,000).

Return on = Stockholders’ Equity =

Net Income Average Total Stockholders’ Equity $928,000 $3,736,000 *

= 24.8%

* Average total stockholders’ equity = [($1,072,000 + $1,600,000 + $800,000) + $4,000,000] ÷ 2 f.

Return on Common = Stockholders’ Equity =

Net Income – Preferred Dividends Average Common Stockholders’ Equity $928,000 – $80,000* $2,936,000**

= 28.9%

* Preferred dividends = ($800,000 ÷ $100) × $10 ** Average common stockholders’ equity = $3,736,000 – $800,000

CHAPTER 17

Financial Statement Analysis

Ex. 17-20 a.

Times Interest Earned = =

Income Before Income Tax + Interest Expense Interest Expense $5,280,000 + $600,000* $600,000

= 9.8 times

* Interest expense = $7,500,000 bonds payable × 8% b.

Earnings per Share = on Common Stock =

Net Income – Preferred Dividends Common Stock Outstanding $3,975,000* – $300,000** 750,000 shares***

= $4.90

* $5,280,000 − $1,305,000 ** $3,750,000 ÷ $50 × $4 per share *** Shares of common stock outstanding = $7,500,000 ÷ $10 par value per share c.

Price-Earnings Ratio = =

Dividends per Share = of Common Stock =

Dividend Yield = =

Market Price per Share of Common Stock Earnings per Share $53.90 $4.90

= 11.0

Dividends on Common Stock Shares of Common Stock Outstanding $1,950,000 = $2.60 750,000 shares Dividends per Share of Common Stock Market Price per Share of Common Stock $2.60 $53.90

= 4.8%

CHAPTER 17

Financial Statement Analysis

Ex. 17-21 a.

Earnings per Share = =

Net Income – Preferred Dividends Shares of Common Stock Outstanding $2,010,000 – $90,000* 400,000 shares**

= $4.80

* Preferred dividends = ($1,500,000 ÷ $50) × $3 ** Shares of common stock outstanding = $8,000,000 ÷ $20 b.

Price-Earnings Ratio = =

Dividends per Share = =

Dividend Yield = =

Market Price per Share of Common Stock Earnings per Share of Common Stock $72.00 $4.80

= 15.0

Common Dividends Shares of Common Stock Outstanding $1,728,000 400,000 shares

= $4.32

Dividends per Share of Common Stock Market Price per Share of Common Stock $4.32 $72.00

= 6.0%

CHAPTER 17

Financial Statement Analysis

Ex. 17-22 a.

Price-Earnings Ratio =

Deere & Company:

$135.44 $7.34

= 18.5

Alphabet:

$1,035.61 $44.22

= 23.4

The Coca-Cola Company:

$47.35 $1.58

= 30.0

Dividend Yield =

Market Price per Share of Common Stock Earnings per Share

Dividends per Share of Common Stock Market Price per Share of Common Stock

Deere & Company:

$2.58 $135.44

= 1.9%

Alphabet:

$0.00 $1,035.61

= 0.0%

The Coca-Cola Company:

$1.56 $47.35

= 3.3%

Coca-Cola has a large dividend yield and a high price-earnings ratio. Stock market participants value Coca-Cola common stock on the basis of its dividend and its potential share price appreciation. Alphabet pays no dividend and, thus, has no dividend yield. However, Alphabet has the second-largest price-earnings ratio of the three companies. Stock market participants are expecting a return on their investment from appreciation in the stock price. Deere & Company has the lowest price-earnings ratio. Deere & Company has a solid dividend, producing a yield of 1.9%. Deere & Company is expected to produce shareholder returns through a combination of some share price appreciation and a moderate dividend. However, the market does not expect the same share price appreciation it expects from Coca-Cola.

CHAPTER 17

Financial Statement Analysis

Appendix Ex. 17-23 a.

Earnings per share on income before discontinued operations: Net income………………………………………………………………………… Less gain on discontinued operations……………………………………… Income before discontinued operations…………………………………… Earnings Before Disc. Operations = per Share on Common Stock

$4,000,000 400,000 $3,600,000

Income Before Discontinued Operations – Preferred Dividends Shares of Common Stock Outstanding $3,600,000 – $200,000* 500,000 shares

= $6.80 per share * Preferred dividends = 100,000 shares × $2.00 per share b.

Earnings per Share on = Common Stock =

Net Income – Preferred Dividends Shares of Common Stock Outstanding $4,000,000 – $200,000 500,000 shares

= $7.60 per share

CHAPTER 17

Financial Statement Analysis

Appendix Ex. 17-24 a.

Apex Inc. Partial Income Statement For the Year Ended December 31 Income from continuing operations before income tax expense Income tax expense* Income from continuing operations Loss on discontinued operations Net income

$1,000,000 400,000 $ 600,000 (240,000) $ 360,000

* Income tax expense = $1,000,000 × 40%

Apex Inc. Partial Income Statement For the Year Ended December 31 Earnings per share: Income from continuing operations Loss from discontinued operations Net income 1 2

$ 30.001 (12.00)2 $ 18.00

EPS on Income from continuing operations = $30.00 = $600,000 ÷ 20,000 EPS on Loss from discontinued operations = –$12.00 = $(240,000) ÷ 20,000

Appendix Ex. 17-25 a.

Colston Company reported this item correctly in the financial statements. This item is an error in the recognition, measurement, or presentation in the financial statements, which is handled correctly by retroactively restating prior-period earnings.

Colston Company did not report this item correctly. This item is a change from one generally accepted accounting principle to another, which is handled correctly by retroactively restating prior-period earnings. In this case, Colston reports this change cumulatively in the current period, which is incorrect.

CHAPTER 17

Financial Statement Analysis

PROBLEMS Prob. 17-1A 1.

McDade Company Comparative Income Statement For the Years Ended December 31, 20Y2 and 20Y1

Sales Cost of merchandise sold Gross profit Selling expenses Administrative expenses Total operating expenses Income from operations Other revenue Income before income tax expense Income tax expense Net income

Increase (Decrease) Amount Percent

20Y2

20Y1

$16,800,000 11,500,000 $ 5,300,000 $ 1,770,000 1,220,000 $ 2,990,000 $ 2,310,000 256,950

$15,000,000 10,000,000 $ 5,000,000 $ 1,500,000 1,000,000 $ 2,500,000 $ 2,500,000 225,000

$1,800,000 1,500,000 $ 300,000 $ 270,000 220,000 $ 490,000 $ (190,000) 31,950

12.0% 15.0% 6.0% 18.0% 22.0% 19.6% (7.6%) 14.2%

$ 2,566,950 1,413,000 $ 1,153,950

$ 2,725,000 1,500,000 $ 1,225,000

$ (158,050) (87,000) $ (71,050)

(5.8%) (5.8%) (5.8%)

2. Net income has declined from 20Y1 to 20Y2. Sales have increased by 12.0%; however, the cost of merchandise sold has increased by 15.0%, causing the gross profit to increase at a slower pace than sales. In addition, total operating expenses have increased at a faster rate than sales (19.6% increase vs. 12.0% sales increase). Increases in costs and expenses that are higher than the increase in sales have caused the net income to decline by 5.8%.

CHAPTER 17

Financial Statement Analysis

Prob. 17-2A 1.

Tri-Comic Company Comparative Income Statement For the Years Ended December 31, 20Y2 and 20Y1 20Y2

Amount

Percent

20Y1 Amount Percent

$1,500,000 510,000 $ 990,000 $ 270,000 180,000 $ 450,000 $ 540,000 60,000

100.0% 34.0% 66.0% 18.0% 12.0% 30.0% 36.0% 4.0%

$1,250,000 475,000 $ 775,000 $ 200,000 156,250 $ 356,250 $ 418,750 50,000

100.0% 38.0% 62.0% 16.0% 12.5% 28.5% 33.5% 4.0%

$ 600,000 450,000 $ 150,000

40.0% 30.0% 10.0%

$ 468,750 375,000 $ 93,750

37.5% 30.0% 7.5%

The vertical analysis indicates that the costs other than selling expenses (cost of merchandise sold and administrative expenses) improved as a percentage of sales. As a result, net income as a percentage of sales increased from 7.5% to 10.0%. The sales promotion campaign appears to have been successful. While selling expenses as a percent of sales increased slightly (2.0%), the increased cost was more than made up for by increased sales.

CHAPTER 17

Financial Statement Analysis

Prob. 17-3A 1.

Working Capital

= Current Assets – Current Liabilities

$900,000 = $1,650,000 – $750,000 b.

Current Assets Current Liabilities

Current Ratio = =

$1,650,000 $750,000

= 2.2

Quick Assets Current Liabilities

Quick Ratio =

$412,500 + $187,500 + $300,000 $750,000

= 2. Transaction

Working Capital

Current Ratio

Quick Ratio

Current Assets

a. b. c. d. e. f. g. h. i. j.

$ 900,000 900,000 900,000 900,000 750,000 900,000 1,125,000 900,000 1,500,000 900,000

2.2 2.4 2.0 2.4 1.8 2.2 2.5 2.2 3.0 2.2

1.2 1.2 1.0 1.2 1.0 1.2 1.5 1.2 2.0 1.2

$1,650,000 1,525,000 1,760,000 1,550,000 1,650,000 1,650,000 1,875,000 1,650,000 2,250,000 1,650,000

= 1.2

Supporting Data Quick Current Assets Liabilities $ 900,000 775,000 900,000 800,000 900,000 900,000 1,125,000 900,000 1,500,000 890,000

$750,000 625,000 860,000 650,000 900,000 750,000 750,000 750,000 750,000 750,000

18.

16. 17.

15.

14.

10. 11. 12. 13.

6. 7.

2. 3. 4. 5.

17-35

$82.60

100,000

$100,000 $1.00

$5.90

100,000

$82.60

$600,000 – $10,000

($4,694,000 + $4,204,000) ÷ 2

1.2%

$1.00

14.0

$5.90

13.3%

12.8%

($4,944,000 + $4,454,000) ÷ 2

$600,000 $600,000 – $10,000

8.7 1.3 8.5%

0.8

$132,000 ($9,024,000 + $8,254,000) ÷ 2 ($9,024,000 + $8,254,000) ÷ 2

$4,944,000

1.8

24.3

15.0

18.3

2.8 2.2 20.0

Calculated Value

$1,020,000 + $132,000 $10,850,000 $600,000 + $132,000

$4,080,000

$3,200,000

$6,000,000 ÷ 365

($420,000 + $380,000) ÷ 2 $5,760,000

($420,000 + $380,000) ÷ 2

$10,850,000 ÷ 365

($585,000 + $500,000) ÷ 2 $6,000,000

$880,000 $880,000 ($585,000 + $500,000) ÷ 2

Denominator

$2,464,000 $1,936,000 $10,850,000

Numerator

Financial Statement Analysis

Current ratio Quick ratio Accounts receivable turnover Number of days’ sales in receivables Inventory turnover Number of days’ sales in inventory Ratio of fixed assets to long-term liabilities Ratio of liabilities to stockholders’ equity Times interest earned Asset turnover Return on total assets Return on stockholders’ equity Return on common stockholders’ equity Earnings per share on common stock Price-earnings ratio Dividends per share of common stock Dividend yield

Ratio

Prob. 17-4A 1. Working Capital: $2,464,000 – $880,000 = $1,584,000

CHAPTER 17

Financial Statement Analysis

Prob. 17-5A 1. a.

60.0%

Return on Total Assets

50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s return on total assets Industry return on total assets

Return on Total Assets =

Net Income + Interest Expense Average Total Assets

20Y8:

$889,453 $4,270,764

= 20.8%

20Y5:

$1,379,000 $3,044,250

= 45.3%

20Y7:

$939,979 $3,928,396

= 23.9%

20Y4:

$1,240,000 $2,475,000

= 50.1%

20Y6:

$1,159,341 $3,535,472

= 32.8%

CHAPTER 17

Financial Statement Analysis

Prob. 17-5A (Continued) 1. b.

80.0%

Return on Stockholders’ Equity

70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s return on stockholders’ equity Industry return on stockholders’ equity

Return on Stockholders’ Equity =

Net Income Average Total Stockholders’ Equity

20Y8:

$273,406 $3,569,855

= 7.7%

20Y5:

$884,000 $1,992,000

= 44.4%

20Y7:

$367,976 $3,249,164

= 11.3%

20Y4:

$800,000 $1,150,000

= 69.6%

20Y6:

$631,176 $2,749,588

= 23.0%

CHAPTER 17

Financial Statement Analysis

Prob. 17-5A (Continued) 1. c.

3.5

Times Interest Earned

3.0 2.5 2.0 1.5 1.0 0.5 0.0 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s times interest earned

Times Interest Earned =

Industry times interest earned

Net Income + Income Tax Expense + Interest Expense Interest Expense

20Y8:

$921,202 $616,047

= 1.5

20Y5:

$1,539,000 $495,000

= 3.1

20Y7:

$993,539 $572,003

= 1.7

20Y4:

$1,440,000 $440,000

= 3.3

20Y6:

$1,266,061 = 2.4 $528,165

CHAPTER 17

Financial Statement Analysis

Prob. 17-5A (Continued) 1. d.

0.9

Ratio of Liabilities to Stockholders’ Equity

0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s liabilities to equity Industry liabilities to equity

Ratio of Liabilities to = Stockholders’ Equity

Total Liabilities Total Stockholders’ Equity

20Y8:

$710,621 $3,706,557

0.2

20Y5:

$904,500 $2,434,000

= 0.4

20Y7:

$691,198 $3,433,152

0.2

20Y4:

$1,200,000 $1,550,000

= 0.8

20Y6:

$667,267 $3,065,176

0.2

Note: The total liabilities are the difference between the total assets and total stockholders’ equity ending balances.

CHAPTER 17

Financial Statement Analysis

Prob. 17-5A (Concluded) 2.

Both the return on total assets and the return on stockholders’ equity have been moving in a negative direction in the last five years. Both measures have moved below the industry average over the last two years. The cause of this decline is driven by a rapid decline in earnings. The use of debt can be seen from the ratio of liabilities to stockholders’ equity. The ratio has declined over the time period and has declined below the industry average. Thus, the level of debt relative to the stockholders’ equity has gradually improved over the five years. The times interest earned has been below the industry average for several years. This is the result of low profitability combined with high interest costs. The times interest earned fell to a dangerously low level in 20Y8.

Prob. 17-1B 1.

Gerhardt Inc. Comparative Income Statement For the Years Ended December 31, 20Y2 and 20Y1

20Y2

20Y1

Increase (Decrease) Amount Percent

$805,200 365,400 $439,800 $117,200 87,400 $204,600 $235,200 43,700

$610,000 280,000 $330,000 $ 92,000 68,000 $160,000 $170,000 40,000

$195,200 85,400 $109,800 $ 25,200 19,400 $ 44,600 $ 65,200 3,700

32.0% 30.5% 33.3% 27.4% 28.5% 27.9% 38.4% 9.3%

$278,900 69,700 $209,200

$210,000 51,500 $158,500

$ 68,900 18,200 $ 50,700

32.8% 35.3% 32.0%

The profitability has improved significantly from 20Y1 to 20Y2. Sales have increased by 32.0% over the 20Y1 base year, while the cost of merchandise sold, selling expenses, and administrative expenses grew at a slower rate. Increasing sales combined with costs that increase at a slower rate results in strong earnings growth. In this case, net income grew 32.0% over the base year.

CHAPTER 17

Financial Statement Analysis

Prob. 17-2B 1.

Fielder Industries Inc. Comparative Income Statement For the Years Ended December 31, 20Y2 and 20Y1

20Y2 Amount Percent

20Y1 Amount Percent

$1,300,000 682,500 $ 617,500 $ 260,000 169,000 $ 429,000 $ 188,500 78,000

100.0% 52.5% 47.5% 20.0% 13.0% 33.0% 14.5% 6.0%

$1,180,000 613,600 $ 566,400 $ 188,800 177,000 $ 365,800 $ 200,600 70,800

100.0% 52.0% 48.0% 16.0% 15.0% 31.0% 17.0% 6.0%

$ 266,500 117,000 $ 149,500

20.5% 9.0% 11.5%

$ 271,400 106,200 $ 165,200

23.0% 9.0% 14.0%

The net income as a percent of sales has declined. All the costs and expenses, other than selling expenses, have maintained their approximate cost as a percent of sales between 20Y1 and 20Y2. Selling expenses as a percent of sales, however, have grown from 16.0% to 20.0% of sales. Apparently, the new advertising campaign has not been successful. The increased expense has not produced sufficient sales to maintain relative profitability. Thus, selling expenses as a percent of sales have increased.

CHAPTER 17

Financial Statement Analysis

Prob. 17-3B 1.

Working Capital = Current Assets – Current Liabilities $1,200,000 = $3,200,000 – $2,000,000

Current Assets Current Liabilities

Current Ratio = =

$3,200,000 $2,000,000

= 1.6

Quick Assets Current Liabilities

Quick Ratio =

$800,000 + $550,000 + $850,000 $2,000,000

= 2. Transaction

Working Capital

Current Ratio

Quick Ratio

Current Assets

a. b. c. d. e. f. g. h. i. j.

$1,200,000 1,200,000 1,200,000 1,200,000 875,000 1,200,000 2,200,000 1,200,000 3,200,000 1,200,000

1.6 1.7 1.5 1.6 1.4 1.6 2.1 1.6 2.6 1.6

1.1 1.1 0.9 1.1 0.9 1.1 1.6 1.1 2.1 1.0

$3,200,000 2,912,500 3,600,000 3,075,000 3,200,000 3,200,000 4,200,000 3,200,000 5,200,000 3,200,000

= 1.1

Supporting Data Quick Current Assets Liabilities $2,200,000 1,912,500 2,200,000 2,075,000 2,200,000 2,200,000 3,200,000 2,200,000 4,200,000 2,000,000

$2,000,000 1,712,500 2,400,000 1,875,000 2,325,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000

18.

16. 17.

15.

14.

10. 11. 12. 13.

6. 7.

2. 3. 4. 5.

17-43

$119.70

100,000

$50,000 $0.50

$8.55

100,000

$119.70

$900,000 – $45,000

($6,680,000 + $5,875,000) ÷ 2

0.4%

$0.50

14.0

$8.55

13.6%

13.3%

($7,180,000 + $6,375,000) ÷ 2

$900,000 $900,000 – $45,000

7.6 1.1 11.5%

0.4

$170,000 ($9,780,000 + $8,755,000) ÷ 2 ($9,780,000 + $8,755,000) ÷ 2

$7,180,000

2.2

73.0

5.0

22.8

4.1 2.5 16.0

Calculated Value

$1,130,000 + $170,000 $10,000,000 $900,000 + $170,000

$2,600,000

$1,700,000

$5,350,000 ÷ 365

($1,190,000 + $950,000) ÷ 2 $3,740,000

($1,190,000 + $950,000) ÷ 2

$10,000,000 ÷ 365

($740,000 + $510,000) ÷ 2 $5,350,000

$900,000 $900,000 ($740,000 + $510,000) ÷ 2

Denominator

$3,690,000 $2,250,000 $10,000,000

Numerator

Financial Statement Analysis

Ratio

Prob. 17-4B 1. Working Capital: $3,690,000 – $900,000 = $2,790,000

CHAPTER 17

Financial Statement Analysis

Prob. 17-5B a.

30.0% 25.0% Return on Total Assets

20.0% 15.0% 10.0% 5.0% 0.0% 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s return on total assets Industry return on total assets

Return on Total Assets =

Net Income + Interest Expense Average Total Assets

20Y8:

$6,623,780 $25,988,665

= 25.5%

20Y5:

$2,458,000 $11,370,240

= 21.6%

20Y7:

$4,606,056 $19,859,586

= 23.2%

20Y4:

$1,900,000 $8,676,000

= 21.9%

20Y6:

$3,540,600 $14,854,406

= 23.8%

CHAPTER 17

Financial Statement Analysis

Prob. 17-5B (Continued) 1. b. 40.0%

Return on Stockholders’ Equity

35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s return on stockholders’ equity Industry return on stockholders’ equity

Return on Stockholders’ Equity =

Net Income Average Total Stockholders’ Equity

20Y8:

$5,571,720 $15,920,340

= 35.0%

20Y5:

$1,848,000 $5,724,000

= 32.3%

20Y7:

$3,714,480 $11,277,240

= 32.9%

20Y4:

$1,400,000 $4,100,000

= 34.1%

20Y6:

$2,772,000 $8,034,000

= 34.5%

CHAPTER 17

Financial Statement Analysis

Prob. 17-5B (Continued) c.

8.0 7.0 6.0 Times Interest Earned

5.0 4.0 3.0 2.0 1.0 0.0 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s times interest earned

Times Interest Earned =

Industry times interest earned

Net Income + Income Tax Expense + Interest Expense Interest Expense

20Y8:

$7,849,352 $1,052,060

= 7.5

20Y5:

$2,899,600 $610,000

= 4.8

20Y7:

$5,451,278 $891,576

= 6.1

20Y4:

$2,220,000 $500,000

= 4.4

20Y6:

$4,180,920 $768,600

= 5.4

CHAPTER 17

Financial Statement Analysis

Prob. 17-5B (Continued) d. 1.6 1.4 Ratio of Liabilities to Stockholders’ Equity

1.2 1.0 0.8 0.6 0.4 0.2 0.0 20Y8

20Y7

20Y6

20Y5

20Y4

Year Company’s liabilities to equity Industry liabilities to equity

Ratio of Liabilities to Total Liabilities = Stockholders’ Equity Total Stockholders’ Equity 20Y8:

$10,672,291 $18,706,200

= 0.6

20Y5:

$5,940,480 $6,648,000

= 0.9

20Y7:

$9,464,359 $13,134,480

= 0.7

20Y4:

$5,352,000 $4,800,000

= 1.1

20Y6:

$7,700,333 $9,420,000

= 0.8

Note: Total liabilities are determined by subtracting stockholders’ equity (ending balance) from the total assets (ending balance).

CHAPTER 17

Financial Statement Analysis

Prob. 17-5B (Concluded) 2.

Both the return on total assets and the return on stockholders’ equity are above the industry average for all five years. The return on total assets is improving gradually. The return on stockholders’ equity exceeds the return on total assets, providing evidence of the positive use of leverage. The company is clearly growing earnings as fast as the asset and equity base. In addition, the ratio of liabilities to stockholders’ equity indicates that the proportion of debt to stockholders’ equity has been declining over the period. The firm is adding to debt at a slower rate than the assets are growing from earnings. The times interest earned ratio is improving during this time period. Again, the firm is increasing earnings faster than the increase in interest charges. Overall, these ratios indicate excellent financial performance coupled with appropriate use of debt (leverage).

CHAPTER 17

Financial Statement Analysis

NIKE, INC., PROBLEM

May 31, 2018 Current assets……………………………………………… $15,134.0 6,040.0 Current liabilities…………………………………………… Working capital……………………………………………… $ 9,094.0

$16,061.0 5,474.0 $10,587.0

Current assets……………………………………………… $15,134.0 6,040.0 ÷ Current liabilities………………………………………… 2.5 Current ratio…………………………………………………

$16,061.0 5,474.0 2.9

Quick assets: Cash………………………………………………………… $ 4,249.0 Short-term investments………………………………… 996.0 3,498.0 Accounts receivable……………………………………… Total quick assets……………………………………… $ 8,743.0 6,040.0 ÷ Current liabilities………………………………………… 1.4 Quick ratio……………………………………………………

Sales…………………………………………………………… $36,397.0 Accounts receivable (net): Beginning of year……………………………………… $ 3,677.0 3,498.0 End of year……………………………………………… Total…………………………………………………… $ 7,175.0 Average accounts receivable (Total ÷ 2)………………… 3,587.5 Accounts receivable turnover 10.1 (Sales ÷ Average accounts receivable)……………… Average daily sales: Sales……………………………………………………… ÷ Days in the year……………………………………… Average daily sales (Sales ÷ 365)……………………

May 31, 2017

$ 3,808.0 2,371.0 3,677.0 $ 9,856.0 5,474.0 1.8 $34,350.0 $ 3,241.0 3,677.0 $ 6,918.0 3,459.0 9.9

$36,397.0 365 $ 99.7

$34,350.0 365 $ 94.1

Average accounts receivable [from (d)]………………… $ 3,587.5 99.7 ÷ Average daily sales……………………………………… 36.0 Number of days’ sales in receivables……………………

$ 3,459.0 94.1 36.8

Cost of merchandise sold………………………………… $20,441.0 Merchandise inventories: Beginning of year……………………………………… $ 5,055.0 5,261.0 End of year……………………………………………… Total……………………………………………………… $10,316.0 5,158.0 Average merchandise inventory (Total ÷ 2)……………

$19,038.0

Inventory turnover (Cost of merchandise sold ÷ Average merchandise inventory)……………………

$ 4,838.0 5,055.0 $ 9,893.0 4,946.5

4.0

3.8

CHAPTER 17

Financial Statement Analysis

NIKE, INC., PROBLEM (Continued) May 31, 2018

May 31, 2017

Average merchandise inventory [from (f)]…………… $ 5,158.0 Cost of merchandise sold……………………………… 20,441.0 56.0 Average daily cost of merchandise sold (÷ 365)…… Number of days’ sales in inventory (Average inventory ÷ Average daily cost 92.1 of merchandise sold)……………………………………

$ 4,946.5 19,038.0 52.2

Total liabilities……………………………………………… $12,724.0 9,812.0 ÷ Total stockholders’ equity…………………………… 1.3 Ratio of liabilities to stockholders’ equity……………

$10,852.0 12,407.0 0.9

Sales………………………………………………………… $36,397.0 Total assets: Beginning of year……………………………………… $23,259.0 End of year……………………………………………… 22,536.0 Total…………………………………………………… $45,795.0 22,897.5 Average total assets (Total ÷ 2)………………………… 1.6 Asset turnover………………………………………………

$34,350.0

94.8

$21,379.0 23,259.0 $44,638.0 22,319.0 1.5

Net income………………………………………………… $ 1,933.0 54.0 Interest expense…………………………………………… Total……………………………………………………… $ 1,987.0 ÷ Average total assets [from (i)]………………………… 22,897.5 8.7% Return on total assets……………………………………

$ 4,240.0 59.0

Net income………………………………………………… $ 1,933.0 Stockholders’ equity: Beginning of year……………………………………… $12,407.0 9,812.0 End of year……………………………………………… Total…………………………………………………… $22,219.0 11,109.5 Average common stockholders’ equity (Total ÷ 2)… 17.4% Return on common stockholders’ equity……………

$ 4,240.0

Market price per share of common stock…………… $ Earnings per share on common stock………………… Price-earnings ratio………………………………………

72.12 1.19 60.6

$ 4,299.0 22,319.0 19.3%

$12,258.0 12,407.0 $24,665.0 12,332.5 34.4% $

53.06 2.56 20.7

CHAPTER 17

Financial Statement Analysis

NIKE, INC., PROBLEM (Concluded) 2.

Before reaching definitive conclusions, each measure should be compared with past years, industry averages, and similar firms in the industry. a.

The working capital decreased between years.

b. and c.

The current and quick ratios both decreased during 2018.

d. and e.

The accounts receivable turnover and the number of days’ sales in receivables indicate an increase in the efficiency of collecting accounts receivable. The accounts receivable turnover increased from 9.9 to 10.1. The number of days’ sales in receivables decreased slightly from 36.8 to 36.0. Thus, it takes the company slightly over a month to collect its accounts receivable from credit sales. These numbers should be compared to Nike’s competitors, industry averages, and Nike’s credit policy to draw definitive conclusions.

f. and g.

The results of these two analyses show a very slight increase in inventory turnover and a decrease in the number of days’ sales in inventory. Both changes are small. Inventory management is critical to Nike, so this indicates a favorable change.

The margin of protection to creditors declined.

These analyses indicate that the effectiveness in the use of assets to generate revenues was very similar in both years.

The return on total assets decreased during 2018. This decrease was from Nike’s net income decreasing at a faster pace than total assets during 2018. Overall, returns on assets that exceed 10% are usually considered good performance. Nike’s return dropped significantly from 19.3% to 8.7%, which is below the indicated 10% for good performance.

The return on common stockholders’ equity decreased. This decrease was due to the impact of the Tax Cuts and Jobs Act in 2018.

The price-earnings ratio increased from 2017 to 2018. This increase was driven by a decrease in Nike’s earnings per share (from $2.56 in 2017 to $1.19 in 2018) combined with a sizable increase in stock price during the same period.

CHAPTER 17

Financial Statement Analysis

CASES & PROJECTS CP 17-1 No. Josh did not behave ethically. The Sarbanes-Oxley Act of 2002 requires a report on internal control by management. This report acknowledges management’s responsibility for establishing and maintaining internal control. In addition, management’s assessment of the effectiveness of internal controls over financial reporting is included in the report. Josh committed a violation of the Sarbanes-Oxley Act when he falsely reported that the company’s internal controls were effective. This is punishable by both fines and imprisonment.

CHAPTER 17

Financial Statement Analysis

CP 17-2 Sample solution based on Nike’s 2018 financial statements. a.

(1) Current assets………………………………………………………………… $15,134.0 6,040.0 – Current liabilities…………………………………………………………… Working capital………………………………………………………………… $ 9,094.0 (2) Current assets………………………………………………………………… ÷ Current liabilities…………………………………………………………… Current ratio……………………………………………………………………

$15,134.0 6,040.0 2.5

(3) Quick assets: Cash…………………………………………………………………………… $ 4,249.0 Short-term investments…………………………………………………… 996.0 3,498.0 Accounts receivable………………………………………………………… Total quick assets………………………………………………………… $ 8,743.0 6,040.0 ÷ Current liabilities………………………………………………………… 1.4 Quick ratio……………………………………………………………………… (4) Sales……………………………………………………………………………… $36,397.0 Accounts receivable (net): Beginning of year………………………………………………………… $ 3,677.0 3,498.0 End of year………………………………………………………………… Total……………………………………………………………………… $ 7,175.0 3,587.5 Average accounts receivable (Total ÷ 2)………………………………… Accounts receivable turnover (Sales ÷ Average accounts receivable)…………………………………

10.1

(5) Average daily sales: Sales………………………………………………………………………… ÷ Days in the year………………………………………………………… Average daily sales (Sales ÷ 365)………………………………………

$36,397.0 365 99.7

Average accounts receivable [from (4)]…………………………………… $ 3,587.5 99.7 ÷ Average daily sales………………………………………………………… 36.0 Number of days’ sales in receivables……………………………………… (6) Cost of merchandise sold…………………………………………………… $20,441.0 Merchandise inventories: Beginning of year………………………………………………………… $ 5,055.0 5,261.0 End of year………………………………………………………………… Total………………………………………………………………………… $10,316.0 5,158.0 Average merchandise inventory (Total ÷ 2)……………………………… Inventory turnover (Cost of merchandise sold ÷ Average merchandise inventory)……

4.0

CHAPTER 17

Financial Statement Analysis

CP 17-2 (Continued) May 31, 2018

(7) Average merchandise inventory [from (6)]…………………………… Cost of merchandise sold……………………………………………… Average daily cost of merchandise sold ……………………………… Number of days’ sales in inventory (Average merchandise inventory ÷ Average daily cost of merchandise sold)………………………………………

$ 5,158.0 20,441.0 56.0

(1) Total liabilities……………………………………………………………… ÷ Total stockholders’ equity…………………………………………… Ratio of liabilities to stockholders’ equity……………………………

$12,724.0 9,812.0 1.3

92.1

(2) Nike has minimal interest expense. As a result, the times interest earned is not applicable. c.

(1) Sales………………………………………………………………………… Total assets: Beginning of year……………………………………………………… End of year……………………………………………………………… Total…………………………………………………………………… Average total assets (Total ÷ 2)………………………………………… Asset turnover ……………………………………………………………

$36,397.0

(2) Net income………………………………………………………………… Interest expense…………………………………………………………… Total……………………………………………………………………… ÷ Average total assets [from (c1)]………………………………… Return on total assets ……………………………………………………

$ 1,933.0 54.0

(3) Net income………………………………………………………………… Stockholders’ equity: Beginning of year……………………………………………………… End of year……………………………………………………………… Total…………………………………………………………………… Average common stockholders’ equity (Total ÷ 2)………………… Return on common stockholders’ equity……………………………

$23,259.0 22,536.0 $45,795.0 22,897.5 1.6

$ 1,987.0 22,897.5 8.7% $ 1,933.0 $12,407.0 9,812.0 $22,219.0 11,109.5 17.4%

CHAPTER 17

Financial Statement Analysis

CP 17-2 (Concluded) May 31, 2018 (4) Net income………………………………………………………………… ÷ Number of shares of common stock………………………………… Earnings per share…………………………………………………………

$1,933.0 1,624* $ 1.19

(5) Market price per share of common stock…………………………… Earnings per share on common stock………………………………… Price-earnings ratio………………………………………………………

$86.54** 1.19 72.7

* From Note 12—Earnings per Share ** Closing market price on July 19, 2019.

CP 17-3 To: From: Re:

Boss Freeman A+ Student Debt vs. Equity Financing

I have reviewed your company history and appreciate the challenges your company has faced in the past during economic downturns. While your conservative approach to debt financing is commendable, your unwillingness to issue debt could limit your potential for future success. Financing future growth exclusively through retained earnings and additional stock sales does not allow the shareholders to take advantage of leverage. As a result, the return on stockholders’ equity is limited. While no debt does provide the company with great flexibility in the event of a national calamity, the probability of this happening is very low. During normal business operations, your company can assume some debt without significantly increasing the risk of losing control of the company. Freeman Industries is competing against companies that will not be so inclined to avoid debt. As a result, your competitors will likely be able to grow faster. Management should carefully consider the strategic risks that could result from the company’s conservative financing policies when establishing the company’s debt load.

CHAPTER 17

Financial Statement Analysis

CP 17-4 1. Sales................................................................. Cost of sales.................................................... Gross profit...................................................... Selling, general, and administrative expenses........................................................ Other operating expenses.............................. Income from operations..................................

Amazon 100.0% 59.8%

Best Buy 100.0% 76.8%

Walmart 100.0% 74.9%

40.2%

23.2%

25.1%

34.9% 0.0% 5.3%

18.7% 0.1%

20.8% 0.0%

4.4%

4.3%

2. Amazon has the highest gross profit on a percentage basis but has the lowest income from operations on a percentage basis. This is because of the relatively large percentage of sales that is used for selling, general, and administrative activities. Walmart has a lower gross profit on a percentage basis but generates a very strong income from operations on a percentage basis. This is consistent with the company’s business strategy, in that it seeks to sell a large quantity of items at a very low margin. Comparatively, Best Buy has relatively strong gross profit and income from operations percentages. This is also consistent with Best Buy’s strategy, which is to sell fewer goods at a higher profit margin.

CP 17-5 1. a. Return on Total Assets =

Net Income + Interest Expense Average Total Assets

Year 3:

$2,368.4 + $1,203.6 = 5.3% $67,947

Year 2:

$2,159.1 + $899.5 $61,852

= 4.9%

Year 1:

$1,523.9 + $763.7 $57,933

= 3.9%

Return on = Stockholders’ Equity

Net Income Average Stockholders’ Equity

Year 3:

$2,368.4 $10,426

= 22.7%

Year 2:

$2,159.1 $8,046

= 26.8%

Year 1:

$1,523.9 $6,644

= 22.9%

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Financial Statement Analysis

CP 17-5 (Concluded) c.

Earnings per Share = Year 3:

$2,368.4 – $0 = $7.33 323

Year 2:

$2,159.1 – $0 = $6.75 320

Year 1:

$1,523.9 – $0 = $4.84 315

d. Dividend Yield =

Net Income – Preferred Dividends Shares of Common Stock Outstanding

Dividend per Share of Common Stock Market Price per Share of Common Stock

Year 3:

$2.58 $134.16

= 1.9%

Year 2:

$2.40 $110.59

= 2.2%

Year 1:

$2.40 $83.94

= 2.9%

Price-Earnings Ratio =

Market Price per Share of Common Stock Earnings per Share

Year 3:

$134.16 $7.33

= 18.3

Year 2:

$110.59 $6.75

= 16.4

Year 1:

$83.94 $4.84

= 17.3

2. Deere’s profitability, as measured by earnings per share, has improved significantly during the three-year period presented. The returns on total assets also improved during this period. The returns on stockholders’ equity varied between 22.9% and 26.8%. The improved earnings per share and return on total assets may be due to an improvement in the overall economy as well as in the construction industry. The dividend yield deteriorated in Year 3 due to a large increase in the market price per share. For the same reason, the price-earnings ratio increased during this period.

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Financial Statement Analysis

CP 17-6 1. a.

Marriott:

$1,907 + $340 = $23,771

Hyatt:

$769 + $76 $7,608

9.5%

= 11.1%

Return on Net Income = Stockholders’ Equity Average Total Stockholders’ Equity Marriott:

$1,907 $2,903

= 65.7%

Hyatt:

$769 $3,760

= 20.5%

Times Interest Earned = Marriott:

Income Before Income Tax + Interest Expense Interest Expense

$2,345 + $340 = 7.9 $340

Hyatt: d.

Net Income + Interest Expense Average Total Assets

Return on Total Assets =

$951 + $76 $76

= 13.5

Ratio of Liabilities to = Stockholders’ Equity Marriott:

$21,471 $2,225

= 9.6

Hyatt:

$3,966 $3,677

= 1.1

Total Liabilities Total Stockholders’ Equity

Summary Table: a. Return on total assets b. Return on stockholders’ equity c. Times interest earned d. Ratio of liabilities to stockholders’ equity

Marriott 9.5% 65.7% 7.9 9.6

Hyatt 11.1% 20.5% 13.5 1.1

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Financial Statement Analysis

CP 17-6 (Concluded) 2. Hyatt has a slightly higher return on total assets (11.1% vs. 9.5%), while Marriott has a significantly higher return on stockholders’ equity (65.7% vs. 20.5%). Hyatt’s weaker performance relative to Marriott’s appears to be due to its weak earnings relative to its debt level. Hyatt has less leverage than Marriott. This is confirmed by the ratio of liabilities to stockholders’ equity, which shows that the relative debt held by Marriott is 9.6 times stockholders’ equity, compared to 1.1 times for Hyatt. The times interest earned ratio shows that Marriott covers its interest charges 7.9 times. The comparable number for Hyatt is 13.5, which is strong. In summary, Hyatt’s weaker earnings and lower debt levels relative to Marriott’s are affecting the company’s ability to earn large returns for stockholders.

CHAPTER 18 INTRODUCTION TO MANAGERIAL ACCOUNTING DISCUSSION QUESTIONS 1.

Financial accounting and managerial accounting are different in several ways. Financial accounting information is reported in statements that are useful to persons or groups outside a company. These statements objectively report the results of operations for fixed periods of time and the financial condition of the business under generally accepted accounting principles. Managerial accounting information uses both subjective and objective information to meet the specific needs of management. This non-GAAP information can be reported periodically or as needed by management and can be reported for the entire entity or for segments of the organization. This information includes (1) historical data, which provide objective measures of past operations, and (2) estimated data, which provide subjective estimates about future decisions.

a. b.

A line department is directly involved in providing goods and services to customers, while a staff department provides service, assistance, or advice to line departments or other staff departments. (1) Sales Department (2) Personnel Department

Direct materials cost

Prime costs are the combination of direct materials and direct labor costs, while conversion costs are the combination of direct labor costs and factory overhead costs.

Product costs are composed of three elements of manufacturing costs: direct materials cost, direct labor cost, and factory overhead cost. These costs are treated as assets until the product is sold. Period costs consist of selling and administrative expenses that are used in generating revenue during the current period. They are recognized as expenses on the current period’s income statement

The three inventory accounts for a manufacturing business are as follows: a. Finished goods inventory consists of completed (or finished) products that have not been sold. b. Work in process inventory consists of the direct materials, direct labor, and factory overhead costs for products that have entered the manufacturing process but are not yet completed. c. Materials inventory consists of the costs of the direct and indirect materials that have not entered the manufacturing process.

Finished goods, work in process, and materials

The cost of finished goods and the cost of work in process included the following: a. Direct materials—the costs of materials that enter directly into the finished product b. Direct labor—the wages of factory workers who convert materials into a finished product c. Factory overhead—the costs, other than direct materials and direct labor, that are incurred in the manufacturing process

Sustainability is the practice of operating a business to maximize profits while attempting to preserve the environment, economy, and needs of future generations. Sustainable business practices consider the role that environmental and social resources play in decision making and act in a manner to preserve and protect these resources.

10.

A merchandising business purchases merchandise (products) in a finished state for resale to customers. The cost of product sold is called cost of merchandise sold. A manufacturer makes the product it sells using direct materials, direct labor, and factory overhead. The cost of the product sold is generally called cost of goods sold.

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Introduction to Managerial Accounting

PRACTICE EXERCISES PE 18-1A Controlling (a) Planning (c) Decision making (b)

PE 18-1B Planning (a) Directing (c) Controlling (b)

PE 18-2A a. b. c. d.

DL FO DM FO

PE 18-2B a. b. c. d.

DM (or FO if the cost is immaterially small) DL FO DM

PE 18-3A a. b. c. d.

B C P C

PE 18-3B a. b. c. d.

P B C (or P if significant) C

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Introduction to Managerial Accounting

PE 18-4A a. b. c. d.

Product cost Product cost Period cost Period cost

PE 18-4B a. b. c. d.

Period cost Product cost Product cost Period cost

PE 18-5A a.

Work in process inventory, May 1………………………………… Cost of direct materials used in production…………………… $17,300 Direct labor…………………………………………………………… 44,700 Factory overhead…………………………………………………… 28,800 Total manufacturing costs incurred during May……………… Total manufacturing costs………………………………………… Less work in process inventory, May 31………………………… Cost of goods manufactured……………………………………… Finished goods inventory, May 1………………………………… Cost of goods manufactured*…………………………………… Cost of finished goods available for sale……………………… Less finished goods inventory, May 31………………………… Cost of goods sold…………………………………………………

$ 72,100

90,800 $162,900 76,400 $ 86,500 $ 30,300 86,500 $116,800 34,600 $ 82,200

* From part (a) above PE 18-5B a.

Work in process inventory, November 1………………………… Cost of direct materials used in production…………………… $230,700 Direct labor…………………………………………………………… 267,000 Factory overhead…………………………………………………… 155,800

$ 59,600

Total manufacturing costs incurred during November……… Total manufacturing costs………………………………………… Less work in process inventory, November 30………………… Cost of goods manufactured………………………………………

653,500

Finished goods inventory, November 1………………………… Cost of goods manufactured*…………………………………… Cost of finished goods available for sale……………………… Less finished goods inventory, November 30………………… Cost of goods sold…………………………………………………

$713,100 63,300 $649,800 $ 42,600 649,800 $692,400 44,100 $648,300

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Introduction to Managerial Accounting

EXERCISES Ex. 18-1 a. b. c. d.

Direct materials cost Direct materials cost Direct labor cost Direct materials cost

e. f. g. h.

Factory overhead cost Direct materials cost Factory overhead cost Factory overhead cost

f. g. h. i. j.

Factory overhead cost Direct materials cost Direct labor cost Direct labor cost Factory overhead cost

j. k. l. m. n. o. p. q.

Period cost Product cost Product cost Period cost Period cost Product cost Product cost Product cost

e. f. g.

work in process inventory conversion decreases

Ex. 18-2 a. b. c. d. e.

Direct materials cost Direct materials cost Factory overhead cost Factory overhead cost Factory overhead cost

Ex. 18-3 a, b, d, f, g

Ex. 18-4 a. b. c. d. e. f. g. h. i.

Period cost Product cost Product cost Period cost Period cost Product cost Product cost Period cost Period cost

Ex. 18-5 a. b. c. d.

period improve costs cost object

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Introduction to Managerial Accounting

Ex. 18-6 a. b. c. d.

improving conversion period indirect

e. f. g.

strategic materials inventory electricity used to run assembly line

g. h. i. j. k. l.

indirect indirect indirect direct indirect indirect

Ex. 18-7 a. b. c. d. e. f.

direct indirect direct direct indirect indirect

Ex. 18-8 1. c., 2. d., 3. b., 4. a.

Ex. 18-9 1.

The maintenance salaries of $84,400 and indirect materials of $56,200 should be included as factory overhead.

The factory overhead incorrectly includes the following items: sales salaries of $348,750, promotional expenses of $315,000, corporate office insurance and property taxes of $219,400, and corporate office depreciation of $90,000. These items should not be included as factory overhead, but instead they should be recorded as period costs. Marching Ants Inc. Manufacturing Costs For the Quarter Ended June 30 Cost of direct materials used in production Direct labor Factory overhead: Maintenance salaries Indirect materials Supervisor salaries Heat, light, and power Insurance and property taxes—plant Depreciation—plant and equipment Total manufacturing costs incurred

$ 551,300 478,100 $ 84,400 56,200 517,500 140,650 151,900 123,750

1,074,400 $2,103,800

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Introduction to Managerial Accounting

Ex. 18-10 Technology Treasures Manufacturing Company Income Statement For the Month Ended January 31

Revenues Cost of goods sold Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses Net income b.

$742,000 445,200 $296,800 $106,000 67,800 173,800 $123,000

Inventory balances on January 31: Materials ($142,900 – $126,600)………………………………………………… $16,300 Work in Process ($126,600 + $305,300 + $101,800 – $508,800)…………… $24,900 Finished Goods ($508,800 – $445,200)………………………………………… $63,600

Ex. 18-11 Upper Crust Company Balance Sheet August 31 Current assets: Cash Accounts receivable Inventories: Finished goods Work in process Materials Total inventories Supplies Prepaid insurance Total current assets

$ 243,400 505,700 $129,800 88,200 38,900 256,900 20,300 13,100 $1,039,400

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Introduction to Managerial Accounting

Ex. 18-12 Materials inventory, November 1………………………………………………… Purchases…………………………………………………………………………… Cost of materials available for use……………………………………………… Less materials inventory, November 30 ……………………………………… Cost of direct materials used in production…………………………………

$ 75,700 572,400 $648,100 94,800 $553,300

Ex. 18-13 a. b. c. d. e. f.

$410,900 $383,500 $552,800 $538,400 $192,400 $200,600

($22,900 + $388,000) ($410,900 – $27,400) ($601,400 – $48,600) ($601,400 – $63,000) ($1,445,900 – $1,253,500) ($1,445,900 – $1,245,300)

Ex. 18-14 Work in process inventory, July 1……………………………… Add manufacturing costs incurred during July: Cost of direct materials used ……………………………… $1,150,000 Direct labor……………………………………………………… 966,000 490,500 Factory overhead……………………………………………… Total manufacturing costs incurred……………………… Total manufacturing costs……………………………………… Less work in process inventory, July 31……………………… Cost of goods manufactured……………………………………

$ 316,400

2,606,500 $2,922,900 355,500 $2,567,400

Ex. 18-15 a. b. c. d. e. f.

$1,099,000 $947,400 $584,300 $548,000 $1,072,700 $180,700

($136,000 + $963,000) ($1,099,000 – $151,600) ($629,600 – $45,300) ($629,600 – $81,600) ($1,282,600 – $209,900) ($1,282,600 – $1,101,900)

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Introduction to Managerial Accounting

Ex. 18-16 a.

Disksan Manufacturing Company Statement of Cost of Goods Manufactured For the Month Ended January 31 Work in process inventory, January 1 Direct materials: Materials inventory, January 1 Purchases

$ 334,600 $ 180,000 1,375,000

Cost of materials available for use Less materials inventory, January 31

$1,555,000 145,500

Cost of direct materials used Direct labor Factory overhead: Indirect labor Machinery depreciation Heat, light, and power Supplies Property taxes Miscellaneous cost Total factory overhead Total manufacturing costs incurred

$1,409,500 2,260,000 $ 115,000 90,000 55,000 18,500 10,000 33,100 321,600 3,991,100

Total manufacturing costs Less work in process inventory, January 31 Cost of goods manufactured

$4,325,700 290,700 $4,035,000

b. Finished goods inventory, January 1…………………………………………… $ 675,000 Cost of goods manufactured*……………………………………………………… 4,035,000 Cost of finished goods available for sale……………………………………… $4,710,000 715,000 Less finished goods inventory, January 31…………………………………… Cost of goods sold………………………………………………………………… $3,995,000 * From part (a) above

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Introduction to Managerial Accounting

Ex. 18-17 Finished goods inventory, January 1………………………… Cost of goods manufactured…………………………………… Cost of finished goods available for sale…………………… Less finished goods inventory, January 31………………… Cost of goods sold………………………………………………

$ 707,000 3,606,000

Sales………………………………………………………………… Cost of goods sold……………………………………………… Gross profit…………………………………………………………

$5,300,000 3,691,000 $1,609,000

Gross profit………………………………………………………… Operating expenses: Selling expenses……………………………………………… $426,000 273,000 Administrative expenses……………………………………

$1,609,000

Total operating expenses……………………………… Net income…………………………………………………………

699,000 $ 910,000

$4,313,000 622,000 $3,691,000

Ex. 18-18 a.

Sales………………………………………………………………… Less gross profit………………………………………………… Cost of goods sold………………………………………………

$792,000 462,000 $330,000

Cost of goods manufactured…………………………………… Less cost of goods sold………………………………………… Finished goods inventory………………………………………

$396,000 330,000 $ 66,000

Purchased materials……………………………………………… Less materials inventory………………………………………… Direct materials cost……………………………………………

$244,200 33,000 $211,200

Total manufacturing costs……………………………………… Less: Direct materials………………………………………… $211,200 Factory overhead costs (indirect labor and factory depreciation)*…………………………… 198,000

$455,400

Direct labor cost…………………………………………………

409,200 $ 46,200

* $171,600 + $26,400 e.

Total manufacturing costs……………………………………… Less cost of goods manufactured…………………………… Work in process inventory………………………………………

$455,400 396,000 $ 59,400

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Introduction to Managerial Accounting

Ex. 18-19 The Hotel Monaco has excess capacity for this day, so it is willing to accept additional customers. To determine whether or not to accept Natalie Mooney’s bid, the Hotel Monaco could use managerial accounting information to determine the additional cost of servicing the room during and following Natalie’s stay. These costs would include the housekeeping labor cost per room, the cost of room supplies (soap, paper, etc.), laundry labor and material cost, and utility cost during her stay. If Natalie’s bid is greater than the additional cost of servicing Natalie’s room for the night, then the Hotel Monaco will likely accept her bid. This use and analysis of managerial accounting information is called differential analysis and is discussed in greater detail in Chapter 25.

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Introduction to Managerial Accounting

PROBLEMS Prob. 18-1A Product Costs

Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w. x. y. z.

Direct Materials Cost

Direct Labor Cost

Period Costs Factory Overhead Cost

Selling Expense

Administrative Expense

X X X X X X X X X X X X X X X X X X X X X X X X X X

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Introduction to Managerial Accounting

Prob. 18-2A Product Costs

Cost a. b. c. d. e. f. g. h i. j. k. l. m. n. o. p. q. r. s. t. u. v. w. x.

Direct Materials Cost

Direct Labor Cost

Period Costs Factory Overhead Cost

Selling Expense

Administrative Expense

X X X X X X X X X X X X X X X X X X X X X X X X

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Introduction to Managerial Accounting

Prob. 18-3A 1.

The most logical definition for the final cost object would be the patient. The reason is that the cost can be accumulated at the patient level for billing and insurance reimbursement. Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u.

Direct

Indirect

X X X X X X X X X X X X X X X X X X X X X

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Introduction to Managerial Accounting

Prob. 18-4A 1. Rainier Company a. b. c. d. e. f.

$111,500 $5,598,500 $5,616,500 $5,635,000 $3,585,000 $2,585,000

($950,000 + $100,000 – $938,500) ($938,500 + $2,860,000 + $1,800,000) ($5,598,500 + $400,000 – $382,000) ($615,000 + $5,616,500 – $596,500) ($9,220,000 – $5,635,000) ($3,585,000 – $1,000,000)

Yakima Company a. b. c. d. e. f. 2.

$708,200 $1,330,000 $169,100 $211,500 $2,080,000 $580,000

($48,200 + $710,000 – $50,000) ($2,484,200 – $708,200 – $446,000) ($2,660,600 – $2,491,500) ($2,491,500 + $190,000 – $2,470,000) ($4,550,000 – $2,470,000) ($2,080,000 – $1,500,000) Yakima Company Statement of Cost of Goods Manufactured For the Month Ended May 31

Work in process inventory, May 1 Direct materials: Materials inventory, May 1 Purchases

$ 176,400 $ 48,200 710,000 $758,200 50,000

Cost of materials available for use Less materials inventory, May 31

$ 708,200 1,330,000 446,000

Cost of direct materials used Direct labor Factory overhead Total manufacturing costs incurred

2,484,200 $2,660,600 169,100 $2,491,500

Total manufacturing costs Less work in process inventory, May 31 Cost of goods manufactured

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Introduction to Managerial Accounting

Prob. 18-4A (Concluded) 3.

Yakima Company Income Statement For the Month Ended May 31 Sales Cost of goods sold: Finished goods inventory, May 1 Cost of goods manufactured

$4,550,000 $ 190,000 2,491,500 $2,681,500 211,500

Cost of finished goods available for sale Less finished goods inventory, May 31 Cost of goods sold

2,470,000 $2,080,000 580,000 $1,500,000

Gross profit Operating expenses Net income

Prob. 18-5A 1.

Lagakos Corporation Statement of Cost of Goods Manufactured For the Year Ended December 31, 20Y8 Work in process inventory, January 1, 20Y8 Direct materials: Materials inventory, January 1, 20Y8 Purchases Cost of materials available for use Less materials inventory, December 31, 20Y8 Cost of direct materials used Direct labor Factory overhead: Indirect labor Depreciation expense—factory equipment Heat, light, and power—factory Property taxes—factory Rent expense—factory Supplies—factory Miscellaneous costs—factory Total factory overhead Total manufacturing costs incurred Total manufacturing costs Less work in process inventory, December 31, 20Y8 Cost of goods manufactured

72,400

$ 50,100 630,300 $680,400 35,900 $ 644,500 1,245,700 $130,200 90,500 60,400 45,300 30,600 10,800 12,900 380,700 2,270,900 $2,343,300 90,600 $2,252,700

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Introduction to Managerial Accounting

Prob. 18-5A (Concluded) 2.

Lagakos Corporation Income Statement For the Year Ended December 31, 20Y8 Sales Cost of goods sold: Finished goods inventory, January 1, 20Y8 Cost of goods manufactured

$4,360,000 $ 114,600 2,252,700

Cost of finished goods available for sale Less finished goods inventory, December 31, 20Y8 Cost of goods sold Gross profit Operating expenses: Administrative expenses: Office salaries expense Depreciation expense—office equipment Property taxes—office building

$2,367,300 113,000 2,254,300 $2,105,700

$360,100

Selling expenses: Advertising expense Sales salaries expense Total operating expenses Net income

34,000 28,300

$ 422,400

$453,000 226,500

679,500 1,101,900 $1,003,800

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Introduction to Managerial Accounting

Prob. 18-1B Product Costs

Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w. x. y. z.

Direct Materials Cost

Direct Labor Cost

Period Costs Factory Overhead Cost

Selling Expense

Administrative Expense

X X X X X X X X* X X X X X X X X X X X X X X X X X X

* Item h might also be classified as direct material cost if the cost is significant because it can be traced directly to the end product.

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Introduction to Managerial Accounting

Prob. 18-2B Product Costs

Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w. x.

Direct Materials Cost

Direct Labor Cost

Period Costs Factory Overhead Cost

Selling Expense

Administrative Expense

X X X X X X X X X X X X X X X X X X X X X* X X X

* Health insurance premiums are employment benefits for direct labor and are included as part of the direct labor cost.

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Introduction to Managerial Accounting

Prob. 18-3B 1.

The most logical definition for the final cost object would be a hotel guest. Guests consume services such as a meal, a night’s stay in a hotel room, room service, and a telephone call. Cost

Direct

a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t. u. v. w.

Indirect

X X X X X X X X X X X X X X X X X X X X X X

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Introduction to Managerial Accounting

Prob. 18-4B 1.

On Company a. b. c. d. e. f.

$30,800 $854,000 $800,800 $827,400 $299,600 $182,000

($282,800 + $65,800 – $317,800) ($317,800 + $387,800 + $148,400) ($854,000 + $119,000 – $172,200) ($224,000 + $800,800 – $197,400) ($1,127,000 – $827,400) ($299,600 – $117,600)

Off Company a. b. c. d. e. f.

$581,560 $685,720 $195,300 $256,060 $399,280 $234,360

($685,720* + $91,140 – $195,300) ($1,519,000 – $256,060 – $577,220) ($1,727,320 – $1,532,020) ($1,532,020 + $269,080 – $1,545,040) ($1,944,320 – $1,545,040) ($399,280 – $164,920)

* Note: The student must determine part (b) prior to computing part (a) because the solution to part (b) is needed as an input to part (a). 2.

On Company Statement of Cost of Goods Manufactured For the Month Ended December 31 Work in process inventory, December 1 Direct materials: Materials inventory, December 1 Purchases Cost of materials available for use Less materials inventory, December 31

$119,000 $ 65,800 282,800 $348,600 30,800 $317,800 387,800 148,400

Cost of direct materials used Direct labor Factory overhead Total manufacturing costs incurred Total manufacturing costs Less work in process inventory, December 31 Cost of goods manufactured

854,000 $973,000 172,200 $800,800

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Introduction to Managerial Accounting

Prob. 18-4B (Concluded) 3.

On Company Income Statement For the Month Ended December 31 Sales Cost of goods sold: Finished goods inventory, December 1 Cost of goods manufactured

$1,127,000 $ 224,000 800,800 $1,024,800 197,400

Cost of finished goods available for sale Less finished goods inventory, December 31 Cost of goods sold

827,400 $ 299,600 117,600 $ 182,000

Gross profit Operating expenses Net income

Prob. 18-5B 1.

Shanika Company Statement of Cost of Goods Manufactured For the Year Ended December 31, 20Y6 Work in process inventory, January 1, 20Y6 Direct materials: Materials inventory, January 1, 20Y6 Purchases Cost of materials available for use Less materials inventory, December 31, 20Y6 Cost of direct materials used Direct labor Factory overhead: Indirect labor Depreciation expense—factory equipment Heat, light, and power—factory Property taxes—factory Rent expense—factory Supplies—factory Miscellaneous costs—factory Total factory overhead Total manufacturing costs incurred Total manufacturing costs Less work in process inventory, December 31, 20Y6 Cost of goods manufactured

$109,200 $ 77,350 123,500 $200,850 95,550 $105,300 186,550 $ 23,660 14,560 5,850 4,095 6,825 3,250 4,420 62,660 354,510 $463,710 96,200 $367,510

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Introduction to Managerial Accounting

Prob. 18-5B (Concluded) 2.

Shanika Company Income Statement For the Year Ended December 31, 20Y6 Sales Cost of goods sold: Finished goods inventory, January 1, 20Y6 Cost of goods manufactured

$864,500 $113,750 367,510

Cost of finished goods available for sale Less finished goods inventory, December 31, 20Y6 Cost of goods sold Gross profit Operating expenses: Administrative expenses: Office salaries expense Depreciation expense—office equipment Property taxes—headquarters building Selling expenses: Advertising expense Sales salaries expense Total operating expenses Net income

$481,260 100,100 381,160 $483,340

$ 77,350 22,750 13,650

$113,750

$ 68,250 136,500

204,750 318,500 $164,840

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Introduction to Managerial Accounting

CASES & PROJECTS CP 18-1 Brian has behaved unethically and violated several of the IMA’s principles of ethical conduct. By determining the price of the lumber he is buying, Brian has created a conflict-of-interest situation that violates the principle of objectivity. For professionals to be objective, they must make decisions that are not influenced by their personal feelings or result in personal gains. Since Brian is in a position to directly influence the price he will pay for the lumber, he cannot be objective. Thus, although it is appropriate for Brian to take advantage of Avett’s policy of allowing employees to purchase materials at cost, he should have had someone else (such as his supervisor) determine the amount he owed for the lumber. Clearly, selecting the lowest price has opened the door for criticism.

CP 18-2 Note to Instructors: Consider having the teams compete for the most examples. Pizza Restaurant Direct Materials

Cost

Ingredients……………………………………… Cook wages…………………………………… Manager salary………………………………… Depreciation on equipment and fixtures…………………………………… Coupon costs………………………………… Advertising…………………………………… To-go boxes…………………………………… Disposable plates, utensils, cups………… Nondisposable plates, utensils, cups…… Repair costs…………………………………… Property taxes………………………………… Store depreciation…………………………… Cashier salary………………………………… Beverages……………………………………… Building heat and A/C………………………… Salad ingredients……………………………… Delivery person wages……………………… Power costs for ovens………………………

Direct Labor

Overhead

Selling Expenses

X X X X X X X X X X X X X X X X X X

In service businesses, the distinction between direct labor and overhead will not always be clear.

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CP 18-3 Memo To: Todd Johnson From: A+ Student Re: Financial vs. Managerial Accounting Information The objectives of financial and managerial accounting are quite different, and your statement does not fully consider these differences. In one sense, your statement may be appropriate at high levels in the organization. For example, it is appropriate to evaluate a division manager who is responsible for the overall performance of a division using the same financial performance measures that shareholders use to evaluate the company. However, these measures are not appropriate for evaluating managerial decision making below the division level. At these levels, summary financial performance measures do not provide the relevant information needed to direct and control the company’s operations. Operational performance measures need to focus on measuring cost, quality, delivery time, equipment availability, inventory levels, scrap, waste, and efficiency. This list is much broader and more detailed than the financial statement numbers provided to the stockholders. The stockholders’ interest in profit is related to increasing shareholder value. Managers must increase long-term shareholder value by engaging in strategies that enhance people, product, and processes in the delivery of value to customers. These strategies can be measured by both financial and nonfinancial means. Therefore, managerial accounting information needs a much broader set of objective and subjective measures used internally in the organization to guide strategy and operations.

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Introduction to Managerial Accounting

CP 18-4 1.

