SOLUTION MANUAL FOR Financial Accounting, 5th EDITION. David Spiceland, Wayne Thomas, Don Herrmann by StudyGuide

Financial Accounting, 5e David Spiceland, Wayne Thomas, Don Herrmann (Solutions Manual All Chapters, 100% Original Verified, A+ Grade) All Chapters Solutions Manual Supplement files download link at the end of this file.

Chapter 1 A Framework for Financial Accounting REVIEW QUESTIONS Question 1-1 (LO 1-1)

Accounting is the language of business. Whereas a basic math class might involve adding, subtracting, and solving for unknown variables, accounting involves learning to measure business transactions and communicating those measurements in a format that is generally understood by decision makers.

Question 1-2 (LO 1-1) Those interested in making decisions about a company include investors, creditors, customers, suppliers, managers, employees, competitors, regulators, tax authorities, and local communities.

Question 1-3 (LO 1-1) Financial accounting seeks to measure business activities of a company and to communicate those measurements to external parties for decision-making purposes. The two primary external, or outside the firm, users of financial accounting information are investors and creditors. Managerial accounting deals with the methods accountants use to provide information to an organization’s internal users, that is, its own managers.

Question 1-4 (LO 1-1)

The two primary functions of financial accounting are to measure business activities of a company and to communicate information about those activities to investors and creditors for decision-making purposes.

Question 1-5 (LO 1-2) The three basic business activities are financing, investing, and operating activities. Financing activities are transactions that raise cash needed to operate the business. Investing activities typically include the purchase or disposal of long-term resources such as land, buildings, equipment, and machinery. Operating activities include the primary operations of the company, providing products and services to customers and the associated costs of doing so, like utilities, taxes, advertising, wages, rent, and maintenance.

Question 1-6 (LO 1-2) Typical financing activities would include selling stock and paying dividends to investors, as well as borrowing and repaying debt to creditors.

Question 1-7 (LO 1-2) Typical investing activities would include the purchase or disposal of land, casino buildings, hotels, gaming tables, chairs, cleaning equipment, and food preparation machines.

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Chapter 1 - A Framework for Financial Accounting

Answers to Review Questions (continued) Question 1-8 (LO 1-2) Typical operating activities would include the sale of software and consulting services, as well as costs related to salaries, research, utilities, advertising, rent, and taxes.

Question 1-9 (LO 1-2) The three major legal forms of business organizations include sole proprietorship, partnership, and corporation? A corporation is chosen by most of the largest companies in the United States.

Question 1-10 (LO 1-2) Assets: Resources owned. Liabilities: Amounts owed. Stockholders’ equity: Owners’ claims to resources. Dividends: Distributions to stockholders. Revenues: Sales of products or services to customers. Expenses: Costs of selling products or services.

Question 1-11 (LO 1-2) The major advantage of a corporation is limited liability. Stockholders of a corporation are not held personally responsible for the financial obligations of the corporation. Owners of sole proprietorships or partnerships remain personally liable for activities of the business. Corporations have the disadvantages of double taxation compared to sole proprietorships and partnerships. Sole proprietorship and partnership forms of business is that income is taxed only once. However, there could be other tax advantages for certain types of corporations, such as a lower overall tax rate.

Question 1-12 (LO 1-3)

1. Income statement: Reports the company’s revenues and expenses during an interval of time. If revenues exceed expenses, then the company reports net income. If expenses exceed revenues, then the company reports a net loss. 2. Statement of stockholders’ equity: Summarizes the changes in stockholders’ equity from net income, dividends, and stock issuances during an interval of time. 3. Balance sheet: Presents the financial position of the company on a particular date. It shows that assets equal liabilities plus stockholders’ equity. 4. Statement of cash flows: Cash activities related to operating, investing, and financing activities during an interval of time.

Question 1-13 (LO 1-3)

Balances of accounts reported in the income statement, statement of stockholders’ equity, and statement of cash flows reflect activity from the beginning of the period through the end of the period. Balances of accounts reported in the balance sheet reflect the financial position of the company as of a single date, the end of the period.

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Chapter 1 - A Framework for Financial Accounting

Answers to Review Questions (continued) Question 1-14 (LO 1-3) Basic revenues would include sale of products (such as toys, dolls, and games) and services (such as theme park tickets). Expenses include cost of merchandise sold, employee salaries, utilities, advertising, taxes, interest, and legal fees.

Question 1-15 (LO 1-3)

The accounting equation is: Assets = Liabilities + Stockholders’ Equity. The format of the balance sheet follows the accounting equation.

Question 1-16 (LO 1-3) Assets would include items such as merchandise inventory, office supplies, buildings, land, trucks, and equipment. Liabilities would include items such as amounts owed to employees, suppliers, taxing authorities, and lenders.

Question 1-17 (LO 1-3) Retained earnings represent the cumulative amount of net income earned over the life of the company that has not been distributed to stockholders as dividends. Net income is shown in the income statement and retained earnings are reported in the balance sheet. Thus, retained earnings represent a balance sheet account which reflects the cumulative result of income statements over the life of the company (less any dividends).

Question 1-18 (LO 1-3) The statement of cash flows reports operating, investing, and financing cash flows. Examples of each include: Operating – selling merchandise, paying employee salaries, and paying for advertisement. Investing – purchasing land and buildings to open new factories. Financing – Borrowing from lenders or issuing stock to owners to obtain funds necessary to expand operations.

Question 1-19 (LO 1-3) Two other important sources of information are the (1) management discussion and analysis of the company’s activities and (2) note disclosures to the financial statements.

Question 1-20 (LO 1-4) Successful companies use their resources efficiently to sell products and services for a profit. Unsuccessful companies either offer lower-quality products and services or do not efficiently keep their costs low. When a company is unprofitable, investors will neither invest in nor lend to the firm. Without these sources of financing, eventually the company will fail. When a company is able to make a profit, investors and creditors are willing to transfer their resources to it, and the company will expand its profitable operations even further. Investors and creditors rely heavily on financial accounting information in making investment and lending decisions.

Chapter 1 - A Framework for Financial Accounting

Answers to Review Questions (continued) Question 1-21 (LO 1-5) GAAP refers to Generally Accepted Accounting Principles, or the rules of financial accounting. The fact that all companies use the same rules is critical to financial statement users, because it allows them to accurately compare financial information among companies when they are making decisions about where to lend or invest their resources.

Question 1-22 (LO 1-5)

The Financial Accounting Standards Board (FASB) is primarily responsible for the establishment of GAAP in the United States. The International Accounting Standards Board (IASB) serves this function on an international basis.

Question 1-23 (LO 1-5)

U.S. GAAP refers to the set of accounting standards being developed in the United States by the Financial Accounting Standards Board (FASB). IFRS (International Financial Reporting Standards) refers to the set of accounting standards being developed by the International Accounting Standards Board (IASB). The IASB promotes the use of IFRS around the world. Today, the IASB and FASB work closely in an effort to converge the two sets of accounting standards.

Question 1-24 (LO 1-5) The 1933 Securities Act and the 1934 Securities Exchange Act were designed to restore investor confidence in financial accounting following the stock market crash in 1929 and the ensuing Great Depression. The SEC has the power to require companies with publicly traded securities to prepare periodic financial statements for distribution to investors and creditors.

Question 1-25 (LO 1-5) The role of auditors is to help ensure that management has in fact appropriately applied GAAP in preparing the company’s financial statements. They are hired by a company as an independent party to express a professional opinion of the conformity of that company’s financial statements with GAAP. Auditors play a major role in investors’ and creditors’ decisions by adding credibility to the financial statements.

Question 1-26 (LO 1-5) The three objectives of financial reporting are providing information that: 1. is useful to investors and creditors in making decisions. 2. helps to predict cash flows. 3. tells about economic resources, claims to resources, and changes in resources and claims.

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Chapter 1 - A Framework for Financial Accounting

Answers to Review Questions (continued) Question 1-27 (LO 1-6) The benefits to obtaining a degree in accounting include a wide variety of job opportunities, high demand, and high salaries. Public accounting firms are professional service firms that traditionally have focused on three areas: auditing, tax preparation/planning, and business consulting. Private accounting means providing accounting services to the company that employs you. Traditional careers include auditor, tax preparer, consultant, and basic accounting services. Accountants are now expanding to work as financial analysts, forensic accountants, tax lawyers, FBI agents, and many others.

Question 1-28 (LO 1-7) Relevance and faithful representation are the two fundamental qualitative characteristics. Relevance implies that information is useful to the decision at hand. Faithful representation indicates that information accurately represents the underlying activity.

Question 1-29 (LO 1-7) The three components/aspects of relevance include: 1. Predictive value – Information is useful in helping to forecast future outcomes. 2. Confirmatory value – Information provides feedback on past activities. 3. Materiality – The nature or amount of an item has the ability to affect decisions. The three components/aspects of faithful representation include: 1. Completeness – All information necessary to describe an item is reported. 2. Verifiability – Measurements that independent parties would agree upon. 3. Free from error – Reported amounts reflect the best available information.

Question 1-30 (LO 1-7)

Cost effectiveness refers to practical boundaries (constraints) to achieving desired qualitative characteristics. Cost effectiveness suggests that financial accounting information is provided only when the benefits of doing so exceed the costs.

Question 1-31 (LO 1-7)

The four basic assumptions underlying GAAP include: 1. Economic entity assumption – All economic events can be identified with a particular economic entity. 2. Monetary unit assumption - A common denominator is needed to measure all elements. The dollar in the United States is the most appropriate common denominator to express information about financial statement elements and changes in those elements. 3. Periodicity assumption – The economic life of an enterprise (presumed to be indefinite) can be divided into artificial time periods for financial reporting. 4. Going concern assumption – In the absence of information to the contrary, it is anticipated that a business entity will continue to operate indefinitely.

Chapter 1 - A Framework for Financial Accounting

BRIEF EXERCISES Brief Exercise 1-1 (LO 1-1) 1. True 2. True 3. False

Brief Exercise 1-2 (LO 1-2) 1. b. 2. c. 3. a.

Brief Exercise 1-3 (LO 1-2) 1. c. 2. a. 3. b.

Brief Exercise 1-4 (LO 1-2) 1. e. 2. f. 3. b. 4. c. 5. a. 6. d.

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Chapter 1 - A Framework for Financial Accounting

Brief Exercise 1-5 (LO 1-2) 1. e. 2. d. 3. f. 4. a. 5. b.

Brief Exercise 1-6 (LO 1-2) 1. b. 2. a. 3. e. 4. c. 5. d.

Brief Exercise 1-7 (LO 1-3) 1. b. 2. a. 3. d. 4. c.

Brief Exercise 1-8 (LO 1-3) 1. c. 2. a. 3. d. 4. b.

Chapter 1 - A Framework for Financial Accounting

Brief Exercise 1-9 (LO 1-5) 1. b. 2. d. 3. a. 4. c.

Brief Exercise 1-10 (LO 1-5) 1. Yes. 2. No. 3. Yes. 4. No. 5. Yes. 6. No.

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Chapter 1 - A Framework for Financial Accounting

Brief Exercise 1-11 (LO 1-6) 1.

True

10. True 11. True 12. True

Brief Exercise 1-12 (LO 1-7) 1. b. 2. a. 3. c.

Brief Exercise 1-13 (LO 1-7) 1. c. 2. b. 3. a.

Chapter 1 - A Framework for Financial Accounting

EXERCISES Exercise 1-1 (LO 1-2) 1. a. 2. c. 3. a. 4. b. 5. c. 6. a. 7. b.

Exercise 1-2 (LO 1-2) Transaction 1. Falcon purchases common stock of Wildcat. 2. Falcon borrows from Wildcat by signing a note. 3. Falcon provides services to Wildcat. 4. Falcon pays interest to Wildcat on borrowing.

Financial Statement Balance sheet

Account

Activity

Asset

Investing

Balance sheet

Liability

Financing

Income statement Income statement

Revenue Expense

Operating Operating

Financial Statement Balance sheet

Account

Activity

Equity

Financing

Balance sheet

Asset

Investing

Income statement

Expense

Operating

Income statement

Revenue

Operating

Exercise 1-3 (LO 1-2) Transaction 1. Wildcat issues common stock to Falcon. 2. Wildcat lends to Falcon by accepting a note. 3. Wildcat receives services from Falcon. 4. Wildcat receives interest from Falcon on lending.

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Chapter 1 - A Framework for Financial Accounting

Exercise 1-4 (LO 1-2) Requirement 1 Revenues $14,000

− −

Expenses $9,000

= Net Income = $5,000

Liabilities $27,000 $27,000

Stockholders’ + equity + $X = $23,000

Requirement 2 Assets $50,000 $50,000

= = −

Exercise 1-5 (LO 1-2) Requirement 1 Revenues $28,000

− −

Expenses $33,000

= =

Net Loss ($5,000)

Liabilities $15,000 $15,000

Stockholders’ + equity + $X = $4,000

Requirement 2 Assets $19,000 $19,000

= = −

Chapter 1 - A Framework for Financial Accounting

Exercise 1-6 (LO 1-3) Cowboy Law Firm Income Statement For the period ended December 31 Service revenue Expenses: Salaries Utilities Total expenses Net income

$9,300 2,200 1,200 3,400 $5,900

Exercise 1-7 (LO 1-3) Buffalo Drilling Statement of Stockholders’ Equity For the year ended December 31

Beginning balance, Jan. 1 Issuance of common stock Add: Net income Less: Dividends Ending balance, Dec. 31

Common Stock

Retained Earnings

$11,000 8,000

$ 8,200

$19,000

8,500 (3,200) $13,500

Total Stockholders’ Equity $19,200 8,000 8,500 (3,200) $32,500

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Chapter 1 - A Framework for Financial Accounting

Exercise 1-8 (LO 1-3) Wolfpack Construction Balance Sheet December 31 Assets Cash Land Equipment

Total assets *

Assets $50,000 $50,000

= = −

$ 6,000 18,000 26,000

Liabilities Accounts payable Notes payable Total liabilities

$50,000

Stockholders’ Equity Common stock 11,000 Retained earnings 16,000 * Total stockholders’ equity 27,000 Total liabilities and stockholders’ equity $50,000

Liabilities $23,000 $23,000

+ + −

$ 3,000 20,000 23,000

Stockholders’ equity ($11,000 + Retained earnings) $11,000 = Retained earnings $16,000 = Retained earnings

Chapter 1 - A Framework for Financial Accounting

Exercise 1-9 (LO 1-3) Requirement 1 Beginning balance

$ 5,000

Cash received from sale of products to customers Cash received from the bank for long-term loan Cash paid to purchase factory equipment Cash paid to merchandise suppliers Cash received from the sale of an unused warehouse Cash paid to workers Cash paid for advertisement Cash received for sale of services to customers Cash paid for dividends to stockholders

40,000 45,000 (50,000) (12,000) 13,000 (24,000) (4,000) 30,000 (6,000)

Ending balance

$37,000

Requirement 2

Tiger Trade Statement of Cash Flows Cash Flows from Operating Activities Cash inflows: From sale of products to customers From sale of services to customers Cash outflows: For merchandise suppliers For workers For advertisement Net cash flows from operating activities Cash Flows from Investing Activities Purchase factory equipment Sale of warehouse Net cash flows from investing activities Cash Flows from Financing Activities Borrow from bank Pay dividends Net cash flows from financing activities Net increase in cash Cash at the beginning of the year Cash at the end of the year

$40,000 30,000 (12,000) (24,000) (4,000) $30,000 (50,000) 13,000 (37,000) 45,000 (6,000) 39,000 32,000 5,000 $37,000

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Chapter 1 - A Framework for Financial Accounting

Exercise 1-10 (LO 1-3) Requirement 1

Fighting Okra Cooking Services Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Supplies Rent Legal fees Postage Total expenses Net income

$75,000 $24,000 14,500 10,600 2,400 1,500 53,000 $22,000

Requirement 2

Fighting Okra Cooking Services Statement of Stockholders’ Equity For the year ended December 31, 2021

Beginning balance Issuance of common stock Add: Net income Less: Dividends Ending balance

Common Stock

Retained Earnings

$200,000 25,000

$32,000

$225,000

22,000 (10,000) $44,000

Total Stockholders’ Equity $232,000 25,000 22,000 (10,000) $269,000

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Chapter 1 - A Framework for Financial Accounting

Exercise 1-11 (LO 1-3) Requirement 1

Artichoke Academy Statement of Stockholders’ Equity For the year ended December 31, 2021

Beginning balance Issuance of common stock Add: Net income Less: Dividends Ending balance

Common Stock

Retained Earnings

$150,000 40,000

$50,000

$190,000

30,000 (10,000) $70,000

Total Stockholders’ Equity $200,000 40,000 30,000 (10,000) $260,000

Requirement 2

Artichoke Academy Balance Sheet December 31, 2021 Assets Cash Supplies Prepaid rent Land

Total assets

$52,600 13,400 24,000 200,000

$290,000

Liabilities Accounts payable Utilities payable Salaries payable Notes payable Total liabilities

$ 9,100 2,400 3,500 15,000 30,000

Stockholders’ Equity Common stock 190,000 Retained earnings 70,000 Total stockholders’ equity 260,000 Total liabilities and stockholders’ equity $290,000

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Chapter 1 - A Framework for Financial Accounting

Exercise 1-12 (LO 1-3) Requirement 1

Squirrel Tree Services Balance Sheet December 31, 2021 Assets Cash $ 7,700 Supplies 1,800 Prepaid insurance 3,500 Building 72,000

Total assets

$85,000

Liabilities Accounts payable Salaries payable Notes payable Total liabilities

$ 9,700 3,500 20,000 33,200

Stockholders’ Equity Common stock 40,000 Retained earnings 11,800 Total stockholders’ equity 51,800 Total liabilities and stockholders’ equity $85,000

Chapter 1 - A Framework for Financial Accounting

Requirement 2

Squirrel Tree Services Statement of Cash Flows For the year ended December 31, 2021 Cash Flows from Operating Activities Cash inflows from customers Cash outflows for salaries Cash outflows for supplies Net cash flows from operating activities Cash Flows from Investing Activities Sale investments Purchase building Net cash flows from investing activities Cash Flows from Financing Activities Borrow from bank Pay dividends Net cash flows from financing activities Net decrease in cash Cash at the beginning of the year* Cash at the end of the year

$ 60,000 (22,000) (4,000) $34,000 10,000 (62,000) (52,000) 20,000 (6,500) 13,500 (4,500) 12,200 $ 7,700

* Plug number in order to calculate correct ending balance

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Chapter 1 - A Framework for Financial Accounting

Exercise 1-13 (LO 1-3) 1.

Revenues − $27,000 −

Expenses $18,000

Change in stockholders’ equity $17,000 $17,000

= =

Net Income $9,000

Issue common stock

Net Income

−

Dividends

= −

$11,000 $11,000

+ −

$12,000 − $12,000 =

$X $6,000

Assets

Liabilities

$24,000 $24,000

= =

$X $9,000

Total change = in cash $26,000 = $26,000 −

Stockholders’ equity + $15,000 + $15,000 +

Operating cash flows $34,000 $34,000

+ + −

Investing cash flows ($17,000) ($17,000)

+ + =

Financing cash flows $X $9,000

Exercise 1-14 (LO 1-3) Year

Net Income

Dividends

Retained Earnings*

$1,700

$ 600

$ 1,100

2,200

600

2,700

3,100

1,500

4,300

4,200

1,500

7,000

5,400

1,500

10,900

* Retained earnings = Beginning retained earnings + Net income − Dividends

Chapter 1 - A Framework for Financial Accounting

Exercise 1-15 (LO 1-3) ($ in billions) Change in retained earnings

Change in retained earnings $3.2 $3.2 Change in retained earnings $3.4 $3.4 Change in retained earnings $1.6 $1.6

Net income

− Dividends

Net income

− Dividends

= =

$6.9 $6.9

Net income

= =

$X $6.0

Net income

= =

$1.6 $1.6

− −

$X $3.7

− Dividends − −

$2.6 $2.6

− Dividends − −

$X $0

Change in retained earnings [$X − (−$1.6)] $X = ($2.6)

Net − Dividends income

($1.0)

Change in retained earnings [$1.56 − $X] $X = $1.19

Net − Dividends income

$0.43

−

$0.06

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Chapter 1 - A Framework for Financial Accounting

Exercise 1-16 (LO 1-3) ($ in billions)

Assets

Liabilities

Stockholders ’ equity

Assets

Liabilities

Stockholders’ equity

$228

$107

$228

$107

$121

Assets

Liabilities

Stockholders’ equity

$1,500

$110

$1,610

$1,500

$110

Assets

Liabilities

Stockholders’ equity

$4.7

$0.3

$4.7

$4.4

$0.3

Change in assets

Change in liabilities

$1.2

$0.3

$1.2

$0.3

$0.9

Change in assets

Change in liabilities

Change in + stockholders’ equity

($0.34)

$0.02

($0.32)

($0.34)

$0.02

Change in + stockholders’ equity

Chapter 1 - A Framework for Financial Accounting

Exercise 1-17 (LO 1-3) ($ in billions)

Total change = in cash

Operating cash flows

Total change = in cash $0 =

Operating cash flows $3.6

Total change = in cash ($X − $0.7) = $X = $0.4

Operating cash flows $1.4

Total change = in cash $0.04 =

Operating cash flows $0.07

Total change = in cash $0.02 =

Operating cash flows $0.60

Total change = in cash $0.02 =

Operating cash flows $0.41

+ +

Investing cash flows Investing cash flows $0.6 Investing cash flows ($0.3)

Investing cash flows $0.63 Investing cash flows ($1.00) Investing cash flows ($1.42)

+ +

Financing cash flows Financing cash flows ($4.2) Financing cash flows ($1.4)

Financing cash flows ($0.66) Financing cash flows $0.42 Financing cash flows $1.03

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Chapter 1 - A Framework for Financial Accounting

Exercise 1-18 (LO 1-5) 1. d. 2. e. 3. a. 4. c. 5. f. 6. b. 7. g.

Exercise 1-19 (LO 1-7) 1. g. Comparability 2. f. Free from error 3. b. Predictive value 4. i. Timeliness 5. a. Confirmatory value 6. e. Neutrality 7. d. Completeness 8. h. Verifiability 9. j. Understandability 10. c. Materiality

Exercise 1-20 (LO 1-7) 1. b. 2. c. 3. d. 4. a.

Chapter 1 - A Framework for Financial Accounting

PROBLEMS: SET A Problem 1-1A (LO 1-2) Type of business activity

Transactions

Financing

Pay amount owed to the bank for previous borrowing

Operating

Pay utility costs

Investing

Purchase equipment to be used in operations

Operating

Provide services to customers

Operating

Purchase office supplies

Investing

Purchase a building

Operating

Pay workers’ salaries

Operating

Pay for research and development costs

Operating

Pay taxes to the IRS

10.

Financing

Sell common stock to investors

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Chapter 1 - A Framework for Financial Accounting

Problem 1-2A (LO 1-2) Account classifications Account Names 1.

Stockholders’ equity

Common stock

Asset

Equipment

Liability

Salaries payable

Revenue

Service revenue

Expense

Utilities expense

Asset

Supplies

Expense

Research and development expense

Asset

Land

Liability

Income tax payable

10.