The vice president of the Information Systems Division can use managerial accounting information in a number of ways. For example, the vice president might use these data to determine resources that will be needed based on a projection of amount and type of work required for the next period. Managerial accounting information would also be used to determine whether the bank should lease additional processing capacity or purchase a new central processing unit. In addition, managerial accounting information could also be used to achieve better control over information systems activities by evaluating the costs of ongoing operations, based on the demand for information services.

The hospital administrator can use managerial accounting information in a number of ways. One way is for cost planning and control. The administrator could use managerial information to keep costs commensurate with services provided and to plan for staffing and nursing levels. This information can be used to determine the cost of various services and, thereby, in making decisions with respect to the amount of service that is appropriate in each case. The administrator can also use managerial accounting information to determine whether the hospital’s costs are being covered by fixed payments from Medicare, Medicaid, or insurance. If not, the administrator needs to know the source of the cost overruns. Does the hospital allow too many procedures? Require longer bed days? Have resources that are underutilized (e.g., a cancer wing with three patients)?

The CEO of the food company will use managerial accounting information to support the control of the three divisions. Each of the three divisions will be subject to a number of financial goals. The CEO also needs to support strategic decision making. In this regard, the CEO needs managerial accounting information on the profitability of various product families, profitability of different regions, and profitability of various customer segments. This information can guide the CEO in allocating future effort and resources.

The copy shop manager needs fairly simple managerial accounting information. At the most basic level, the copy shop manager needs to know the costs of performing various copy tasks, such as one-sided copy, two-sided copy, collating, and binding. These activities will have some direct costs, such as paper, and some indirect costs, such as copy machine time. The manager will need to estimate the impact of both of these costs in order to price the various copy jobs to the public. Managerial accounting information will include the cost details necessary to price the various copy shop services at a level needed to cover equipment costs, lease expenses, and profit.

CHAPTER 18

Introduction to Managerial Accounting

CP 18-5 1.

Obie’s bill has a number of points that should be considered. Some of the points, with the appropriate argument, are identified below. a.

The trip back to the shop resulted in an $80 labor charge. Obie should argue that the whole hour should not be billed. The hour is the result of stocking out of a circuit board on the truck. The circuit board should have been with the repair person. There was a board for the previous customer. However, because only one was stocked, the repair person had to go back to the shop. The trip back to the shop was nonproductive time that should not have been charged directly to Obie but should be part of Geek Chic’s overhead cost to all customers. In other words, Obie should not be responsible for this mistake.

The overtime premium should not have been charged to Obie. What if Obie was the first appointment in the morning? If he was, there would be no overtime premium. It’s only random misfortune that Obie was the last client of the day and therefore received the overtime premium. Add to this the fact that the overtime would not have been necessary without the trip back to the shop, and the conclusion is that Obie should not be charged directly for overtime. The overtime premium should be part of Geek Chic’s overhead charged to all clients equally. Obie should be charged the overtime only if the decision for overtime was caused by or required by Obie.

Thus, the labor portion of the bill should only be $70 + $60 + $60 = $190. There are other parts of the bill that should not be in dispute. ●

The materials storage and handling charge is a normal charge of maintaining a parts inventory for the benefit of clients that need parts.

●

The fringe benefits and overhead added to the hourly rate are both reasonable. The fringe benefit attaches directly to the direct labor. Fringe benefits are just another form of compensation. The overhead must be covered by all customers. Therefore, including overhead in the hourly rate is the most logical method of covering these costs.

●

The additional charge for the first hour is also reasonable. The first hour charge covers the costs of transit, which are directly attributable to making a home visit. Obie requires a home visit, so Obie should be responsible for the costs of making the visit. If Obie brought the computer to the shop, this cost would not be incurred.

CHAPTER 18

Introduction to Managerial Accounting

CP 18-5 (Concluded) 2.

Direct Materials

Cost Circuit board………………………………… Storage and handling……………………… Straight-time labor…………………………… Fringe benefits*……………………………… Overhead……………………………………… Vehicle depreciation and fuel……………… Overtime premium……………………………

Direct Labor

Overhead

X X X X X X X

* Could be considered overhead.

CP 18-6 1.

The High Times manager will use managerial accounting information to accumulate the costs associated with different menu items. The costs, direct and indirect, will help in determining the pricing strategy.

The plant manager is going to use cost information on scrap and rework to identify the amount of waste occurring in the plant. This measure of waste is fairly common in fabrication-type facilities. The measures can guide the plant manager to locations or products where significant waste is occurring. The plant manager can use the scrap and rework measures to guide operational improvement toward the location that is experiencing the greatest level of scrap or rework. The measures can also monitor improvement in rework and control the number of network hours charged by floor personnel.

The cost of ending inventory must be determined as financial statements are prepared. The division controller will likely require inventory valuation at the close of every month in order to have a good understanding of the month-by-month earnings of the division. The division controller will provide the ending inventory information by using managerial accounting information in determining the cost of products. To determine the appropriate cost, the product cost is multiplied by the units left in inventory.

The Maintenance Department manager needs to be able to plan the resources used by his department. The planning process involves identifying the required resources to fulfill the department’s objective. For example, the Maintenance Department manager may know the repair histories of various machines. These histories can be used to forecast the repairs anticipated during the next year. The manager may also know that a new process will be brought online during the next year. New processes are frequently troublesome, so the manager will need to budget additional resources to accommodate introduction of the new technology.

CHAPTER 19 JOB ORDER COSTING DISCUSSION QUESTIONS 1.

a. Job order cost system and process cost system. b. The job order cost system provides a separate record of each quantity of product that passes through the factory. c. Process cost systems accumulate costs for each department or process within a factory.

Job order costing is used by firms that sell custom goods and services to customers. The job order system is frequently associated with firms that will produce a product or service specifically to a customer order.

Work in Process

a. Purchase invoice or receiving report b. Materials requisition

A job cost sheet is the subsidiary ledger to the work in process control account. The cost of materials, labor, and overhead are listed on each separate job cost sheet for each job. A summary of all the job cost sheets during an accounting period is the basis for journal entries to the control accounts.

The clock card is a means of recording the hours spent by employees in the factory. The time ticket is a means of recording the time the employee spends on a specific job.

The predetermined overhead rate is computed using estimated amounts at the beginning of the period. This is because managers need timely information on the product costs of each job. If a company waited until all overhead costs were known at the end of the period, the allocated factory overhead would be accurate but not timely. Only through timely reporting can managers adjust manufacturing methods or product pricing.

a. The predetermined factory overhead rate is determined by dividing the estimated total factory overhead costs for the forthcoming year by an estimated activity base, one that reflects the consumption or use of factory overhead costs. b. Direct labor cost, direct labor hours, and machine hours.

a. (1) If the amount of factory overhead applied is greater than the actual factory overhead incurred, factory overhead is overapplied. (2) If the amount of actual factory overhead is greater than the amount applied, factory overhead incurred is underapplied. b. Underapplied

CHAPTER 19

Job Order Costing

DISCUSSION QUESTIONS (Continued) 10.

Job order cost accumulation would be most appropriate for professional service firms that provide extended, project-type services for clients. Examples would be architectural, consulting, advertising, and legal services. Job cost sheets would accumulate all direct costs of servicing the client. Such costs would include labor, materials, travel, and subcontracted services. In addition, overhead would be applied using a predetermined overhead rate. The costs accumulated by the job cost sheet would be treated as work in process (a current asset) until the service is completed. Once completed, the cost would be transferred to the cost of services on the income statement.

CHAPTER 19

Job Order Costing

PRACTICE EXERCISES PE 19-1A May

7 Materials (12,000 units × $6) Accounts Payable

72,000

31 Work in Process* Materials

59,000

* Job 275 Job 310 Total

$50,400 8,600 $59,000

72,000

59,000 = 8,400 × $6 = 2,150 × $4

PE 19-1B Aug.

4 Materials (31,000 units × $16) Accounts Payable

496,000

31 Work in Process* Materials

184,500

* Job 50 Job 56 Total

496,000

184,500

$ 86,900 = 7,900 × $11 97,600 = 6,100 × $16 $184,500

PE 19-2A Work in Process* Wages Payable * Job 275 Job 310 Total

132,200 132,200 $ 64,600 = 1,900 hours × $34 67,600 = 2,600 hours × $26 $132,200

PE 19-2B Work in Process* Wages Payable * Job 50 Job 56 Total

184,650 184,650 $ 90,300 = 4,300 hours × $21.00 94,350 = 5,100 hours × $18.50 $184,650

CHAPTER 19

Job Order Costing

PE 19-3A Factory Overhead Materials Wages Payable Utilities Payable Accumulated Depreciation—Factory

32,300 9,700 7,300 5,200 10,100

PE 19-3B Factory Overhead Materials Wages Payable Utilities Payable Accumulated Depreciation—Factory

63,700 16,400 21,300 8,900 17,100

PE 19-4A a.

$8.50 per direct labor hour = $867,000 ÷ 102,000 direct labor hours

Job 275 Job 310

$16,150 22,100 $38,250

= 1,900 hours × $8.50 per hour = 2,600 hours × $8.50 per hour

Work in Process Factory Overhead

38,250 38,250

PE 19-4B a.

$12.00 per direct labor hour = $960,000 ÷ 80,000 direct labor hours

Job 50 Job 56

$ 51,600 = 4,300 hours × $12.00 per hour 61,200 = 5,100 hours × $12.00 per hour $112,800

Work in Process Factory Overhead

112,800 112,800

CHAPTER 19

Job Order Costing

PE 19-5A a.

Job 275

Job 310

Direct materials…………………………………………………… $ 50,400 Direct labor………………………………………………………… 64,600 16,150 Factory overhead………………………………………………… $131,150 Total costs……………………………………………………

$ 8,600 67,600 22,100 $98,300

Job 275 Job 310

$26.23 = $131,150 ÷ 5,000 units $49.15 = $98,300 ÷ 2,000 units

PE 19-5B a.

Job 50

Job 56

Direct materials…………………………………………………… $ 86,900 Direct labor………………………………………………………… 90,300 51,600 Factory overhead………………………………………………… $228,800 Total costs……………………………………………………

$ 97,600 94,350 61,200 $253,150

Job 50 Job 56

$228.80 = $228,800 ÷ 1,000 units $506.30 = $253,150 ÷ 500 units

CHAPTER 19

Job Order Costing

EXERCISES Ex. 19-1 a. b. c. d. e.

Materials requisitioned for use (both direct and indirect) Factory labor used (both direct and indirect) Application of factory overhead costs to jobs Jobs completed Goods sold

Ex. 19-2 a.

RECEIVED

ISSUED

BALANCE

Materials Receiving

Requi-

Report Number

Quantity

130

Unit

sition

Price

Number

Unit Quantity

$32.00 91

110

365

38.00 97

100

* May 10 issuance

285 at $30.00 80 at $32.00

$ 8,550 2,560 $11,110

** May 27 issuance

50 at $32.00 50 at $38.00

$1,600 1,900 $3,500

Amount

$11,110*

Date

Quantity

Price

Amount

May

285

$30.00

$8,550

May

285

$30.00

8,550

130

$32.00

4,160

May

$32.00

1,600

May

$32.00

1,600

$38.00 $38.00

4,180

110 60

3,500 ** May

2,280

Ending inventory balance: 60 at $38.00………………………………………………………………………$2,280 14,610

Work in Process ($11,110 + $3,500) Materials

14,610

Comparing quantities on hand as reported in the materials ledger with predetermined order points enables management to order materials before a lack of materials causes idle time. Also, the subsidiary ledger can include columns for recording quantities ordered so that management can have easy access to information about materials on order.

Ex. 19-3 61,600 1,620

Work in Process Factory Overhead Materials

63,220 19-6

CHAPTER 19

Job Order Costing

Ex. 19-4 a.

Materials* Accounts Payable

918,000 918,000

* $396,000 + $162,000 + $324,000 + $36,000 b.

Work in Process* Factory Overhead Materials

851,000 31,300 882,300

* $401,000 + $150,000 + $300,000

c. Fabric Balance, June 1…………… $ 36,500 396,000 June purchases…………… Less June requisitions…… (401,000) Balance, June 30…………… $ 31,500

Polyester Filling

Lumber

Glue

$ 25,700 162,000 (150,000) $ 37,700

$ 56,200 324,000 (300,000) $ 80,200

$ 5,900 36,000 (31,300) $ 10,600

Ex. 19-5 Work in Process Factory Overhead Wages Payable

88,800 8,500 97,300

Ex. 19-6 a.

Work in Process Factory Overhead Wages Payable

3,770 190 3,960

Supporting calculations:

Landon Vincent…… Fahad Hamad……… Ivory Argo…………

Hourly Rate

Job 301

Labor Costs (Hourly Rate × Hours) Direct Labor (sum of Job Job 302 303 job costs)

$35 36 28

$315 396 224

$630 540 560

$385 468 252

Indirect Labor

$1,330 1,404 1,036

$ 70 36 84

$3,770

$190

The direct labor costs for the completed jobs would become part of the finished goods inventory. The direct labor costs for Job 303 would remain part of the work in process inventory.

CHAPTER 19

Job Order Costing

Ex. 19-7 a.

Work in Process Factory Overhead Wages Payable

25,200 4,000

Work in Process Factory Overhead

11,340

29,200

11,340

$25,200 ÷ $40 per hour = 630 hours 630 hours × $18 per hour = $11,340

Ex. 19-8 a.

Factory 1: $37.50 per machine hour ($12,000,000 ÷ 320,000 machine hours)

Factory 2: $19.00 per direct labor hour ($8,360,000 ÷ 440,000 direct labor hours)

Factory 1: Work in Process Factory Overhead ($37.50 × 27,500).

1,031,250 1,031,250

Factory 2: Work in Process Factory Overhead ($19.00 × 36,250). d.

688,750 688,750

Factory 1—$(18,650) credit (overapplied) ($1,012,600 – $1,031,250) Factory 2—$6,250 debit (underapplied) ($695,000 – $688,750)

Ex. 19-9 The estimated shop overhead is determined as follows: Shop and repair equipment depreciation………………………………………… $ 64,000 212,000 Shop supervisor salaries…………………………………………………………… Shop property taxes………………………………………………………………… 35,000 18,000 Shop supplies………………………………………………………………………… Total shop overhead……………………………………………………………… $329,000 The engine parts and shop labor are direct to the jobs and are not included in the shop overhead rate. The advertising and administrative expenses are selling and administrative expenses that are not included in the shop overhead but are treated as period expenses. The estimated activity base is determined by dividing the shop direct labor cost by the direct labor rate, as follows: $770,000 $22 per hour

= 35,000 hours 19-8

CHAPTER 19

Job Order Costing

Ex. 19-9 (Concluded) The predetermined shop overhead rate is: $329,000 35,000 hours

= $9.40 per direct labor hour

Ex. 19-10 a.

Estimated number of operating room hours: Hours per day…………………………………………………… Days per week…………………………………………………… Hours per week………………………………………………… Weeks per year (net of two maintenance weeks)………… Estimated annual operating room hours……………………

8 7

56 × 50 2,800

Estimated annual operating room overhead: $952,000 Predetermined surgical overhead rate: $952,000 2,800 hours

= $340 per hour

Conrad Goldsmith’s procedure: Number of surgical room hours……………………………… Predetermined surgical room overhead rate……………… Procedure overhead……………………………………………

6 × $340 $2,040

Actual hours used in January………………………………………………… Predetermined surgical room overhead rate………………………………… Surgical room overhead applied, January…………………………………… Actual surgical room overhead incurred, January………………………… Overapplied surgical room overhead (credit balance)……………………

235 × $340 $79,900 69,300 $10,600

CHAPTER 19

Job Order Costing

Ex. 19-11 a.

Finished Goods* Work in Process

1,149,800 1,149,800

* $200,000 + $288,000 + $225,000 + $436,800 b.

Cost of unfinished jobs at January 31: Balance in Work in Process at January 1…………… $ 72,000 Add: Direct materials………………………………… 390,000 Direct labor……………………………………… 500,000 Factory overhead……………………………… 250,000 Less: Jobs finished during January……………… Balance in Work in Process at January 31…………

$1,212,000 1,149,800 $ 62,200

Ex. 19-12 a.

Work in Process Factory Overhead Materials

93,500 7,600

Work in Process Factory Overhead Wages Payable

102,000 15,100

101,100

117,100

Predetermined overhead rate based upon direct labor cost is 65%, computed as follows: Job 301: $6,500 ÷ $10,000 = 65% or Job 302:

$15,600 ÷ $24,000 = 65%

Factory overhead applied to Jobs 303 and 304 is as follows: Job 303: $23,400 ($36,000 × 65%) Job 304: $20,800 ($32,000 × 65%) d.

Work in Process* Factory Overhead

66,300 66,300

* Job 301

$ 6,500

Job 302

15,600

Job 303 Job 304

23,400 20,800

Total applied factory overhead

$66,300

or Direct labor cost × Predetermined factory overhead rate: $102,000 × 65% = $66,300

Finished Goods* Work in Process

97,300 97,300

CHAPTER 19

Job Order Costing

Ex. 19-12 (Concluded) f.

Work in process on January 31: Job 303 $ 76,500 ($17,100 + $36,000 + $23,400) 88,000 ($35,200 + $32,000 + $20,800) Job 304 Total $164,500

Ex. 19-13 a.

Migliozzi Inc. Income Statement For the Month Ended July 31 Revenues Cost of goods sold Gross profit Selling and administrative expenses: Selling expenses Administrative expenses Total selling and administrative expenses Income from operations

$1,460,000 806,000 $ 654,000 $328,000 131,000 459,000 $ 195,000

Materials inventory: Purchased materials………………………………………………………… Less: Materials used in production……………………………………… Materials inventory, July 31…………………………………………………

$416,000 358,000 $ 58,000

Work in process inventory: Materials used in production……………………………………………… Direct labor…………………………………………………………………… Factory overhead (75% × $308,000)……………………………………… Additions to work in process……………………………………………… Less: Transferred to finished goods…………………………………… Work in process inventory, July 31………………………………………

$358,000 308,000 231,000 $897,000 851,000 $ 46,000

Finished goods inventory: Transferred to finished goods……………………………………………… Less: Cost of goods sold………………………………………………… Finished goods inventory, July 31…………………………………………

$851,000 806,000 $ 45,000

CHAPTER 19

Job Order Costing

Ex. 19-14 a. Date

Jan. Jan. Feb. Mar. Mar. May June Aug. Sept. Nov. Dec.

2 15 3 7 24 19 12 18 2 14 12

Job. No.

Quantity

Product

Amount

Unit Cost

1 22 30 41 49 58 65 78 82 92 98

520 1,610 1,420 670 2,210 2,550 620 3,110 1,210 750 2,700

TT SS SS TT SLK SLK TT SLK SS TT SLK

$16,120 20,125 25,560 15,075 22,100 31,875 10,540 48,205 16,940 8,250 52,650

$31.00 $12.50 $18.00 $22.50 $10.00 $12.50 $17.00 $15.50 $14.00 $11.00 $19.50

Unit Cost

Unit Costs for TT 35 30 25 20 15 10 5 — 1

Job Number

Unit Cost

Unit Costs for SS 20 18 16 14 12 10 8 6 4 2 — 22

Job Number

Unit Cost

Unit Costs for SLK 22 20 18 16 14 12 10 8 6 4 2 — 49

Job Number

CHAPTER 19

Job Order Costing

Ex. 19-14 (Concluded) As can be seen, the unit costs behave differently for each product. SLK has increasing unit costs during the year, SS is steady, and TT has decreasing unit costs during the year. b.

Management should determine why SLK costs are increasing and why TT costs are decreasing. This information can be determined from the job cost sheets for each job. By comparing the cost sheets from job to job (for a particular product), management can isolate the cause of the cost changes. The cost sheets will show how materials, labor, and overhead are consumed across the production process for each job. This information can isolate the problem or opportunity areas.

CHAPTER 19

Job Order Costing

Ex. 19-15 a.

The first item to note is that the cost did not go up due to any increases in the cost of labor or materials. Rather, the cost of the plaques increased because Job 105 used more labor and materials per unit than did Job 101. Specifically, Job 101 required the same number of backboards and brass plates as the number of actual plaques shipped. However, Job 105 required four more backboards and brass plates than the number actually shipped (34 versus 30). This is illustrated as follows: Job 101: Materials Walnut plaques: Actual units used………………………………………………………… 40 units Expected units needed to produce 40 plaques……………………… 40 units Difference………………………………………………………………………… 0 units Brass plates: Actual units used………………………………………………………… 40 units Expected units needed to produce 40 plaques……………………… 40 units 0 units Difference……………………………………………………………… Labor Engraving: Actual labor hours used………………………………………………… 20 hours Expected labor hours to produce 40 plaques (40 units × 30 min. per unit) ÷ 60 min. per hour…………………… 20 hours 0 hours Difference……………………………………………………………… Assembly: Actual labor hours used………………………………………………… 10 hours Expected labor hours to produce 40 plaques (40 units × 15 min. per unit) ÷ 60 min. per hour…………………… 10 hours Difference……………………………………………………………… 0 hours

CHAPTER 19

Job Order Costing

Ex. 19-15 (Concluded) Job 105: Materials Walnut plaques: Actual units used………………………………………………………… 34 units Expected units needed to produce 30 plaques…………………… 30 units Difference………………………………………………………………………… 4 units Brass plates: Actual units used………………………………………………………… 34 units Expected units needed to produce 30 plaques…………………… 30 units Difference……………………………………………………………… 4 units Labor Engraving: Actual labor hours used………………………………………………… 17 hours Expected labor hours to produce 30 plaques (30 units × 30 min. per unit) ÷ 60 min. per hour…………………… 15 hours Difference……………………………………………………………… 2 hours Assembly: Actual labor hours used………………………………………………… 8.5 hours Expected labor hours to produce 30 plaques (30 units × 15 min. per unit) ÷ 60 min. per hour…………………… 7.5 hours Difference……………………………………………………………… 1.0 hour Job 105’s 25.5 labor hours are 3.0 more (25.5 hrs. – 22.5 hrs.) than should have been expected for a job of 30 plaques [(30 × 45 min.) ÷ 60 min. = 22.5 hrs.]. As a result, the additional hours of labor cost, applied factory overhead, and direct materials cost cause the unit cost of Job 105 to increase. b.

Apparently, the engraving and assembly work is becoming sloppy. Job 105 required 34 engraved brass plates in order to get 30 with acceptable quality. It is likely that the engraver is not being careful in spelling the names correctly. The names should be supplied to the engraver, using large typewritten fonts, so that it is easy to read the names. The engraver should be instructed to be careful in engraving the names. The assembly operation also needs some improvement. It took 34 assembly operations to assemble 30 plaques properly. It may be that the plates are assembled off-register (crooked) to the backboard. This could be improved by using a fixture to align the plate to the backboard properly. Alternatively, it’s possible misengraved plaques were assembled to backboards and needed to be disassembled, reengraved, and reassembled to new backboards.

CHAPTER 19

Job Order Costing

Ex. 19-16 a.

July

3 Work in Process (175 hrs. × $150) Salaries Payable

26,250

10 Work in Process Cash

12,500

14 Work in Process (260 hrs. × $185) Salaries Payable

48,100

18 Work in Process Consultant Fees Payable

30,000

27 Work in Process (435 hrs. × $62) Office Overhead

26,970

31 Office Overhead Cash

28,500

31 Office Overhead Supplies

4,000

31 Salaries Payable Cash

74,350

31 Accounts Receivable Fees Earned

172,500

31 Cost of Services Work in Process*

143,820

26,250

12,500

48,100

30,000

26,970

28,500

4,000

74,350

172,500

143,820

* $26,250 + $12,500 + $48,100 + $30,000 + $26,970 b.

Office overhead incurred ($28,500 + $4,000)……………… Office overhead applied……………………………………… Underapplied overhead…………………………………………

$32,500 26,970 $ 5,530

Fees earned……………………………………………………… Cost of services*………………………………………………… Gross profit………………………………………………………

$172,500 149,350 $ 23,150

* $143,820 + $5,530. Assumes the over- or underapplied office overhead is closed to cost of services monthly.

Note to Instructors: The consultant fees and travel costs can be assigned to the case directly and thus are not treated as office overhead. Costs such as secretarial and administrative salaries and supplies would be part of office overhead incurred.

CHAPTER 19

Job Order Costing

Ex. 19-17 a.

Work in Process Salaries Payable

1,068,000

Work in Process Accounts Payable

2,130,000

Work in Process (65% × $2,130,000) Agency Overhead

1,384,500

Cost of Services Work in Process

2,827,750

1,068,000

2,130,000

1,384,500

2,827,750

Cost of completed jobs, $2,827,750: Vault Bank

August 1 balance………………………………………… August costs: Direct labor…………………………………………… Media…………………………………………………… Overhead……………………………………………… Total costs…………………………………………………

Take Off Airlines

$ 270,000

80,000

190,000 710,000 461,500 * $1,631,500

85,000 625,000 406,250 ** $1,196,250

* 65% × $710,000 ** 65% × $625,000

CHAPTER 19

Job Order Costing

PROBLEMS Prob. 19-1A a.

g. h.

Materials Accounts Payable

203,940

Work in Process Factory Overhead Materials

175,950 15,530

Work in Process Factory Overhead Wages Payable

534,780 63,620

Factory Overhead Selling Expenses Administrative Expenses Accounts Payable

290,400 158,300 110,900

Factory Overhead Selling Expenses Administrative Expenses Prepaid Expenses

21,310 6,250 7,940

Depreciation Expense—Office Building Depreciation Expense—Office Equipment Factory Overhead Accumulated Depreciation—Office Building Accumulated Depreciation—Office Equipment Accumulated Depreciation—Factory Equipment

40,100 13,500 51,200

Work in Process Factory Overhead

452,240

Finished Goods Work in Process

1,003,200

Cost of Goods Sold Finished Goods

992,600

203,940

191,480

598,400

559,600

35,500

40,100 13,500 51,200

452,240

1,003,200

992,600

CHAPTER 19

Job Order Costing

Prob. 19-2A 1. a.

Materials Accounts Payable

33,100

Work in Process Factory Overhead Materials Wages Payable

56,570 5,720

Factory Overhead Accounts Payable

6,470

Factory Overhead Accumulated Depreciation—Machinery and Equipment

1,790

Work in Process Factory Overhead (304 hours × $65)

19,760

Finished Goods Work in Process

39,200

33,100

29,840 32,450

6,470

1,790

19,760

39,200

Computation of cost of jobs finished:

Job

Direct Materials

Direct Labor

Factory Overhead

No. 301…… $2,740 $5,460 $3,380 No. 302…… 3,980 2,930 1,820 No. 303…… 2,570 3,070 2,860 No. 305…… 6,210 1,840 2,340 Total…………………………………………………… g.

Total

$11,580 8,730 8,500 10,390 $39,200

Accounts Receivable Sales

60,020

Cost of Goods Sold Finished Goods

28,810

60,020

28,810

Computation of cost of jobs sold: Job

No. 301…………………………………… $11,580 No. 302…………………………………… 8,730 8,500 No. 303…………………………………… $28,810 Total………………………………………

CHAPTER 19

Job Order Costing

Prob. 19-2A (Concluded) 2.

Work in Process (b) (e) Bal.

56,570 19,760 37,130

(f)

Finished Goods 39,200

(f)

39,200

Bal.

10,390

28,810

Schedule of unfinished jobs: Job

Direct Materials

Direct Labor

Factory Overhead

No. 304…………………………… $8,850 $8,520 $4,225 4,290 6,110 5,135 No. 306…………………………… Balance of Work in Process, January 31………………………………………………… 4.

(g)

Total

$21,595 15,535 $37,130

Schedule of completed jobs: Job No. 305: Direct materials Direct labor Factory overhead Finished Goods, January 31

$ 6,210 1,840 2,340 $10,390

CHAPTER 19

Job Order Costing

Prob. 19-3A 1. and 2. JOB ORDER COST SHEET Customer

Jackson Consulting

Date Date wanted Date completed Job. No.

October 1 October 10 October 10

ESTIMATE Direct Materials

Direct Labor

Amount 200 sq. ft. at $35

Total

Summary Amount

7,000 16 hours at $20

Amount

320 Direct materials

7,000 Total

7,000

Direct labor

320

Factory overhead

240

320 Total cost

7,560

ACTUAL Direct Materials

Direct Labor

Mat.

Time

Req.

Ticket

No.

Description Amount

No.

Description

112

140 sq. ft.

H10

10 hours

at $35 114

68 sq. ft. at $35

Total

4,900

Summary

Amount

at $20 H11

2,380

Item

Amount

200 Direct materials

10 hours at $20

7,280

Direct labor

400

Factory overhead

300

200

7,280 Total

400 Total cost

Comments: The direct materials cost exceeded the estimate by $280 because 8 square feet of materials were spoiled. The direct labor cost exceeded the estimate by $80 because an additional 4 hours of labor were used by an inexperienced employee. The factory overhead cost exceeded the estimate because an additional $60 of factory overhead was allocated due to the increase in direct labor.

7,980

$264,450. From table above.

$370,230. ($264,450 × 1.4) and from table above.

$903,620. ($170,500 + $309,100 + $248,820 + $175,200)

$751,870. From table above.

$65,550. Wages incurred less direct labor applied to production in June. ($330,000 – $264,450)

$ 170,500 309,100 91,300 248,820 175,200 51,760 $1,046,680

Total Cost 440 880 570 420

377.00 365.00

Units Sold

$310.00 281.00

Unit Cost

19-22

$351,500. From table above.

$ 57,750 100,100 30,800 97,020 67,200 17,360 $370,230

$ 41,250 71,500 22,000 69,300 48,000 12,400 $264,450

$60,500. From table above and problem.

$ 55,000 93,500 38,500 82,500 60,000 22,000 $351,500

Factory Overhead

$60,500

$16,500 44,000

Direct Labor

$395,500. Materials applied to production in June + indirect materials. ($351,500 + $44,000)

550 1,100 550 660 480 380 3,720

Direct Materials

Job Order Costing

Quantity

No. 201 No. 202 No. 203 No. 204 No. 205 No. 206 Total

June 1 Work in Process

Supporting calculations:

Job. No.

Prob. 19-4A

CHAPTER 19

$751,870

214,890 153,300

$136,400 247,280

Cost of Goods Sold

CHAPTER 19

Job Order Costing

Prob. 19-4A (Concluded) 2.

June 30 balances: Materials……………………… $ 17,000 Work in Process*…………… 143,060 Finished Goods**…………… 151,750 Factory Overhead…………… 9,820

($82,500 + $330,000 – $395,500) ($91,300 + $51,760, Job 203 and Job 206) ($903,620 – $751,870) Dr. underapplied ($33,000 + $65,550 + $44,000 + $237,500 – $370,230)

* $60,500 + $351,500 + $264,450 + $370,230 – $903,620 = $143,060 ** Job. No. 201 202 204 205 Total

Units in Inventory

Unit Cost

Total Cost

110 220 90 60

$310.00 281.00 377.00 365.00

$ 34,100 61,820 33,930 21,900 $151,750

CHAPTER 19

Job Order Costing

Prob. 19-5A 1.

Ginocera Inc. Income Statement For the Year Ended December 31, 20Y8 Sales Cost of goods sold Gross profit Selling expenses: Infomercial campaign Promotional materials Shipping expenses Total selling expenses Administrative expenses: Legal expenses Total operating expenses Income from operations

$17,920,000 10,864,000 $ 7,056,000 $2,000,000 3,600,000 224,000 $5,824,000 800,000 6,624,000 $ 432,000

Supporting calculations: Sales: 1,120,000 units × $16 = $17,920,000 Cost of goods sold: 1,120,000 units × $9.70 = $10,864,000 Manufacturing cost per unit (knife): Direct materials: Hardened steel blanks………………………………$4.00 Wood (for handle)…………………………………… 1.50 Packaging……………………………………………… 0.50 Total direct materials……………………………… Direct labor……………………………………………… Factory overhead*……………………………………… Total manufacturing cost per knife………………

$6.00 0.50 3.20 $9.70

* $800 ÷ 250 knives per hour Infomercial campaign: $600,000 + $1,400,000 = $2,000,000 Promotional materials: 60,000 stores × $60 = $3,600,000 Shipping expenses: 1,120,000 units × $0.20 = $224,000 2.

Finished Goods balance, December 31, 20Y8: (1,200,000 units – 1,120,000 units) × $9.70 = $776,000 Work in Process, December 31, 20Y8: 25,000 units × ($6.00 + $3.20) = $230,000 The materials, stamping, and factory overhead have already been applied to the 25,000 units. Only the direct assembly labor has yet to be applied for these units.

CHAPTER 19

Job Order Costing

Prob. 19-1B a.

g. h.

Materials Accounts Payable

770,000

Work in Process Factory Overhead Materials

604,200 75,800

Work in Process Factory Overhead Wages Payable

574,000 182,000

Factory Overhead Selling Expenses Administrative Expenses Accounts Payable

245,000 171,500 110,600

Factory Overhead Selling Expenses Administrative Expenses Prepaid Expenses

24,500 28,420 16,660

Factory Overhead Depreciation Expense—Office Equipment Depreciation Expense—Office Building Accumulated Depreciation—Factory Equipment Accumulated Depreciation—Office Equipment Accumulated Depreciation—Office Building

49,500 61,800 14,900

Work in Process Factory Overhead

568,500

Finished Goods Work in Process

1,500,000

Cost of Goods Sold Finished Goods

1,375,000

770,000

680,000

756,000

527,100

69,580

49,500 61,800 14,900

568,500

1,500,000

1,375,000

CHAPTER 19

Job Order Costing

Prob. 19-2B 1.

Materials Accounts Payable

147,000

Work in Process Factory Overhead Materials Wages Payable

262,490 29,160

Factory Overhead Accounts Payable

6,000

Factory Overhead Accumulated Depreciation—Machinery and Equipment

4,100

Work in Process Factory Overhead (1,012 hours × $40)

40,480

Finished Goods Work in Process

175,090

147,000

139,110 152,540

6,000

4,100

40,480

175,090

Computation of cost of jobs finished:

Job

Direct Materials

Direct Labor

Factory Overhead

Total

No. 101…… $19,320 $19,500 $6,160 $ 44,980 No. 102…… 23,100 28,140 6,400 57,640 No. 103…… 13,440 14,000 5,040 32,480 39,990 No. 105…… 18,050 15,540 6,400 Total……………………………………………………… $175,090 g.

Accounts Receivable Sales*

189,100 189,100

* $62,900 + $80,700 + $45,500 Cost of Goods Sold Finished Goods

142,610 142,610

Computation of cost of jobs sold: Job

No. 101…………………………………… $ 44,980 No. 102…………………………………… 57,640 39,990 No. 105…………………………………… Total……………………………………… $142,610

CHAPTER 19

Job Order Costing

Prob. 19-2B (Concluded) 2.

Work in Process (b) (e) Bal.

262,490 40,480 127,880

(f)

Finished Goods 175,090

(f)

175,090

Bal.

32,480

(g)

142,610

Schedule of unfinished jobs: Job

Direct Materials

Direct Labor

Factory Overhead

Total

No. 104……………………… $38,200 $36,500 $9,520 $ 84,220 43,660 18,700 6,960 No. 106……………………… 18,000 Balance of Work in Process, April 30…………………………………………………… $127,880 4.

Schedule of completed jobs: Job No. 103: Direct materials Direct labor Factory overhead Finished Goods, April 30

$13,440 14,000 5,040 $32,480

CHAPTER 19

Job Order Costing

Prob. 19-3B 1. and 2. JOB ORDER COST SHEET Customer

Lunden Consulting

Date Date wanted Date completed Job. No.

May 9 May 15 May 15

ESTIMATE Direct Materials

Direct Labor

Amount 400 sq. ft. at $32

Amount

12,800 30 hours at $20

Total

Summary

12,800 Total

Amount

600 Direct materials

12,800

Direct labor

600

Factory overhead

480

600 Total cost

13,880

ACTUAL Direct Materials

Direct Labor

Mat.

Time

Req.

Ticket

No.

Description

132

360 sq. ft. at $32

134

No.

Description

18 hours

11,520

50 sq. ft. at $32

Total

Amount

at $19 H12

1,600

Summary

Amount

342 Direct materials

18 hours at $19

13,120 Total

Item

Amount 13,120

Direct labor

684

Factory overhead

547

342 684 Total cost

14,351

Comments: The direct materials cost exceeded the estimate by $320 because 10 square feet of materials were spoiled. The direct labor cost exceeded the estimate by $84 because an additional 6 hours of labor were used by inexperienced employees who worked for $1 less per hour. The factory overhead cost exceeded the estimate because an additional $67 of factory overhead was allocated due to the increase in direct labor.

$378,400. From table above.

$189,200. ($378,400 × 0.50) and from table above.

$801,500. ($198,000 + $260,300 + $125,400 + $217,800)

$700,284. From table above.

$17,600. Wages incurred less direct labor applied to production in May. ($396,000 – $378,400)

$ 198,000 260,300 297,000 125,400 217,800 112,200 $1,210,700

Total Cost

264 360 384 530

313.50 330.00

Units Sold

$600.00 685.00

Unit Cost

19-29

$570,700. From table above.

$ 29,700 36,300 55,000 19,800 33,000 15,400 $189,200

$ 59,400 72,600 110,000 39,600 66,000 30,800 $378,400

$72,400. From table above and problem.

$ 82,500 105,400 132,000 66,000 118,800 66,000 $570,700

Factory Overhead

$72,400

$26,400 46,000

Direct Labor

$586,100. Materials applied to production in May + indirect materials. ($570,700 + $15,400)

330 380 500 400 660 330 2,600

Direct Materials

Job Order Costing

Quantity

No. 101 No. 102 No. 103 No. 104 No. 105 No. 106 Total

May 1 Work in Process

Supporting calculations:

Job. No.

Prob. 19-4B

CHAPTER 19

$700,284

120,384 174,900

$158,400 246,600

Cost of Goods Sold

CHAPTER 19

Job Order Costing

Prob. 19-4B (Concluded) 2. May 31 balances: Materials……………………… $ 19,500 Work in Process*…………… 409,200 Finished Goods**…………… 101,216 Factory Overhead…………… (7,300)

($105,600 + $500,000 – $586,100) ($297,000 + $112,200, Job 103 and Job 106) ($801,500 – $700,284) Cr. overapplied ($26,400 + $17,600 + $15,400 + $122,500 – $189,200)

* $72,400 + $570,700 + $378,400 + $189,200 – $801,500 = $409,200 ** Job. No. 101 102 104 105 Total

Units in Inventory

Unit Cost

Total Cost

66 20 16 130

$600.00 685.00 313.50 330.00

$ 39,600 13,700 5,016 42,900 $101,216

CHAPTER 19

Job Order Costing

Prob. 19-5B 1.

Technology Accessories Inc. Income Statement For the Year Ended December 31, 20Y3 Sales Cost of goods sold Gross profit Selling expenses: Salespersons commissions Advertising design Advertising expenses Total selling expenses Income from operations

$18,400,000 11,914,000 $ 6,486,000 $3,680,000 750,000 1,400,000 $

5,830,000 656,000

Supporting calculations: Sales: 460,000 units × $40 = $18,400,000 Cost of goods sold: 460,000 units × $25.90 = $11,914,000 Manufacturing cost per unit: Direct materials: Leather…………………………………………………$10.00 Velvet (for interior)…………………………………… 5.00 Packaging……………………………………………… 0.40 Total direct materials……………………………… Direct labor……………………………………………… Factory overhead cost*………………………………… Total manufacturing cost per unit…………………

$15.40 0.50 10.00 $25.90

* $1,250 ÷ 125 units per hour Salespersons commissions: $18,400,000 × 20% = $3,680,000 2.

Finished Goods balance, December 31, 20Y3: (500,000 units – 460,000 units) × $25.90 = $1,036,000 Work in Process, December 31, 20Y3: 22,000 units × ($15.40 + $10.00) = $558,800 The materials, stitching, and factory overhead have already been applied to the 22,000 units. Only the direct assembly labor has yet to be applied for these units.

CHAPTER 19

Job Order Costing

CASES & PROJECTS CP 19-1 No. Tandy’s plan is not ethical. A job order cost accounting system accumulates and records product costs by jobs. The resulting total and unit product costs can be compared to similar jobs, compared over time, or compared to expected costs. In this way, a job order cost system can be used by managers for cost evaluation and control. By transferring costs from corporate jobs to government jobs, Tandy’s plan would falsify the job cost information for the individual jobs. This is highly unethical and deteriorates the usefulness of job cost information for management decision making. Tandy’s plan is also illegal, as it falsely inflates the purchase price for the government jobs. This plan is a very bad idea.

CP 19-2 1.

Direct labor cost: Total actual (applied) overhead, Year 1–Year 5……… $ 4,200,000 Total direct labor cost, Year 1–Year 5………………… 21,000,000 Predetermined overhead rate ($4,200,000 ÷ $21,000,000)………………………… 20% of direct labor cost Machine hours: Total actual (applied) overhead, Year 1–Year 5……… $4,200,000 500,000 hours Total machine hours, Year 1–Year 5…………………… Predetermined overhead rate ($4,200,000 ÷ 500,000 hours)……………………… $8.40 per machine hour

$ 13,000

$ (12,000)

$870,000 882,000

19-33

$ (17,000)

$760,000 777,000

1,640

5,000

$845,000 843,360

$845,000 840,000

$ 11,000

$935,000 924,000

$ (9,440)

$760,000 769,440

2,600

$935,000 932,400

Year 3 Direct Labor Machine Cost Hours

Year 1 Direct Labor Machine Cost Hours

$ (3,600)

$870,000 873,600

Year 4 Direct Labor Machine Cost Hours

Job Order Costing

Year 2 Direct Labor Machine Cost Hours

8,800

$790,000 781,200

$790,000 777,000

Year 5 Direct Labor Machine Cost Hours

Actual overhead Applied overhead (Over-) underapplied overhead

CP 19-2 (Continued)

CHAPTER 19

Job Order Costing

CP 19-2 (Concluded) 3.

The best predetermined overhead rate is machine hours. Although the total overhead applied for each rate developed in part (1) is the same over the entire five-year period (as a result of the method by which the predetermined overhead rates were developed), the predetermined overhead rate based on machine hours yields the least fluctuations in the amounts of over- or underapplied overhead considered on a year-by-year basis. With the rate based on machine hours, the over- or underapplied overhead ranges from $9,440 overapplied to $8,800 underapplied. This fluctuation in the over- or underapplied overhead compares favorably with the fluctuation resulting from using the current overhead base of direct labor cost ($17,000 overapplied to $13,000 underapplied during the past five years).

CP 19-3 To: From: Re:

Carol Creedence A+ Student Product CCR Job Cost

The graph of job costs for Product CCR indicates two significant trends in job cost. First, there appears to be a strong and consistent “Friday effect.” Unit cost increases significantly on Fridays, then falls on Monday. Each Friday effect is larger than the previous week. There also appears to be a steady increase in the unit cost over time, with unit cost increasing significantly over the time period. The “Friday effect” could be caused by a reduction in the efficiency of the workforce on Fridays, as it is the last day of the workweek. If this is the case and the trend is not product-related, then it should also appear throughout the plant. To test this explanation, management should collect job cost data for other products in the plant. If the trend appears in other products as well, it is a strong indicator that the “Friday effect” is related to the workforce. Additional analysis should also sort the job cost data by shift and employee. It’s possible that the effect is stronger on one shift than on another or that just a few employees are responsible for the effect. Sorting by shift and employee will help isolate the source of the "Friday effect." The increasing trend in job costs is potentially more complicated. This could be caused by any number of factors, including increased raw materials cost, decreased quality of raw materials, or decreased labor efficiency. To evaluate these potential explanations, management should collect additional data on the cost per unit of direct materials, quantity of materials used, labor and machine hours used, and overhead applied. These data will provide critical insight into the factors driving up job cost.

CHAPTER 19

Job Order Costing

CP 19-4 1.

The unit costs are influenced by both the price and quantity of inputs. On the price side, the cost of steel has dropped from $1,200 to $1,100 per ton. This is apparently the result of the purchasing manager’s decision to reduce the cost of raw materials by going to a new vendor. No other input prices change. Some of the input quantities changed for the worse. Specifically, the following: Input Quantity per Unit Job 206 Job 228 Steel input…………………………………………… Foundry labor……………………………………… Welding labor……………………………………… 1 2 3 4 5 6

2.10 tons 3 8.00 hours 5 11.00 hours

2.60 tons 4 10.00 hours 6 14.00 hours

105 tons ÷ 50 units 195 tons ÷ 75 units 400 hours ÷ 50 units 750 hours ÷ 75 units 550 hours ÷ 50 units 1,050 hours ÷ 75 units

These numbers were determined by dividing the total input quantities by the number of units produced to discover the inputs per unit. The inputs for the components were unchanged between the two jobs. 2.

A possible reason for this deterioration in performance is related to the purchasing manager’s decision to change vendors in order to secure a lower price per ton. The new vendor is apparently delivering a lower-quality steel product to the company. As a result, the foundry operation is spending more time forming the steel parts. Moreover, the increased steel tons per unit is likely to be caused by scrapping some of the formed parts. The scrapped parts would need to be replaced with additional steel inputs, which would have the effect of increasing the number of tons required to make a unit of product. The welding operators are also apparently having difficulty welding the lowerquality steel parts. As a result, longer welding time is required to assemble a completed unit. Overall, management has learned that the drive for a lower raw materials price was a poor decision. The overall net result was higher costs from the additional waste caused by lower-quality steel.

CHAPTER 19

Job Order Costing

CP 19-5 1.

Todd should record the debits for factory wages as a debit to Work in Process. The factory wages are product costs that must be accumulated in the cost of producing the product. Eventually, these wage costs will become part of the finished goods inventory and the cost of goods sold when the gift items are sold. Likewise, the depreciation should be recorded as a debit to Factory Overhead. The overhead is then applied to production work in process. Like the wages, the depreciation will also eventually become part of the finished goods inventory and the cost of goods sold when the gift items are sold. Thus, both the wages and depreciation will end up on the income statement as part of the cost of goods sold, not as individual expenses. The reason is because the accountant wants to match revenues and costs. Costs that are accumulated in the manufacture of products do not become expenses until the items are sold. Until that time, the costs are capitalized as inventory. If these costs were expensed immediately, the period’s income for the firm would be understated to the extent there were any increases in the work in process or finished goods inventories.

Jeff would not be concerned about expensing administrative wages and depreciation immediately because the benefits received from these costs are not product costs. Instead, these costs benefit a period of time. Thus, these costs should be expensed during the period.

CHAPTER 20 PROCESS COST SYSTEMS DISCUSSION QUESTIONS 1.

An assembly-type industry using mass production methods, such as TV assembly, would use the process cost system because the products are somewhat standard and lose their identities as individual items. In such industries, it is neither practical nor necessary to identify output by jobs.

b. A job order cost system would be used by a building contractor to accumulate the costs for each building because the costs can be identified with each job without great difficulty. c.

A job order cost system would be best suited for an automobile repair shop because costs can be reasonably identified with each job.

d. A process cost system would be best suited for a paper manufacturer because the processes are continuous and the products are homogeneous. e.

A job order cost system would be best suited for a custom jewelry manufacturer because most of the production consists of job orders and costs can be reasonably identified with each job.

Because all goods produced in a process cost system are identical units, it is not necessary to classify production costs into job orders.

In a process cost system, the direct labor and factory overhead applied are debited to the work in process accounts of the individual production departments in which they occur. The reason is that all products produced by the department are similar. Thus, there is no need to charge these costs to individual jobs. For the process manufacturer, the direct materials and the conversion costs are charged to the department and divided by the completed production of the department to determine a cost per unit.

The cost per equivalent unit is frequently determined separately for direct materials and conversion costs because these two costs are often added at different rates in the production process. For example, materials may be incurred entirely at the beginning of the process, while conversion costs are typically incurred evenly throughout the process.

The cost per equivalent unit is used to allocate direct materials and conversion costs between completed and partially completed units.

The transferred-in cost from Blending to Filling includes the materials costs, direct labor, and applied factory overhead incurred to complete units in Blending.

The most important purpose of the cost of production report is to assist in the control of costs. This is accomplished by holding each department head responsible for the costs incurred in the department.

Cost of production reports can provide detailed data about the process. The reports can provide information on the department by individual cost elements. This can enable management to investigate problems and opportunities.

CHAPTER 20

Process Cost Systems

DISCUSSION QUESTIONS (Continued) 9.

Yield is a measure of the materials usage efficiency of a process manufacturer. It is determined by dividing the output volume of product by the input volume of product. For example, if 950 tons of aluminum were rolled from 1,000 tons of ingot, the yield would be said to be 95%. Five percent of the ingot was scrapped during the rolling process.

10.

Lean manufacturing emphasizes combining process functions into manufacturing cells, involving employees in process improvement efforts, eliminating wasteful activities, and reducing the amount of work in process inventory required to fulfill production targets.

CHAPTER 20

Process Cost Systems

PRACTICE EXERCISES PE 20-1A Steel manufacturing Business consulting Web designer Computer chip manufacturing Candy making Designer clothes manufacturing

Process costing Job order costing Job order costing Process costing Process costing Job order costing

PE 20-1B Dentist Gasoline refining Flour mill Movie studio Paper manufacturing Custom printing

Job order costing Process costing Process costing Job order costing Process costing Job order costing

PE 20-2A 62,000 ounces started and completed (68,000 ounces completed – 6,000 ounces beginning WIP), or (72,000 ounces started – 10,000 ounces ending WIP)

PE 20-2B 11,900 tons started and completed (12,700 tons completed – 800 tons beginning WIP), or (13,900 tons started – 2,000 tons ending WIP)

PE 20-3A

Inventory in process, beginning of period………… Started and completed during the period…………… Transferred out of Filling (completed)……………… Inventory in process, end of period………………… Total units to be assigned costs………………………

Total Whole Units

Percent Materials Added In Period

Equivalent Units for Materials

6,000 62,000 *

0% 100%

0 62,000

100%

62,000 10,000 72,000

68,000 10,000 78,000

* 68,000 – 6,000

CHAPTER 20

Process Cost Systems

PE 20-3B

Inventory in process, beginning of period………… Started and completed during the period…………… Transferred out of Rolling (completed)……………… Inventory in process, end of period………………… Total units to be assigned costs………………………

Total Whole Units

Percent Materials Added In Period

Equivalent Units for Materials

800 11,900*

0% 100%

0 11,900

100%

11,900 2,000 13,900

12,700 2,000 14,700

* 12,700 – 800 PE 20-4A Total Whole Units

Percent Conversion Equivalent Completed Units for in Period Conversion

6,000 62,000*

40% 100%

2,400 62,000

68,000 10,000 78,000

25%

64,400 2,500 66,900

* 68,000 – 6,000

PE 20-4B Total Whole Units

800 11,900* 12,700 2,000 14,700

Percent Conversion Equivalent Completed Units for in Period Conversion

80% 100%

640 11,900

30%

12,540 600 13,140

* 12,700 – 800

CHAPTER 20

Process Cost Systems

PE 20-5A Equivalent units of direct materials:

$43,200 72,000

= $0.60 per ounce

Equivalent units of conversion:

$16,725 66,900

= $0.25 per ounce

Equivalent units of direct materials:

$625,500 13,900

= $45 per ton

Equivalent units of conversion:

$157,680 13,140

= $12 per ton

PE 20-5B

PE 20-6A Direct Materials Costs

Inventory in process, beginning balance…………… 0 + Inventory in process, to complete…………………… Started and completed during the period…………… 62,000 × $0.60 + Transferred out of Filling (completed)……………… Inventory in process, end of period……………………10,000 × $0.60 + Total costs assigned by the Filling Department…… Completed and transferred out of production……… Inventory in process, ending……………………………

Conversion Costs

Total Costs $ 4,500

2,400 × $0.25 62,000 × $0.25

600 52,700

2,500 × $0.25

$57,800 6,625 $64,425

$57,800 $6,625

PE 20-6B Direct Materials Costs

Inventory in process, beginning balance…………… 0 + Inventory in process, to complete…………………… 11,900 × $45 + Started and completed during the period…………… Transferred out of Rolling (completed)……………… Inventory in process, end of period…………………… 2,000 × $45 + Total costs assigned by the Rolling Department…… Completed and transferred out of production……… Inventory in process, ending……………………………

Conversion Costs

Total Costs $ 38,020

11,900 × $12

640 × $12

7,680 678,300

600 × $12

$724,000 97,200 $821,200

$724,000 $97,200

CHAPTER 20

Process Cost Systems

PE 20-7A a.

Work in Process—Filling Work in Process—Blending Materials

43,200

Work in Process—Filling Factory Overhead—Filling Wages Payable

16,725

Finished Goods Work in Process—Filling

57,800

30,300 12,900

5,645 11,080

57,800

$6,625 ($4,500 + $43,200 + $16,725 – $57,800)

PE 20-7B a.

Work in Process—Rolling Work in Process—Casting

625,500

Work in Process—Rolling Factory Overhead—Rolling Wages Payable

157,680

Finished Goods Work in Process—Rolling

724,000

625,500

94,600 63,080

724,000

$97,200 ($38,020 + $625,500 + $157,680 – $724,000)

PE 20-8A Energy cost per pound, June:

$26,160 54,500

= $0.48

Energy cost per pound, July:

$26,265 51,500

= $0.51

The cost of energy has increased by 3 cents per pound between June and July, indicating inefficiency in the use of energy.

PE 20-8B Material cost per ton, September:

$129,600 1,200

= $108

Material cost per ton, October:

$132,500 1,250

= $106

The cost of materials has decreased by $2 per ton between September and October, indicating an improvement in the cost of materials. 20-6 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 20

Process Cost Systems

EXERCISES Ex. 20-1 a.

Work in Process—Blending Department Materials—Cocoa Materials—Sugar Materials—Dehydrated Milk

XXX

Work in Process—Molding Department Work in Process—Blending Department

XXX

Work in Process—Packing Department Work in Process—Molding Department

XXX

Finished Goods Work in Process—Packing Department

XXX

Cost of Goods Sold Finished Goods

XXX

XXX XXX XXX

XXX

Ex. 20-2

Materials

Work in Process— Rolling Dept.

Work in Process— Converting Dept.

Factory Overhead— Rolling Dept.

Factory Overhead— Converting Dept.

Finished Goods— Sheared Sheet

Finished Goods— Rolled Sheet

20-8

Work in Process— Smelting Dept.

Process Cost Systems

Factory Overhead— Smelting Dept.

CHAPTER 20

Cost of Goods Sold

CHAPTER 20

Process Cost Systems

Ex. 20-3 a.

Work in Process—Refining Department Materials

298,700

Work in Process—Refining Department Wages Payable

111,500

Work in Process—Refining Department Factory Overhead—Refining Department

76,100

298,700

111,500

Work in Process—Sifting Department* Work in Process—Refining Department

76,100 490,300 490,300

* $30,200 + $298,700 + $111,500 + $76,100 – $26,200

Ex. 20-4 a.

Factory overhead rate based on direct labor cost: $2,340,000 ÷ $1,800,000 = 130%

Work in Process—Blending Department* Factory Overhead—Blending Department

188,500 188,500

* $145,000 × 130% = $188,500 c.

$3,600 debit ($192,100 – $188,500)

Underapplied factory overhead

Ex. 20-5 Equivalent Units Whole Units Inventory in process, beginning (35% completed) Started and completed Transferred to Packing Department Inventory in process, ending (60% completed) Total 1 2 3

Direct Materials

Conversion

2,600 21,2002 23,800

0 21,200 21,200

1,6901 21,200 22,890

7,400 31,200

7,400 28,600

4,4403 27,330

2,600 units × (100% – 35%) 23,800 units – 2,600 units 7,400 units × 60%

CHAPTER 20

Process Cost Systems

Ex. 20-6 a. Drawing Department Equivalent Units Whole Units Inventory in process, November 1 (70% completed) Started and completed in November Transferred to Winding Department in November Inventory in process, November 30 (40% completed) Total 1 2 3

Direct Materials

Conversion

11,000 71,000 2 82,000

0 71,000 71,000

3,3001 71,000 74,300

9,000 91,000

9,000 80,000

3,600 3 77,900

11,000 units × (100% – 70%) 82,000 units – 11,000 units 9,000 units × 40%

b. Winding Department Equivalent Units Whole Units Inventory in process, November 1 (10% completed) Started and completed in November Transferred to finished goods in November Inventory in process, November 30 (60% completed) Total 1 2 3

Direct Materials

Conversion

2,800 76,500 2 79,300

0 76,500 76,500

2,5201 76,500 79,020

5,500 84,800

5,500 82,000

3,3003 82,320

2,800 units × (100% – 10%) 79,300 units – 2,800 units 5,500 units × 60%

Note: Of the 82,000 units transferred in from Drawing, 76,500 units were started and completed in Winding and 5,500 units are in Winding ending work in process.

CHAPTER 20

Process Cost Systems

Ex. 20-7 a.

Units in process, March 1……………………………………………………… Units placed into production for March……………………………………… Less units finished during March……………………………………………… Units in process, March 31………………………………………………………

32,800 604,000 (594,200) 42,600

Equivalent Units Whole Units Inventory in process, March 1 (1/4 completed) Started and completed in March Transferred to finished goods in March Inventory in process, March 31 (3/5 completed) Total 1 2 3 4

Direct Materials

Conversion

32,800 561,400 2 594,200

0 561,400 561,400

24,600 1 561,400 586,000

42,600 3 636,800

42,600 604,000

25,560 4 611,560

32,800 units × (100% – 25%) 594,200 units – 32,800 units 32,800 units + 604,000 units – 594,200 units 42,600 units × 60%

CHAPTER 20

Process Cost Systems

Ex. 20-8 a.

$0.80 ($483,200 ÷ 604,000 units)

$0.45 [($110,180 + $165,022) ÷ 611,560 units]

$40,590, determined as follows: Work in Process—Baking Department balance, March 1……………… Conversion costs incurred during March (24,600 equivalent units × $0.45)………………………………………… Cost of beginning work in process completed during March…………

$29,520 11,070 $40,590

$701,750 [($0.80 + $0.45) × 561,400 units] Note: The cost of the beginning work in process completed during March, $40,590 (a. 3) plus the cost of the units started and completed during March, $701,750 (a. 4) equals the cost of the units finished during March, $742,340.

$45,582, determined as follows: Direct materials ($0.80 × 42,600 units)…………………………………… Conversion costs ($0.45 × 25,560 equivalent units)…………………… Cost of ending work in process……………………………………………

$34,080 11,502 $45,582

The conversion costs in March increased by $0.05 per equivalent unit, determined as follows: Work in Process—Baking Department balance, March 1…………………… $29,520 Deduct direct materials cost incurred in February ($0.80 × 32,800 units, same cost per unit as March)………………………… 26,240 Conversion costs incurred in February………………………………………… $ 3,280 February conversion cost per equivalent unit [$3,280 ÷ (32,800 units × 1/4)]……………………………………………………

$0.40

March conversion cost per equivalent unit…………………………………… Less February conversion cost per equivalent unit………………………… Increase in conversion cost per equivalent unit………………………………

$0.45 0.40 $0.05

CHAPTER 20

Process Cost Systems

Ex. 20-9 Equivalent units of production: Cereal (in pounds)

Inventory in process, March 1……………… 0 96,900 Started and completed in March…………… Transferred to finished goods in March……………………………………… 96,900 900 Inventory in process, March 31…………… 97,800 Total……………………………………………

Boxes (in boxes)

Conversion Cost (in boxes)

0 64,600

800 64,600

64,600 600 65,200

65,400 0 65,400

Supporting explanation: The whole unit inventory in process on March 1 includes both the cereal in the hopper and the boxes in the carousel and thus includes no equivalent units for the material during the current period. The reason is because the costs for the cereal and boxes were introduced to the Packing Department in February. Because conversion costs are incurred only when the cereal is filled into boxes, all 800 boxes of the March 1 inventory in process will have conversion costs incurred in March. The product started and completed in March includes 64,600 boxes (65,400 boxes completed less the 800 in the carousel on March 1). These boxes represent 96,900 pounds of cereal [64,600 × (24 oz. ÷ 16 oz.)] because there are 16 ounces to a pound. The inventory in process on March 31 includes the remaining pounds of cereal in the hopper and boxes in the carousel that are properly included in the equivalent unit computation for March (because the costs were incurred in the department in March). No conversion costs have been applied to these boxes because they remain unfilled. Note to Instructors: An actual cereal-filling line begins with the empty box carousel. The box carousel holds flattened boxes that are fed into a high-speed line that opens the box up and places it on a conveyor. The conveyor brings the opened box under a filler head. The cereal pours from the hopper through the filler head into the open box (actually into the inner sealer bag). The box then moves down the line to be boxed into a large shipping carton, which is then moved to the warehouse.

CHAPTER 20

Process Cost Systems

Ex. 20-10 a.

Direct labor…………………………………………………………………………… $104,130 51,630 Factory overhead applied………………………………………………………… Total conversion cost……………………………………………………………… $155,760

Equivalent units of production for conversion costs: Beginning inventory…………………………………………………………… 0 Started and completed………………………………………………………… 124,200 5,600 Ending inventory (2/5 × 14,000 units)………………………………………… Total equivalent units for conversion costs………………………………… 129,800 Conversion cost per equivalent unit: $155,760 129,800

= $1.20 conversion cost per equivalent unit

Equivalent units of production for direct materials costs: Beginning inventory…………………………………………………………… 0 Started and completed………………………………………………………… 124,200 Ending inventory (all units completed as to direct materials)…………… 14,000 Total equivalent units for direct materials costs…………………………… 138,200 Direct materials cost per equivalent unit: $815,380 138,200

= $5.90 direct materials cost per equivalent unit

CHAPTER 20

Process Cost Systems

Ex. 20-11 a.