Liability

Interest payable

Chapter 1 - A Framework for Financial Accounting

Problem 1-3A (LO 1-3) Longhorn Corporation Income Statement For the year ended Dec. 31, 2021 Service revenue Expenses: Cost of goods sold Salaries Delivery Total expenses Net income

$67,700 53,400 5,500 2,600 61,500 $ 6,200

Longhorn Corporation Statement of Stockholders’ Equity For the year ended Dec. 31, 2021

Beginning balance Issuance of common stock Add: Net income Less: Dividends Ending balance

Common Stock

Retained Earnings

$40,000 4,000

$18,200

$44,000

6,200 (0) $24,400

Total Stockholders’ Equity $58,200 4,000 6,200 (0) $68,400

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Chapter 1 - A Framework for Financial Accounting

Problem 1-3A (concluded)

Longhorn Corporation Balance Sheet Dec. 31, 2021 Assets Cash Supplies Equipment Buildings

$ 1,200 3,400 29,000 40,000

Total assets

$73,600

Liabilities Accounts payable Salaries payable Total liabilities

$ 4,400 800 5,200

Stockholders’ Equity Common stock 44,000 Retained earnings 24,400 Total stockholders’ equity 68,400 Total liabilities and stockholders’ equity $73,600

Chapter 1 - A Framework for Financial Accounting

Problem 1-4A (LO 1-3) (Suggested order of calculation) On the statement of stockholders’ equity, $7,000 + (c) − $3,000 = $10,000 (c) = $6,000 From (c), (b) = $6,000 From (b), $39,000 − (a) − $6,000 − $4,000 = $6,000 (b) (a) = $23,000 From the statement of stockholders’ equity, (e) = $11,100 (f) = $10,000 From total assets, (g) = $26,000 From (e), (f), and (g), (d) + $11,100 (e) + $10,000 (f) = $26,000 (g) (d) = $4,900

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Chapter 1 - A Framework for Financial Accounting

Problem 1-5A (LO 1-3) Cornhusker Company Income Statement For the year ended December 31, 2021 Service revenues Expenses: Rent Utilities Salaries Insurance Total expenses Net income

$37,000 7,000 4,900 13,300 3,500 28,700 $ 8,300

Cornhusker Company Statement of Stockholders’ Equity For the year ended December 31, 2021

Beginning balance (Jan. 1) Issuance of common stock Add: Net income Less: Dividends Ending balance (Dec. 31)

Common Stock

Retained Earnings

$16,000 0

$7,300

$16,000

8,300 (3,200) $12,400

Total Stockholders’ Equity $23,300 0 8,300 (3,200) $28,400

Chapter 1 - A Framework for Financial Accounting

Problem 1-5A (concluded)

Cornhusker Company Balance Sheet December 31, 2021 Assets Cash $ 4,800 Accounts receivable 7,200 Land 21,000

Total assets

$33,000

Liabilities Accounts payable Salaries payable Total liabilities

$ 2,200 2,400 4,600

Stockholders’ Equity Common stock 16,000 Retained earnings 12,400 Total stockholders’ equity 28,400 Total liabilities and stockholders’ equity $33,000

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Chapter 1 - A Framework for Financial Accounting

Problem 1-6A (LO 1-7) Assumption violated 1.

Going concern

Economic entity

Monetary unit

Periodicity

Problem 1-7A (LO 1-7) 1. d. 2. b. 3. i. 4. c. 5. a. 6. g. 7. h. 8. f. 9. e.

Chapter 1 - A Framework for Financial Accounting

PROBLEMS: SET B Problem 1-1B (LO 1-2) Type of business activity

Transactions

Operating

Pay for advertising

Financing

Pay dividends to stockholders

Operating

Collect cash from customer for previous sale

Investing

Purchase a building to be used for operations

Investing

Purchase equipment

Investing

Sell land

Financing

Receive a loan from the bank by signing a note

Operating

Pay suppliers for purchase of supplies

Operating

Provide services to customers

10.

Investing

Invest in securities of another company

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Chapter 1 - A Framework for Financial Accounting

Problem 1-2B (LO 1-2) Account classifications Account Names 1.

Asset

Cash

Revenue

Service Revenue

Asset

Supplies

Asset

Buildings

Expense

Advertising Expense

Asset

Equipment

Expense

Interest Expense

Liability

Accounts Payable

Dividends

10.

Liability

Notes Payable

Chapter 1 - A Framework for Financial Accounting

Problem 1-3B (LO 1-3) Gator Investments Income Statement For the year ended Dec. 31, 2021 Service revenue Expenses: Advertising Salaries Utilities Interest Total expenses Net income

$127,600 33,500 65,100 15,500 3,500 117,600 $ 10,000

Gator Investments Statement of Stockholders’ Equity For the year ended Dec. 31, 2021

Beginning balance Issuance of common stock Add: Net income Less: Dividends Ending balance

Common Stock

Retained Earnings

$100,000 11,000

$30,300

$111,000

10,000 (5,200) $35,100

Total Stockholders’ Equity $130,300 11,000 10,000 (5,200) $146,100

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Chapter 1 - A Framework for Financial Accounting

Problem 1-3B (concluded)

Gator Investments Balance Sheet Dec. 31, 2021 Assets Cash Equipment Buildings

Total assets

$ 5,500 27,000 150,000

Liabilities Accounts payable Notes payable Total liabilities

$182,500

Stockholders’ Equity Common stock 111,000 Retained earnings 35,100 Total stockholders’ equity 146,100 Total liabilities and stockholders’ equity $182,500

$ 6,400 30,000 36,400

Chapter 1 - A Framework for Financial Accounting

Problem 1-4B (LO 1-3) (Suggested order of calculation) On the statement of stockholders’ equity, $14,000 + (c) = $17,000 (c) = $3,000 $7,000 + $5,000 − (d) = $8,000 (d) = $4,000 (b) = $5,000 From (b), (a) − $13,000 − $7,000 − $5,000 = $5,000 (b) (a) = $30,000 From the statement of stockholders’ equity, (g) = $17,000 (h) = $8,000 From (g) and (h), $4,000 + $17,000 (g) + $8,000 (h) = (i) (i) = $29,000 From total liabilities and stockholders’ equity, (f) = $29,000 From (f), $1,100 + (e) + $6,000 + $16,000 = $29,000 (f) (e) = $5,900

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Chapter 1 - A Framework for Financial Accounting

Problem 1-5B (LO 1-3) Tar Heel Corporation Income Statement For the year ended December 31, 2021 Service revenues Expenses: Advertising Utilities Salaries Interest Total expenses Net income

$69,400 10,400 6,000 26,700 2,100 45,200 $24,200

Tar Heel Corporation Statement of Stockholders’ Equity For the year ended December 31, 2021 Common Stock

Retained Earnings

Beginning balance Issuance of common stock Add: Net income Less: Dividends Ending balance

$21,000 6,000

$26,800

* Beginning retained earnings + Net income − Dividends = Ending retained earnings

$26,800 24,200 ? $40,000

$27,000

24,200 (11,000) * $40,000

Total Stockholders’ Equity $47,800 6,000 24,200 (11,000) $67,000

Chapter 1 - A Framework for Financial Accounting

Problem 1-5B (concluded)

Tar Heel Corporation Balance Sheet December 31, 2021 Assets Cash $ 5,200 Accounts receivable 13,200 Supplies 4,600 Building 80,000

Total assets

$103,000

Liabilities Accounts payable Salaries payable Note payable Total liabilities

$ 7,700 3,300 25,000 36,000

Stockholders’ Equity Common stock 27,000 Retained earnings 40,000 Total stockholders’ equity 67,000 Total liabilities and stockholders’ equity $103,000

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Chapter 1 - A Framework for Financial Accounting

Problem 1-6B (LO 1-7) Assumption violated 1.

Periodicity

Monetary unit

Going concern

Economic entity

Problem 1-7B (LO 1-7) 1. h. 2. g. 3. f. 4. a. 5. d. 6. e. 7. i. 8. b. 9. c.

Chapter 1 - A Framework for Financial Accounting

ADDITIONAL PERSPECTIVES Additional Perspective 1-1 Requirement 1

The three primary forms of business organizations include sole proprietorship, partnership, and corporation. The major advantage of a corporation is limited liability. Stockholders of a corporation are not held personally responsible for the financial obligations of the corporation. Owners of sole proprietorships or partnerships remain personally liable for activities of the business. Corporations have the disadvantages of double taxation compared to sole proprietorships and partnerships. Because of the higher risk of personal injury due to outdoor adventure activities, it is recommended that Great Adventures be organized as a corporation.

Requirement 2

Typical financing activities include issuing common stock, borrowing, and repayment of borrowing. Typical investing activities include the purchase of long-term assets such as land, buildings, equipment, vehicles, and machinery. Typical operating activities include providing services and products to customers and the associated costs of running the business such as advertising, rent, insurance, wages, and taxes.

Requirement 3

Assets – cash, accounts receivable, supplies, and equipment. Liabilities – accounts payable, salaries payable, and notes payable. Stockholders’ equity – common stock and retained earnings. Revenues – service revenue. Expenses – advertising, salaries, insurance, and supplies.

Requirement 4

Income statement – revenues less expenses equal net income during an interval of time. Statement of stockholders’ equity – changes in common stock and retained earnings during an interval of time. Balance sheet – assets equal liabilities plus stockholders’ equity at a point in time. Statement of cash flows – cash inflows and outflows related to operating, investing, and financing activities during an interval of time.

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Chapter 1 - A Framework for Financial Accounting

Additional Perspective 1-2

AMERICAN EAGLE OUTFITTERS ($ in thousands) Requirement 1 Total assets Total liabilities Stockholders’ equity Assets $1,816,313

= $1,816,313 = $569,522 = $1,246,791 = =

Liabilities $569,522

+ +

Stockholders’ Equity $1,246,791

Requirement 2 Consolidated Statements of Operations Requirement 3 Net sales Net income Requirement 4 Investing activities Financing activities

= $3,795,549 = $204,163 Inflows There are none Net proceeds from stock options exercised

Outflows Capital expenditures for property and equipment Cash dividends paid

Requirement 5 The company’s auditor is Ernst & Young LLP. The auditor states, “We have audited the accompanying consolidated balance sheets of American Eagle Outfitters, Inc. (the Company) as of February 3, 2018 and January 28, 2017, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the three years in the period ended February 3, 2018, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at February 3, 2018 and January 28, 2017, and the results of its operations and its cash flows for each of the three years in the period ended February 3, 2018, in conformity with U.S. generally accepted accounting principles.”

Chapter 1 - A Framework for Financial Accounting

Additional Perspective 1-3 BUCKLE ($ in thousands)

Requirement 1 Total assets Total liabilities Stockholders’ equity Assets $538,116

= $538,116 = $146,868 = $391,248 = =

Liabilities $146,868

+ +

Stockholders’ Equity $391,248

Requirement 2 Consolidated Statements of Income Requirement 3 Net sales Net income Requirement 4 Investing activities Financing activities

= $913,380 = $89,707 Inflows Proceeds from sales/maturities of investments There are none

Outflows Purchases of investments Payment of dividends

Requirement 5 The company’s auditor is Deloitte & Touche LLP. The auditor states, “We have audited the accompanying consolidated balance sheets of The Buckle, Inc. and subsidiary (the “Company”) as of February 3, 2018 and January 28, 2017, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the three fiscal years in the period ended February 3, 2018, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of February 3, 2018 and January 28, 2017, and the results of its operations and its cash flows for each of the three fiscal years in the period ended February 3, 2018, in conformity with accounting principles generally accepted in the United States of America.” ©2019 McGraw-Hill Education. All rights reserved .Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 1-42 Financial Accounting, 5e

Chapter 1 - A Framework for Financial Accounting

Additional Perspective 1-4 Requirement 1 The total assets of American Eagle are higher than the total assets of Buckle. Requirement 2 The total liabilities of American Eagle are higher than the total liabilities of Buckle. A higher amount of liabilities does not necessarily mean a higher chance of bankruptcy. The probability of bankruptcy relates to the ability of a company to repay its liabilities as they become due. If sufficient resources are available, then high levels of debt can be paid. Requirement 3 Ability to repay debt. The ratio of total liabilities to total assets can be used as one measure of a company’s ability to repay its liabilities. The higher the ratio, the more difficult it will be for a company to pay its liabilities. Requirement 4 The net income of American Eagle is higher than the net income of Buckle. When one company has a higher net income than another company does, this does not always mean the company’s operations are more successful. One company may be larger than another company so it has higher net income in absolute dollar amounts because operations are larger, but it may be making less profit per dollar of invested assets. Requirement 5 Ability to generate profits. Net income provides a measure of a company’s ability to generate profit for its owners. In the case of American Eagle and Buckle, the owners are the stockholders of the company. An increase in net income is a desirable characteristic of a company that, along with other factors, increases the value (or stock price) of the company to its owners.

Chapter 1 - A Framework for Financial Accounting

Additional Perspective 1-5 1. Yes. The role of an auditor is to express an independent, professional opinion of the extent to which financial statements are prepared in compliance with Generally Accepted Accounting Principles. An auditor’s ethics might be challenged because of the need to retain the client as a source of revenue. In this case, the auditor might fear losing the audit fee if it upsets its largest client by requiring a correction to the financial statements because of questionable accounting practices. The company may fire the auditor and retain the services of someone else. This problem is further worsened by the company offering an additional $200,000 in audit fees this year and the promise of continued services for the next five years. Management may be using these monetary incentives as a way to entice the auditor to allow certain reporting practices. If the auditor upsets the client, the auditor faces the possibility of losing revenue each year from audit services. 2. No. Auditors are not employees of the company. They are hired by a company as an independent party. To the extent they feel management’s reporting practices violate Generally Accepted Accounting Principles, they can issue an opinion stating so. 3. Yes. Although ultimate responsibility for fair presentation of financial statements lies with management, the auditor’s opinion lends additional credibility to those financial statements. These statements are useful to investors, creditors and others for making decisions. In addition, if the auditor detects that financial statements are misstated and does not disclose this opinion, then the auditor likely faces monetary penalties and other sanctions that could limit its ability to perform any audits in the future.

4. No. Even though the auditor faces this ethical dilemma, they serve an important role in the reporting of financial information to help investors and creditors make decisions. Auditors follow a strict set of guidelines in providing auditing services. In addition, they typically face severe legal and monetary penalties in the case of negligence or willful allowance of materially misstated financial statements by management. The auditor should issue an opinion stating its belief that financial statements are materially misstated. ©2019 McGraw-Hill Education. All rights reserved .Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 1-44 Financial Accounting, 5e

Chapter 1 - A Framework for Financial Accounting

Additional Perspective 1-6 Requirement 1 The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The SEC was created to restore investor confidence in our capital markets by providing investors and the markets with more reliable information and clear rules of honest dealing. The Securities Act of 1933 has two basic objectives: •

require that investors receive financial and other significant information concerning securities being offered for public sale; and

•

prohibit deceit, misrepresentations, and other fraud in the sale of securities.

The Securities Exchange Act of 1934 created the Securities and Exchange Commission. The Act empowers the SEC to require periodic reporting of information by companies with publicly traded securities.

Chapter 1 - A Framework for Financial Accounting

Additional Perspective 1-6 (continued) Requirement 2 The four main financial statements discussed by the SEC are: (1) balance sheets; (2) income statements; (3) cash flow statements; and (4) statements of shareholders’ equity. A balance sheet provides detailed information about a company’s assets, liabilities and shareholders’ equity. An income statement is a report that shows how much revenue a company earned over a specific time period (usually for a year or some portion of a year). An income statement also shows the costs and expenses associated with earning that revenue. The literal “bottom line” of the statement usually shows the company’s net earnings or losses. This tells you how much the company earned or lost over the period. Cash flow statements report a company’s inflows and outflows of cash from three types of activities: (1) operating activities; (2) investing activities; and (3) financing activities. The statement of shareholders’ equity shows changes in the interests of the company’s shareholders over time. The disclosure notes provide additional information beyond that reported in the financial statements. This information includes items such as significant accounting policies and practices, income taxes, pension and other retirement plans, stock options, and much more. MD&A is management’s opportunity to provide investors with its view of the financial performance and condition of the company. It’s management’s opportunity to tell investors what the financial statements show and do not show, as well as important trends and risks that have shaped the past or are reasonably likely to shape the company’s future.

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Chapter 1 - A Framework for Financial Accounting

Additional Perspective 1-6 (concluded) Requirement 3 The mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information. The Securities and Exchange Commission (SEC) has statutory authority to establish financial accounting and reporting standards for publicly held companies under the Securities Exchange Act of 1934. Throughout its history, however, the Commission’s policy has been to rely on the private sector (like the FASB) for this function to the extent that the private sector demonstrates ability to fulfill the responsibility in the public interest. Requirement 4 (a) Yes; Nike properly prepared the four financial statements. (b) NIKE designs, develops, markets, and sells athletic footwear, apparel, equipment, accessories, and services worldwide. (c) In the segment disclosure note, the company reports amounts for items such as revenue, depreciation, net income, accounts receivable, inventories and capital expenditures for each segment.

Chapter 1 - A Framework for Financial Accounting

Additional Perspective 1-7 The functions of financial accounting are to measure business activities of a company and to communicate information about those activities to investors and creditors and other outside users for decision-making purposes. The four financial statements include: 1. Income statement, which shows revenues and expenses during the reporting period. 2. Statement of stockholders’ equity, which shows the change in stockholders’ equity during the reporting period. 3. Balance sheet, which shows a company’s resources (assets), creditors’ claims to those assets (liabilities), and the remaining claims of stockholders’ to those assets (stockholders’ equity) at the end of the period. 4. Statement of cash flows, which shows a company’s inflows and outflows of cash arising from operating, investing, and financing activities during the reporting period. The role of auditors is to help ensure that management has in fact appropriately applied Generally Accepted Accounting Principles in preparing the company’s financial statements. Auditors are trained individuals hired by a company as an independent party to express a professional opinion of that company’s financial statements.

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Chapter 2 - The Accounting Cycle: During the Period

Chapter 2 The Accounting Cycle: During the Period REVIEW QUESTIONS Question 2-1 (LO 2-1)

External transactions are transactions between the company and a separate economic entity. Internal transactions do not include an exchange with a separate economic entity. Purchasing supplies from a local vendor is classified as an external transaction.

Question 2-2 (LO 2-1) 1. Use source documents to identify accounts affected by external transactions. 2. Analyze the impact of the transaction on the accounting equation. 3. Assess whether the transaction results in a debit or a credit to the account balance. 4. Record the transaction in the journal using debits and credits. 5. Post the transaction to the T-accounts in the general ledger. 6. Prepare a trial balance.

Question 2-3 (LO 2-2) Dual effect refers to each transaction having an effect on at least two accounts of the accounting equation such that the accounting equation will always be in balance. If an economic event increases (decreases) one side of the equation, then it also increases (decreases) the other side of the equation by the same amount, or, it increases one account and decreases another account on the same side of the equation.

Question 2-4 (LO 2-2) Assets

Liabilities

Stockholders’ equity

(a)

Increase

No change

(b)

Decrease

No change

Decrease

(c)

Increase

No change

Increase

(d) No change* =

No change

* One asset (equipment) increases while another asset (cash) decreases.

Question 2-5 (LO 2-2) Jerry is not correct. While it is possible for a transaction to increase one account and decrease another, dual effect simply indicates that at least two accounts will always be affected. However, the accounting equation must always remain in balance. It is not possible for one side of the equation to increase while the other side decreases. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. Solutions Manual, Chapter 2 2-1

Chapter 2 - The Accounting Cycle: During the Period

Answers to Review Questions (continued) Question 2-6 (LO 2-3) Accounts

Normal balance

Assets

Debit

Liabilities

Credit

Stockholders’ equity

Credit

Revenues

Credit

Expenses

Debit

Question 2-7 (LO 2-3) Jenny is not correct. Any account can be debited or credited. Since an asset has a normal debit balance, it would be debited when it increases and credited when it decreases. Similarly, since a liability has a normal credit balance, it would be credited when it increases and debited when it decreases.

Question 2-8 (LO 2-3) Accounts

Increase

(a) Cash

Debit

(b) Salaries payable

Credit

Debit

(d) Service revenue

Credit

Question 2-9 (LO 2-3) Accounts

Decrease*

(a) Cash

Credit

(b) Salaries payable

Debit

Credit

(d) Service revenue

Debit

* Answers are opposite of those in Question 2-8

Chapter 2 - The Accounting Cycle: During the Period

Answers to Review Questions (continued) Question 2-10 (LO 2-3)

These statements are consistent. Retained earnings has three components – revenues, expenses, and dividends. Changing the balance of any of these components changes the balance of retained earnings. Retained earnings increases with a credit and decreases with a debit. Since expenses reduce retained earnings, an increase to an expense decreases retained earnings.

Question 2-11 (LO 2-4) A journal provides a chronological record of all transactions affecting a firm. A journal entry is used to describe the format for recording a transaction.

Question 2-12 (LO 2-4) Date

Debit

Credit

Account Name . . . . . . . . . . . . . . . . . . . . . . Amount Account Name . . . . . . . . . . . . . . . (Description of transaction)

Amount

Question 2-13 (LO 2-4) In each journal entry, the sum of all amounts debited equals the sum of all amounts credited.

Question 2-14 (LO 2-4) (a)

Debit

Cash

Credit

1,200 Service Revenue (Receive cash from providing services)

1,200

(b)

Debit

Credit

Rent Expense Cash (Pay rent for the current month)

500

(c)

Debit

Credit

Building 10,000 Notes Payable (Purchase building with note payable)

10,000

500

Chapter 2 - The Accounting Cycle: During the Period

Answers to Review Questions (continued) Question 2-15 (LO 2-4) (a) Purchase supplies by paying cash of $20,000. (b) Provide services to customer on account for $30,000. (c) Pay cash on accounts payable of $10,000.

Question 2-16 (LO 2-5) A T-account is an informal means to show the balance in an account. The left side is referred to as a debit and the right side is referred to as a credit.

Question 2-17 (LO 2-5)

Posting is the process of transferring the debit and credit information from the journal to individual accounts in the general ledger. (a)

Supplies 20,000

(b)

Accounts Receivable 30,000

Cash 20,000

Service Revenue 30,000 Cash 10,000

Question 2-18 (LO 2-6)

The general ledger is the collection of all accounts used to record the company’s transactions. A chart of accounts is a listing of all account names.

Question 2-19 (LO 2-6) A trial balance is a list of all accounts and their balances at a particular date. Balance refers to the fact that the sum of the accounts with debit balances should equal the sum of the accounts with credit balances.

Question 2-20 (LO 2-6)

Not necessarily. While total debits equaling total credits is a good indication that all accounts have been appropriately accounted for, the accounts could contain offsetting errors. For example, if one account with a debit (credit) balance is understated by the same amount that another account with a debit (credit) balance is overstated, the trial balance will show equal debit and credit totals.

Chapter 2 - The Accounting Cycle: During the Period

BRIEF EXERCISES Brief Exercise 2-1 (LO 2-1) Proper order: (c) Use source documents to identify accounts affected by external transactions. (d) Analyze the impact of the transaction on the accounting equation. (b) Assess whether the impact of the transaction results in a debit or credit to the account balance. (f) Record transactions using debits and credits. (a) Post the transaction to the T-accounts in the general ledger. (e) Prepare a trial balance.

Brief Exercise 2-2 (LO 2-2) Liabilities

Possible + Stockholders’ Equity (Yes/No)

Assets

(a)

Increase (Cash ↑)

= Decrease + (Accounts Payable ↓)

(b)

No change

(c)

Decrease (Cash ↓)

No change

Increase + Increase (Salaries Payable ↑) (Service Revenues ↑) No Change

+ Decrease (Advertising Expense ↑)

Yes

Brief Exercise 2-3 (LO 2-2) Cash Supplies Prepaid Rent Land Equipment

Total Assets $ 7,200 2,100 3,200 9,000 16,000 $37,500

Total Liabilities and Stockholders’ Equity Accounts Payable $ 1,700 Salaries Payable 4,300 Notes Payable 18,000 Stockholders’ Equity 13,500 $37,500

Chapter 2 - The Accounting Cycle: During the Period

Brief Exercise 2-4 (LO 2-2) Assets

Liabilities

+ Stockholders’ Equity

(a)

+$50,000

(b)

+$42,000 −$42,000

(c)

+$35,000

(d)

−$5,000

Brief Exercise 2-5 (LO 2-3) Account

Debit

Credit

Asset

−

Liability

−

Common Stock

−

Retained Earnings

−

Dividends

−

Revenue

−

Expense

−

Chapter 2 - The Accounting Cycle: During the Period

Brief Exercise 2-6 (LO 2-3) (a) The balance of an asset account increases with a debit and decreases with a credit. (b) The balance of a liability account increases with a credit and decreases with a debit. (c) The balance of a stockholders’ equity account increases with a credit and decreases with a debit. (d) The balance of a revenue account increases with a credit and decreases with a debit. (e) The balance of an expense account increases with a debit and decreases with a credit.

Brief Exercise 2-7 (LO 2-4) (1)

Debit

Credit

Equipment 15,000 Notes Payable 15,000 (Purchase equipment with note payable) (2) Supplies Cash (Purchase office supplies for cash)

600 600

(3) Rent Expense Cash (Pay rent for the current month)

800 800

Chapter 2 - The Accounting Cycle: During the Period

Brief Exercise 2-8 (LO 2-4) (1)

Debit

Cash

17,000 Service Revenue (Provide services for cash)

Credit 17,000

(2) Prepaid Insurance 4,200 Cash (Purchase one year of prepaid insurance with cash)

4,200

(3) Equipment Cash (Purchase equipment with cash)

20,000 20,000

(4) Cash

30,000 Notes Payable (Obtain bank loan)

30,000

Brief Exercise 2-9 (LO 2-5) 1.

Cash 13,000 8,200 4,400 1,900 3,500 5,500 5,300

2. Postings on the left side (or debit side) of the cash T-account represent increases to cash, such as receiving cash from customers, selling assets, borrowing money, and issuing stock. 3. Postings on the right side (or credit side) of the cash T-account represent decreases to cash, such as paying cash for rent, supplies, equipment, employee salaries, utilities, repayment of debt, and dividends. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 2-8 Financial Accounting, 5e

Chapter 2 - The Accounting Cycle: During the Period

Brief Exercise 2-10 (LO 2-2, 2-3, 2-4, 2-5) Assets

Liabilities

Stockholders’ Equity

(a)

+$30,000

(b)

+$20,000

(c)

−$7,000

(a)

Debit

Credit

Cash

30,000 Service Revenue (Provide services for cash)

30,000

(b) Supplies 20,000 Accounts Payable 20,000 (Purchase office supplies on account) (c) Salaries Expense 7,000 Cash (Pay salaries for the current month) Cash 0 (a) 30,000 7,000 (c) 23,000

Supplies 0 (b) 20,000 20,000

7,000

Service Revenue 0 30,000 (a) 30,000 Accounts Payable 0 20,000 (b) 20,000

Salaries Expense 0 (c) 7,000 7,000

Chapter 2 - The Accounting Cycle: During the Period

Brief Exercise 2-11 (LO 2-6) Trial Balance Accounts Cash Accounts Receivable Prepaid Rent Accounts Payable Salaries Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Rent Expense Advertising Expense Totals

Debit $ 6,100 4,400 900

Credit

$ 2,000 700 6,200 2,000 500 7,100 3,000 2,000 1,100 $18,000

$18,000

Brief Exercise 2-12 (LO 2-6) Trial Balance Accounts Cash Accounts Receivable Equipment Accounts Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Utilities Expense Totals

Debit $ 7,300 2,100 10,400

Credit

$ 3,900 1,100 11,000 3,900 600 4,500 3,200 800 $24,400

$24,400

Chapter 2 - The Accounting Cycle: During the Period

EXERCISES Exercise 2-1 (LO 2-1) 1. d. 2. b. 3. a. 4. e. 5. c.

Exercise 2-2 (LO 2-2) Assets

Liabilities

Stockholders’ Equity

Increase

No effect

Increase

No effect

Increase

No effect

Increase

Decrease

No effect

Decrease

No effect

Decrease

No effect* =

No effect

* One asset (cash) increases while another asset (accounts receivable) decreases.

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-3 (LO 2-2) Dual Effect 1. Issue 10,000 shares of common stock in exchange for $32,000 in cash.

Assets increase

Stockholders’ equity increases

2. Purchase land for $19,000. A note payable is signed for the full amount.

Assets increase

Liabilities increase

3. Purchase storage containers for $8,000.

One asset (containers) increases and another asset (cash) decreases

4. Hire three employees for $2,000 per month.

No effect on the accounting equation

5. Receive cash of $12,000 in rental fees for the current month.

Assets increase

Stockholders’ equity increases

6. Purchase office supplies for $2,000 on account.

Assets increase

Liabilities increase

7. Pay employees $6,000 for the first month’s salaries.

Assets decrease

Stockholders’ equity decreases

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-4 (LO 2-2) Dual Effect 1. Paint houses in the current month for $15,000 on account. 2. Purchase painting equipment for $16,000 cash.

Assets increase

Stockholders’ equity increases

One asset (equipment) increases and another asset (cash) decreases

3. Purchase office supplies on account for $2,500.

Assets increase

Liabilities increase

4. Pay employee salaries of $3,200 for the current month.

Assets decrease

Stockholders’ equity decreases

5. Purchase advertising to appear in the current month, $1,200.

Assets decrease

Stockholders’ equity decreases

6. Pay office rent of $4,400 for the current month.

Assets decrease

Stockholders’ equity decreases

7. Receive $10,000 from customers in (1) above.

One asset (cash) increases and another asset (accounts receivable) decreases

8. Receive cash of $5,000 in advance from a customer that plans to have his house painted in the following month.

Assets increase

Liabilities increase

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-5 (LO 2-2) Transaction

Balance

Retained earnings, April 1

$13,000

1. Issue common stock for cash, $11,000

2. Provide services to customers on account, $8,500.

+8,500

3. Provide services to customers in exchange for cash, $3,200.

+3,200

4. Purchase equipment and pay cash, $7,600.

5. Pay rent for April, $1,100.

−1,100

6. Pay employee salaries for April, $3,500.

−3,500

7. Pay dividends to stockholders, $2,000.

−2,000

Retained earnings, April 30

$18,100

Exercise 2-6 (LO 2-3) Debit or Credit

Account

Debit

Cash

Credit

Service Revenue

Debit

Salaries Expense

Credit

Accounts Payable

Debit

Equipment

Credit

Retained Earnings

Debit

Utilities Expense

Debit

Accounts Receivable

Debit

Dividends

10.

Credit

Common Stock

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-7 (LO 2-3) Account Debited

Account Credited

Example: Purchase equipment in exchange for cash.

Equipment

Cash

1. Pay a cash dividend.

Dividends

Cash

2. Pay rent in advance for the next three months.

Prepaid Rent

Cash

3. Provide services to customers on account.

Accounts Receivable

Service Revenue

4. Purchase office supplies on account.

Supplies

Accounts Payable

5. Pay salaries for the current month.

Salaries Expense

Cash

6. Issue common stock in exchange for cash.

Cash

Common Stock

7. Collect cash from customers for services provided in (3) above.

Cash

Accounts Receivable

8. Borrow cash from the bank and sign a note.

Cash

Notes Payable

9. Pay for the current month’s utilities.

Utilities Expense

Cash

10. Pay for office supplies purchased in (4) above.

Accounts Payable

Cash

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-8 (LO 2-4) (1)

Debit

Equipment Cash (Purchase equipment with cash)

23,400

Credit 23,400

(2) Cash

6,800 Service Revenue (Provide services for cash)

6,800

(3) Rent Expense Cash (Pay current month’s rent)

1,300 1,300

(4) Supplies 1,000 Accounts Payable (Purchase office supplies on account)

1,000

(5) Salaries Expense Cash (Pay current month’s salaries)

2,100 2,100

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-9 (LO 2-4) 1. Purchase equipment with cash, $8,800. 2. Provide services to customers on account, $3,200. 3. Pay current month’s salaries, $1,900. 4. Receive cash from customers in advance of services, $1,500. 5. Pay dividends to stockholders, $900.

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-10 (LO 2-4) February 2

Debit

Advertising Expense Cash (Pay advertising for current month)

700

Credit 700

February 7 Supplies 1,300 Accounts Payable (Purchase beauty supplies on account)

1,300

February 14 Cash

2,900 Service Revenue (Provide beauty services for cash)

2,900

February 15 Salaries Expense Cash (Pay salaries for current month)

900 900

February 25 Accounts Receivable 1,000 Service Revenue (Provide beauty services on account)

1,000

February 28 Utilities Expense Cash (Pay utilities for current month)

300 300

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-11 (LO 2-4) March 1

Debit

Cash

21,000 Common Stock (Issue common stock)

Credit 21,000

March 5 Cash

9,000 Notes Payable (Obtain bank loan)

9,000

March 10 Equipment 25,000 Cash (Purchase construction equipment for cash)

25,000

March 15 Advertising Expense 1,100 Cash (Purchase advertising for current month)

1,100

March 22 Accounts Receivable 18,000 Service Revenue (Provide construction services on account)

18,000

March 27 Cash

13,000 Accounts Receivable (Receive cash on account)

13,000

March 28 Salaries Expense Cash (Pay salaries for current month)

6,000 6,000

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-12 (LO 2-4) Corrections 1.

2. 3.

4. 5.

External Transaction Owners invest $15,000 in the company and receive common stock.

Accounts Cash Common Stock

Debit 15,000

Receive cash of $4,000 for services provided in the current period.

Cash Service Revenue

4,000

Purchase office supplies on account, $300.

Supplies Accounts Payable

300

Pay $600 for next month’s rent.

Prepaid Rent Cash

600

Equipment Cash

2,200

Purchase office equipment with cash of $2,200.

Credit 15,000

4,000

300 600 2,200

Note: Accounts in blue are corrected items. Accounts in black need no correction.

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-13 (LO 2-4) Corrections 1.

2. 3.

External Transaction Pay cash dividends of $800 to stockholders.

Accounts Dividends Cash

Debit 800

Provide services on account for customers, $3,400

Accounts Receivable Service Revenue

3,400

Pay a $500 utilities bill for the current period.

Utilities Expense Cash

Receive cash of $400 from previously billed customers.

Cash 400 Accounts Receivable

Pay for supplies previously purchased on account, $1,200.

Accounts Payable Cash

Credit 800

3,400 500 500 400

1,200 1,200

Note: Accounts in blue are corrected items. Accounts in black need no correction.

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-14 (LO 2-5)

(1) (4) (6)

Cash 5,000 15,000 9,000 8,000 3,000 4,000 1,000 7,000 12,000

(2) (3) (5) (7)

Transaction (8) is not posted to the Cash T-account because a purchase on account does not involve cash.

Exercise 2-15 (LO 2-5)

(3) (6)

(2)

Cash 3,400 10,200 1,000 (4) 1,100 3,700 (5) 10,000

Accounts Receivable 4,200 (1) 8,400 10,200 (3)

Supplies 400 2,300 2,700

Accounts Payable 3,500 (5) 3,700 2,300 (2) 2,100

2,400

Deferred Revenue 300 1,100 (6) 1,400

(4)

Service Revenue 0 8,400 8,400

(1)

Advertising Expense 0 1,000 1,000

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-16 (LO 2-5) 1. Provide services to customers for cash, $20,000. 2. Provide services to customers on account, $5,000. 3. Receive cash from customers on account, $4,000. 4. Purchase supplies on account, $6,000. 5. Pay employees for current salaries, $14,000. 6. Pay cash on account, $7,000.

Exercise 2-17 (LO 2-6) Sooner Company Trial Balance April 30 Accounts Debit Cash $ 3,900 Accounts Receivable 6,100 Prepaid Rent 7,400 Land 60,000 Accounts Payable Deferred Revenue Common Stock Retained Earnings Service Revenue Supplies Expense 9,400 Salaries Expense 8,200 Totals $95,000

Credit

$ 4,300 2,300 40,000 23,000 25,400 $95,000

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-18 (LO 2-6) Cobras Incorporated Trial Balance March 31 Accounts Debit Cash $ 3,500 Accounts Receivable 4,200 Supplies 1,000 Prepaid Insurance 1,200 Buildings 55,000 Accounts Payable Salaries Payable Common Stock Retained Earnings Service Revenue Salaries Expense 6,400 Utilities Expense 3,700 Totals $75,000

Credit

$ 2,200 500 35,000 17,800 19,500 $75,000

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-19 (LO 2-4, 2-5, 2-6) Requirement 1 (1) January 1

Debit

Cash

42,000 Common Stock (Issue common stock)

Credit 42,000

(2) January 5 Land

24,000 Notes Payable (Purchase land with note payable)

24,000

(3) January 9 Equipment Cash (Purchase storage containers)

9,000 9,000

(4) January 12 No entry (5) January 18 Cash

13,000 Service Revenue (Receive cash for current month’s rent)

13,000

(6) January 23 Supplies 3,000 Accounts Payable (Purchase office supplies on account)

3,000

(7) January 31 Salaries Expense Cash (Pay salaries for the current month)

9,000 9,000

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-19 (continued) Requirement 2

(1)

Cash 0 42,000

Common Stock 0 42,000

(1)

9,000 (3) (5)

13,000 9,000 (7) 37,000

(2)

(3)

42,000

Land 0 24,000 24,000

Notes Payable

Equipment 0 9,000 9,000

Service Revenue 0 13,000 13,000

0 24,000 24,000

(2)

(5)

Accounts Payable (6)

(7)

Supplies 0 3,000 3,000

0 3,000 3,000

(6)

Salaries Expense 0 9,000 9,000

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-19 (concluded) Requirement 3 Green Wave Company Trial Balance Accounts Cash Supplies Land Equipment Accounts Payable Notes Payable Common Stock Service Revenue Salaries Expense Totals

Debit $37,000 3,000 24,000 9,000

Credit

$ 3,000 24,000 42,000 13,000 9,000 $82,000

$82,000

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-20 (LO 2-4, 2-5, 2-6) Requirement 1 (1) September 3

Debit

Accounts Receivable Service Revenue (Provide painting on account) (2) September 8

20,000

Equipment Cash (Purchase painting equipment) (3) September 12

21,000

Credit 20,000

21,000

Supplies 3,500 Accounts Payable (Purchase office supplies on account) (4) September 15 Salaries Expense Cash (Pay salaries for the current month) (5) September 19

3,500

4,200 4,200

Advertising Expense 1,000 Cash (Pay advertising for the current month) (6) September 22 Rent Expense Cash (Pay rent for the current month) (7) September 26

5,400

Cash

15,000

1,000

5,400

Accounts Receivable (Receive cash on account) (8) September 30 Cash

15,000

6,000 Deferred Revenue (Receive cash in advance for painting)

6,000

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-20 (continued) Requirement 2 Accounts Receivable Beg. 1,700 (1) 20,000 15,000 (7) 6,700 Beg. (2)

Equipment 7,400 21,000

Beg.

(7) (8) 28,400 Beg. (3)

Supplies 500 3,500 4,000

Beg. (4)

Salaries Expense 0 4,200 4,200

Beg. (6)

Rent Expense 0 5,400 5,400

20,000 Cash 46,100 21,000 4,200 1,000 5,400 15,000 6,000 35,500

(2) (4) (5) (6)

Accounts Payable 1,200 Beg. 3,500 (3) 4,700 Advertising Expense Beg. 0 (5) 1,000 1,000

Common Stock 25,000 Beg. 25,000

Service Revenue 0 Beg. 20,000 (1)

Deferred Revenue 0 Beg. 6,000 (8) 6,000 Retained Earnings 29,500

Beg.

29,500

Chapter 2 - The Accounting Cycle: During the Period

Exercise 2-20 (concluded) Requirement 3 Boilermaker House Painting Company Trial Balance Accounts Cash Accounts Receivable Supplies Equipment Accounts Payable Deferred Revenue Common Stock Retained Earnings Service Revenue Salaries Expense Advertising Expense Rent Expense Totals

Debit $35,500 6,700 4,000 28,400

Credit

$ 4,700 6,000 25,000 29,500 20,000 4,200 1,000 5,400 $85,200

$85,200

Chapter 2 - The Accounting Cycle: During the Period

PROBLEMS: SET A Problem 2-1A (LO 2-2) Transaction

Assets

Liabilities

Stockholders’ Equity

1. Issue common stock in exchange for cash.

Increase

No effect

Increase

2. Purchase business supplies on account.

Increase =

Increase

No effect

3. Pay for legal services for the current month.

Decrease =

No effect

Decrease

4. Provide services to customers on account.

Increase =

No effect

Increase

5. Pay employee salaries for the current month.

Decrease =

No effect

Decrease

6. Provide services to customers for cash.

Increase =

No effect

Increase

7. Pay for advertising for the current month.

Decrease =

No effect

Decrease

8. Repay loan from the bank.

Decrease =

Decrease

No effect

9. Pay dividends to stockholders.

Decrease =

No effect

Decrease

10. Receive cash from customers in (4) above.

No effect* =

No effect

11. Pay for supplies Decrease = purchased in (2) above.

Decrease

No effect

*One asset (cash) increases and another asset (accounts receivable) decreases

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-2A (LO 2-2)

Stockholders’ + Equity

Transaction

Assets

Liabilities

1. Provide services to customers on account, $1,600.

+$1,600

2. Pay $400 for current month’s rent.

−$400

3. Hire a new employee, who will be paid $500 at the end of each month.

4. Pay $100 for advertising aired in the current period.

−$100

5. Purchase office supplies for cash.

+$400 −$400

6. Receive cash of $1,000 from customers in (1) above.

+$1,000 −$1,000

7. Obtain a loan from the bank for $7,000.

+$7,000

8. Receive a bill of $200 for utility costs of the current period.

+$200

−$200

9. Issue common stock for $10,000 cash.

+$10,000 =

+$10,000

10. Pay $500 to employee in (3) above.

−$500

$17,600

$7,200

$10,400

Totals

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-3A (LO 2-3) Type of Account

Normal Balance (Debit or Credit)

1. Salaries Payable

Liability

Credit

2. Common Stock

Stockholders’ equity

Credit

3. Prepaid Rent

Asset

Debit

4. Buildings

Asset

Debit

5. Utilities Expense

Expense

Debit

6. Equipment

Asset

Debit

7. Rent Expense

Expense

Debit

8. Notes Payable

Liability

Credit

9. Salaries Expense

Expense

Debit

10. Insurance Expense

Expense

Debit

11. Cash

Asset

Debit

12. Service Revenue

Revenue

Credit

Accounts

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-4A (LO 2-4) Transactions for Jake’s Lawn Maintenance Company July 3

Debit

Accounts Receivable Service Revenue (Provide services on account) July 6

500

Repairs and Maintenance Expense Accounts Payable (Receive maintenance on account) July 9

450

Cash

500

450

Accounts Receivable (Receive cash on account) July 14

500

Notes Receivable 600 Cash (Loan cash by accepting note receivable) July 18 Advertising Expense 110 Cash (Pay advertising for the current month) July 20 Accounts Payable Cash (Pay cash on account) July 27

Credit

600

110

450 450

No entry for Jake. July 30 No entry for Jake. July 31 Cash

600 Notes Receivable (Receive cash on note receivable)

600

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-5A (LO 2-2, 2-4) Transactions for Luke’s Repair Shop July 3 Repairs and Maintenance Expense Accounts Payable (Receive services on account) July 6 Accounts Receivable Service Revenue (Provide services on account) July 9 Accounts Payable Cash (Pay cash on account) July 14 Cash Notes Payable (Borrow by signing note payable) July 18 No entry for Luke. July 20 Cash Accounts Receivable (Receive cash on account) July 27 Cash Service Revenue (Provide services for cash) July 30 Salaries Expense Cash (Pay salaries to employees) July 31 Notes Payable Cash (Pay note payable)

Debit 500

Credit 500

450 450 500 500 600 600

450 450 800 800 300 300 600 600

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-5A (concluded) Jake’s Lawn Maintenance Company

Luke’s Repair Shop

Stockholders’ Stockholders’ Assets = Liabilities + Equity Assets = Liabilities + Equity July 3 +$500 = =

+$500

= +$500

+$450

−$450

+$450 =

−$500

+$450

+$500 = −$500

−$500 = −$500

+$600 = −$600

+$600 = +$600

−$110 =

−$110

−$450 =

−$450

+$450 = −$450

+$800 =

+$800

−$300 =

−$300

+$600 = −$600

−$600 = −$600

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-6A (LO 2-6) Bruins Company Trial Balance November 30 Accounts Cash Accounts Receivable Supplies Prepaid Rent Equipment Accounts Payable Salaries Payable Interest Payable Deferred Revenue Notes Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Rent Expense Interest Expense Supplies Expense Utilities Expense Totals

Debit $ 40,000 50,000 1,100 3,000 60,800

Credit

$ 17,000 5,000 3,000 9,000 30,000 50,000 35,000 1,100 65,000 30,000 12,000 3,000 7,000 6,000 $214,000

$214,000

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-7A (LO 2-4, 2-5, 2-6)

Requirement 1 Entries are numbered for posting. (1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

(9)

March 1 Debit Cash 3,000 Common Stock (Issue common stock) March 3 Equipment 2,700 Notes Payable (Purchase sewing equipment with note payable) March 5 Rent Expense 600 Cash (Pay rent for current month) March 7 No entry March 12 Supplies 130 Accounts Payable (Purchase sewing supplies on account) March 15 Cash 800 Service Revenue (Provide services for cash) March 19 Cash 700 Deferred Revenue (Receive cash in advance from customer) March 25 Deferred Revenue 700 Service Revenue (Provide services to customer) March 30 Utilities Expense 95 Cash (Pay utilities for current month) March 31 Dividends 150 Cash (Pay dividends)

Credit 3,000

2,700

600

130

800

700

150

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-7A (continued) Requirements 2 and 3

Cash (1) 3,000 600 (3) (5) 800 95 (8) (6) 700 150 (9) 3,655

Supplies (4) 130 130

(2) 2,700 2,700

Accounts Payable 130 (4) 130

Notes Payable

Common Stock

2,700 (2) 2,700

3,000 (1) 3,000

Service Revenue 800 (5) 700 (7) 1,500

Equipment

Rent Expense

Deferred Revenue (7) 700

700 (6) 0

Dividends (9) 150 150 Utilities Expense

(3) 600

(8) 95

600

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-7A (concluded) Requirement 4 Ute Sewing Shop Trial Balance March 31 Accounts Cash Supplies Equipment Accounts Payable Deferred Revenue Notes Payable Common Stock Dividends Service Revenue Rent Expense Utilities Expense Totals

Debit $3,655 130 2,700

Credit

$ 130 0 2,700 3,000 150 1,500 600 95 $7,330

$7,330

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-8A (LO 2-4, 2-5, 2-6)

Requirement 1 Entries are numbered for posting. (1) Sep. 1 Debit Cash 4,700 Service Revenue (Provide services for cash) (2) Sep. 2 Land 6,400 Notes Payable (Purchase land with note payable) (3) Sep. 4 Advertising Expense 500 Accounts Payable (Receive invoice for current advertising) (4) Sep. 8 Accounts Receivable 6,000 Service Revenue (Provide services on account) (5) Sep. 10 Supplies 1,100 Accounts Payable (Purchase supplies on account) (6) Sep. 13 Notes Payable 4,000 Cash (Pay note payable) (7) Sep. 18 Cash 5,000 Accounts Receivable (Receive cash on account) (8) Sep. 20 Rent Expense 900 Cash (Pay rent for current month) (9) Sep. 30 Utilities Expense 2,000 Cash

Credit 4,700

6,400

500

6,000

1,100

4,000

5,000

900

2,000

(Pay utilities for current month)

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-8A (continued) (10) Sep. 30 Salaries Expense Cash (Pay salaries for current month) (11) Sep. 30 Dividends Cash (Pay dividends)

4,000 4,000 1,100 1,100

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-8A (continued) Requirements 2 and 3

Cash Bal. 6,500 4,000 (6) (1) 4,700 900 (8) (7) 5,000 2,000 (9) 4,000 (10) 1,100 (11) 4,200 Land Bal. 11,200 (2) 6,400

Accounts Receivable Bal. 2,500 5,000 (7) (4) 6,000

3,500

Supplies Bal. 7,600 (5) 1,100

8,700 Notes Payable (6) 4,000 3,000 Bal. 6,400 (2)

17,600

Accounts Payable 7,500 Bal. 500 (3) 1,100 (5) 9,100

Common Stock

Retained Earnings

Dividends

9,000 Bal. 9,000 Service Revenue 4,700 (1) 6,000 (4) 10,700

8,300 Bal. 8,300 Salaries Expense

5,400

(11) 1,100 1,100 Rent Expense

(10) 4,000

(8) 900

4,000

900

Advertising Expense

Utilities Expense

(3) 500 500

(9) 2,000 2,000

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-8A (continued) Requirement 4

Pirates Incorporated Trial Balance September 30 Accounts Cash Accounts Receivable Supplies Land Accounts Payable Notes Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Rent Expense Advertising Expense Utilities Expense Totals

Debit $ 4,200 3,500 8,700 17,600

Credit

$ 9,100 5,400 9,000 8,300 1,100 10,700 4,000 900 500 2,000 $42,500

$42,500

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-9A (LO 2-4, 2-5, 2-6)

Requirement 1 Entries are numbered for posting. (1) December 1 Debit Rent Expense 900 Cash (Pay rent for December) (2) December 5 Cash 2,800 Service Revenue (Provide services for cash) (3) December 8 Cash 10,000 Notes Payable (Borrow by signing note payable) (4) December 12 Cash 3,500 Accounts Receivable (Receive cash from customers on account) (5) December 13 Cash 20,000 Common Stock (Issue shares of common stock) (6) December 15 Salaries Expense 1,200 Cash (Pay salaries for December) (7) December 17 Advertising Expense 1,000 Cash (Purchase advertising for December) (8) December 22 Accounts Receivable 3,200 Service Revenue (Provide services on account) December 23 No journal entry required

Credit 900

2,800

10,000

3,500

20,000

1,200

1,000

3,200

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-9A (continued) (9) December 26 Equipment Cash (Purchase equipment) (10) December 28 Accounts Payable Cash (Pay cash on account) (11) December 31 Dividends Cash (Pay dividends)

28,500 28,500 1,500 1,500 2,000 2,000

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-9A (continued) Requirements 2 and 3 Cash Bal. 9,200 900 (1) (2) 2,800 1,200 (6) (3)10,000 1,000 (7) (4) 3,500 28,500 (9) (5) 20,000 1,500 (10) 2,000 (11) 10,400

Accounts Receivable Bal. 4,500 3,500 (4) (8) 3,200

Equipment Bal. 24,100 (9) 28,500 52,600

Land Bal. 170,000

Notes Payable 50,000 Bal. 10,000 (3) 60,000 Dividends Bal. 5,000 (11) 2,000 7,000

Salaries Expense Bal. 28,300 (6) 1,200 29,500

4,200

Prepaid Insurance Bal. 400

400 Accounts Payable (10) 1,500 3,300 Bal.

170,000

1,800

Common Stock 120,000 Bal. 20,000 (5) 140,000

Retained Earnings 14,100 Bal.