Units in process at beginning of period…………………………………… Units placed in production during period…………………………………… Less units finished during period…………………………………………… Units in process at end of period……………………………………………

b. Whole Units

Inventory in process, beginning (40% completed) Started and completed Transferred to finished goods Inventory in process, ending (25% completed) Total units 1 2 3

6,400 116,000 (119,400) 3,000

Equivalent Units Direct Materials Conversion

6,400 113,0002 119,400

0 113,000 113,000

3,8401 113,000 116,840

3,000 122,400

3,000 116,000

750 3 117,590

6,400 units × (100% – 40%) 119,400 units – 6,400 units 3,000 units × 25%

Costs

Total costs for period in Assembly Department Total equivalent units (from above) Cost per equivalent unit

Direct Materials

Conversion

$725,000 ÷116,000 $ 6.25

$235,180 * ÷117,590 $ 2.00

* $145,160 + $90,020 d.

$932,250 [($6.25 + $2.00) × 113,000 units]

CHAPTER 20

Process Cost Systems

Ex. 20-12 a.

$53,440; determined as follows: Beginning work in process balance……………………………………… Conversion costs incurred during period (3,840 equivalent units × $2.00)………………………………………… Cost of beginning work in process completed during period…………

$45,760 7,680 $53,440

Cost of beginning work in process………………………………………… $ 53,440 Cost of units started and completed during period*…………………… 932,250 Cost of units transferred to finished goods during period…………… $985,690 * ($6.25 + $2.00) × 113,000 units

$20,250; determined as follows: Direct materials ($6.25 × 3,000 units)……………………………………… Conversion costs ($2.00 × 750 equivalent units)……………………… Cost of ending work in process inventory………………………………

$18,750 1,500 $20,250

Note: The cost of the ending work in process is also the ending balance of Work in Process—Assembly Department. 4.

$8.35 ($53,440 ÷ 6,400 units)

Yes. The production costs per unit decreased during the current period. The cost per unit of the units started and completed during the period is $8.25 ($6.25 + $2.00). Because the cost per unit of the beginning work in process is $8.35 [see part (4) above], the production costs during the current period must have decreased.

The conversion cost in the current period decreased by $0.10 per equivalent unit, determined as follows: Beginning work in process……………………………………………………… $45,760 Deduct direct materials cost incurred in prior period ($6.25 × 6,400 units, cost per unit unchanged)……………………………… 40,000 Conversion costs incurred in prior period…………………………………… $ 5,760 Current period conversion cost per equivalent unit………………………… $ Less prior-period conversion cost per equivalent unit [$5,760 ÷ (6,400 units × 40%)]………………………………………………… Decrease in conversion cost per equivalent unit during current period…………………………………………………………………… $

2.00 2.25 0.25

CHAPTER 20

Process Cost Systems

Ex. 20-13 1.

In computing the equivalent units for conversion costs applicable to the June 1 inventory, the 6,400 units were multiplied by 3/5 rather than 2/5, which is the portion of the work completed in June. Therefore, the equivalent units should be 2,560 (6,400 × 2/5) instead of 3,840.

In computing the equivalent units for conversion costs for units started and completed in June, the June 1 inventory of 6,400 units rather than the June 30 inventory of 5,200 units was subtracted from 55,000 units started in the department during June. Therefore, the equivalent units started and completed should be 49,800 instead of 48,600.

The correct equivalent units for conversion costs should be 53,400, determined as follows: To process units in inventory on June 1: 6,400 × 2/5………………………………………………………………………… 2,560 To process units started and completed in June: 55,000 – 5,200…………………………………………………………………… 49,800 To process units in inventory on June 30: 5,200 × 1/5………………………………………………………………………… 1,040 Equivalent units of production………………………………………………… 53,400

CHAPTER 20

Process Cost Systems

Ex. 20-14 a. 12,400 units (900 + 12,900 – 1,400) b. Whole Units

Inventory in process, November 1 (60% completed) Started and completed in November Transferred to finished goods in November Inventory in process, November 30 (70% completed) Total units 1 2 3

Equivalent Units Direct Materials Conversion

900 11,500 2

0 11,500

360 1 11,500

12,400

11,500

11,860

1,400 13,800

1,400 12,900

980 3 12,840

900 units × (100% – 60%) 12,400 units – 900 units 1,400 units × 70%

Costs

Total costs for November in Forging Department Total equivalent units (from above) Cost per equivalent unit

Direct Materials

Conversion

$123,840 ÷ 12,900 $ 9.60

$38,520* ÷12,840 $ 3.00

* $21,650 + $16,870 c. $144,900 [11,500 units × ($9.60 + $3.00)]

CHAPTER 20

Process Cost Systems

Ex. 20-15 a.

$11,646; determined as follows: Beginning work in process balance…………………………………………… Conversion costs incurred during November (360 equivalent units × $3.00)…………………………………………………… Cost of beginning work in process completed during November…………

$10,566 1,080 $11,646

Cost of beginning work in process……………………………………………… $ 11,646 144,900 Cost of units started and completed during November*…………………… Cost of units transferred to finished goods during period………………… $156,546 * ($9.60 + $3.00) × 11,500 units

$16,380; determined as follows: Direct materials ($9.60 × 1,400 units)…………………………………………… Conversion costs ($3.00 × 980 equivalent units)……………………………… Cost of ending work in process inventory………………………………………

$13,440 2,940 $16,380

Note: The cost of the ending work in process is also the ending balance of the Work in Process—Forging Department as of November 30. d.

Direct materials cost per equivalent unit: $10.00 ($9,000 ÷ 900 units) Conversion cost per equivalent unit: $2.90 ($1,566* ÷ 540 units**) * Work in process, November 1………………………………………………… Less direct materials cost……………………………………………………… Conversion cost included in November 1, work in process……………

$10,566 9,000 $ 1,566

** Equivalent units in November 1, work in process (900 × 60%) = 540 units e.

Direct materials: Decrease of $0.40 ($9.60 – $10.00) Conversion: Increase of $0.10 ($3.00 – $2.90)

CHAPTER 20

Process Cost Systems

Ex. 20-16 a.

Daybreak Brew Coffee Company Cost of Production Report—Roasting Department For the Month Ended August 31 Equivalent Units

Units charged to production: Inventory in process, August 1 Received from materials storeroom Total units accounted for by the Roasting Department Units to be assigned costs: Inventory in process, August 1 (30% completed) Started and completed in August Transferred to finished goods in August Inventory in process, August 31 (80% completed) Total units to be assigned costs

2 3

Conversion (1)

1,200 18,900 2 20,100

0 18,900 18,900

840 1 18,900 19,740

900 21,000

900 19,800

720 3 20,460

Whole Units

UNITS

Direct Materials (1)

1,200 19,800 21,000

1,200 units × (100% – 30%) 19,800 units – 900 units 900 units × 80%

CHAPTER 20

Process Cost Systems

Ex. 20-16 (Concluded) Costs COSTS

Direct Materials

Conversion

Costs per equivalent unit: Total costs for August in Roasting Department Total equivalent units Cost per equivalent unit (2)

$81,180 ÷19,800 $ 4.10

$59,334 ÷ 20,460 $ 2.90

Costs assigned to production: Inventory in process, August 1 Costs incurred in August Total costs accounted for by the Roasting Department

$ 5,970 140,5141 $146,484

Costs allocated to completed and partially completed units: Inventory in process, August 1 balance To complete inventory in process, August 1 Cost of completed August 1 work in process Started and completed in August Transferred to finished goods in August (3) Inventory in process, August 31 (4) Total costs assigned by the Roasting Department 1 2 3 4 5 6

Total

$ 0

$ 2,4362

77,490 3

54,810 4

3,690 5

2,088 6

5,970 2,436

$ 8,406 132,300 $140,706 5,778 $146,484

$81,180 + $59,334 840 units × $2.90 18,900 units × $4.10 18,900 units × $2.90 900 units × $4.10 720 units × $2.90

Materials:

From current period……………………………………………… $ 4.10 4.15 From beginning inventory……………………………………… Decrease…………………………………………………………… $(0.05)

Conversion: From current period……………………………………………… From beginning inventory……………………………………… Increase……………………………………………………………

$2.90 2.75 $0.15

The cost per equivalent unit of materials decreased by $0.05 per pound, and the cost per equivalent unit of conversion cost increased by $0.15 per pound. Management may wish to investigate the causes for the increase in the conversion cost.

CHAPTER 20

Process Cost Systems

Ex. 20-17 a. Karachi Carpet Company Cost of Production Report—Cutting Department For the Month Ended January 31 Equivalent Units Whole Units

UNITS Units charged to production: Inventory in process, January 1 Received from Weaving Department Total units accounted for by the Cutting Department Units to be assigned costs: Inventory in process, January 1 (75% completed) Started and completed in January Transferred to finished goods in January Inventory in process, January 31 (30% completed) Total units to be assigned costs 1 2 3

Direct Materials

Conversion

1,400 54,800 2

0 54,800

350 1 54,800

56,200

54,800

55,150

3,200 59,400

3,200 58,000

960 3 56,110

1,400 58,000 59,400

1,400 units × (100% – 75%) 58,000 units – 3,200 units 3,200 units × 30%

CHAPTER 20

Process Cost Systems

Ex. 20-17 (Concluded) Costs COSTS Costs per equivalent unit: Total costs for January in Cutting Department Total equivalent units Cost per equivalent unit

Direct Materials

Conversion

$742,400 ÷ 58,000

$286,1611 ÷ 56,110

12.80

5.10

Costs assigned to production: Inventory in process, January 1 Costs incurred in January

Total costs accounted for by the Cutting Department

Cost of completed January 1 work in process Started and completed in January

$ $

1,785 3

$701,440 4

279,480 5

24,745 980,920

40,960 6

4,896 7

$1,005,665 45,856

Total costs assigned by the Cutting Department

3 4 5 6 7

22,960 1,785

Transferred to finished goods in January Inventory in process, January 31

22,960 1,028,561 2

$1,051,521

Cost allocated to completed and partially completed units: Inventory in process, January 1 balance To complete inventory in process, January 1

Total

$1,051,521

$134,550 + $151,611 $742,400 + $134,550 + $151,611 350 units × $5.10 54,800 units × $12.80 54,800 units × $5.10 3,200 units × $12.80 960 units × $5.10

Materials:

From current period………………………………………… $12.80 From beginning inventory………………………………… 12.65 Increase……………………………………………………… $ 0.15

Conversion:

From current period………………………………………… From beginning inventory………………………………… Increase………………………………………………………

$5.10 5.00 $0.10

The cost per equivalent unit of materials increased by $0.15 per unit, and the cost per equivalent unit of conversion cost increased by $0.10 per unit. Management may want to investigate the causes for these changes in cost.

CHAPTER 20

Process Cost Systems

Ex. 20-18 a.

Work in Process—Casting Department Materials—Alloy

350,000

Work in Process—Casting Department Wages Payable Factory Overhead*

49,600

350,000

19,840 29,760

* $19,840 × 150% 3.

Work in Process—Machining Department* Work in Process—Casting Department

402,684 402,684

* Supporting calculations: Cost of 2,530 transferred-out pounds: Inventory in process, May 1………………………………………………………… $ 32,844 Cost to complete May 1 inventory: 1,840 92 pounds × $20/lb. (see calculations below)………………………………… Pounds started and completed in May [2,300 lbs. × ($140 + $20)]………………………………………………………… 368,000 Transferred to Machining Department…………………………………………… $402,684 Supporting equivalent unit and cost per equivalent unit calculations: Equivalent Units

Inventory in process, May 1 (60% completed) Started and completed in May Transferred to Machining Department in May Inventory in process, May 31 (44% completed) Total 1 2 3 4

Whole Units

Materials

Conversion

230 2,300 2

0 2,300

921 2,300

2,530

2,300

2,392

200 3 2,730

200 2,500

884 2,480

230 units × (100% – 60%) 2,530 units – 230 units 230 units + 2,500 units – 2,530 units 200 units × 44%

Cost per equivalent unit of materials:

$350,000 2,500

= $140 per pound

Cost per equivalent unit of conversion:

$49,600 2,480

= $20 per pound

CHAPTER 20

Process Cost Systems

Ex. 20-18 (Concluded) b.

$29,760, determined as follows: Direct materials (200 × $140)……………………………… $28,000 1,760 Conversion (200 × 44% × $20)…………………………… $29,760 or $29,760 = $32,844 + $350,000 + $49,600 – $402,684

Materials:

From current period…………………………………… $140 From beginning inventory……………………………… 132 Increase…………………………………………………… $ 8

Conversion:

From current period…………………………………… From beginning inventory……………………………… Increase……………………………………………………

$20 18 $ 2

The cost per equivalent unit of materials increased by $8 per pound, and the cost per equivalent unit of conversion cost increased by $2 per pound. Management may want to investigate the causes for these increases in cost.

CHAPTER 20

Process Cost Systems

Ex. 20-19 a.

Work in Process—Papermaking Department Materials—Pulp

330,750

Work in Process—Papermaking Department Wages Payable Factory Overhead

95,355

Work in Process—Converting Department* Work in Process—Papermaking Department

420,925

330,750

40,560 54,795

420,925

* Supporting calculations: Cost of 103,900 transferred-out units: Inventory in process, March 1……………………………………………………… Cost to complete March 1 inventory: 1,690 units × $0.90/unit (see calculations below)……………………………… Pounds started and completed in March [101,300 units × ($3.15 + $0.90)]………………………………………………… Transferred to Converting Department……………………………………………

9,139 1,521

410,265 $420,925

Supporting equivalent unit and cost per equivalent unit calculations: Equivalent Units

Inventory in process, March 1 (35% completed) Started and completed in March Transferred to Converting Department in March Inventory in process, March 31 (80% completed) Total 1 2

Whole Units

Materials

Conversion

2,600 101,300

0 101,300

1,690 1 101,300

103,900

101,300

102,990

3,700 107,600

3,700 105,000

2,960 2 105,950

2,600 units × (100% – 35%) 3,700 units × 80%

Cost per equivalent unit of materials:

$330,750 105,000

= $3.15 per unit

Cost per equivalent unit of conversion:

$95,355 105,950

= $0.90 per unit

$14,319; determined as follows: Direct materials (3,700 × $3.15)……………… Conversion (3,700 × 80% × $0.90)……………

$11,655 2,664 $14,319

or $14,319 = $9,139 + $330,750 + $95,355 – $420,925

CHAPTER 20

Process Cost Systems

Ex. 20-20 a. Cost per megawatt hour (MWh): Fossil plant costs: Conversion costs…………………………………… Fuel…………………………………………………… Total…………………………………………………… Fossil plant megawatt hours (MWh): Megawatts…………………………………………… × Hours………………………………………………… Total…………………………………………………… Cost per megawatt hour = Wind farm costs: Conversion costs…………………………………… Wind farm megawatt hours (MWh): Megawatts…………………………………………… × Hours………………………………………………… Total…………………………………………………… Cost per megawatt hour =

$40,500,000 10,800,000 $51,300,000

900 600 540,000 MWhs $51,300,000 540,000

= $95 per MWh

$2,700,000

100 300 30,000 MWhs $2,700,000 30,000

= $90 per MWh

The wind farm cost per megawatt hour was $90, compared to the fossil plant cost of $95 per megawatt hour. The wind farm is the less costly resource. Note: These figures are close to the national average and show the slight advantage of wind farms. b. Equivalent units of production are calculated when there are beginning or ending inventories that are partially completed to either coversion costs or materials. There are no beginning or ending inventories for generating electricity; thus, there is no need to determine equivalent units of production. c. While the wind farm has a cost advantage over the fossil fuel plant, the wind farm is subject to the presence of wind. Thus, the wind farm is not as reliable as the fossil fuel plant for generating electricity. The fossil fuel plant can be turned on and off on a schedule, while the wind farm is subject to the varieties of nature.

CHAPTER 20

Process Cost Systems

Ex. 20-21 Memo To: Production Manager The cost of production report is used to identify the cost per case for each of the four flavors as follows:

Total cost Number of cases Cost per case

Orange

Cola

Lemon-Lime

Root Beer

$19,125

÷ 2,500

$391,800 ÷ 60,000

$324,000 ÷ 50,000

$36,000 ÷ 4,000

7.65

6.53

6.48

9.00

As can be seen, the cost per case of root beer is significantly above the cost per case of the other three flavors. A more detailed analysis is necessary to understand the causes of this difference. The individual cost elements that determine the total cost can be divided by the number of cases. This analysis follows: Cost per Case by Cost Element Orange

Concentrate Water Sugar Bottles Flavor changeover Conversion cost Total cost per case

$1.85 0.50 1.20 2.20 1.20 0.70 $7.65

Cola $2.15 0.50 1.20 2.20 0.08 0.40 $6.53

Lemon-Lime

Root Beer

$2.10 0.50 1.20 2.20 0.08 0.40 $6.48

$1.90 0.50 1.20 2.20 2.50 0.70 $9.00

This table indicates that the concentrate per case is actually less for orange and root beer than for cola and lemon-lime. This is because the concentrate supplier charges a higher price for the more popular flavors. The costs per case for water, sugar, and bottles are the same for each flavor. However, the costs per case for changeover are much greater for orange and root beer than for the other two flavors. In addition, the conversion costs per unit for orange and root beer are $0.30 higher than for cola and lemon-lime. These last two cost elements are sufficient to cause the cost per case of orange and root beer to be greater than cola and lemon-lime. Although further analysis is necessary, it appears that orange and root beer are bottled in short production runs, meaning more frequent changeovers, or that each orange and root beer changeover is very difficult and expensive. The conversion cost per case is larger because the bottling line rate appears slower for orange and root beer compared to cola and lemon-lime. It’s possible that shorter run sizes are related to the slower line rate because it takes some run time to work the line rate up to a fast speed after a changeover. Root beer costs more per case than orange because it may have the shortest run length.

CHAPTER 20

Process Cost Systems

Ex. 20-22 The solution to this exercise is to determine if the cost per pound trends in paper stock, conversion, and coating costs are remaining stable over time. The following table can be developed from the data: a.

January February Paper stock ($ ÷ pounds output) Coating ($ ÷ pounds output) Conversion cost ($ ÷ pounds output) Yield (pounds transferred out ÷ pounds input)

March

April

May

June

$0.70

$0.12

$0.13

$0.15

$0.17

$0.20

$0.24

$0.40

96%

The cost per pound information is determined by dividing the costs by the pounds transferred out. The yield is determined by dividing the pounds transferred out by the pounds input. b.

Operator 1 believes that energy consumption is becoming less efficient. The energy cost is part of the conversion cost. The conversion cost per output pound has remained constant for the six months. If the energy efficiency were declining, it would take more energy per pound of output over time. Thus, we would expect to see the conversion rate per pound increasing if Operator 1 were correct. Operator 2 believes that there are increasing materials losses from increasing startup and shutdown activity. Yield data would help determine if this were true. If materials losses were growing, then there would be less materials transferred out per pound of inputs over time. The yield has remained constant over the six-month period. Thus, Operator 2’s hypothesis is not validated. The stable cost of the paper stock per output pound also suggests that the yields are remaining stable. Operator 3 is concerned about coating costs. The coating cost per output pound is increasing over time. Thus, we can conclude that the coating efficiency is declining over time. Apparently, twice the coating material was being spread per pound of output in June than in January. The coating operation may need to be repaired or recalibrated. Too much coating is being spread on the paper stock.

CHAPTER 20

Process Cost Systems

Ex. 20-23 The Hawkeye Machining managers are displaying typical fears to a lean manufacturing system. Lean manufacturing removes the safety provided by materials, in-process, and finished goods inventory balances. Indeed, these types of comments reflect conventional manufacturing philosophy, which views inventory as a necessary buffer against surprises and other unwelcome events. Lean manufacturing focuses on removing the causes that require a need for inventory. In the case of materials inventories, lean manufacturing requires all suppliers to provide high-quality materials on a daily basis in just the right quantities needed for a day’s production. If the supplier has unreliable production schedules or quality, then the sources of unreliability would need to be fixed before moving to delivery with lean manufacturing. Only when suppliers are reliable can Hawkeye Manufacturing move to a lean manufacturing strategy without exposing the company to significant risk. The in-process inventories can be reduced significantly if the underlying manufacturing processes are made reliable. The director of manufacturing is correct in his observation but his solution is wrong. The solution is not to increase inventory but to improve the reliability of the machines so that they do not experience emergency breakdowns. Thus, the manufacturing operation must be improved to produce the right product, in the right quantities, at the right quality, and at the right time. Only with this level of reliability can a plant responsibly remove in-process inventories from the system. The finished goods inventory can also be reduced if the manufacturing system can be made responsive to customer demands. A company will no longer have to stock warehouses with product based on guesses at what the customer will want many weeks ahead of demand. Rather, goods are produced at the time the customer orders them. This is what Dell Inc. does. It builds a computer to order rather than stocking the computer and selling it from inventory. In other words, inventory covers a “multitude of sins.” When the “sins” are removed, the inventory can be removed. Appendix Ex. 20-24 a. and b. a. Whole Units

Units to be accounted for: Beginning work in process Units started during period Total

1,900 15,100 1 17,000

Units to be assigned costs: Transferred to Packing Department Inventory in process, ending (30% completed) Total

15,800 1,200 17,000

1 2

b. Equivalent Units of Production

15,800 360 2 16,160

15,800 units – 1,900 units + 1,200 units 30% × 1,200 units

CHAPTER 20

Process Cost Systems

Appendix Ex. 20-25 a.

Drawing Department Whole Units

Units to be accounted for: Beginning work in process Units started during period Total

500 11,600 1 12,100

Units to be assigned costs: Transferred to Winding Department in July Inventory in process, July 31 (55% completed) Total 1 2

Equivalent Units of Production

11,400

700 12,100

385 2 11,785

Whole Units

Equivalent Units of Production

11,400 units – 500 units + 700 units 55% × 700 units

Winding Department

Units to be accounted for: Beginning work in process Units started during period Total

350 11,400 1 11,750

Units to be assigned costs: Transferred to finished goods in July Inventory in process, July 31 (25% completed) Total 1 2

10,950

800 11,750

2002 11,150

10,950 units – 350 units + 800 units 25% × 800 units

CHAPTER 20

Process Cost Systems

Appendix Ex. 20-26 a.

4,200 23,600 (24,700) 3,100

Units in process, May 1…………………………………………………………… Units placed into production for May………………………………………… Less units finished during May………………………………………………… Units in process, May 31…………………………………………………………

b. Whole Units

Units to be accounted for: Beginning work in process Units started during the period Total

Equivalent Units of Production

4,200 23,600 27,800

Units to be assigned costs: Transferred to finished goods in May Inventory in process, May 31 (30% completed) Total

24,700

3,100 27,800

930* 25,630

* 30% × 3,100 units Appendix Ex. 20-27 a. and b. Whole Units

Units to be accounted for: Beginning work in process Units started during the period Total

900 8,400 9,300

Units to be assigned costs: Transferred to finished goods Inventory in process, ending (60% completed) Total

8,100 1,200 9,300

Equivalent Units of Production

8,100 720 * 8,820

* 60% × 1,200 units c.

Cost per Equivalent Unit =

Total Production Costs Total Equivalent Units

Cost per Equivalent Unit =

$61,740* = $7.00 8,820 units

* $2,466 + $34,500 + $16,200 + $8,574 d.

Cost of units transferred to Finished Goods: $56,700 (8,100 units × $7.00)

Cost of units in ending Work in Process: $5,040 (1,200 units × 60% × $7.00) 20-32 © 2021 Cengage Learning, Inc. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 20

Process Cost Systems

Appendix Ex. 20-28 a. Whole Units

Units to be accounted for: Beginning work in process Units started during the period Total

Equivalent Units of Production

500 3,700 4,200

Units to be assigned costs: Transferred to finished goods in June Inventory in process, June 30 (70% completed) Total

3,600

600 4,200

420* 4,020

* 70% × 600 units Cost per Equivalent Unit =

Total Production Costs Total Equivalent Units

Cost per Equivalent Unit =

$104,520** 4,020 units

= $26.00

** $5,000 + $49,200 + $25,200 + $25,120 b.

Cost of units transferred to Finished Goods: $93,600 (3,600 units × $26.00)

Cost of units in ending Work in Process: $10,920 (600 units × 70% × $26.00)

CHAPTER 20

Process Cost Systems

Appendix Ex. 20-29 Highlands Coffee Company Cost of Production Report—Roasting Department For the Month Ended May 31 Whole Units

UNITS

Units to account for during production: Inventory in process, May 1 Received from materials storeroom Total units accounted for by the Roasting Department Units to be assigned costs: Transferred to finished goods in May Inventory in process, May 31 (80% completed) Total units to be assigned costs

Equivalent Units of Production

1,150 10,900 12,050 11,250

11,250

800 12,050

640 * 11,890

* 80% × 800 units COSTS

Costs

Costs per equivalent unit: Total costs for May in Roasting Department Total equivalent units Cost per equivalent unit

$42,8041 ÷ 11,890 $ 3.60

Costs assigned to production: Inventory in process, May 1 Costs incurred in May Total costs accounted for by the Roasting Department

$ 1,700 41,1042 $42,804

Costs allocated to completed and partially completed units: Transferred to finished goods in May (11,250 units × $3.60) Inventory in process, May 31 (800 units × 80% × $3.60) Total costs assigned by the Roasting Department 1

$1,700 + $28,600 + $12,504

$28,600 + $12,504

$40,500 2,304 $42,804

CHAPTER 20

Process Cost Systems

Appendix Ex. 20-30 Dalton Carpet Company Cost of Production Report—Cutting Department For the Month Ended January 31 Whole Units

UNITS

Units charged to production: Inventory in process, January 1 Received from Weaving Department Total units accounted for by the Cutting Department

Equivalent Units of Production

3,400 64,000 67,400

Units to be assigned costs: Transferred to finished goods in January Inventory in process, January 31 (10% completed) Total units to be assigned costs

63,500

3,900 67,400

390 * 63,890

* 10% × 3,900 units COSTS

Costs

Costs per equivalent unit: Total costs for January in Cutting Department Total equivalent units Cost per equivalent unit

$575,0101 ÷ 63,890 $ 9.00

Costs assigned to production: Inventory in process, January 1 Costs incurred in January Total costs accounted for by the Cutting Department

$ 23,000 552,010 2 $575,010

Costs allocated to completed and partially completed units: Transferred to finished goods in January (63,500 units × $9.00) Inventory in process, January 31 (3,900 units × 10% × $9.00) Total costs assigned by the Cutting Department 1 2

$571,500 3,510 $575,010

$23,000 + $366,200 + $105,100 + $80,710 $366,200 + $105,100 + $80,710

CHAPTER 20

Process Cost Systems

PROBLEMS Prob. 20-1A 1.

Materials Accounts Payable

410,000

Work in Process—Spinning Department Work in Process—Tufting Department Factory Overhead—Spinning Department Factory Overhead—Tufting Department Materials

225,500 90,200 37,700 29,800

Work in Process—Spinning Department Work in Process—Tufting Department Factory Overhead—Spinning Department Factory Overhead—Tufting Department Wages Payable

151,700 80,300 14,900 7,500

Factory Overhead—Spinning Department Factory Overhead—Tufting Department Accumulated Depreciation

10,200 7,000

Factory Overhead—Spinning Department Factory Overhead—Tufting Department Prepaid Insurance

1,600 820

Work in Process—Spinning Department Work in Process—Tufting Department Factory Overhead—Spinning Department Factory Overhead—Tufting Department

64,600 45,100

Work in Process—Tufting Department Work in Process—Spinning Department

448,500

Finished Goods Work in Process—Tufting Department

661,900

Cost of Goods Sold Finished Goods

639,100

410,000

383,200

254,400

17,200

2,420

64,600 45,100

448,500

661,900

639,100

CHAPTER 20

Process Cost Systems

Prob. 20-1A (Concluded) 2. Materials

Balance, January 1…… $ 13,900 Debits…………………… 410,000 (383,200) Credits………………… Balance, January 31… $ 40,700 1 2

Work in Process— Spinning Dept.

Work in Process— Tufting Dept.

Finished Goods

$ 28,700 441,8001 (448,500)

$ 23,400 664,100 2 (661,900)

$ 50,800 661,900 (639,100)

$ 22,000

$ 25,600

$ 73,600

$225,500 + $151,700 + $64,600 $90,200 + $80,300 + $45,100 + $448,500

Factory Overhead— Spinning Dept.

1 2

Balance, January 1…… Debits…………………… Credits…………………

Balance, January 31…

0 64,400 1 (64,600) (200) Cr.

Factory Overhead— Tufting Dept.

0 45,120 2 (45,100) 20 Dr.

$37,700 + $14,900 + $10,200 + $1,600 $29,800 + $7,500 + $7,000 + $820

CHAPTER 20

Process Cost Systems

Prob. 20-2A 1. Mochaccino Express Coffee Company Cost of Production Report—Roasting Department For the Month Ended July 31 Equivalent Units Whole Units

UNITS

Units charged to production: Inventory in process, July 1 Received from materials storeroom Total units accounted for by the Roasting Department

2 3 4

Conversion

63,000 250,000 2

0 250,000

6,300 1 250,000

313,000

250,000

256,300

74,000 3 387,000

74,000 324,000

40,700 4 297,000

63,000 324,000 387,000

Units to be assigned costs: Inventory in process, July 1 (90% completed) Started and completed in July Transferred to Packing Department in July Inventory in process, July 31 (55% completed) Total units to be assigned costs 1

Direct Materials

63,000 units × (100% – 90%) 313,000 units – 63,000 units 63,000 units + 324,000 units – 313,000 units 74,000 units × 55%

CHAPTER 20

Process Cost Systems

Prob. 20-2A (Continued) Costs COSTS

Direct Materials

Conversion

Costs per equivalent unit: Total costs for July in Roasting Department Total equivalent units Cost per equivalent unit

$1,328,400 ÷ 324,000 $ 4.10

$445,500 1 ÷297,000 $ 1.50

Costs assigned to production: Inventory in process, July 1 Costs incurred in July Total costs accounted for by the Roasting Department Cost allocated to completed and partially completed units: Inventory in process, July 1 balance To complete inventory in process, July 1 Cost of completed July 1 work in process Started and completed in July Transferred to Packing Department in July Inventory in process, July 31 Total costs assigned by the Roasting Department

Total

$ 344,295 1,773,900 2 $2,118,195

$ 344,295 9,450 3

9,450

1,025,000 4

375,000 5

$ 353,745 1,400,000

303,400 6

61,050 7

$1,753,745 364,450

$2,118,195

Costs transferred to Packing Department: $1,753,745 Work in process, July 31: 74,000 units at a cost of $364,450 1 2 3 4 5 6 7

$325,200 + $120,300 $1,328,400 + $325,200 + $120,300 6,300 units × $1.50 250,000 units × $4.10 250,000 units × $1.50 74,000 units × $4.10 40,700 units × $1.50

CHAPTER 20

Process Cost Systems

Prob. 20-2A (Concluded) 2.

Direct materials cost increased $0.03, from $4.07 in June to $4.10 in July. Conversion cost decreased $0.05, from $1.55 in June to $1.50 in July. Computations: Direct materials: Conversion:

$4.07 ($256,410 ÷ 63,000 units) $1.55, determined as follows:

July 1, work in process………………………………………………………… $344,295 256,410 Less direct materials…………………………………………………………… Conversion costs included in July 1, work in process…………………… $ 87,885 Conversion cost equivalent units: 56,700 units (63,000 × 90%) Conversion cost per equivalent unit: $1.55 ($87,885 ÷ 56,700)

Prob. 20-3A 1. White Diamond Flour Company Cost of Production Report—Sifting Department For the Month Ended July 31 Equivalent Units Whole Units

UNITS

Units charged to production: Inventory in process, July 1 Received from Milling Department Total units accounted for by the Sifting Department

2 3

Conversion

900 14,600 2

0 14,600

360 1 14,600

15,500

14,600

14,960

1,100 16,600

1,100 15,700

880 3 15,840

900 15,700 16,600

Units to be assigned costs: Inventory in process, July 1 (3/5 completed) Started and completed in July Transferred to Packaging Department in July Inventory in process, July 31 (4/5 completed) Total units to be assigned costs 1

Direct Materials

900 units × (1 – 3/5) 15,700 units – 1,100 units 1,100 units × 4/5

CHAPTER 20

Process Cost Systems

Prob. 20-3A (Continued) Costs COSTS

Direct Materials

Conversion

Costs per equivalent unit: Total costs for July in Sifting Department Total equivalent units Cost per equivalent unit

$33,755 ÷15,700 $ 2.15

$ 7,128 1 ÷15,840 $ 0.45

Costs assigned to production: Inventory in process, July 1 Costs incurred in July Total costs accounted for by the Sifting Department

$ 2,061 40,883 2 $42,944

Cost allocated to completed and partially completed units: Inventory in process, July 1 balance To complete inventory in process, July 1 Cost of completed July 1 work in process Started and completed in July Transferred to Packaging Department in July Inventory in process, July 31 Total costs assigned by the Sifting Department 1 2 3 4 5 6 7

Total

$ 2,061 162 3

162

31,390 4

6,570 5

$ 2,223 37,960

2,365 6

396 7

$40,183 2,761

$42,944

$4,420 + $2,708 $33,755 + $4,420 + $2,708 360 units × $0.45 14,600 units × $2.15 14,600 units × $0.45 1,100 units × $2.15 880 units × $0.45

CHAPTER 20

Process Cost Systems

Prob. 20-3A (Concluded) 2.

Work in Process—Sifting Department Work in Process—Milling Department

33,755

Work in Process—Packaging Department Work in Process—Sifting Department

40,183

33,755

40,183

Direct materials: Conversion:

$0.10 increase ($2.15 – $2.05) $0.05 increase ($0.45 – $0.40)

The cost of production report may be used as the basis for allocating product costs between Work in Process and Transferred-Out (or Finished) Goods. The report can also be used to control costs by holding each department head responsible for the units entering production and the costs incurred in the department. Any differences in unit product costs from one month to another, such as those in part (3), can be studied carefully and any significant differences investigated.

Prob. 20-4A Work in Process—Filling

1. and 2.

Balance Date Apr.

May

Item 1 30 30 30 30 30 31 31 31 31 31

Dr.

Bal., 800 units, 30% completed Cooking Dept., 7,800 units at $4.40 Direct labor Factory overhead Finished goods* Bal., 550 units, 90% completed Cooking Dept., 9,600 units at $4.60 Direct labor Factory overhead Finished goods* Bal., 300 units, 35% completed

Cr.

34,320 8,562 6,387 49,818 44,160 12,042 6,878 64,801

Dr.

Cr.

3,860 38,180 46,742 53,129 3,311 3,311 47,471 59,513 66,391 1,590 1,590

* The credits are determined from the supporting cost of production reports.

CHAPTER 20

Process Cost Systems

Prob. 20-4A (Continued) 1. Hearty Soup Co. Cost of Production Report—Filling Department For the Month Ended April 30 Equivalent Units

UNITS

Units charged to production: Inventory in process, April 1 Received from Cooking Department Total units accounted for by the Filling Department

2 3

Conversion (a)

800 7,250 2 8,050

0 7,250 7,250

560 1 7,250 7,810

550 8,600

550 7,800

495 3 8,305

800 7,800 8,600

Units to be assigned costs: Inventory in process, April 1 (30% completed) Started and completed in April Transferred to finished goods in April Inventory in process, April 30 (90% completed) Total units to be assigned costs 1

Direct Materials (a)

Whole Units

800 units × (100% – 30%) 7,800 units – 550 units 550 units × 90%

CHAPTER 20

Process Cost Systems

Prob. 20-4A (Continued) Costs COSTS

Direct Materials

Conversion

Costs per equivalent unit: Total costs for April in Filling Department Total equivalent units Cost per equivalent unit (b)

$34,320 ÷ 7,800 $ 4.40

$14,9491 ÷ 8,305 $ 1.80

Costs assigned to production: Inventory in process, April 1 Costs incurred in April Total costs accounted for by the Filling Department

$ 3,860 49,269 2 $53,129

Cost allocated to completed and partially completed units: Inventory in process, April 1 balance (c) To complete inventory in process, April 1 (c) Cost of completed April 1 work in process Started and completed in April (c) Transferred to finished goods in April (c) Inventory in process, April 30 (d) Total costs assigned by the Filling Department 1 2 3 4 5 6 7

Total

$ 3,860 $

$ 1,008 3

1,008

13,050 5

$ 4,868 44,950

2,420 6

8917

$49,818 3,311

31,900

$53,129

$8,562 + $6,387 $34,320 + $8,562 + $6,387 560 units × $1.80 7,250 units × $4.40 7,250 units × $1.80 550 units × $4.40 495 units × $1.80

CHAPTER 20

Process Cost Systems

Prob. 20-4A (Continued) 2. Hearty Soup Co. Cost of Production Report—Filling Department For the Month Ended May 31 Equivalent Units

Units charged to production: Inventory in process, May 1 Received from Cooking Department Total units accounted for by the Filling Department

550 9,300 2

0 9,300

55 1 9,300

9,850

9,300

9,355

300 10,150

300 9,600

105 3 9,460

550 9,600 10,150

Units to be assigned costs: Inventory in process, May 1 (90% completed) Started and completed in May Transferred to finished goods in May Inventory in process, May 31 (35% completed) Total units to be assigned costs

Conversion (a)

Whole Units

UNITS

Direct Materials (a)

550 units × (100% – 90%) 9,600 units – 300 units 300 units × 35%

CHAPTER 20

Process Cost Systems

Prob. 20-4A (Concluded) Costs COSTS

Direct Materials

Conversion

Costs per equivalent unit: Total costs for May in Filling Department Total equivalent units Cost per equivalent unit (b)

$44,160 ÷ 9,600 $ 4.60

$18,920 1 ÷ 9,460 $ 2.00

Costs assigned to production: Inventory in process, May 1 Costs incurred in May Total costs accounted for by the Filling Department

$ 3,311 63,080 2 $66,391

Cost allocated to completed and partially completed units: Inventory in process, May 1 balance (c) To complete inventory in process, May 1 (c) Cost of completed May 1 work in process Started and completed in May (c) Transferred to finished goods in May (c) Inventory in process, May 31 (d) Total costs assigned by the Filling Department 1 2 3 4 5 6 7

Total

$ 3,311 110 3

110

42,7804

18,600 5

$ 3,421 61,380

1,3806

210 7

$64,801 1,590

$66,391

$12,042 + $6,878 $44,160 + $12,042 + $6,878 55 units × $2.00 9,300 units × $4.60 9,300 units × $2.00 300 units × $4.60 105 units × $2.00

The cost per equivalent unit for direct materials increased from $4.30 in March to $4.40 in April to $4.60 in May. Similarly, the cost per equivalent unit for conversion costs increased from $1.75 in March to $1.80 in April to $2.00 in May. These increases should be investigated for their underlying causes, and any necessary corrective actions should be taken.

CHAPTER 20

Process Cost Systems

Appendix Prob. 20-5A Sunrise Coffee Company Cost of Production Report—Roasting Department For the Month Ended December 31 Whole Units

UNITS

Units to account for during production: Inventory in process, December 1 Received from materials storeroom Total units accounted for by the Roasting Department Units to be assigned costs: Transferred to Packing Department in December Inventory in process, December 31 (25% completed) Total units to be assigned costs 1 2

Equivalent Units of Production

10,500 210,400 220,900

208,900

12,000 1 220,900

3,000 2 211,900

10,500 units + 210,400 units – 208,900 units 25% units × 12,000 units

COSTS

Costs

Unit costs: Total costs for December in Roasting Department Total equivalent units Cost per equivalent unit Costs assigned to production: Inventory in process, December 1 Costs incurred in December Total costs accounted for by the Roasting Department Costs allocated to completed and partially completed units: Transferred to Packing Department in December (208,900 units × $2.70) Inventory in process, December 31 (12,000 units × 25% × $2.70) Total costs assigned by the Roasting Department

$572,130 ÷211,900 $ 2.70 $ 21,000 551,130 * $572,130

$564,030 8,100 $572,130

* $246,800 + $135,700 + $168,630

CHAPTER 20

Process Cost Systems

Prob. 20-1B 1.

Materials Accounts Payable

149,800

Work in Process—Making Department Work in Process—Packing Department Factory Overhead—Making Department Factory Overhead—Packing Department Materials

105,700 31,300 4,980 1,530

Work in Process—Making Department Work in Process—Packing Department Factory Overhead—Making Department Factory Overhead—Packing Department Wages Payable

32,400 40,900 15,400 18,300

Factory Overhead—Making Department Factory Overhead—Packing Department Accumulated Depreciation

10,700 7,900

Factory Overhead—Making Department Factory Overhead—Packing Department Prepaid Insurance

2,000 1,500

Work in Process—Making Department Work in Process—Packing Department Factory Overhead—Making Department Factory Overhead—Packing Department

32,570 30,050

Work in Process—Packing Department Work in Process—Making Department

166,790

Finished Goods Work in Process—Packing Department

263,400

Cost of Goods Sold Finished Goods

265,200

149,800

143,510

107,000

18,600

3,500

32,570 30,050

166,790

263,400

265,200

CHAPTER 20

Process Cost Systems

Prob. 20-1B (Concluded) 2.

1 2

Materials

Work in Process— Making Dept.

Work in Process— Packing Dept.

Balance, July 1……… Debits………………… Credits………………

5,100 149,800 (143,510)

6,790 170,670 1 (166,790)

7,350 269,040 2 (263,400)

$ 13,500 263,400 (265,200)

Balance, July 31……

$ 11,390

$ 10,670

$ 12,990

$ 11,700

$105,700 + $32,400 + $32,570 $31,300 + $40,900 + $30,050 + $166,790

Factory Overhead— Making Dept.

1 2

Finished Goods

Balance, July 1……… Debits………………… Credits………………

Balance, July 31……

0 33,080 1 (32,570) 510 Dr.

Factory Overhead— Packing Dept.

0 29,230 2 (30,050)

(820)

Cr.

$4,980 + $15,400 + $10,700 + $2,000 $1,530 + $18,300 + $7,900 + $1,500

CHAPTER 20

Process Cost Systems

Prob. 20-2B 1. Bavarian Chocolate Company Cost of Production Report—Blending Department For the Month Ended October 31 Equivalent Units Whole Units

UNITS

Units charged to production: Inventory in process, October 1 Received from materials storeroom Total units accounted for by the Blending Department Units to be assigned costs: Inventory in process, October 1 (3/5 completed) Started and completed in October Transferred to Molding Department in October Inventory in process, October 31 (1/5 completed) Total units to be assigned costs 1 2 3 4

Direct Materials

Conversion

2,300 23,400 2

0 23,400

920 1 23,400

25,700

23,400

24,320

2,600 3 28,300

2,600 26,000

520 4 24,840

2,300 26,000 28,300

2,300 units × (1 – 3/5) 25,700 units – 2,300 units 2,300 units + 26,000 units – 25,700 units 2,600 units × 1/5

CHAPTER 20

Process Cost Systems

Prob. 20-2B (Continued) Costs COSTS

Direct Materials

Conversion

Costs per equivalent unit: Total costs for October in Blending Department Total equivalent units Cost per equivalent unit

$429,000 ÷ 26,000 $ 16.50

$149,0401 ÷ 24,840 $ 6.00

Costs assigned to production: Inventory in process, October 1 Costs incurred in October Total costs accounted for by the Blending Department

Total

$ 46,368 578,040 2 $624,408

Cost allocated to completed and partially completed units: Inventory in process, October 1 balance To complete inventory in process, October 1 Cost of completed October 1 work in process Started and completed in October Transferred to Molding Department in October Inventory in process, October 31 Total costs assigned by the Blending Department

$ 46,368 5,520 3

5,520

$386,100 4

140,400 5

$ 51,888 526,500

42,900 6

3,120 7

$578,388 46,020

$624,408

Costs transferred to Molding Department: $578,388 Work in process, October 31: 2,600 units at a cost of $46,020 1 2 3 4 5 6 7

$100,560 + $48,480 $429,000 + $100,560 + $48,480 920 units × $6.00 23,400 units × $16.50 23,400 units × $6.00 2,600 units × $16.50 520 units × $6.00

CHAPTER 20

Process Cost Systems

Prob. 20-2B (Concluded) 2.

Direct materials cost decreased $0.15, from $16.65 in September to $16.50 in October. Conversion cost increased $0.15, from $5.85 in September to $6.00 in October. Computations: Direct materials:

$16.65 ($38,295 ÷ 2,300 units)

Conversion:

$5.85, determined as follows:

October 1, work in process……………………………………………………… $46,368 Less direct materials……………………………………………………………… 38,295 Conversion costs included in October 1, work in process………………… $ 8,073 Conversion cost equivalent units: 1,380 units (2,300 × 60%) Conversion cost per equivalent unit: $5.85 ($8,073 ÷ 1,380)

CHAPTER 20

Process Cost Systems

Prob. 20-3B 1. Dover Chemical Company Cost of Production Report—Filling Department For the Month Ended January 31 Equivalent Units Whole Units

UNITS

Units charged to production: Inventory in process, January 1 Received from Reaction Department Total units accounted for by the Filling Department

2 3

Conversion

3,400 49,600 2

0 49,600

1,3601 49,600

53,000

49,600

50,960

2,700 55,700

2,700 52,300

810 3 51,770

3,400 52,300 55,700

Units to be assigned costs: Inventory in process, January 1 (60% completed) Started and completed in January Transferred to finished goods in January Inventory in process, January 31 (30% completed) Total units to be assigned costs 1

Direct Materials

3,400 units × (100% – 60%) 52,300 units – 2,700 units 2,700 units × 30%

CHAPTER 20

Process Cost Systems

Prob. 20-3B (Continued) Costs COSTS

Costs per equivalent unit: Total costs for January in Filling Department Total equivalent units Cost per equivalent unit Costs assigned to production: Inventory in process, January 1 Costs incurred in January Total costs accounted for by the Filling Department Cost allocated to completed and partially completed units: Inventory in process, January 1 balance To complete inventory in process, January 1 Cost of completed January 1 work in process Started and completed in January Transferred to finished goods in January Inventory in process, January 31 Total costs assigned by the Filling Department 1 2 3 4 5 6 7

Direct Materials

Conversion

$496,850 ÷ 52,300 $ 9.50

$196,726 1 ÷ 51,770 $ 3.80

Total

$ 40,528 693,576 2 $734,104

$ 40,528 $

5,168 3

471,2004

188,480

25,650 6

3,078 7

5,168 $ 45,696 659,680 $705,376 28,728 $734,104

$101,560 + $95,166 $496,850 + $101,560 + $95,166 1,360 units × $3.80 49,600 units × $9.50 49,600 units × $3.80 2,700 units × $9.50 810 units × $3.80

CHAPTER 20

Process Cost Systems

Prob. 20-3B (Concluded) 2.

Work in Process—Filling Department Work in Process—Reaction Department

496,850

Finished Goods Work in Process—Filling Department

705,376

496,850

705,376

Direct materials: Conversion:

–$0.08 decrease ($9.50 – $9.58) –$0.10 decrease ($3.80 – $3.90)

The cost of production report may be used as the basis for allocating product costs between Work in Process and Finished Goods. The report can also be used to control costs by holding each department head responsible for the units entering production and the costs incurred in the department. Any differences in unit product costs from one month to another, such as those in part (3), can be studied carefully and any significant differences investigated.

Prob. 20-4B Work in Process—Rolling

1. and 2.

Balance Date Sept.

Oct.

Item 1 30 30 30 30 30 31 31 31 31 31

Dr.

Bal., 2,600 units, 1/4 completed Smelting Dept., 28,900 units at $16.00/unit Direct labor Factory overhead Finished goods* Bal., 2,900 units, 4/5 completed Smelting Dept., 31,000 units at $16.50/unit Direct labor Factory overhead Finished goods* Bal., 2,000 units, 2/5 completed

Cr.

Dr.

Cr.

45,825 462,400 158,920 101,402 702,195

511,500 162,850 104,494 805,156

508,225 667,145 768,547 66,352 66,352 577,852 740,702 845,196 40,040 40,040

* The credits are determined from the supporting cost of production reports.

CHAPTER 20

Process Cost Systems

Prob. 20-4B (Continued) 1. Pittsburgh Aluminum Company Cost of Production Report—Rolling Department For the Month Ended September 30 Equivalent Units

UNITS

Units charged to production: Inventory in process, September 1 Received from Smelting Department Total units accounted for by the Rolling Department Units to be assigned costs: Inventory in process, September 1 (1/4 completed) Started and completed in September Transferred to finished goods in September Inventory in process, September 30 (4/5 completed) Total units to be assigned costs 1 2 3

Direct Materials (a)

Conversion (a)

2,600 26,000 2

0 26,000

1,950 1 26,000

28,600

26,000

27,950

2,900 31,500

2,900 28,900

2,320 3 30,270

Whole Units

2,600 28,900 31,500

2,600 units × (1 – 1/4) 28,900 units – 2,900 units 2,900 units × 4/5

CHAPTER 20

Process Cost Systems

Prob. 20-4B (Continued) Costs COSTS

Direct Materials

Conversion

Costs per equivalent unit: Total costs for September in Rolling Department Total equivalent units Cost per equivalent unit (b)

$462,400 ÷ 28,900 $ 16.00

$260,3221 ÷ 30,270 $ 8.60

Costs assigned to production: Inventory in process, September 1 Costs incurred in September Total costs accounted for by the Rolling Department

$ 45,825 722,722 2 $768,547

Cost allocated to completed and partially completed units: Inventory in process, September 1 balance (c) To complete inventory in process, September 1 (c) Cost of completed September 1 work in process Started and completed in September (c) Transferred to finished goods in September (c) Inventory in process, September 30 (d) Total costs assigned by the Rolling Department 1 2 3 4 5 6 7

Total

$ 45,825 0

$ 16,7703

416,000 4

223,600

46,400 6

19,9527

16,770 $ 62,595 639,600 $702,195 66,352 $768,547

$158,920 + $101,402 $462,400 + $158,920 + $101,402 1,950 units × $8.60 26,000 units × $16.00 26,000 units × $8.60 2,900 units × $16.00 2,320 units × $8.60

CHAPTER 20

Process Cost Systems

Prob. 20-4B (Continued) 2. Pittsburgh Aluminum Company Cost of Production Report—Rolling Department For the Month Ended October 31 Equivalent Units

Units charged to production: Inventory in process, October 1 Received from Smelting Department Total units accounted for by the Rolling Department Units to be assigned costs: Inventory in process, October 1 (4/5 completed) Started and completed in October Transferred to finished goods in October Inventory in process, October 31 (2/5 completed) Total units to be assigned costs

2 3

Conversion (a)

2,900 29,000 2

0 29,000

580 1 29,000

31,900

29,000

29,580

2,000 33,900

2,000 31,000

800 3 30,380

Whole Units

UNITS

Direct Materials (a)

2,900 31,000 33,900

2,900 units × (1 – 4/5) 31,000 units – 2,000 units 2,000 units × 2/5

CHAPTER 20

Process Cost Systems

Prob. 20-4B (Concluded) Costs COSTS

Costs per equivalent unit: Total costs for October in Rolling Department Total equivalent units Cost per equivalent unit (b) Costs assigned to production: Inventory in process, October 1 Costs incurred in October Total costs accounted for by the Rolling Department Cost allocated to completed and partially completed units: Inventory in process, October 1 balance (c) To complete inventory in process, October 1 (c) Cost of completed October 1 work in process Started and completed in October (c) Transferred to finished goods in October (c) Inventory in process, October 31 (d) Total costs assigned by the Rolling Department 1 2 3 4 5 6 7

Direct Materials

Conversion

$511,500 ÷ 31,000 $ 16.50

$267,344 1 ÷ 30,380 $ 8.80

Total

$ 66,352 778,844 2 $845,196

$ 66,352 5,104 3

5,104

478,500 4

255,200 5

$ 71,456 733,700

33,000 6

7,040 7

$805,156 40,040

$845,196

$162,850 + $104,494 $511,500 + $162,850 + $104,494 580 units × $8.80 29,000 units × $16.50 29,000 units × $8.80 2,000 units × $16.50 800 units × $8.80

The cost per equivalent unit for direct materials increased from $15.50 in August to $16.00 in September to $16.50 in October. The cost per equivalent unit for conversion costs increased from $8.50 in August to $8.60 in September to $8.80 in October. These increases should be investigated for their underlying causes, and any necessary corrective actions should be taken.

CHAPTER 20

Process Cost Systems

Appendix Prob. 20-5B Blue Ribbon Flour Company Cost of Production Report—Sifting Department For the Month Ended May 31 Whole Units

UNITS

Units charged to production: Inventory in process, May 1 Received from Milling Department Total units accounted for by the Sifting Department Units to be assigned costs: Transferred to Packaging Department in May Inventory in process, May 31 (75% completed) Total units to be assigned costs

Equivalent Units of Production

1,500 18,300 19,800

18,000

1,800 19,800

1,350 * 19,350

* 75% units × 1,800 units COSTS

Costs

Costs per equivalent unit: Total costs for May in Sifting Department1 Total equivalent units Cost per equivalent unit Costs assigned to production: Inventory in process, May 1 2

Costs incurred in May Total costs accounted for by the Sifting Department Costs allocated to completed and partially completed units: Transferred to Packaging Department in May (18,000 units × $3.00) Inventory in process, May 31 (1,800 units × 75% × $3.00) Total costs assigned by the Sifting Department 1

$3,400 + $32,600 + $14,560 + $7,490

$32,600 + $14,560 + $7,490

$58,050 ÷19,350 $ 3.00 $ 3,400 54,650 $58,050

$54,000 4,050 $58,050

CHAPTER 20

Process Cost Systems

CASES & PROJECTS CP 20-1 This case comes from a real story. In that story, the first reduction in chips had no impact on the marketplace. The manager was promoted, and the next manager attempted the same strategy—reduce chips by 10%. Again, it worked. The next manager did the same thing. All of a sudden, the market demand dropped for the cookie. A threshold was reached, and the cookie was in trouble in the marketplace. The current cookie was nothing like the original recipe. The cookie’s integrity was slowly eroded until it wasn’t “Full of Chips.” Senior management had no idea this was happening because it occurred slowly over a period of many years. Now with respect to the controller, there are a number of options. a.

Do nothing. This is a safe strategy. It would be highly unlikely that failing to reveal this information to anybody would ever be discovered or “pinned” on you. Unfortunately, this is one of those situations where silence has very little penalty, yet speaking up entails some risk. However, silence may not be the best option. Silence may allow the product quality erosion to continue, which could be harmful to the company.

Talk to Bishop. You can have a conversation with Bishop. This is also a reasonably safe strategy and probably the best start. For example, you may discover that the reduction in chips was okayed by the vice president or that there was a market study that revealed that the market thought the cookie had too many chips. This kind of information could be discovered very easily and without any risk through a personal conversation with Bishop.

Talk to the vice president. You also could go over Bishop’s head to the vice president. This strategy might label you as “not a team player,” so some care is in order here. You might get Bishop in trouble, or you may get yourself in some trouble. This is probably not the best first move. It is within Bishop’s authority to make the chip decision, so you are, in a sense, second-guessing Bishop when you go to the vice president. You could be accused of being out of your expertise. After all, what do you know about chips and the marketplace?

Probably the best move is to talk to Bishop. If you discover that Bishop is acting independently, with the primary motivation being to improve the “bottom line,” then you may need to talk to the vice president. This is a delicate situation. You would need to make your case that the reduction in chips strikes you as a short-term decision that may have short-term benefits but may be a poor long-term decision. Again, Bishop has the prerogative to make the chip decision; so in a sense, you are second-guessing Bishop. Your objections should be done lightly and carefully.

CHAPTER 20

Process Cost Systems

CP 20-2 This activity can be accomplished with multiple groups assigned to one or more of the industry categories. Assign at least one group to each industry category. (Some are easier than others, so some groups may be assigned multiple categories.) Have the groups report their research back to the class. The class’s final product should be a table identifying a company, products, materials, and processes used by these industries. The most difficult information to obtain is the processes and the materials used in the processes. However, Internet and annual report information provide good information for answers. The text problems also provide examples of processes used in these industries. Use this case to familiarize students with process industries. Note that a set of example companies is provided for these industry categories early in the chapter. You may require that the groups select different companies than those already listed in the text. A suggested solution following this approach is provided on the next page.

E. I. du Pont de Nemours and Company

Kraft Heinz Company

International Paper Company AK Steel Holding Corporation BP

Eli Lilly and Company

Unilever

Chemicals

Food

Forest and paper products

Metals

Petroleum refining

Pharmaceuticals

Soap and cosmetics

Hydrochloride

Fatty acids, water, fragrances

Prozac®, Humulin® Lever 2000® soap

20-63

Oil

Iron ore, coke

Wood, wood chips, water, sulfuric acid

Gasoline, diesel, kerosene

Steel

Paper, paperboard, cardboard

Tomato, sugar, salt, spices

Petroleum and petroleumbased intermediates (esters and olefins)

Stainmaster®, Kevlar®, Lycra®, Teflon®, refrigerants, electronic materials Ketchup

Sugar, carbonated water, concentrate

Materials

Pepsi, Diet Pepsi

Products

Process Cost Systems

Processes

Making, column blowing, packing

Blending, distilling, packing, pelletizing

Catalytic converting, distilling

Melting, casting, rolling

Chipping, pulping, papermaking, pressing, cutting

Cooking, blending, packaging

Reaction, blending, distilling, extruding

Mixing, bottling

PepsiCo, Inc.

Example Company

Beverages

Industry Category

CP 20-2 (Concluded)

CHAPTER 20

Process Cost Systems

CP 20-3 To: From: Re:

Jamarcus Bradshaw Student Name Analysis of August Increase in Unit Costs for Papermaking Department

The increase in the unit costs from July to August occurred for both the conversion and materials (pulp and chemicals) costs in the Papermaking Department, as indicated in the table below.

Materials cost per ton……………………………………… Conversion cost per ton…………………………………… Total……………………………………………………………

July

August

$246.33 121.67 $368.00

$269.12 132.39 $401.51

An analysis was done to isolate the cause of the increased cost per ton. My interviews indicated that there were two possible causes. First, we changed the specification of the green paper in early August. This may have altered the way the paper machines process the green paper. Thus, it is possible that the paper machines have improper settings for the new specification and are overapplying materials. Second, there is some question as to whether paper machine No. 1 is in need of repairs. It is possible that our problem is due to lack of repairs on this machine. Fortunately, we run both colors on paper machine No. 1. Thus, we can separate the analysis between these two possible explanations. I have provided the following cost per ton data for the two paper machines and the two product colors: Paper machine analysis: Materials Cost per Ton

Conversion Cost per Ton

Total

$290.54 248.07 $ 42.47

$143.04 121.93 $ 21.11

$433.58 370.00 $ 63.58

Materials Cost per Ton

Conversion Cost per Ton

Total

$269.15 269.07 $ 0.08

$132.37 132.41 $ (0.04)

$401.52 401.48 $ 0.04

Paper machine No. 1…………………… Paper machine No. 2…………………… Difference………………………………… Product color analysis:

Green……………………………………… Yellow……………………………………… Difference…………………………………

CHAPTER 20

Process Cost Systems

CP 20-3 (Concluded) The results are clear. Paper machine 1 has a much higher materials and conversion cost per ton in August. Apparently, the paper machine is overapplying pulp. This is resulting in an increase in both the materials and conversion cost per ton. Paper machine No. 2 is running at a cost near our historical cost per ton. There is no evidence of a color problem. Both color papers are running at or near the same materials and conversion cost per ton. Thus, the specification change for green has not appeared to cause a problem in the papermaking operation. I predict that if we improve the operation of paper machine No. 1, we will be able to run the department near the historical average cost per ton. Note to Instructors: The paper machine and product line analysis are determined by summarizing the data from the computer run provided in the problem. Students must divide costs by ton-volume for each paper machine and then do the same thing for each product color. The tables in the memo show the results of the following analysis (a spreadsheet is recommended for performing this analysis): Average materials cost per ton for paper machine No. 1: ($40,300 + $41,700 + $44,600 + $36,100) ÷ (150 + 140 + 150 + 120) = $290.54 Average conversion cost per ton for paper machine No. 1: ($18,300 + $21,200 + $22,500 + $18,100) ÷ (150 + 140 + 150 + 120) = $143.04 Average materials cost per ton for paper machine No. 2: ($38,300 + $33,900 + $35,600 + $33,600) ÷ (160 + 140 + 130 + 140) = $248.07 Average conversion cost per ton for paper machine No. 2: ($18,900 + $15,200 + $18,400 + $17,000) ÷ (160 + 140 + 130 + 140) = $121.93 Average materials cost per ton for green paper: ($40,300 + $44,600 + $38,300 + $35,600) ÷ (150 + 150 + 160 + 130) = $269.15 Average conversion cost per ton for green paper: ($18,300 + $22,500 + $18,900 + $18,400) ÷ (150 + 150 + 160 + 130) = $132.37 Average materials cost per ton for yellow paper: ($41,700 + $36,100 + $33,900 + $33,600) ÷ (140 + 120 + 140 + 140) = $269.07 Average conversion cost per ton for yellow paper: ($21,200 + $18,100 + $15,200 + $17,000) ÷ (140 + 120 + 140 + 140) = $132.41

CHAPTER 20

Process Cost Systems

CP 20-4 a.

This accounting procedure has the effect of rewarding the production of broke. In essence, the procedure communicates to operating personnel that broke is a normal part of doing business. In fact, besides broke being a normal part of business, its production is attractive because of the favorable impact on direct materials costs of the papermaking operation. Recording broke as acceptable and favorable is inconsistent with a total quality perspective, which is based on the concept of producing the product right the first time, every time. Recycling is considered non-value-added in the context of a total quality perspective.

The accounting for broke that is typical in the industry fails to account for the total impact of broke. It is true that the use of recycled materials may reduce the direct materials cost to the operation. However, such a view is very limited. For example, the production of broke has a cost. Machine capacity was used to produce the broke in the first place. Therefore, broke has an original materials cost and a machine cost. Both of these together are likely to be greater than the cost of virgin material. One mill manager once commented, “There is a free paper machine out there.” What he was implying is that if all the machine capacity used to produce broke could be harnessed for good production, it would have been equal to a “free” paper machine. The cost of misused capacity is not captured by most accounting systems in the accounting for broke. There are other hidden costs. Broke production makes the total amount produced difficult to predict. As a result of this source of variation (broke), production schedules are difficult to maintain. For example, if a particular production run has a high amount of broke, then the scheduled run will need to be longer. The longer run, however, has ripple effects throughout the mill because all the following production runs will be delayed, as will downstream operations. Also, the complete recycle operation has a cost associated with it (flow control, piping, maintenance, etc.). Typical accounting systems aggregate the cost of the recycle operation with papermaking. Therefore, it is not made visible as a source of wasted resources.