Service Revenue 75,000 Bal. 2,800 (2) 3,200 (8) 81,000

Advertising Expense Bal. 11,000 (7) 1,000

14,100

12,000

Rent Expense Bal. 9,900 (1) 900 10,800

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-9A (continued) Requirement 4

RiverHawk Expeditions Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Prepaid Insurance Equipment Land Accounts Payable Notes Payable Common Stock Retained Earnings Dividends Service Revenue Advertising Expense Salaries Expense Rent Expense Totals

Debit $ 10,400 4,200 400 52,600 170,000

Credit

$ 1,800 60,000 140,000 14,100 7,000 81,000 12,000 29,500 10,800 $296,900

$296,900

Chapter 2 - The Accounting Cycle: During the Period

PROBLEMS: SET B Problem 2-1B (LO 2-2) Transaction

Assets

Liabilities

Stockholders’ Equity

1. Obtain a loan at the bank

Increase

No effect

2. Purchase a machine to use in operations for cash.

No effect* =

No effect

3. Provide services to customers for cash.

Increase =

No effect

Increase

4. Pay employee salaries for the current month.

Decrease =

No effect

Decrease

5. Repay loan from the bank in (1) above.

Decrease =

Decrease

No effect

6. Customers pay cash in advance of services.

Increase =

Increase

No effect

7. Pay for maintenance costs Decrease = in the current month.

No effect

Decrease

8. Pay for advertising in the Decrease = current month.

No effect

Decrease

9. Purchase office supplies on account.

Increase =

Increase

No effect

10. Provide services to customers on account.

Increase =

No effect

Increase

11. Pay dividends to stockholders.

Decrease =

No effect

Decrease

*One asset (machine) increases and another asset (cash) decreases

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-2B (LO 2-2) Transaction

Assets

1. Issue common stock in exchange for cash, $15,000.

+$15,000 =

2. Obtain a loan from the bank for $9,000.

+$9,000

3. Receive cash of $1,200 in advance from customers.

Liabilities

Stockholders’ + Equity

+$15,000

+$9,000

+$1,200

4. Purchase supplies on account, $2,400.

+$2,400

5. Pay one year of rent in advance, $12,000.

+$12,000

6. Provide services to customers on account, $3,000.

+$3,000

7. Repay $4,000 of the loan in (2) above.

−$4,000

8. Pay full amount for supplies purchased in (4) above.

−$2,400

9. Provide services to customers in (3) above.

−$1,200

+$1,200

−$1,000

$23,200

$5,000

$18,200

10. Pay cash dividends of $1,000 to stockholders. Totals

−$12,000

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-3B (LO 2-3) Type of Account

Normal Balance (Debit or Credit)

1. Supplies

Asset

Debit

2. Advertising Expense

Expense

Debit

3. Prepaid Insurance

Asset

Debit

4. Supplies Expense

Expense

Debit

5. Accounts Payable

Liability

Credit

6. Equipment

Asset

Debit

7. Dividends

Dividends

Debit

8. Accounts Receivable

Asset

Debit

9. Retained Earnings

Stockholders’ equity

Credit

10. Deferred Revenue

Liability

Credit

11. Service Revenue

Revenue

Credit

12. Utilities Payable

Liability

Credit

Accounts

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-4B (LO 2-4) Transactions for Eli’s Insurance Services May 2

Debit

Cash

300 Deferred Revenue (Receive cash in advance from customer)

Credit 300

May 5 Repairs and Maintenance Expense 425 Accounts Payable (Receive maintenance services on account) May 7 Cash

425

500

Notes Payable (Receive cash and sign note payable) May 14

500

No entry for Eli. May 19 Accounts Payable Cash (Pay cash on account) May 25

425

Utilities Expense Cash (Pay utilities for the current month) May 28

135

Deferred Revenue Service Revenue (Provide service previously paid) May 31

300

Notes Payable Cash (Pay cash on note payable)

500

425

135

300

500

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-5B (LO 2-2, 2-4) Transactions for Olivia’s Maintenance Services May 2

Debit

Prepaid Insurance 300 Cash (Pay for insurance services in advance) May 5 Accounts Receivable Service Revenue (Provide services on account) May 7

425

Notes Receivable Cash (Loan cash and issue note receivable) May 14

500

300

425

500

Supplies 200 Cash (Purchase maintenance supplies with cash) May 19 Cash

Credit

200

425

Accounts Receivable (Receive cash on account) May 25

425

No entry for Olivia. May 28 Insurance Expense Prepaid Insurance (Received services paid in advance) May 31

300

Cash

500 Notes Receivable (Receive cash on note receivable)

300

500

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-5B (concluded) Eli’s Insurance Services

Olivia’s Maintenance Services

Stockholders’ Stockholders’ Assets = Liabilities + Equity Assets = Liabilities + Equity May 2 +$300 = +$300

+$300 = −$300

+$425

−$425

+$425 =

+$425

+$500 =

+$500

+$500 = −$500

+$200 = −$200

−$425 =

−$425

+$425 = −$425

−$135 =

−$135

−$300

+$300

−$300 =

−$300

−$500 =

−$500

+$500 = −$500

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-6B (LO 2-6) Ducks Company Trial Balance September 30 Accounts Cash Accounts Receivable Supplies Prepaid Insurance Equipment Accounts Payable Salaries Payable Utilities Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Insurance Expense Advertising Expense Supplies Expense Entertainment Expense Utilities Expense Totals

Debit $ 25,000 14,000 7,000 5,000 28,000

Credit

$ 7,000 4,000 1,100 9,000 29,000 13,000 4,000 55,100 9,000 8,000 1,100 10,000 6,000 1,100 $118,200

$118,200

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-7B (LO 2-4, 2-5, 2-6)

Requirement 1 Entries are numbered for posting. (1) June 1 Debit Cash 70,000 Notes Payable (Obtain loan from bank) (2) June 2 Cash 40,000 Common Stock (Issue common stock) (3) June 7 Equipment 75,000 Cash (Purchase equipment) (4) June 10 Supplies 8,000 Accounts Payable (Purchase cleaning supplies on account) (5) June 12 Cash 5,000 Service Revenue (Provide car washes for cash) (6) June 16 Salaries Expense 900 Cash (Pay salaries to employees) (7) June 19 Advertising Expense 500 Cash (Pay for current advertising) (8) June 23 Accounts Receivable 6,000 Service Revenue (Provide car washes on account)

Credit 70,000

40,000

75,000

8,000

5,000

900

500

6,000

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-7B (continued) (9) June 29 Salaries Expense Cash (Pay salaries to employees) (10) June 30 Utilities Expense Cash (Pay current utility bill) (11) June 30 Dividends Cash (Pay dividends to stockholders)

950 950 1,400 1,400 600 600

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-7B (continued) Requirements 2 and 3 Cash (1) 70,000 75,000 (3) (2) 40,000 900 (6) (5) 5,000 500 (7) 950 (9) 1,400 (10) 600 (11) 35,650 Notes Payable

Accounts Receivable (8) 6,000 6,000 Equipment

(4) 8,000 8,000 Accounts Payable

(3) 75,000

8,000 (4)

75,000 Common Stock

70,000 (1) 70,000

40,000 (2) 40,000

Service Revenue

Salaries Expense

5,000 (5) 6,000 (8) 11,000

Supplies

(6) 900 (9) 950 1,850

8,000 Dividends (11) 600 600 Advertising Expense (7) 500 500

Utilities Expense (10) 1,400 1,400

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-7B (concluded) Requirement 4 Salukis Car Cleaning Trial Balance June 30 Accounts Cash Accounts Receivable Supplies Equipment Accounts Payable Notes Payable Common Stock Dividends Service Revenue Salaries Expense Advertising Expense Utilities Expense Totals

Debit $ 35,650 6,000 8,000 75,000

Credit

$ 8,000 70,000 40,000 600 11,000 1,850 500 1,400 $129,000

$129,000

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-8B (LO 2-4, 2-5, 2-6)

Requirement 1 Entries are numbered for posting. (1) Nov. 1 Debit Cash 13,000 Common Stock (Issue common stock) (2) Nov. 2 Equipment 3,500 Notes Payable (Purchase equipment with note payable) (3) Nov. 4 Supplies 1,000 Accounts Payable (Purchase supplies on account) (4) Nov. 10 Accounts Receivable 9,000 Service Revenue (Provide services on account) (5) Nov. 15 Accounts Payable 1,100 Cash (Pay cash on account) (6) Nov. 20 Salaries Expense 3,000 Cash (Pay current salaries) (7) Nov. 22 Cash 11,000 Service Revenue (Provide services for cash) (8) Nov. 24 Notes Payable 1,400 Cash (Pay note payable) (9) Nov. 26 Cash 7,000 Accounts receivable

Credit 13,000

3,500

1,000

9,000

1,100

3,000

11,000

1,400

7,000

(Receive cash on account)

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Chapter 2 - The Accounting Cycle: During the Period

Problem 2-8B (continued) (10) Nov. 28 Utilities Expense Cash (Pay utilities for current month) (11) Nov. 30 Rent Expense Cash

1,100 1,100 5,000 5,000

(Pay rent for current month)

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-8B (continued) Requirements 2 and 3 Cash Bal. 3,200 1,100 (5) (1) 13,000 3,000 (6) (7) 11,000 1,400 (8) (9) 7,000 1,100 (10) 5,000 (11) 22,600

Accounts Receivable Bal. 600 7,000 (9) (4) 9,000

Equipment Bal. 9,400 (2) 3,500 12,900

Accounts Payable 2,000 Bal. (5)1,100 1,000 (3) 1,900

Notes Payable (8) 1,400 4,000 Bal. 3,500 (2) 6,100

Common Stock 7,000 Bal. 13,000 (1) 20,000

Retained Earnings 900 Bal.

Service Revenue 9,000 (4) 11,000 (7) 20,000

Salaries Expense (6) 3,000

Utilities Expense (10) 1,100

3,000

2,600

Supplies Bal. 700 (3) 1,000

1,700

900

1,100

Rent Expense (11) 5,000 5,000

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-8B (continued) Requirement 4

Buckeye Incorporated Trial Balance November 30 Accounts Cash Accounts Receivable Supplies Equipment Accounts Payable Notes Payable Common Stock Retained Earnings Service Revenue Salaries Expense Utilities Expense Rent Expense Totals

Debit $22,600 2,600 1,700 12,900

Credit

$ 1,900 6,100 20,000 900 20,000 3,000 1,100 5,000 $48,900

$48,900

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-9B (LO 2-4, 2-5, 2-6)

Requirement 1 Entries are numbered for posting. (1) December 1-31 Debit Credit Cash 27,400 Service Revenue 27,400 (Provide services for cash) (2) December 4 Supplies 2,900 Accounts Payable 2,900 (Purchase supplies on account) (3) December 8 Advertising Expense 3,200 Cash 3,200 (Purchase advertising for December) (4) December 9 Accounts Payable 2,900 Cash 2,900 (Pay cash on account) (5) December 12 Cash 5,000 Common Stock 5,000 (Issue shares of common stock) (6) December 16 Accounts Payable 6,300 Cash 6,300 (Pay cash on account) (7) December 19 Equipment 7,700 Cash 7,700 (Purchase equipment) (8) December 22 Utilities Expense 4,500 Cash 4,500 (Pay utilities for current month) (9) December 24 Cash 2,300 Deferred Revenue 2,300 (Receive cash in advance from customers)

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-9B (continued) December 27 No journal entry is required (10) December 30 Salaries Expense Cash (Pay salaries for December) (11) December 31 Dividends Cash (Pay dividends)

7,000 7,000 3,000 3,000

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-9B (continued) Requirements 2 and 3 Cash Bal. 19,400 3,200 (3) (1) 27,400 2,900 (4) (5) 5,000 6,300 (6) (9) 2,300 7,700 (7) 4,500 (8) 7,000 (10) 3,000 (11) 19,500

Supplies Bal. 1,500 (2) 2,900

Equipment Bal. 83,700 (7) 7,700 91,400

Buildings Bal. 240,000

Deferred Revenue 2,000 Bal. 2,300 (9) 4,300 Dividends Bal. 9,000 (11) 3,000 12,000

Advertising Expense Bal. 18,200 (3) 3,200 21,400

4,400

240,000

Prepaid Rent Bal. 7,200

7,200 Accounts Payable (4) 2,900 9,800 Bal. (6) 6,300 2,900 (2) 3,500

Common Stock 125,000 Bal. 5,000 (5) 130,000

Retained Earnings 75,500 Bal.

Service Revenue 264,000 Bal. 27,400 (1) 291,400

Salaries Expense Bal. 65,000 (10) 7,000 72,000

75,500

Utilities Expense Bal. 32,300 (8) 4,500 36,800

Chapter 2 - The Accounting Cycle: During the Period

Problem 2-9B (continued) Requirement 4

Thunder Cat Services Trial Balance December 31, 2021 Accounts Cash Supplies Prepaid Rent Equipment Buildings Accounts Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Advertising Expense Utilities Expense Totals

Debit $ 19,500 4,400 7,200 91,400 240,000

Credit

$ 3,500 4,300 130,000 75,500 12,000 291,400 72,000 21,400 36,800 $504,700

$504,700

Chapter 2 - The Accounting Cycle: During the Period

ADDITIONAL PERSPECTIVES Additional Perspective 2-1 Requirement 1 Entries are numbered for posting. (1) July 1, 2021 Debit Cash 10,000 Common Stock (Issue common stock to Suzie) (2) July 1, 2021 Cash 10,000 Common Stock (Issue common stock to Tony) (3) July 1, 2021 Prepaid Insurance 4,800 Cash (Purchase one-year insurance policy) (4) July 2, 2021 Legal Fees Expense 1,500 Cash (Pay legal fees for incorporation) (5) July 4, 2021 Supplies (Office) 1,800 Accounts Payable (Purchase office supplies on account) (6) July 7, 2021 Advertising Expense 300 Cash (Pay cash for advertising) (7) July 8, 2021 Equipment (Bikes) 12,000 Cash (Pay cash for mountain bikes) (8) July 15, 2021 Cash 2,000 Service Revenue (Receive cash for mountain bike clinic)

Credit 10,000

10,000

4,800

1,500

1,800

300

12,000

2,000

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective 2-1 (continued) Requirement 1 (concluded) (9)

(10)

(11)

July 22, 2021 Cash 2,300 Service Revenue (Receive cash for mountain bike clinic) July 24, 2021 Advertising Expense 700 Cash (Pay cash for advertising) July 30, 2021 Cash 4,000 Deferred Revenue (Receive cash in advance for kayak clinic)

2,300

700

4,000

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective P2-1 (continued) Requirement 2 Cash Prepaid Insurance (1) 10,000 4,800 (3) (3) 4,800 (2) 10,000 1,500 (4) 4,800 (8) 2,000 300 (6) (9) 2,300 12,000 (7) (11) 4,000 700 (10) Equipment 9,000 (7) 12,000 12,000

Deferred Revenue 4,000 (11) 4,000

Common Stock 10,000 (1) 10,000 (2) 20,000

Advertising Expense (6) 300 (10) 700 1,000

Legal Fees Expense (4) 1,500 1,500

Supplies (5) 1,800 1,800

Accounts Payable 1,800 (5) 1,800

Service Revenue 2,000 (8) 2,300 (9) 4,300

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective 2-1 (concluded) Requirement 3

Great Adventures, Inc. Trial Balance July 31, 2021 Accounts Cash Prepaid Insurance Supplies Equipment Accounts Payable Deferred Revenue Common Stock Service Revenue Advertising Expense Legal Fees expense Totals

Debit $ 9,000 4,800 1,800 12,000

Credit

$ 1,800 4,000 20,000 4,300 1,000 1,500 $30,100

$30,100

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective 2-2 ($ in thousands) Requirement 1 Percentage change in total assets = ($1,816,313 − $1,782,660) / $1,782,660 = 1.9% Percentage change in net sales = ($3,795,549 − $3,609,865) / $3,609,865 = 5.1% Requirement 2 Percentage change in net income = ($204,163 − $212,449) / $212,449 = -3.9% Requirement 3 No. Based on the statement of stockholders’ equity, American Eagle did not issue common stock in the most recent year. Requirement 4 No. The terms “debit” and “credit” are not shown in the balance sheet. Asset accounts, such as cash, merchandise inventory, accounts receivable, and property and equipment, increase with a debit. Liability accounts, such as accounts payable, accrued rent, and other liabilities increase with a credit. Stockholders’ equity accounts, such as common stock and retained earnings, also increase with a credit. Requirement 5 No. The terms “debit” and “credit” are not shown in the income statement. Expense accounts, such as cost of sales and selling, general and administrative expenses increase with a debit. Revenue accounts, such as net revenue, increase with a credit.

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective 2-3 ($ in thousands) Requirement 1 Percentage change in total assets = ($538,116 − $579,847) / $579,847 = -7.2% Percentage change in net sales = ($913,380 − $974,873) / $974,873 = -6.3% Requirement 2 Percentage change in net income = ($89,707 − $97,961) / $97,961 = -8.4% Requirement 3 Yes. Based on the statement of stockholders’ equity, The Buckle did issue a small amount of common stock in the most recent year. Requirement 4 No. The terms “debit” and “credit” are not shown in the balance sheet. Asset accounts, such as cash, inventory, accounts receivable, and property and equipment increase with a debit. Liability accounts, such as accounts payable, accrued employee compensation, and income taxes increase with a credit. Stockholders’ equity accounts, such as common stock and retained earnings, also increase with a credit. Requirement 5 No. The terms “debit” and “credit” are not shown in the income statement. Expense accounts, such as cost of sales and selling, general, and administrative expenses, increase with a debit. Revenue accounts, such as net sales, increase with a credit.

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective 2-4 American Eagle for all three. American Eagle has a larger increase in terms of total assets, and also showed growth in net sales whereas Buckle’s net sales declined. Buckle’s net income declined by a larger percentage. Without reading more of the financial reports at this point, it appears from the financial statements that the apparel business is slumping and Buckle is struggling to find its place, having already shown operations that it discontinued and perhaps a need to re-strategize its operations.

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective 2-5 1. Increases reported profit by $75,000, from a loss of $50,000 to a profit of $25,000 (ignoring any tax effects). 2. Yes. Robert, the company’s president, benefits from false reporting by maintaining the company’s profitable appearance. The incentives could be bonus compensation plans, a desire to please stockholders, meeting analysts’ earnings forecasts for the company, or maintaining good standing with creditors. Larry benefits from false reporting by keeping his friendship with Robert, keeping his job for the longer-term, and getting a free dinner tonight. However, if the false reporting is discovered by authorities, both parties face legal penalties and suffer reputational damage. 3. Yes. Outside decisions makers, such as investors and creditors, view companies that report a profit instead of a loss as being more financially stable. 4. No. As the accountant, Larry should understand that his responsibilities are to accurately record and report the company’s activities. Larry must be aware that Robert may have incentives for falsely reporting to Larry about the additional revenue. Without source documents, an important step in the measurement process, Larry should not record any transactions.

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective 2-6 (Note to instructor: Answers are based on items in Apple’s September 30, 2017 annual report. Dollar amounts are in millions) Requirement 1 Accounts receivable = $17,874. The accounts receivable account represents the amount owed to Apple by its customers. Requirement 2 Accounts payable = $49,049. The accounts payable account represents the amount owed by Apple to its suppliers. Requirement 3 Accrued expenses could include income taxes payable, salaries payable, interest payable, and rent payable. Requirement 4 Common stock (including additional paid-in capital) = $35,867. The common stock account represents capital contributed to the company by stockholders. Requirement 5 Assets ($375,319) = Liabilities ($241,272) + Stockholders’ equity ($134,047) Requirement 6 Net sales = $229,234. The period of net sales is for the year ended September 30, 2017. Requirement 7 Expenses include cost of sales; research and development; selling, general, and administrative; and provision for income taxes. Requirement 8 Yes, the company’s revenues exceed expenses. The difference is net income of $48,351.

Chapter 2 - The Accounting Cycle: During the Period

Additional Perspective 2-7 For transaction (a): Step 1. Analyze customer invoice. Step 2. Determine assets increase and stockholders’ equity increases (and revenues increase). Step 3. Increase assets with a debit and increase revenues with a credit. Step 4. Accounts Receivable 500 Service Revenue 500 (Provide services on account) For transaction (b): Step 1. Analyze employee paycheck. Step 2. Determine assets decrease and stockholders’ equity decreases (and expenses increase). Step 3. Decrease assets with a credit and increase expenses with a debit. Step 4. Salaries Expense 1,200 Cash 1,200 (Pay salary for the current month) For transaction (c): Step 1. Analyze purchase receipt for equipment. Step 2. Determine one asset increases and another asset decreases. Step 3. Increase assets with a debit and decrease assets with a credit. Step 4. Equipment 2,700 Cash 2,700 (Purchase office equipment) Step 5. All transactions are posted to the general ledger accounts. Step 6. A trial balance is prepared using the balance of each general ledger account. Total debits should equal total credits in the trial balance.

Chapter 3 - The Accounting Cycle: End of the Period

Chapter 3 The Accounting Cycle: End of the Period REVIEW QUESTIONS Question 3-1 (LO 3-1) The revenue recognition principle states that we record revenue in the period in which we provide products or services to customers. If a company sells products or provides services to a customer in the current year, then the company should report the revenue in its current income statement. If the company sells products or provides services to a customer in the following year, then it should report the revenue in the following year’s income statement, and so on.

Question 3-2 (LO 3-1)

The concept of expense recognition suggests that we recognize expenses in the same period as costs are used for providing goods and services to customers. In other words, we report expenses with the revenues they help to generate. There is a cause-and-effect relationship between revenue and expense recognition implicit in this principle. Some costs are more difficult to match with revenue and are expensed in the period in which they occur or are used in business operations.

Question 3-3 (LO 3-1)

Net income is an important profitability measure used by investors, creditors, and others in assessing the performance of the company. Net income equals revenues minus expenses. Therefore, to accurately assess profitability, it is important that revenues and the expenses that helped to generate those revenues be reported in the same period. Otherwise, it would be difficult to tell from period to period the company’s profit-generating ability.

Question 3-4 (LO 3-2) Under cash-basis accounting, revenues are recorded when cash is received and expenses are recorded when cash is paid. In contrast, under accrual-basis accounting, revenues are recorded when goods and services are provided to customers (revenue recognition principle) and expenses are recorded when used to generate revenues.

Question 3-5 (LO 3-2) (1) April 10th. (2) April 10th. (3) April 10th.

Question 3-6 (LO 3-2) (1) March 28th. (2) April 10th. (3) May 2nd.

Chapter 3 - The Accounting Cycle: End of the Period

Answers to Review Questions (continued) Question 3-7 (LO 3-2) (1) April 10th. (2) April 10th. (3) April 10th.

Question 3-8 (LO 3-2) (1) March 28th. (2) April 10th. (3) May 2nd.

Question 3-9 (LO 3-3) One of the primary purposes of adjusting entries is to allow for proper application of the revenue recognition principle (revenues) and expense recognition (expenses). The revenue recognition principle and expense recognition concept are key components of accrual-basis accounting.

Question 3-10 (LO 3-3) Prepayments are cases where cash is received before revenue is recognized or where cash is paid before the expense is recognized. Accruals are cases where cash is received after revenue is recognized or where cash is paid after the expense is recognized.

Question 3-11 (LO 3-3) A prepaid expense includes the purchase of supplies, prepaid insurance, and prepaid rent. At the time of purchase, the purchase is recorded as an asset. When that asset is used (or expires), an adjusting entry is needed to reduce the asset to its remaining amount and to recognize an expense.