CHAPTER 20

Process Cost Systems

CP 20-5 This case is abstracted from a real situation, where higher raw materials costs due to tin content were more than offset by lower energy costs. The cost system used in the real situation was a sophisticated “real-time” expense tracking system. The subtlety of this trade-off analysis is impressive. The first step is to translate the monthly materials and energy costs into their respective costs per unit of monthly production. In this way, the costs can be compared across the months. April Materials cost per unit…………………$0.28 Energy cost per unit…………………… 0.26 Total cost per unit………………………$0.54

May

June

July

Aug.

Sept.

$0.29 0.24

$0.30 0.22

$0.31 0.20

$0.32 0.19

$0.33 0.16

$0.53

$0.52

$0.51

$0.49

The graph below shows the total unit cost data for each month. $0.60

Cost per Unit

$0.50 $0.40 Materials cost per unit

$0.30

Energy cost per unit Total cost per unit

$0.20 $0.10 $0.00 April

May

June

July

Aug.

Sept.

Month

The graph reveals that the tin content and energy costs are inversely related. That is, as the materials cost increased due to higher tin content, the energy costs dropped. In fact, the total cost line shows that the energy savings exceeds the additional materials cost, due to higher tin content. Thus, the recommendation should be to purchase raw can stock with the tin content at the $0.33-per-unit level (September level). This is the material that minimizes the total production cost for this set of data. Additional data could be used to determine the optimal tin content, or the point where energy cost savings fail to overcome additional material costs.

CHAPTER 21 COST-VOLUME-PROFIT ANALYSIS DISCUSSION QUESTIONS 1.

Total variable costs change in proportion to changes in the level of activity. Unit variable costs remain the same regardless of the level of activity.

a. b.

Total fixed cost remains the same regardless of changes in the level of activity. Fixed cost per unit decreases as the activity level increases and increases as the activity level decreases.

Mixed costs are costs that have characteristics of both a variable and a fixed cost. The high-low method uses the highest and lowest activity levels and their related costs to estimate the variable cost per unit and the fixed cost. The total fixed cost does not change with changes in activity level. Thus, the difference in the total cost between the highest and lowest levels of activity is the change in the total variable cost. Dividing this difference by the difference in activity level is an estimate of the variable cost per unit. The fixed cost is then estimated by subtracting the total variable costs from the total costs for the level of activity.

a. b.

A high contribution margin ratio, coupled with idle capacity, indicates a potential for increased income from operations if additional sales can be made. A large percentage of each additional sales dollar would be available, after providing for variable costs, to cover promotion efforts and to increase income from operations. Thus, a substantial sales promotion campaign should be considered in order to expand sales to maximum capacity and to take advantage of the low ratio of variable costs to sales.

Decreases in unit variable costs, such as a decrease in the unit cost of direct materials, will decrease the break-even point.

Austin Company had lower fixed costs and a higher percentage of variable costs to sales than did Hill Company. Such a situation resulted in a lower break-even point for Austin Company.

The individual products are treated as components of one overall enterprise product. These components are weighted by the sales mix percentages when determining the contribution margin. Therefore, the sales mix affects the contribution margin and thus the break-even point.

10.

Operating leverage measures the relationship between a company’s contribution margin and income from operations. The difference between contribution margin and income from operations is fixed costs. Thus, companies with high fixed costs normally have a high operating leverage. Low operating leverage is normal for companies that are labor-intensive, such as professional service companies, which have low fixed costs.

Variable costs Variable costs

No impact on the contribution margin. Income from operations would decrease.

It is computed as follows: Operating Leverage =

Contribution Margin Income from Operations

CHAPTER 21

Cost-Volume-Profit Analysis

PRACTICE EXERCISES PE 21-1A a.

$20 per unit = ($3,200,000 – $2,400,000) ÷ (50,000 units – 10,000 units)

$2,200,000 = $3,200,000 – ($20 × 50,000 units), or $2,400,000 – ($20 × 10,000 units)

PE 21-1B a.

$16 per unit = ($551,000 – $495,000) ÷ (6,600 units – 3,100 units)

$445,400 = $551,000 – ($16 × 6,600 units), or $495,000 – ($16 × 3,100 units)

PE 21-2A a.

30.0% = ($60 – $42) ÷ $60, or ($5,400,000 – $3,780,000) ÷ $5,400,000

$18 per unit = $60 – $42

Sales……………………………………… $5,400,000 3,780,000 Variable costs…………………………… Contribution margin…………………… $1,620,000 550,000 Fixed costs……………………………… Income from operations………………… $1,070,000

(90,000 units × $60 per unit) (90,000 units × $42 per unit) (90,000 units × $18 per unit)

PE 21-2B a.

25% = ($16 – $12) ÷ $16, or ($1,984,000 – $1,488,000) ÷ $1,984,000

$4 per unit = $16 – $12

Sales……………………………………… $1,984,000 1,488,000 Variable costs…………………………… Contribution margin…………………… $ 496,000 144,000 Fixed costs……………………………… Income from operations………………… $ 352,000

(124,000 units × $16 per unit) (124,000 units × $12 per unit) (124,000 units × $4 per unit)

CHAPTER 21

Cost-Volume-Profit Analysis

PE 21-3A a.

7,800 units = $1,170,000 ÷ ($500 – $350)

5,850 units = $1,170,000 ÷ ($550 – $350)

PE 21-3B a.

2,600 units = $65,000 ÷ ($90 – $65)

1,625 units = $65,000 ÷ ($105 – $65)

PE 21-4A a.

60,000 units = $1,800,000 ÷ ($50 – $20)

69,000 units = ($1,800,000 + $270,000) ÷ ($50 – $20)

PE 21-4B a.

3,600 units = $180,000 ÷ ($220 – $170)

4,720 units = ($180,000 + $56,000) ÷ ($220 – $170)

PE 21-5A Unit selling price of E: [($125 × 0.40) + ($90 × 0.60)] Unit variable cost of E: [($85 × 0.40) + ($40 × 0.60)] Unit contribution margin of E

= =

$104 58 $ 46

Break-Even Sales (units) = 8,000 units = $368,000 ÷ $46 Break-Even Sales (units) for AA = 8,000 units of E × 40% = 3,200 units of Product AA Break-Even Sales (units) for BB = 8,000 units of E × 60% = 4,800 units of Product BB

PE 21-5B Unit selling price of E: [($40 × 0.70) + ($60 × 0.30)] Unit variable cost of E: [($15 × 0.70) + ($25 × 0.30)] Unit contribution margin of E

= =

$46 18 $28

Break-Even Sales (units) = 16,400 units = $459,200 ÷ $28 Break-Even Sales (units) for QQ = 16,400 units of E × 70% = 11,480 units of Product QQ Break-Even Sales (units) for ZZ = 16,400 units of E × 30% = 4,920 units of Product ZZ

CHAPTER 21

Cost-Volume-Profit Analysis

PE 21-6A Operating Leverage =

Contribution Margin Income from Operations

$190,000 $95,000

= 2

Contribution Margin Income from Operations

$352,000 $220,000

= 1.6

PE 21-6B Operating Leverage =

PE 21-7A Margin of Safety =

Sales – Sales at Break-Even Point Sales $36,400,000 – $24,024,000 $36,400,000

= 34%

PE 21-7B Margin of Safety = =

Sales – Sales at Break-Even Point Sales $740,000 – $547,600 $740,000

= 26%

CHAPTER 21

Cost-Volume-Profit Analysis

EXERCISES Ex. 21-1 1. 2. 3. 4. 5. 6. 7. 8.

Variable Fixed Variable Variable Variable Variable Fixed Fixed

9. 10. 11. 12. 13. 14. 15.

Variable Variable Mixed Mixed Fixed Variable Variable

d. e.

Cost Graph One Cost Graph One

4. 5. 6.

f b d

Ex. 21-2 a. b. c.

Cost Graph Four Cost Graph Two Cost Graph Three

Ex. 21-3 1. 2. 3.

a c e

Ex. 21-4 1. 2. 3.

e f c

For 3, c is better than b because the administrative costs would be the same for expensive and inexpensive cars.

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-5 a. b. c. d. e.

Variable Variable Fixed Variable Fixed

f. g. h. i. j.

Fixed Fixed* Fixed Variable Variable

* The developer salaries are fixed because they are more variable to the number of titles or releases than to the number of units sold. For example, a title could sell one copy or a million copies and the salaries of the developers would not be affected.

Ex. 21-6 Components produced………………

45,000

60,000

Total costs: Total variable costs……………… Total fixed costs………………… Total costs…………………………

$1,350,000 (d) 810,000 (e) $2,160,000 (f)

$1,800,000 (j) 810,000 (k) $2,610,000 (l)

$2,250,000 810,000 $3,060,000

$30.00 (g) 18.00 (h) $48.00 (i)

$30.00 (m) 13.50 (n) $43.50 (o)

$30.00 10.80 $40.80

Cost per unit: Variable cost per unit……………(a) Fixed cost per unit……………… (b) Total cost per unit………………… (c)

75,000

Supporting calculations: a.

$30.00 ($1,350,000 ÷ 45,000 units)

$18.00 ($810,000 ÷ 45,000 units)

$48.00 ($30.00 + $18.00)

$1,800,000 ($30.00 × 60,000)

$810,000 (fixed costs do not change with volume)

$2,610,000 ($1,800,000 + $810,000)

$30.00 ($1,800,000 ÷ 60,000 units; variable costs per unit do not change with changes in volume)

h. i.

$13.50 ($810,000 ÷ 60,000 units) $43.50 ($30.00 + $13.50)

$2,250,000 ($30.00 × 75,000 units)

$810,000 (fixed costs do not change with volume)

$3,060,000 ($2,250,000 + $810,000)

m. $30.00 ($2,250,000 ÷ 75,000 units; variable costs per unit do not change with changes in volume) n.

$10.80 ($810,000 ÷ 75,000 units)

$40.80 ($30.00 + $10.80)

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-7 a.

Variable Cost per Unit =

Difference in Total Costs Difference in Units Produced

$24,090,000 – $19,200,000 90,000 units – 60,000 units

$4,890,000 30,000 units

= $163.00 per unit

The fixed cost can be determined by subtracting the estimated total variable cost from the total cost at either the highest or lowest level of production, as follows: Total Cost = (Variable Cost per Unit × Units Produced) + Fixed Costs Highest level: $24,090,000 = ($163.00 × 90,000 units) + Fixed Costs $24,090,000 = $14,670,000 + Fixed Costs $9,420,000 = Fixed Costs Lowest level: $19,200,000 = ($163.00 × 60,000 units) + Fixed Costs $19,200,000 = $9,780,000 + Fixed Costs $9,420,000 = Fixed Costs b.

Total Cost = (Variable Cost per Unit × Units Produced) + Fixed Costs Total cost for 86,000 units: Variable cost: Units………………………………………… Variable cost per unit……………………… Total variable cost………………………… Fixed costs……………………………………… Total cost………………………………………

86,000 × $163.00 $14,018,000 9,420,000 $23,438,000

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-8 Variable Cost per = Gross-Ton Mile

Difference in Total Costs Difference in Gross-Ton Miles

$2,700,000 – $1,440,000 1,000,000 gross-ton miles – 400,000 gross-ton miles

$1,260,000 600,000 gross-ton miles

= $2.10 per gross-ton mile

The fixed costs can be determined by subtracting the estimated total variable cost from the total cost at either the highest or lowest level of gross-ton mile, as follows: Total Cost = (Variable Cost per Gross-Ton Mile × Gross-Ton Miles) + Fixed Costs Highest level: $2,700,000 = ($2.10 × 1,000,000 gross-ton miles) + Fixed Costs $2,700,000 = $2,100,000 + Fixed Costs $600,000 = Fixed Costs Lowest level: $1,440,000 = ($2.10 × 400,000 gross-ton miles) + Fixed Costs $1,440,000 = $840,000 + Fixed Costs $600,000 = Fixed Costs

Ex. 21-9 a.

Sales…………………………………………………………………………….. $1,800,000 Variable costs…………………………………………………………………… 1,116,000 Contribution margin…………………………………………………………… $ 684,000 Contribution = Margin Ratio =

Sales – Variable Costs Sales $684,000 $1,800,000

= 38%

Sales…………………………………………………………………………….. $2,500,000 42% Contribution margin ratio……………………………………………………… × Contribution margin…………………………………………………………… $1,050,000 590,000 Less fixed costs………………………………………………………………… Income from operations……………………………………………………… $ 460,000

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-10 a. Sales (in millions)……………………………………………………………………

$12,718.9

Variable costs (in millions): Food and packaging…………………………………………………………… Payroll…………………………………………………………………………… General, selling, and administrative expenses (40% × $2,231.3)……… Total variable costs…………………………………………………………

$ 4,033.5 3,528.5 892.5 $ 8,454.5

Contribution margin (in millions)…………………………………………………

$ 4,264.4

Contribution Margin Ratio =

Sales – Variable Costs Sales

$4,264.4 million = 33.5% $12,718.9 million

c. Same-store sales increase (in millions)………………………………………… Contribution margin ratio [from part (b)]……………………………………… Increase in income from operations (in millions)……………………………

$500.0 × 33.5% $167.5

Note to Instructors: Part (c) emphasizes “same-store sales” because of the assumption of no change in fixed costs. McDonald’s will also increase sales from opening new stores. However, the impact on income from operations for these additional store sales would need to include an increase in fixed costs in the computation.

Ex. 21-11 a.

Break-Even Sales (units) =

Sales (units) =

Fixed Costs Unit Contribution Margin $12,600,000 $540 – $360

= 70,000 units

Fixed Costs + Target Profit Unit Contribution Margin $12,600,000 + $810,000 $540 – $360

= 74,500 units

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-12

Cost of goods sold………………………… Selling, general, and administrative expenses……………………….…………

Cost of goods sold………………………… Selling, general, and administrative expenses……………………….………… Total fixed costs………………………

Total Cost (in millions) $20,360 16,438 Total Cost (in millions) $20,360 16,438

Total Amount (in millions) $54,619 Net sales…………………………………… Variable cost of goods sold……………… 15,270 Variable selling, general, 8,219 and administrative expenses………… Break-Even Sales (units) =

Variable Cost Percentage × 75% = ×

50%

Variable Cost (in millions) – $15,270 = –

8,219

÷ ÷

Number of Barrels (in millions) 400 400

= =

400

Variable Cost (in millions) $15,270 8,219 Fixed Cost (in millions) $ 5,090 8,219 $13,309

Per-Unit Amount $136.55 38.18 20.55

Fixed Costs Unit Contribution Margin 1

$13,309 million $136.55 2 – $38.18 3 – $20.55 4

= 171 million barrels The variable costs per unit are determined by multiplying the total amount of each cost by the variable cost percentage (75% for cost of goods sold and 50% for selling, general, and administrative expenses), then dividing by the number of barrels. 1

($20,360,000,000 × 25%) + ($16,438,000,000 × 50%) $54,619,000,000 ÷ 400,000,000 3 ($20,360,000,000 × 75%) ÷ 400,000,000 4 ($16,438,000,000 × 50%) ÷ 400,000,000 2

Break-Even Sales (units) =

$13,309 million + $300 million $136.55 – $38.18 – $20.55

= 175 million barrels Ex. 21-13 a.

Break-Even Sales (units) = =

Fixed Costs Unit Contribution Margin $2,550,000 $750 – $600

= 17,000 units

Fixed Costs Unit Contribution Margin $2,550,000 $800 – $600

= 12,750 units

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-14 Fixed Costs Unit Contribution Margin

Break-Even Sales (units) =

= Variable Cost per Unit =

$4,000 $18 – X

= 2,000 units

$4,000 = 2,000 × ($18 – X)

$4,000 2,000 units

$2 = $18 – X

$16

= $18 – X

Ex. 21-15 The cost of the promotional campaign is the fixed cost in this analysis because we’re trying to determine the break-even adoption rate of the campaign. The contribution margin earned per new subscriber is essentially the revenue earned less the variable cost over the 14-month subscription period. Revenue: (14 mos. – 2 free mos.) × $10/mo. = $120 per new account Variable cost: 14 mos. × $5/mo. = $70 per new account Note: The variable cost is for 14 months because the costs are incurred, even during the free months. The break-even number of subscribers necessary to cover the fixed cost of the promotion is computed as follows: Break-Even =

Fixed Costs Contribution Margin per Unit $4,200,000 $120 – $70

= 84,000 accounts

Therefore, if ESPN.com yielded more than 84,000 new subscribers out of the promotional campaign, the costs of the campaign would be covered.

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-16 a.

Break-Even =

Fixed Costs Revenue per Account – Variable Cost per Account $18,241.5 million 3 $1,030.71 – $359.0 2

= 27.2 million (rounded) accounts 1

Revenue per account (in millions): $33,600 million ÷ 32.6 million = $1,030.7 (rounded)

Variable cost per account (in millions, except variable cost per account): Cost of revenue………………………………………………

$13,389

Selling, general, and administrative expenses…………

7,774

70% = $ 9,372.3 2,332.2 30% =

Divided by number of accounts……………………………

$11,704.5 32.6 ÷

Variable cost per account (rounded)………………………

Total variable cost……………………………………………

Fixed costs (in millions): Cost of revenue………………………………………………

$13,389

30% = $ 4,016.7

Selling, general, and administrative expenses…………

7,774

70% =

Depreciation……………………………………………………

8,783

× 100% =

Total fixed costs………………………………………………

359.0

Break-Even =

5,441.8 8,783.0 $18,241.5

Fixed Cost Revenue per Account – Variable Cost per Account

32.6 million accounts =

$18,241.5 million X – $359.0

32.6X – $11,703.4* =

$18,241.5

32.6X =

$29,944.9

X =

$918.6 million (rounded)

* Difference between $11,704.5 in Part (a) and $11,703.4 is due to rounding. Note to Instructors: The rate charged per minute and the number of average minutes of digital service influence the revenue per account. An interesting question is whether the costs are variable to the number of minutes or number of accounts. If we assume that the costs are variable to the number of minutes, then the break-even analysis revolves around the number of minutes. More likely, the costs are variable to the number of accounts for this business (mostly customer acquisition and service costs), while the variable cost per minute is likely to be small.

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-17 a.

$1,500,000 (the intersection of the total sales line and the total costs line)

The graphic format permits the user (management) to visually determine the break-even point and the operating profit or loss for any given level of sales.

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-18 a.

$600,000 (total fixed costs)

Sales (20,000 units × $125)……………………………… Fixed costs………………………………………………… $ 600,000 Variable costs (20,000 units × $75)……………………… 1,500,000 Income from operations……………………………………

$2,500,000* 2,100,000 $ 400,000

* 20,000 units = $2,500,000 maximum sales ÷ $125 unit selling price

12,000 units (the intersection of the profit line and the horizontal axis)

Ex. 21-19 Cost-volume-profit chart a. b. c.

break-even point operating loss area total fixed costs

d. e. f.

total costs line operating profit area total sales line

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-20 Profit-volume chart a. b. c. d. e. f.

break-even point total fixed costs operating loss area maximum operating profit profit line operating profit area

Ex. 21-21 a.

Unit Selling Price of E = ($95 × 60%) + ($115 × 40%) = $57 + $46 = $103 Unit Variable Cost of E = ($55 × 60%) + ($75 × 40%) = $33 + $30 = $63 Unit Contribution Margin of E = $103 – $63 = $40 Break-Even Sales (units) =

= b.

Fixed Costs Unit Contribution Margin $712,000 $40

= 17,800 units

10,680 units of baseball bats (17,800 units × 60%) 7,120 units of baseball gloves (17,800 units × 40%)

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-22 a.

Unit contribution margin of overall product (E): Unit selling price of E [(10% × $800) + (90% × $300)]………………………$350 Unit variable cost of E [(10% × $140) + (90% × $120)]…………………… 122 Unit contribution margin of E………………………………………………… $228 Fixed costs of the Los Angeles to Kona round-trip flight: Fuel………………………………………………… Flight crew salaries…………………………… Airplane depreciation………………………… Total fixed costs…………………………………

$ 7,000 3,200 3,480 $13,680

Break-even sales (units) of overall product: Break-Even Sales (units) =

Fixed Costs Unit Contribution Margin $13,680 $228 per seat

= b.

= 60 seats (tickets)

Business class break-even (60 seats × 10%)……………………… Economy class break-even (60 seats × 90%)……………………… Total break-even…………………………………………………………

Ex. 21-23 a. (1)

6 seats 54 seats 60 seats

Margin of Safety (dollars) = Sales – Sales at Break-Even Point = $1,450,000 – $1,160,000 = $290,000

(2)

Margin of Safety (percentage) =

Sales – Sales at Break-Even Point Sales

= $290,000 ÷ $1,450,000 = 20% b.

The break-even point (S) is determined as follows: Break-Even Sales (dollars) = Total Fixed Costs + Total Variable Costs (at Break-Even) Break-Even Sales (dollars) = Total Fixed Costs + 80% Break-Even Sales (dollars) Break-Even Sales (dollars) = $2,500,000 + 80% Break-Even Sales (dollars) Break-Even Sales (dollars) – 80% Break-Even Sales (dollars) = $2,500,000 20% Break-Even Sales (dollars) = $2,500,000 Break-Even Sales (dollars) = $12,500,000 If the margin of safety is 20%, the actual sales are determined as follows: Sales = Break-Even Sales (dollars) + (Sales × Margin of Safety) Sales (dollars) = $12,500,000 + 20% Sales Sales – 20% Sales = $12,500,000 80% Sales = $12,500,000 Sales = $15,625,000

CHAPTER 21

Cost-Volume-Profit Analysis

Ex. 21-24 If 420,000 units are sold and sales at the break-even point are 472,500 units, there is no margin of safety.

Ex. 21-25 a.

Beck Inc.: Operating Leverage =

Contribution Margin Income from Operations $500,000 $100,000

= 5.0

Bryant Inc.: Operating Leverage =

Contribution Margin Income from Operations $750,000 $300,000

= 2.5

Beck Inc.’s income from operations would increase by 100% (5.0 × 20%), or $100,000 (100% × $100,000), and Bryant Inc.’s income from operations would increase by 50% (2.5 × 20%), or $150,000 (50% × $300,000).

The difference in the increases of income from operations is due to the difference in the operating leverages. Beck Inc.’s higher operating leverage means that its fixed costs are a larger percentage of contribution margin than are Bryant Inc.’s. Thus, increases in sales increase operating profit at a faster rate for Beck Inc. than for Bryant Inc.

Appendix Ex. 21-26 a. b. c.

Variable cost of goods sold Variable selling and administrative expenses Fixed costs

CHAPTER 21

Cost-Volume-Profit Analysis

Appendix Ex. 21-27 a. Rhys Company Income Statement—Variable Costing For the Month Ended July 31 Sales Variable cost of goods sold: Variable cost of goods manufactured Less ending inventory (24,000 units × $24.90) Variable cost of goods sold Manufacturing margin Variable selling and administrative expenses Contribution margin Fixed costs: Fixed manufacturing costs Fixed selling and administrative expenses Income from operations

$4,440,000 $2,988,000 597,600 2,390,400 $2,049,600 115,200 $1,934,400 $ 132,000 172,800

304,800 $1,629,600

Computations: Variable cost of goods manufactured: $3,120,000 – $132,000 = $2,988,000 Units Sold = Units Manufactured – Units in Ending Inventory 96,000 = Units Manufactured – 24,000 120,000 = Units Manufactured Unit cost of ending inventory: Variable cost of goods manufactured per unit: $2,988,000 ÷ 120,000 units manufactured = $24.90 Thus, variable cost of goods sold could alternatively be calculated: $2,390,400 = 96,000 units × $24.90/unit Fixed selling and administrative expenses: $288,000 – $115,200 = $172,800 b.

Absorption costing income from operations………………………… $1,656,000 1,629,600 Variable costing income from operations…………………………… Difference……………………………………………………………….…… $ 26,400 Note: The difference between the two income numbers can be reconciled as follows: Unit change in inventory………………… 24,000 units Fixed manufacturing cost per unit……… × $1.10 ($132,000 ÷ 120,000 units) Income from operations difference…… $26,400

CHAPTER 21

Cost-Volume-Profit Analysis

Appendix Ex. 21-28 a. Tudor Manufacturing Co. Income Statement—Absorption Costing For the Month Ended June 30 Sales Cost of goods sold: Cost of goods manufactured (500,000 units × $14.32) Less ending inventory (80,000 units × $14.32) Cost of goods sold Gross profit Selling and administrative expenses ($80,000 + $75,000) Income from operations

$7,450,000 $7,160,000 1,145,600 6,014,400 $1,435,600 155,000 $1,280,600

Computations: Cost of goods manufactured: $7,000,000 + $160,000 = $7,160,000 Unit cost of ending inventory: Total cost of goods manufactured: $7,160,000 ÷ 500,000 units manufactured = $14.32 b.

Variable costing income from operations…………………………………… $1,255,000 Absorption costing income from operations………………………………… 1,280,600 Difference…………………………………………………………………………… $ 25,600 Note: The difference between the two income numbers can be reconciled as follows: Unit change in inventory……………………… Fixed manufacturing cost per unit…………… Income from operations difference…………

80,000 units × $0.32 ($160,000 ÷ 500,000 units) $25,600

CHAPTER 21

Cost-Volume-Profit Analysis

PROBLEMS Prob. 21-1A Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t.

Fixed Cost

Variable Cost

Mixed Cost

X X X X X X X X X X X X X X X X X X X X

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-2A 1. Cost of goods sold…………… Selling expenses……………… Administrative expenses……… Total variable cost……………

Cost of goods sold…………… Selling expenses……………… Administrative expenses……… Total fixed cost……………… 2. Sales……………………………… Variable costs…………………… Contribution margin……………

Total Cost $25,000,000 4,000,000 3,000,000 $32,000,000

Total Cost $25,000,000 4,000,000 3,000,000

Total Amount $47,000,000 22,000,000 $25,000,000

× ×

Variable Cost Percentage 70% 75%

= =

50%

– – –

÷ ÷

Variable Cost $17,500,000 3,000,000 1,500,000 $22,000,000 Number of Units 500,000 500,000

= = =

Variable Cost $17,500,000 3,000,000 1,500,000 $22,000,000 Fixed Cost $ 7,500,000 1,000,000 1,500,000 $10,000,000

= =

Per Unit $94.00 44.00 $50.00

a. $44 ($22,000,000 ÷ 500,000 units) b. $50 ($94 – $44) 3. Break-Even Sales (units)

4. Break-Even Sales (units)

Fixed Costs Unit Contribution Margin $10,000,000 $50 per unit

= 200,000 units

Fixed Costs Unit Contribution Margin

$10,000,000 + $1,800,000 $50 per unit

5. Sales (units) =

Fixed Costs + Target Profit Unit Contribution Margin

$11,800,000 + $15,000,000 $50 per unit

6. Sales ($47,000,000 + $3,760,000)…………………………… Less: Fixed costs…………………………………………… Variable costs (540,000* units × $44)…………… Income from operations………………………………………

$26,800,000 $50 per unit

= 236,000 units

536,000 units $50,760,000

$11,800,000 23,760,000

35,560,000 $15,200,000

* ($3,760,000 ÷ $94) + 500,000 7. Present income from operations…………………………… Less additional fixed costs………………………………… Income from operations………………………………………

$15,000,000 1,800,000 $13,200,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-2A (Concluded) 8.

In favor of the proposal is the possibility of increasing income from operations from $15,000,000 to $15,200,000. However, there are many points against the proposal, including: a.

The break-even point increases by 36,000 units (from 200,000 to 236,000).

The sales necessary to maintain the current income from operations of $15,000,000 would be 536,000 units, or $3,384,000 (36,000 units × $94) in excess of current sales.

If future sales remain at the current level, the income from operations of $15,000,000 will decline to $13,200,000.

The company should determine the sales potential if the additional product is produced and then evaluate the advantages and disadvantages enumerated above, in light of these sales possibilities.

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-3A 1.

Break-Even = Sales (units) =

Total Fixed Costs Unit Contribution Margin $480,000 $40*

Total Fixed Costs Unit Selling Price – Unit Variable Cost

= 12,000 units

* $100 unit selling price – $60 unit variable cost

Sales (units) =

Fixed Costs + Target Profit Unit Contribution Margin $480,000 + $240,000 $40 $720,000 $40

= 18,000 units

Total Sales Total Costs

4. Sales (16,000 × $100)……………………………… Total fixed costs…………………………………… Total variable costs (16,000 × $60)……………… Income from operations…………………………

$1,600,000 $480,000 960,000

1,440,000 $ 160,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-4A 1.

$75,000 30% = $250,000

Total Fixed Costs Contribution Margin Ratio

$250 Unit Selling Price – $175 Unit Variable Cost $250 Unit Selling Price

Unit Contribution Margin Unit Selling Price

$75,000 $250 Unit Selling Price – $175 Unit Variable Cost

Unit Contribution Margin

Total Fixed Costs

Cost-Volume-Profit Analysis

Total Fixed Costs

Unit Selling Price – Unit Variable Cost Unit Selling Price

1,000 units

Unit Selling Price – Unit Variable Cost

= 30%

21-25

or Break-Even (dollars) = 1,000 units × $250 per unit = $250,000

Break-Even (dollars) =

Contribution Margin Ratio =

Break-Even Dollars:

Break-Even Sales (units) =

Break-Even Units:

Prob. 21-4A (Continued)

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-4A (Continued) 2.

Units sold: $500,000 ÷ $250 per unit = 2,000 units

Sales………………………………………………………………… Variable costs……………………………………………………… Fixed costs………………………………………………………… Total costs………………………………………………………… Income from operations…………………………………………

a. 2,000 units

b. 2,500 units

$500,000

$625,000

$350,000 75,000 $425,000 $ 75,000

$437,500 75,000 $512,500 $112,500

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-4A (Continued) 3.

$75,000 + $33,750 30% =

Total Fixed Costs Contribution Margin Ratio $362,500

$250 Unit Selling Price – $175 Unit Variable Cost $250 Unit Selling Price

$75,000 + $33,750 $250 – $175 Unit Contribution Margin Unit Selling Price

Total Fixed Costs Unit Contribution Margin

Cost-Volume-Profit Analysis

= 30%

Unit Selling Price – Unit Variable Cost Unit Selling Price

1,450 units

Total Fixed Costs Unit Selling Price – Unit Variable Cost

21-28

or Break-Even (dollars) = 1,450 units × $250 per unit = $362,500

Break-Even (dollars) =

Contribution Margin Ratio =

Break-Even Dollars:

Break-Even Sales (units) =

Break-Even Units:

Prob. 21-4A (Continued)

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-4A (Concluded) 4.

a. 2,000 units

b. 2,500 units

Sales………………………………………………………………… $500,000 Variable costs……………………………………………………… $350,000 Fixed costs………………………………………………………… 108,750 Total costs………………………………………………………… $458,750 Income from operations………………………………………… $ 41,250

$625,000 $437,500 108,750 $546,250 $ 78,750

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-5A (Overall product is labeled E.) 1.

Unit selling price of E [($1,600 × 40%) + ($850 × 60%)]……………………………$1,150 530 Unit variable cost of E [($800 × 40%) + ($350 × 60%)]…………………………… Unit contribution margin of E………………………………………………………… $ 620 Fixed Costs Unit Contribution Margin

Break-Even Sales (units) =

$2,498,600 = 4,030 units $620 per unit

4,030 units of E × 40% = 1,612 units of laptops 4,030 units of E × 60% = 2,418 units of tablets

Unit selling price of E [($1,600 × 50%) + ($850 × 50%)]……………………………$1,225 575 Unit variable cost of E [($800 × 50%) + ($350 × 50%)]…………………………… $ 650 Unit contribution margin of E………………………………………………………… Fixed Costs Unit Contribution Margin

Break-Even Sales (units) = =

$2,498,600 = 3,844 units $650 per unit

3,844 units of E × 50% = 1,922 units of laptops 3,844 units of E × 50% = 1,922 units of tablets The break-even point is lower in this scenario than in part (1) because the sales mix is weighted more heavily toward the product with the higher contribution margin per unit of product.

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-6A 1. Wolsey Industries Inc. Estimated Income Statement For the Year Ended December 31, 20Y8 Sales (21,875 × $160) Cost of goods sold: Direct materials (21,875 × $46) Direct labor (21,875 × $40) Factory overhead [$200,000 + (21,875 × $20)] Cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries and commissions [$110,000 + (21,875 × $8)] Advertising Travel Miscellaneous selling expense [$7,600 + (21,875 × $1)]

$3,500,000 $1,006,250 875,000 637,500 2,518,750 $ 981,250

$285,000 40,000 12,000 29,475

Total selling expenses Administrative expenses: Office and officers’ salaries Supplies [$10,000 + (21,875 × $4)] Miscellaneous administrative expense [$13,400 + (21,875 × $1)] Total administrative expenses Total expenses Income from operations

$ 366,475 $132,000 97,500 35,275 264,775 631,250 $ 350,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-6A (Continued) 2.

Contribution Margin Ratio =

Break-Even Sales (units) =

Break-Even Sales (dollars) =

Sales – Variable Costs Sales $3,500,000 – (21,875 × $120) $3,500,000 $875,000 $3,500,000

= 25%

Fixed Costs Unit Contribution Margin $525,000 $160 – $120

= 13,125 units

Fixed Costs Contribution Margin Ratio $525,000 25%

= $2,100,000

or Break-Even Sales (dollars) = 13,125 units × $160 per unit = $2,100,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-6A (Concluded) 4.

Total Sales Total Costs

Margin of safety: In dollars: Expected sales (21,875 × $160)……………………………… $3,500,000 Break-even point (13,125 × $160)……………………………… 2,100,000 Margin of safety………………………………………………… $1,400,000 As a percentage of sales: Margin of Safety =

Operating Leverage =

Sales – Sales at Break-Even Point Sales $1,400,000 $3,500,000

= 40%

Contribution Margin Income from Operations 21,875 units × $40 $350,000

$875,000 $350,000

= 2.5

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-1B Cost a. b. c. d. e. f. g. h. i. j. k. l. m. n. o. p. q. r. s. t.

Fixed Cost

Variable Cost

Mixed Cost

X X X X X X X X X X X X X X X X X X X X

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-2B 1.

Total Cost Cost of goods sold………………… Selling expenses…………………… Administrative expenses………… Total variable cost………………

$1,280,000 320,000 620,000

× × ×

– – –

2. Total Amount $3,150,000 ÷ 1,400,000 ÷ $1,750,000

Sales………………………………… Variable costs……………………… Contribution margin……………… a. b. 3.

Break-Even Sales (units) =

Break-Even Sales (units) = =

Sales (units) =

$ 960,000 192,000 248,000

Variable Cost $960,000 = 192,000 = 248,000 = $1,400,000 Number of Units 35,000 35,000

= =

Fixed Cost $320,000 128,000 372,000 $820,000

Per Unit $90.00 40.00 $50.00

Fixed Costs Unit Contribution Margin $820,000 $50 per unit

= 16,400 units

Fixed Costs Unit Contribution Margin $820,000 + $270,000 $50 per unit

21,800 units

40,400 units

Fixed Costs + Target Profit Unit Contribution Margin

= 6.

= = =

$40 ($1,400,000 ÷ 35,000 units) $50 ($90 – $40)

= 4.

75% 60% 40%

Variable Cost

$1,400,000 Total Cost $1,280,000 320,000 620,000

Cost of goods sold………………… Selling expenses…………………… Administrative expenses………… Total fixed cost…………………

Variable Cost Percentage

$1,090,000 + $930,000 $50 per unit

Sales ($3,150,000 + $720,000)…………………………… Less: Fixed costs……………………………………… Variable costs (43,000* units × $40)……… Income from operations…………………………………

$2,020,000 $50 per unit

$3,870,000 $1,090,000 1,720,000

2,810,000 $1,060,000

* ($720,000 ÷ $90) + 35,000 7.

Present income from operations……………………… Less additional fixed costs……………………………… Income from operations…………………………………

$930,000 270,000 $660,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-2B (Concluded) 8.

In favor of the proposal is the possibility of increasing income from operations from $930,000 to $1,060,000. However, there are many points against the proposal, including: a.

The break-even point increases by 5,400 units (from 16,400 to 21,800).

The sales necessary to maintain the current income from operations of $930,000 would be 40,400 units, or $486,000 (5,400 units × $90) in excess of current sales.

If future sales remain at the current level, the income from operations of $930,000 will decline to $660,000.

The company should determine the sales potential if the additional product is produced and then evaluate the advantages and disadvantages enumerated above, in light of these sales possibilities.

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-3B 1.

Total Fixed Costs Break-Even = = Unit Contribution Margin Sales (units) =

$800,000 $40*

Total Fixed Costs Unit Selling Price – Unit Variable Cost

= 20,000 units

* $150 unit selling price – $110 unit variable cost

Sales (units) =

Total Fixed Costs + Target Profit Unit Contribution Margin

$800,000 + $300,000 $40 per unit

$1,100,000 $40 per unit

= 27,500 units

Sales (32,000 × $150)…………………………… Total fixed costs…………………………………… Total variable costs (32,000 × $110)…………… Income from operations…………………………

$4,800,000 $ 800,000 3,520,000

4,320,000 $ 480,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-4B 1.

1. =

Total Fixed Costs

$225,000 37.5% = $600,000

Total Fixed Costs Contribution Margin Ratio

= 37.5%

Unit Selling Price – Unit Variable Cost Unit Selling Price

$200 Unit Selling Price – $125 Unit Variable Cost $200 Unit Selling Price

Unit Contribution Margin Unit Selling Price

= 3,000 units

Unit Selling Price – Unit Variable Cost

$225,000 $200 Unit Selling Price – $125 Unit Variable Cost

Unit Contribution Margin

Total Fixed Costs

Cost-Volume-Profit Analysis

or Break-Even (dollars) = 3,000 units × $200 per unit = $600,000

Break-Even (dollars) =

Contribution Margin Ratio =

Break-Even Dollars:

Break-Even Sales (units) =

Break-Even Units:

Prob. 21-4B (Continued)

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-4B (Continued) 2.

a. 4,500 units

b. 7,500 units

Sales…………………………………………………………… $900,000 Variable costs………………………………………………… $562,500 Fixed costs…………………………………………………… 225,000 Total costs…………………………………………………… $787,500 Income from operations…………………………………… $112,500

$1,500,000 $ 937,500 225,000 $1,162,500 $ 337,500

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-4B (Continued) 3.

$225,000 + $112,500 37.5%

Total Fixed Costs Contribution Margin Ratio = $900,000

= 37.5%

21-42

= 4,500 units

Unit Selling Price – Unit Variable Cost Unit Selling Price

$200 Unit Selling Price – $125 Unit Variable Cost $200 Unit Selling Price

or Break-Even (dollars) = 4,500 units × $200 per unit = $900,000

Break-Even (dollars) =

Unit Contribution Margin Unit Selling Price

$225,000 + $112,500 $200 Unit Selling Price – $125 Unit Variable Cost

Total Fixed Costs Unit Selling Price – Unit Variable Cost

Total Fixed Costs Unit Contribution Margin =

Cost-Volume-Profit Analysis

Contribution Margin Ratio =

Break-Even Dollars:

Break-Even Sales (units)

Break-Even Units:

Prob. 21-4B (Continued)

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-4B (Concluded) 4.

a. 6,000 units

b. 7,500 units

Sales…………………………………………………………… $1,200,000 Variable costs………………………………………………… $ 750,000 Fixed costs……………………………………………………… 337,500 Total costs……………………………………………………… $1,087,500 Income from operations……………………………………… $ 112,500

$1,500,000 $ 937,500 337,500 $1,275,000 $ 225,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-5B (Overall product is labeled E.) 1.

Unit selling price of E [($13 × 20%) + ($16 × 80%)]……………………………… $15.40 Unit variable cost of E [($4 × 20%) + ($5 × 80%)]………………………………… 4.80 Unit contribution margin of E……………………………………………………… $10.60 Break-Even Sales (units) =

Fixed Costs Unit Contribution Margin

$55,120 = 5,200 units $10.60 per unit

5,200 units of E × 20% = 1,040 units of 12" pizza 5,200 units of E × 80% = 4,160 units of 16" pizza

Unit selling price of E [($13 × 50%) + ($16 × 50%)]……………………………… $14.50 Unit variable cost of E [($4 × 50%) + ($5 × 50%)]………………………………… 4.50 Unit contribution margin of E……………………………………………………… $10.00 Fixed Costs Unit Contribution Margin

Break-Even Sales (units) = =

$55,120 $10.00

= 5,512 units

5,512 units of E × 50% = 2,756 units of 12" pizza 5,512 units of E × 50% = 2,756 units of 16" pizza The break-even point is higher in scenario 2 because the mix changes to be less weighted toward the higher-contribution-margin-per-unit product in part (3).

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-6B 1. Belmain Co. Estimated Income Statement For the Year Ended December 31, 20Y7 Sales (12,000 × $240) Cost of goods sold: Direct materials (12,000 × $50) Direct labor (12,000 × $30) Factory overhead [$350,000 + (12,000 × $6)] Cost of goods sold Gross profit Expenses: Selling expenses: Sales salaries and commissions [$340,000 + (12,000 × $4)] Advertising Travel Miscellaneous selling expense [$2,300 + (12,000 × $1)]

$2,880,000 $600,000 360,000 422,000 1,382,000 $1,498,000

$388,000 116,000 4,000 14,300

Total selling expenses Administrative expenses: Office and officers’ salaries Supplies [$6,000 + (12,000 × $4)] Miscellaneous administrative expense [$8,700 + (12,000 × $1)] Total administrative expenses Total expenses Income from operations

$522,300 $325,000 54,000 20,700 399,700 922,000 $ 576,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-6B (Continued) 2.

Contribution Margin Ratio =

Break-Even Sales (units) =

Break-Even Sales (dollars) =

Sales – Variable Costs Sales $2,880,000 – (12,000 × $96) $2,880,000 $1,728,000 $2,880,000

= 60%

Fixed Costs Unit Contribution Margin $1,152,000 $240 – $96

= 8,000 units

Fixed Costs Contribution Margin Ratio $1,152,000 60%

= $1,920,000

or Break-Even Sales (dollars) = 8,000 units × $240 per unit = $1,920,000

CHAPTER 21

Cost-Volume-Profit Analysis

Prob. 21-6B (Concluded) 4.

Margin of safety: In dollars: Expected sales (12,000 units × $240)………………………… $2,880,000 1,920,000 Break-even point (8,000 units × $240)……………………… Margin of safety………………………………………………… $ 960,000 As a percentage of sales: Margin of Safety =

Operating Leverage =

Sales – Sales at Break-Even Point Sales $960,000 $2,880,000

= 33.3%

Contribution Margin Income from Operations 12,000 units × $144* $576,000

$1,728,000 $576,000

= 3

* Unit Contribution = Unit Selling Price – Unit Variable Cost $144 = $240 – $96

CHAPTER 21

Cost-Volume-Profit Analysis

CASES & PROJECTS CP 21-1 In an absolute sense, Edward’s actions are devious. He is clearly attempting to use the first four-year scenario, which is favorable, as a way to market the partnerships. They are really longer-term investments. After the first four years, the risk increases dramatically. The break-even occupancy becomes more difficult to achieve at 95% than it does at 65%. Focusing on the 65% and remaining silent about the increase to 95% is deceptive. One might argue “let the buyer beware.” After all, the information is in the fine print. A little spadework would reveal the longer-term reality of these partnerships. This is not a compelling argument. Clearly, Edward is putting a favorable spin on this offering. It’s likely that this will come back to haunt him in a court of law. Some investors may claim they were defrauded by less than complete disclosure. Edward has a responsibility to provide objective information. The integrity standard requires that Edward communicate constraints that would preclude the successful performance of an activity. Also, Edward must communicate unfavorable as well as favorable information. Clearly, the increase in the mortgage rate and its impact on the break-even point is unfavorable information that should be given as much visibility as the favorable 65% break-even information. CP 21-2 There are many possible applications of break-even analysis in a school environment. Below are just a few possible ideas. Break-Even Analysis

Revenues

Fixed Costs

Variable Costs

Break-even number of students in a class

Student tuition for a class

Faculty salary, space costs

Supplies, copying

Break-even sales in the bookstore

Book sales

Manager’s salary, space costs

Cashier salaries, cost of books

Break-even daily meal revenues

Meal revenue

Salaries, space

Food costs

Break-even students in a dorm

Room revenue

Space, staff salaries, utilities

Janitorial costs

Break-even number

Ticket and

Space, staff

Clean-up costs,

of tickets sold for a basketball game

concession revenue

salaries, utilities

concession costs

Break-even number

Network user fees

Network depreciation,

User support,

network maintenance, trunk line lease costs

electricity

Concert hall

Salaries of some

depreciation, salaries of

support staff, very

musicians, utilities expense

few variable costs

of users on a computer network 7

Break-even number

Ticket revenue

of tickets sold for a concert season

CHAPTER 21

Cost-Volume-Profit Analysis

CP 21-3 To: From: Re:

Neil Armstrong, CEO Sun Airlines Ima Student Increasing Ticket Prices

In recent months, Sun Airlines has struggled to stay above break-even sales volume, which has led to a string of monthly losses. Sun’s break-even volume is 75% of capacity, which is significantly higher than the industry average of 65% of capacity. To address this problem, the airline is considering a strategy of increasing ticket prices. This strategy will reduce the break-even sales volume, because higher ticket prices will generate a higher contribution margin. However, higher ticket prices could also reduce the number of tickets sold (passenger volume). If the drop in sales volume exceeds the drop in break-even volume, the strategy will fail and losses will increase. For this strategy to succeed, the airline will have to minimize the impact of the ticket price increase on sales volume. The airline might consider targeting business travelers who need to fly regardless of ticket price. If successful, this strategy can reduce the break-even point without significantly decreasing ticket sales. Restrictions such as allowing reduced fares only on round-trip tickets that include a Saturday night stay-over achieve this objective, because business travelers do not want to be out of town over the weekend. Another way to target business travelers is to require higher fares for tickets purchased with little advance notice, because business travel is typically planned with little advance notice.

CHAPTER 21

Cost-Volume-Profit Analysis

CP 21-4 Do-Nothing Strategy: Revenue – Variable Costs – Fixed Costs ($80 × 1,000,000) – ($35 × 1,000,000) – $35,000,000 $80,000,000 – $35,000,000 – $35,000,000

= Profit = Profit = $10,000,000

Thomas’s Strategy: Revenue – Variable Costs – Fixed Costs ($60 × 2,000,000) – ($35 × 2,000,000) – $35,000,000 $120,000,000 – $70,000,000 – $35,000,000

= Profit = Profit = $15,000,000

James’s Strategy: Revenue – Variable Costs – Fixed Costs ($80 × 1,400,000) – ($35 × 1,400,000) – $45,000,000 $112,000,000 – $49,000,000 – $45,000,000

= Profit = Profit = $18,000,000

James’s strategy, which is to maintain the price but increase advertising, appears superior.

CP 21-5 The direct labor costs are not variable to the increase in unit volume. The unit volume is the wrong activity base for direct labor costs. The “number of impressions” is a more accurate reflection of the direct labor cost. An impression is a separate printing color application on the banners. Thus, the analysis should be done as follows: One Three Two Four Color Color Total Color Color Number of banners Number of impressions

212 212

274 548

616 1,848

698 2,792

1,800 5,400

Last year’s impressions: 1,800 (180 + 480 + 1,140) Total increase:

5,400 – 1,800 1,800

= 200%

Thus, a 125% assumed increase from the unit volume information will understate the potential increase in direct labor cost.

CHAPTER 21

Cost-Volume-Profit Analysis

CP 21-6 The Shipping Department manager should respond by pointing out that the activities performed by his department are not related to sales volume but to sales orders. The orders require inventory pulling and sorting activities as well as paperwork activities. Thus, even though the sales volume is decreasing, the number of sales orders processed has increased from 1,180 to 1,475 (25%) during the last eight months. The reason for this increase in sales orders is that customers are ordering lower quantities per order than in the past. Thus, it is no wonder the Shipping Department manager is experiencing financial pressure. The amount of work performed by the department is increasing even though sales volume is down.

CHAPTER 22 BUDGETING DISCUSSION QUESTIONS 1.

The three major objectives of budgeting are (1) to establish specific goals for future operations, (2) to execute plans to achieve the goals, and (3) to periodically compare actual results with the goals.

If goals set by the budgets are viewed as unrealistic or unachievable, employees and managers may become discouraged and may not be committed to the achievement of the goals, resulting in the budget becoming less effective as a planning and control tool.

A budget that is set too loosely may fail to motivate managers and other employees to perform efficiently. In addition, a loose budget may cause a “spend it or lose it” mentality, where excess budget resources are spent in order to protect the budget from future reductions.

Conflicting goals can cause employees or department managers to act in their own selfinterests to the detriment of the organization’s objectives.

A static budget is most appropriate in situations where costs are not variable to an underlying activity level. As a result, it is reasonable to plan spending on the basis of a fixed quantity of resources for the year. This will occur in some administrative functions, such as human resources, accounting, or public relations.

Computers not only speed up the budgeting process, but they also reduce the cost of budget preparation when large quantities of data need to be processed. In addition, by using computerized simulation models, management can determine the impact of various operating alternatives on the master budget.

The production requirements must be carefully coordinated with the sales budget to ensure that production and sales are kept in balance during the period. Ideally, manufacturing operations should be maintained at 100% of capacity, with no idle time or overtime, and there should be neither excessive inventories nor inventories insufficient to fill sales orders.

Purchases of direct materials should be closely coordinated with the production budget so that inventory levels can be maintained within reasonable limits.

The cash budget contributes to effective cash planning. This involves advance planning so that a cash shortage does not arise and excess cash is not permitted to remain “idle.”

The excess cash can be invested in readily marketable income-producing securities or used to reduce loans.

10.

The capital expenditures budget should be integrated with the operating and financial budgets. For example, depreciation of new manufacturing equipment affects the factory overhead cost budget. The plans for financing the capital expenditures also affect the cash budget.

CHAPTER 22

Budgeting

PE 22-1A Variable cost: Direct labor (7,200 hours × $19.00* per hour)…………………………………… $136,800 Fixed cost: 14,700 Property tax…………………………………………………………………………… Total department costs………………………………………………………………… $151,500 * $123,500 ÷ 6,500 hours

PE 22-1B Variable cost: Direct labor (800 hours × $26.50* per hour)……………………………………… $21,200 Fixed cost: Equipment depreciation……………………………………………………………… 4,900 Total department costs………………………………………………………………… $26,100 * $22,260 ÷ 840 hours

PE 22-2A Harbour Inc. Production Budget For the Year Ending December 31, 20Y6 Expected units to be sold Plus desired ending inventory, December 31, 20Y6 Total units required Less estimated beginning inventory, January 1, 20Y6 Total units to be produced

252,000 19,700 271,700 13,700 258,000

PE 22-2B Soft Glow Candle Inc. Production Budget For the Year Ending December 31, 20Y4 Expected units to be sold Plus desired ending inventory, December 31, 20Y4 Total units required Less estimated inventory, January 1, 20Y4 Total units to be produced

96,000 5,100 101,100 4,300 96,800

CHAPTER 22

Budgeting

PE 22-3A Harbour Inc. Direct Materials Purchases Budget For the Year Ending December 31, 20Y6 Square yards required for production: Personal journals (258,000 × 5 sq. yds.) Plus desired ending inventory, December 31, 20Y6 Total square yards required Less estimated beginning inventory, January 1, 20Y6 Total square yards to be purchased Unit price (per square yard) Total direct materials to be purchased

1,290,000 17,000 1,307,000 25,100 1,281,900 $0.60 $769,140

PE 22-3B Soft Glow Candle Inc. Direct Materials Purchases Budget For the Year Ending December 31, 20Y4 Pounds of wax required for production: Candles [(96,800 × 8 oz.) ÷ 16 oz.] Plus desired ending inventory, December 31, 20Y4 Total pounds required Less estimated beginning inventory, January 1, 20Y4 Total pounds to be purchased Unit price (per pound) Total direct materials to be purchased

48,400 5,200 53,600 3,100 50,500 $3.80 $191,900

PE 22-4A Harbour Inc. Direct Labor Cost Budget For the Year Ending December 31, 20Y6 Hours required for assembly: Personal journals (258,000 × 6 min.) Convert minutes to hours Assembly hours Hourly rate Total direct labor cost

1,548,000 min. 60 min. ÷ 25,800 hrs. × $16.50 $425,700

CHAPTER 22

Budgeting

PE 22-4B Soft Glow Candle Inc. Direct Labor Cost Budget For the Year Ending December 31, 20Y4 Hours required for molding: Candles (96,800 × 9 min.) Convert minutes to hours Molding hours Hourly rate Total direct labor cost

871,200 min. 60 min. ÷ 14,520 hrs. × $15.00 $217,800

PE 22-5A Harbour Inc. Cost of Goods Sold Budget For the Year Ending December 31, 20Y6 Finished goods inventory, January 1, 20Y6 Work in process inventory, January 1, 20Y6 Direct materials: Direct materials inventory, January 1, 20Y6 (25,100 × $0.60, from PE 22-3A) Direct materials purchases (from PE 22-3A) Cost of direct materials available for use Less direct materials inventory, December 31, 20Y6 (17,000 × $0.60, from PE 22-3A) Cost of direct materials placed in production Direct labor (from PE 22-4A) Factory overhead Total manufacturing costs Total work in process during period Less work in process inventory, December 31, 20Y6 Cost of goods manufactured Cost of finished goods available for sale Less finished goods inventory, December 31, 20Y6 Cost of goods sold

$ $

41,100

35,700

$ 15,060 769,140 $784,200

10,200 $774,000 425,700 197,200 1,396,900 $1,432,600 50,900 1,381,700 $1,422,800 49,800 $1,373,000

CHAPTER 22

Budgeting

PE 22-5B Soft Glow Candle Inc. Cost of Goods Sold Budget For the Year Ending December 31, 20Y4 Finished goods inventory, January 1, 20Y4 Work in process inventory, January 1, 20Y4 Direct materials: Direct materials inventory, January 1, 20Y4 (3,100 × $3.80, from PE 22-3B) Direct materials purchases (from PE 22-3B) Cost of direct materials available for use Less direct materials inventory, December 31, 20Y4 (5,200 × $3.80) Cost of direct materials placed in production Direct labor (from PE 22-4B) Factory overhead Total manufacturing costs Total work in process during period Less work in process inventory, December 31, 20Y4 Cost of goods manufactured Cost of finished goods available for sale Less finished goods inventory, December 31, 20Y4 Cost of goods sold

$ 10,560 $

6,440

$ 11,780 191,900 $203,680 19,760 $183,920 217,800 95,170 496,890 $503,330 5,920 497,410 $507,970 13,050 $494,920

PE 22-6A October Collections from September sales (75% × $246,000)……………………………… $184,500 71,000 Collections from October sales (25% × $284,000)………………………………… $255,500 Total receipts from sales on account…………………………………………………

PE 22-6B April Payments for March purchases (90% × $36,800)………………………………… $33,120 4,010 Payments for April purchases (10% × $40,100)…………………………………… Total payments for purchases on account………………………………………… $37,130

CHAPTER 22

Budgeting

EXERCISES Ex. 22-1 a.

Katherine Malloy Cash Budget For the Four Months Ending December 31 Estimated cash receipts from: Part-time job Deposit Total cash receipts Estimated cash payments for: Season football tickets Additional entertainment Tuition Rent Food Deposit Total cash payments Cash increase (decrease) Cash balance at beginning of month Cash balance at end of month

September

October

November

December

$ 1,400

$1,400

$ 1,400

$1,400

$1,400 500 $1,900

$ 275

210 275 3,700 600 235 500 $ 5,520 $(4,120)

600 235

$1,110 $ 290

$1,110 $ 790

5,750 $ 1,630

1,630 $1,920

1,920 $2,210

2,210 $3,000

The four-month budgets do not change with any identified activity level; thus, they are static budgets.

While Malloy’s budget might first appear satisfactory, Malloy must earn enough cash in order to pay for the spring semester tuition. Her present budget shows that she will be $700 short of the tuition amount ($3,700 – $3,000) by the time she needs to pay her spring tuition. Thus, Malloy will likely need to adjust the plan before the fall term even begins. Some possibilities would be to rent a lower cost apartment or to get a roommate. Other considerations include increasing her part-time job hours and reducing her monthly entertainment and food allowance, or making up the income difference with additional hours during Christmas break. Malloy might also see about scholarship opportunities to reduce the tuition payment. The budget gives Malloy time to adjust her plans to future events. In this case, Malloy can see that her present plan will not provide sufficient cash, thus giving her four months to adjust. If Malloy did not budget but went ahead with the original plan, she would be $700 short at the end of December, with no time left to adjust.

CHAPTER 22

Budgeting

Ex. 22-2 Daybreak Technologies Inc. Flexible Selling and Administrative Expenses Budget For the Month Ending April 30 Total sales Variable cost: Sales commissions (16% of sales) Advertising expense (12% of sales) Miscellaneous administrative expense (10% of sales) Customer support expense (18% of sales) Total variable cost Fixed cost: Miscellaneous administrative expense Office salaries expense Customer support expense Research and development expense Total fixed cost Total selling and administrative expenses

$200,000

$300,000

$400,000

$ 32,000 24,000

$ 48,000 36,000

$ 64,000 48,000

20,000 36,000 $112,000

30,000 54,000 $168,000

40,000 72,000 $224,000

5,000 19,000 8,000 22,000 $ 54,000 $166,000

5,000 19,000 8,000 22,000 $ 54,000 $222,000

5,000 19,000 8,000 22,000 $ 54,000 $278,000

CHAPTER 22

Budgeting

Ex. 22-3 Celtic Company—Machining Department Flexible Production Budget For the Three Months Ending March 31

January

Units of production

February

March

68,000

76,000

84,000

Wages Utilities Depreciation Total

$816,000 66,300 42,000 $924,300

$ 912,000 74,100 42,000 $1,028,100

$1,008,000 81,900 42,000 $1,131,900

Supporting computations: Units of production Hours per unit Total hours of production Wages per hour Total wages

68,000 0.75 × 51,000 × $16.00 $816,000

76,000 0.75 × 57,000 × $16.00 $912,000

84,000 0.75 × 63,000 × $16.00 $1,008,000

Total hours of production Utility costs per hour Total utilities

51,000 × $1.30 $66,300

57,000 × $1.30 $74,100

63,000 × $1.30 $81,900

Depreciation is a fixed cost, so it does not “flex” with changes in production. Because it is the only fixed cost, the variable and fixed costs are not classified in the budget. b. Actual cost……………………………… Total flexible budget…………………… Excess of actual cost over budget…

January

February

March

$ 994,500 (924,300) $ 70,200

$ 1,078,500 (1,028,100) $ 50,400

$ 1,174,900 (1,131,900) $ 43,000

The excess of actual cost over the flexible budget suggests that the Machining Department has not performed as well as originally thought. The department is spending more than would be expected. The flexible budget is a superior budgeting approach in this situation because wages and utility costs vary with production. Thus, the budget for these costs should adjust (flex) to the actual level of production. Actual costs can rightfully be compared to the flexible budget because both numbers are based on actual volumes.

CHAPTER 22

Budgeting

Ex. 22-4 Steelcase Inc.—Assembly Department Flexible Production Budget For the Month Ending August 31 (assumed data) Units of production Variable cost: Direct labor Fixed cost: Supervisor salaries Depreciation Total fixed cost Total department cost 1 2 3

18,000

20,000

22,000

$ 79,2001

$ 88,000 2

$ 96,8003

$150,000 24,500 $174,500 $253,700

$150,000 24,500 $174,500 $262,500

$150,000 24,500 $174,500 $271,300

18,000 × 12/60 min. × $22 20,000 × 12/60 min. × $22 22,000 × 12/60 min. × $22

Ex. 22-5 FitHealth Inc. Production Budget For the Month Ending October 31 Units

Expected units to be sold Plus desired inventory, October 31 Total units required Less estimated inventory, October 1 Total units to be produced

Bath Scale

Gym Scale

190,000 16,000 206,000 21,000 185,000

75,000 9,000 84,000 4,500 79,500

CHAPTER 22

Budgeting

Ex. 22-6 a.

Vibrant Inc. Sales Budget For the Month Ending June 30 Product and Area

Unit Sales Volume

Unit Selling Price

15,000 20,000 35,000

$140 140

$2,100,000 2,800,000 $4,900,000

2,500 3,000 5,500

$220 220

$ 550,000 660,000 $1,210,000 $6,110,000

Model Rumble: North Region South Region Total Model Thunder: North Region South Region Total Total revenue from sales

Total Sales

Vibrant Inc. Production Budget For the Month Ending June 30 Units Model Rumble

Expected units to be sold Plus desired inventory, June 30 Total units required Less estimated inventory, June 1 Total units to be produced

35,000 950 35,950 800 35,150

Model Thunder

5,500 400 5,900 200 5,700

CHAPTER 22

Budgeting

Ex. 22-7 Rollins and Cohen, CPAs Professional Fees Earned Budget For the Month Ending January 31, 20Y7

Audit Department: Staff Partners Total Tax Department: Staff Partners Total Small Business Accounting Department: Staff Partners Total Total professional fees earned

Billable Hours

Hourly Rate

Total Revenue

22,400 7,900 30,300

$150 320

$ 3,360,000 2,528,000 $ 5,888,000

13,200 5,500 18,700

$150 320

$ 1,980,000 1,760,000 $ 3,740,000

3,000 600 3,600

$150 320

450,000 192,000 $ 642,000 $10,270,000

Ex. 22-8 Rollins and Cohen, CPAs Professional Labor Cost Budget For the Month Ending January 31, 20Y7 Staff

Hours required for professional services: Audit Department hours Tax Department hours Small Business Accounting Department hours Total hours Average compensation per hour Total professional labor cost

Partners

22,400 13,200

7,900 5,500

3,000 38,600 × $45 $1,737,000

600 14,000 × $140 $1,960,000

Total

$3,697,000

CHAPTER 22

Budgeting

Ex. 22-9 Lorenzo’s Frozen Pizza Inc. Direct Materials Purchases Budget For the Month Ending September 30 Units required for production: 12" pizza 16" pizza Plus desired inventory, September 30 Total pounds required Less estimated inventory, September 1 Total pounds to be purchased Unit price (per pound) Total direct materials to be purchased 1 2 3 4 5 6

Dough

Tomato

Cheese

10,0001 32,7004

6,250 2 15,2605

8,7503 28,3406

580 43,280

185 21,695

340 37,430

490 42,790 × $0.50

230 21,465 × $2.20

275 37,155 × $2.60

$21,395

$47,223

$96,603

Total

$165,221

12,500 × 0.80 lb. 12,500 × 0.50 lb. 12,500 × 0.70 lb. 21,800 × 1.50 lb. 21,800 × 0.70 lb. 21,800 × 1.30 lb.