Question 3-12 (LO 3-3) Deferred revenue includes a customer paying cash before receiving the related product or service, such as a magazine subscription. At the time the cash is received, a liability is recorded. When those products and services are provided to customers, an adjusting entry is needed to reduce the liability to its remaining amount and to recognize revenue.

Question 3-13 (LO 3-3) An accrued expense includes incurring an expense before the related cash outflow, such as when the cost of employees’ salaries, utilities, taxes, and interest are incurred but not paid until a later time. In the period the cost occurs, an adjusting entry is needed to record the liability for the amount to be paid and to recognize an expense.

Question 3-14 (LO 3-3) An accrued revenue includes recording a revenue before the related cash inflow, such as providing products or services to customers on account. In the period the goods and services are provided to customers, an adjusting entry is needed to record an asset for the amount to be received and to recognize revenue.

Chapter 3 - The Accounting Cycle: End of the Period

Answers to Review Questions (continued) Question 3-15 (LO 3-3) October 31

Debit

Supplies Expense ($75 − $25) Supplies (Consume supplies during the current period)

Credit 50

Question 3-16 (LO 3-3)

Yes. Utilities expense and utilities payable will be understated at the end of September. Utilities expense should be recorded during the period incurred (that is, in the period it helps to produce revenues), regardless of whether it is paid. Utilities payable should be recorded in the period the obligation (debt) arises.

Question 3-17 (LO 3-3) November 30

Debit

Deferred Revenues Service Revenue (Provide services to customers who paid in advance)

20,000

Credit 20,000

Question 3-18 (LO 3-3)

Yes. Accounts receivable and service revenue will be understated at the end of May. Accounts receivable should be recorded in the period the right to receive cash arises. Service revenue should be recorded in the period the service is provided to the customer, regardless of whether cash is received.

Question 3-19 (LO 3-3) (a) Prepaid expense: Debit Supplies Expense; credit Supplies. (b) Deferred revenue: Debit Deferred Revenue; credit Service Revenue. (c) Accrued expense: Debit Salaries Expense; credit Salaries Payable. (d) Accrued revenue: Debit Accounts Receivable; credit Service Revenue.

Question 3-20 (LO 3-4) The purpose of the adjusted trial balance is to list all accounts and their balances after updating account balances for adjusting entries and check the equality of total debits and total credits. Account balances reported on the (unadjusted) trial balance do not include the effects of adjusting entries. Account balances reported on the adjusted trial balance do include the effects of adjusting entries.

Question 3-21 (LO 3-5)

Classified indicates that assets are separated into those that provide a benefit over the next year (current assets) and those that provide a benefit for more than one year (long-term assets) from the date of the balance sheet. Similarly, liabilities are divided into those due over the next year (current liabilities) and those due in more than one year (long-term liabilities) from the date of the balance sheet. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. Solutions Manual, Chapter 3 3-3

Chapter 3 - The Accounting Cycle: End of the Period

Answers to Review Questions (continued) Question 3-22 (LO 3-5)

Assets

Liabilities

Stockholders’ + equity

$12,000

$8,000

$12,000

−

$8,000

$4,000

Question 3-23 (LO 3-6) The two purposes of closing entries are (1) to transfer the balances of temporary accounts (revenues, expenses, and dividends) to the retained earnings account and (2) to reduce the balances of these temporary accounts to zero to prepare them for measuring activity in the next period.

Question 3-24 (LO 3-6)

To “close” temporary accounts indicates that temporary account balances should be reduced to zero at the end of the accounting period. The reason is that temporary accounts measure activity over a single period only and therefore need to start each period at zero. To start a period at zero, it is necessary to end the previous period with a zero balance. Dividends, revenues, and expenses are closed.

Question 3-25 (LO 3-6)

The first closing entry transfers revenue transactions to retained earnings by debiting all revenue accounts (reducing their balances to zero) and crediting retained earnings. The second closing entry transfers expense transactions to retained earnings by crediting all expense accounts (reducing their balance to zero) and debiting retained earnings. The third closing entry transfers dividend transactions to retained earnings by crediting the dividends account (reducing its balance to zero) and debiting retained earnings.

Question 3-26 (LO 3-6)

Year 1 Year 2 Year 3 Year 4

Net Income

Dividends

$ 300 900 1,500 2,400

$200 200 200 200

Retained Earnings* $ 100 800 2,100 4,300

* Retained earnings = Previous year’s retained earnings + Net income − Dividends

Chapter 3 - The Accounting Cycle: End of the Period

Answers to Review Questions (continued) Question 3-27 (LO 3-6)

It is important to understand that transactions are recorded from the company’s perspective. The company is paying dividends to its stockholders. From the company’s perspective, there is a reduction in total assets of the company (generally cash) and total stockholders’ equity when dividends are paid. [The personal accounting records of the stockholder would show an increase in cash and stockholders’ equity when the dividend is received from the company.]

Question 3-28 (LO 3-7)

The adjusted trial balance does not include the effect of closing entries while the post-closing trial balance does. This means that revenues, expenses, and dividends will be reported in the adjusted trial balance but not in the post-closing trial balance. The balance of retained earnings will differ in the two trial balances. In the post-closing trial balance, all balances for revenue, expense, and dividends accounts will have been transferred to the balance of retained earnings.

Chapter 3 - The Accounting Cycle: End of the Period

BRIEF EXERCISES Brief Exercise 3-1 (LO 3-1) (a) $0; Cash received in advance is recorded as Deferred revenue (liability). (b) $900. (c) $2,300.

Brief Exercise 3-2 (LO 3-1) (a) $600. (b) $200. (c) $0; The payment would reduce accounts payable (liability).

Brief Exercise 3-3 (LO 3-1) Revenues $17,000

− −

Expenses $12,000

= Net Income = $5,000

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-4 (LO 3-1, 3-2) Cash Balance

Cash-basis Net Income

Accrual-basis Net Income

Receive $1,500 from customers who were billed for services in April.

+$1,500

Provide $3,200 of consulting services to a local business. Payment is not expected until June.

+$3,200

Purchase office supplies for $400 on account. All supplies are used by the end of May.

−$400

Pay $600 to workers. $400 is for work in May and $200 is for work in April.

−$600

−$400

Pay $200 to advertise in a local newspaper in May.

−$200

+$700

+$2,200

Impact on: (a)

(b)

(c)

(d)

(e)

Total

Brief Exercise 3-5 (LO 3-1, 3-2) Cash-basis

Accrual

Accrual-basis

net income

adjustments

net income

Cash inflows

$50,000

+$6,900*

$56,900

Cash outflows

21,900

−$3,000**

18,900

$28,100

$38,000

* The increase in accounts receivable ($6,900) represents accrual-basis revenues with no corresponding cash inflows. ** The decrease in salaries owed ($3,000) represents cash outflows for salaries of the prior year and would not be expensed in the current year.

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-6 (LO 3-3) (1) May 15

Debit

Supplies Cash (Purchase supplies for cash) (2) May 31

3,300 3,300

Debit

Supplies Expense Supplies (Adjust supplies)

Credit

3,500 3,500

(3) Supplies

Supplies Expense $

May 1

Beginning balance

$ 500

May 15

Purchase

3,300

Adjustment Supplies used during May

(3,500)

3,500

May 31

$ 300

$3,500

Ending balance

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-7 (LO 3-3) (1) Oct. 1

Debit

Prepaid Rent Cash (Pay for rent in advance)

Credit

25,200

(2) Dec. 31

25,200

Debit

Rent Expense Prepaid Rent (Adjust prepaid rent)

Credit

6,300 6,300

= $2,100 per month x 3 months (Oct., Nov., and Dec.)

(3)

Prepaid Rent

Rent Expense $

Jan. 1

Beginning balance

Oct. 1

Payment

25,200

Adjustment Prepaid rent expired during year

(6,300)

6,300

Dec. 31

$18,900

$6,300

Ending balance

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-8 (LO 3-3) (1) Mar. 1

Debit

Prepaid Insurance Cash (Purchase insurance in advance) (2) Dec. 31

36,000 36,000

Debit

Insurance Expense Prepaid Insurance (Adjust prepaid insurance)

Credit

30,000 30,000

= $3,000 per month x 10 months (Mar. – Dec.)

(3)

Prepaid Insurance

Insurance Expense $

Jan. 1

Beginning balance

Mar. 1

Payment

36,000

Adjustment Insurance expired during year

(30,000)

30,000

Dec. 31

$ 6,000

$30,000

Ending balance

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-9 (LO 3-3) (1) Apr. 1

Debit

Equipment Cash (Purchase equipment)

Credit

50,400 50,400

(2) Dec. 31

Debit

Depreciation Expense Accumulated Depreciation (Adjust accumulated depreciation)

Credit

5,400 5,400

= $600 per month x 9 months (Apr. – Dec.)

(3) Jan. 1

Beginning balance

Accumulated Depreciation

Depreciation Expense

Adjustment Depreciation during year

5,400

Dec. 31

$5,400

Ending balance

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-10 (LO 3-3) (1) Nov. 1 Cash

Debit

Credit

6,000 Deferred Revenue (Receive cash in advance from customer)

6,000

(2) Dec. 31

Debit

Deferred Revenue Service Revenue (Adjust deferred revenue)

Credit

4,000 4,000

= $2,000 per month x 2 months (Nov. and Dec.)

Deferred Revenue

(3) Jan. 1

Beginning balance

Nov. 1

Cash received

6,000

Adjustment Revenue recognized during year

(4,000)

4,000

Dec. 31

$2,000

$4,000

Ending balance

Service Revenue $

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-11 (LO 3-3) (1) Dec. 31, 2021

Debit

Credit

Salaries Expense 1,200 Salaries Payable 1,200 (Record salaries owed at December 31; $400 per day x 3 days [Dec. 29 – 31] = $1,200) Salaries Payable

(2) Jan. 1, 2021

Beginning balance

$ 0

Adjustment

Salaries incurred but not paid

1,200

Dec. 31, 2021 Ending balance

$1,200

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-12 (LO 3-3) (1) Jul. 1, 2021

Debit

Cash

15,000 Notes Payable (Borrow cash)

(2) Dec. 31, 2021

15,000

Debit

Interest Expense Interest Payable (Record interest payable)

Credit

900 900

= $150 (or 1% of $15,000) per month x 6 months (Jul. – Dec.)

(3)

Interest Payable

Interest Expense

Jan. 1, 2021

Beginning balance

$ 0

Adjustment

Interest incurred but not paid

900

$900

Dec. 31, 2021 Ending balance

Brief Exercise 3-13 (LO 3-3) (1) Jul. 1, 2021 Notes Receivable Cash (Lend cash) (2) Dec. 31, 2021 Interest Receivable Interest Revenue (Record interest receivable)

Debit

Credit

15,000 15,000

Debit

Credit

900 900

= $150 (or 1% of $15,000) per month x 6 months (Jul. – Dec.)

Chapter 3 - The Accounting Cycle: End of the Period

(3)

Interest Receivable

Interest Revenue

Jan. 1, 2021

Beginning balance

$ 0

Adjustment

Interest earned but not received

900

$900

Dec. 31, 2021 Ending balance

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-14 (LO 3-5) Account

Financial Statement

1. Accounts Receivable

Balance Sheet

2. Deferred Revenue

Balance Sheet

3. Supplies Expense

Income Statement

4. Salaries Payable

Balance Sheet

5. Depreciation Expense

Income Statement

6. Service Revenue

Income Statement

Brief Exercise 3-15 (LO 3-5) 1. (b) 2. (d) 3. (a) 4. (c)

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-16 (LO 3-5) Beavers Corporation Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Supplies Rent Depreciation Delivery Total expenses Net income

$275,000 110,000 20,000 26,000 44,000 18,000 218,000 $ 57,000

Brief Exercise 3-17 (LO 3-5) Spiders Corporation Statement of Stockholders’ Equity For the year ended December 31, 2021

Balance at January 1 Issuance of common stock Add: Net income for 2021 Less: Dividends Balance at December 31

Common Stock

Retained Earnings

$30,000 0

$ 8,000

$30,000

3,000 * (1,000) $10,000

Total Stockholders’ Equity $38,000 0 3,000 (1,000) $40,000

* $3,000 is calculated as total revenues ($28,000) less total expenses ($25,000) for the year.

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-18 (LO 3-5) Blue Devils Corporation Balance Sheet December 31, 2021 Assets Current assets: Cash $ 5,000 Accounts receivable 9,000 Supplies 19,000 Total current assets 33,000 Long-term assets: Equipment Accumulated depr.

120,000 (45,000)

Total assets

$108,000

Assets $108,000 $108,000

= = −

Liabilities $42,000 $42,000

+ + −

Liabilities Current liabilities: Accounts payable Salaries payable Total current liabilities

$ 26,000 16,000 42,000

Stockholders’ Equity Common stock 60,000 Retained earnings 6,000 * Total stockholders’ equity 66,000 Total liabilities and stockholders’ equity $108,000 Stockholders’ equity ($60,000 + Retained earnings) $60,000 = Retained earnings $6,000 = Retained earnings

Chapter 3 - The Accounting Cycle: End of the Period

Brief Exercise 3-19 (LO 3-6) December 31

Debit

Credit

Service Revenue Retained Earnings (Close revenue accounts)

900,000

Retained Earnings Salaries Expense Rent Expense Interest Expense (Close expense accounts)

625,000

Retained Earnings Dividends (Close dividends account)

60,000

900,000

390,000 150,000 85,000

60,000

Brief Exercise 3-20 (LO 3-7) Hilltoppers Corporation Post-Closing Trial Balance Accounts Cash Equipment Accounts Payable Common Stock Retained Earnings Totals

Debit $ 5,000 17,000

16,000

$ 3,000 11,000 8,000 * $22,000

$22,000

* Retained Earnings + Revenues − Expenses (before closing) 8,100

Credit

−

15,000

− Dividends

−

1,100

Retained Earnings (after closing) 8,000

Chapter 3 - The Accounting Cycle: End of the Period

EXERCISES Exercise 3-1 (LO 3-1) 1. August 16. 2. January 27. 3. April 2. 4. Revenue would be recognized as each magazine is delivered.

Exercise 3-2 (LO 3-1) 1. August 16. 2. January 27. 3. One month’s worth of insurance expense is recorded each month. 4. February 4.

Exercise 3-3 (LO 3-2) 1. June 12. 2. February 2. 3. April 2. 4. July 1.

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-4 (LO 3-2) 1. September 2. 2. January 6. 3. January 1. 4. February 23.

Exercise 3-5 (LO 3-1) Net income (unadjusted)

$100,000

1. Record insurance expense of $2,000 per month

(6,000)

2. Reclassify service revenue as deferred revenue (liability)

(4,000)

3. Reclassify supplies expense as supplies (asset)

2,750

4. Record interest expense of $525 per month (9%/12 of $70,000)

(2,100)

Net income (adjusted)

$ 90,650

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-6 (LO 3-3, 3-4, 3-5, 3-6, 3-7) (i) Use source documents to identify accounts affected by external transactions. (g) Analyze the impact of the transaction on the accounting equation. (h) Assess whether the transaction results in a debit or a credit to the account balance. (c) Record the transaction. (b) Post the transaction to the T-account in the general ledger. (f) Prepare a trial balance. (a) Record and post adjusting entries. (d) Prepare financial statements (income statement, statement of stockholders’ equity, balance sheet, and statement of cash flows). (e) Record and post closing entries.

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-7 (LO 3-3) (1)

Debit

Credit

Supplies Expense Supplies (Supplies used during December)

3,000

(2)

Debit

Insurance Expense Prepaid Insurance (Reduce prepaid insurance)

2,000

(3)

Debit

Credit

Salaries Expense 16,000 Salaries Payable (Record salaries owed at December 31)

16,000

3,000

Credit 2,000

Note: The November salaries paid in December are not an adjusting entry in December. When those salaries are paid, the Salaries Payable account is reduced and cash is reduced. Thus, the Salaries Payable account is zero at December 31 until the December unpaid salaries are accrued.

(4)

Debit

Deferred Revenue 1,500 Service Revenue (Reduce deferred revenue for rental space used by tenant during December)

Credit 1,500

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-8 (LO 3-3) (1)

Debit

Depreciation Expense 7,000 Accumulated Depreciation (Depreciation expense = $7,000 for the year) (2)

Credit 7,000

Debit

Credit

Interest Receivable 1,750 Interest Revenue (Interest revenue = $50,000 × 0.07 × 6/12)

1,750

(3)

Credit

Debit

Deferred Revenue 4,000 Service Revenue (Recognize revenue for three months of twelve months received in advance; $16,000 × 3/12)

4,000

Exercise 3-9 (LO 3-3) If the adjusting entry is NOT made: Revenues

−

Expenses

Net Income

(1)

−

−$7,000

+$7,000

(2)

−$1,750

−

−$1,750

(3)

−$4,000

−

−$4,000

Total

+$1,250

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-10 (LO 3-3) (1)

Debit

Credit

Deferred Revenue 1,500 Service Revenue (Recognize revenue for one month = $4,500 ÷ 3 = $1,500) (2)

1,500

Debit

Credit

Advertising Expense 900 Prepaid Advertising (Recognize advertising expense for one month; 10 ads used ÷ 30 prepaid = $2,700 × 1/3 = $900 ) (3)

Debit

Salaries Expense Salaries Payable (Record salaries payable)

8,000

(4)

Debit

900

Credit 8,000

Interest Expense 2,100 Interest Payable (Record interest payable; $70,000 × 0.09 × 4/12)

Credit 2,100

Exercise 3-11 (LO 3-3, 3-4) If the adjusting entry is NOT made: Assets

Liabilities

Stockholders’ Equity

(1)

+$1,500

−$1,500

(2)

+$900

(3)

−$8,000

+$8,000

(4)

−$2,100

+$2,100

Chapter 3 - The Accounting Cycle: End of the Period

Total

+$900

−$8,600

+$9,500

Exercise 3-12 (LO 3-3) (1)

Debit

Deferred Revenue 2,000 Service Revenue (Recognize revenue for one month = $4,000 ÷ 2 months received = $2,000) (2)

Credit 2,000

Debit

Credit

Insurance Expense 6,600 Prepaid Insurance (Recognize insurance expense for 6 months)

6,600

(3)

Debit

Credit

Salaries Expense 3,000 Salaries Payable (Record salaries owed at December 31)

3,000

(4)

Credit

Debit

Interest Expense 250 Interest Payable (Record interest expense; $15,000 × 0.10 × 2/12 = $250) (5)

Debit

Supplies Expense 3,900 Supplies (Office supplies used during year; $1,000 + $3,400 – $500 = $3,900)

250

Credit 3,900

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-13 (LO 3-3) (1)

Debit

Interest Receivable 270 Interest Revenue (Record interest revenue not received; $9,000 × 0.12 × 3/12 = $270) (2)

Debit

Rent Expense 3,000 Prepaid Rent (Reduce prepaid rent for two months used of three months prepaid; $4,500 × 2/3 =$3,000 ) (3)

Debit

Deferred Revenue 5,500 Service Revenue (Recognize revenue for five months of 12 months collected in advance; $13,200 × 5/12 ) (4)

Credit 270

Credit 3,000

Credit 5,500

Debit

Credit

Depreciation Expense 5,500 Accumulated Depreciation (Depreciation expense = $5,500 for year)

5,500

Debit

Credit

Salaries Expense 5,000 Salaries Payable (Record salaries owed at December 31)

5,000

(6)

Credit

Debit

Supplies Expense 3,500 Supplies (Supplies used during year; $1,500 + $5,500 – $3,500 = $3,500)

3,500

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-14 (LO 3-3, 3-4) Requirement 1 (1)

Debit

Rent Expense 2,400 Prepaid Rent (Adjust prepaid rent to recognize two months used of six months prepaid = $7,200 × 2/6 = $2,400)

Credit 2,400

(2)

Debit

Credit

Deferred Revenue Service Revenue (Adjust deferred revenue for service provided)

750

(3)

Debit

Credit

Salaries Expense 700 Salaries Payable (Record salaries owed at December 31)

700

(4)

Credit

750

Debit

Supplies Expense 3,200 Supplies (Supplies used during year; $1,700 + $2,300 – $800 = $3,200)

3,200

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-14 (concluded) Requirement 2 Demon Deacons Corporation Adjusted Trial Balance December 31, 2021 Accounts Debit Cash $ 10,000 Accounts Receivable 15,000 Prepaid Rent 4,800 Supplies 800 Deferred Revenue Salaries Payable Common Stock Retained Earnings Service Revenue Salaries Expense 35,700 Rent Expense 2,400 Supplies Expense 3,200 Totals $71,900

Credit

$ 2,250 700 11,000 6,000 51,950

$71,900

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-15 (LO 3-5)

Year 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Volunteers Inc. (in millions) Net Retained Income (Loss) Earnings — $ 0 $ 30 30 (7) 23 41 64 135 199 30 229 (131) 98 577 675 359 1,034 360 1,394

Raiders Inc. (in millions) Net Retained Income (Loss) Earnings $ 35 $ 11 (43) (32) 63 31 63 94 102 196 135 331 (42) 289 74 363 110 473 162 635

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-16 (LO 3-5) Requirement 1

Fightin’ Blue Hens Corporation Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Rent Depreciation Interest Total expenses Net income

$500,000 400,000 20,000 40,000 5,000 465,000 $ 35,000

Requirement 2

Fightin’ Blue Hens Corporation Statement of Stockholders’ Equity For the period ended December 31, 2021

Balance at July 1 Issuance of common stock Add: Net income for 2021 Less: Dividends Balance at December 31

Common Stock

Retained Earnings

$300,000 0

$60,000

$300,000

35,000 (0) $95,000

Total Stockholders’ Equity $360,000 0 35,000 (0) $395,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-16 (concluded) Requirement 3

Fightin’ Blue Hens Corporation Balance Sheet December 31, 2021

Assets Current assets: Cash Accounts receivable Prepaid rent Supplies Total current assets

$ 12,000 150,000 6,000 30,000 198,000

Long-term assets: Equipment Accumulated depr.