CHAPTER 22

Budgeting

Ex. 22-10 Coca-Cola Enterprises—Wakefield Plant Direct Materials Purchases Budget For the Month Ending May 31 (assumed data) 2-Liter Bottles

Carbonated Water

459 * lb.

153,000 btls.

306,000 ltrs.

173 *

86,500

173,000

239,500 btls. × $0.08

479,000 ltrs. × $0.06

$19,160

$28,740

$95,300

Coke®

Sprite®

* Production in liters (bottles × 2 liters/bottle)………………………………… 306,000 Divide by 100……………………………………………………………………… ÷ 100

173,000 ÷ 100

3,060 0.15 459

× 0.10

Concentrate

Total

Materials required for production: Coke

Sprite

Total materials required Unit price

632 $75

Total direct materials to be purchased

$47,400

lb.

Multiply by concentrate pounds per 100 liters……………………………… × Concentrate pounds required for production…………………………………

1,730

173

CHAPTER 22

Budgeting

Ex. 22-11 Solid Grip Company Direct Materials Purchases Budget For the Year Ending December 31, 20Y8 Rubber

Pounds required for production: Passenger tires Truck tires Plus desired inventory, December 31, 20Y8 Total pounds required Less estimated inventory, January 1, 20Y8 Total pounds to be purchased Unit price (per pound) Total direct materials to be purchased 1 2 3 4

Steel Belts

1,368,000 lb.1 1,920,000 3

228,000 lb. 2 240,000 4

35,000 3,323,000 lb.

12,000 480,000 lb.

40,000 3,283,000 lb. $1.40 ×

10,000 470,000 lb. × $0.90

$4,596,200

$423,000

Total

$5,019,200

Rubber: 38,000 units × 36 lb. per unit = 1,368,000 lb. Steel belts: 38,000 units × 6 lb. per unit = 228,000 lb. Rubber: 24,000 units × 80 lb. per unit = 1,920,000 lb. Steel belts: 24,000 units × 10 lb. per unit = 240,000 lb.

Ex. 22-12 Rip Court Racket Company Direct Labor Cost Budget For the Month Ending March 31

Hours required for production: Junior Pro Striker Total hours required Hourly rate Total direct labor cost 1 2 3 4

Forming Department

Assembly Department

3401 1,440 3 1,780 ×$18.00 $32,040

680 2 2,400 4 3,080 × $16.00 $49,280

Junior: 0.10 hr. × 3,400 = 340 hrs. Junior: 0.20 hr. × 3,400 = 680 hrs. Pro Striker: 0.15 hr. × 9,600 = 1,440 hrs. Pro Striker: 0.25 hr. × 9,600 = 2,400 hrs.

CHAPTER 22

Budgeting

Ex. 22-13 Ambassador Suites Inc. Direct Labor Cost Budget For a Weekday or a Weekend Day Weekday

Room occupancy Room capacity Occupied percent (occupancy) (a) Rooms occupied

Housekeeping (b) Number of minutes to clean a room Total minutes [(a) × (b)] Total hours (Total minutes ÷ 60 min.) Labor rate per hour (c) Housekeeping daily labor budget Restaurant staff Base restaurant staff Incremental 60 room blocks [(a) ÷ 60 rooms] Total staff Hours per day Total hours Labor rate per hour (d) Restaurant staff daily labor budget Total daily labor budget [(c) + (d)]

300 80% 240

30 7,200 120.0 × $14.00 $1,680 ×

6 4 10 8 × 80 × $12.00 $ 960 $2,640

Weekend Day

300 40% 120

30 3,600 60.0 × $14.00 $ 840 ×

6 2 8 8 × 64 × $12.00 $ 768 $1,608 +

CHAPTER 22

Budgeting

Ex. 22-14 a. Levi Strauss & Co. Production Budget For the Month Ending May 31 (assumed data) Dockers

501® Jeans 53,100 1,860 54,960 1,660 53,300

23,600 420 24,020 670 23,350

Expected units to be sold Plus May 31 desired inventory Total units required Less May 1 estimated inventory Total units to be produced b.

Levi Strauss & Co. Direct Labor Cost Budget For the Month Ending May 31 (assumed data) Outerseam

Pockets

42,030 47,9705 90,000

46,700 2 74,620 6 121,320

14,010 47,970 7 61,980

1,500 $13 $19,500

Inseam

Zipper

Total

Hours required for production: Dockers® (in minutes) 501® Jeans (in minutes) Total minutes Convert minutes to hours (÷ 60 minutes) Hourly rate Total direct labor cost 1 2 3 4 5 6 7 8

2,022 $13 $26,286

1,033 $15 $15,495

28,0204 31,980 8 60,000 1,000 $15 $15,000

$76,281

(23,350 ÷ 10 pairs) × 18 min. = 42,030 min. (23,350 ÷ 10 pairs) × 20 min. = 46,700 min. (23,350 ÷ 10 pairs) × 6 min. = 14,010 min. (23,350 ÷ 10 pairs) × 12 min. = 28,020 min. (53,300 ÷ 10 pairs) × 9 min. = 47,970 min. (53,300 ÷ 10 pairs) × 14 min. = 74,620 min. (53,300 ÷ 10 pairs) × 9 min. = 47,970 min. (53,300 ÷ 10 pairs) × 6 min. = 31,980 min.

CHAPTER 22

Budgeting

Ex. 22-15 Toot Sweet Candy Company Factory Overhead Cost Budget For the Month Ending August 31 Variable factory overhead costs: Manufacturing supplies Power and light Production supervisor wages Production control wages Materials management wages Total variable factory overhead costs Fixed factory overhead costs: Factory insurance Factory depreciation Total fixed factory overhead costs Total factory overhead costs

$ 15,680 53,760 151,200 35,840 43,650 $300,130 $ 33,700 24,000 57,700 $357,830

Note: Advertising expenses, sales commissions, and executive officer salaries are selling and administrative expenses.

CHAPTER 22

Budgeting

Ex. 22-16 Wilmington Chemical Company Cost of Goods Sold Budget For the Month Ending June 30 Finished goods inventory, June 11

Work in process inventory, June 1 Direct materials: Direct materials inventory, June 1

Direct materials purchases Cost of direct materials available for use Less direct materials inventory, June 30 Cost of direct materials placed in production Direct labor Factory overhead Total manufacturing costs

$2,515,500 16,100

$3,302,800 4,000 3,298,800 $3,347,100 53,500 $3,293,600

Less finished goods inventory, June 303 Cost of goods sold

$ 15,500 2,500,000

3,299,400

Cost of finished goods available for sale

3,400

$2,499,400 300,000 500,000

Total work in process during the period Less work in process inventory, June 30 Cost of goods manufactured

48,300

$25,400 + $22,900 50,000 barrels × $50 per barrel $28,500 + $25,000

CHAPTER 22

Budgeting

Ex. 22-17 MingWare Ceramics Inc. Cost of Goods Sold Budget For the Month Ending September 30 Finished goods inventory, September 1 Work in process inventory, September 1 Direct materials: Direct materials inventory, September 1 Direct materials purchases

$ 11,500 $ $

Cost of direct materials available for use Less direct materials inventory, September 30

3,400

6,440 188,410

$194,850 8,830

Cost of direct materials placed in production Direct labor Factory overhead Total manufacturing costs

$186,020 193,600 105,500 485,120

Total work in process during the period Less work in process inventory, September 30 Cost of goods manufactured Cost of finished goods available for sale Less finished goods inventory, September 30 Cost of goods sold

$488,520 1,990 486,530 $498,030 9,670 $488,360

CHAPTER 22

Budgeting

Ex. 22-18 Bark & Purr Supplies Inc. Schedule of Collections from Sales For the Three Months Ending July 31 May

May sales on account: Collected in May ($184,000 × 60%) Collected in June ($184,000 × 35%) Collected in July ($184,000 × 5%)

June

July

$110,400 $ 64,400 $

June sales on account: Collected in June ($192,000 × 60%) Collected in July ($192,000 × 35%)

9,200

115,200 67,200

July sales on account: Collected in July ($201,000 × 60%) Total cash collected

$110,400

$179,600

120,600 $197,000

CHAPTER 22

Budgeting

Ex. 22-19 Office World Inc. Schedule of Collections from Sales For the Three Months Ending December 31 Receipts from cash sales: Cash sales (25% × current month’s sales) September sales on account: Collected in October (Accounts Receivable balance) 1 October sales on account: Collected in October ($525,000 × 40%) Collected in November ($525,000 × 60%)

October

November

December

$175,000

$162,500

$125,000

290,000 210,000 315,000

November sales on account: Collected in November ($487,500 × 40%) Collected in December ($487,500 × 60%)

195,000 292,500

December sales on account: Collected in December ($375,000 × 40%) $675,000 1 2 3

$672,500

150,000 $567,500

$700,000 × 75% = $525,000 $650,000 × 75% = $487,500 $500,000 × 75% = $375,000

CHAPTER 22

Budgeting

Ex. 22-20 Oakwood Financial Inc. Schedule of Cash Payments for Selling and Administrative Expenses For the Three Months Ending May 31 March

April

May

March expenses: Paid in March ($52,600 × 60%) Paid in April ($52,600 × 40%)

$31,560 $21,040

April expenses: Paid in April ($59,400 × 60%) Paid in May ($59,400 × 40%)

35,640 $23,760

May expenses: Paid in May ($65,300 × 60%) Total cash payments 1 2 3

$31,560

$56,680

39,180 $62,940

$59,600 – $7,000 = $52,600 $66,400 – $7,000 = $59,400 $72,300 – $7,000 = $65,300

Note: Insurance, property taxes, and depreciation are expenses that do not result in cash payments in March, April, or May.

CHAPTER 22

Budgeting

Ex. 22-21 EastGate Physical Therapy Inc. Schedule of Cash Payments for Operations For the Three Months Ending March 31 Payments of prior month’s expense

Payments of current month’s expense2 Total payment 1

January

February

March

$15,000

$ 26,430

$ 32,610

61,670

76,090

81,130

$76,670

$102,520

$113,740

$15,000, given as Accrued Expenses Payable, January 1 $26,430 = ($91,600 – $3,000 – $500) × 30% $32,610 = ($112,200 – $3,000 – $500) × 30%

$61,670 = ($91,600 – $3,000 – $500) × 70% $76,090 = ($112,200 – $3,000 – $500) × 70% $81,130 = ($119,400 – $3,000 – $500) × 70%

Note: Insurance and depreciation are expenses that do not result in cash payments in January, February, or March.

Ex. 22-22 Omicron Inc. Capital Expenditures Budget For the Four Years Ending December 31, 20Y2−20Y5 Building Equipment Information systems Total 1 2

20Y2

20Y3

$4,000,000

$6,000,000 1,500,000

$4,000,000

$7,500,000

20Y4

20Y5 1

$200,000 450,0002 $650,000

$3,500,000 1,000,000

$4,500,000

$10,000,000 × 35% = $3,500,000 $800,000 × 75% × 75% = $450,000

CHAPTER 22

Budgeting

PROBLEMS Prob. 22-1A 1. Unit Sales, Year Ended 20Y6 Budget Actual Sales

Increase (Decrease) Actual Over Budget Amount Percent

8" × 10" Frame: East Central West

8,500 6,200 12,600

8,755 6,510 12,348

255 310 (252)

3% 5% (2)%

12" × 16" Frame: East Central West

3,800 3,000 5,400

3,686 3,090 5,616

(114) 90 216

(3)% 3% 4%

Percentage Increase (Decrease)

20Y7 Budgeted Units (rounded)

2. 20Y6 Actual Units

8" × 10" Frame: East Central West

8,755 6,510 12,348

3% 5% (2)%

9,018 6,836 12,101

12" × 16" Frame: East Central West

3,686 3,090 5,616

(3)% 3% 4%

3,575 3,183 5,841

CHAPTER 22

Budgeting

Prob. 22-1A (Concluded) Raphael Frame Company Sales Budget For the Year Ending December 31, 20Y7

Unit Sales Volume

Product and Area

8" × 10" Frame: East Central West Total 12" × 16" Frame: East Central West Total Total revenue from sales

Unit Selling Price

Total Sales

9,018 6,836 12,101 27,955

$17 17 17

$153,306 116,212 205,717 $475,235

3,575 3,183 5,841 12,599

$32 32 32

$114,400 101,856 186,912 $403,168 $878,403

CHAPTER 22

Budgeting

Prob. 22-2A 1.

Gourmet Grill Company Sales Budget For the Month Ending March 31 Product and Area

Unit Sales Volume

Unit Selling Price

350 400 320 1,070

$ 800 825 850

$ 280,000 330,000 272,000 $ 882,000

200 240 200 640

$1,400 1,500 1,600

$ 280,000 360,000 320,000 $ 960,000 $1,842,000

Backyard Chef: Maine Vermont New Hampshire Total Master Chef: Maine Vermont New Hampshire Total Total revenue from sales

Total Sales

Gourmet Grill Company Production Budget For the Month Ending March 31 Units Backyard Chef

Expected units to be sold Plus desired inventory, March 31 Total units required Less estimated inventory, March 1 Total units to be produced

1,070 40 1,110 30 1,080

Master Chef

640 26 666 36 630

CHAPTER 22

Budgeting

Prob. 22-2A (Continued) 3. Gourmet Grill Company Direct Materials Purchases Budget For the Month Ending March 31 Stainless Steel (lb.)

Grates (units)

Required units for production: Backyard Chef Master Chef Plus desired inventory, March 31

Burner Subassemblies (units)

Shelves (units)

3,2401 3,780 5

25,920 2 26,460 6

2,160 3 2,520 7

4,320 4 3,1508

300

1,500

210

400

7,320

53,880

4,890

7,870

320

1,700

190

350

Total units to be purchased Unit price

7,000 $16.00 ×

52,180 × $8.00

4,700 $120.00 ×

7,520 $12.00 ×

Total direct materials to be purchased

$112,000

$417,440

$564,000

$90,240

Total units required Less estimated inventory, March 1

1 2 3 4 5 6 7 8

Total

$1,183,680

1,080 × 3 grates = 3,240 grates 1,080 × 24 lb. = 25,920 lb. 1,080 × 2 subassemblies = 2,160 subassemblies 1,080 × 4 shelves = 4,320 shelves 630 × 6 grates = 3,780 grates 630 × 42 lb. = 26,460 lb. 630 × 4 subassemblies = 2,520 subassemblies 630 × 5 shelves = 3,150 shelves

CHAPTER 22

Budgeting

Prob. 22-2A (Concluded) 4. Gourmet Grill Company Direct Labor Cost Budget For the Month Ending March 31 Stamping Department

Forming Department

Assembly Department

540

648

1,080

378

504

945

918 × $18 $16,524

1,152 × $16 $18,432

2,025 × $15 $30,375

Total

Hours required for production: Backyard Chef 1 Master Chef

Total hours required Hourly rate Total direct labor cost 1

$65,331

This line is computed as 1,080 Backyard Chef units from the production budget multiplied by the hours per unit in each department estimated for the Backyard Chef. 540 = 1,080 × 0.5; 648 = 1,080 × 0.6; 1,080 = 1,080 × 1.0 This line is computed as 630 Master Chef units from the production budget multiplied by the hours per unit in each department estimated for the Master Chef. 378 = 630 × 0.6; 504 = 630 × 0.8; 945 = 630 × 1.5

CHAPTER 22

Budgeting

Prob. 22-3A 1.

Birds and Beyond Inc. Sales Budget For the Month Ending January 31 Unit Sales Volume

Unit Selling Price

7,500 5,000

$66.00 82.00

Birdhouse Bird feeder Total revenue from sales

Total Sales

$495,000 410,000 $905,000

Birds and Beyond Inc. Production Budget For the Month Ending January 31 Units Birdhouse

Expected units to be sold Plus desired inventory, January 31 Total units required Less estimated inventory, January 1 Total units to be produced

7,500 400 7,900 500 7,400

Bird Feeder

5,000 250 5,250 210 5,040

CHAPTER 22

Budgeting

Prob. 22-3A (Continued) 3.

Birds and Beyond Inc. Direct Materials Purchases Budget For the Month Ending January 31 Required units for production: Birdhouse Bird feeder Plus desired inventory, January 31 Total units required Less estimated inventory, January 1 Total units to be purchased Unit price Total direct materials to be purchased 1 2 3 4

Wood

Plastic

Total

5,9201 6,0483 220 12,188 198 11,990 × $9.00 $107,910

3,700 2 3,7804 340 7,820 420 7,400 × $1.40 $10,360

$118,270

7,400 × 0.80 ft. = 5,920 ft. 7,400 × 0.50 lb. = 3,700 lb. 5,040 × 1.20 ft. = 6,048 ft. 5,040 × 0.75 lb. = 3,780 lb.

CHAPTER 22

Budgeting

Prob. 22-3A (Continued) 4.

Birds and Beyond Inc. Direct Labor Cost Budget For the Month Ending January 31 Fabrication Department

Assembly Department

Birdhouse

1,8501

2,220 2

Bird feeder

2,0163

1,7644

Total

Hours required for production:

Total hours required Hourly rate Total direct labor cost 1 2 3 4

3,866 $20 $77,320

3,984 $15 $59,760

$137,080

7,400 × 0.25 hr. = 1,850 hrs. 7,400 × 0.30 hr. = 2,220 hrs. 5,040 × 0.40 hr. = 2,016 hrs. 5,040 × 0.35 hr. = 1,764 hrs.

Birds and Beyond Inc. Factory Overhead Cost Budget For the Month Ending January 31 Indirect factory wages Depreciation of plant and equipment Power and light Insurance and property tax Total

$ 92,000 34,000 10,100 2,800 $138,900

CHAPTER 22

Budgeting

Prob. 22-3A (Continued) 6. Birds and Beyond Inc. Cost of Goods Sold Budget For the Month Ending January 31 Finished goods inventory, January 11

$ 22,400

Work in process inventory, January 1 Direct materials:

$ 33,600

Direct materials inventory, January 12 Direct materials purchases

Cost of direct materials available for use Less direct materials inventory,

$120,640

January 313 Cost of direct materials placed in production Direct labor Factory overhead Total manufacturing costs

2,370 118,270

2,456 $118,184 137,080 138,900 394,164

Total work in process during period Less work in process, January 31 Cost of goods manufactured

$427,764 41,200 386,564

Cost of finished goods available for sale

$408,964 21,200 $387,764

Less finished goods inventory, January 314 Cost of goods sold 1

Birdhouse (500 × $28)…………………………………………………………… Bird feeder (210 × $40)…………………………………………………………… Finished goods inventory, January 1…………………………………………

$14,000 8,400 $22,400

Wood (198 × $9.00)………………………………………………………………… Plastic (420 × $1.40)……………………………………………………………… Direct materials inventory, January 1…………………………………………

$ 1,782 588 $ 2,370

Wood (220 × $9.00)………………………………………………………………… Plastic (340 × $1.40)……………………………………………………………… Direct materials inventory, January 31…………………………………………

$ 1,980 476 $ 2,456

Birdhouse (400 × $28)…………………………………………………………… Bird feeder (250 × $40)…………………………………………………………… Finished goods inventory, January 31…………………………………………

$11,200 10,000 $21,200

CHAPTER 22

Budgeting

Prob. 22-3A (Concluded) 7.

Birds and Beyond Inc. Selling and Administrative Expenses Budget For the Month Ending January 31 Selling expenses: Sales salaries expense Advertising expense Telephone expense—selling Travel expense—selling

$85,100 17,600 1,000 3,800

Total selling expenses Administrative expenses: Office salaries expense Depreciation expense—office equipment Telephone expense—administrative Office supplies expense Miscellaneous administrative expense Total administrative expenses Total operating expenses

$107,500 $19,200 1,100 400 350 250 21,300 $128,800

Birds and Beyond Inc. Budgeted Income Statement For the Month Ending January 31 Revenue from sales Cost of goods sold

$905,000 387,764

Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses

$517,236 $107,500 21,300 128,800

Income from operations Other revenue and expense: Interest revenue Interest expense

$388,436 $

Income before income tax Income tax expense (25% rate) Net income

450 (294)

156 $388,592 97,148 $291,444

CHAPTER 22

Budgeting

Prob. 22-4A 1.

Sonoma Housewares Inc. Cash Budget For the Three Months Ending July 31 May

June

July

$ 8,600

$ 9,000

68,400

75,780

79,920

$77,000

$84,780

$ 89,420

Manufacturing costsb

$30,400

$34,500

$ 39,500

Selling and administrative expenses

15,000

16,000

22,000

Estimated cash receipts from: Cash sales (10% of monthly sales) Collection of accounts receivablea Total cash receipts

9,500

Estimated cash payments for:

Capital expenditures

80,000

Other purposes: Income tax

14,000

Dividends

5,000

Total cash payments

$45,400

$64,500

$146,500

Cash increase or (decrease)

$31,600

$20,280

$ (57,080)

Cash balance at beginning of month

33,000

64,600

84,880

Cash balance at end of month

$64,600

$84,880

$ 27,800

Minimum cash balance

30,000

Excess (deficiency)

$34,600

$54,880

$ (2,200)

CHAPTER 22

Budgeting

Prob. 22-4A (Concluded) Computations: a

Collections of accounts receivable:

May

June

July

March sales…………………………………………

$18,000

April sales……………………………………………

50,400 2

$21,600

54,180

$23,2205 56,7006

$68,400

$75,780

$79,920

May

June

July

$ 6,000 24,400

$ 6,100 28,400

$ 7,100 32,400

$30,400

$34,500

$39,500

May sales…………………………………………… June sales…………………………………………… Total……………………………………………… 1 2 3 4 5 6 b

$60,000 × 30% = $18,000 $72,000 × 70% = $50,400 $72,000 × 30% = $21,600 $86,000 × 90% × 70% = $54,180 $86,000 × 90% × 30% = $23,220 $90,000 × 90% × 70% = $56,700

Payments for manufacturing costs: Payment of accounts payable, beginning c

of month balance ……………………………… d

Payment of current month’s cost ……………… Total……………………………………………… c

Accounts payable, May 1 balance = $6,000 ($34,000 – $3,500) × 20% = $6,100 ($39,000 – $3,500) × 20% = $7,100

($34,000 – $3,500) × 80% = $24,400 ($39,000 – $3,500) × 80% = $28,400 ($44,000 – $3,500) × 80% = $32,400

The budget indicates that the minimum cash balance will not be maintained in July. This is due to the capital expenditures requiring significant cash outflows during this month. This situation can be corrected by borrowing and/or by the sale of the marketable securities, if they are held for such purposes. At the end of May and June, the cash balance will exceed the minimum desired balance, and the excess could be considered for temporary investment.

CHAPTER 22

Budgeting

Prob. 22-5A 1. Regina Soap Co. Budgeted Income Statement For the Year Ending December 31, 20Y4 1

Sales Cost of goods sold: 2 Direct materials 3 Direct labor Factory overhead4 Cost of goods sold Gross profit Operating expenses: Selling expenses: 5 Sales salaries and commissions Advertising 6 Miscellaneous selling expenses Total selling expenses Administrative expenses: 7 Office and officers salaries 8 Supplies 9 Miscellaneous administrative expense Total administrative expenses Total operating expenses Income before income tax Income tax expense Net income 1 2 3 4 5 6 7 8 9

$1,000,000 $220,000 130,000 132,000 482,000 $ 518,000

$136,000 64,000 56,000 $256,000 $ 96,400 25,000 14,000 135,400 391,400 $ 126,600 30,000 $ 96,600

200,000 units × $5.00 200,000 units × $1.10 200,000 units × $0.65 (200,000 units × $0.40) + $40,000 + $12,000 (200,000 units × $0.45) + $46,000 (200,000 units × $0.25) + $6,000 (200,000 units × $0.12) + $72,400 (200,000 units × $0.10) + $5,000 (200,000 units × $0.05) + $4,000

CHAPTER 22

Budgeting

Prob. 22-5A (Continued) 2. Regina Soap Co. Budgeted Balance Sheet December 31, 20Y4 Assets Current assets: Cash 1 Accounts receivable Inventories: Finished goods Work in process Materials Prepaid expenses Total current assets Property, plant, and equipment:

$135,800 125,600 $69,300 32,500 48,900

150,700 2,600 $414,700

Plant and equipment 2 Less accumulated depreciation 3 Total assets

$400,000 196,200

203,800 $618,500

Liabilities Current liabilities: Accounts payable

$ 62,000

Stockholders’ Equity Common stock

$180,000 376,500

Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 1

556,500 $618,500

Cash balance, December 31, 20Y4: Balance, January 1, 20Y4………………………………………………………… Add: Cash from operations Net income*……………………………………………………………… Depreciation of plant and equipment………………………………… Less: Dividends to be paid in 20Y4 (18,000 × $0.15 × 4 qtrs.)…………… Plant and equipment to be acquired in 20Y4……………………… Cash balance, December 31, 20Y4………………………………………………

$ 85,000 $96,600 40,000

136,600

$10,800 75,000

(85,800) $135,800

* As per question: Balances of accounts receivable, prepaid expenses, and accounts payable at the end of the year are not expected to differ significantly from the beginning balances. Therefore, there is no need to adjust net income for changes to current assets and/or current liabilities to arrive at the cash from operating activities.

CHAPTER 22

Budgeting

Prob. 22-5A (Concluded) 2 3

$325,000 + $75,000 = $400,000 $156,200 + $40,000 = $196,200

4 Retained earnings balance, December 31, 20Y4:

Balance, January 1, 20Y4……………………………………………… Plus net income for 20Y4……………………………………………… Less dividends to be paid in 20Y4 (18,000 × $0.15 × 4 qtrs.)……… Balance, December 31, 20Y4……………………………………………

$290,700 96,600 (10,800) $376,500

CHAPTER 22

Budgeting

Prob. 22-1B 1. Unit Sales, Year Ended 20Y8 Budget Actual Sales

Home Alert System: United States Europe Asia Business Alert System: United States Europe Asia

Increase (Decrease) Actual Over Budget Amount Percent

1,700 580 450

1,734 609 432

34 29 (18)

2%* 5% (4)%

980 350 240

1,078 329 252

98 (21) 12

10% (6)% 5%

Percentage Increase (Decrease)

20Y9 Budgeted Units (rounded)

* 34 ÷ 1,700 2. 20Y8 Actual Units

Home Alert System: United States Europe Asia

1,734 609 432

2% 5% (4)%

1,769 639 415

Business Alert System: United States Europe Asia

1,078 329 252

10% (6)% 5%

1,186 309 265

CHAPTER 22

Budgeting

Prob. 22-1B (Concluded) 3.

Sentinel Systems Inc. Sales Budget For the Year Ending December 31, 20Y9 Product and Area

Unit Sales Volume

Home Alert System: United States Europe Asia Total Business Alert System: United States Europe Asia Total Total revenue from sales

Unit Selling Price

Total Sales

1,769 639 415 2,823

$250 250 250

$ 442,250 159,750 103,750 $ 705,750

1,186 309 265 1,760

$820 820 820

$ 972,520 253,380 217,300 $1,443,200 $2,148,950

CHAPTER 22

Budgeting

Prob. 22-2B 1.

Royal Furniture Company Sales Budget For the Month Ending February 28 Product and Area

King: Northern Domestic Southern Domestic International Total Prince: Northern Domestic Southern Domestic International Total Total revenue from sales

Unit Sales Volume

Unit Selling Price

610 340 360 1,310

$780 780 850

$ 475,800 265,200 306,000 $1,047,000

750 440 290 1,480

$550 550 600

$ 412,500 242,000 174,000 $ 828,500 $1,875,500

Total Sales

Royal Furniture Company Production Budget For the Month Ending February 28 Units King

Expected units to be sold Plus desired inventory, February 28 Total units required Less estimated inventory, February 1 Total units to be produced

1,310 80 1,390 90 1,300

Prince

1,480 35 1,515 25 1,490

CHAPTER 22

Budgeting

Prob. 22-2B (Continued) 3. Royal Furniture Company Direct Materials Purchases Budget For the Month Ending February 28 Direct Materials Fabric (sq. yds.)

Wood (linear ft.)

Filler (cu. ft.)

Springs (units)

Total

Required units for production: King Prince

7,8001

49,400 2

5,460 3

20,800 4

17,8808

5,960

38,740

5,066

Plus desired inventory, February 28 Total units required

390

650

300

540

14,150

88,790

10,826

39,220

420

580

250

660

88,210

Less estimated inventory, February 1 Total units to be purchased Unit price

10,576

38,560

× $12.00

13,730

$7.00

× $3.00

× $4.50

$164,760

$617,470

$31,728

$173,520

Total direct materials to be purchased 1 2 3 4 5 6 7 8

$987,478

1,300 × 6.0 yds. = 7,800 sq. yds. 1,300 × 38 linear ft. = 49,400 linear ft. 1,300 × 4.2 cu. ft. = 5,460 cu. ft. 1,300 × 16 units = 20,800 units 1,490 × 4.0 sq. yds. = 5,960 sq. yds. 1,490 × 26 linear ft. = 38,740 linear ft. 1,490 × 3.4 cu. ft. = 5,066 cu. ft. 1,490 × 12 units = 17,880 units

CHAPTER 22

Budgeting

Prob. 22-2B (Concluded) 4. Royal Furniture Company Direct Labor Cost Budget For the Month Ending February 28 Framing Department

Cutting Department

Upholstery Department

1,560

650

1,040

1,490

596

894

3,050 $12.00 × $36,600

1,246 $14.00 × $17,444

1,934 $15.00 × $29,010

Total

Hours required for production: King1 2

Prince Total hours required Hourly rate Total direct labor cost 1

$83,054

This line is computed as 1,300 King chairs from the production budget multiplied by the hours per unit in each department estimated for the King chairs. 1,560 = 1,300 × 1.2; 650 = 1,300 × 0.5; 1,040 = 1,300 × 0.8 This line is computed as 1,490 Prince chairs from the production budget multiplied by the hours per unit in each department estimated for the Prince chairs. 1,490 = 1,490 × 1.0; 596 = 1,490 × 0.4; 894 = 1,490 × 0.6

CHAPTER 22

Budgeting

Prob. 22-3B 1.

Gold Medal Athletic Co. Sales Budget For the Month Ending March 31 Unit Sales Volume

Unit Selling Price

1,200 6,500

$ 40 160

Batting helmet Football helmet Total revenue from sales

Total Sales

48,000 1,040,000 $1,088,000

Gold Medal Athletic Co. Production Budget For the Month Ending March 31 Units Batting Helmet

Expected units to be sold Plus desired inventory, March 31 Total units required Less estimated inventory, March 1 Total units to be produced

1,200 50 1,250 40 1,210

Football Helmet

6,500 220 6,720 240 6,480

CHAPTER 22

Budgeting

Prob. 22-3B (Continued) Gold Medal Athletic Co. Direct Materials Purchases Budget For the Month Ending March 31

Pounds required for production: Batting helmet Football helmet Plus desired inventory, March 31 Total pounds required Less estimated inventory, March 1 Total pounds to be purchased Unit price (per pound) Total direct materials to be purchased 1 2 3 4

Plastic

Foam Lining

Total

1,4521 22,6803 50 24,182 90 24,092 × $6.00 $144,552

6052 9,7204 65 10,390 80 10,310 × $4.00 $41,240

$185,792

1,210 × 1.20 lb. = 1,452 lb. 1,210 × 0.50 lb. = 605 lb. 6,480 × 3.50 lb. = 22,680 lb. 6,480 × 1.50 lb. = 9,720 lb.

CHAPTER 22

Budgeting

Prob. 22-3B (Continued) 4.

Gold Medal Athletic Co. Direct Labor Cost Budget For the Month Ending March 31 Molding Department

Assembly Department

Batting helmet

2421

605 2

Football helmet

3,2403

11,6644

Total

Hours required for production:

Total hours required Hourly rate Total direct labor cost 1 2 3 4

3,482

12,269

$20 × $69,640

$14 × $171,766

$241,406

1,210 × 0.20 hr. = 242 hrs. 1,210 × 0.50 hr. = 605 hrs. 6,480 × 0.50 hr. = 3,240 hrs. 6,480 × 1.80 hrs. = 11,664 hrs.

Gold Medal Athletic Co. Factory Overhead Cost Budget For the Month Ending March 31 Indirect factory wages Depreciation of plant and equipment Power and light Insurance and property tax Total

$ 86,000 12,000 4,000 2,300 $104,300

CHAPTER 22

Budgeting

Prob. 22-3B (Continued) 6. Gold Medal Athletic Co. Cost of Goods Sold Budget For the Month Ending March 31 Finished goods inventory, March 11

$ 19,480

Work in process inventory, March 1 Direct materials:

$ 15,300

Direct materials inventory, March 12 Direct materials purchases

Cost of direct materials available for use Less direct materials inventory,

$186,652

March 313 Cost of direct materials placed in production Direct labor Factory overhead Total manufacturing costs

860 185,792

560 $186,092 241,406 104,300 531,798

Total work in process during period Less work in process, March 31 Cost of goods manufactured

$547,098 14,800 532,298

Cost of finished goods available for sale Less finished goods inventory, March 31 Cost of goods sold 1

$551,778 18,410 $533,368

Batting helmet (40 × $25.00)…………………………………………………… Football helmet (240 × $77.00)………………………………………………… Finished goods inventory, March 1…………………………………………

$ 1,000 18,480 $19,480

Plastic (90 × $6.00)……………………………………………………………… Foam lining (80 × $4.00)………………………………………………………… Direct materials inventory, March 1…………………………………………

Plastic (50 × $6.00)……………………………………………………………… Foam lining (65 × $4.00)………………………………………………………… Direct materials inventory, March 31…………………………………………

Batting helmet (50 × $25.00)…………………………………………………… Football helmet (220 × $78.00)………………………………………………… Finished goods inventory, March 31…………………………………………

$ 1,250 17,160 $18,410

540 320 860 300 260 560

CHAPTER 22

Budgeting

Prob. 22-3B (Concluded) 7.

Gold Medal Athletic Co. Selling and Administrative Expenses Budget For the Month Ending March 31 Selling expenses: Sales salaries expense Advertising expense Telephone expense—selling Travel expense—selling

$184,300 87,200 5,800 9,000

Total selling expenses

$286,300

Administrative expenses: Office salaries expense Depreciation expense—office equipment Telephone expense—administrative Office supplies expense Miscellaneous administrative expense Total administrative expenses Total operating expenses

$ 32,400 3,800 1,200 1,100 1,000 39,500 $325,800

Gold Medal Athletic Co. Budgeted Income Statement For the Month Ending March 31 Revenue from sales Cost of goods sold

$1,088,000 533,368

Gross profit Operating expenses: Selling expenses Administrative expenses Total operating expenses

$ 554,632 $286,300 39,500 325,800

Income from operations Other revenue and expense: Interest revenue Interest expense

$ 228,832 $

Income before income tax Income tax expense (30% rate) Net income

940 (872)

68 $ 228,900 68,670 $ 160,230

CHAPTER 22

Budgeting

Prob. 22-4B 1.

Mercury Shoes Inc. Cash Budget For the Three Months Ending June 30 June July Estimated cash receipts from: Cash sales Collection of accounts receivable Total cash receipts

Estimated cash payments for: Manufacturing costsb Selling and administrative expenses Capital expenditures Other purposes: Income tax Dividends Total cash payments

August

$ 16,000 138,000 $154,000

$ 18,500 146,400 $164,900

$ 20,000 157,500 $177,500

$ 56,200 40,000

$ 66,800 46,000

$ 88,400 51,000 120,000

24,000 $ 96,200

$136,800

15,000 $274,400

Cash increase or (decrease) Cash balance at beginning of month

$ 57,800 42,000

$ 28,100 99,800

$ (96,900) 127,900

Cash balance at end of month Minimum cash balance Excess (deficiency)

$ 99,800 40,000 $ 59,800

$127,900 40,000 $ 87,900

$ 31,000 40,000 $ (9,000)

CHAPTER 22

Budgeting

Prob. 22-4B (Concluded) Computations: a

Collections of accounts receivable:

June

July

April sales…………………………………………

$ 48,000 1

May sales……………………………………………

90,000

August 3

$ 60,000

86,4004

$ 57,600 5 99,900 6

$138,000

$146,400

$157,500

June

July

August

$13,000 43,200

$10,800 56,000

$14,000 74,400

$56,200

$66,800

$88,400

June sales………………………………………… July sales…………………………………………… Total…………………………………………… 1 2 3 4 5 6 b

$120,000 × 40% = $48,000 $150,000 × 60% = $90,000 $150,000 × 40% = $60,000 $160,000 × 90% × 60% = $86,400 $160,000 × 90% × 40% = $57,600 $185,000 × 90% × 60% = $99,900

Payments for manufacturing costs: Payment of accounts payable, c

beginning of month balance ………………… d

Payment of current month’s cost …………… Total…………………………………………… c

Accounts payable, June 1 balance = $13,000 ($66,000 – $12,000) × 20% = $10,800 ($82,000 – $12,000) × 20% = $14,000

($66,000 – $12,000) × 80% = $43,200 ($82,000 – $12,000) × 80% = $56,000 ($105,000 – $12,000) × 80% = $74,400

The budget indicates that the minimum cash balance will not be maintained in August. This is due to the capital expenditures requiring significant cash outflows during this month. This situation can be corrected by borrowing and/or by the sale of the marketable securities, if they are held for such purposes. At the end of June and July, the cash balance will exceed the minimum desired balance, and the excess could be considered for temporary investment.

CHAPTER 22

Budgeting

Prob. 22-5B 1. Mesa Publishing Co. Budgeted Income Statement For the Year Ending December 31, 20Y8 1

Sales Cost of goods sold: 2 Direct materials Direct labor3 Factory overhead4 Cost of goods sold Gross profit Operating expenses: Selling expenses: 5 Sales salaries and commissions Advertising 6 Miscellaneous selling expenses Total selling expenses Administrative expenses: 7 Office and officers salaries Supplies8 Miscellaneous administrative expense9 Total administrative expenses Total operating expenses Income before income tax Income tax expense Net income 1 2 3 4 5 6 7 8 9

$456,000 $114,000 31,920 23,640 169,560 $286,440

$64,100 13,200 10,500 $ 87,800 $34,400 5,060 9,520 48,980 136,780 $149,660 35,000 $114,660

3,800 units × $120 3,800 units × $30 3,800 units × $8.40 (3,800 units × $4.80) + $4,000 + $1,400 (3,800 units × $13.50) + $12,800 (3,800 units × $2.50) + $1,000 (3,800 units × $7.00) + $7,800 (3,800 units × $1.20) + $500 (3,800 units × $2.40) + $400

CHAPTER 22

Budgeting

Prob. 22-5B (Continued) 2. Mesa Publishing Co. Budgeted Balance Sheet December 31, 20Y8 Assets Current assets: Cash 1 Accounts receivable Inventories: Finished goods Work in process Materials Prepaid expenses Total current assets Property, plant, and equipment:

$106,660 23,800 $16,900 4,200 6,400

27,500 600 $158,560

Plant and equipment 2 Less accumulated depreciation 3 Total assets

$104,000 36,000

68,000 $226,560

Liabilities Current liabilities: Accounts payable

$ 14,800

Stockholders’ Equity Common stock

$ 30,000 181,760

Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 1

211,760 $226,560

Cash balance, December 31, 20Y8: Balance, January 1, 20Y8………………………………………………………… Add: Cash from operations Net income*……………………………………………………………… Depreciation of plant and equipment………………………………… Less: Dividends to be paid in 20Y8 (20,000 shares × $0.20 × 4 qtrs.)… Plant and equipment to be acquired in 20Y8……………………… Cash balance, December 31, 20Y8………………………………………………

$ 26,000 $114,660 4,000 $ 16,000 22,000

118,660 (38,000) $106,660

CHAPTER 22

Budgeting

Prob. 22-5B (Concluded) 2 3

$82,000 + $22,000 = $104,000 $32,000 + $4,000 = $36,000

4 Retained earnings balance, December 31, 20Y8:

Balance, January 1, 20Y8……………………………………………………… Plus net income for 20Y8………………………………………………………… Less dividends to be paid in 20Y8 (20,000 shares × $0.20 × 4 qtrs.)…… Balance, December 31, 20Y8……………………………………………………

$ 83,100 114,660 (16,000) $181,760

CHAPTER 22

Budgeting

CASES & PROJECTS CP 22-1 Cam should reject Megan’s request to charge the convention-related costs against July’s budget. This is just one example of many attempts to slide expenses into different budget periods than when actually incurred. This is a common issue that controllers face. Often, operating managers will attempt to accelerate future expenditures into low-expenditure months or delay present expenditures into future periods in order to avoid going over budget. These attempts to “slide” expenditures should not be supported, or else the whole concept of the budget will begin to become an accounting game. The integrity of the budget process must be defended by the controller. Thus, expenditures should be accrued to the period in which the benefit is received. Cam should reassure Megan that management will not take a single month’s results as an indication of either good or poor management. Month-tomonth variation should be expected. Rather, management will take a long-term perspective and evaluate whether the department is staying within budget over a longer period of time. Abnormal month-to-month variations from budget can “wash out” over time.

CHAPTER 22

Budgeting

CP 22-2 Answers will vary per state selected. Examples from the state of Tennessee are shown here.

Fiscal Year 2018–2019

CHAPTER 22

Budgeting

CP 22-2 (Concluded) Total State Budget Comparison of Programs and Revenue Sources Fiscal Years 2016–2017, 2017–2018, and 2018–2019

1 2 3 4

General Fund includes Education Lottery-funded programs. Includes tax revenues and bonds. Includes Higher Education tuition and student fees. Includes departmental operating revenues.

CHAPTER 22

Budgeting

CP 22-3 Memo To: From: Re:

Stacy Collins Ima Student Evaluating City of Milton Budget

After reviewing the city of Milton’s budget data, it appears that considerable goal conflict exists within departments, resulting in department managers making poor budgeting and spending decisions. The amount of actual expenditures was less than budgeted for the first 10 months of the budget year. As the budget year-end approached, department managers appear to have spent the remaining excess budget, going over budget in May and June. The amount spent for the year was equal to the total amount budgeted because the difference between the annual actual and budgeted totals is zero. Thus, the managers did not spend more than was authorized for the year. However, the managers appear to have spent the remaining available annual authorization in the last two months to avoid returning those amounts to the General Fund. This is an example of a “spend it or lose it” mentality. The managers appear to be holding back spending during the year to create a small cushion. If an emergency arises, then the manager has resources available to address it. If the emergency doesn’t arise, then the manager uses the amount held back in a flurry of year-end spending, some of which is likely to be wasteful. There are a number of techniques that the city could undertake to more effectively budget and align departmental behavior with the city’s goals. First, departments could adopt flexible budgets, which allow for monthly budgets to change with underlying activity. For example, if the number of prisoners in the jail increased, then the budget would increase proportionately. Department managers with a flexible budget would be less likely to “reserve” a large portion of the budget during the year because an activity change would automatically be reflected in the monthly budget. This reduces the department managers’ ability to create budgetary slack. Another solution would be to allow a manager to request additional funds after the budget year has begun. With this solution, department managers would not need to hold back spending for emergencies, because emergencies could be handled with a separate request. For example, if the town had a natural disaster, police and fire departments could request additional funding to meet the increased budget need. Finally, the budget could be designed to encourage thrift. For example, the budget could be designed so that managers carry forward a portion of their unspent budget to future years. This system would reward departmental thrift by allowing the department to keep a portion of the savings for future needs while reducing the incentive for aggressive year-end spending. This would allow the department manager to spend the budgetary slack when needed, rather than forcing the manager to spend this amount frivolously at year-end.

CHAPTER 22

Budgeting

CP 22-4 a.

The hospital’s new budget method is clearly an example of a flexible budget. The budget changes with changes in underlying activity, such as patient-days. Patient-days are the number of patients multiplied by the number of days in the hospital. As the number of patient-days changes, it would be reasonable to expect that the hospital’s variable costs should also change. In addition, the last quote suggests that the new budget approach is a monthly continuous budget. The budget helps the managers plan month-by-month expenditures.

The advantage of a flexible budget is to accurately plan variable costs of the hospital with changes in the underlying activity base. Using a static budget would create actual deviations from budget that would be difficult to interpret. Managers would not be able to determine if the deviations were the result of cost (in)efficiencies or whether they were due to changes in activity level. A flexible budget causes the budget to “flex” with changes in underlying activity level so that any remaining actual deviations from budget can be identified more clearly with (in)efficiency or other special causes. The continuous budget also provides timely information to managers so that they can adjust actual spending patterns to the budgeted amounts.

CP 22-5 a.

The budget information indicates that the actual expenditures by the Operations Department exceeded what was planned by $12,000. The bank manager may ask the operations manager why the travel and training expenditures exceeded the plan by a total of $20,000. It may be that the additional expenditures were necessary, but an explanation is in order.

The bank manager does not know if the actual resources consumed by the Operations Department are the right amount of resources for doing the right things. In other words, this budget doesn’t say anything about the actual work of the Operations Department and how much cost this work consumes. The bank manager doesn’t have a good sense if there is waste in the department or not. The $12,000 excess expenditure over budget raises several questions. If the department did twice as much work as planned, then the $12,000 is a bargain. If, on the other hand, the department did much less work than planned, then the $12,000 understates how poorly the department used resources. Again, how much work the department actually did is unknown, so these questions cannot be answered. A flexible budget would provide more information about the work of the department. Examples of the kind of work conducted by the department might include processing credit card statements, processing checking statements, processing loan repayments, and correcting errors.

CHAPTER 22

Budgeting

CP 22-5 (Concluded) The budget doesn’t indicate why there was more travel and training than expected. Maybe the department introduced a new computer system, and all employees needed off-site training in order to use the system. This would explain the additional spending on travel and training. The training needed to be done, regardless of the budget. The lower than expected overtime may be a favorable result. However, there may have been less overtime because employees were involved in more training days than expected or performed less work than planned. Again, a flexible budget would provide more information for evaluating the department’s performance.

CP 22-6 Domino’s could use a master budget to plan operations consistent with the sales forecast. The sales forecast could be used to develop the production budget for pizzas. The sales and production budgets would be identical because there would be no finished goods inventory for cooked pizzas. The sales (production) budget would be used to develop a direct materials purchases budget. For example, the pizza ingredients, packaging materials, beverages, and other materials could be planned from the sales budget. In addition, the cost of delivery fuel (driver reimbursement for gas) could be planned from the sales budget. The sales (production) budget could also be used to develop the direct labor budget for cooks, counter staff, dough making labor, and drivers. Much of the overhead is related to the number of restaurants, rather than the number of pizzas sold. That is, the number of restaurant locations will drive management salaries, rent, utilities, insurance, and other overhead costs. The drivers own the delivery vehicles; thus, vehicle depreciation and maintenance costs are not part of Domino’s overhead budget. The budget process could be used to direct and coordinate all the various restaurants. In this way, all the managers would be operating under the same set of assumptions. The actual performance of the company and the individual stores could be compared with the budget in order to provide all levels of the organization appropriate feedback and control. This feedback can be used to adjust operations to any changes that may be occurring. Thus, if sales are expanding faster or slower than planned, costs could be brought into line rapidly. This would help prevent the company from becoming either short of drivers and food due to sales outpacing projections or overbuilding stores before sales have materialized in sufficient volume to justify the cost.

CHAPTER 23 EVALUATING VARIANCES FROM STANDARD COSTS DISCUSSION QUESTIONS 1.

Standards are performance goals. Manufacturing companies normally use standard cost for each of the three following product costs: a. Direct materials b. Direct labor c. Factory overhead Standard cost systems enable management to determine the following: a. How much a product should cost (standard cost) b. How much it does cost (actual cost)

Reporting by the “principle of exceptions” is the reporting of only variances (or “exceptions”) between standard and actual costs to the individual responsible for cost control. This reporting allows management to focus on correcting cost variances.

The two variances in direct materials cost are: a. Direct materials price b. Direct materials quantity

The offsetting variances might have been caused by the purchase of low-priced, inferior materials. The low price of the materials would generate a favorable materials price variance, while the inferior quality of the materials would cause abnormal spoilage and waste, thus generating an unfavorable materials quantity variance.

The two variances in direct labor costs are: (1) Direct labor rate (2) Direct labor time

The direct labor cost variance is usually under the control of the production supervisor.

No. Even though the assembly workers are covered by union contracts, direct labor cost variances still might result. For example, direct labor rate variances could be caused by scheduling overtime to meet production demands or by assigning higher-paid workers to jobs normally performed by lower-paid workers. Likewise, direct labor time variances could result during the training of new workers or from a shortage of skilled employees.

Standards can be very appropriate in repetitive service operations. Fast-food restaurants can use standards for evaluating the productivity of the counter and food preparation employees. In addition, standards could be used to plan staffing patterns around various times of the day (e.g., increasing staff during the lunch hour).

CHAPTER 23

Evaluating Variances from Standard Costs

DISCUSSION QUESTIONS (Continued) 8.

The variable factory overhead controllable variance results from incurring a total amount of variable factory overhead cost greater or less than the amount budgeted for the level of operations achieved. The fixed factory overhead volume variance results from operating at a level above or below 100% of normal capacity.

The factory overhead cost variance report presents the standard factory overhead cost variance data (i.e., the volume and the controllable variance).

Net unfavorable direct materials price variance

10.

Nonfinancial performance measures provide managers additional measures beyond the dollar impact of decisions. Nonfinancial considerations may help the organization include external customer perspectives about quality and service in performance measurements. These bring added perspectives in evaluating performance.

CHAPTER 23

Evaluating Variances from Standard Costs

PRACTICE EXERCISES PE 23-1A a.

Direct materials price variance (unfavorable)

$14,400 = ($5.40 – $5.10) × 48,000 lb.

Direct materials quantity variance (favorable)

$(5,100) = (48,000 lb. – 49,000* lb.) × $5.10

* 3.5 standard lb. × 14,000 units c.

Direct materials cost variance (unfavorable)

$9,300 = $14,400 + $(5,100), or = ($5.40 × 48,000 lb.) – ($5.10 × 49,000 lb.) = $259,200 – $249,900

PE 23-1B a.

Direct materials price variance (unfavorable)

$3,350 = ($2.00 – $1.75) × 13,400 lb.

Direct materials quantity variance (favorable)

$(700) = (13,400 lb. – 13,800* lb.) × $1.75

* 6 standard lb. × 2,300 units c.

Direct materials cost variance (unfavorable)

$2,650 = $3,350 + $(700), or = ($2.00 × 13,400 lb.) – ($1.75 × 13,800 lb.) = $26,800 – $24,150

PE 23-2A a.

Direct labor rate variance (favorable)

$(8,700) = ($11.85 – $12.00) × 58,000 hrs.

Direct labor time variance (unfavorable)

$24,000 = (58,000 hrs. – 56,000* hrs.) × $12.00

* 4 standard hrs. × 14,000 units c.

Direct labor cost variance (unfavorable)

$15,300 = $(8,700) + $24,000, or = ($11.85 × 58,000 hrs.) – ($12.00 × 56,000 hrs.) = $687,300 – $672,000

PE 23-2B a.

Direct labor rate variance (favorable)

$(3,300) = ($20.50 – $21.00) × 6,600 hrs.

Direct labor time variance (favorable)

$(6,300) = (6,600 hrs. – 6,900* hrs.) × $21.00

* 3 standard hrs. × 2,300 units c.

Direct labor cost variance (favorable)

$(9,600) = $(3,300) + $(6,300), or = ($20.50 × 6,600 hrs.) – ($21.00 × 6,900 hrs.) = $135,300 – $144,900 23-3

CHAPTER 23

Evaluating Variances from Standard Costs

PE 23-3A Variable Factory Overhead = $46,100 – [$0.80 × (14,000 units × 4 hrs.)] Controllable Variance = $46,100 – $44,800 = $1,300 Unfavorable

PE 23-3B Variable Factory Overhead = $11,905 – [$1.90 × (2,300 units × 3 hrs.)] Controllable Variance = $11,905 – $13,110 = $(1,205) Favorable

PE 23-4A $(950) Favorable

= $0.95 × [55,000 hrs. – (14,000 units × 4 hrs.)]

PE 23-4B $240 Unfavorable

= $1.20 × [7,100 hrs. – (2,300 units × 3 hrs.)]

CHAPTER 23

Evaluating Variances from Standard Costs

PE 23-5A Work in Process (49,000* lb. × $5.10) Direct Materials Quantity Variance** Materials (48,500 lb. × $5.10)

249,900 2,550 247,350

* 14,000 units × 3.5 standard lb. per unit ** [(48,500 lb. – 49,000 lb.) × $5.10]

PE 23-5B Work in Process (13,800* lb. × $1.75) Direct Materials Quantity Variance** Materials (13,600 lb. × $1.75)

24,150 350 23,800

* 2,300 units × 6 standard lb. per unit ** [(13,600 lb. – 13,800 lb.) × $1.75]

PE 23-6A Venneman Company Income Statement Through Gross Profit For the Month Ended March 31 Sales (14,000 units × $165) Cost of goods sold—at standard* Gross profit—at standard

$2,310,000 1,019,900 $1,290,100 Unfavorable (Favorable)

Variance adjustments to gross profit at standard: Direct materials price (PE23-1A) Direct materials quantity (PE23-1A) Direct labor rate (PE23-2A) Direct labor time (PE23-2A) Factory overhead controllable (PE23-3A) Factory overhead volume (PE23-4A) Less net unfavorable variance from standard Gross profit

$14,400 $(5,100) (8,700) 24,000 1,300 (950)

* Direct materials (14,000 units × 3.5 lb. × $5.10)………………………………………………… Direct labor (14,000 units × 4 hrs. × $12.00)……………………………………………………… Factory overhead [14,000 units × 4 hrs. × ($0.80 + $0.95)]…………………………………… Cost of goods sold at standard……………………………………………………………………

24,950 $1,265,150 $ 249,900 672,000 98,000 $1,019,900

CHAPTER 23

Evaluating Variances from Standard Costs

PE 23-6B Encinas Company Income Statement Through Gross Profit For the Month Ended July 31 Sales (2,300 units × $270) Cost of goods sold—at standard* Gross profit—at standard

$621,000 190,440 $430,560 Unfavorable (Favorable)

Variance adjustment to gross profit at standard: Direct materials price (PE23-1B) Direct materials quantity (PE23-1B) Direct labor rate (PE23-2B) Direct labor time (PE23-2B) Factory overhead controllable (PE23-3B) Factory overhead volume (PE23-4B) Add net favorable variance from standard Gross profit

$3,350 $ (700) (3,300) (6,300) (1,205) 240

* Direct materials (2,300 units × 6 lb. × $1.75)……………………………………………………… Direct labor (2,300 units × 3 hrs. × $21.00)……………………………………………………… Factory overhead [2,300 units × 3 hrs. × ($1.90 + $1.20)]……………………………………… Cost of goods sold at standard……………………………………………………………………

7,915 $438,475 $ 24,150 144,900 21,390 $190,440

PE 23-7A Number of employee errors…………………………………………………………… Input Number of times paper supply runs out…………………………………………… Input Copy machine downtime (broken)…………………………………………………… Input Number of pages copied per hour…………………………………………………… Output Number of customer complaints…………………………………………………… Output Percent of jobs done on time…………………………..…………………………… Output

PE 23-7B Number of times ingredients are missing………………………………………… Input Number of customer complaints…………………………………………………… Output Number of hours kitchen equipment is down for repairs……………………… Input Number of server order mistakes…………………………………………………… Input Percent of meals prepared on time………………………………………………… Output Number of unexpected cook absences…………………………………………… Input

CHAPTER 23

Evaluating Variances from Standard Costs

EXERCISES Ex. 23-1 Ingredient

Cocoa Sugar Milk Total cost

Quantity

Price

600 lb. 120 lb. 180 gal.

× × ×

$1.25 per lb. $0.50 per lb. $2.60 per gal.

Total

$ 750 60 468 $1,278

Standard direct materials cost per bar of chocolate: $1,278 per batch 7,100 bars

= $0.18 per bar

Ex. 23-2 a.

Direct labor……………………………………… $19.00 Direct materials………………………………… $16.50 Variable factory overhead……………………… $3.90 Fixed factory overhead………………………… $2.10 Total cost per unit……………………………

× 3.5 hrs. × 27 bd. ft. × 3.5 hrs. × 3.5 hrs.

$ 66.50 445.50 13.65 7.35 $533.00

A standard cost system provides the company’s management a cost control tool using the principle of management by exception. Using this principle, costs that deviate significantly from standards can be investigated and corrected. The standard cost system also can be used to motivate employees to work efficiently with their time, use of materials, and other factory overhead resources.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-3 Genie in a Bottle Company Manufacturing Cost Budget For the Month Ended July 31

Standard Cost at Planned Volume (400,000 Bottles)

Manufacturing costs: Direct labor Direct materials Factory overhead Total

$ 8,000* 36,400** 2,200*** $46,600

* $2.00 × (400,000 ÷ 100) = $8,000 ** $9.10 × (400,000 ÷ 100) = $36,400 *** $0.55 × (400,000 ÷ 100) = $2,200 Note: The cost standards are expressed as “per 100 bottles.” b.

Genie in a Bottle Company Manufacturing Costs—Budget Performance Report For the Month Ended July 31 Actual Costs

Manufacturing costs: Direct labor Direct materials Factory overhead Total manufacturing cost

$ 7,540 35,750 2,680 $45,970

Standard Cost at Cost Variance— Actual Volume (Favorable) (406,000 Bottles)* Unfavorable

$ 8,120 36,946 2,233 $47,299

$ (580) (1,196) 447 $(1,329)

* $2.00 × (406,000 ÷ 100) = $8,120 $9.10 × (406,000 ÷ 100) = $36,946 $0.55 × (406,000 ÷ 100) = $2,233

Genie in a Bottle Company’s actual costs were $1,329 less than budgeted. Favorable direct labor and direct materials cost variances more than offset a small unfavorable factory overhead cost variance.

Note to Instructors: The budget prepared in part (a) at the beginning of the month should not be used in the budget performance report because actual volumes were greater than planned (406,000 vs. 400,000).

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-4 a.

Price variance: Direct Materials = (Actual Price – Standard Price) × Actual Quantity Price Variance = ($3.00 per lb. – $2.95 per lb.) × 438,000 lb. = $21,900 Unfavorable Quantity variance: Direct Materials = (Actual Quantity – Standard Quantity) × Standard Price Quantity Variance = (438,000 lb. – 446,000 lb.) × $2.95 per lb. = $(23,600) Favorable Total direct materials cost variance: Direct Materials Direct Materials Price Variance + = Direct Materials Quantity Variance Cost Variance = $21,900 + $(23,600) = $(1,700) Favorable

The direct materials price variance should normally be reported to the Purchasing Department, which may or may not be able to control this variance. If materials of the same quality were purchased from another supplier at a price higher than the standard price, the variance was controllable. However, if the variance resulted from a market-wide price increase, the variance was not subject to control. The direct materials quantity variance should be reported to the proper level of operating management. For example, if lower amounts of direct materials had been used because of production efficiencies, the variance would be reported to the production supervisor. However, if the favorable use of raw materials had been caused by the purchase of higher-quality raw materials, the variance should be reported to the Purchasing Department. The total materials cost variance should be reported to senior plant management, such as the plant manager or materials manager.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-5 Price variance: Direct Materials Price Variance = (Actual Price – Standard Price) × Actual Quantity = ($21.75 per unit* – $23.00 per unit) × 960 = $(1,200) Favorable * $20,880 ÷ 960 units = $21.75 per unit Quantity variance: Direct Materials (Actual Quantity – Standard Quantity) = Quantity Variance × Standard Price = (960 units – 935 units) × $23.00 per unit = $575 Unfavorable Total direct materials cost variance: Direct Materials Price Variance + Direct Materials Quantity Variance = $(1,200) Favorable + $575 Unfavorable

Direct Materials Cost Variance =

= $(625) Favorable

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-6 Product finished……………………………………………………… Standard finished product for direct materials used (3,000 lb. ÷ 2 lb.)…………………………………………………… Deficiency of finished product for materials used………… Standard cost for direct materials: Quantity variance divided by deficiency of product for materials used ($1,000 ÷ 100 units)……………………… Alternate solution: Price variance, unfavorable…………………………………… ÷ Materials used…………………………………………………… Price variance per lb., unfavorable…………………………… Unit price of direct materials…………………………………… Less price variance (unfavorable) per lb. (from above)…… Standard price per lb.…………………………………………… × Pounds per unit of product…………………………………… Standard direct materials cost per unit of product…………

1,400 units 1,500 (100) units

$10.00 per unit $1,500 3,000 lb. $ 0.50 $ 5.50 (0.50) $ 5.00 2 × $10.00

Alternative Solution for Standard Price: Direct Materials Price Variance = (Actual Price – Standard Price) × Actual Quantity $1,500 U = ($5.50 – Standard Price) × 3,000 $1,500 U = $16,500 – (3,000 × Standard Price) $15,000 = 3,000 × Standard Price $5.00 = Standard Price or: Direct Materials (Actual Quantity – Standard Quantity) = Quantity Variance × Standard Price $1,000 U = (3,000 lb. – 2,800 lb.) × Standard Price $1,000 U = 200 lb. × Standard Price $5.00 = Standard Price

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-7 a. Standard Quantity

Whole tomatoes… 4,000 lb. Vinegar…………… 260 gal. 25 gal. Corn syrup………… Salt………………… 100 lb.