400,000 (135,000)

Total assets

$463,000

Liabilities Current liabilities: Accounts payable $ 12,000 Salaries payable 11,000 Interest payable 5,000 Total current liabilities 28,000 Notes payable 40,000 Total liabilities 68,000 Stockholders’ Equity Common stock 300,000 Retained earnings 95,000 * Total stockholders’ equity 395,000 Total liabilities and stockholders’ equity $463,000

Retained earnings = Beginning retained earnings + Net income − Dividends = $60,000 + $35,000 − $0 = $95,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-17 (LO 3-6) Requirement 1

December 31, 2021

Debit

Service Revenue Interest Revenue Retained Earnings (Close revenue accounts)

50,000 6,000

Retained Earnings Salaries Expense Rent Expense Advertising Expense Depreciation Expense Interest Expense (Close expense accounts)

40,000

Retained Earnings Dividends (Close dividends account)

3,000

Credit

56,000

15,000 6,000 3,000 11,000 5,000

3,000

Requirement 2 Retained Earnings 30,000 40,000

56,000

3,000 43,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-18 (LO 3-6) Requirement 1

December 31, 2021

Debit

Service Revenue Retained Earnings (Close revenue accounts)

54,000

Retained Earnings Salaries Expense Advertising Expense Rent Expense Utilities Expense (Close expense accounts)

51,000

Retained Earnings Dividends (Close dividends account)

4,000

Credit 54,000

20,000 13,000 10,000 8,000

4,000

Requirement 2 Retained Earnings 9000 51,000

54,000

4,000 8,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-18 (concluded) Requirement 3 Laker Incorporated Post-Closing Trial Balance December 31, 2021 Accounts Cash Supplies Prepaid Rent Accounts Payable Notes Payable Common Stock Retained Earnings Totals

Debit $12,000 39,000 30,000

$81,000

Credit

$ 3,000 30,000 40,000 8,000 $81,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-19 (LO 3-6, 3-7) Requirement 1 December 31, 2021

Debit

Credit

Service Revenue Retained Earnings (Close revenue accounts)

500,000

Retained Earnings Salaries Expense Rent Expense Depreciation Expense Interest Expense (Close expense accounts)

465,000

Requirement 2

500,000

400,000 20,000 40,000 5,000

Fightin’ Blue Hens Corporation Post-Closing Trial Balance December 31, 2021

Accounts Cash Accounts Receivable Prepaid Rent Office Supplies Equipment Accumulated Depreciation Accounts Payable Salaries Payable Interest Payable Notes Payable Common Stock Retained Earnings Totals

Debit $ 12,000 150,000 6,000 30,000 400,000

$598,000

Credit

$135,000 12,000 11,000 5,000 40,000 300,000 95,000 $598,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-20 (LO 3-3, 3-4, 3-5, 3-6, 3-7) Requirement 1 February 15

Debit

1. Cash Common Stock (Issue shares of common stock) May 20

20,000

2. Cash Accounts Receivable Service Revenue (Provide services to customers for cash and on account) August 31

35,000 30,000

3. Salaries Expense Cash (Pay salaries to employees) October 1

23,000

4. Prepaid Rent Cash (Pay for one-year of rental space) November 17

12,000

5. Supplies Accounts Payable (Purchase supplies on account) December 30

22,000

6. Dividends Cash (Pay dividends)

2,000

Credit 20,000

65,000

23,000

12,000

22,000

2,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-20 (continued) Requirement 2 December 31

Debit

Credit

1. Salaries Expense 4,000 Salaries Payable (Record salaries owed at December 31)

4,000

2. Rent Expense 3,000 Prepaid Rent (Reduce prepaid rent for three months used = $12,000 × 3/12 = $3,000) 3. Supplies Expense 25,000 Supplies (Supplies used during year = $8,000 + $22,000 – $5,000 = $25,000) 4. Deferred Revenue Service Revenue (Reduce deferred revenue for services performed)

3,000

25,000

5,000 5,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-20 (continued) Requirement 3

Red Flash Photography Adjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Prepaid Rent Land Accounts Payable Salaries Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Rent Expense Supplies Expense Total

Debit $ 30,000 30,000 5,000 9,000 60,000

Credit

$ 22,000 4,000 70,000 25,000 2,000 70,000 27,000 3,000 25,000 $191,000

$191,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-20 (continued) Requirement 4

Red Flash Photography Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Rent Supplies

$70,000

Total expenses Net income

55,000 $15,000

27,000 3,000 25,000

Red Flash Photography Statement of Stockholders’ Equity For the period ended December 31, 2021

Balance at January 1 Issuance of common stock Add: Net income for 2021 Less: Dividends Balance at December 31

Common Stock

Retained Earnings

$50,000 20,000

$25,000

$70,000

15,000 (2,000) $38,000

Total Stockholders’ Equity $ 75,000 20,000 15,000 (2,000) $108,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-20 (continued) Requirement 4 (continued)

Red Flash Photography Balance Sheet December 31, 2021 Assets Current assets: Cash $ 30,000 Accounts receivable 30,000 Supplies 5,000 Prepaid rent 9,000 Total current assets 74,000 Long-term assets: Land 60,000 Total assets

$134,000

Liabilities Current liabilities: Accounts payable $ 22,000 Salaries payable 4,000 Total current liabilities 26,000 Stockholders’ Equity Common stock 70,000 Retained earnings 38,000 Total stockholders’ equity 108,000 Total liabilities and stockholders’ equity $134,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-20 (concluded) Requirement 5 December 31, 2021

Debit

Service Revenue Retained Earnings (Close revenue accounts)

70,000

Retained Earnings Salaries Expense Rent Expense Supplies Expense (Close expense accounts)

55,000

Retained Earnings Dividends (Close dividends account)

2,000

Credit 70,000

27,000 3,000 25,000

2,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-21 Requirement 1

January 2 Prepaid Rent Cash (Pay for one year of rent in advance)

Debit 6,000

Credit

January 9 Supplies Accounts Payable (Purchase supplies on account)

Debit 3,500

Credit

January 13 Accounts Receivable Service Revenue (Provide services on account)

Debit 25,500

Credit

6,000

3,500

25,500

January 17 Debit Cash 3,700 Deferred Revenue (Receive cash in advance from customers)

Credit

January 20 Salaries Expense Cash (Pay cash for salaries)

Debit 11,500

Credit

January 22 Cash Accounts Receivable (Receive cash on account)

Debit 24,100

January 29 Accounts Payable Cash (Pay cash on account)

Debit 4,000

3,700

11,500 Credit 24,100 Credit 4,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-21 (continued) Requirement 2 (a) January 31 Debit Rent Expense 500 Prepaid Rent (Reduce prepaid rent for one month used of twelve months prepaid)

Credit

(b) January 31 Supplies Expense Supplies (Supplies used during January; $3,100+$3,500−$2,800 = $3,800)

Credit

Debit 3,800

500

3,800

Credit

(d) January 31 Salaries Expense Salaries Payable (Record salaries owed at January 31)

Credit

Debit 5,800

3,200

5,800

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-21 (continued) Requirement 3 Dynamite Fireworks Adjusted Trial Balance January 31, 2021 Accounts Debit Cash $ 30,100 Accounts Receivable 6,600 Supplies 2,800 Prepaid Rent 5,500 Land 50,000 Accounts Payable Deferred Revenue Salaries Payable Common Stock Retained Earnings Service Revenue Salaries Expense 17,300 Rent Expense 500 Supplies Expense 3,800 Totals $116,600

Credit

$ 2,700 500 5,800 65,000 13,900 28,700

$116,600

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-21 (continued) Requirement 3 (continued) Accounts Cash Accounts Receivable Supplies Prepaid Rent Land Accounts Payable Deferred Revenue Salaries Payable Common Stock Retained Earnings Service Revenue Salaries Expense Rent Expense Supplies Expense

Ending Balance 30,100 6,600 2,800 5,500 50,000 2,700 500 5,800 65,000 13,900 28,700 17,300 500 3,800

= = = = = = = = = = = = = =

Beginning balance in bold, entries during January in blue, and adjusting entries in red. 23,800−6,000+3,700−11,500+24,100−4,000 5,200+25,500−24,100 3,100+3,500−3,800 6,000−500 50,000 3,200+3,500−4,000 3,700−3,200 5,800 65,000 13,900 25,500+3,200 11,500+5,800 500 3,800

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-21 (continued) Requirement 4 Dynamite Fireworks Income Statement For the year ended January 31, 2021 Revenues: Service revenue $28,700 Expenses: Salaries Expense 17,300 Rent Expense 500 Supplies Expense 3,800 Total expenses 21,600 Net income Requirement 5

Assets Current assets: Cash Accounts Receivable Supplies Prepaid Rent Total current assets

$ 7,100

Dynamite Fireworks Balance Sheet January 31, 2021 $30,100 6,600 2,800 5,500 45,000

Long-term assets: Land

50,000

Total assets

$95,000

Liabilities Current liabilities Accounts payable $ 2,700 Deferred revenue 500 Salaries payable 5,800 Total current liabilities 9,000 Stockholders’ Equity Common stock 65,000 Retained earnings 21,000 * Total stockholders’ equity 86,000 Total liabilities and stockholders’ equity $95,000

* Retained earnings = Beginning retained earnings + Net income − Dividends = $13,900 + $7,000 − $0 = $21,000

Chapter 3 - The Accounting Cycle: End of the Period

Exercise 3-21 (concluded) Requirement 6 January 31, 2021 Service Revenue Retained Earnings (Close revenue accounts)

Debit 28,700

Retained Earnings Salaries Expense Rent Expense Supplies Expense (Close expense accounts)

21,600

Credit 28,700

17,300 500 3,800

Requirement 7 (a) Profit is the amount of net income reported in the income statement = $7,100. (b) Currents assets ($45,000) divided by current liabilities ($9,000) = 5.00. (c) Profits greater than zero indicate a company’s ability to generate revenues from its customers in excess of the costs of providing services to those customers and operating the business. For the month of January, Dynamite Fireworks recognizes revenues from customers of $28,700, while costs (or expenses) associated with those revenues are only $21,600. The difference is a profit of $7,100. A positive amount for profit generally is a sign of the company’s success. Current assets represent cash, items expected to be converted to cash within one year (accounts receivable), or items that benefit the company within the next year (supplies and prepaid rent). Current liabilities are amounts due within the next year. At the end of January, Dynamite Fireworks’ current assets are five times its current liabilities (5.00), which would suggest that the company will be able to pay obligations as they come due. Based on its profit and its ratio of current assets to current liabilities, Dynamite Fireworks appears to be in good financial condition.

Chapter 3 - The Accounting Cycle: End of the Period

PROBLEMS: SET A Problem 3-1A (LO 3-1, 3-2) Transaction 1. Receive cash from customers in advance, $600. 2. Pay utilities bill for the previous month, $150. 3. Pay for insurance one year in advance, $2,000. 4. Pay workers’ salaries for the current month, $800. 5. Incur costs for employee salaries in the current month but do not pay, $1,000. 6. Receive cash from customers at the time of service, $1,700. 7. Purchase office supplies on account, $330. 8. Borrow cash from the bank, $4,000. 9. Receive cash from customers for services performed last month, $750. 10. Pay for advertising to appear in the current month, $450.

Accrual-Basis Revenue Expense

Cash-Basis Revenue Expense

$600

$150

$2,000

$800

$1,000

$1,700

$0 $0

$750

$450

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-2A (LO 3-1, 3-2) Minutemen Law Services Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Supplies Rent Insurance Utilities Total expenses Net income

$73,000a 37,700b 7,000c 5,000d 3,300e 3,000f 56,000 $17,000

a $70,000 (cash from customers) + $3,000 (increase in accounts receivable) = $73,000 b $36,000 (cash paid for salaries) + $1,700 (increase in salaries payable) = $37,700 c $4,000 (cash paid for supplies) + $3,000 (decrease in supplies) = $7,000 d $5,000 (cash paid for rent) +/− $0 (decrease/increase in prepaid rent) = $5,000 e $7,000 (cash paid for insurance) − $3,700 (increase in prepaid insurance) = $3,300 f $3,000 (cash paid for utilities) +/− $0 (increase/decrease in utilities payable) = $3,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-3A (LO 3-3) (1)

Debit

Deferred Revenue 3,600 Service Revenue (Reduce deferred revenue for six months provided of ten months revenue received in advance; $60,000 × 6/10 = $3,600) (2)

Debit

Depreciation Expense 7,000 Accumulated Depreciation (Record depreciation expense for year; $28,000 ÷ 4 = $7,000) (3)

Debit

Insurance Expense 1,600 Prepaid Insurance (Reduce prepaid insurance for eight months used of twenty-four months prepaid; $4,800 × 8/24 = $1,600) (4)

Debit

Interest Expense 800 Interest Payable (Record interest expense for four months not yet paid; $20,000 × 0.12 × 4/12 = $800) (5)

Debit

Supplies Expense 1,700 Supplies (Supplies used during year; $2,700 – $1,000 = $1,700)

Credit 3,600

Credit 7,000

Credit 1,600

Credit 800

Credit 1,700

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-4A (LO 3-3) (1)

Debit

Insurance Expense 3,000 Prepaid Insurance (Reduce prepaid insurance for six months used of thirty-six months paid in advance; $18,000 × 6/36 = $3,000) (2)

Credit 3,000

Debit

Credit

Salaries Expense 25,000 Salaries Payable (Record salaries owed at December 31)

25,000

(3)

Credit

Debit

Deferred Revenue 4,000 Service Revenue (Reduce deferred revenue for completion of four custom bikes of six custom bikes paid for in advance; $6,000 × 4/6 = $4,000) (4)

Debit

4,000

Credit

Supplies Expense 16,000 Supplies 16,000 (Supplies used during year; $2,000 + $18,000 − $4,000 = $16,000) (5)

Debit

Credit

Advertising Expense 3,000 Prepaid Advertising 3,000 (Reduce prepaid advertising for one month used of four months prepaid; $12,000 × ¼ = $3,000) (6)

Debit

Credit

Interest Expense 3,000 Interest Payable 3,000 (Record ten months interest expense not yet paid; ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 3-52 Financial Accounting, 5e

Chapter 3 - The Accounting Cycle: End of the Period

$36,000 × 10% × 10/12 = $3,000)

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-5A (LO 3-5) Boilermaker Unlimited Income Statement For the year ended December 31, 2021 Service revenues: New construction Remodel Total revenues Expenses: Salaries Supplies Depreciation Insurance Utilities Interest Service fee Total expenses Net income

$450,000 280,000 730,000 160,000 285,000 50,000 25,000 42,000 9,000 73,000 644,000 $ 86,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-5A (concluded)

Boilermaker Unlimited Statement of Stockholders’ Equity For the year ended December 31, 2021

Balance at January 1 Issuance of common stock Add: Net income for 2021 Less: Dividends Balance at December 31

Common Stock

Retained Earnings

$170,000 30,000

$ 31,000

$200,000

86,000 (26,000) $91,000

Total Stockholders’ Equity $201,000 30,000 86,000 (26,000) $291,000

Boilermaker Unlimited Balance Sheet December 31, 2021 Assets Current assets: Cash $ 16,000 Accounts receivable 25,000 Supplies 32,000 Prepaid insurance 7,000 Total current assets 80,000 Long-term assets: Equipment Accumulated depr.

625,000 (200,000)

Total assets

$505,000

Liabilities Current liabilities: Accounts payable $ 31,000 Salaries payable 28,000 Utilities payable 5,000 Total current liabilities 64,000 Notes payable 150,000 Total Liabilities 214,000 Stockholders’ Equity Common stock 200,000 Retained earnings 91,000 Total stockholders’ equity 291,000 Total liabilities and stockholders’ equity $505,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-6A (LO 3-6, 3-7) Requirement 1 December 31

Debit

Credit

Service Revenue Retained Earnings (Close revenue accounts)

77,500

Retained Earnings Salaries Expense Utilities Expense Insurance Expense Supplies Expense (Close expense accounts)

62,100

Retained Earnings Dividends (Close dividends account)

6,000

77,500

46,000 8,200 5,800 2,100

6,000

Requirement 2 Rattlers Tax Services Post-Closing Trial Balance Accounts Cash Accounts Receivable Land Accounts Payable Common Stock Retained Earnings Totals

Debit $ 4,700 7,200 115,000

$126,900

Credit

$ 3,000 90,000 33,900 $126,900

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7A (LO 3-4, 3-5, 3-6, 3-7)

Requirements 1 and 2 (adjusting entries posted in red) Cash Accounts Receivable 10,300

9,500

Supplies 2,000 1,300

10,300

9,500

Interest Receivable

Prepaid Rent

700 Land

7,200

800 800

78,000 5,400

1,800

Notes Receivable

78,000

20,000

Accounts Payable 7,700

20,000

7,700

Utilities Payable 0 200

Deferred Revenue

24,500 2,100 26,600

Common Stock

5,300

79,000

2,000

79,000

Service Revenue

Interest Revenue

0 42,200 3,300 45,500

19,700 19,700 Salaries Expense

0 2,100 2,100

3,300

200 Retained Earnings

Salaries Payable

Utilities Expense 2,400 200 2,600

0 800 800 Rent Expense 0 5,400 5,400

Supplies Expense 0 1,300 1,300 ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. Solutions Manual, Chapter 3 3-57

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7A (continued) Requirement 3

Crimson Tide Music Academy Adjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Interest Receivable Supplies Prepaid Rent Land Notes Receivable Accounts Payable Salaries Payable Deferred Revenue Utilities Payable Common Stock Retained Earnings Service Revenue Interest Revenue Salaries Expense Rent Expense Supplies Expense Utilities Expense Total

Debit $ 10,300 9,500 800 700 1,800 78,000 20,000

Credit

$ 7,700 2,100 2,000 200 79,000 19,700 45,500 800 26,600 5,400 1,300 2,600 $157,000

$157,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7A (continued) Requirement 4

Crimson Tide Music Academy Income Statement For the year ended December 31, 2021 Revenues: Service Interest Total revenues Expenses: Salaries Rent Supplies Utilities

$45,500 800 46,300 26,600 5,400 1,300 2,600

Total expenses Net income (Loss)

35,900 $10,400

Crimson Tide Music Academy Statement of Stockholders’ Equity For the year ended December 31, 2021

Balance at January 1 Issuance of common stock Less: Net income for 2021 Less: Dividends Balance at December 31

Common Stock

Retained Earnings

$79,000 0

$19,700

$79,000

10,400 (0) $30,100

Total Stockholders’ Equity $ 64,000 0 10,400 (0) $109,100

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7A (continued)

Crimson Tide Music Academy Balance Sheet December 31, 2021 Assets Current assets: Cash $ 10,300 Accounts receivable 9,500 Interest receivable 800 Supplies 700 Prepaid rent 1,800 Total current assets 23,100

Liabilities Current liabilities: Accounts payable Salaries payable Deferred revenue Utilities payable Total current liabilities

Long-term assets: Land Notes receivable

Stockholders’ Equity Common stock 79,000 Retained earnings 30,100 Total stockholders’ equity 109,100 Total liabilities and stockholders’ equity $121,100

Total assets

78,000 20,000 98,000 $121,100

$ 7,700 2,100 2,000 200 12,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7A (continued) Requirement 5 December 31, 2021

Debit

Service Revenue Interest Revenue Retained Earnings (Close revenue accounts)

45,500 800

Retained Earnings Salaries Expense Rent Expense Supplies Expense Utilities Expense (Close expense accounts)

35,900

Credit

46,300

26,600 5,400 1,300 2,600

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7A (concluded) Requirement 6 (closing entries posted in red) Retained Earnings Service Revenue 19,700 35,900

46,300 30,100

Interest Revenue

42,200 45,500

3,300 0

800

800 0

Salaries Expense

Rent Expense

24,500 2,100

0 5,400

26,600

5,400

Supplies Expense 0 1,300

1,300

Utilities Expense 2,400 200

2,600

Requirement 7

Crimson Tide Music Academy Post-Closing Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Interest Receivable Supplies Prepaid Rent Land Notes Receivable Accounts Payable Salaries Payable Deferred Revenue Utilities Payable Common Stock Retained Earnings Total

Debit $ 10,300 9,500 800 700 1,800 78,000 20,000

$121,100

Credit

$ 7,700 2,100 2,000 200 79,000 30,100 $121,100

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (LO 3-3, 3-4, 3-5, 3-6, 3-7) Requirement 1 Cash 20,000 20,000

Accounts Receivable 8,000 8,000

Equipment

Salaries Payable

5,000 5,000

7,500 7,500

Retained Earnings

Service Revenue

25,000 25,000 Dividends 0 0 Depr. Expense 0 0

4,000 4,000

Accumulated Depr.

15,000 15,000 Common Stock

Supplies

9,500 9,500 Salaries Expense 0 0

0 0 R&M Expense 0 0

Supplies Expense 0 0

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (continued) Requirement 2 (1) March 12

Debit

Credit

Accounts Receivable 21,000 Cash 39,000 Service Revenue (Service revenue on account and for cash) (2) May 2 Debit

60,000

Cash

18,000

Accounts Receivable (Collect on account) (3) June 30

Debit

Cash

6,000

Common Stock (Issue common stock) (4) August 1 Salaries Payable Cash (Pay for past salaries) (5) September 25

Credit 18,000 Credit 6,000

Debit

Credit

7,500 7,500 Debit

Repairs and Maintenance Expense 13,000 Cash (Pay repairs and maintenance expenses) (6) October 19 Debit Equipment Cash (Purchase equipment) (7) December 30

8,000

Dividends Cash (Pay dividends)

1,100

Credit 13,000 Credit 8,000

Debit

Credit 1,100

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (continued) Requirement 3 (entries posted in red) Cash Accounts Receivable 20,000 39,000 18,000 6,000 53,400

7,500 13,000 8,000 1,100

8,000 21,000

18,000 4,000

Accumulated Depr.

Salaries Payable

5,000

7,500

15,000 8,000 23,000

7,500 5,000

Common Stock

Dividends 0 1,100 1,100 Depr. Expense

Retained Earnings

Service Revenue

9,500

0 60,000 60,000

25,000 6,000 31,000

0 0

4,000

11,000

Equipment

Supplies

9,500 Salaries Expense 0 0

R&M Expense 0 13,000 13,000

Supplies Expense 0 0

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (continued) Requirement 4 Red Storm Cleaners Unadjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Equipment Accumulated Depreciation Salaries Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Repairs and Main. Expense Depreciation Expense Supplies Expense Total Requirement 5 December 31

Debit $ 53,400 11,000 4,000 23,000

Credit

$ 5,000 0 31,000 9,500 1,100 60,000 0 13,000 0 0 $105,500

$105,500

Debit

Credit

Salaries Expense 19,600 Salaries Payable (Record salaries owed at December 31)

19,600

Depreciation Expense 5,000 Accumulated Depreciation (Record depreciation expense for the year)

5,000

Supplies Expense 2,800 Supplies (Supplies used during year; $4,000 – $1,200 = $2,800)

2,800

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (continued) Requirement 6 (adjusted entries posted in red) Cash Accounts Receivable 20,000 39,000 18,000 6,000 53,400

7,500 13,000 8,000 1,100

8,000 21,000

4,000 18,000

11,000

Equipment

1,200 Salaries Payable

5,000

7,500

5,000 10,000

23,000

0 1,100

7,500

19,600 19,600

Retained Earnings

Service Revenue

9,500

0 60,000 60,000

25,000 6,000 31,000 Dividends

2,800

Accumulated Depr.

15,000 8,000

Common Stock

Supplies

9,500 Salaries Expense 0

1,100

19,600 19,600

Depr. Expense

Supplies Expense

5,000 5,000

2,800 2,800

R&M Expense 0 13,000 13,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (continued) Requirement 7

Red Storm Cleaners Adjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Equipment Accumulated Depreciation Salaries Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Repairs and Main. Expense Depreciation Expense Supplies expense Total

Debit $ 53,400 11,000 1,200 23,000

Credit

$ 10,000 19,600 31,000 9,500 1,100 60,000 19,600 13,000 5,000 2,800 $130,100

$130,100

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (continued) Requirement 8

Red Storm Cleaners Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Repairs and main. Depreciation Supplies

$60,000

Total expenses Net income

40,400 $19,600

19,600 13,000 5,000 2,800

Red Storm Cleaners Balance Sheet December 31, 2021 Assets Current assets Cash Accounts receivable Supplies Total current assets Long-term assets: Equipment Accumulated depr. Total assets *

$53,400 11,000 1,200 65,600 23,000 (10,000) $78,600

Liabilities Current liabilities. Salaries payable

$19,600

Stockholders’ Equity Common stock 31,000 Retained earnings 28,000 * Total stockholders’ equity 59,000 Total liabilities and stockholders’ equity $78,600

Retained earnings = Beginning retained earnings + Net income − Dividends = $9,500 + $19,600 − $1,100 = $28,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (continued) Requirement 9 December 31

Debit

Service Revenue Retained Earnings (Close revenue accounts)

60,000

Retained Earnings Salaries Expense Repairs and Main. Expense Depreciation Expense Supplies Expense (Close expense accounts)

40,400

Retained Earnings Dividends (Close dividends account)

1,100

Credit 60,000

19,600 13,000 5,000 2,800

1,100

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (continued) Requirement 10 (closing entries posted in red) Cash 20,000 39,000 18,000 6,000 53,400

Accounts Receivable 7,500 13,000 8,000 1,100

8,000 21,000

4,000 18,000

11,000

Equipment

1,200 Salaries Payable

5,000

7,500

5,000 10,000

23,000

25,000 6,000

2,800

Accumulated Depr.