Standard Price

$ 0.60 per lb. 2.25 per gal. 28.00 per gal. 2.25 per lb.

Standard Cost per Batch $2,400 585 700 225

$3,910 ÷ Pounds per batch………………………………………… 3,128 lb. $ 1.25 per lb. b.

Actual Standard Quantity for Quantity per = Batch K-111 – Batch 4,250 lb. 275 gal. 22 gal. 90 lb.

4,000 lb. 260 gal. 25 gal. 100 lb.

Quantity Difference 250 lb. 15 gal. (3) gal. (10) lb.

Standard Price $ 0.60 per lb. 2.25 per gal. 28.00 per gal. 2.25 per lb.

Materials Quantity = Variance $150.00 U 33.75 U (84.00) F (22.50) F $ 77.25 U

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-8 a.

Rate variance: Direct Labor (Actual Rate per Hour – Standard Rate per Hour) = Rate Variance × Actual Hours = ($49.50 – $51.00) × 6,330 hours = $(9,495) Favorable Time variance: Direct Labor (Actual Direct Labor Hours – Standard Direct Labor Hours) = Time Variance × Standard Rate per Hour = (6,330 hrs. – 6,240 hrs.) × $51.00 per hour = $4,590 Unfavorable Total direct labor cost variance: Direct Labor = Direct Labor Rate Variance + Direct Labor Time Variance Cost Variance = $(9,495) Favorable + $4,590 Unfavorable = $(4,905) Favorable

The employees may have been less-experienced workers who were paid less than more-experienced workers or poorly trained, thereby resulting in a lower labor rate than planned. The lower level of experience or training may have resulted in less efficient performance. Thus, the actual time required was more than standard. Fortunately, the lost efficiency is more than offset by the lower labor rate.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-9 a.

Rate variance: (Actual Rate per Hour – Standard Rate per Hour) Direct Labor = Rate Variance × Actual Hours = ($18.30 – $17.80) × 4,140 hrs. = $2,070 Unfavorable Time variance: Direct Labor (Actual Direct Labor Hours – Standard Direct Labor Hours) = × Standard Rate per Hour Time Variance = (4,140 hrs. – 4,640 hrs.*) × $17.80 per hour = $(8,900) Favorable * 5.8 hrs. × 800 units Total direct labor cost variance: Direct Labor = Direct Labor Rate Variance + Direct Labor Time Variance Cost Variance = $2,070 Unfavorable + $(8,900) Favorable = $(6,830) Favorable

Debit to Work in Process: $82,592 Standard hours at actual production………………………………………… × Standard rate…………………………………………………………………… Standard direct labor cost………………………………………………………

4,640 $ 17.80 $82,592

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-10 a.

(1) Cutting Department Rate variance: Direct Labor (Actual Rate per Hour – Standard Rate per Hour) = Rate Variance × Actual Hours = ($10.90 – $11.00) × 6,380 hours = $(638) Favorable Time variance: Direct Labor (Actual Direct Labor Hours – Standard Direct Labor = Time Variance Hours) × Standard Rate per Hour = (6,380 hrs. – 6,250 hrs.*) × $11.00 per hour = $1,430 Unfavorable * 0.25 hr. × 25,000 units Total direct labor cost variance: Direct Labor = Direct Labor Rate Variance + Direct Labor Time Variance Cost Variance = $(638) Favorable + $1,430 Unfavorable = $792 Unfavorable

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-10 (Concluded) (2) Sewing Department Rate variance: Direct Labor (Actual Rate per Hour – Standard Rate per Hour) = Rate Variance × Actual Hours = ($11.12 – $11.00) × 9,875 hours = $1,185 Unfavorable Time variance: Direct Labor (Actual Direct Labor Hours – Standard Direct Labor Hours) = Time Variance × Standard Rate per Hour = (9,875 hrs. – 10,000 hrs.*) × $11.00 per hour = $(1,375) Favorable * 0.40 hr. × 25,000 units Total direct labor cost variance: Direct Labor = Direct Labor Rate Variance + Direct Labor Time Variance Cost Variance = $1,185 Unfavorable + $(1,375) Favorable = $(190) Favorable b.

The two departments have opposite results. The Cutting Department has a favorable rate and an unfavorable time variance, resulting in a total unfavorable cost variance of $792. In contrast, the Sewing Department has an unfavorable rate variance but has a favorable time variance, resulting in a total favorable cost variance of $190. The causes of this disparity are worthy of investigation. There are many possible causes including tight or loose standards, inferior or superior operating methods, and inappropriate or appropriate use of overtime. Combining both departments, the overall operation shows an unfavorable cost variance of $602 ($792 – $190) as a result of the weak performance in the Cutting Department.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-11 a. Actual weekly expenditure: 4 people × $15 per hour × 40 hrs. per week = $2,400 b. Standard time used for the volume of admissions: Unscheduled

Scheduled

140 30 min. 4,200 min.

350 15 min. 5,250 min.

Number of admissions……… × Standard time……………… Total……………………………

Total

9,450 min. or (157.5 hrs. × 60 min.)

c. Actual productive minutes available (4 employees × 40 hrs. × 60 min.)………………………… 9,600 minutes Less standard minutes used at actual volume………… 9,450 minutes Time difference from standard……………………………… 150 minutes 1 × Standard rate per minute ………………………………… $ 0.25 Direct labor time variance—unfavorable………………… $37.50 or [(4 × 40 hrs.) – 157.5 hrs.] × $15 per hr. = $37.50 or $2,400 [from (a)] – $2,362.502 = $37.50 1

Standard direct labor rate: $15 ÷ 60 min. = $0.25 per min.

Standard labor cost at actual volume: Productive time (9,450 ÷ 60) × $15 = $2,362.50

The Admissions Department consumed 150 minutes, or 2.5 hours, more than the standard hours needed for the week’s admissions. This is equal to $37.50 at the standard rate of $15 per hour.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-12 a.

Standard Sorts per Minute × Standard Sorts per Hour = Standard Minutes per Hour (per employee) 90 sorts per min. × 60 min. per hr. = 5,400 standard sorts per hr. Pieces of Mail ÷ = Number of Hours Planned Standard Sorts per Hour 24,192,000 letters ÷ 5,400 sorts per hr. = 4,480 hrs. planned Number of Hours Planned ÷ = Number of Hires Hours per Temporary Employee per Month 4,480 hrs. ÷ 160 hrs. = 28 temporary hires for December

Actual pieces sorted = 23,895,000 Actual Pieces of Mail Sorted ÷ Standard Number of Hours = Standard Sorts per Hour for Actual Production 23,895,000 ÷ 5,400 standard sorts per hr. =

4,425 standard hrs. for actual production

Actual hours staffed……………………………………………………………… Standard hours for actual production………………………………………… Excess of actual over standard hours………………………………………… × Standard hourly rate…………………………………………………………… Direct labor time variance—unfavorable………………………………………

4,480 4,425 55 $16.40 $ 902

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-13 a.

Rate variance: Direct Labor (Actual Rate per Hour – Standard Rate per Hour) = Rate Variance × Actual Hours = ($15.00 – $15.50) × 24 hours = $(12) Favorable Time variance: Direct Labor (Actual Direct Labor Hours – Standard Direct Labor Hours) = Time Variance × Standard Rate per Hour = (24 hrs. – 20 hrs.*) × $15.50 per hour = $62 Unfavorable * 0.1 hr. × 200 meals Total direct labor cost variance: Direct Labor = Direct Labor Rate Variance + Direct Labor Time Variance Cost Variance = $(12) Favorable + $62 Unfavorable = $50 Unfavorable

The mobile kitchen must be staffed with at least three employees to meet demand (200 meals). Employees are unable to move to another truck once they are assigned for the day. As a result, an unfavorable time variance will occur any time the number of meals actually made falls below the maximum number of meals that could be generated by three employees. In this case, three employees were assigned to the truck with the potential to make 240 meals [24 standard hours (3 employees × 8 hours per day) ÷ 0.1 standard hour per meal]. Hit-n-Run could reduce the time variance and improve the profitability of the Jose O’Brien truck by targeting locations that could allow it to increase sales volume to 240 meals, the maximum that could be produced by three employees.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-14 Step 1: Determine the standard direct materials and direct labor per unit. Standard direct materials quantity per unit: Direct materials lb. budgeted for June: $88,000 $5.50 per lb.

= 16,000 lb.

Standard pounds per unit: 16,000 lb. 6,400 units

= 2.5 standard lb. per unit

Standard direct labor time per unit: Direct labor hrs. budgeted for June: $56,320 $22.00 per hr.

= 2,560 direct labor hrs.

Standard direct labor hrs. per unit: 2,560 hrs. 6,400 units

= 0.40 standard direct labor hr. per unit

Step 2: Using the standard quantity and time rates in step 1, determine the standard costs for the actual June production. Standard direct materials at actual volume: 6,500 units × 2.5 lb. per unit × $5.50…………………………………………… $ 89,375 Standard direct labor at actual volume: 57,200 6,500 units × 0.40 direct labor hr. per unit × $22.00………………………… Total…………………………………………………………………………………… $146,575 Step 3: Determine the direct materials quantity and direct labor time variances, assuming no direct materials price or direct labor rate variances. Actual direct materials used in production……………………………………… $ 82,060 (89,375) Standard direct materials (step 2)………………………………………………… Direct materials quantity variance—favorable*………………………………… $ (7,315) * (14,920 lbs. – 16,250 lbs.) × $5.50 = $(7,315) F $82,060 ÷ $5.50 = 14,920 actual lbs. $89,375 ÷ $5.50 = 16,250 standard lbs.

Actual direct labor…………………………………………………………………… $ 50,600 Standard direct labor (step 2)……………………………………………………… (57,200) Direct labor time variance—favorable**………………………………………… $ (6,600) ** (2,300 hrs. – 2,600 hrs.) × $22.00 = $(6,600) F 6,500 units × 0.40 hr. = 2,600 standard hrs. $50,600 ÷ $22.00 = 2,300 actual hrs.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-15 Leno Manufacturing Company Factory Overhead Cost Budget—Press Department For the Month Ended November 30 Direct labor hours Variable overhead cost: Indirect factory labor Power and light Indirect materials Total variable factory overhead Fixed factory overhead cost: Supervisory salaries Depreciation of plant and equipment Insurance and property taxes Total fixed factory overhead Total factory overhead 1 2 3

18,000

20,000

22,000

$162,0001 10,800 2 57,600 3 $230,400

$180,000 12,000 64,000 $256,000

$198,000 13,200 70,400 $281,600

$ 80,000 50,000 32,000 $162,000 $392,400

$ 80,000 50,000 32,000 $162,000 $418,000

$ 80,000 50,000 32,000 $162,000 $443,600

($180,000 ÷ 20,000) × 18,000 units ($12,000 ÷ 20,000) × 18,000 units ($64,000 ÷ 20,000) × 18,000 units

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-16 a.

Wiki Wiki Company Monthly Factory Overhead Cost Budget—Fabrication Department Direct labor hours Variable factory overhead cost Fixed factory overhead cost Total factory overhead

9,000

10,000

11,000

$ 40,500 60,000 $100,500

$ 45,000 60,000 $105,000

$ 49,500 60,000 $109,500

Overhead applied at actual production: Actual hours……………………………………………………………………… × Overhead application rate*…………………………………………………… Factory overhead applied………………………………………………………

9,000 $ 10.50 $94,500

* Total factory overhead rate to be applied to production: Variable factory overhead…………………………………………… $ 4.50 Fixed factory overhead**……………………………………………… 6.00 Total……………………………………………………………………… $10.50

** Fixed factory overhead rate:

$60,000

= $6.00 per hr.

10,000 hrs.

Note: The fixed factory overhead rate is determined at normal production.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-17 Variable factory overhead controllable variance: Actual variable factory overhead cost incurred……… $192,000 Less budgeted variable factory overhead for 15,600 hrs. [15,600 × ($20.00 – $8.00)]…………… 187,200 Variance—unfavorable…………………………………

$4,800

Fixed factory overhead volume variance: 16,000 hrs. 15,600 hrs.

Productive capacity at 100%……………………………… Less standard for amount produced…………………… Productive capacity not used…………………………… × Standard fixed factory overhead rate………………… Variance—unfavorable………………………………… Total factory overhead cost variance—unfavorable*……

400 hrs. ×$8.00 3,200 $8,000

* Actual Overhead – Applied Overhead = Total Overhead Variance: ($192,000 + $128,000) – $312,000 = $8,000

Alternative Computation of Overhead Variances Factory Overhead Actual costs Balance (underapplied) Actual Factory Overhead $320,000

320,000

Applied costs

312,000

8,000 Applied Factory Overhead

Budgeted Factory Overhead for Amount Produced Variable cost [15,600 × ($20.00 – $8.00)]…… $187,200 128,000 Fixed cost ($8.00 × 16,000 hrs.)……………… Total………………………………………………… $315,200 $4,800 U Controllable Variance

$312,000

$3,200 U Volume Variance $8,000 U Total Factory Overhead Cost Variance

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-18 a.

Controllable variance: Actual variable factory overhead ($782,000 – $240,000)…………………………… Less standard variable factory overhead at actual production: Standard hours at actual production…… × Variable factory overhead rate1………… Standard variable factory overhead………… Controllable variance—favorable………………

$542,000

92,500 × $6.00 555,000 $(13,000)

Volume variance: Volume at 100% of normal capacity…………………………… 100,000 92,500 Less standard hours…………………………………………… Idle capacity……………………………………………………… 7,500 2 × Fixed overhead rate …………………………………………… × $2.40 Volume variance—unfavorable………………………………… Total factory overhead cost variance—unfavorable………………………………………… 1

Variable factory overhead rate:

Fixed factory overhead rate:

$540,000 90,000 hrs. $240,000 100,000 hrs.

18,000 $ 5,0003

= $6.00 per hour

= $2.40 per hour

Actual Overhead – Applied Overhead = Total Overhead Variance: $782,000 – [($6.00 + $2.40) × 92,500 hrs.] = $5,000

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-18 (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs Balance (underapplied)

777,000 *

Applied costs

Applied Factory Overhead

Budgeted Factory Overhead for Amount Produced

Actual Factory Overhead $782,000

782,000 5,000

Variable cost (92,500 × $6.00)………… Fixed cost………………………………… Total………………………………………

$555,000 240,000

$777,000 *

$795,000 $18,000 U Volume Variance

$(13,000) F Controllable Variance $5,000 U Total Factory Overhead Cost Variance

* ($6.00 + $2.40) × 92,500

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-19 In determining the volume variance, the productive capacity overemployed (2,000 hours) should be multiplied by the standard fixed factory overhead rate of $3.80 ($7.30 – $3.50) to yield a favorable variance of $7,600. The variance analysis provided by the chief cost accountant incorrectly multiplied the 2,000 hours by the total factory overhead rate of $7.30 per hour and reported it as unfavorable. A correct determination of the factory overhead cost variances is as follows: Variable factory overhead controllable variance: Actual variable factory overhead cost incurred……… $458,000 Budgeted variable factory overhead for 462,000 132,000 hours (132,000 × $3.50)……………………… Variance—favorable……………………………………

$ (4,000)

Fixed factory overhead volume variance: 130,000 hrs. Productive capacity at 100%…………………………… Standard for amount produced………………………… 132,000 hrs. Productive capacity overemployed…………………… (2,000) hrs. × Standard fixed factory overhead rate……………… × $3.80 Variance—favorable…………………………………… Total factory overhead cost variance—favorable………

(7,600) $(11,600)

Alternative Computation of Overhead Variances

Actual costs ($458,000 + $494,000)

Factory Overhead 952,000 Applied costs

963,600

[($3.50 + $3.80) × 132,000] Balance (overapplied)

11,600

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$952,000

Variable cost (132,000 × $3.50)……… $462,000 494,000 Fixed cost………………………………… $956,000 Total………………………………………

$963,600

$(4,000) F Controllable Variance

$(7,600) F Volume Variance $(11,600) F Total Factory Overhead Cost Variance

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-20 Tannin Products Inc. Factory Overhead Cost Variance Report—Trim Department For the Month Ended July 31 Productive capacity for the month Actual productive capacity used for the month

25,000 hrs. 22,000 hrs.

Actual

Budget (at actual production)

$ 49,700 13,000 24,000

$ 50,600 13,200 22,000

$ 86,700

$ 85,800

$ 54,500

40,000 35,500

$130,000 $216,700

$130,000 $215,800

Variances Unfavorable (Favorable)

Variable factory overhead costs: Indirect factory labor Power and light Indirect materials Total variable factory overhead cost

Fixed factory overhead costs: Supervisory salaries Depreciation of plant and equipment Insurance and property taxes Total fixed factory overhead cost Total factory overhead cost Total controllable variances

(900) (200)

$2,000

Net controllable variance—unfavorable Volume variance—unfavorable: Idle hours at the standard rate for fixed factory overhead: (25,000 hrs. – 22,000 hrs.) × $5.20 2 Total factory overhead cost variance—unfavorable 1

$ (1,100) $

15,600 $16,500

The budgeted variable factory overhead costs are determined by multiplying 22,000 hours by the variable factory overhead cost rate for each variable cost category. These rates are determined by dividing each budgeted amount (estimated at the beginning of the month) by the planned (budgeted) volume of 20,000 hours. Thus, for example: $50,600 = ($46,000 ÷ 20,000 hrs.) × 22,000 hrs. $13,200 = ($12,000 ÷ 20,000 hrs.) × 22,000 hrs. $22,000 = ($20,000 ÷ 20,000 hrs.) × 22,000 hrs.

Fixed factory overhead rate:

$130,000 25,000 hrs.

900

= $5.20 per hr.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-20 (Concluded) Alternative Computation of Overhead Variances

Actual costs

Factory Overhead 216,700 Applied costs

Balance (underapplied)

16,500

200,200

[22,000 × ($3.90* + $5.20)]

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$216,700

Variable cost (22,000 × $3.90)………… $ 85,800 Fixed cost………………………………… 130,000 Total……………………………………… $215,800

$200,200

$900 U Controllable Variance

$15,600 U Volume Variance $16,500 U Total Factory Overhead Cost Variance

* $78,000 ÷ 20,000 hours budgeted at the beginning of the month

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-21 Materials1 2 Direct Materials Price Variance

118,825 8,575

127,400

Accounts Payable 1 2 3

2,450 × $48.50 2,450 × $3.50 ($52.00 – $48.50) 2,450 × $52.00 1

Work in Process

97,000 2

4,850

Direct Materials Quantity Variance 3

92,150

Materials 1 2 3

200 × 10 units × $48.50 (2,000 units – 1,900 units) × $48.50 1,900 × $48.50

Ex. 23-22 Mar.

31 Work in Process

198,000

Direct Labor Time Variance

9,000

Direct Labor Rate Variance Wages Payable2 1

5,000 × 2.20 hrs. × $18.00 Direct labor time variance: (11,500 – 11,000) × $18.00 = $9,000 U Direct labor rate variance: ($17.60 – $18.00) × 11,500 = $(4,600) F

11,500 hours × $17.60 per hour

4,600 202,400

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-23 Arseneault Company Income Statement For the Month Ended December 31 Sales Cost of goods sold—at standard Gross profit—at standard

$996,000 634,000 $362,000 Unfavorable

(Favorable)

Variance adjustments to gross profit at standard: Direct materials price Direct materials quantity Direct labor rate Direct labor time Variable factory overhead controllable Fixed factory overhead volume Less net unfavorable variance from standard Gross profit Operating expenses: Selling expenses Administrative expenses Income from operations Other expense: Interest expense Income before income tax

$1,830 $

(720) (1,240)

490 (250) 4,190 4,300 $357,700 $136,500 114,100

250,600 $107,100 3,150 $103,950

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-24 a. and b. Input Measure

Output Measure

Explanation

Average computer response time to customer “clicks”

A measure of the speed of the ordering process. If the speed is too slow, we may lose customers.

Dollar amount of returned goods

An important measure of customer satisfaction with the final product that was ordered.

Elapsed time between customer order and product delivery

An important overall measure of

Maintenance dollars divided by hardware investment

process responsiveness. If the company is too slow in providing product, we may lose customers. X

A driver of the ordering system’s reliability and downtime. The maintenance dollars should be divided by the amount of hardware in order to facilitate comparison across time.

Number of customer complaints divided by the number of orders

An extreme measure of customer dissatisfaction with the ordering process.

Number of misfilled orders divided by the number of orders

Incorrectly filled orders reduce the customer’s satisfaction with the order process. A measure of output quality of the process.

Number of orders per warehouse employee

This measure is related to the capacity of the warehouse relative to the demands placed upon it. This relationship will impact the delivery cycle time.

Number of page faults or errors due to software programming errors

The page errors will negatively impact the customer’s ordering experience. It’s a measure of process output quality.

Number of software fixes per week

Software bugs reduce the effectiveness of the order fulfillment system; thus, fixes are an input that will improve the performance of the order fulfillment system.

Server (computer) downtime

Training dollars per programmer

A measure of computer system reliability. Trained programmers should enhance the software’s responsiveness and reliability.

CHAPTER 23

Evaluating Variances from Standard Costs

Ex. 23-25 a.

Possible Input Measures Registration staffing per student Technology investment per period for registration process Training hours per registration personnel Amount of faculty staffing Amount of technology capacity (size of computer, number of input lines) for registration process Maintenance dollars spent on the registration system Employee satisfaction score Number of hours per day registration is available Possible Output Measures Cycle time for a student to register for classes Number of times a course is unavailable Number of separate registration events or steps (log-ons or line waits) per student Number of times a replacement course was used by a student Number of registration errors Student satisfaction score with the registration process Number of student complaints about registration process Number of registration rework steps per student Cost of registration per student Number of personnel overtime hours during registration Labor time variance for registration process (standard hours less actual hours at standard labor rate) Number of computer registration failures

Alpha University is interested in not only the efficiency of the process but also the quality of the process. This means that the process must meet multiple objectives. The college wants this process to meet the needs of students, which means it should not pose a burden to students. Students should be able to register for classes quickly, get the courses they want, and avoid registration errors, hassles, and problems. Thus, the nonfinancial measures are used to balance the need for a cost-efficient process with one that will meet the needs of the student.

CHAPTER 23

Evaluating Variances from Standard Costs

PROBLEMS Prob. 23-1A a.

Standard Materials and Labor Cost per Faucet

Direct materials ($2.40 × 3.0 lb.)………………………………………………… $ 7.20 10.00 Direct labor [$15.00 × (40 min. ÷ 60 min.)]…………………………………… $17.20 b.

Direct Materials Cost Variance Price variance: Direct Materials = (Actual Price – Standard Price) × Actual Quantity Price Variance = ($2.50 per lb. – $2.40 per lb.) × 14,350 lb. = $1,435 Unfavorable Quantity variance: Direct Materials = (Actual Quantity – Standard Quantity) × Standard Price Quantity Variance = (14,350 lb. – 14,400 lb.*) × $2.40 per lb. = $(120) Favorable * 4,800 units × 3.0 lb. Total direct materials cost variance: Direct Materials Direct Materials Price Variance + = Cost Variance Direct Materials Quantity Variance = $1,435 Unfavorable + $(120) Favorable = $1,315 Unfavorable

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-1A (Concluded) c.

Direct Labor Cost Variance Rate variance: Direct Labor (Actual Rate per Hour – Standard Rate per Hour) = Rate Variance × Actual Hours = ($14.40 – $15.00) × 3,240 hrs.* = $(1,944) Favorable * 90 employees × 36 hrs. Time variance: Direct Labor (Actual Direct Labor Hours – Standard Direct Labor = Time Variance Hours) × Standard Rate per Hour = (3,240 hrs.* – 3,200 hrs.**) × $15.00 per hour = $600 Unfavorable * 90 employees × 36 hrs. ** 4,800 units × (40 min. ÷ 60 min.) Total direct labor cost variance: Direct Labor Direct Labor Rate Variance + Direct Labor Time = Cost Variance Variance = $(1,944) Favorable + $600 Unfavorable = $(1,344) Favorable

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-2A 1.

Direct Materials Variance

Cocoa

Sugar

Total

Price variance: $

7.33 7.25

1.35 1.40

0.08 140,300

(0.05) 188,000

$ 11,224 U

$ (9,400) F

Actual quantity used…………………………… Standard quantity1………………………………

140,300 140,000

188,000 190,000

Variance………………………………………… × Standard price………………………………… Direct materials quantity variance………

300 $7.25

(2,000) $1.40

Actual price……………………………………… Standard price………………………………… Variance………………………………………… × Actual quantity……………………………… Direct materials price variance…………

$1,824 U

Quantity variance:

2,175 U

$ (2,800) F

(625) F $1,199 U

Total direct materials cost variance…………… Alternatively, total direct materials cost variance: Actual cost 2…………………………………… Standard cost 3………………………………… Total direct materials cost variance…… 1

$1,028,399 1,015,000

$253,800 266,000

$ (12,200) F

13,399 U

$1,199 U

140,000 = (12 lb. × 5,000 actual production of dark chocolate) + (8 lb. × 10,000 actual production of light chocolate) 190,000 = (10 lb. × 5,000 actual production of dark chocolate) + (14 lb. × 10,000 actual production of light chocolate)

$1,028,399 = $7.33 × 140,300 lb. $253,800 = $1.35 × 188,000 lb.

$1,015,000 = $7.25 × 140,000 lb. $266,000 = $1.40 × 190,000 lb.

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-2A (Concluded) 1.

b. Dark Chocolate

Light Chocolate

$ 15.25 15.50

$ 15.80 15.50

$ (0.25) × 2,360 $ (590) F

$ 0.30 × 6,120 $ 1,836 U

Actual time…………………………………… Standard time 1………………………………

2,360 2,500

6,120 6,000

Variance……………………………………… × Standard rate……………………………… Direct labor time variance………………

(140) $ 15.50

120 $ 15.50

$ (2,170) F

$ 1,860 U

Direct Labor Variance

Total

Rate variance: Actual rate…………………………………… Standard rate………………………………… Variance……………………………………… × Actual time………………………………… Direct labor rate variance………………

$1,246 U

Time variance:

(310) F $ 936 U

Total direct labor cost variance……………… Alternatively, total direct labor cost variance: Actual cost 2………………………………… Standard cost 3……………………………… Total direct labor cost variance……… 1

$35,990 38,750

$96,696 93,000

$ (2,760) F

$ 3,696 U

$ 936 U

2,500 = 0.50 hr. × 5,000 actual production of dark chocolate 6,000 = 0.60 hr. × 10,000 actual production of dark chocolate

$35,990 = 2,360 hrs. × $15.25 $96,696 = 6,120 hrs. × $15.80

$38,750 = 2,500 hrs. × $15.50 $93,000 = 6,000 hrs. × $15.50

The variance analyses should be based on the standard amounts at actual volumes. The budget must flex with the volume changes. If the actual volume is different from the planned volume, as it was in this case, then the budget used for performance evaluation should reflect the amount of direct materials and direct labor that will be required for the actual production. In this way, spending from volume changes can be separated from efficiency and price variances.

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-3A Direct Materials Cost Variance

a. Price variance:

Direct Materials = (Actual Price – Standard Price) × Actual Quantity Price Variance = ($3.25 per lb. – $3.20 per lb.) × 118,500 lb. = $5,925 Unfavorable Quantity variance: Direct Materials = (Actual Quantity – Standard Quantity) × Standard Price Quantity Variance = (118,500 lb. – 120,000 lb.) × $3.20 per lb. = $(4,800) Favorable Total direct materials cost variance: Direct Materials Price Variance + Direct Materials = Direct Materials Quantity Variance Cost Variance = $5,925 Unfavorable + $(4,800) Favorable = $1,125 Unfavorable Direct Labor Cost Variance

b. Rate variance:

(Actual Rate per Hour – Standard Rate per Hour) Direct Labor = × Actual Hours Rate Variance = ($25.00 – $24.40) × 11,700 hrs. = $7,020 Unfavorable Time variance: (Actual Direct Labor Hours – Standard Direct Labor Direct Labor = Hours) × Standard Rate per Hour Time Variance = (11,700 hrs. – 12,000 hrs.) × $24.40 per hour = $(7,320) Favorable Total direct labor cost variance: Direct Labor Direct Labor Rate Variance + Direct Labor Time = Cost Variance Variance = $7,020 Unfavorable + $(7,320) Favorable = $(300) Favorable

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-3A (Concluded) c.

Factory Overhead Cost Variance Variable factory overhead controllable variance: Actual variable factory overhead cost incurred……………… $91,200 Less budgeted variable factory overhead for 12,000 hrs.* ……………………………………………………… 96,000 ** Variance—favorable……………………………………………

$ (4,800)

Fixed factory overhead volume variance: Normal capacity at 100%………………………………………… 15,000 hrs. Less standard for amount produced…………………………… 12,000 3,000 hrs. Productive capacity not used…………………………………… × Standard fixed factory overhead cost rate………………… $10.00 Variance—unfavorable………………………………………

30,000 $25,200

Total factory overhead cost variance—unfavorable……………

* 40,000 units × 0.3 hr. per unit ** 12,000 hrs. × $8.00 Alternative Computation of Overhead Variances

Actual costs ($91,200 + $150,000) Balance (underapplied)

216,000

[12,000 × ($8.00 + $10.00)] 25,200 Budgeted Factory Overhead for Amount Produced

Actual Factory Overhead $241,200

Factory Overhead 241,200 Applied costs

Applied Factory Overhead

Variable cost (12,000 × $8.00)………… $ 96,000 Fixed cost………………………………… 150,000 Total………………………………………… $246,000 $(4,800) F Controllable Variance

$216,000

$30,000 U Volume Variance $25,200 U Total Factory Overhead Cost Variance

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-4A Tiger Equipment Inc. Factory Overhead Cost Variance Report—Welding Department For the Month Ended May 31 8,400 hrs. 8,860 hrs.

Normal capacity for the month Actual production for the month

Actual

Budget

$ 32,400 21,000 18,250 $ 71,650

$ 31,896 21,264 17,720 $ 70,880

$ 20,000

36,200 15,200 $ 71,400 $143,050

36,200 15,200 $ 71,400 $142,280

Variances Unfavorable (Favorable)

Variable costs:

Indirect factory wages Power and light Indirect materials Total variable cost Fixed costs: Supervisory salaries Depreciation of plant and equipment Insurance and property taxes Total fixed cost Total factory overhead cost Total controllable variances

$ 504 $ (264) 530

$1,034

Net controllable variance—unfavorable Volume variance—favorable: Excess hours used over normal at the standard rate for fixed factory overhead: (8,400 hrs. – 8,860 hrs.) × $8.50 2 Total factory overhead cost variance—favorable 1

$ (264)

(3,910) $(3,140)

The budgeted variable costs are determined by multiplying the 8,860 actual hours by the variable overhead rate (the May budget divided by 8,400 hours for each variable overhead cost). Thus, Indirect factory wages, $31,896 = 8,860 hrs. × ($30,240 ÷ 8,400 hrs.) Power and light, $21,264 = 8,860 hrs. × ($20,160 ÷ 8,400 hrs.) Indirect materials, $17,720 = 8,860 hrs. × ($16,800 ÷ 8,400 hrs.)

Fixed factory overhead rate:

$71,400 8,400 hrs.

770

= $8.50 per hr.

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-4A (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs

143,050

Applied costs*

146,190

[8,860 × ($8.00 + $8.50)] Balance (overapplied)

3,140

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$143,050

Variable cost (8,860 × $8.00)…………… $ 70,880 71,400 Fixed cost………………………………… Total………………………………………… $142,280

$146,190

$770 U Controllable Variance

$(3,910) F Volume Variance $(3,140) F Total Factory Overhead Cost Variance

* $67,200 ÷ 8,400 hrs. = $8.00 $71,400 ÷ 8,400 hrs. = $8.50

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-5A 1.

* 2.

4,650 lines 25 lines per hr.

14 $32 × $448

= 186 hrs. 200 226

Actual hours provided (5 × 40 hrs.)……………………………………………… Standard hours required for the actual results*……………………………… Labor time difference……………………………………………………………… × Standard labor rate……………………………………………………………… Direct labor time variance—favorable…………………………………………… *

200 186

Actual hours provided (5 × 40 hrs.)……………………………………………… Standard hours required for the original plan*………………………………… Labor time difference……………………………………………………………… × Standard labor rate……………………………………………………………… Direct labor time variance—unfavorable………………………………………

5,650 lines 25 lines per hr.

(26) $32 × $(832)

= 226 hrs.

Actual labor rate…………………………………………………………………… Standard labor rate………………………………………………………………… Difference…………………………………………………………………………… × Actual hours provided (5 × 40 hrs.)…………………………………………… Direct labor rate variance—unfavorable…………………………………………

40 32

$ 8 × 200 $1,600

The labor cost variance is $768 unfavorable [($832) favorable time variance + $1,600 unfavorable rate variance]. 4.

The labor rate and time variances fail to consider the number of errors in the code from programmer fatigue. A program that has many errors will require significant time for debugging at a later date. In addition, hidden errors can cause possible field failures with customers. Thus, managers should consider not only the efficiency of doing the work but also the quality of the work.

Actual hours provided (6 × 40 hrs.)……………………………………………… Standard hours required for the actual results*……………………………… Labor time difference……………………………………………………………… × Standard labor rate……………………………………………………………… Direct labor time variance—unfavorable………………………………………

240 226 14 × $32 $448

* From part (2) above 6.

Hiring an extra employee is less costly than the bonus by $320. The direct labor cost variance for paying the bonus was $768 unfavorable, which is the sum of the rate variance and the time variance [$(832) F + $1,600 U] shown in parts (2) and (3) above. The cost variance that would result from hiring another employee would have been $448 unfavorable, shown in part (5) above. Thus, the net benefit for hiring another employee over paying the bonus is $320 ($768 U – $448 U).

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-1B a.

Standard Materials and Labor Cost per Unit

Direct materials ($5.00 × 5.0 yds.)……………………………………………… Direct labor [$12.00 × (12 min. ÷ 60 min.)]……………………………………

$25.00 2.40 $27.40

Direct Materials Cost Variance Price variance: Direct Materials = (Actual Price – Standard Price) × Actual Quantity Price Variance = ($5.10 per yd. – $5.00 per yd.) × 26,200 yds. = $2,620 Unfavorable Quantity variance: Direct Materials = (Actual Quantity – Standard Quantity) × Standard Price Quantity Variance = (26,200 yds. – 26,100 yds.*) × $5.00 per yd. = $500 Unfavorable * 5,220 units × 5.0 yds. Total direct materials cost variance: Direct Materials Direct Materials Price Variance + = Cost Variance Direct Materials Quantity Variance = $2,620 Unfavorable + $500 Unfavorable = $3,120 Unfavorable

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-1B (Concluded) c.

Direct Labor Cost Variance Rate variance: Direct Labor (Actual Rate per Hour – Standard Rate per Hour) = Rate Variance × Actual Hours = ($11.80 – $12.00) × 1,000 hrs.* = $(200) Favorable * 25 employees × 40 hrs. Time variance: Direct Labor (Actual Direct Labor Hours – Standard Direct Labor = Time Variance Hours) × Standard Rate per Hour = (1,000 hrs. – 1,044 hrs.*) × $12.00 per hour = $(528) Favorable * (12 min. ÷ 60 min.) × 5,220 Total direct labor cost variance: Direct Labor = Direct Labor Rate Variance + Direct Labor Time Variance Cost Variance = $(200) Favorable + $(528) Favorable = $(728) Favorable

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-2B 1.

Direct Materials Variance

Filler

Liner

Total

Price variance: Actual price………………………………… Standard price……………………………… Variance……………………………………… × Actual quantity…………………………… Direct materials price variance………

1.90 2.00

8.20 8.00

$ (0.10) × 48,000 $ (4,800) F

$ 0.20 × 85,100 $17,020 U

Actual quantity used……………………… Standard quantity used 1…………………

48,000 47,760

85,100 85,320

Variance……………………………………… × Standard price…………………………… Direct materials quantity variance…

240 × $2.00 $ 480 U

(220) × $8.00 $ (1,760) F

$12,220 U

Quantity variance:

(1,280) F $10,940 U

Total direct materials cost variance………… Alternatively, total direct materials cost variance: Actual cost 2………………………………… Standard cost 3……………………………… Total direct materials cost variance… 1

$91,200 95,520

$697,820 682,560

$ (4,320) F

$ 15,260 U

$10,940 U

47,760 = (4.0 lb. × 4,400 actual production of women’s coats) + (5.2 lb. × 5,800 actual production of of men’s coats) 85,320 = (7.0 yds. × 4,400 actual production of women’s coats) + (9.4 yds. × 5,800 actual production of men’s coats)

$91,200 = $1.90 × 48,000 lb. $697,820 = $8.20 × 85,100 yds.

$95,520 = $2.00 × 47,760 lb. $682,560 = $8.00 × 85,320 yds.

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-2B (Concluded) 1.

b. Women’s Coats

Men’s Coats

$ 14.10 14.00

$ 13.30 13.00

$ 0.10 × 1,825 $182.50 U

$ 0.30 × 2,800 $ 840 U

Actual time…………………………………… Standard time 1………………………………

1,825 1,760

2,800 2,900

Variance……………………………………… × Standard rate……………………………… Direct labor time variance………………

65 × $14.00 $910.00 U

(100) × $ 13.00 $(1,300) F

Direct Labor Variance

Total

$1,022.50 U

Time variance:

(390) F $ 632.50 U

$25,732.50 24,640.00

$37,240.00 37,700.00

$ 1,092.50 U

(460.00) F

$ 632.50 U

1,760 = 0.40 hr. × 4,400 actual production of women’s coats 2,900 = 0.50 hr. × 5,800 actual production of men’s coats

$25,732.50 = 1,825 hrs. × $14.10 $37,240.00 = 2,800 hrs. × $13.30

$24,640.00 = 1,760 hrs. × $14.00 $37,700.00 = 2,900 hrs. × $13.00

The variance analyses should be based on the standard amounts at actual volumes. The budget must flex with the volume changes. If the actual volume is different from the planned volume, as it was in this case, then the budget used for performance evaluation should reflect the change in direct materials and direct labor that will be required for the actual production. In this way, spending from volume changes can be isolated from efficiency and price variances.

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-3B Direct Materials Cost Variance

a. Price variance:

Direct Materials = (Actual Price – Standard Price) × Actual Quantity Price Variance = ($7.30 per lb. – $7.25 per lb.) × 252,500 lb. = $12,625 Unfavorable Quantity variance: Direct Materials = (Actual Quantity – Standard Quantity) × Standard Price Quantity Variance = (252,500 lb. – 250,000 lb.) × $7.25 per lb. = $18,125 Unfavorable Total direct materials cost variance: Direct Materials Direct Materials Price Variance + = Cost Variance Direct Materials Quantity Variance = $12,625 Unfavorable + $18,125 Unfavorable = $30,750 Unfavorable b.

Direct Labor Cost Variance Rate variance: (Actual Rate per Hour – Standard Rate per Hour) Direct Labor = Rate Variance × Actual Hours = ($16.70 – $17.00) × 5,000 hrs. = $(1,500) Favorable Time variance: Direct Labor (Actual Direct Labor Hours – Standard Direct Labor = Time Variance Hours) × Standard Rate per Hour = (5,000 hrs. – 5,200 hrs.) × $17.00 per hour = $(3,400) Favorable Total direct labor cost variance: Direct Labor Direct Labor Rate Variance + Direct Labor Time = Cost Variance Variance = $(1,500) Favorable + $(3,400) Favorable = $(4,900) Favorable

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-3B (Concluded) c.

Factory Overhead Cost Variance Variable factory overhead controllable variance: Actual variable factory overhead cost incurred…………… Less budgeted variable factory overhead for 5,200 hrs.* ………………………………………………… Variance—favorable…………………………………………

$40,000

Fixed factory overhead volume variance: Normal capacity at 100%……………………………………… Less standard for amount produced………………………… Productive capacity overemployed………………………… × Standard fixed factory overhead cost rate……………… Variance—favorable………………………………………… Total factory overhead cost variance—favorable……………

41,600 ** $(1,600) 5,000 hrs. 5,200 (200) hrs. $15.00 (3,000) $(4,600)

* 10,400 units × 0.5 hr. ** 5,200 hrs. × $8.00 Alternative Computation of Overhead Variances Factory Overhead Actual costs

115,000

($40,000 + $75,000)

Applied costs

119,600

[5,200 × ($8.00 + $15.00)] Balance (overapplied)

4,600

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$115,000

Variable cost (5,200 × $8.00)………… $ 41,600 75,000 Fixed cost……………………………… Total……………………………………… $116,600

$119,600

$(1,600) F Controllable Variance

$(3,000) F Volume Variance $(4,600) F Total Factory Overhead Cost Variance

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-4B Feeling Better Medical Inc. Factory Overhead Cost Variance Report—Assembly Department For the Month Ended October 31 30,000 hrs. 28,500 hrs.

Normal capacity for the month Actual production for the month

Actual

Budget

$234,000 178,500 50,600 $463,100

$235,125 179,550 49,875 $464,550

$126,000

70,000 44,000 $240,000 $703,100

70,000 44,000 $240,000 $704,550

Variances Unfavorable (Favorable)

Variable costs:1 Indirect factory wages Power and light Indirect materials Total variable cost Fixed costs: Supervisory salaries Depreciation of plant and equipment Insurance and property taxes Total fixed cost Total factory overhead cost Total controllable variances

$725

$ (2,175) $ (1,450)

Net controllable variance—favorable Volume variance—unfavorable: Idle hours at the standard rate for fixed factory overhead: (30,000 hrs. – 28,500 hrs.) × $8.00 2 Total factory overhead cost variance – unfavorable 1

$ (1,125) (1,050)

12,000 $10,550

The budgeted variable costs are determined by multiplying 28,500 actual hours by the variable overhead rate (the October budget divided by 30,000 hours for each variable overhead cost). Thus, Indirect factory wages, $235,125 = 28,500 hrs. × ($247,500 ÷ 30,000 hrs.) Power and light, $179,550 = 28,500 hrs. × ($189,000 ÷ 30,000 hrs.) Indirect materials, $49,875 = 28,500 hrs. × ($52,500 ÷ 30,000 hrs.)

Fixed factory overhead rate:

$240,000 30,000 hrs.

= $8.00 per hr.

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-4B (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs

703,100

Applied costs*

692,550

[28,500 × ($16.30 + $8.00)] Balance (underapplied)

10,550

Actual Factory Overhead

Budgeted Factory Overhead for Amount Produced

Applied Factory Overhead

$703,100

Variable cost (28,500 × $16.30)……… $464,550 Fixed cost………………………………… 240,000 Total……………………………………… $704,550

$692,550

$(1,450) F Controllable Variance

$12,000 U Volume Variance $10,550 U Total Factory Overhead Cost Variance

* $489,000 ÷ 30,000 hrs. = $16.30 $240,000 ÷ 30,000 hrs. = $8.00

CHAPTER 23

Evaluating Variances from Standard Costs

Prob. 23-5B 1.

* 2.

81,900 lines 700 lines per hr.

88,900 lines 700 lines per hr.

3 $ 23 $ 69

= 117 hrs.

Actual hours provided (3 × 40 hrs.)……………………………………………… Standard hours required for the actual results*……………………………… Labor time difference……………………………………………………………… × Standard labor rate………………………………………………………………… Direct labor time variance—favorable…………………………………………… *

120 117

Actual hours provided (3 × 40 hrs.)……………………………………………… Standard hours required for the original plan*………………………………… Labor time difference……………………………………………………………… × Standard labor rate………………………………………………………………… Direct labor time variance—unfavorable…………………………………………

120 127 (7) $ 23 $(161)

= 127 hrs.

Actual labor rate……………………………………………………………………… Standard labor rate………………………………………………………………… Difference……………………………………………………………………………… × Actual hours provided (3 × 40 hrs.)…………………………………………… Direct labor rate variance—unfavorable…………………………………………

$ 30 23 $

7 120 $ 840

The labor cost variance is $679 unfavorable [$(161) favorable time variance + $840 unfavorable rate variance]. 4.

Actual hours provided (4 × 40 hrs.)……………………………………………… Standard hours required for the actual results………………………………… Labor time difference……………………………………………………………… × Standard labor rate………………………………………………………………… Direct labor time variance—unfavorable…………………………………………

160 127 33 $ 23 $ 759

The bonus is the better approach by $80. The direct labor cost variance for paying the bonus was $679 unfavorable which is the sum of the time variance and rate variance from parts (2) and (3) above [$(161) F + $840 U]. The cost variance that would result from hiring another employee would have been $759 unfavorable from part (4) above. Thus, the net benefit for paying the bonus over hiring another employee is $80 ($679 U – $759 U).

The labor rate and time variances fail to consider the number of errors in the report from typist fatigue. A report that has many errors will require significant time for correction at a later date. In addition, report errors can cause doctors to draw incorrect conclusions from the test analyses. Thus, managers should consider not only the efficiency of doing the work but also the quality of the work.

CHAPTER 23

Evaluating Variances from Standard Costs

COMPREHENSIVE PROBLEM 5 Part A 1.

Variable Cost per Unit =

Difference in Total Cost Difference in Production $740 – $600 = $0.20 per case 1,200 cases – 500 cases

Total Cost = (Variable Cost per Unit × Units of Production) + Fixed Cost At the high point: $740 = ($0.20 × 1,200 units) + Fixed Cost Fixed Cost = $500 2.

At the low point: $600 = ($0.20 × 500 units) + Fixed Cost Fixed Cost = $500

Selling price…………………………………………………………… Less variable costs per case: Direct materials…………………………………………………… Direct labor………………………………………………………… Utilities [see part (1)]……………………………………………… Selling expenses…………………………………………………… Total variable costs per case…………………………………… Contribution margin per case………………………………………

$100.00 $17.00 7.20 0.20 20.00

Total fixed costs: Utilities [see part (1)]…………………………………………………………… Facility lease……………………………………………………………………… Equipment depreciation………………………………………………………… Supplies……………………………………………………………………………

Break-Even Sales (units) =

Fixed Costs Unit Contribution Margin

Break-Even Sales (units) =

$19,460 $55.60

44.40 $ 55.60

$ 500 14,000 4,300 660 $19,460

= 350 cases

CHAPTER 23

Evaluating Variances from Standard Costs

Comp. Prob. 5 (Continued) Part B 5.

Genuine Spice Inc. Production Budget For the Month Ended August 31 Cases

Expected cases to be sold Plus desired ending inventory Total units required Less estimated beginning inventory Total units to be produced

1,500 175 1,675 300 1,375

Genuine Spice Inc. Direct Materials Purchases Budget For the Month Ended August 31

1 2 3

Cream Base (oz.)

Natural Oils (oz.)

Bottles (bottles)

Units required for production Plus desired ending inventory

137,500 1 1,000

41,250 2 360

16,500 3 240

Total units required Less estimated beginning inventory

138,500 250

41,610 290

16,740 600

Total materials to be purchased × Unit price Total direct materials to be purchased

138,250 $0.02 $2,765

41,320 $0.30 $12,396

16,140 $0.50 $8,070

$23,231

Mixing

Filling

Total

458 1 $18.00 $8,244

1152 $14.40 $1,656

$9,900

Total

Cream base: 1,375 cases × 100 oz. = 137,500 oz. Natural oils: 1,375 cases × 30 oz. = 41,250 oz. Bottles: 1,375 cases × 12 bottles = 16,500 bottles

Genuine Spice Inc. Direct Labor Cost Budget For the Month Ended August 31 Hours required for production of: Hand and body lotion × Hourly rate Total direct labor cost 1 2

Mixing: (1,375 cases × 20 min.) ÷ 60 min. = 458 hrs. Filling: (1,375 cases × 5 min.) ÷ 60 min. = 115 hrs.

CHAPTER 23

Evaluating Variances from Standard Costs

Comp. Prob. 5 (Continued) 8.

Genuine Spice Inc. Factory Overhead Cost Budget For the Month Ended August 31 Utilities Facility lease Equipment depreciation Supplies Total factory overhead cost 1 2

Fixed1

Variable2

$ 500 14,000 4,300 660 $19,460

$275

Total

775 14,000 4,300 660 $19,735

Fixed costs [from part (3)] Variable utility cost: $0.20 × 1,375 cases = $275

Genuine Spice Inc. Budgeted Income Statement For the Month Ended August 31

Sales Finished goods inventory, August 1 Direct materials: Direct materials inventory, August 12 Direct materials purchases [from part (6)] Cost of direct materials available for use

$150,000 $12,000

Less direct materials inventory, August 31 Cost of direct materials placed in production Direct labor [from part (7)] Factory overhead [from part (8)] Cost of goods manufactured Cost of finished goods available for sale Less finished goods inventory, August 31 Cost of goods sold Gross profit

$ 392 23,231 $23,623 248 $23,375 9,900 19,735 53,010 $65,010 7,000

Selling expenses Income from operations 1 2 3 4

58,010 $ 91,990 30,000 $ 61,990

Sales: 1,500 cases × $100 per case = $150,000 Direct materials inventory, August 1: (250 × $0.02) + (290 × $0.30) + (600 × $0.50) = $392 Direct materials inventory, August 31: (1,000 × $0.02) + (360 × $0.30) + (240 × $0.50) = $248 Selling expenses: 1,500 cases × $20 per case = $30,000

CHAPTER 23

Evaluating Variances from Standard Costs

Comp. Prob. 5 (Continued) Part C 10. Direct Materials Price Variance: Cream Base

Actual price………………………… $ 0.016 0.020 Standard price……………………… Difference…………………………… $ (0.004) 153,000 oz. × Actual quantity (units)*………… (612) F Direct materials price variance… $

Natural Oils

0.32 0.30

0.02 46,500 oz. $ 930 U

Bottles

0.42 0.50

$ (0.08) 18,750 btls. $ (1,500) F

* Actual quantity: Cream base: 1,500 cases × 102 oz. = 153,000 oz. Natural oils: 1,500 cases × 31 oz. = 46,500 oz. Bottles: 1,500 cases × 12.5 bottles = 18,750 bottles

The fluctuation in market prices caused the direct material price variances. Prices increased for natural oils compared to standard and declined for cream base and bottles compared to standard. Direct Materials Quantity Variance: Cream Base 1

Actual quantity …………………… 2

Standard quantity ………………… Difference…………………………… × Standard price…………………… Direct materials quantity variance……………………………

Natural Oils

Bottles

153,000 oz. 150,000

46,500 oz. 45,000

18,750 btls. 18,000

3,000 oz. 0.02

1,500 oz. $ 0.30

750 btls. $ 0.50

60 U

$ 450 U

$ 375 U

Note: All the direct materials quantity variances were unfavorable, indicating some material losses, scrap, and quality rejections. All the quantity variances were unfavorable because the standards were set at ideal quantity amounts. Thus, only unfavorable variances were possible. The standard quantities were ideal standards for 12 8-ounce bottles per case (96 oz. total), as shown below. 1

Actual quantity: Cream base: 1,500 cases × 102 oz. = 153,000 oz. Natural oils: 1,500 cases × 31 oz. = 46,500 oz. Bottles: 1,500 cases × 12.5 bottles = 18,750 bottles Standard quantity: Cream base: 1,500 cases × 100 oz. = 150,000 oz. Natural oils: 1,500 cases × 30 oz. = 45,000 oz. Bottles: 1,500 cases × 12 bottles = 18,000 bottles

CHAPTER 23

Evaluating Variances from Standard Costs

Comp. Prob. 5 (Continued) 11. Direct Labor Rate Variance: Actual rate………………………………………………… Standard rate……………………………………………… Difference………………………………………………… × Actual time (hours)1…………………………………… Direct labor rate variance………………………………

Mixing Department

Filling Department

$18.20 18.00

$ 14.00 14.40

$ 0.20 487.5 $97.50 U

$ (0.40) 140.00 $ (56.00) F

The Mixing Department has an unfavorable direct labor rate variance from using a higher classification of labor. The higher labor classification costs an additional $0.20 per hour. The Filling Department has a favorable direct labor rate variance due to using a lower classification of labor. The lower labor classification saved $0.40 per hour. Direct Labor Time Variance:

Mixing Department

Actual time (hours) ……………………………………… 2

Standard time (hours) ………………………………… Difference………………………………………………… × Standard rate…………………………………………… Direct labor time variance……………………………… 1

Filling Department

487.5 500

140 125

(12.5) $ 18 $ (225) F

15 $14.40 $ 216 U

Actual time: Mixing: (1,500 units × 19.50 min.) ÷ 60 min. = 487.5 hrs. Filling: (1,500 units × 5.60 min.) ÷ 60 min. = 140 hrs. Standard time: Mixing: (1,500 units × 20.00 min.) ÷ 60 min. = 500 hrs. Filling: (1,500 units × 5.00 min.) ÷ 60 min. = 125 hrs.

The Mixing Department is producing at a labor time that is slightly better than standard, thus producing a favorable direct labor time variance. This may be the result of using a higher grade of labor. The net impact for the Mixing Department is favorable by $127.50 ($97.50 – $225). The Filling Department had an unfavorable direct labor time variance. This may be the result of using a lower grade of labor in the department. The net impact for the department is unfavorable by $160.00 [$216.00 + $(56.00)]. Thus, the savings in the labor rate from using a lower grade classification of labor was insufficient to offset the loss of efficiency from such labor.

CHAPTER 23

Evaluating Variances from Standard Costs

Comp. Prob. 5 (Continued) 12. Factory Overhead Controllable Variance: Actual variable overhead……………………………………………………… Variable overhead at standard cost*………………………………………… Factory overhead controllable variance……………………………………

$305 300 $ 5 U

* Variance overhead (utility cost) at standard cost: $0.20 × 1,500 cases = $300 13. Factory Overhead Volume Variance: 1,600 Normal volume (cases)………………………………………………………… 1,500 Actual volume (cases)………………………………………………………… Difference………………………………………………………………………… 100 × Fixed factory overhead rate*………………………………………………… $ 12.1625 $1,216.25 U * Fixed factory overhead rate: $19,460** ÷ 1,600 cases = $12.1625 per case ** Total fixed factory overhead shown in part (8) The unfavorable volume variance indicates the cost of underused capacity of 100 cases per month.

CHAPTER 23

Evaluating Variances from Standard Costs

Comp. Prob. 5 (Concluded) Alternative Computation of Overhead Variances Factory Overhead Actual costs

19,765.00

($19,460 + $305) Balance (underapplied)

Applied costs

18,543.75

[1,500 × ($12.1625 + $0.20)] 1,221.25

Actual

Budgeted Factory

Factory

Overhead for Amount

Factory

Overhead

Produced

Overhead

$19,765.00

Applied

Variable cost (1,500 × $0.20)…………… $ Fixed cost…………………………………

300.00 19,460.00

$18,543.75

Total………………………………………… $19,760.00 $5 U

$1,216.25 U

Controllable

Volume

Variance

Variance $1,221.25 U Total Factory Overhead Cost Variance

14. The production volume of 1,375 cases determined in part (5) was planned at the beginning of August. The variances compare the actual cost and the standard cost of actual production for the month. Thus, the standard cost must be based on the 1,500 units of actual production. This amount is compared with an actual cost also based on 1,500 units. The variable costs of the budget must flex to the actual production volume so that variances are compared across the same production volume.

CHAPTER 23

Evaluating Variances from Standard Costs

CASES & PROJECTS CP 23-1 The use of ideal standards is a legitimate concern for Henry. It is likely that such standards are too tight and do not include the necessary fatigue factors that are likely in this type of operation. It seems as though Henry is arguing for practical standards that can be attained if the operation is running well. Maybe some standard in between is warranted, but that is not the issue. The issue is Dash’s method of operation. Dash has effectively agreed to have this dispute arbitrated with a senior official. However, Dash is trying to seal the fate of the argument behind the scenes, before the issue is discussed openly as agreed. Moreover, Dash is attributing poor motives to Henry behind his back. Dash may have short-term success with this method of operation, but in the long term, he will likely alienate himself within the organization. He may create a distrustful environment that would eventually hamper his ability to provide open, honest feedback. People eventually may avoid him and hide the truth from him.

CHAPTER 23

Evaluating Variances from Standard Costs

CP 23-2 Use this activity to compare performance measures from different groups and their selected cities. The following are examples of performance measures from Worcester, Massachusetts: ECONOMIC DEVELOPMENT Indicator

Outcome Type

Measured As

Growth of commercial and residential tax base

Performance

Change in total assessed value over time

Job growth

Performance

Jobs created (and lost) by category

Amount of private investment

Performance

Total annual new construction, business expansion, and R&D investment

PUBLIC SAFETY Indicator

Outcome Type

Measured As

All measured both citywide and by neighborhood Level of crime

Performance

Crime rate and clearance rate by type of crime

Police community relations

Performance

Responses to annual citizen survey questions, performance of personnel on tests of courtesy, professionalism, and respect

Allegations of police misconduct

Performance

The annual number of complaints of excessive force received by the police department

Level of fire activity

Performance

# of structure fires; # of fire inspections performed; # of arson cases

Responses to fire calls

Performance

# of fire calls answered as a % of total calls for service, average response time, % of responses < 5 minutes

CHAPTER 23

Evaluating Variances from Standard Costs

CP 23-2 (Continued) IMPROVED MUNICIPAL SERVICES Indicator Outcome Type

Measured As

Cleanliness of streets

Performance

Responses to questions on the annual citizen survey, objective resident ratings

Cleanliness of streets

Efficiency

Cost per mile of street swept

Snow clearance

Performance

Miles of road cleared to pavement within 6 hours of a snowstorm

Condition of streets and roads

Performance

Responses to questions on the annual citizen survey, Pavement Condition Index (PCI)

Effectiveness of recycling program Performance

% of trash recycled

Effectiveness of anti-graffiti program

Performance

# of graffiti incident responses, response time from call for service to cleanup

Cost effectiveness of solid waste collection

Efficiency

Cost per ton of waste collected

Library usage

Performance

Circulation per capita

Citizen involvement (citywide and by neighborhood)

Performance

% of eligible voters registered; % of registered voters voting

EDUCATION Indicator

Outcome Type

Measured As

Student and school achievement

Performance

MCAS test scores

Graduation rate

Performance

Percent graduating

Dropout rate

Performance

Percent dropouts

Employer satisfaction with graduates

Performance

Employer survey

Post-graduate plans Parent involvement in schools

Percent of graduates going to college; percent going to work Performance

Attendance at parent-teacher conferences; survey of parents, teachers, and principals

CHAPTER 23

Evaluating Variances from Standard Costs

CP 23-2 (Concluded) IMPROVED YOUTH SERVICES Indicator Outcome Type

Measured As

Presence of “at risk youth”

Performance

Responses to questions from the Youth Risk Behavior Survey (includes questions on drug and alcohol use and violent behavior) by high school

Extent of juvenile crime

Performance

Juvenile crime rate, citywide and by neighborhood

Teen pregnancies

Performance

Teen pregnancy rate

Infant mortality

Performance

Infant mortality rate

Teen youth services

Program availability

Number of programs and participation rates (by race, ethnicity, and gender) by neighborhood

Source: Michael D. Goodman and Roberta R. Schaefer, Benchmarking Municipal Performance: A Tool for Streamlining Municipal Government, Worcester Municipal Research Bureau, 2013.

CP 23-3 To: David Tungston From: IMA Student Re: Performance Measurement System Although the Tungston Company’s performance measurement system uses both financial and nonfinancial measures, there may still be some serious performance omissions. Net income as a percent of stockholders’ equity and revenue growth are good measures of financial performance. Likewise, employee satisfaction provides good insight into employee morale, which is necessary for overall business success. There is, however, at least one major shortcoming to the proposed measures. None of the three measures has a customer focus. Management should consider adding a performance measure that reflects customer satisfaction. Measures such as product quality, warranty experience, or on-time delivery would be excellent ways to evaluate customer satisfaction. The addition of this fourth measure would provide the company with a complete portfolio of performance measures which will help guide the business’s overall success.

CHAPTER 23

Evaluating Variances from Standard Costs

CP 23-4 This is a case where there is strong evidence that the poor performance that is occurring inside the Assembly Department may be the result of behaviors outside of the department. This is one of the classic problems with variance analysis. Often, the variances reflect causes outside of the responsibility center manager’s control. That is what appears to be happening here. The Assembly supervisor complains that both the purchased parts and incoming material from the Fabrication Department have been giving them trouble. A review of performance reports reveals the following: (1) the materials price variance is very favorable; (2) the Fabrication Department’s labor time variance is also very favorable. A possible explanation is that the Purchasing Department found a low-price supplier. The low price translated into a favorable variance. Unfortunately, it appears the company is “getting what it paid for.” Specifically, it appears that the quality of the purchased parts has gone down, thus making assembly much more difficult in the Assembly Department. The Fabrication Department may be performing work faster than standard—again, resulting in a favorable labor time variance. It may be that the department is working too fast. Specifically, the speed is resulting in poor fabrication quality. Again, the Assembly Department is bearing the cost of poorly fabricated parts. The problem in both instances is that the variances measure only productivity and price savings but not quality. As a result, there are strong incentives to purchase from lowest bidders, work fast, cut corners, and push work on through. Unfortunately, the company is worse off, as a whole, due to this set of situations. The sum of the unfavorable variances in Assembly exceeds the favorable variances in the other departments. The analyst will need to confirm these suspicions. If they are supported, the company may wish to introduce quality measures in addition to the variance information in order to avoid the counterproductive behaviors in Purchasing and Fabrication.

CHAPTER 23

Evaluating Variances from Standard Costs

CP 23-5 The plant manager is placing pressure on the controller because the controllable variance is very unfavorable. The claim is that these costs are not really variable at all. This is a very difficult claim to accept. This is a small company, so it purchases its power from the outside. The power and light bill is variable to the amount of energy used in the plant. Energy usage is likely a function of the number of units produced except for the power required to keep the business open. Likewise, the supplies are likely variable to machine usage, which is also related to the number of units produced. However, these two costs are not where the problem lies. The problem is with the indirect factory wages. The indirect wages may not be completely variable. However, the variance is $8,500, or 28% higher than the standard. This is much greater than the 10% difference between the existing production volume and full capacity. In other words, even granting the plant manager’s position on the indirect wages still does not explain the overall size of the variance. More is being spent on indirect wages than would be implied by even 100% production. Something appears amiss. The controller should discuss these matters with the plant manager and attempt to discover why the indirect labor costs are so completely out of line with the standards. The plant manager has not complained about the standards yet but may do so in the future. It’s very common for the standards to be criticized as too tight.

CHAPTER 24 DECENTRALIZED OPERATIONS DISCUSSION QUESTIONS 1.

In a centralized operation, all major planning and operating decisions are made by top management. In a decentralized operation, managers of separate divisions or units are delegated operating responsibility. The division (unit) managers are responsible for planning and controlling the operations of their divisions. Divisions are often structured around products, customers, or regions.

The department manager of a profit center has responsibility for and authority over costs and revenues, while the manager of an investment center has responsibility for and authority over controlling investments in assets as well as costs and revenues.

Payroll: Number of checks issued. Accounts payable: Number of invoices paid. Accounts receivable: Number of sales invoice payments collected. Database administration: Number of reports generated.

The major shortcoming of using income from operations as a measure of investment center performance is that it ignores the amount of investment committed to each center. Because investment center managers also control the amount of assets invested in their centers, they should be held accountable for the use of invested assets.

A division of a decentralized company could be considered the least profitable even though it earned the largest amount of income from operations, when its rate of return on investment is the lowest. In this situation, the division would be considered the least profitable per dollar invested in the division because it generated less profit out of each dollar of assets invested.

By dividing income from operations by the amount of invested assets, each division is placed on a comparable basis of income from operations per dollar invested.

The balanced scorecard attempts to identify the underlying nonfinancial drivers, or causes, of financial performance related to innovation and learning, customer service, and internal processes. In this way, the financial performance may be improved. For example, customer satisfaction is often measured by the number of repeat customers. By increasing the number of repeat customers, sales and income from operations can be increased.

The objective of transfer pricing is to encourage each division manager to work in the best interests of the company. Thus, transfer prices should encourage managers to transfer goods between divisions if the overall company income can be increased.

When unused capacity exists in the supplying division, the negotiated price approach is preferred over the market price approach.

10.

When using the negotiated price approach to transfer pricing, the transfer price should be less than the market price but greater than the supplying division’s variable cost per unit.

CHAPTER 24

Decentralized Operations

PRACTICE EXERCISES PE 24-1A $285,700 over budget ($248,800 over budget + $(36,900) under budget)

PE 24-1B $(600,300) under budget [$(475,200) under budget – $125,100 over budget]

PE 24-2A South Division Service Allocation for Travel Department: $235,040 = 2,260 billed reservations × ($405,600 ÷ 3,900 reservations) West Division Service Allocation for Travel Department: $170,560 = 1,640 billed reservations × ($405,600 ÷ 3,900 reservations)

PE 24-2B Retail Division Service Allocation for Computer Technology Department: $442,500 = 5,900 billed hours × ($982,500 ÷ 13,100 hours billed) Commercial Division Service Allocation for Computer Technology Department: $540,000 = 7,200 billed hours × ($982,500 ÷ 13,100 hours billed)

PE 24-3A

Sales……………………………………………………… Cost of goods sold…………………………………… Gross profit……………………………………………… Selling expenses……………………………………… Income from operations before service department allocations……………………………… Service department allocations……………………… Income from operations………………………………

South Division

West Division

$3,150,470 1,638,240

$2,929,810 1,669,990

$1,512,230 786,360

$1,259,820 718,100

$ 725,870 235,040 $ 490,830

$ 541,720 170,560 $ 371,160

CHAPTER 24

Decentralized Operations

PE 24-3B

Sales………………………………………………… Cost of goods sold………………………………… Gross profit………………………………………… Selling expenses………………………………… Income from operations before service department allocations………………………… Service department allocations………………… Income from operations…………………………

Retail Division

Commercial Division

$6,320,000 3,190,000

$4,950,000 2,220,000

$3,130,000 502,000

$2,730,000 489,000

$2,628,000 442,500 $2,185,500

$2,241,000 540,000 $1,701,000

PE 24-4A a. b. c.

Profit Margin = $64,800 ÷ $810,000 = 8.0% Investment Turnover = $810,000 ÷ $540,000 = 1.5 Return on Investment = 8.0% × 1.5 = 12.0%

PE 24-4B a. b. c.

Profit Margin = $232,800 ÷ $3,880,000 = 6.0% Investment Turnover = $3,880,000 ÷ $970,000 = 4.0 Return on Investment = 6.0% × 4.0 = 24.0%

PE 24-5A Income from operations………………………………………………… Less minimum acceptable income from operations as a percent of assets ($57,900,000 × 11%)……………………………… Residual income…………………………………………………………

$9,043,000 6,369,000 $2,674,000

PE 24-5B Income from operations………………………………………………… Less minimum acceptable income from operations as a percent of assets ($440,000 × 8%)…………………………………… Residual income…………………………………………………………

$202,700 35,200 $167,500

CHAPTER 24

Decentralized Operations

PE 24-6A Increase in South (Supplying) (Transfer Price – Variable Cost per Unit) = × Units Transferred Division’s Income from Operations = ($88 – $79) × 72,000 units = $648,000 (Market Price – Transfer Price) Increase in North (Purchasing) = Division’s Income from Operations × Units Transferred = ($96 – $88) × 72,000 units = $576,000

PE 24-6B Increase in Pembroke (Supplying) (Transfer Price – Variable Cost per Unit) = Division’s Income from Operations × Units Transferred = ($36 – $28) × 24,000 units = $192,000 Increase in Multinomah (Purchasing) (Market Price – Transfer Price) = Division’s Income from Operations × Units Transferred = ($42 – $36) × 24,000 units = $144,000

CHAPTER 24

Decentralized Operations

EXERCISES Ex. 24-1 a.

(a) (b) (c) (d) (e) (f)

$297,950 $275,000 $22,950 $1,517,750 $1,500,000 $26,150

(g) $1,517,750 (h) $1,500,000 (i) $17,750 (j) $6,925,550 (k) $6,920,000 (l) $17,750

Schedules of supporting computations (answers in italics; the solution requires working from the department level up to the plant level, then to the vice president of production level): Garland Company Budget Performance Report—Vice President, Production For the Month Ended November 30 Plant

Eastern Region Central Region Western Region

Actual

Budget

$2,409,400 2,998,400 1,517,750 (g) $6,925,550 (j)

$2,420,000 3,000,000 1,500,000 (h) $6,920,000 (k)

Over Budget

(Under) Budget

$(10,600) (1,600) $17,750 (i) $17,750 (l)

$(12,200)

Garland Company Budget Performance Report—Manager, Western Region Plant For the Month Ended November 30 Department

Chip Fabrication Electronic Assembly Final Assembly

Actual

Budget

$ 297,950 (a) 703,200 516,600 $1,517,750 (d)

$ 275,000 (b) 700,000 525,000 $1,500,000 (e)

Over Budget

(Under) Budget

$22,950 (c) 3,200 $26,150 (f)

$(8,400) $(8,400)

CHAPTER 24

Decentralized Operations

Ex. 24-1 (Concluded) Garland Company Budget Performance Report—Supervisor, Chip Fabrication For the Month Ended November 30 Cost

Actual

Budget

Factory wages Materials Power and light Maintenance

$ 95,500 115,300 49,950 37,200 $297,950

$ 82,000 120,000 45,000 28,000 $275,000

Over Budget

(Under) Budget

$13,500 $(4,700) 4,950 9,200 $27,650

$(4,700)

MEMO To: Cassandra Reid, Vice President of Production The Western Region plant has experienced a budget overrun, while the Eastern and Central Region plants have experienced a budget surplus. The budget of the Western Region plant reveals that the Chip Fabrication Department causes the majority of the budget overrun. The budget for the Chip Fabrication Department indicates that the budget overrun was caused by a combination of budget overruns in wages, power and light, and maintenance that exceeded a budget surplus in materials. The supervisor of the Chip Fabrication Department should investigate the reasons for the budget overruns in wages, power and light, and maintenance. It is possible that all three of these budget overruns have the same cause, such as a need for unplanned overtime or weekend work to meet schedules.

Ex. 24-2 South Seas Coast Construction Company Divisional Income Statements For the Year Ended June 30, 20Y8

Sales Cost of goods sold Gross profit Administrative expenses Income from operations before service department allocations Service department allocations Income from operations

Commercial Division

Residential Division

$1,625,400 1,094,700 $ 530,700 179,760

$892,540 508,410 $384,130 154,350

$ 350,940 135,070 $ 215,870

$229,780 81,400 $148,380

CHAPTER 24

Decentralized Operations

Ex. 24-3 Expense

Cost Drivers Number of hours of legal service Number of pages copied Number of help desk requests

Legal Duplication services Information technology help desk Central purchasing

e. f.

Networking Accounts receivable

a. b. c.

Number of requisitions, number of purchase orders Number of network connections, number of units Number of invoices, number of customers

Ex. 24-4 a. b. c. d.

3 7 4 5

e. f. g. h.

6 2 8 1

CHAPTER 24

Decentralized Operations

Ex. 24-5 Government a.

Residential

Commercial

Contract

Total

9,880 2,400 12,280

14,560 1,320 15,880

50,620

4,600

3,800

13,600

Service Dept. Cost

Cost Driver

Charge Rate

Service department allocation rates: Payroll Department……………………… $126,550

50,620

$68,000

13,600

= $2.50/payroll distribution = $5.00/req.

Total

Number of payroll checks: Weekly payroll × 52……… 21,320 Monthly payroll × 12……… 1,140 Total……………………… 22,460 Number of purchase requisitions per year………… 5,200

Purchasing Department…………………

Residential

Commercial

Government Contract

Service department allocations: Payroll Department………… $56,1501 26,000 4 Purchasing Department… Total……………………… $82,150

$30,700 2 23,000 5 $53,700

$39,700 3 19,000 6 $58,700

22,460 checks × $2.50 per distribution

12,280 checks × $2.50 per distribution

15,880 checks × $2.50 per distribution

5,200 requisitions × $5.00 per requisition

4,600 requisitions × $5.00 per requisition

3,800 requisitions × $5.00 per requisition

$126,550 68,000

The service department allocations are determined by multiplying the service department allocation rate by the cost driver for each division. c.

Residential’s service department allocation is higher than the other two divisions because Residential is a heavy user of service department services. Residential has many employees on a weekly payroll, which translates into a larger number of payroll transactions. This may be because residential jobs are less productive per labor hour compared to larger commercial and government contract jobs. In addition, Residential uses purchasing services more than the other two divisions. This may be because the division has many different smaller jobs requiring frequent purchase transactions.

CHAPTER 24

Decentralized Operations

Ex. 24-6 a.

Help desk:

$160,000 3,200 calls

= $50 per call

Network center:

$735,000 9,800 devices

$75 per device monitored

Electronic mail:

$100,000 10,000 accounts

$10 per user or e-mail account

Handheld technology support:

$124,600 8,900 devices

= $14 per device

October allocations to the COMM sector: Help desk allocation: (5,200 employees × 25% × 99% × 1.2) × $50/call = $77,220 Network center allocation: [(5,200 employees × 25% × 99%) + 600 additional printers] × $75/device = $141,525 Electronic mail: (5,200 employees × 25% × 99% × 100%) × $10/user or e-mail account = $12,870 Handheld technology support: (5,200 employees × 75%) × $14/device = $54,600

CHAPTER 24

Decentralized Operations

Ex. 24-7 Grael Technology Divisional Income Statements For the Year Ended December 31, 20Y7 Consumer Division

Commercial Division

Revenues Cost of goods sold

$5,900,000 3,304,000

$4,950,000 2,475,000

Gross profit Operating expenses

$2,596,000 1,180,000

$2,475,000 1,237,500

Income from operations before service department allocations

$1,416,000

$1,237,500

Less service department cost allocations: Tech Support Department (Note 1) Purchasing Department (Note 2) Income from operations

$210,000 27,000

$126,000 237,000 $1,179,000

40,500

166,500 $1,071,000

Supporting computations for controllable service department allocations: Note 1:

Consumer Division ($336,000 ÷ 480 computers) × 300 computers = $210,000 Commercial Division ($336,000 ÷ 480 computers) × 180 computers = $126,000

Note 2:

Consumer Division ($67,500 ÷ 4,500 orders) × 1,800 orders = $27,000 Commercial Division ($67,500 ÷ 4,500 orders) × 2,700 orders = $40,500

CHAPTER 24

Decentralized Operations

Ex. 24-8 a. The reported income from operations does not accurately measure performance because the service department allocations are based on revenues. Revenues are not associated with the profit center manager’s use of the service department services. For example, the Reservations Department serves only the Passenger Division. Thus, by allocating this cost on the basis of revenues, these costs are incorrectly allocated to the Cargo Division. In addition, the Passenger Division requires additional personnel. Because these personnel must be trained, the training costs assigned to the Passenger Division should be greater than those of the Cargo Division. b. Wild Sun Airlines Inc. Divisional Income Statements For the Year Ended December 31, 20Y9 Passenger Division

Revenues Operating expenses Income from operations before service department allocations Less service department cost allocations: Training (Note 1) Flight Scheduling (Note 2) Reservations (Note 3) Income from operations

$175,000 86,400 302,400

Cargo Division

$3,025,000 2,450,000

$3,025,000 2,736,000

$ 575,000

$ 289,000

563,800 $ 11,200

$ 75,000 129,600 0

204,600 $ 84,400

Supporting computations for controllable service department allocations: (Note 1) Training:

Passenger Division, ($250,000 ÷ 500 personnel trained) × 350 personnel trained Cargo Division, ($250,000 ÷ 500 personnel trained) × 150 personnel trained

(Note 2) Flight Scheduling:

Passenger Division, ($216,000 ÷ 2,000 flights) × 800 flights Cargo Division, ($216,000 ÷ 2,000 flights) × 1,200 flights

(Note 3) Reservations:

Passenger Division, ($302,400 ÷ 20,000 reservations) × 20,000 reservations Cargo Division, ($302,400 ÷ 20,000 reservations) × 0 reservations

CHAPTER 24

Decentralized Operations

Ex. 24-9 Glades Sporting Goods Co. Divisional Income Statements For the Year Ended December 31, 20Y8 Winter Sports Division Sales $12,600,000 Cost of goods sold 7,560,000 Gross profit $ 5,040,000 Divisional selling expenses $ 2,016,000 Divisional administrative expenses 1,260,000 Total divisional expenses $ 3,276,000 Income from operations before service department allocations $ 1,764,000 Less service department cost allocations: Advertising expense (Note 1) $ 252,000 Transportation expense (Note 2) 127,280 Accounts receivable collection expense (Note 3) 69,000 Warehouse expense (Note 4) 714,000 Total $ 1,162,280 Income from operations $ 601,720 Supporting computations: Note (1) Winter Sports Division: Summer Sports Division:

Summer Sports Division $16,300,000 9,454,000 $ 6,846,000 $ 2,282,000 1,450,700 $ 3,732,700 $ 3,113,300 $

326,000 138,380 105,000 826,000 $ 1,395,380 $ 1,717,920

$252,000 $326,000

Note (2)

Winter Sports Division: Summer Sports Division:

(17,200 bills of lading × $7.40 per bill of lading) (18,700 bills of lading × $7.40 per bill of lading)

Note (3)

Winter Sports Division: Summer Sports Division:

(11,500 invoices × $6.00 per invoice) (17,500 invoices × $6.00 per invoice)

Note (4)

Winter Sports Division: Summer Sports Division:

($1,540,000 ÷ 220,000 sq. ft.) × 102,000 sq. ft. ($1,540,000 ÷ 220,000 sq. ft.) × 118,000 sq. ft.

Service Department Allocations Winter Summer Sports Sports Division Division Advertising expense…………………………… $252,000 7.40 17,200 $127,280

6.00 Accounts receivable collection rate………… $ 11,500 × Number of sales invoices………………… $ 69,000 Accounts receivable collection expense…

Transportation rate per bill of lading……… × Number of bills of lading…………………… Transportation expense………………………

$326,000

Warehouse rate per sq. ft. $ 7.00 ($1,540,000 ÷ 220,000 sq. ft.)……………… 102,000 × Number of square feet……………………… Warehouse expense…………………………… $714,000

7.40 18,700 $138,380 6.00 17,500 $105,000 7.00 118,000 $826,000

Total $ 578,000

$ 265,660

$ 174,000

$1,540,000

CHAPTER 24

Decentralized Operations

Ex. 24-10 a.

Retail Division: 17% ($9,350,000 ÷ $55,000,000) Commercial Division: 28% ($10,640,000 ÷ $38,000,000) Internet Division: 14% ($2,240,000 ÷ $16,000,000)

Commercial Division

Ex. 24-11 a.

Retail Division

Income from operations…………………… $9,350,000 Minimum amount of income from operations: $55,000,000 × 8%………………………… 4,400,000 $38,000,000 × 8%………………………… $16,000,000 × 8%………………………… $4,950,000 Residual income…………………………… b.

Commercial Division

Internet Division

$10,640,000

$2,240,000

3,040,000 $ 7,600,000

1,280,000 $ 960,000

Commercial Division

Ex. 24-12 a. b. c. d. e.

2.20 = 13.2% ÷ 6% 18% = 10% × 1.80 7% = 10.5% ÷ 1.50 3.00 = 15.0% ÷ 5% 13.2% = 12% × 1.10

CHAPTER 24

Decentralized Operations

Ex. 24-13 a.

Return on = Profit Margin × Investment Turnover Investment Income from Operations Sales

Return on = Investment =

$13,200,000 $82,500,000

Sales Invested Assets

$82,500,000 $55,000,000

= 16% × 1.50 = 24% b.

The profit margin would increase from 16% to 18%, the investment turnover would remain unchanged, and the return on investment would increase from 24% to 27%, as shown below. Return on = Profit Margin × Investment Turnover Investment Income from Operations Sales

Return on = Investment =

$14,850,000 * × $82,500,000

Sales Invested Assets

$82,500,000 $55,000,000

= 18% × 1.50 = 27% * $13,200,000 + $1,650,000

CHAPTER 24

Decentralized Operations

Ex. 24-14 a.

Return on = Investment Media Networks:

Income from Operations Revenues $6,625 $24,500

Revenues Invested Assets

$24,500 $35,899

= 27.0% × 0.68 = 18.4% (rounded) Parks and Resorts:

$4,469 $20,296

$20,296 $30,670

= 22.0% × 0.66 = 14.5% (rounded) Studio Entertainment:

$2,980 $9,987

$9,987 $17,154

= 29.8% × 0.58 = 17.3% (rounded) Consumer Products:

$1,632 $4,651

$4,651 $8,793

= 35.1% × 0.53 = 18.6% (rounded) b.

The four sectors are different from each other. Media Networks combines a good profit margin of 27.0% with an investment turnover of 0.68. Media Networks is sensitive to advertising revenue, while the Studio Entertainment sector is sensitive to producing box office hits. The Parks and Resorts sector has a profit margin of 22.0% with an investment turnover of 0.66. The combination produces an ROI of 14.5%. Studio Entertainment has a profit margin of 29.8% and an investment turnover of 0.58, which generates a 17.3% return on investment. The Consumer Products division combines a good profit margin of 35.1% with an investment turnover of 0.53, which produces an ROI of 18.6%.

CHAPTER 24

Decentralized Operations

Ex. 24-15 a. b. c. d. e. f.

20.0% ($185,000 ÷ $925,000) $138,750 ($925,000 × 15%) $46,250 ($185,000 – $138,750) $116,250 ($93,000 + $23,250) 15.0% ($116,250 ÷ $775,000) 12.0% ($93,000 ÷ $775,000)

g. h. i. j. k. l.

$81,000 ($450,000 × 18%) 13.0% ($58,500 ÷ $450,000) $22,500 ($81,000 – $58,500) 16.0% ($97,600 ÷ $610,000) $73,200 ($610,000 × 12%) $24,400 ($97,600 – $73,200)

Ex. 24-16 a.

(a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l)

$60,200 ($860,000 × 7%) $344,000 ($60,200 ÷ 17.5%) 2.5 (17.5% ÷ 7%) or $860,000 ÷ $344,000 $1,140,000 ($51,300 ÷ 4.5%) $300,000 ($1,140,000 ÷ 3.8) 17.1% (4.5% × 3.8) $102,000 ($680,000 × 15%) 10.0% ($102,000 ÷ $1,020,000) 1.5 ($1,020,000 ÷ $680,000) 16.0% ($89,600 ÷ $560,000) 8.0% ($89,600 ÷ $1,120,000) 2.0 ($1,120,000 ÷ $560,000)

North Division: South Division: East Division: West Division:

(1) (2)

$18,920 [$60,200 – ($344,000 × 12%)] $15,300 [$51,300 – ($300,000 × 12%)] $20,400 [$102,000 – ($680,000 × 12%)] $22,400 [$89,600 – ($560,000 × 12%)]

The North Division has the highest return on investment (17.5%). The West Division has the largest residual income.

CHAPTER 24

Decentralized Operations

Ex. 24-17 a.

Return on = Investment Company-Owned (CO): =

Income from Operations Revenues $617 $2,651

Revenues Invested Assets

$2,651 $3,930

= 23.3% × 0.67 = 15.6% (rounded) Franchised = Operations (FO):

$86 $335

$335 $586

= 25.7% × 0.57 = 14.6% (rounded) b. Income from operations……………………………… Less minimum return (15% of assets)…………… Residual income (loss)………………………………

CompanyOwned

Franchised Operations

$617 590 * $ 27

$86 88** $ (2)

* $3,930 × 15% ** $586 × 15% c. The Franchised Operations (FO) segment has the lowest return on investment, which is mainly the result of a lower investment turnover. The FO segment earns higher profit margins than the Company-Owned (CO) segment (25.7% vs. 23.3%). However, a lower investment turnover is causing the ROI for the FO segment to be lower. The residual income is negative for FO, which is consistent with a ROI less than the acceptable 15% minimum return. This weak performance is due primarily to the lower turnover in FO operations. While both CO and FO have solid ROIs, the FO segment could benefit from improved investment turnover.

CHAPTER 24

Decentralized Operations

Ex. 24-18 Although there is some judgment in classifying each of these measures, the following represents the author’s assessment with explanations: Average card member spending

Customer—demonstrates the usefulness of the card to the customer.

Cards in force

Customer—if customers did not value the card, they would not have one.

Earnings growth

Financial

Hours of credit consultant training

Internal process—advisers will do their job better if they are trained.

Investment in information technology

Internal process (or innovation)—shows the investment in improving processes.

Number of card choices

Customer—more choices are more valuable to customers.

Number of Internet features

Internal process (or innovation)—shows new process investments in a new channel.

Number of merchant signings

Customer—the larger the number of merchants that honor the card, the more valuable it is to cardholders.

Number of new card launches

Innovation—measures the new cards (affinity, regional, etc.) being developed and marketed.

Return on equity

Financial

Revenue growth

Financial

CHAPTER 24

Decentralized Operations

Ex. 24-19 This exercise is intended to spark discussion around using the balanced scorecard in an emerging business. Some possible metrics are included below. Innovation and Learning Number of training hours Employee turnover Number of employees cross-trained between trucks Number of new meals developed Number of new locations per time period Customer Service Number of new customers Ability to retain existing customers Quality of food Quality of customer interaction Speed of the experience (how quickly customers can be served) Internal Processes Order delivery time Consistency of portion size Consistency of meal quality Quality of meal Quality of ingredients Time to sell out (how long it takes to sell out of meals during a shift) Cleanup time Setup time Financial Number of meals served per shift (Note: Shift might be considered breakfast, lunch, dinner, or late night.) Number of shifts per truck Number of trucks Fuel costs Food costs Food waste Compensated meals

CHAPTER 24

Decentralized Operations

Ex. 24-20 a.

Increase in T_Kong Industries’ Income from Operations

Market Price

Variable Cost Unit × – per Unit Transferred

$3,816,000

($155

–

$102)

Increase in the Instrument Division’s Income from Operations

Market Price

–

Transfer Price

× Transferred

$1,944,000

($155

–

$128)

Increase in the Components Division’s Income from Operations

Transfer Price

–

$1,872,000

($128

–

Increase in T_Kong Industries’ Income from Operations

Market Price

–

$3,816,000

($155

–

72,000 Unit

72,000

Variable Cost Unit × Transferred per Unit

$102)

72,000

Ex. 24-21 a.

Variable Cost Units × Transferred per Unit

$102)

72,000

This amount is the same amount by which T_Kong Industries’ income from operations increased in Ex. 24-20, when a transfer price of $128 was used. b.

Increase in the Instrument Division’s Income from Operations

Market Price

–

Transfer Price

× Transferred

Units

$1,080,000

($155

–

$140)

72,000

This is the amount the Instrument Division saves by purchasing from the Components Division at an internal price that is lower than the market price. c.

Increase in the Components Division’s Income from Operations

$2,736,000

Transfer Price

Variable Cost Units × Transferred – per Unit

($140

–

$102)

72,000

This is the amount the Components Division earns by using available excess capacity to produce and sell products above variable cost to the Instrument Division. d.

Any transfer price will cause the total income of the company to increase, as long as the supplier division capacity is used to make materials for products that are ultimately sold to the outside. However, transfer prices should be set between variable cost and the market price in order to give the division managers proper incentives. A transfer price set below variable cost would cause the supplier division to incur a loss, while a transfer price set above market price would cause the purchasing division to incur opportunity costs. Neither situation is an attractive alternative for an investment center manager. Thus, the general rule is to negotiate transfer prices between variable cost and market price when the supplier division has excess capacity. The range of acceptable transfer prices for T_Kong Industries would be between $155 and $102.

CHAPTER 24

Decentralized Operations

PROBLEMS Prob. 24-1A 1.

Funderburk, Inc. Budget Performance Report—Director, Consumer Products Division For the Month Ended January 31

Customer service salaries Insurance and property taxes Distribution salaries Marketing salaries Engineer salaries Warehouse wages Equipment depreciation Total 2.

Actual

Budget

$ 692,700 126,780 990,380 1,248,010 943,010 647,030 211,150 $4,859,060

$ 628,870 131,860 1,003,190 1,182,630 962,380 674,030 211,360 $4,794,320

Over Budget

(Under) Budget

$ 63,830 $ (5,080) (12,810) 65,380

$129,210

(19,370) (27,000) (210) $(64,470)

The customer service and marketing salaries are significantly over budget. The director should investigate the cause of these results. One possibility is that the company is having an increase in sales, requiring greater marketing effort and customer service. However, the warehouse and distribution costs have not shown similar increases. Thus, it’s also possible that marketing and customer service salaries are increasing because of service problems and unplanned efforts to market the company’s service.

CHAPTER 24

Decentralized Operations

Prob. 24-2A 1. Conico Railroad Inc. Divisional Income Statements For the Quarter Ended December 31 Revenues Operating expenses Income from operations before service department allocations Less service department cost allocations: Customer Support (Note A) Legal (Note B) Total service department allocations Income from operations

East

West

Central

$1,960,000 1,120,000

$2,800,000 1,890,000

$4,480,000 2,660,000

$ 840,000

$ 910,000

$1,820,000

$ 156,800 274,400 $ 431,200 $ 478,800

$ 319,200 236,320 $ 555,520 $1,264,480

84,000 116,480 $ 200,480 $ 639,520

Supporting computations: Service department allocation rates for the two service departments, Customer Support and Legal, are determined as follows: Number of customer contacts… Number of hours billed……………

East

West

Central

Total

2,100 1,040

3,920 2,450

7,980 2,110

14,000 5,600

Service Cost

Output

Customer contact rate…………… $560,000 ÷ Legal billing rate…………………… 627,200 ÷

14,000 5,600

= =

Note (A)

East Division: West Division: Central Division:

$40 per contact × 2,100 contacts $40 per contact × 3,920 contacts $40 per contact × 7,980 contacts

Note (B)

East Division: West Division: Central Division:

$112 per hour × 1,040 hours $112 per hour × 2,450 hours $112 per hour × 2,110 hours

Rate

$40 per contract $112 per hour

Note: The Shareholder Relations Department and general corporate officers’ salaries are not controllable by division management and thus are not included in determining division income from operations.

CHAPTER 24

Decentralized Operations

Prob. 24-2A (Concluded) 2.

The CEO evaluates the three divisions using income from operations as a percent of revenues (profit margin). This measure is computed for the three divisions as follows:* East Division: West Division: Central Division:

33% ($639,520 ÷ $1,960,000) 17% ($478,800 ÷ $2,800,000) 28% ($1,264,480 ÷ $4,480,000)

* Rounded to nearest whole percent.

According to the CEO’s measure, the East Division has the highest performance. 3.

To: CEO The method used to evaluate the performance of the divisions should be reevaluated. The present method identifies the amount of income from operations per dollar of earned revenue. However, this company requires a significant investment in fixed assets for production and distribution facilities. The amount of assets may not be related to the revenue earned. The present measure fails to incorporate these differences in asset utilization into the measure. Naturally, the amount of assets used by a division in earning a return is a very important consideration in evaluating divisional performance. Therefore, a better divisional performance measure would be either (a) rate of return on investment (income from operations divided by divisional assets) or (b) residual income (income from operations less a minimal return on divisional assets). Both measures incorporate the assets used by the divisions.

CHAPTER 24

Decentralized Operations

Prob. 24-3A 1.

The Whole Life Baked Goods Company Divisional Income Statements For the Year Ended June 30, 20Y7

Sales Cost of goods sold Gross profit Operating expenses Income from operations 2.

Cereal Division

Snack Cake Division

Retail Bakeries Division

$17,600,000 10,600,000 $ 7,000,000 6,120,000 $ 880,000

$18,000,000 12,550,000 $ 5,450,000 4,730,000 $ 720,000

$9,520,000 6,630,000 $2,890,000 2,318,800 $ 571,200

Return on = Profit Margin × Investment Turnover Investment (ROI) Return on = Investment (ROI)

Income from Operations Sales

Sales Invested Assets

Cereal Division: ROI =

$880,000 $17,600,000

$17,600,000 $8,000,000

= 5% × 2.2 = 11.0% Snack Cake Division: ROI =

$720,000 $18,000,000

$18,000,000 $6,000,000

$9,520,000 $6,800,000

= 4% × 3.0 = 12.0% Retail Bakeries Division: ROI =

$571,200 $9,520,000

= 6% × 1.4 = 8.4%

CHAPTER 24

Decentralized Operations

Prob. 24-3A (Concluded) 3. Per dollar of invested assets, the Snack Cake Division is the most profitable of the three divisions. Assuming that the return on investments do not change in the future, an expansion of the Snack Cake Division will return 12.0 cents (12.0%) on each dollar of invested assets, while the Cereal and Retail Bakeries divisions will return only 11.0 cents (11.0%) and 8.4 cents (8.4%), respectively. Thus, when faced with limited funds for expansion, management should consider an expansion of the Snack Cake Division first.

Prob. 24-4A 1.

Return on = Profit Margin × Investment Turnover Investment (ROI) Return on = Investment (ROI) Commercial Division: ROI =

Income from Operations Sales $420,000 $3,500,000

Sales Invested Assets

$3,500,000 $2,500,000

= 12.0% × 1.40 = 16.8% Maxell Manufacturing Inc.—Commercial Division Estimated Income Statements For the Year Ended December 31

1 2 3 4 5 6 7 8

Proposal 1

Proposal 2

Proposal 3

Sales Cost of goods sold Gross profit Operating expenses Income from operations

$3,500,000 2,585,0001 $ 915,000 600,000 $ 315,000

$3,500,000 1,920,000 3 $1,580,000 600,000 $ 980,000

$2,905,000 5 2,073,300 6 $ 831,700 425,000 7 $ 406,700

Invested assets

$2,187,500 2

$4,375,000 4

$1,162,000 8

$2,480,000 + $105,000 $2,500,000 – $312,500 $2,480,000 – $560,000 $2,500,000 + $1,875,000 $3,500,000 – $595,000 $2,480,000 – $406,700 $600,000 – $175,000 $2,500,000 – $1,338,000

CHAPTER 24

Decentralized Operations

Prob. 24-4A (Concluded) 3.

Return on = Profit Margin × Investment Turnover Investment (ROI) Income from Operations Sales

Return on = Investment (ROI) Proposal 1:

ROI =

$315,000 $3,500,000

$3,500,000 $2,187,500

$3,500,000 $4,375,000

$2,905,000 $1,162,000

Sales Invested Assets

= 9.0% × 1.6 = 14.4% Proposal 2:

ROI =

$980,000 $3,500,000

= 28.0% × 0.8 = 22.4% Proposal 3:

ROI =

$406,700 $2,905,000

= 14.0% × 2.5 = 35.0% 4.

Proposal 3 would yield a rate of return on investment of 35.0%. Proposal 2 would yield a rate of return on investment of 22.4%. Return on = Profit Margin × Investment Turnover Investment (ROI) 21% = 12% × Required Investment Turnover Required = 1.75 (21% ÷ 12%) Investment Turnover Current = 1.40 Investment Turnover Increase in = 0.35 Investment Turnover or 25.00% Increase (0.35 ÷ 1.40)

CHAPTER 24

Decentralized Operations

Prob. 24-5A 1.

Pavone Company Divisional Income Statements For the Year Ended December 31

Sales Cost of goods sold Gross profit Operating expenses Income from operations 2.

Business Division

Consumer Division

$2,500,000 1,320,000 $1,180,000 930,000 $ 250,000

$2,550,000 1,350,000 $1,200,000 843,000 $ 357,000

Return on = Profit Margin × Investment Turnover Investment (ROI) Return on = Investment (ROI) Business Division:

ROI =

Income from Operations Sales $250,000 $2,500,000

$2,500,000 $1,250,000

$2,550,000 $2,125,000

Sales Invested Assets

= 10.0% × 2.0 = 20.0% Consumer Division:

ROI =

$357,000 $2,550,000

= 14.0% × 1.2 = 16.8% 3.

Business Division: $37,500 = [$250,000 – ($1,250,000 × 17%)] Consumer Division: $(4,250) = [$357,000 – ($2,125,000 × 17%)]

CHAPTER 24

Decentralized Operations

Prob. 24-5A (Concluded) 4.

On the basis of income from operations, the Consumer Division generated $107,000 ($357,000 – $250,000) more income from operations than did the Business Division. However, income from operations does not consider the amount of invested assets in each division. On the basis of the rate of return on investment, the Business Division earned 20.0 cents (20.0%) on each dollar of invested assets, while the Consumer Division earned only 16.8 cents (16.8%) on each dollar of invested assets. Although the Consumer Division has a higher profit margin than that of the Business Division (14.0% vs. 10.0%), the Business Division has a higher investment turnover (2.0 vs. 1.2), which generated its higher rate of return on investment. Residual income can be viewed as a combination of the preceding two performance measures. Residual income considers the absolute dollar amount of income from operations generated by each division and considers a minimum rate of return to be earned by each division. On the basis of residual income, the Business Division is the only profitable division.

CHAPTER 24

Decentralized Operations

Prob. 24-6A 1.

No. When unused capacity exists in the supplying division (the Consumer Division), the use of the market price approach may not lead to the maximization of total company income.

The Consumer Division’s income from operations would increase by $31,680: Increase in Consumer (Supplying) Division’s Income from Operations

$31,680

Transfer Price

($115

–

Variable Cost per Unit

Units × Transferred

–

$104)

2,880

By selling to the Commercial Division, the Consumer Division earns $11 per unit on these sales. The Commercial Division’s income from operations would increase by $100,800: Increase in Commercial (Purchasing) Division’s Income from Operations

Market Price

–

Transfer Price

× Transferred

$100,800

($150

–

$115)

Units

2,880

By purchasing from the Consumer Division, the Commercial Division saves $35 per unit on its purchases. Garcon Inc.’s total income from operations would increase by $132,480:

Increase in Garcon Income from Operations

$132,480

Market Price

–

Variable Cost per Unit

($150

–

$104)

Units × Transferred

2,880

The increase in total company income from operations is also equal to the sum of the increases in the division incomes from operations.

CHAPTER 24

Decentralized Operations

Prob. 24-6A (Continued) 3.

Garcon Inc. Divisional Income Statements For the Year Ended December 31, 20Y8 Consumer Division

Sales: 14,400 units × $144 per unit 2,880 units × $115 per unit 21,600 units × $275 per unit

Commercial Division

Total

$5,940,000 $5,940,000

$2,073,600 331,200 5,940,000 $8,344,800

$ 455,040 3,612,960 520,000 $4,588,000 $1,352,000

$1,797,120 455,040 3,612,960 720,000 $6,585,120 $1,759,680

$2,073,600 331,200 $2,404,800

Expenses: Variable: 17,280 units × $104 per unit 2,880 units × $158* per unit 18,720 units × $193** per unit Fixed Total expenses Income from operations

$1,797,120

200,000 $1,997,120 $ 407,680

* The 2,880 units are transferred in at $115 per unit plus $43 operating expenses in the division. ** The remaining 18,720 (21,600 – 2,880) units are purchased on the outside at a market price of $150 per unit plus $43 operating expenses in the division.

CHAPTER 24

Decentralized Operations

Prob. 24-6A (Concluded) 4.

The Consumer Division’s income from operations would increase by $63,360: Increase in Consumer (Supplying) Division’s Income from Operations

$63,360

Transfer Price

($126

–

Variable Cost per Unit

Units × Transferred

–

$104)

2,880

By selling to the Commercial Division, the Consumer Division earns $22 per unit on these sales. The Commercial Division’s income from operations would increase by $69,120: Increase in Commercial (Purchasing) Division’s Income from Operations

Market Price

–

Transfer Price

× Transferred

$69,120

($150

–

$126)

Units

2,880

By purchasing from the Consumer Division, the Commercial Division saves $24 per unit on its purchases. Garcon Inc.’s total income from operations would increase by the same amount as in part (2), $132,480: Increase in Garcon Income from Operations

Market Price

–

Variable Cost per Unit

$132,480

($150

–

$104)

Units

× Transferred ×

2,880

The increase in total company income from operations is also equal to the sum of the increases in the division incomes from operations. 5.

Any transfer price greater than the Consumer Division’s variable expenses per unit of $104 but less than the market price of $150 would be acceptable.

If the division managers cannot agree on a transfer price, a price of $127* would be the best compromise. In this way, each division’s income from operations would increase by $66,240.

* $150 – $104 = $46 $46 ÷ 2 = $23 $150 – $23 = $127 $104 + $23 = $127

CHAPTER 24

Decentralized Operations

Prob. 24-1B 1.

Adelson Inc. Budget Performance Report—Manager, Eastern District For the Month Ended December 31

Sales salaries System administration salaries Customer service salaries Billing salaries Maintenance Depreciation of plant and equipment Insurance and property taxes Total 2.

Actual

Budget

$ 818,880 447,720 183,120 98,100 273,000

$ 819,840 448,152 152,600 98,760 271,104

92,232 41,400 $1,954,452

92,232 41,280 $1,923,968

Over Budget

(Under) Budget

$ (960) (432) $30,520 (660) 1,896

120 $32,536

$(2,052)

The customer service salaries exceed the budget by 20% ($30,520 ÷ $152,600). The manager should request additional detailed information about the customer service department. There are several possible reasons for the budget variance. The manager should determine whether the cause is related to an increase in salaries or an increase in time incurred by additional employees. If the latter, the manager may want to determine if there has been an increase in customer service problems, hence a need to hire additional people. Such information could be used by the manager to solve customer service complaints and to reduce the number of future complaints.

CHAPTER 24

Decentralized Operations

Prob. 24-2B 1. Thomas Railroad Company Divisional Income Statements For the Quarter Ended December 31 Revenues Operating expenses Income from operations before service department allocations Less service department cost allocations: Dispatching (Note A) Equipment Management (Note B) Income from operations

North

South

West

$3,780,000 2,678,500

$5,673,000 4,494,890

$5,130,000 3,770,050

$1,101,500

$1,178,110

$1,359,950

45,500 300,000 $ 345,500 $ 756,000

77,350 420,000 $ 497,350 $ 680,760

59,150 480,000 $ 539,150 $ 820,800

Supporting computations: Service department allocation rates for the two service departments, Dispatching and Equipment Management, are determined as follows: Number of scheduled trains……… Number of railroad cars in inventory……………………………

North

South

West

Total

650

1,105

845

2,600

6,000

8,400

9,600

24,000

Note (A)

North Division: South Division: West Division:

($182,000 ÷ 2,600 scheduled trains) × 650 ($182,000 ÷ 2,600 scheduled trains) × 1,105 ($182,000 ÷ 2,600 scheduled trains) × 845

Note (B)

North Division: South Division: West Division:

($1,200,000 ÷ 24,000 railroad cars) × 6,000 railroad cars ($1,200,000 ÷ 24,000 railroad cars) × 8,400 railroad cars ($1,200,000 ÷ 24,000 railroad cars) × 9,600 railroad cars

Note: The Treasurer’s Department and general corporate officers’ salaries are not controllable by division management and thus are not included in determining division income from operations.

CHAPTER 24

Decentralized Operations

Prob. 24-2B (Concluded) 2.

The CEO evaluates the three regions using income from operations as a percent of revenues. This measure is computed for the three regions as follows: North Region: South Region: West Region:

20% ($756,000 ÷ $3,780,000) 12% ($680,760 ÷ $5,673,000) 16% ($820,800 ÷ $5,130,000)

Thus, according to the CEO’s measure, the North Region has the highest performance. 3.

To: CEO The method used to evaluate the performance of the regions should be reevaluated. The present method identifies the amount of income from operations per dollar of earned revenue. However, a railroad company requires a significant investment in fixed assets, such as track, engines, and railcars. In addition, the amount of assets may not be related to the revenue earned. For example, some regions may be able to concentrate assets in a densely populated regional area and run a high amount of traffic over those assets. Other regions, however, may have widely distributed assets over sparsely populated areas that run a small amount of traffic over those assets. The present measure fails to incorporate these differences in asset utilization into the measure. Naturally, the amount of assets used by a region in earning a return is a very important consideration in evaluating regional performance. Therefore, a better regional performance measure would be either (a) rate of return on investment (income from operations divided by regional assets) or (b) residual income (income from operations less a minimal return on regional assets). Both measures incorporate the assets used by the regions.

CHAPTER 24

Decentralized Operations

Prob. 24-3B E.F. Lynch Company Divisional Income Statements For the Year Ended June 30, 20Y8

Fee revenue Operating expenses Income from operations 2.

Mutual Fund Division

Electronic Brokerage Division

Investment Banking Division

$4,140,000 2,980,800 $1,159,200

$3,360,000 3,091,200 $ 268,800

$4,560,000 3,739,200 $ 820,800

Return on = Profit Margin × Investment Turnover Investment (ROI) Return on = Investment (ROI)

Income from Operations Sales

Sales Invested Assets

Mutual Fund Division: ROI =

$1,159,200 $4,140,000

$4,140,000 $5,175,000

$3,360,000 $1,120,000

$4,560,000 $3,800,000

= 28.0% × 0.8 = 22.4% Electronic Brokerage Division: ROI =

$268,800 $3,360,000

= 8.0% × 3.0 = 24.0% Investment Banking Division: ROI =

$820,800 $4,560,000

= 18.0% × 1.2 = 21.6%

CHAPTER 24

Decentralized Operations

Prob. 24-3B (Concluded) 3.

Per dollar of invested assets, the Electronic Brokerage Division is the most profitable of the three divisions. Assuming that the return on investments do not change in the future, an expansion of the Electronic Brokerage Division will return 24.0 cents (24.0%) on each dollar of invested assets, while the Mutual Fund and Investment Banking divisions will return only 22.4 cents (22.4%) and 21.6 cents (21.6%), respectively. Thus, when faced with limited funds for expansion, management should consider an expansion of the Electronic Brokerage Division first. Note to Instructors: The Mutual Fund Division has excellent profit margins, but the investment turnover is very low. The investment in the “bricks and mortar” of the Mutual Fund Division offices causes the return on investment to be depressed. However, the Electronic Brokerage Division has very thin margins because the fees earned per trade are very small. However, the assets required to execute trades are much less than the Mutual Fund Division because there is no need for offices (trades are executed over the Internet). As a result of the high investment turnover in the Electronic Brokerage Division, the rate of return on investment is much better.

CHAPTER 24

Decentralized Operations

Prob. 24-4B Return on = Profit Margin × Investment Turnover Investment (ROI)

Return on = Investment (ROI)

Income from Operations Sales

Sales Invested Assets

Electronics Division: ROI =

$126,000 $1,575,000

$1,575,000 $1,050,000

= 8.0% × 1.5 = 12.0% Gihbli Industries Inc.—Electronics Division Estimated Income Statements For the Year Ended December 31

Proposal 1

Proposal 2

Proposal 3

Sales Cost of goods sold Gross profit Operating expenses Income from operations

$1,575,000 859,600 1 $ 715,400 558,000 $ 157,400

$1,395,000 3 771,450 4 $ 623,550 498,000 5 $ 125,550

$1,575,000 702,000 7 $ 873,000 558,000 $ 315,000

Invested assets

$ 750,000 2

$ 937,500 6

$1,968,750 8

$891,000 – $31,400

$1,050,000 – $300,000

$1,575,000 – $180,000

$891,000 – $119,550

$558,000 – $60,000

$1,050,000 – $112,500

$891,000 – $189,000

$1,050,000 + $918,750

CHAPTER 24

Decentralized Operations

Prob. 24-4B (Concluded) 3.

Return on = Profit Margin × Investment Turnover Investment (ROI) Income from Operations Sales

Return on = Investment (ROI) Proposal 1:

ROI =

$157,400 $1,575,000

$1,575,000 $750,000

$1,395,000 $937,500

$1,575,000 $1,968,750

Sales Invested Assets

= 10.0% × 2.1 = 21.0% Proposal 2:

ROI =

$125,550 $1,395,000

= 9.0% × 1.5 = 13.5% Proposal 3:

ROI =

$315,000 $1,575,000

= 20.0% × 0.8 = 16.0% 4. 5.

Proposal 1 would yield a rate of return on investment of 21.0%. Return on = Profit Margin × Required Investment Turnover Investment (ROI) 20% = 8% × Required Investment Turnover Required = 2.5 (20% ÷ 8%) rounded Investment Turnover Current = 1.5 Investment Turnover Increase in = 1.0 Investment Turnover or 66.7% Increase (1.0 ÷ 1.5)

CHAPTER 24

Decentralized Operations

Prob. 24-5B 1.

Free Ride Bike Company Divisional Income Statements For the Year Ended December 31, 20Y7

Sales Cost of goods sold Gross profit Operating expenses Income from operations 2.

Road Bike Division

Mountain Bike Division

$1,728,000 1,380,000 $ 348,000 175,200 $ 172,800

$1,760,000 1,400,000 $ 360,000 236,800 $ 123,200

Return on = Profit Margin × Investment Turnover Investment (ROI) Return on = Investment (ROI)

Income from Operations Sales

Sales Invested Assets

Road Bike Division: ROI =

$172,800 $1,728,000

$1,728,000 $1,440,000

$1,760,000 $800,000

= 10.0% × 1.2 = 12.0% Mountain Bike Division: ROI =

$123,200 $1,760,000

= 7.0% × 2.2 = 15.4% 3.

Road Bike Division: $28,800 = [$172,800 – ($1,440,000 × 10%)] Mountain Bike Division: $43,200 = [$123,200 – ($800,000 × 10%)]

CHAPTER 24

Decentralized Operations

Prob. 24-5B (Concluded) 4.

On the basis of income from operations, the Road Bike Division generated $49,600 ($172,800 – $123,200) more income from operations than did the Mountain Bike Division. However, income from operations does not consider the amount of invested assets in each division. On the basis of the return on investment, the Road Bike Division earned 12.0 cents (12.0%) on each dollar of invested assets, while the Mountain Bike Division earned 15.4 cents (15.4%) on each dollar of invested assets. Although the profit margin of the Road Bike Division exceeds the Mountain Bike Division (10.0% vs. 7.0%), the investment turnover in the Road Bike Division is much less than that of the Mountain Bike Division (1.2 vs. 2.2). The combination of these factors caused the Mountain Bike Division to have a higher return on investment than did the Road Bike Division. Residual income can be viewed as a combination of the absolute dollar amount of income from operations generated by each division and considers a minimum return to be earned by each division. On the basis of residual income, the Mountain Bike Division is the more profitable of the two divisions.

CHAPTER 24

Decentralized Operations

Prob. 24-6B 1.

No. When unused capacity exists in the supplying division (the Semiconductors Division), the use of the market price approach may not lead to the maximization of total company income.

The Semiconductors Division’s income from operations would increase by $45,240: Increase in Semiconductors (Supplying) Division’s Income from Operations

$45,240

Transfer Price

–

Variable Cost per Unit

($310

–

$232)

Units

× Transferred ×

580

By selling to the Navigational Systems Division, the Semiconductors Division earns $78 per unit on these sales. The Navigational Systems Division’s income from operations would increase by $70,760: Increase in Navigational Systems (Purchasing) Division’s Income from Operations

$70,760

Market Price

($432

–

Transfer Price

× Transferred

Units

–

$310)

580

By purchasing from the Semiconductors Division, the Navigational Systems Division saves $122 per unit on its purchases. Exoplex Industries Inc.’s total income from operations would increase by $116,000:

Increase in Exoplex Industries Income from Operations

$116,000

Market Price

–

Variable Cost per Unit

($432

–

$232)

Units × Transferred

580

The increase in total company income from operations is also equal to the sum of the increases in the division incomes from operations.

CHAPTER 24

Decentralized Operations

Prob. 24-6B (Continued) 3.

Exoplex Industries Inc. Divisional Income Statements For the Year Ended December 31, 20Y8 Semiconductors Division

Sales: 2,240 units × $396 per unit 580 units × $310 per unit 3,675 units × $590 per unit

Total

$2,168,250 $2,168,250

$ 887,040 179,800 2,168,250 $3,235,090

$ 203,000 1,460,840 325,000 $1,988,840 $ 179,410

$ 654,240 203,000 1,460,840 545,000 $2,863,080 $ 372,010

$ 887,040 179,800 $1,066,840

Expenses: Variable: 2,820 units × $232 per unit 580 units × $350* per unit 3,095 units × $472** per unit Fixed Total expenses Income from operations

Navigational Systems Division

$ 654,240

220,000 $ 874,240 $ 192,600

* The 580 units are transferred in at $310 per unit plus $40 operating expenses in the division. ** The remaining 3,095 (3,675 – 580) units are purchased on the outside at a market price of $432 per unit plus $40 operating expenses in the division.

CHAPTER 24

Decentralized Operations

Prob. 24-6B (Concluded) 4.

The Semiconductors Division’s income from operations would increase by $62,640: Increase in Semiconductors (Supplying) Division’s Income from Operations

$62,640

Transfer Price

–

Variable Cost per Unit

($340

–

$232)

Units

× Transferred ×

580

By selling to the Navigational Systems Division, the Semiconductors Division earns $108 per unit on these sales. The Navigational Systems Division’s income from operations would increase by $53,360: Increase in Navigational Systems (Purchasing) Division’s Income from Operations =

$53,360

Market Price

($432

–

Transfer Price

Units × Transferred

–

$340)

580

By purchasing from the Semiconductors Division, the Navigational Systems Division saves $92 per unit on its purchases. Exoplex Industries Inc.’s total income from operations would increase by the same amount as in part (2), $116,000: Increase in Ecoplex Industries Income from Operations

$116,000

Market Price

–

Variable Cost per Unit

($432

–

$232)

Units × Transferred

580

The increase in total company income from operations is also equal to the sum of the increases in the division incomes from operations. 5.

Any transfer price greater than the Semiconductors Division’s variable expenses per unit of $232 but less than the market price of $432 would be acceptable.

If the division managers cannot agree on a transfer price, a price of $332* would be the best compromise. In this way, each division’s income from operations would increase by $58,000.

* $432 – $232 = $200 $200 ÷ 2 = $100 $432 – $100 = $332 $232 + $100 = $332

CHAPTER 24

Decentralized Operations

CASES & PROJECTS CP 24-1 This scenario is a negotiation between two divisions. Dave is not behaving unethically by attempting to get a better price from the Semiconductor Division than from the market. He is not behaving unethically because he refuses market price. This may not seem “fair,” but price negotiation is a very typical business activity and is part of Dave’s job. It would be unethical only if the X-ray Division refused to deal with the Semiconductor Division to hurt the Semiconductor Division’s performance purposely so that X-ray could look good in comparison. This claim could only be supported if the X-ray Division’s refusal to purchase from the Semiconductor Division was economically unsound. For example, maybe there are no transportation costs because the Semiconductor Division plant is on site. In this case, the total cost to the X-ray Division would be less by purchasing from the Semiconductor Division. Refusing to do so could be the basis for claiming an ethical breach. Because the X-ray Division has overall profit responsibility and authority, this means that the X-ray Division has the choice of purchasing from the inside or the outside. The X-ray Division should have incentives to purchase from the inside in order to maximize overall corporate income. This means that the transfer price should be set below market price in order to give Dave an incentive to purchase from the Semiconductor Division. Howard’s refusal to budge on market price will likely hurt the Semiconductor Division and the company as a whole. If there are no alternative buyers, the Semiconductor Division should negotiate with the X-ray Division and accept a price lower than market price. This produces a win-win for both divisions. Thus, although neither party appears to be behaving unethically, Howard’s price position appears to be the weakest.

CHAPTER 24

Decentralized Operations

CP 24-2 Examples of balanced scorecard metrics employed by Mobil’s North America Marketing and Refining are provided below. Mobil North America Marketing and Refining Balanced Scorecard Dimension Innovation

Customer Service

Internal Process

Financial

Employee survey

Market share

New product return on investment (ROI)

Return on capital employed (ROCE)

Personal balanced scorecard

Mystery shopper rating

New product acceptance rate

Cash flow

Strategic competency availability

Dealer gross profit growth

Dealer quality score

Net margin rank vs. competition

Strategic information availability

Dealer survey

Inventory levels

Volume growth rate vs. industry

Source: R. Kaplan and D. P. Norton, The Strategy-Focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment (Harvard Business School Press, 2013).

CP 24-3 Memo To: Tom Yang From: Ima Student Re: Norsk Division Financial Performance The Norsk Division’s revenues, gross profit, and income from operations have increased significantly from 20Y6 to 20Y8. While these increases indicate that the division is growing profitability, return on investment is falling. The division’s profit margin, investment turnover, and return on investment are as follows: Profit margin Investment turnover Return on investment

20Y6 15% ×2.0 30.0%

20Y7 18% ×1.4 25.2%

20Y8 22% ×0.7 15.4%

The detailed breakdown of return on investment shows that the investment turnover is dropping faster than profit margin is increasing, causing return on investment to fall. It appears as though the Norsk Division has made very large investments in the business but has not been able to reap the returns required to support these investments. The invested asset base more than tripled during the period, while

CHAPTER 24

Decentralized Operations

CP 24-3 (Concluded) revenue has not even doubled. Revenues are not growing fast enough to support the underlying asset investment. While profit margins have improved, the increase in profit margin for each revenue dollar has not been sufficient to make up for the revenue shortfall. If this trend continues, the division may not be able to maintain the division’s minimum required return on investment going forward.

CP 24-4 The Customer Service Department head is responsible for the quantity of service but not the source of the service (i.e., not the price). Most accountants would hold the department head responsible for the cost by transferring the cost of the brochures to the Customer Service Department, even though the price is 25% higher than could be obtained from the outside. This may not seem fair, but it does control the use of internal services to some degree. If there were no internal transfer price, departments would view the Publications Department as a “free good.” This would likely result in an overdemand for the service because there would be no pricing discipline on the user groups. This does not mean that all is well. On the contrary, the Publications Department is free to pass on its inefficiencies because it has a captive client. A possible change in policy would be to allow internal users to go to outside vendors for printing services. This would have the effect of bringing the pressures of competition to the internal service group. It would have to offer the service competitively or watch its demand disappear. In this way, the internal publications group would have an incentive to be as cost effective as outside printers. Another possible change in policy would be to allocate Publications Department services at standard cost. In this way, inefficiencies in the Publications Department would not be transferred to user departments.

CHAPTER 24

Decentralized Operations

CP 24-5 1.

The rate of return on invested assets is computed as follows:

Income from operations…………… ÷ Invested assets……………………… ROI………………………………………

Snack Goods

Cereal

Frozen Foods

$ 396,000 2,000,000 19.8%

$ 554,400 1,680,000 33.0%

$ 420,000 1,750,000 24.0%

The Cereal Division appears to be making the best use of invested assets because its ROI is the highest. 2.

Not all projects that have a greater than 19% rate of return would be accepted. This is because all three divisions have an ROI that is greater than 19%. Thus, any project that is accepted between the 19% minimum and their existing ROI would cause their ROI to drop. This is true because of averaging. There would be little incentive to accept such projects if the divisions know they are competing against each other on the basis of ROI.

There are two approaches to improving ROI: (1) improving the profit margin or (2) improving the investment turnover. For all three divisions, the profit margin is excellent: Snack Goods Cereal Frozen Foods

18% ($396,000 ÷ $2,200,000) 22% ($554,400 ÷ $2,520,000) 20% ($420,000 ÷ $2,100,000)

However, the investment turnover is slow in all three divisions. The company doesn’t return many sales dollars per dollar invested in assets, as shown below. Snack Goods Cereal Frozen Foods

1.1 ($2,200,000 ÷ $2,000,000) 1.5 ($2,520,000 ÷ $1,680,000) 1.2 ($2,100,000 ÷ $1,750,000)

The divisions need to work on increasing revenues or reducing invested assets in order to improve ROI.

CHAPTER 24

Decentralized Operations

CP 24-6 1.

Return on = Investment (ROI) =

Income from Operations Invested Assets $4,860,000 $27,000,000

= 18.0% or Return on = Investment (ROI) =

Income from Operations Sales $4,860,000 $32,400,000

Sales Invested Assets

$32,400,000 $27,000,000

= 15.0% × 1.2 = 18.0% 2. 3.

$64,000 (8.0 × $8,000 = $64,000, where 8.0 = 18.0% – 10.0%) Return on = Investment (ROI) =

Income from Operations Invested Assets $2,332,800 $14,400,000

= 16.2% or Return on = Investment (ROI) =

Income from Operations Sales $2,332,800 $12,960,000

$12,960,000 $14,400,000

= 18.0% × 0.90 = 16.2% 4.

Even though the addition of the new product line would increase the overall company return on investment, its addition would decrease the Specialty Products Division’s rate of return on investment from 18.0% to 17.4% ($7,192,800 ÷ $41,400,000). This decrease could negatively influence management’s evaluation of the division manager. In addition, this decrease in the division’s rate of return on investment would also decrease the division manager’s bonus by $8,000 (1 × $8,000, where 1 = 18% – 17%).

CHAPTER 24

Decentralized Operations

CP 24-6 (Concluded) 5.

Use of residual income as a performance measure and as the basis for granting bonuses would motivate division managers to accept investment opportunities that exceed a minimum rate of return. If the minimum rate of return was set at 10%, the overall company average rate of return, any investment opportunity whose rate exceeded 10% would be viewed as acceptable. If this performance measure had been used, the Specialty Products Division manager would have increased the division’s residual income by $892,800 through the addition of the new product line, as shown below. Projected income from operations of new product line……………… Less minimum amount of desired income from operations ($14,400,000 × 10%)………………………………………………………… Residual income from new product line…………………………………

$2,332,800 1,440,000 $ 892,800

The manager’s bonus could then be computed as a percent of residual income. In this case, a bonus equal to 3% of residual income would achieve a bonus similar to the initial plan: Income from operations…………………………………………………… Less minimum desired income (10% × $27,000,000)…………………… Residual income……………………………………………………………… × Bonus percentage………………………………………………………… Bonus……………………………………………………………………………

$4,860,000 2,700,000 $2,160,000 3.0% $ 64,800

The new project would add $26,784 (3% × $892,800) to the bonus. Income from operations with new product line………………………… Less minimum desired income (10% × $14,400,000)…………………… Residual income……………………………………………………………… × Bonus percentage………………………………………………………… Bonus……………………………………………………………………………

$2,332,800 1,440,000 $ 892,800 3.0% $ 26,784

In addition, nonfinancial performance indicators about product quality and customer satisfaction can be used to supplement the financial numbers.

CHAPTER 25 DIFFERENTIAL ANALYSIS, PRODUCT PRICING, AND ACTIVITY-BASED COSTING DISCUSSION QUESTIONS 1.

Differential revenue is the amount of increase or decrease in revenue expected from a particular course of action compared to an alternative.

Differential cost is the amount of increase or decrease in cost expected from a particular course of action compared to an alternative.

Differential profit is the difference between differential revenue and differential cost.

The differential revenue and costs of the lease option should be compared to selling the building. The differential revenue would be the lease revenue compared to the proceeds from sale. The differential expenses would be the costs associated with leasing the building, including maintenance, property tax, and insurance, compared to the expenses of selling, such as sales commissions. The opportunity cost of money should also be considered in the analysis.

If there is demand for the premium-grade product, the differential revenue (premium less commodity) may exceed the differential cost to process the product to premium grade.

A business should only accept business at a special price if the lower price will not contaminate the regular pricing for other customers or induce other customers to demand the special price. In addition, the business must be careful not to violate the Robinson-Patman Act, which prohibits uncompetitive price differences across different markets for the same product. Finally, the business must consider the longer-term ramifications of offering discount business to a customer that may want to order in the future.

It is reasonable to purchase from the supplier if the fixed cost per unit is less than 50 cents. That is, if the fixed cost is less than 50 cents per unit, then the variable cost per unit will exceed the supplier’s price, making the supplier price more attractive.