15,000 8,000

Common Stock

Supplies

7,500

19,600 19,900

Retained Earnings

Service Revenue

9,500

0 60,000

40,400

60,000

1,100 31,000

28,000

Dividends

Salaries Expense

R&M Expense

0 1,100

0 19,600

0 13,000

1,100

Depr. Expense

13,000

Supplies Expense

5,000

2,800 5,000

19,600

2,800 0

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8A (concluded) Requirement 11

Red Storm Cleaners Post-Closing Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Equipment Accumulated Depreciation Salaries Payable Common Stock Retained Earnings Total

Debit $53,400 11,000 1,200 23,000

$88,600

Credit

$10,000 19,600 31,000 28,000 $88,600

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (LO 3-3, 3-4, 3-5, 3-6, 3-7) Requirement 1 Cash

Accounts Receivable

24,600 24,600

15,400 15,400

Supplies

Accounts Payable

148,000 148,000

Deferred Revenue

Service Revenue

6,700 6,700

Common Stock

5,800 5,800

Salaries Expense

Retained Earnings

143,000 143,000 Dividends

0 0

12,000 12,000

Land

0 0

Prepaid Insurance

0 0 Insurance Expense 0 0

44,500 44,500 Property Tax Expense 0 0 Supplies Expense 0 0

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (continued) Requirement 2 (1) January 9 Debit Credit Cash 134,100 Accounts Receivable 52,200 Service Revenue 186,300 (Provide services for cash and on account) (2) February 12 Debit Credit Cash 51,500 Accounts Receivable 51,500 (Collect on account) (3) April 25 Debit Credit Cash 12,900 Deferred Revenue 12,900 (Receive cash in advance from customers) (4) May 6 Debit Credit Supplies 9,200 Accounts Payable 9,200 (Purchase supplies on account) (5) July 15 Debit Credit Property Tax Expense 8,500 Cash 8,500 (Pay property taxes) (6) September 10 Debit Credit Accounts Payable 11,400 Cash 11,400 (Pay on account) (7) October 31 Debit Credit Salaries Expense 123,600 Cash 123,600 (Pay salaries for the current year) (8) November 20 Debit Credit Cash 27,000 Common Stock 27,000 (Issue shares of common stock) (9) December 30 Debit Credit Dividends 2,800 Cash 2,800 (Pay dividends) ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 3-74 Financial Accounting, 5e

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (continued) Requirement 3 (entries posted in red) Cash Accounts Receivable 24,600 134,100 51,500 12,900 27,000 103,800

8,500 11,400 123,600 2,800

15,400 52,200

0 9,200 9,200

51,500

12,000

Land

Accounts Payable

148,000 11,400 148,000

Deferred Revenue

Common Stock

5,800 12,900 18,700 Dividends

Salaries Expense

6,700 9,200 4,500

Retained Earnings

143,000 27,000 170,000

44,500

Service Revenue

Property Tax Expense

0 2,800 2,800

0 123,600 123,600

12,000

16,100

Supplies

Prepaid Insurance

0 186,300 186,300 Insurance Expense

44,500

0 8,500 8,500 Supplies Expense

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (continued) Requirement 4 Zips Storage Unadjusted Trial Balance December 31, 2021 Accounts Debit Cash $103,800 Accounts Receivable 16,100 Prepaid Insurance 12,000 Supplies 9,200 Land 148,000 Accounts Payable Deferred Revenue Common Stock Retained Earnings Dividends 2,800 Service Revenue Property Tax Expense 8,500 Salaries Expense 123,600 Insurance Expense 0 Supplies Expense 0 Total $424,000 Requirement 5 December 31

Credit

$ 4,500 18,700 170,000 44,500 186,300

$424,000

Debit

Credit

Insurance Expense 7,000 Prepaid Insurance 7,000 (Reduce prepaid insurance due to passage of time) Supplies Expense 6,300 Supplies (Supplies used during the year; $0 + $9,200 − $2,900 = $6,300)

6,300

Deferred Revenue 11,800 Service Revenue 11,800 (Provide services to customers who paid in advance)

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (continued) Requirement 6 (adjusted entries posted in red) Cash Accounts Receivable 24,600 134,100 51,500 12,900 27,000 103,800

8,500 11,400 123,600 2,800

Land

Accounts Payable 11,400

148,000 Common Stock

5,800 12,900 6,900

6,700 9,200 4,500

Retained Earnings

143,000 27,000 170,000

44,500

Service Revenue

Property Tax Expense

0 2,800

0 186,300 11,800 198,100

2,800 Salaries Expense

7,000

5,000

6,300

Dividends

0 123,600 123,600

51,500

148,000

Deferred Revenue 11,800

12,000

16,100

Supplies 0 9,200 2,900

15,400 52,200

Prepaid Insurance

Insurance Expense 0 7,000 7,000

44,500

0 8,500 8,500 Supplies Expense 0 6,300 6,300

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (continued) Requirement 7 Zips Storage Adjusted Trial Balance December 31, 2021 Accounts Debit Cash $103,800 Accounts Receivable 16,100 Prepaid Insurance 5,000 Supplies 2,900 Land 148,000 Accounts Payable Deferred Revenue Common Stock Retained Earnings Dividends 2,800 Service Revenue Property Tax Expense 8,500 Salaries Expense 123,600 Insurance Expense 7,000 Supplies Expense 6,300 Total $424,000

Credit

$ 4,500 6,900 170,000 44,500 198,100

$424,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (continued) Requirement 8

Zips Storage Income Statement For the year ended December 31, 2021 Service revenue Expenses: Property Tax Salaries Insurance Supplies

$198,100

Total expenses Net income

145,400 $ 52,700

8,500 123,600 7,000 6,300

Zips Storage Balance Sheet December 31, 2021 Assets Current assets: Cash $103,800 Accounts receivable 16,100 Prepaid Insurance 5,000 Supplies 2,900 Total current assets 127,800 Long-term assets: Land 148,000 Total assets *

$275,800

Liabilities Current liabilities: Accounts Payable $ 4,500 Deferred Revenue 6,900 Total current liabilities 11,400 Stockholders’ Equity Common stock 170,000 Retained earnings 94,400 * Total stockholders’ equity 264,400 Total liabilities and stockholders’ equity $275,800

Retained earnings = Beginning retained earnings + Net income − Dividends = $44,500 + $52,700 − $2,800 = $94,400

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (continued) Requirement 9 December 31

Debit

Service Revenue Retained Earnings (Close revenue accounts)

198,100

Retained Earnings Property Tax Expense Salaries Expense Insurance Expense Supplies Expense (Close expense accounts)

145,400

Retained Earnings Dividends (Close dividends account)

2,800

Credit 198,100

8,500 123,600 7,000 6,300

2,800

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (continued) Requirement 10 (closing entries posted in red) Cash 24,600 134,100 51,500 12,900 27,000 103,800

Accounts Receivable

8,500 11,400 123,600 2,800

6,300

Land 148,000

11,400

Common Stock

6,700 9,200 4,500

Retained Earnings

143,000 27,000

6,900

170,000

94,400

Service Revenue

Property Tax Expense

2,800 198,100

0 Salaries Expense 0 123,600 0

Accounts Payable

5,800 12,900

Dividends 0 2,800

7,000

5,000

148,000

Deferred Revenue 11,800

12,000 51,500

16,100

Supplies 0 9,200 2,900

15,400 52,200

Prepaid Insurance

123,600

0 186,300 11,800 0

Insurance Expense 0 7,000 0

7,000

145,400 2,800

0 8,500

44,500 198,100

8,500

0 Supplies Expense 0 6,300 0

6,300

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9A (concluded) Requirement 11 Zips Storage Unadjusted Trial Balance December 31, 2021 Accounts Debit Cash $103,800 Accounts Receivable 16,100 Prepaid Insurance 5,000 Supplies 2,900 Land 148,000 Accounts Payable Deferred Revenue Common Stock Retained Earnings Total $275,800

Credit

$ 4,500 6,900 170,000 94,400 $275,800

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Chapter 3 - The Accounting Cycle: End of the Period

PROBLEMS: SET B Problem 3-1B (LO 3-1, 3-2) Transaction 1. Receive cash from customers at the time of service, $3,700 2. Issue common stock for cash, $6,000. 3. Receive cash from customers who were previously billed, $1,700 4. Incur utilities cost in the current month but do not pay, $600. 5. Pay workers’ salaries for the current month, $700. 6. Pay for rent one year in advance, $3,600 7. Repay a long-term note to the bank, $3,000. 8. Pay workers’ salaries for the previous month, $850. 9. Pay dividends to stockholders, $500. 10. Purchase office supplies for cash, $540.

Accrual-Basis Revenue Expense

Cash-Basis Revenue Expense

$3,700

$1,700

$600

$700

$3,600

$0 $0

$850 $0

$540

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-2B (LO 3-1, 3-2) Horned Frogs Fine Cooking Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Supplies Repairs and maintenance Insurance Advertising Total expenses Net income

$60,000a 21,600b 7,000c 8,000d 1,500e 6,000f 44,100 $15,900

a $65,000 (cash from customers) − $5,000 (decrease in accounts receivable) = $60,000 b $23,000 (cash paid for salaries) − $1,400 (decrease in salaries payable) = $21,600 c $9,000 (cash paid for supplies) − $2,000 (increase in supplies) = $7,000 d $8,000 (cash paid for maintenance) +/− $0 (increase/decrease in maintenance payable) = $8,000 e $4,000 (cash paid for insurance) − $2,500 (increase in prepaid insurance) = $1,500 f $6,000 (cash paid for advertising) +/− $0 (decrease/increase in prepaid advertising) = $6,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-3B (LO 3-3) (1)

Debit

Depreciation Expense 7,000 Accumulated Depreciation (Record depreciation expense for year) (2) Debit Salaries Expense 4,000 Salaries Payable (Record salaries owed at December 31) (3) Debit Interest Receivable 1,500 Interest Revenue (Record interest revenue for ten months not yet received; $20,000 × 0.09 × 10/12 = $1,500) (4) Debit Insurance Expense 4,950 Prepaid Insurance (Reduce prepaid insurance for nine months used of twenty-four months paid in advance; $13,200 × 9/24 = $4,950) (5) Debit Supplies Expense Supplies (Supplies used during year) (6)

Credit 7,000 Credit 4,000 Credit 1,500

Credit 4,950

Credit

1,700 1,700 Debit

Deferred Revenue 1,800 Service Revenue (Reduce deferred revenue for two months provided of three months revenue received in advance; $2,700 × 2/3 = $1,800) (7) Debit Rent Expense 2,000 Prepaid Rent (Reduce prepaid rent for one month used of three months paid in advance)

Credit 1,800

Credit 2,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-4B (LO 3-3) (1)

Debit

Credit

Interest Expense 1,200 Interest Payable 1,200 (Record interest expense for three months not yet paid; $60,000 × 8% × 3/12) (2)

Debit

Credit

Rent Expense 5,000 Prepaid Rent 5,000 (Reduce prepaid rent for two months used of three months prepaid; $7,500 × 2/3 = $5,000) (3)

Debit

Deferred Revenue 5,000 Service Revenue (Reduce deferred revenue for five months provided of twelve months received in advance; $12,000 × 5/12 = $5,000) (4)

Credit 5,000

Debit

Credit

Depreciation Expense 18,000 Accumulated Depreciation (Record depreciation expense for year)

18,000

(5)

Debit

Credit

Salaries Expense 8,000 Salaries Payable (Record salaries owed at December 31)

8,000

(6)

Credit

Debit

Supplies Expense 57,000 Supplies 57,000 (Supplies used during year; $17,000 + $62,000 − $22,000 = $57,000) ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 3-86 Financial Accounting, 5e

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-5B (LO 3-5) Orange Designs Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Rent Depreciation Supplies Advertising Utilities Interest

$111,900

Total expenses Net income

109,000 $ 2,900

43,000 19,000 8,000 9,000 14,000 13,000 3,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-5B (concluded)

Orange Designs Statement of Stockholders’ Equity For the year ended December 31, 2021

Balance at January 1 Issuance of common stock Add: Net income for 2021 Less: Dividends Balance at December 31

Common Stock

Retained Earnings

$49,000 11,000

$16,000

$60,000

2,900 (0) $18,900

Total Stockholders’ Equity $65,000 11,000 2,900 (0) $78,900

Orange Designs Balance Sheet December 31, 2021 Assets Current assets: Cash $ 6,000 Accounts receivable 5,000 Supplies 3,000 Prepaid rent 7,000 Total current assets 21,000 Long-term assets: Buildings Accum. depr.

120,000 (22,000)

Total assets

$119,000

Liabilities Current liabilities: Accounts payable $ 4,000 Salaries payable 5,000 Utilities payable 1,100 Total current liabilities 10,100 Notes payable 30,000 Total liabilities 40,100 Stockholders’ Equity Common stock 60,000 Retained earnings 18,900 Total stockholders’ equity 78,900 Total liabilities and stockholders’ equity $119,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-6B (LO 3-6, 3-7) December 31

Debit

Credit

Service Revenue Retained Earnings (Close revenue accounts)

89,700

Retained Earnings Salaries Expense Supplies Expense Rent Expense Delivery Expense (Close expense accounts)

73,300

Retained Earnings Dividends (Close dividends account)

7,000

89,700

50,000 10,100 8,500 4,700

7,000

Fighting Illini Post-Closing Trial Balance Accounts Cash Accounts Receivable Land Accounts Payable Common Stock Retained Earnings Totals

Debit $ 7,600 10,200 120,000

$137,800

Credit

$ 5,100 90,000 42,700 $137,800

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7B (LO 3-4, 3-5, 3-6, 3-7)

Requirements 1 and 2 (adjusting entries posted in red) Cash Accounts Receivable 76,000

15,000

Supplies 27,000 22,000

76,000

15,000

Prepaid Insurance 24,000

5,000

Equipment

Accumulated Depr.

95,000

37,000 10,000 47,000

20,000 4,000

95,000

Accounts Payable

Salaries Payable

12,000

0 4,000 4,000

12,000 Interest Payable

Notes Payable

0 1,000 1,000 Retained Earnings 10,000 10,000 Salaries Expense

Deferred Revenue 15,000

45,000 Common Stock

35,000

Dividends

Service Revenue 227,000 15,000 242,000

3,000 3,000 Depreciation Expense

164,000 4,000 168,000

0 10,000 10,000

Supplies Expense

Utilities Expense

0 22,000 22,000

12,000 12,000

60,000

Insurance Expense 0 20,000 20,000 Interest Expense 0 1,000 1,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7B (continued) Requirement 3 Jaguar Auto Company Adjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Prepaid Insurance Equipment Accumulated Depreciation Accounts Payable Salaries Payable Deferred Revenue Interest Payable Notes Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Depreciation Expense Insurance Expense Supplies Expense Utilities Expense Interest Expense Total

Debit $ 76,000 15,000 5,000 4,000 95,000

Credit

$ 47,000 12,000 4,000 45,000 1,000 35,000 35,000 10,000 3,000 242,000 168,000 10,000 20,000 22,000 12,000 1,000 $431,000

$431,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7B (continued) Requirement 4

Jaguar Auto Company Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Depreciation Insurance Supplies Utilities Interest

$242,000

Total expenses Net income

233,000 $ 9,000

168,000 10,000 20,000 22,000 12,000 1,000

Jaguar Auto Company Statement of Stockholders’ Equity For the year ended December 31, 2021

Balance at January 1 Issuance of common stock Less: Net income for 2021 Less: Dividends Balance at December 31

Common Stock

Retained Earnings

$35,000 0

$10,000

$35,000

9,000 (3,000) $ 16,000

Total Stockholders’ Equity $45,000 0 9,000 (3,000) $51,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7B (continued)

Jaguar Auto Company Balance Sheet December 31, 2021 Assets Current assets Cash $ 76,000 Accounts receivable 15,000 Supplies 5,000 Prepaid insurance 4,000 Total current assets 100,000 Long-term assets: Equipment Accumulated depr.

95,000 (47,000)

Total assets

$148,000

Liabilities Current liabilities Accounts payable $12,000 Salaries payable 4,000 Deferred revenue 45,000 Interest payable 1,000 Total current liabilities 62,000 Notes payable 35,000 Total liabilities 97,000 Stockholders’ Equity Common stock 35,000 Retained earnings 16,000 Total stockholders’ equity 51,000 Total liabilities and stockholders’ equity $148,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7B (continued) Requirement 5 December 31, 2021

Debit

Service Revenue Retained Earnings (Close revenue accounts)

242,000

Retained Earnings Salaries Expense Depreciation Expense Insurance Expense Supplies Expense Utilities Expense Interest Expense (Close expense accounts)

233,000

Retained Earnings Dividends (Close dividends account)

3,000

Credit 242,000

168,000 10,000 20,000 22,000 12,000 1,000

3,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-7B (concluded) Requirement 6 (closing entries posted in red) Retained Earnings Dividends 233,000 3,000

10,000 242,000

3,000

242,000 3,000

16,000 Salaries Expense 164,000 4,000

Service Revenue

168,000

242,000

Depreciation Expense 0 10,000

Insurance Expense 0 20,000

10,000

Supplies Expense

Utilities Expense

0 22,000

12,000 22,000

20,000

Interest Expense 0 1,000

12,000 0

1,000

Requirement 7 Jaguar Auto Company Post-Closing Trial Balance December 31, 2021 Accounts Debit Cash $ 76,000 Accounts Receivable 15,000 Supplies 5,000 Prepaid Insurance 4,000 Equipment 95,000 Accumulated Depreciation Accounts Payable Salaries Payable Deferred Revenue Interest Payable Notes Payable Common Stock Retained Earnings Total $195,000

Credit

$ 47,000 12,000 4,000 45,000 1,000 35,000 35,000 16,000 $195,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (LO 3-3, 3-4, 3-5, 3-6, 3-7) Requirement 1 Cash

Accounts Receivable

4,500 4,500

9,500 9,500

Equipment

3,500 3,500

Accumulated Depr.

Accounts Payable

8,000 8,000

6,000 6,000

36,000 36,000 Utilities Payable

Deferred Revenue

7,000 7,000 Retained Earnings 9,500 9,500 Salaries Expense 0 0

Supplies

Common Stock 0 0

Dividends

23,000 23,000 Service Revenue

0 0 Utilities Expense 0 0

0 0 Supplies Expense 0 0

Depr. Expense 0 0

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (continued) Requirement 2 (1) January 24

Debit

Credit

Accounts Receivable 65,000 Cash 20,000 Service Revenue (Provide services on account and for cash) (2) March 13 Debit

85,000

Cash

53,000

Accounts Receivable (Collect on account) (3) May 6

Debit

Cash

11,000

Common Stock (Issue common stock) (4) June 30 Salaries Expense Cash (Pay current salaries) (5) September 15

53,000

Debit 33,000

Credit 33,000

Debit 7,000

Cash

10,000

Dividends Cash (Pay dividends)

Credit 11,000

Utilities Payable Cash (Pay for past utilities) (6) November 24 Deferred Revenue (Receive cash in advance) (7) December 30

Credit

Credit 7,000

Debit

Credit 10,000

Debit

Credit

3,000 3,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (continued) Requirement 3 (entries posted in red) Cash Accounts Receivable 4,500 20,000 53,000 11,000 10,000 55,500

9,500 33,000 7,000 3,000

65,000

3,500 53,000

21,500

Equipment

3,500

Accumulated Depr.

Accounts Payable

8,000 8,000

6,000 6,000

36,000 36,000 Utilities Payable

Deferred Revenue

7,000 0

9,500 9,500 Salaries Expense 0 33,000 33,000

Common Stock

0 10,000 10,000

7,000

Retained Earnings

Supplies

Dividends

23,000 11,000 34,000 Service Revenue

0 3,000 3,000 Utilities Expense

0 85,000 85,000 Supplies Expense

Depr. Expense 0 0

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (continued) Requirement 4

Pipers Plumbing Unadjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Equipment Accumulated Depreciation Accounts Payable Utilities Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Utilities Expense Supplies Expense Depreciation Expense Total Requirement 5 December 31

Debit $ 55,500 21,500 3,500 36,000

Credit

$ 8,000 6,000 0 10,000 34,000 9,500 3,000 85,000 33,000 0 0 0 $152,500

Depreciation Expense Accumulated Depreciation (Record depreciation expense for year)

$152,500 Debit

Credit

8,000 8,000

Supplies Expense 2,400 Supplies (Supplies used during year; $3,500 – $1,100 = $2,400)

2,400

Deferred Revenue 7,000 Service Revenue (Reduce deferred revenue for services completed)

7,000

Utilities Expense Utilities Payable (Record utilities owed at December 31)

6,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (continued) Requirement 6 (adjusted entries posted in red) Cash Accounts Receivable 4,500 20,000 53,000 11,000 10,000 55,500

9,500 33,000 7,000 3,000

65,000

53,000

7,000 6,000 6,000

Retained Earnings

1,100 Accounts Payable

8,000 8,000 16,000

6,000

36,000 Utilities Payable

2,400

Accumulated Depr.

36,000

7,000

3,500

21,500

Equipment

Supplies

Deferred Revenue 7,000

0 3,000

9,500

3,000

Common Stock

0 10,000 3,000

Dividends

9,500

6,000

Salaries Expense

Utilities Expense

0 33,000 33,000

0 6,000 6,000

23,000 11,000 34,000 Service Revenue 0 85,000 7,000 92,000 Supplies Expense 0 2,400 2,400

Depr. Expense 0 8,000 8,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (continued) Requirement 7

Pipers Plumbing Adjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Equipment Accumulated Depreciation Accounts Payable Utilities Payable Deferred Revenue Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Utilities Expense Supplies Expense Depreciation Expense Total

Debit $ 55,500 21,500 1,100 36,000

Credit

$ 16,000 6,000 6,000 3,000 34,000 9,500 3,000 92,000 33,000 6,000 2,400 8,000 $166,500

$166,500

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (continued) Requirement 8

Pipers Plumbing Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Utilities Supplies Depreciation

$92,000

Total expenses Net income

49,400 $42,600

33,000 6,000 2,400 8,000

Pipers Plumbing Balance Sheet December 31, 2021 Assets Current assets: Cash Accounts receivable Supplies Total current assets

$55,500 21,500 1,100 78,100

Long-term assets: Equipment Accumulated depr.

36,000 (16,000)

Total assets

$98,100

Liabilities Current liabilities: Accounts payable Utilities payable Deferred revenue Total current liabilities

$ 6,000 6,000 3,000 15,000

Stockholders’ Equity Common stock 34,000 Retained earnings 49,100 * Total stockholders’ equity 83,100 Total liabilities and stockholders’ equity $98,100

Retained earnings = Beginning retained earnings + Net income − Dividends = $9,500 + $42,600 − $3,000 = $49,100

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (continued) Requirement 9 December 31

Debit

Service Revenue Retained Earnings (Close revenue accounts)

92,000

Retained Earnings Salaries Expense Utilities Expense Supplies Expense Depreciation Expense (Close expense accounts)

49,400

Retained Earnings Dividends (Close dividends account)

3,000

Credit 92,000

33,000 6,000 2,400 8,000

3,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (continued) Requirement 10 (closing entries posted in red) Cash Accounts Receivable 4,500 20,000 53,000 11,000 10,000 55,500

9,500 33,000 7,000 3,000

65,000

Utilities Payable 7,000 6,000 6,000

Retained Earnings 9,500 92,000

1,100

8,000 8,000 16,000

6,000

Deferred Revenue 7,000

Common Stock

0 10,000 3,000

Dividends 0 3,000

6,000

23,000 11,000 34,000 Service Revenue

3,000 92,000

49,100

0 85,000 7,000 0

Salaries Expense

Utilities Expense

0 33,000 0

0 6,000 0

33,000

2,400

Accounts Payable

36,000

49,400 3,000

53,000

Accumulated Depr.