One of the financial considerations is the profitability of the store, including all the revenues and the variable and fixed costs associated with the store because they would be differential to the decision. In addition, any costs of closing the store and preparing the store for disposal must be considered (legal costs, demolition costs, employee severance costs). Finally, the opportunity cost of the value of the equipment and land (either in cash or rental income) should be considered. For example, if the opportunity value of the assets were $500 per month, then the store would need to have a profitability exceeding this amount to remain an attractive alternative.

In the long run, the normal selling price must be set high enough to cover all costs (both fixed and variable) and provide a reasonable amount for profit.

In setting prices, managers should consider such factors as the prices of competing products and the general economic conditions of the marketplace.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

DISCUSSION QUESTIONS (Continued) 9.

The target cost concept begins with a price that can be sustained in the marketplace, then subtracts a target profit, thus determining the target cost. The cost is made to conform to the price required in the market. In contrast, under cost-plus, a markup is added to the cost. The resulting price is assumed to be acceptable in the market.

10.

The proper measure of product value in a bottlenecked process is the contribution margin per bottleneck hour.

11.

Activity-based costing should be used when a business has a combination of wide product variety and complex production and support processes. In these circumstances, activity-based costing will more accurately allocate factory overhead to products. This occurs because factory overhead allocated by a single predetermined rate assumes that all factory overhead is associated with products using a single allocation base. In complex environments, however, factory overhead may be associated with products according to how they consume activities. Thus, multiple activity rates are needed to more closely capture how factory overhead is actually used by products.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PRACTICE EXERCISES PE 25-1A Differential Analysis Lease Machine (Alt. 1) or Sell Machine (Alt. 2) February 21

Revenues Costs Profit (loss)

Lease Machine (Alternative 1)

Sell Machine (Alternative 2)

Differential Effects (Alternative 2)

$ 74,000 (10,500) $ 63,500

$66,000 (3,300) * $62,700

$(8,000) 7,200 $ (800)

* $66,000 × 5% Yokoyama Company should lease the machine.

PE 25-1B Differential Analysis Lease Equipment (Alt. 1) or Sell Equipment (Alt. 2) March 23

Revenues Costs Profit (loss)

Lease Equipment (Alternative 1)

Sell Equipment (Alternative 2)

Differential Effects (Alternative 2)

$115,100 (11,890) $103,210

$113,000 (6,780)* $106,220

$(2,100) 5,110 $ 3,010

* $113,000 × 6% Ferrigno Company should sell the equipment.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PE 25-2A Differential Analysis Continue Product Sigma (Alt. 1) or Discontinue Product Sigma (Alt. 2) December 10 Continue Discontinue Product Sigma Product Sigma (Alternative 1) (Alternative 2)

Revenues Costs: Variable cost of goods sold Variable selling expenses Fixed costs Profit (loss)

Differential Effects (Alternative 2)

$ 436,000

$(436,000)

(320,000) (53,000) (71,000) $ (8,000)

0 0 (71,000) $(71,000)

320,000 53,000 0 $ (63,000)

Product Sigma should be continued.

PE 25-2B Differential Analysis Continue Product X (Alt. 1) or Discontinue Product X (Alt. 2) May 9 Continue Product X (Alternative 1)

Revenues Costs: Variable cost of goods sold Variable selling expenses Fixed costs Profit (loss)

Discontinue Product X (Alternative 2)

Differential Effects (Alternative 2)

$ 94,800

$(94,800)

(61,200) (39,700) (36,000) $(42,100)

0 0 (36,000) $(36,000)

61,200 39,700 0 $ 6,100

Product X should be discontinued.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PE 25-3A Differential Analysis Make Bread (Alt. 1) or Buy Bread (Alt. 2) July 7 Make Bread (Alternative 1)

Buy Bread (Alternative 2)

Differential Effects (Alternative 2)

$(148) (15) 0 (39) $(202)

$(148) (15) 151 0 $ (12)

Make Bottles (Alternative 1)

Buy Bottles (Alternative 2)

Differential Effects (Alternative 2)

$ 0 0 (38) (18) $(56)

$(29) (4) 0 (18) $(51)

$(29) (4) 38 0 $ 5

Unit costs: Purchase price Delivery Variable costs ($190 – $39) Fixed factory overhead Total unit costs

0 0 (151) (39) $(190)

The company should make the bread.

PE 25-3B Differential Analysis Make Bottles (Alt. 1) or Buy Bottles (Alt. 2) March 30

Unit costs: Purchase price Freight Variable costs ($56 – $18) Fixed factory overhead Total unit costs The company should buy the bottles.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PE 25-4A Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) October 3 Continue with Old Machine (Alternative 1)

Replace Old Machine (Alternative 2)

Differential Effects (Alternative 2)

$ 390,000

(473,000) (444,000)2 $(527,000)

(473,000) 102,000 $ 19,000

Revenues: Proceeds from sale of old machine Costs: Purchase price Direct labor (6 years) Profit (loss) 1 2

0 (546,000) 1 $(546,000)

$91,000 × 6 years $74,000 × 6 years

The company should replace the old machine.

PE 25-4B Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) April 11 Continue with Old Machine (Alternative 1)

Revenues: Proceeds from sale of old machine Costs: Purchase price Direct labor (5 years) Profit (loss) 1 2

Replace Old Machine (Alternative 2)

Differential Effects (Alternative 2)

$ 39,400

0 (43,500)1 $(43,500)

(58,500) (29,500)2 $(48,600)

(58,500) 14,000 $ (5,100)

$8,700 × 5 years $5,900 × 5 years

The company should continue with the old machine.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PE 25-5A Differential Analysis Sell Product F (Alt. 1) or Process Further into Product G (Alt. 2) November 15 Sell Product F (Alternative 1)

Process Further into Product G (Alternative 2)

Differential Effects (Alternative 2)

$139 (98) $ 41

$ 158 (111) * $ 47

$ 19 (13) $ 6

Revenues, per unit Costs, per unit Profit (loss), per unit * $98 + $13

The company should process further into Product G.

PE 25-5B Differential Analysis Sell Product P (Alt. 1) or Process Further into Product Q (Alt. 2) February 26 Sell Product P (Alternative 1)

Process Further into Product Q (Alternative 2)

Differential Effects (Alternative 2)

$ 47 (31) $ 16

$ 50 (38) * $ 12

$3 (7) $(4)

Revenues, per unit Costs, per unit Profit (loss), per unit * $31 + $7

The company should sell Product P without further processing.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PE 25-6A Differential Analysis Reject Order (Alt. 1) or Accept Order (Alt. 2) March 5 Reject Accept Differential Order Order Effects (Alternative 1) (Alternative 2) (Alternative 2)

Revenues, per unit Costs: Variable manufacturing costs, per unit Export tariff, per unit Profit (loss), per unit

$0.00

$ 380.00

0.00 0.00 $0.00

(270.00) (114.00) * $ (4.00)

(270.00) (114.00) $ (4.00)

* $380.00 × 30% The company should not accept the special order.

PE 25-6B Differential Analysis Reject Order (Alt. 1) or Accept Order (Alt. 2) March 16 Reject Accept Differential Order Order Effects (Alternative 1) (Alternative 2) (Alternative 2)

Revenues, per unit Costs: Variable manufacturing costs, per unit Export tariff, per unit Profit (loss), per unit

$0.00

$ 16.10

0.00 0.00 $0.00

(11.20) (3.22) * $ 1.68

(11.20) (3.22) $ 1.68

* $16.10 × 20% The company should accept the special order.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PE 25-7A Markup percentage on product cost:

Desired Profit + Selling and Admin. Exp. Total Product Cost $20 + $40 $50

= 120%

PE 25-7B Markup percentage on product cost:

Desired Profit + Selling and Admin. Exp. Total Product Cost $75 + $90 $220

= 75%

PE 25-8A Unit contribution margin……………………………………………… ÷ Testing hours per unit……………………………………………… Unit contribution margin per production bottleneck hour………

Product R

Product S

$91 7 $13

$88 8 $11

Product K

Product L

$360 5 $ 72

$300 4 $ 75

Product R is the most profitable in using bottleneck resources.

PE 25-8B Unit contribution margin……………………………………………… ÷ Furnace hours per unit……………………………………………… Unit contribution margin per production bottleneck hour……… Product L is the most profitable in using bottleneck resources.

ActivityBase Usage $275 /dlh $90 /dlh $3,350 /setup $530 /insp.

25-10

$ 330,000 162,000 201,000 318,000 $1,011,000 200 ÷ $ 5,055

Activity Cost 1,800 dlh 1,200 dlh 100 setups 200 insp.

ActivityBase Usage ×

$275 /dlh $90 /dlh $3,350 /setup $530 /insp.

Activity Rate

Speedboat

Bass Boat

Differential Analysis, Product Pricing, and Activity-Based Costing

$825,000 ÷ 3,000 direct labor hours = $275 per dlh $270,000 ÷ 3,000 direct labor hours = $90 per dlh $536,000 ÷ 160 setups = $3,350 per setup $424,000 ÷ 800 inspections = $530 per inspection

Fabrication 1,200 dlh Assembly 1,800 dlh Setup 60 setups 600 insp. Inspection Total ÷ Budgeted units to be produced Factory overhead per unit

Activity

Fabrication: Assembly: Setup: Inspection:

PE 25-9A

CHAPTER 25

$ 495,000 108,000 335,000 106,000 $1,044,000 200 ÷ $ 5,220

Activity Cost

ActivityBase Usage $54 /dlh $17 /dlh $60 /setup $75 /insp.

25-11

$27,000 17,000 15,000 7,500 $66,500 ÷ 10,000 $ 6.65

Activity Cost 1,000 dlh 500 dlh 750 setups 400 insp.

ActivityBase Usage ×

$54 /dlh $17 /dlh $60 /setup $75 /insp.

Activity Rate

Jeans

Khakis

Differential Analysis, Product Pricing, and Activity-Based Costing

$81,000 ÷ 1,500 direct labor hours = $54 per dlh $25,500 ÷ 1,500 direct labor hours = $17 per dlh $60,000 ÷ 1,000 setups = $60 per setup $37,500 ÷ 500 inspections = $75 per inspection

Cutting 500 dlh Sewing 1,000 dlh Setup 250 setups 100 insp. Inspection Total ÷ Budgeted units to be produced Factory overhead per unit

Activity

Cutting: Sewing: Setup: Inspection:

PE 25-9B

CHAPTER 25

$ 54,000 8,500 45,000 30,000 $137,500 ÷ 10,000 $ 13.75

Activity Cost

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

EXERCISES Ex. 25-1 Differential Analysis Lease Machinery (Alt. 1) or Sell Machinery (Alt. 2) May 25

Lease Machinery (Alternative 1)

Sell Machinery (Alternative 2)

Differential Effects (Alternative 2)

$125,000 (36,500) $ 88,500

$102,000 (5,100) * $ 96,900

$(23,000) 31,400 $ 8,400

Revenues Costs Profit (loss) * $102,000 × 5%

b. Rhombus should sell the machinery. The differential effect from selling is $8,400.

Ex. 25-2 Note to Instructors: This differential analysis is a lease-or-buy decision, which is from the user perspective. A lease-or-sell decision is from the perspective of the equipment owner. Thus, the analysis is similar to the text examples but must be set up from the user’s, rather than the owner’s, perspective. Differential Analysis Lease Equipment (Alt. 1) or Buy Equipment (Alt. 2) December 11 Lease Equipment (Alternative 1)

Unit costs: Purchase price Freight and installation Repair and maintenance (4 years) Lease (4 years) Total unit costs 1 2

0 0 0 (116,800) 2 $(116,800)

Buy Equipment (Alternative 2)

Differential Effects (Alternative 2)

$ (95,000) (4,500) (14,400)1 0 $(113,900)

$ (95,000) (4,500) (14,400) 116,800 $ 2,900

$3,600 × 4 years $29,200 × 4 years

The company should buy the equipment.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-3 a.

Differential Analysis Continue Star Cola (Alt. 1) or Discontinue Star Cola (Alt. 2) January 21 Continue Star Cola (Alternative 1)

Revenues Costs: Variable cost of goods sold Variable operating expenses Fixed costs Profit (loss) 1 2 3

Discontinue Star Cola (Alternative 2)

Differential Effects (Alternative 2)

$ 390,000

$(390,000)

(147,200)1 (178,500) 2 (113,300) 3 $ (49,000)

0 0 (113,300) $(113,300)

147,200 178,500 0 $ (64,300)

(100% – 20%) × $184,000 (100% – 30%) × $255,000 (20% × $184,000) + (30% × $255,000)

Star Cola should be retained. As indicated by the differential analysis in part (a), the income would decrease by $64,300 if the product was discontinued.

Ex. 25-4 a.

Differential Analysis Continue Cups (Alt. 1) or Discontinue Cups (Alt. 2) For the Month Ended May 31 Continue Cups (Alternative 1)

Revenues Costs: Variable cost of goods sold Variable selling and admin. expenses Fixed costs Profit (loss) 1 2 3

$ 43,500

Discontinue Cups (Alternative 2)

Differential Effects (Alternative 2)

$(43,500)

(22,695) 1

22,695

(16,800) 2 (9,605) 3 $ (5,600)

0 (9,605) $(9,605)

16,800 0 $ (4,005)

$26,700 × (100% – 15%) $22,400 × (100% – 25%) ($26,700 × 15%) + ($22,400 × 25%)

The Cups line should be retained. As indicated by the differential analysis in part (a), the income will decrease by $4,005 if the Cups line is discontinued.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-5 Note to Instructors: Many students may be unfamiliar with the financial services industry. This exercise provides an opportunity to introduce students to some basic terms and concepts used in the industry. a.

The Investor Services segment serves the retail customer, you and me. These are the brokerage, Internet, and mutual fund services used by individual investors. The Advisor Services segment provides custodial, trading, support, and retirement business services. The custodial and support services are targeted toward serving independent investment advisors.

Variable costs in the Investor Services segment include: 1.

Commissions to brokers

Fees paid to exchanges for executing trades

Transaction fees incurred by Schwab mutual funds to purchase and sell shares

Advertising

Fixed costs in the Investor Services segment include: 1.

Depreciation on brokerage offices

Depreciation on brokerage office equipment, such as computers and computer networks

Property taxes on brokerage offices

Income from operations……………………………………… Plus depreciation……………………………………………… Estimated contribution margin……………………………… d.

Investor Services (in millions)

Advisor Services (in millions)

$3,176 186 $3,362

$1,386 120 $1,506

If one assumes that the fixed costs that serve the Advisor Services business (computers, servers, and facilities) would not be sold but would be used by the other sector, then the contribution margin of $1,506 million would be an estimate of the reduced profitability if sold. If the fixed assets were sold with the business, then the operating income decline would approach $1,386 million. Because the Investor Services and Advisor Services businesses share many of the same assets, the $1,506 million answer is probably the better estimate.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-6 The flaw in the decision is the failure to focus on the differential revenues and costs, which indicate that operating income would be reduced by $39,000 if Children’s Shoes were discontinued. This differential income from sales of Children’s Shoes can be determined from the following differential analysis: Differential Analysis Continue Children’s Shoes (Alt. 1) or Discontinue Children’s Shoes (Alt. 2) Continue Discontinue Children’s Children’s Differential Shoes Shoes Effects (Alternative 1) (Alternative 2) (Alternative 2)

Revenues Costs: Variable cost of goods sold Variable selling and admin. expenses Fixed costs Profit (loss)

$ 165,000

$(165,000)

(105,000) (21,000) (49,000) * $ (10,000)

0 0 (49,000) $(49,000)

105,000 21,000 0 $ (39,000)

* $32,000 + $17,000

Ex. 25-7 Differential Analysis Make Carrying Case (Alt. 1) or Buy Carrying Case (Alt. 2) February 24

Make Buy Carrying Carrying Differential Case Case Effects (Alternative 1) (Alternative 2) (Alternative 2)

Unit costs: Purchase price Direct materials per unit Direct labor per unit Variable factory overhead per unit Fixed factory overhead per unit Total unit costs 1 2

$ 0.00 (53.00) (26.00) (3.90) 1 (6.50) 2 $(89.40)

$(89.00) 0.00 0.00 0.00 (6.50) $(95.50)

$(89.00) 53.00 26.00 3.90 0.00 $ (6.10)

$26.00 × 15% $10.40 – $3.90

b. Assuming that there were no better alternative uses for the spare capacity, it would be advisable to manufacture the carrying cases because the cost savings would be $6.10 per unit. Fixed factory overhead is irrelevant because it will continue whether the carrying cases are purchased or manufactured.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-8 a.

Differential Analysis Lay Out Pages Internally (Alt. 1) or Purchase Layout Services (Alt. 2) February 22 Lay Out Pages Internally (Alternative 1)

Unit costs: Purchase price of layout work Salaries Benefits Supplies Office expenses Office depreciation Computer depreciation Total unit costs

0 (224,000) (36,000) (21,000) (39,000) (28,000) (24,000) $(372,000)

Purchase Layout Services (Alternative 2)

Differential Effects (Alternative 2)

$(312,000) * 0 0 0 0 (28,000) (24,000) $(364,000)

$(312,000) 224,000 36,000 21,000 39,000 0 0 $ 8,000

* 24,000 pages × $13 per page b.

The benefit from using an outside service is shown to be $8,000 greater than performing the layout work internally. The fixed costs (depreciation expenses) in the budget are irrelevant to the decision. Thus, the work should be purchased from the outside on a strictly financial basis.

Before electing to lay off the five employees, the guild should consider the long-run impact of the decision. Specifically, future page layout rates may grow faster than the cost of internal salaries, thus favoring the use of employees over the long term. This would especially be the case if the outside company provided a low bid in order to win the initial business. In addition, the guild may want to consider noneconomic factors, such as the ability to control more directly the quality and timing of the layout work by internal employees.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-9 a.

Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) April 29 Continue with Old Machine (Alternative 1)

Revenues: Proceeds from sale of old machine Costs: Purchase price Variable production costs (8 years) Profit (loss) 1 2

0 (89,600) 1 $(89,600)

Replace Old Machine (Alternative 2)

Differential Effects (Alternative 2)

$ 90,100

(107,900) (64,000) 2 $ (81,800)

(107,900) 25,600 $ 7,800

$11,200 × 8 years $8,000 × 8 years

The company should replace the old machine. b. The sunk cost is the $80,000 book value ($168,000 cost less $88,000 accumulated depreciation) of the present machine. The original cost and accumulated depreciation were incurred in the past and are irrelevant to the decision to replace the machine.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-10 a.

Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) May 4 Continue Replace with Old Old Differential Machine Machine Effects (Alternative 1) (Alternative 2) (Alternative 2)

Revenues: Sales (5 years)* Costs: Purchase price Direct materials (5 years)* Direct labor (5 years)* Power and maintenance (5 years)* Taxes, insurance, etc. (5 years)* Selling and admin. expenses (5 years)* Profit (loss)

$1,025,000

0 (360,000) (255,000) (25,000) (7,500)

(180,000) (360,000) 0 (90,000) (20,000)

(180,000) 0 255,000 (65,000) (12,500)

(225,000) $ 152,500

(225,000) $ 150,000

0 (2,500)

* Each annual revenue and cost is multiplied by 5 years. b.

The proposal should not be accepted.

In addition to the factors given, consideration should be given to factors such as these: Do both present and proposed operations provide the same capacity? What opportunity costs are associated with alternative uses of the $180,000 outlay required to purchase the automatic machine? Is the product improved by using automatic machinery? Does the federal income tax have an effect on the decision?

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-11 Differential Analysis Sell Rough Cut (Alt. 1) or Process Further into Finished Cut (Alt. 2) August 9 Sell Rough Cut (Alternative 1)

Process Further into Finished Cut (Alternative 2)

Differential Effects (Alternative 2)

$ 532 (398) $ 134

$ 656 (515) $ 141

$ 124 (117) $ 7

Revenues, per 100 board ft. Costs, per 100 board ft. Profit (loss), per 100 board ft.

Timberland Lumber Company should process further and sell finished-cut lumber.

Ex. 25-12 a. Differential Analysis Sell Regular Columbian (Alt. 1) or Process Further into Decaf Columbian (Alt. 2) October 6

Revenues Costs Profit (loss) 1 2 3 4

Sell Regular Columbian (Alternative 1)

Process Further into Decaf Columbian (Alternative 2)

Differential Effects (Alternative 2)

$ 55,320 1 (33,000) 3 $ 22,320

$ 67,716 2 (43,230) 4 $ 24,486

$ 12,396 (10,230) $ 2,166

$9.22 × 6,000 lb. $11.88 × (6,000 lb. × 95%) $5.50 × 6,000 lb. $33,000 + $10,230

b. The differential revenue from processing further to Decaf Columbian is more than the differential cost of selling regular by $2,166. Thus, Rise N’ Shine Coffee Company should process further to Decaf Columbian.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-12 (Concluded) c.

The price of Decaf Columbian would need to decrease to $11.50 per pound in order for the differential analysis to yield neither an advantage nor a disadvantage (indifference). This is determined as follows: Net Advantage of Further Processing Volume of Decaf Columbian

$2,166 5,700 lb.*

= $0.38 per lb.

* 6,000 lb. × 95% The price of Decaf Columbian would need to be $0.38 lower, or $11.50, to yield no net differential income or loss. This is verified by the following differential analysis: Differential Analysis Sell Regular Columbian (Alt. 1) or Process Further into Decaf Columbian (Alt. 2) October 6

Revenues Costs Profit (loss)

Sell Regular Columbian (Alternative 1)

Process Further into Decaf Columbian (Alternative 2)

Differential Effects (Alternative 2)

$ 55,320 (33,000) $ 22,320

$ 65,550 * (43,230) $ 22,320

$ 10,230 (10,230) $ 0

* $11.50 × (6,000 lb. × 95%)

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-13 a.

Differential Analysis Reject Order (Alt. 1) or Accept Order (Alt. 2) November 12 Reject Order (Alternative 1)

Accept Order (Alternative 2)

Differential Effects (Alternative 2)

$ 576,0001

$ 576,000

0 $0

(522,000) 2 $ 54,000

(522,000) $ 54,000

Revenues Costs: Variable manufacturing costs Profit (loss) 1 2

18,000 units × $32 per unit 18,000 units × $29 per unit

The additional units can be sold for $32 each, and because unused capacity is available, the only costs that would be added if this additional production were accepted are the variable costs of $29 per unit. The differential revenue is therefore $32 per unit, and the differential cost is $29 per unit. Thus, the net gain is $3 per unit × 18,000 units, or $54,000.

$29.01. Any selling price above $29 (variable costs per unit) would produce a positive contribution margin.

Ex. 25-14 Total costs…………………………………………………………………………… Less fixed costs…………………………………………………………………… Total variable costs…………………………………………………………………

$868,750 261,250 $607,500

Variable cost per unit: $607,500 ÷ 45,000 batteries = $13.50 The lowest bid should be sufficient to cover the variable cost of $13.50 per unit.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-15 a.

Differential Analysis Reject Order (Alt. 1) or Accept Order (Alt. 2) January 21 Reject Order (Alternative 1)

Accept Order (Alternative 2)

Differential Effects (Alternative 2)

$ 2,320,0001

$ 2,320,000

0 0 0

(1,120,000) 2 (440,000) 3 (300,000) 4

(1,120,000) (440,000) (300,000)

0 0 0 $0

(59,000) 5 (150,000) 6 (165,000) $ 86,000

(59,000) (150,000) (165,000) $ 86,000

Revenues Costs: Direct materials Direct labor Variable factory overhead Variable selling and admin. expenses Shipping costs Certification costs Profit (loss) 1 2 3 4 5 6

20,000 tires × $116 per tire 20,000 tires × $56 per tire 20,000 tires × $22 per tire 20,000 tires × ($25 per tire × 60%) 20,000 tires × [($26 per tire × 45%) – ($175 × 5%)*] 20,000 tires × $7.50 per tire

* 5% × $175. The avoided sales commission should not be computed on the basis of the $116 price to Euro Motors, but on the existing domestic sales price of $175.

Brightstone should accept the special order from Euro Motors. b.

$116 –

$86,000 20,000

= $116.00 – $4.30 = $111.70

This is the price at which the differential income would be zero.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-16 a.

Contribution margin per room night: Rate per room night Less variable costs per room night: Housekeeping service Utilities Amenities Total variable cost per room night Contribution margin per room night

$180 $23 7 3 33 $147

The discount price should be set greater than the variable costs per room night so that the resulting contribution margin contributes to fixed costs and profitability. Thus, the price should be greater than $33. The fixed costs are not incremental to this decision and, thus, are sunk. However, the hotel must also consider the lost revenue from discounted prices to the existing weekend traffic volume. Thus, the price must be set so that the additional contribution margin from the incremental demand offsets the lost revenue from the reduced price to the existing demand. So while $33 may be a minimum, the actual price will be set much higher so as to reduce the lost revenue from the existing traffic.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-17 a.

Desired Profit = $345,000 × 26% = $89,700

Cost amount (product cost) per unit: $154,000 ÷ 1,400 units = $110.00

Markup Percentage

= =

Desired Profit + Total Selling and Administrative Expenses Total Manufacturing Costs $89,700 + $33,500 $154,000

= 80% d.

Cost amount (product cost) per unit……………………………………………… Markup ($110.00 × 80%)……………………………………………………………… Selling price……………………………………………………………………………

$110.00 88.00 $198.00

Ex. 25-18 a.

Desired Profit = $1,200,000 × 30% = $360,000

Cost amount (product cost) per unit: $2,500,000* ÷ 10,000 units = $250 * ($215 manufacturing variable cost per unit × 10,000 units) + $350,000 manfacturing fixed cost

Markup Percentage

Desired Profit + Total Selling and Administrative Expenses Total Manufacturing Costs

$360,000 + $140,000 + ($25 × 10,000) $2,500,000

$360,000 + $140,000 + $250,000 $2,500,000

$750,000 $2,500,000

= 30% d.

Cost amount per unit………………………………………………………………… $250 Markup ($250 × 30%)………………………………………………………………… 75 Selling price…………………………………………………………………………… $325

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-19 a.

The price will be set at the estimated market price required to remain competitive, or $27,000. Under the target cost concept, the market dictates the price, not the markup on cost.

The required profit margin of 20% of the estimated $27,000 price implies a $21,600 target product cost as follows: Target Product Cost

= $27,000 – ($27,000 × 20%) = $27,000 – $5,400 = $21,600

Because the estimated manufacturing cost of $22,500 exceeds the target cost of $21,600, Toyota must reduce $900 from its total costs in order to maintain competitive pricing within its profit objectives. Note to Instructors: Target costing provides pressure to keep costs competitive. The method assumes that the company may not be able to add a markup to its costs successfully because the resulting price may be too high in the marketplace. For example, merely adding the 25% markup on the $22,500 product cost would result in an uncompetitive price of $28,125. The target cost concept moves backward by taking the price as given and then determining the cost that is required for a given profit objective.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-20 a.

Historical markup percentage on product cost: or

$230 $460

$460 – $230 $230

= 100%

= 50% of selling price

$400 revised selling price × 50% = $200 amount of markup on target product cost $400 selling price – $200 markup = $200 target product cost (Also, $200 × 100% = $200 markup on product cost; $200 + $200 = $400 selling price) b.

Required cost reduction: $230 – $200 = $30

Direct labor reduction:

$30 60 min.

× 15 min. =

Additional inspection:

$30 60 min.

× 6 min. =

$ 7.50 $ (3.00)

Direct material reduction:

20.00

17.00

Injection molding productivity improvement: Direct labor improvement (25%* × 40% × $40) Factory overhead improvement (25%* × 48% × $15) Total savings per unit

$ 4.00 1.80

5.80 $30.30

* Improving the cycle time from 4 minutes to 3 minutes is a 25% reduction. The total savings exceeds the required target cost reduction by $0.30. Thus, these improvements are sufficient to meet the target cost.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-21 Determine the contribution margin per furnace hour as follows: Type 5 Revenue……………………………………… $43,000 Variable cost………………………………… 34,000 Contribution margin……………………… $ 9,000 ÷ Number of units…………………………… 5,000 units Unit contribution margin………………… $ 1.80 Unit contribution margin per furnace hour*………………………… $

0.30

Type 10

Type 20

$49,000 28,000

$56,500 26,500

$21,000 5,000 units $ 4.20

$30,000 5,000 units $ 6.00

0.70

0.50

* Computed as follows: Type 5:

$1.80 6 hours

= $0.30 per furnace hour

Type 10:

$4.20 6 hours

= $0.70 per furnace hour

Type 20:

$6.00 12 hours

= $0.50 per furnace hour

Emphasize Type 10. In a production-constrained environment, Type 10 generates the most unit contribution margin per hour of furnace resource and, thus, is the most profitable. While Type 20 has the largest profit per unit ($4.40) and unit contribution margin ($6.00), these would not be the correct metrics for determining the product to emphasize in the marketing campaign, assuming that the furnace is a bottleneck resource.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-22 a.

Large

Medium

Small

3,000

Revenues*……………………… $552,000 390,000 Less variable costs**………… Contribution margin…………… $162,000 Less fixed costs……………… Income from operations………

$480,000 360,000 $120,000

$300,000 228,000 $ 72,000

Units produced…………………

Total $1,332,000 978,000 $ 354,000 85,000 $ 269,000

* 3,000 units × sales price per unit ** 3,000 units × variable cost per unit b.

The Small glass product is the most profitable in a bottleneck operation, demonstrated as follows: Contribution margin…………………………… ÷ Autoclave hours per unit…………………… Unit contribution margin per production bottleneck hour…………………………………

Large

Medium

Small

$54 3

$40 2

$24 1

$18

$20

$24

ActivityBase Usage

$8 /prod. order $5 /purch. ord.

$22 /mh $12 /dlh $40 /setup $18 /insp.

Activity Rate =

25-29

32 prod. orders 98 purch. ord.

$36,960 2,916 1,800 2,844 480 1,200 $46,200 ÷ 500 $ 92.40

1,070 mh 131 dlh 20 setups 94 insp.

Activity Cost ×

$8 /prod. order $5 /purch. ord.

$22 /mh $12 /dlh $40 /setup $18 /insp.

Activity Rate

Treadmill

ActivityBase Usage

Differential Analysis, Product Pricing, and Activity-Based Costing

Stationary Bicycle

Fabrication 1,680 mh Assembly 243 dlh Setup 45 setups Inspecting 158 insp. Production scheduling 60 prod. orders 240 purch. ord. Purchasing Total ÷ Number of units Activity cost per unit

Activity

Ex. 25-23

CHAPTER 25

256 490 $28,350 ÷ 350 $ 81.00

$23,540 1,572 800 1,692

Activity Cost

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Ex. 25-24 a.

Production Setup

Procurement

Quality Control

Materials Management

$13,500 900

$97,500 1,500

$84,000 700

$15/PO

$65/inspection

$120/component

Activity cost…… $44,000 400 ÷ Activity base… Activity rate……… $110/setup

Custom Number of setups…………………… × Rate per setup………………………

290 $110

Number of purchase orders………… × Rate per purchase order…………

760 $15

Standard 110 $110

$ 31,900

$12,100 140 $15

11,400

2,100

Number of inspections………………

1,200

300

× Rate per inspection…………………

$65

$65 78,000

Number of components…………… × Rate per component………………

500 $120

Total product cost…………………… ÷ Unit volume………………………… Unit cost………………………………

19,500 200 $120

60,000

24,000

$181,300 2,000

$57,700 2,000

$ 28.85

90.65

The factory overhead allocated to each product on the basis of direct labor hours would be 50% because each product has the same 2,000 direct labor hours. The factory overhead per direct labor hour for each product is computed as follows: $239,000 4,000 per direct labor hour

= $59.75 per hour

Because each product requires 1 direct labor hour, the factory overhead cost per unit is also $59.75 for each product. d.

The factory overhead allocated to the custom power unit is much higher under the activity-based approach compared to the direct labor method. The reason is because the setup, procurement, and quality control activities are not related to the number of direct labor hours but are instead related to the number of setups, purchase orders, and inspections. In addition, the custom product has a more complex design (more components) than does the standard product. As a result, the custom product will consume more materials management activities than will the standard product.

Activity

ActivityBase Usage 800 mh 500 dlh 140 insp. 80 setups 50 loads

$42,000 13,500 5,800 16,800 3,600

Estimated Activity Cost 1,400 mh 900 dlh 290 insp. 140 setups 90 loads

Activity Rate $30 /mh $15 /dlh $20 /insp. $120 /setup $40 /load

Activity Rate

Activity Cost $24,000 7,500 2,800 9,600 2,000 $45,900 ÷ 1,200 $ 38.25

$30 /mh $15 /dlh $20 /insp. $120 /setup $40 /load

25-31

Entry Lighting Fixtures

Total ActivityBase Usage

Dining Room Lighting Fixtures ActivityBase Activity Activity Usage × Rate = Cost $30 /mh $18,000 600 mh $15 /dlh 6,000 400 dlh $20 /insp. 3,000 150 insp. $120 /setup 7,200 60 setups $40 /load 1,600 40 loads $35,800 ÷ 500 $ 71.60

Differential Analysis, Product Pricing, and Activity-Based Costing

Activity Casting Assembly Inspecting Setup Materials handling Total activity cost ÷ Number of units Activity cost per unit

Casting Assembly Inspecting Setup Materials handling

Ex. 25-25

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Appendix Ex. 25-26 a.

Total costs: Variable ($240 × 10,000 units)………………………………………………… $2,400,000 490,000 Fixed ($350,000 + $140,000)………………………………………………… Total…………………………………………………………………………………… $2,890,000 Cost amount per unit: $2,890,000 ÷ 10,000 units = $289

Markup Percentage = = =

Desired Profit Total Costs $360,000 * $2,890,000 12.46% (rounded)

* $1,200,000 × 30% = $360,000 c.

Cost amount per unit……………………………………………………………… Markup ($289 × 12.46%)…………………………………………………………… Selling price…………………………………………………………………………

$289 36 $325

Appendix Ex. 25-27 a.

Total variable costs: ($240 × 10,000 units)…………………………………… $2,400,000 Cost amount per unit: $2,400,000 ÷ 10,000 units = $240

Markup Percentage =

Desired Profit + Total Fixed Costs Total Costs

$360,000 * + $350,000 + $140,000 $2,400,000

$850,000 $2,400,000

= 35.42% * $1,200,000 × 30% = $360,000 c.

Cost amount per unit……………………………………………………………… Markup ($240 × 35.42%)…………………………………………………………… Selling price…………………………………………………………………………

$240 85 $325

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

PROBLEMS Prob. 25-1A 1.

Differential Analysis Operate Retail Store (Alt. 1) or Invest in Bonds (Alt. 2) October 1

Revenues Costs: Costs to operate store Cost of equipment less residual value Profit (loss) 1 2 3 4

Operate Retail Store (Alternative 1)

Invest in Bonds (Alternative 2)

Differential Effects (Alternative 2)

$1,264,0001

$172,800 2

$(1,091,200)

(928,000) 3

928,000

(165,000) 4 $ 171,000

0 $172,800

165,000 1,800

(8 yrs. × $85,000) + (8 yrs. × $73,000) 6% × $180,000 × 16 yrs. $58,000 × 16 yrs. $180,000 – $15,000

2. The proposal to operate the retail store should be rejected. 3. Total estimated revenue from operating store………… Total estimated expenses to operate store: Costs to operate store, excluding depreciation…… Cost of store equipment less residual value……… Total estimated income from operating store*…………

$1,264,000 $928,000 165,000

1,093,000 $ 171,000

* The $171,000 income could also be determined by subtracting the $1,800 differential loss from operating the store as derived in part (1) from the $172,800 of investment income forgone by electing to operate the store.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-2A 1.

Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) April 30 Continue Replace with Old Old Machine Machine (Alternative 1) (Alternative 2)

Revenues Proceeds from sale of old machine Costs Purchase price Annual manufacturing costs (6 years) Profit (loss) 1 2

Differential Effects (Alternative 2)

$ 25,500

(102,300)

(120,600)1 $(120,600)

(35,400) 2 $(112,200)

85,200 8,400

$20,100 × 6 years $5,900 × 6 years

Note: Revenues and nonmanufacturing operating expenses are not affected by the decision to replace the old machine and, thus, are not included in the analysis. If they were included, both alternatives would include them, causing the differential effects to net to zero for both items. Depreciation is ignored because it is a sunk cost for the old machine and is incorporated in the purchase price for the new machine. Fontasia Printing Company should replace the old machine with the new machine. 2. Other factors to be considered include: a. Are there any improvements in the quality of work turned out by the new machine? b. What effect does the federal income tax have on the decision? c. What opportunities are available for the use of the $76,800 of funds ($102,300 less $25,500 proceeds from the old machine) that are required to purchase the new machine? After considering such factors as those listed above, the net cost reduction anticipated over the 6-year period may not be sufficient to justify the replacement. For example, if there is an opportunity to invest the $76,800 ($102,300 – $25,500) of additional funds required for the replacement in a project that earns a return of 5% (assumed for illustration), the amount of the return over the 6-year period would be $23,040 ($76,800 × 5% × 6), which is more advantageous than the replacement, other factors being equal.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-3A Differential Analysis Promote Moisturizer (Alt. 1) or Promote Perfume (Alt. 2) August 21

Revenues Costs:* Direct materials Direct labor Variable factory overhead Variable selling expenses Sales promotion Profit (loss) 1 2

Promote Moisturizer (Alternative 1)

Promote Perfume (Alternative 2)

Differential Effects (Alternative 2)

$1,210,0001

$1,200,000 2

$ (10,000)

(198,000) (66,000) (66,000) (352,000) (140,000) $ 388,000

(280,000) (100,000) (100,000) (300,000) (140,000) $ 280,000

(82,000) (34,000) (34,000) 52,000 0 $(108,000)

22,000 units × $55 20,000 units × $60

* Costs, except sales promotion, are the costs per unit multiplied by the increase in unit volume for each cosmetic. Because fixed costs are not relevant to the decision, they are not included.

Parisian should promote moisturizer. 2. The sales manager’s tentative decision should be opposed. The sales manager erroneously considered the full unit costs instead of the differential (additional) revenue and differential (additional) costs. An analysis similar to that presented in part (1) would lead to the selection of moisturizer for the promotional campaign because this alternative would contribute $108,000 ($388,000 – $280,000) more to operating income than would be contributed by promoting perfume.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-4A Differential Analysis Sell Raw Sugar (Alt. 1) or Process Further into Refined Sugar (Alt. 2) March 24

Sell Raw Sugar (Alternative 1)

Process Further into Refined Sugar (Alternative 2)

Differential Effects (Alternative 2)

$ 58,8001 (35,000)3 $ 23,800

$ 73,920 2 (56,000) 4 $ 17,920

$ 15,120 (21,000) $ (5,880)

Revenues, per batch Costs, per batch Profit (loss), per batch 1 2 3 4

$1.40 per pound × 42,000 pounds $2.20 per pound × (42,000 pounds ÷ 1.25) $0.35 per pound × 100,000 pounds $35,000 + ($0.50 per pound × 42,000 pounds)

2. Dominican Sugar Company should not process raw sugar further to produce refined sugar because profits would be reduced by $5,880 per batch.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-5A 1. $225,000 ($1,500,000 × 15%) 2. a. Total manufacturing costs: Variable ($200* × 5,000 units)………………………………………………… $1,000,000 250,000 Fixed factory overhead………………………………………………………… Total……………………………………………………………………………… $1,250,000 Cost amount per unit: $1,250,000 ÷ 5,000 units………………………… $

250

* $120 + $30 + $50

Desired Profit + Total Selling and Administrative Expenses Markup Percentage = Total Product Costs =

$225,000 + $150,000 + ($35 × 5,000 units) $1,250,000

$225,000 + $150,000 + $175,000 $1,250,000

$550,000 $1,250,000

= 44% c. Cost amount per unit………………………………………………………… Markup ($250 × 44%)…………………………………………………………… Selling price………………………………………………………………………

$250 110 $360

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-5A (Continued) 3. (Appendix) a. Total costs: Variable ($235 × 5,000 units)…………………………………………… $1,175,000 400,000 Fixed ($250,000 + $150,000)…………………………………………… Total…………………………………………………………………………… $1,575,000 Cost amount per unit: $1,575,000 ÷ 5,000 units……………………… b.

Markup Percentage = = =

315

Desired Profit Total Costs $225,000 $1,575,000 14.29% (rounded)

c. Cost amount per unit……………………………………………………… Markup ($315 × 14.29%)…………………………………………………… Selling price…………………………………………………………………

$315 45 $360

4. (Appendix) a. Variable cost amount per unit: $235 Total variable costs: $235 × 5,000 units = $1,175,000 b.

Markup Percentage =

Desired Profit + Total Fixed Costs Total Variable Costs

$225,000 + $250,000 + $150,000 $1,175,000

$625,000 $1,175,000

= 53.19% c. Cost amount per unit……………………………………………………… Markup ($235 × 53.19%)…………………………………………………… Selling price…………………………………………………………………

$235 125 $360

5. The cost-plus approach price of $360 should be viewed as a general guideline for establishing long-run normal prices. Other considerations, such as the price of competing products and general economic conditions of the marketplace, could lead management to establish a short-run price more or less than $360.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-5A (Concluded) 6. a. Differential Analysis Reject Order (Alt. 1) or Accept Order (Alt. 2) August 3 Reject Order (Alternative 1)

Revenues Costs: Variable manufacturing costs Profit (loss) 1

Accept Differential Order Effects (Alternative 2) (Alternative 2)

$ 180,000

0 $0

(160,000)1 $ 20,000

(160,000) $ 20,000

800 units × ($235 – $35*)

* Excluding variable selling and administrative expenses b. The proposal should be accepted.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-6A 1. Selling price………………………………………… Variable conversion cost per unit……………… Direct materials cost per unit…………………… Total variable costs per unit Contribution margin per unit………………………

High Grade

Good Grade

Regular Grade

$280

$270

$250

$180 * 90 $270 $ 10

$165 ** 84 $249 $ 21

$150 *** 80 $230 $ 20

* $15 × 12 process hours = $180 ** $15 × 11 process hours = $165 *** $15 × 10 process hours = $150 2. The contribution margin per unit may give false signals when an organization has production bottlenecks. Instead, Hercules should use the contribution margin per bottleneck hour to determine relative product profitability, as follows: High Grade

Good Grade

Regular Grade

Contribution margin per unit……………………… $10 4 ÷ Furnace (bottleneck) hours per unit…………… $2.50 Contribution margin per furnace hour…………

$21 3 $7.00

$20 2.5 $8.00

The Good Grade steel has the largest contribution margin per unit ($21); however, the Regular Grade has the largest contribution margin per furnace hour ($8.00). Thus, using production bottleneck analysis indicates that the Regular Grade is actually more profitable at an $8.00 contribution margin per furnace hour than High Grade’s $2.50 or Good Grade’s $7.00 contribution margin per furnace hour. Therefore, the company would want to sell product in the following preference order: 1. Regular Grade 2. Good Grade 3. High Grade

1. Production

Production Setup Inspection Shipping Customer service Total activity cost ÷ Units Activity cost per unit

Activity

Production Setup Inspection Shipping Customer service Total activity cost ÷ Units Activity cost per unit

Activity $55 /mh $240 /setup $25 /insp. $30 /cust. ord. $80 /request

Activity Rate

× $55 /mh $240 /setup $25 /insp. $30 /cust. ord. $80 /request

Activity Rate

Powdered Sugar

White Sugar

$48,000 200 setups $ 240 /setup

Setup

25-41

$ 68,750 19,200 6,000 24,000 9,600 $127,550 ÷ 5,000 $ 25.51

Activity Cost

$110,000 12,000 2,500 12,300 2,000 $138,800 ÷ 8,000 $ 17.35

Activity Cost

25 /insp.

$12,500 500 insp.

Inspection

1,250 mh 70 setups 160 insp. 1,100 cust. ord. 200 requests

ActivityBase Usage

$69,300 2,310 cust. ord. $ 30 /cust. ord.

Shipping

Differential Analysis, Product Pricing, and Activity-Based Costing

$27,600 345 req. $ 80 /req.

Customer Service

$55 /mh $240 /setup $25 /insp. $30 /cust. ord. $80 /request

Activity Rate

Brown Sugar

1,250 mh 80 setups 240 insp. 800 cust. ord. 120 requests

ActivityBase Usage

2,000 mh 50 setups 100 insp. 410 cust. ord. 25 requests

ActivityBase Usage

Total activity cost…………… $247,500 4,500 mh 55 /mh Activity rate………………… $

÷ Total activity base…………

Prob. 25-7A

CHAPTER 25

$ 68,750 16,800 4,000 33,000 16,000 $138,550 ÷ 5,000 $ 27.71

Activity Cost

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-7A (Concluded) 3. The unit costs are different even though each product requires 0.25 machine hour because the products consume many activities in ratios different from the volume. For example, the brown sugar consumes setup, inspection, shipping, and customer service activities proportionately greater than its volume, while white sugar consumes the same activities proportionately less than its volume. This can be seen from the activity cost per unit. If costs were proportional to volume, then the activity cost per unit would be equal for all three products.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-1B 1.

Differential Analysis Operate Warehouse (Alt. 1) or Invest in Bonds (Alt. 2) July 1

Revenues Costs: Costs to operate warehouse Cost of equipment less residual value Profit (loss) 1 2 3 4

Operate Warehouse (Alternative 1)

Invest in Bonds (Alternative 2)

Differential Effects (Alternative 2)

$ 3,640,0001

$518,000 2

$(3,122,000)

(2,450,000) 3

2,450,000

(665,000)4 $ 525,000

0 $518,000

665,000 (7,000)

(7 yrs. × $280,000) + (7 yrs. × $240,000) 5% × $740,000 × 14 years $175,000 × 14 years $740,000 – $75,000

2. The proposal to operate the warehouse should be accepted. 3. Total estimated revenue from operating warehouse… Total estimated expenses to operate warehouse: Costs to operate warehouse, excluding depreciation………………………………… Cost of warehouse equipment less residual value…………………………………………… Total estimated income from operating warehouse*…

$3,640,000

$2,450,000 665,000 3,115,000 $ 525,000

* The $525,000 income from operations could also be determined by adding the $7,000 differential income from operating the warehouse as derived in part (1) to the $518,000 of investment income forgone by electing to operate the warehouse.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-2B 1.

Differential Analysis Continue with Old Machine (Alt. 1) or Replace Old Machine (Alt. 2) November 8 Continue Replace with Old Old Differential Machine Machine Effects (Alternative 1) (Alternative 2) (Alternative 2)

Revenues: Proceeds from sale of old machine Costs: Purchase price Annual manufacturing costs (6 years) Profit (loss) 1 2

$ 12,900

(57,000)

(20,400) 2 $(64,500)

54,000 $ 9,900

(74,400)1 $(74,400)

$12,400 × 6 years $3,400 × 6 years

Note: Revenues and nonmanufacturing operating expenses are not affected by the decision to replace the old machine and, thus, are not included in the analysis. If they were, both alternatives would include them, causing the differential effects to net to zero for both items. Depreciation is ignored because it is a sunk cost for the old machine and is incorporated in the purchase price for the new machine. Flint Tooling Company should replace the old machine with the new machine. 2. Other factors to be considered include the following: a. Are there any improvements in the quality of work turned out by the new machine? b. What effect does the federal income tax have on the decision? c. What opportunities are available for the use of the $44,100 of funds ($57,000 less $12,900 proceeds from the old machine) that are required to purchase the new machine? After considering such factors as those listed above, the net cost reduction anticipated over the 6-year period may not be sufficient to justify the replacement. For example, if there is an opportunity to invest the $44,100 ($57,000 – $12,900) of additional funds required for the replacement in a project that earns a return of 3% (assumed for illustration), the amount of the return over the 6-year period would be $7,938 ($44,100 × 3% × 6). However, this is less than the differential income determined in part (1), suggesting that the proposal to replace is still preferred.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-3B Differential Analysis Promote Tennis Shoes (Alt. 1) or Promote Walking Shoes (Alt. 2) June 19

Revenues Costs:* Direct materials Direct labor Variable factory overhead Variable operating expenses Sales promotion Profit (loss) 1 2

Promote Tennis Shoes (Alternative 1)

Promote Walking Shoes (Alternative 2)

Differential Effects (Alternative 2)

$ 595,000 1

$ 700,000 2

$105,000

(133,000) (56,000) (49,000) (42,000) (100,000) $ 215,000

(224,000) (84,000) (35,000) (70,000) (100,000) $ 187,000

(91,000) (28,000) 14,000 (28,000) 0 $ (28,000)

7,000 shoes × $85 7,000 shoes × $100

* Costs, except sales promotion, are the costs per unit multiplied by the increase in unit volume for each shoe. Becaues fixed costs are not relevant to the decision, they are not included.

Sole Mates Inc. should promote tennis shoes. 2. The sales manager’s tentative decision should be opposed. The sales manager erroneously considered the full unit costs instead of the differential (additional) revenue and differential (additional) costs. An analysis similar to that presented in part (1) would lead to the selection of tennis shoes for the promotional campaign because this alternative would contribute $28,000 ($215,000 – $187,000) more to operating income than would be contributed by promoting walking shoes.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-4B Differential Analysis Sell Aluminum Ingot (Alt. 1) or Process Further into Rolled Aluminum (Alt. 2) February 5

Sell

Aluminum Ingot (Alternative 1)

Revenues, per ton Costs, per ton Profit (loss), per ton 1 2 3 4

$ 88,000 (52,500) 3 $ 35,500

Process Further into Rolled Aluminum (Alternative 2)

Differential Effects (Alternative 2)

$ 140,800 2 (102,100) 4 $ 38,700

$ 52,800 (49,600) $ 3,200

$1,100 per ton × 80 tons $2,200 per ton × (80 tons ÷ 1.25) $105 per ton × 500 tons $52,500 + ($620 per ton × 80 tons)

2. International Aluminum Co. should decide to process aluminum ingot further rather than sell aluminum ingot because profits would be increased by $3,200 per batch if ingot was processed further into rolled aluminum.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-5B 1. $60,000 ($600,000 × 10%) 2. a. Total manufacturing costs: Variable ($52* × 10,000 units)………………………………………………… Fixed factory overhead………………………………………………………… Total………………………………………………………………………………

$520,000 180,000 $700,000

Cost amount per unit: $700,000 ÷ 10,000 units……………………………

* $32 + $12 + $8

Desired Profit + Total Selling and Administrative Expenses b. Markup Percentage = Total Product Costs =

$60,000 + $80,000 + ($7 × 10,000 units) $520,000 + $180,000

$60,000 + $80,000 + $70,000 $700,000

$210,000 $700,000

= 30% c. Cost amount per unit…………………………………………………………… Markup ($70 × 30%)…………………………………………………………… Selling price………………………………………………………………………

$70 21 $91

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-5B (Continued) 3. (Appendix) a. Total costs: Variable ($59 × 10,000 units)………………………………………………… $590,000 Fixed ($180,000 + $80,000)…………………………………………………… 260,000 Total……………………………………………………………………………… $850,000 Cost amount per unit: $850,000 ÷ 10,000 units………………………… b.

Markup Percentage = = =

$85.00

Desired Profit Total Costs $60,000 $850,000 7.06%

c. Cost amount per unit………………………………………………………… Markup ($85.00 × 7.06%)……………………………………………………… Selling price……………………………………………………………………

$85 6 $91

4. (Appendix) a. Variable cost amount per unit: $59.00 Total variable costs: $59 × 10,000 units = $590,000 b.

Markup Percentage =

Desired Profit + Total Fixed Costs Total Variable Costs

$60,000 + $180,000 + $80,000 $590,000

$320,000 $590,000

= 54.24% (rounded) c. Cost amount per unit………………………………………………………… Markup ($59 × 54.24%)………………………………………………………… Selling price……………………………………………………………………

$59 32 $91

5. The cost-plus approach price of $91 should be viewed as a general guideline for establishing long-run normal prices. Other considerations, such as the price of competing products and general economic conditions of the marketplace, could lead management to establish a short-run price more or less than $91.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-5B (Concluded) 6. a. Differential Analysis Reject Order (Alt. 1) or Accept Order (Alt. 2) September 5 Reject Order (Alternative 1)

Accept Order (Alternative 2)

Differential Effects (Alternative 2)

$ 91,200 1

$ 91,200

0 $0

(83,200) 2 $ 8,000

(83,200) $ 8,000

Ethylene

Butane

Ester

$170

$155

$130

$ 40* 115 $155 $ 15

$ 40 * 88 $128 $ 27

$ 30 ** 85 $115 $ 15

Revenues Costs Variable manufacturing costs Profit (loss) 1 2

1,600 units × $57 1,600 units × ($59 – $7*)

* Excluding variable selling and administrative expenses b. The proposal should be accepted. Prob. 25-6B 1. Selling price………………………………… Variable conversion cost per unit……… Direct materials cost per unit…………… Total variable costs per unit…………… Contribution margin per unit…………… * $10 × 4 process hours = $40 ** $10 × 3 process hours = $30 2. The contribution margin per unit may give false signals when an organization has production bottlenecks. Instead, Wilmington Chemical Company should use the contribution margin per bottleneck hour to determine relative product profitability as follows: Ethylene

Butane

Ester

$15 1.5 $10

$27 1.0 $27

$15 0.5 $30

Contribution margin per unit…………… ÷ Reactor (bottleneck) hours per unit… Contribution margin per reactor hour…

Unlike the analysis in part (1), this analysis shows ester, not butane, to be the most profitable product. The reason is that ester delivers more contribution margin per bottleneck hour than does ethylene or butane ($30 vs. $10 and $27).

1. Production

Production Setup Moving Shipping Product engineering Total ÷ Number of units Activity cost per unit

Activity

Production Setup Moving Shipping Product engineering Total ÷ Number of units Activity cost per unit

Activity

$200 /mh $450 /setup $35 /move $105 /cust. ord. $600 /test run

Activity Rate

Specialty Paper

$200 /mh $450 /setup $35 /move $105 /cust. ord. $600 /test run

Activity Rate

Computer Paper

$117,000 260 setups $ 450 /setup

Setup

25-50

$ 40,000 67,500 10,500 57,750 63,000 $238,750 500 ÷ $ 477.50

Activity Cost

$ 80,000 36,000 8,050 32,550 30,000 $186,600 ÷ 1,000 $ 186.60

Activity Cost

35 /move

$21,000 600 moves

Moving

500 mh 30 setups 70 moves 140 cust. ord. 15 test runs

ActivityBase Usage

$105,000 1,000 cust. ord. $ 105 /cust. ord.

Shipping

Differential Analysis, Product Pricing, and Activity-Based Costing

$200 /mh $450 /setup $35 /move $105 /cust. ord. $600 /test run

Activity Rate

Newsprint

$102,000 170 test runs $ 600 /test run

Product Engineering

200 mh 150 setups 300 moves 550 cust. ord. 105 test runs

ActivityBase Usage

400 mh 80 setups 230 moves 310 cust. ord. 50 test runs

ActivityBase Usage

Total activity cost…………… $220,000 1,100 mh 200 /mh Activity rate………………… $

÷ Total activity base…………

Prob. 25-7B

CHAPTER 25

$100,000 13,500 2,450 14,700 9,000 $139,650 ÷ 1,250 $ 111.72

Activity Cost

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

Prob. 25-7B (Concluded) 3. The unit costs are different even though each product requires 0.4 machine hour because the products consume many activities in ratios different from the volume. For example, the specialty paper consumes setup, moving, shipping, and product engineering activities proportionately greater than its volume, while the newsprint consumes the same activities proportionately less than its volume. This can be seen from the activity cost per unit. If costs were proportional to volume, then the activity cost per unit would be equal for all three products.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

CASES & PROJECTS CP 25-1 No, it would not be ethical for Aaron to attend the meeting. Such a meeting would be considered price fixing and would be a violation of federal law. Thus, Aaron’s attendance would be a criminal act. His actions would also discredit his reputation and that of the profession.

CP 25-2 This activity is designed to have students access a number of products and services on the Internet to see their commercial potential. Each of the listed sites will provide product descriptions (1) and pricing (2). The list of costs (3) for the products will not be directly obtainable from the company’s website, but can be assumed based on the company and industry. Some examples include: Delta Air Lines—Airline tickets

Fixed or Variable?

Fuel…………………………………………………………………… Crew salaries………………………………………………………… Plane depreciation…………………………………………………… Landing fees………………………………………………………… Travel agent commissions………………………………………… Lease costs (gates)………………………………………………… Ground salaries……………………………………………………… Equipment depreciation……………………………………………

V F F V V F F F

For Delta Air Lines, the likely activity base for determining fixed and variable costs is the number of passenger miles. Employees’ salaries for an airline are relatively fixed and only become variable when there are significant changes to the flight schedule. Amazon.com—Merchandise

Fixed or Variable?

Cost of merchandise (purchased for resale)…………………… Web page design and programming…………………………… Computer depreciation…………………………………………… Order handling and packing wages……………………………… Freight…………………………………………………………………

V F F V V

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

CP 25-2 (Concluded) For Amazon, a possible activity base for determining fixed and variable costs is the amount sold. Dell Inc.—Personal computers

Fixed or Variable?

Cost of computers (dl, dm, and foh)……………………………… Web page design and programming…………………………… Advertising…………………………………………………………… Order handling and packing wages……………………………… Freight………………………………………………………………… Bundled software*……………………………………………………

V (mostly) F F V V V

* Depends on contract terms with software vendor For Dell, the likely activity base for determining fixed and variable costs is the number of computers sold. 4. The Delta Air Lines ticket is likely to have the largest contribution margin per incremental unit (ticket) sold. The portion of variable cost to total cost for an airline will be much smaller than the other two products. This is because the largest costs (the fleet, equipment, and personnel costs) are most fixed to the volume of activity. In addition, an airline ticket does not have as much material cost as do computers and merchandise.

CP 25-3 Memo To: Juanita Jackson From: Les Miles Re: New Product Pricing Thank you again for taking the time to meet with me and discuss the pricing of our new computer. While I understand your desire to set an appropriate price for this new product, it would be inappropriate to exclude fixed costs in the pricing decision. Ignoring fixed costs would be the equivalent of treating the new computer as an incremental decision, which is not the case. The new computer was designed and developed to be part of the company’s core product portfolio. As a result, the revenues from the sale of this product must contribute to covering fixed costs. If the sales price does not cover fixed costs and provide a profit, then the company will not be competitive in the long term.

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

CP 25-3 (Concluded) Target costing provides a potential solution to the pricing issue. This approach treats the market price as given and adjusts the cost in order to yield the required profitability. Target costing is particularly effective in highly competitive product markets where declining prices require cost reduction in order to compete. Under target costing, the company would begin with the price the market is willing to pay, which is $1,250. This price should then be reduced by the required profit markup. This would yield a target cost of $1,000 ($1,250 ÷ 1.25), which is $200 lower than the current product cost. The new target cost would then be established as a cost-reduction target. Our focus should then be on improving product design and processes in order to reduce the product cost to $1,000.This will allow the company to develop a competitive price and cost structure for the new computer.

CP 25-4 The contribution margin is $4 ($22 – $18) per dozen on the special order. Thus, Varden’s manager can contribute to fixed costs by accepting the order. However, there are some additional considerations the manager must consider before accepting this order. 1. Have we ever done business overseas? Exports require additional administrative activities. Have these additional administrative costs been considered in the differential analysis? 2. Will the customer sell the golf balls overseas, or will they relabel the golf balls and have them imported back into the United States? Such a situation would cause Varden to be competing against itself. 3. Is it likely that other customers will learn of the “special deal” the overseas company received and demand equal treatment? That is, is there a risk that we’ll spoil the pricing structure in the domestic market? 4. Will the overseas customer want to do business in the future, or is this just a single sale? If the overseas customer is expected to purchase more golf balls in the future, then it is likely that the customer will come to expect the $22 price in the future. 5. Is there a possibility of another customer being willing to purchase the golf balls at the $35 price? If so, Varden may not want to commit capacity to the overseas customer. Once the capacity is committed, it will be difficult to sell to anyone else. 6. Will we help the overseas customer establish a presence in the overseas golf ball market where we may want to compete in the future?

CHAPTER 25

Differential Analysis, Product Pricing, and Activity-Based Costing

CP 25-5 First, Marriott has excess capacity for this day, so it should be willing to accept additional customers. The Priceline.com customer generates incremental revenue that will not reduce other business. Given this, however, the price must at least cover variable cost; otherwise, Marriott will incur a loss. The variable cost per room night is shown below. Housekeeping labor cost………………………………………………………………… Cost of room supplies (soap, paper, etc.)……………………………………………… Laundry labor and material cost………………………………………………………… Utility cost (mostly air conditioning)…………………………………………………… Total variable cost per day per room……………………………………………………

$38 8 10 5 $61

These costs are mostly avoidable or are variable to room nights. This answer assumes that the maid and laundry staff hours are highly flexible and can be staffed to demand. Likewise, the air conditioning and lights can be turned off if the room is not rented for the night, saving most of the utility cost. The desk staff and hotel depreciation are either sunk (depreciation) or mostly fixed to the number of room nights. Therefore, they are not relevant to accepting this business. The total variable costs are $61 per night, so the $85 customer bid should be accepted. Note to Instructors: There could be some discussion about the degree to which some of these costs are fully variable. For example, it’s likely that some utility cost must be incurred for the room, whether it is occupied or not. Likewise, the housekeeping and laundry staff hours may not be as flexible to demand as assumed here. There should be very little question about the room supplies (full variable) or the hotel depreciation (sunk). Regardless of the assumptions, the decision would remain the same.

CP 25-6 The product profitability report indicates that the two products are equal in terms of profitability (on a per-case basis). However, the additional information indicates that there will be more activities required for Jamaican Punch than for King Kola. Apparently, the factory overhead costs are being allocated on the basis of a single activity base that does not capture these product differences. Because the direct labor costs are equal for producing a case of each product, the factory overhead allocated to each case would also be the same under the single factory overhead rate method. Thus, they would appear to have similar cost and profitability. An activity-based costing approach would likely demonstrate that the Jamaican Punch is less profitable and the King Kola is more profitable than indicated by the single plant-wide factory overhead rate method. In addition, activity-based costing information would guide management in more accurate pricing decisions based on markup on product cost.