36,000

7,000

3,500

21,500

Equipment

Supplies

6,000

Supplies Expense 0 2,400 0

2,400

Depr. Expense 0 8,000 0

8,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-8B (concluded) Requirement 11

Pipers Plumbing Post-Closing Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Equipment Accumulated Depreciation Accounts Payable Utilities Payable Deferred Revenue Common Stock Retained Earnings Total

Debit $ 55,500 21,500 1,100 36,000

$114,100

Credit

$ 16,000 6,000 6,000 3,000 34,000 49,100 $114,100

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (LO 3-3, 3-4, 3-5, 3-6, 3-7) Requirement 1 Cash

Accounts Receivable

41,500 41,500

25,700 25,700

Land

0 0

Accounts Payable

110,800 110,800

Supplies

Salaries Payable

15,300 15,300

Interest Payable

Notes Payable 0 0

Retained Earnings 32,700 32,700 Salaries Expense 0 0

0 0 Common Stock

30,000 30,000 Dividends

100,000 100,000 Service Revenue

0 0 Advertising Expense 0 0

0 0 Interest Expense 0 0

Supplies Expense 0 0

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (continued) Requirement 2 (1) January 12 Debit Accounts Receivable 62,400 Service Revenue (Provide services on account) (2) February 25 Debit Cash 75,300 Service Revenue (Provide services for cash) (3) March 19 Debit Cash 45,700 Accounts Receivable (Receive cash on account) (4) April 30 Debit Cash 30,000 Common Stock (Issue common stock) (5) June 16 Debit Supplies 12,100 Accounts Payable (Purchase supplies on account) (6) July 7 Debit Accounts Payable 11,300 Cash (Pay cash on account) (7) September 30 Debit Salaries Expense 64,200 Cash (Pay salaries for work in the current period) (8) November 22 Debit Advertising Expense 22,500 Cash (Pay advertising for the current period) (9) December 30 Debit Dividends 2,900 Cash (Pay dividends)

Credit 62,400 Credit 75,300 Credit 45,700 Credit 30,000 Credit 12,100 Credit 11,300 Credit 64,200 Credit 22,500 Credit 2,900

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (continued) Requirement 3 (entries posted in red) Cash Accounts Receivable 41,500 75,300 45,700 30,000 91,600

11,300 64,200 22,500 2,900

Land

25,700 62,400

12,100

Accounts Payable

Salaries Payable

11,300 110,800

30,000

30,000 Dividends

32,700

0 2,900

32,700

2,900

Salaries Expense 0 64,200 64,200

15,300 12,100 16,100

Notes Payable

Retained Earnings

0 12,100

42,400

110,800

Interest Payable

45,700

Supplies

Advertising Expense 0 22,500 22,500

0 0 Common Stock 100,000 30,000 130,000 Service Revenue 0 62,400 75,300 137,700 Interest Expense 0 0

Supplies Expense 0 0

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (continued) Requirement 4

Jackrabbit Rentals Unadjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Land Accounts Payable Salaries Payable Interest Payable Notes Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Advertising Expense Interest Expense Supplies Expense Total

Debit $ 91,600 42,400 12,100 110,800

Credit

$ 16,100 0 0 30,000 130,000 32,700 2,900 137,700 64,200 22,500 0 0 $346,500

Requirement 5 December 31 Interest Expense Interest Payable (Accrue interest on notes payable)

$346,500

Debit

Credit

2,500

Salaries Expense 1,500 Salaries Payable (Record salaries owed at December 31) Supplies Expense 9,800 Supplies (Supplies used during the year; $0 + $12,100 − $2,300 = $9,800)

2,500

1,500

9,800

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (continued) Requirement 6 (adjusted entries posted in red) Cash Accounts Receivable 41,500 75,300 45,700 30,000 91,600

11,300 64,200 22,500 2,900

25,700 62,400

45,700

42,400

Land

11,300 110,800 Interest Payable

Retained Earnings

Dividends

32,700

2,900

0 64,200 1,500 65,700

Common Stock 100,000 30,000 130,000

30,000

0 2,900

Salaries Expense

0 1,500 1,500

30,000

32,700

9,800

Salaries Payable

15,300 12,100 16,100

Notes Payable

0 2,500 2,500

0 12,100 2,300

Accounts Payable

110,800

Supplies

Advertising Expense

Service Revenue 0 62,400 75,300 137,700 Interest Expense

0 22,500

0 2,500

22,500

2,500

Supplies Expense 0 9,800 9,800

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (continued) Requirement 7

Jackrabbit Rentals Adjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Land Accounts Payable Salaries Payable Interest Payable Notes Payable Common Stock Retained Earnings Dividends Service Revenue Salaries Expense Advertising Expense Interest Expense Supplies Expense Total

Debit $ 91,600 42,400 2,300 110,800

Credit

$ 16,100 1,500 2,500 30,000 130,000 32,700 2,900 137,700 65,700 22,500 2,500 9,800 $350,500

$350,500

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (continued) Requirement 8

Jackrabbit Rentals Income Statement For the year ended December 31, 2021 Service revenue Expenses: Salaries Advertising Interest Supplies

$137,700

Total expenses Net income

100,500 $ 37,200

65,700 22,500 2,500 9,800

Jackrabbit Rentals Balance Sheet December 31, 2021 Assets Current assets: Cash $ 91,600 Accounts Receivable 42,400 Supplies 2,300 Total current assets 136,300

Long-term assets: Land

110,800

Total assets

$247,100

Liabilities Current liabilities: Accounts Payable $ 16,100 Salaries Payable 1,500 Interest Payable 2,500 Total current liabilities 20,100 Notes Payable 30,000 Total liabilities 50,100 Stockholders’ Equity Common stock 130,000 Retained earnings 67,000 * Total stockholders’ equity 197,000 Total liabilities and stockholders’ equity $247,100

Retained earnings = Beginning retained earnings + Net income − Dividends = $32,700 + $37,200 − $2,900 = $67,000

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (continued) Requirement 9 December 31

Debit

Service Revenue Retained Earnings (Close revenue accounts)

137,700

Retained Earnings Salaries Expense Advertising Expense Interest Expense Supplies Expense (Close expense accounts)

100,500

Retained Earnings Dividends (Close dividends account)

2,900

Credit 137,700

65,700 22,500 2,500 9,800

2,900

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (continued) Requirement 10 (closing entries posted in red) Cash Accounts Receivable 41,500 75,300 45,700 30,000 91,600

11,300 64,200 22,500 2,900

25,700 62,400 42,400

Land

11,300 110,800 Interest Payable

Retained Earnings 32,700 137,700

Common Stock 100,000 30,000 130,000

30,000 Dividends

Service Revenue 2,900 137,700

67,000 Salaries Expense 0 64,200 1,500 0

0 1,500 1,500

30,000

0 2,900 0

Advertising Expense 0 22,500

9,800

Salaries Payable

15,300 12,100 16,100

Notes Payable

0 2,500 2,500

0 12,100 2,300

Accounts Payable

110,800

100,500 2,900

45,700

Supplies

22,500

0 62,400 75,300 0

Interest Expense 0 2,500

2,500

65,700 0

Supplies Expense 0 9,800 0

9,800

Chapter 3 - The Accounting Cycle: End of the Period

Problem 3-9B (concluded) Requirement 11

Jackrabbit Rentals Post-Closing Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Supplies Land Accounts Payable Salaries Payable Interest Payable Notes Payable Common Stock Retained Earnings Total

Debit $ 91,600 42,400 2,300 110,800

$247,100

Credit

$ 16,100 1,500 2,500 30,000 130,000 67,000 $247,100

Chapter 3 - The Accounting Cycle: End of the Period

ADDITIONAL PERSPECTIVES Additional Perspective 3-1 Requirement 1 July 1, 2021 Cash Common Stock (Issue common stock to Suzie) July 1, 2021 Cash Common Stock (Issue common stock to Tony) July 1, 2021 Prepaid Insurance Cash (Purchase one-year insurance policy) July 2, 2021 Legal Fees Expense Cash (Pay legal fees for incorporation) July 4, 2021 Supplies (Office) Accounts Payable (Purchase office supplies on account) July 7, 2021 Advertising Expense Cash (Pay cash for advertising) July 8, 2021 Equipment (Bikes) Cash (Pay cash for mountain bikes) July 15, 2021 Cash Service Revenue (Clinic) (Receive cash for mountain bike clinic)

Debit 10,000

Credit 10,000

10,000 10,000 4,800 4,800 1,500 1,500 1,800 1,800 300 300 12,000 12,000 2,000 2,000

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 1 (continued) July 22, 2021 Cash 2,300 Service Revenue (Clinic) (Receive cash for mountain bike clinic) July 24, 2021 Advertising Expense 700 Cash (Pay cash for advertising) July 30, 2021 Cash 4,000 Deferred Revenue (Receive cash in advance for kayak clinic) Aug. 1, 2021 Debit Cash 30,000 Notes Payable (Obtain loan from city council) Aug. 4, 2021 Equipment (Kayaks) 28,000 Cash (Pay cash for kayaks) Aug. 10, 2021 Cash 3,000 Deferred Revenue 4,000 Service Revenue (Clinic) (Receive cash and hold kayak clinic) Aug. 17, 2021 Cash 10,500 Service Revenue (Clinic) (Receive cash and hold kayak clinic) Aug. 24, 2021 Accounts Payable 1,800 Cash (Pay cash on account)

2,300

700

4,000 Credit 30,000

28,000

7,000

10,500

1,800

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 1 (concluded) Sep. 1, 2021 Prepaid Rent Cash (Pay cash for one-year rental policy) Sep. 21, 2021 Cash Service Revenue (Clinic) (Receive cash for rock climbing clinic) Oct. 17, 2021 Cash Service Revenue (Clinic) (Receive cash for orienteering clinic) Dec. 8, 2021 Miscellaneous Expense Cash (Pay cash for race permit) Dec. 12, 2021 Supplies (Racing) Accounts Payable (Purchase racing supplies on account) Dec. 15, 2021 Cash Service Revenue (Racing) (Receive cash for adventure race) Dec. 16, 2021 Salaries Expense Cash (Pay cash for salary) Dec. 31, 2021 Dividend Cash (Pay cash for dividend)

2,400 2,400 13,200 13,200 17,900 17,900

1,200 1,200 2,800 2,800 20,000 20,000 2,000 2,000 4,000 4,000

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 2 Dec. 31, 2021 Debit Depreciation Expense 8,000 Accumulated Depreciation (Record depreciation expense) Dec. 31, 2021 Insurance Expense 2,400 Prepaid Insurance (Reduce prepaid insurance for six months used of twelve months paid in advance) Dec. 31, 2021 Rent Expense 800 Prepaid Rent (Reduce prepaid rent for four months used of twelve months paid in advance) Dec. 31, 2021 Supplies Expense (Office) 1,500 Supplies (Office) (Office supplies used; $1,800 – $300 = $1,500) Dec. 31, 2021 Interest Expense 750 Interest Payable (Accrue five months interest not yet paid; $30,000 × 0.06 × 5/12 = $750) Dec. 31, 2021 Supplies Expense (Racing) 2,600 Supplies (Racing) (Racing supplies used; $2,800 – $200 = $2,600) Dec. 31, 2021 Income Tax Expense 14,000 Income Tax Payable (Accrue income tax payable)

Credit 8,000

2,400

800

1,500

750

2,600

14,000

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 3 (Note: adjusting entries in italics) Cash 10,000 4,800 10,000 1,500 2,000 300 2,300 12,000 4,000 700 30,000 28,000 3,000 1,800 10,500 2,400 13,200 1,200 17,900 2,000 20,000 4,000 64,200

Prepaid Insurance 4,800 2,400 2,400

Prepaid Rent 2,400 800 1,600

Supplies (Office) 1,800 1,500 300

Supplies (Racing) 2,800 2,600 200

Equipment (Bikes) 12,000 12,000

Equipment (Kayaks) 28,000 28,000

Accum. Depr. 8,000 8,000

Accounts Payable 1800 1,800 2,800 2,800

Deferred Revenue 4,000 4,000 0

Interest Payable 750 750

Income Tax Payable 14,000 14,000

Notes Payable 30,000 30,000

Common Stock 10,000 10,000 20,000

Dividends 4,000 4,000

Service Revenue (Clinic) 2,000 2,300 7,000 10,500 13,200 17,900 52,900

Service Revenue (Racing) 20,000 20,000

Legal Fees Expense 1,500 1,500

Rent Expense 800 800

Salaries Expense 2,000 2,000

Advertising Expense 300 700 1,000

Supplies Expense (Office) 1,500 1,500

Depr. Expense 8,000 8,000

Insurance Expense 2,400 2,400

Interest Expense 750 750

Income Tax Expense Miscellaneous Expense 14,000 1,200 14,000 1,200

Supplies Expense (Racing) 2,600 2,600

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 4 Great Adventures, Inc. Adjusted Trial Balance December 31, 2021 Accounts Cash Prepaid Insurance Prepaid Rent Supplies (Office) Supplies (Racing) Equipment (Bikes) Equipment (Kayaks) Accumulated Depreciation Accounts Payable Income Tax Payable Interest Payable Notes Payable Common Stock Dividends Service Revenue (Clinic) Service Revenue (Racing) Advertising Expense Depreciation Expense Income Tax Expense Insurance Expense Interest Expense Legal Fees Expense Miscellaneous Expense Rent Expense Salaries Expense Supplies Expense (Office) Supplies Expense (Racing) Totals

Debit $ 64,200 2,400 1,600 300 200 12,000 28,000

Credit

$ 8,000 2,800 14,000 750 30,000 20,000 4,000 1,000 8,000 14,000 2,400 750 1,500 1,200 800 2,000 1,500 2,600 $148,450

52,900 20,000

$148,450

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 5

Great Adventures, Inc. Income Statement For the period ended December 31, 2021 Revenues: Service revenue (clinic) Service revenue (racing) Total revenues Expenses: Advertising expense Depreciation expense Income tax expense Insurance expense Interest expense Legal fees expense Miscellaneous expense Rent expense Salaries expense Supplies expense (office) Supplies expense (racing) Total expenses Net income

$52,900 20,000 $72,900 1,000 8,000 14,000 2,400 750 1,500 1,200 800 2,000 1,500 2,600 35,750 $37,150

Great Adventures, Inc. Statement of Stockholders’ Equity For the period ended December 31, 2021

Balance at July 1 Issuance of common stock Add: Net income for 2021 Less: Dividends Balance at December 31

Common Stock

Retained Earnings

$ 0 20,000

$20,000

37,150 (4,000) $33,150

Total Stockholders’ Equity $

0 20,000 37,150 (4,000) $53,150

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 5 (concluded)

Great Adventures, Inc. Balance Sheet December 31, 2021 Assets Current assets: Cash $ 64,200 Prepaid insurance 2,400 Prepaid rent 1,600 Supplies (office) 300 Supplies (racing) 200 Total current assets 68,700 Long-term assets: Equipment (bikes) 12,000 Equipment (kayaks) 28,000 Accumulated depr. (8,000) Total assets

$100,700

Liabilities Current liabilities: Accounts payable $ 2,800 Interest payable 750 Income tax payable 14,000 Total current liabilities 17,550 Notes payable 30,000 Total liabilities 47,550 Stockholders’ Equity Common stock 20,000 Retained earnings 33,150 Total stockholders’ equity 53,150 Total liabilities and stockholders’ equity $100,700

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 6 Dec. 31, 2021 Service Revenue (Clinic) Service Revenue (Racing) Retained Earnings (Close revenue accounts) Dec. 31, 2021 Retained Earnings Advertising Expense Depreciation Expense Income Tax Expense Insurance Expense Interest Expense Legal Fees Expense Miscellaneous Expense Rent Expense Salaries Expense Supplies Expense (Office) Supplies Expense (Racing) (Close expense accounts) Dec. 31, 2021 Retained Earnings Dividends (Close dividends account)

Debit 52,900 20,000

Credit 72,900

35,750 1,000 8,000 14,000 2,400 750 1,500 1,200 800 2,000 1,500 2,600 4,000 4,000

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (continued) Requirement 7 (Note: closing entries in italics) Cash 10,000 4,800 10,000 1,500 2,000 300 2,300 12,000 4,000 700 30,000 28,000 3,000 1,800 10,500 2,400 13,200 1,200 17,900 2,000 20,000 4,000 64,200

Prepaid Insurance 4,800 2,400 2,400

Prepaid Rent 2,400 800 1,600

Supplies (Office) 1,800 1,500 300

Supplies (Racing) 2,800 2,600 200

Equipment (Bikes) 12,000 12,000

Equipment (Kayaks) 28,000 28,000

Accum. Depr. 8,000 8,000

Accounts Payable 1800 1,800 2,800 2,800

Deferred Revenue 4,000 4,000 0

Interest Payable 750 750

Income Tax Payable 14,000 14,000

Notes Payable 30,000 30,000

Common Stock 10,000 10,000 20,000

Dividends 4,000 4,000 0

Service Revenue (Clinic) 52,900 2,000 2,300 7,000 10,500 13,200 17,900 0

Service Revenue (Racing) 20,000 20,000 0

Legal Fees Expense 1,500 1,500 0

Rent Expense 800 800 0

Salaries Expense 2,000 2,000 0

Supplies Expense (Racing) 2,600 2,600 0

Supplies Expense (Office) 1,500 1,500 0

Advertising Expense 300 1,000 700 0 Depr. Expense 8,000 8,000 0

Insurance Expense 2,400 2,400 0

Interest Expense 750 750 0

Income Tax Expense Miscellaneous Expense 14,000 14,000 1,200 1,200 0 0

Retained Earnings 35,750 72,900 4,000 33,150

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-1 (concluded) Requirement 8 Great Adventures, Inc. Post-closing Trial Balance December 31, 2021 Accounts Cash Prepaid Insurance Prepaid Rent Supplies (Office) Supplies (Racing) Equipment (Bikes) Equipment (Kayaks) Accumulated Depreciation Accounts Payable Income Tax Payable Interest Payable Notes Payable Common Stock Retained Earnings Totals

Debit $ 64,200 2,400 1,600 300 200 12,000 28,000

$108,700

Credit

$ 8,000 2,800 14,000 750 30,000 20,000 33,150 $108,700

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-2 American Eagle ($ in thousands) Requirement 1 Current assets equal $968,530. The ratio of current assets to total assets is 0.53 (= $968,530 / $1,816,313). Requirement 2 Current liabilities equal $485,221. The ratio of current liabilities to total liabilities is 0.85 (= $485,221 / $569,522). Requirement 3 The change in retained earnings is $107,817 (= $1,883,592 − $1,775,775). Requirement 4 The amount of net income is $204,163. Requirement 5 The change in retained earnings typically represents net income for the year less dividends. If the change in retained earnings is $107,817 and net income equals $204,163, then dividends normally would be $96,346 thousand. The statement of stockholders’ equity shows cash dividends equal to only $90,858. The reasons for the inequality are due to the reissuance of treasury stock. Normally, these types of events do not occur and the change in retained earnings would equal net income less dividends.

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-3 Buckle ($ in thousands) Requirement 1 Current assets equal $360,584. The ratio of current assets to total assets is 0.67 (= $360,584 / $538,116). Requirement 2 Current liabilities equal $97,906. The ratio of current liabilities to total liabilities is 0.67 (= $97,906 / $146,868). Requirement 3 The change in retained earnings is $(44,167) (= $246,570 − $290,737). Requirement 4 The amount of net income is $89,707. Requirement 5 The change in retained earnings typically represents net income for the year less dividends. If the change in retained earnings is $(44,167) and net income equals $89,707, then dividends should be $133,874. This is verified looking at the retained earnings column in the statement of stockholders’ equity which shows dividends of $133,874.

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-4 Compare American Eagle and Buckle Requirement 1 Buckle has the higher ratio of current assets to total assets. For American Eagle, the ratio of current assets to total assets is 0.53 (= $968,530 / $1,816,313). For Buckle, the ratio of current assets to total assets is 0.67 (= $360,584 / $538,116). A higher ratio indicates that a higher portion of the company’s assets will provide benefits within the next year or become cash in the next year. With more cash-based resources, the company may be better able to respond to competitive opportunities. Requirement 2 American Eagle has the higher ratio of current liabilities to total liabilities. For American Eagle, the ratio of current liabilities to total liabilities is 0.85 (= $485,221 / $569,522). For Buckle, the ratio of current liabilities to total liabilities is 0.67 (= $97,906 / $146,868). A higher ratio indicates that a higher portion of the company’s liabilities are due within the next year. With more current debt, the company may be less able to respond quickly to new competitive opportunities, and face a higher risk of bankruptcy if it cannot pay its current liabilities as they come due. Requirement 3 Buckle has a higher dividend payout ratio. For American Eagle, the dividend payout ratio is 0.45 (= $90,858 / $204,163). For Buckle, the dividend payout ratio is 1.49 (= $133,874 / $89,707). A higher ratio indicates that a higher portion of the company’s net income is paid in dividends. More often, growth companies pay fewer dividends because they are using available cash to expand the company. Mature companies typically have more cash available to pay dividends.

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-5 1. Profits are overstated. By reporting the $80,000 as Service Revenue instead of Deferred Revenue, pretax profit will increase from $280,000 to $360,000, giving a false appearance that this year’s profit is higher than last year’s. 2. Liability. Cash received from customers in advance of performing services is a liability, representing an obligation to customers. 3. Yes. Next year the $80,000 cannot be counted again in pretax profits, likely causing a big decline in reported performance. When this occurs, investors and other employees, who bought the company’s stock when the price was high and who thought that profitability was increasing, may sustain large losses as the stock price falls. 4. No. As the assistant controller (accountant), you should understand that your responsibilities include accurately recording and reporting the company’s activities. By falsely reporting activities this year, you mislead people (investors and other employees) who are relying on your financial reports. Because you are new to the position, you might not be sure that it’s right for you to question any decision of the company’s president. You have just been hired and don’t want to lose your job. If you do make the adjustment, then the company’s president will know he can count on you, and this could be your fast track to the top.

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-6

(Note to instructor: Answers are based on McDonald’s December 2016 annual report, and dollar amounts are in millions.) Requirement 1 Revenues exceed expenses because the company reports net income of $4,686.5 (in millions). Requirement 2 Net income increased from $4,529.3 to $4,686.5. Requirement 3 Current assets include cash and equivalents, accounts and notes receivable, inventories, and prepaid expenses and other current assets. Other assets include assets that will provide a benefit for more than one year. Requirement 4 Current liabilities include accounts payable, income taxes, other taxes, accrued interest, and accrued payroll and other liabilities. Other liabilities include liabilities that are due in more than one year. Requirement 5 Retained earnings increased $1,628.2, from $44,594.5 to $46,222.7. Requirement 6 The amount of dividends paid equals $3,058.2. Requirement 7 In most instances, the change in retained earnings equals net income less dividends. For McDonald’s, net income in requirement 1 ($4,686.5) less dividends in requirement 6 ($3,058.2) equals $1,628.3, which is slightly different from the change in retained earnings in requirement 5 ($1,628.2). The difference of $0.1 is due to unusual adjustments beyond the scope of this course.

Chapter 3 - The Accounting Cycle: End of the Period

Additional Perspective 3-7 Requirement 1 Prepaid revenues occur when cash is received before the related revenues are reported. Prepaid expenses occur when cash (or an obligation to pay cash) is paid before the related expenses are reported. Accrued revenues occur when cash is received after the related revenues are reported. Accrued expenses occur when cash is paid after the related expenses and liabilities are reported. Requirement 2 The adjusting entry for prepaid expenses includes a debit to an expense and a credit to an asset. The adjusting entry for deferred revenue includes a debit to deferred revenue (liability) and a credit to a revenue. By not recording an adjusting entry for a prepaid expense, expenses will be understated and assets will be overstated. By not recording an adjusting entry for deferred revenue, liabilities will be overstated and revenues will be understated. Requirement 3 The adjusting entry for accrued expenses includes a debit to an expense and a credit to a liability. The adjusting entry for accrued revenues includes a debit to an asset and a credit to a revenue. By not recording an adjusting entry for an accrued expense, expenses will be understated and liabilities will be understated. By not recording an adjusting entry for an accrued revenue, assets will be understated and revenues will be understated.

Chapter 4 - Cash and Internal Controls

Chapter 4 Cash and Internal Controls REVIEW QUESTIONS Question 4-1 (LO 4-1)

Occupational fraud is the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources. Occupational fraud occurs through theft or misuse of the company’s resources and through financial statement manipulation.

Question 4-2 (LO 4-1)

Internal control is a company’s plan to (1) safeguard the company’s assets and (2) improve the accuracy and reliability of accounting information. Effective internal control builds a wall to prevent misuse of company funds by employees and fraudulent or errant financial reporting. Strong internal control systems allow greater reliance by investors on reported financial statements.

Question 4-3 (LO 4-1)

Managers are entrusted with the resources of both the company’s lenders (liabilities) and owners (stockholders' equity). They have an ethical responsibility to appropriately use and accurately report the company’s funds.

Question 4-4 (LO 4-1)

Managers are motivated to manipulate financial statements to maximize their compensation, increase the company’s stock price, and preserve their job.

Question 4-5 (LO 4-1)

The fraud triangle represents the three elements of fraud: motive, rationalization, and opportunity. To help prevent fraud, companies can eliminate the opportunity element by implementing internal controls.

Question 4-6 (LO 4-1) The major provisions of the Sarbanes-Oxley Act include the Public Company Accounting Oversight Board, corporate executive accountability, limitation on nonaudit services, retention of work papers, auditor rotation, restrictions related to conflicts of interest, audit committee hires the auditor, and documentation of internal control.

Chapter 4 - Cash and Internal Controls

Answers to Review Questions (continued) Question 4-7 (LO 4-2)

1. Control Environment – The overall ethical tone of the company with respect to internal control. 2. Risk Assessment – Identification and analysis of internal and external risk factors that could prevent a company’s objectives from being achieved. 3. Control Activities – The policies and procedures that help ensure that management’s directives are being carried out. 4. Monitoring – Continuous observation of the internal control system. 5. Information and Communication – Systems designed to ensure accurate measurement of business transactions and reliability of financial reports.

Question 4-8 (LO 4-2) Detective controls are designed to detect errors or fraud that have already occurred, while preventive controls are designed to keep errors or fraud from occurring in the first place. Preventive controls include separation of duties, physical controls, proper authorizations, and employee management. Detective controls include reconciliations and performance reviews.

Question 4-9 (LO 4-2) Authorizing transactions, recording transactions, and maintaining control of the related assets should be separated among employees.

Question 4-10 (LO 4-2) Everyone in a company has an impact on the operation and effectiveness of internal controls, but the top executives are the ones who must take final responsibility for their establishment and success. The CEO and CFO sign a report each year assessing whether the internal controls are adequate. Section 404 of SOX requires not only that companies document their internal controls and assess their adequacy, but that the company’s auditors provide an opinion on management’s assessment.

Question 4-11 (LO 4-2) Internal controls cannot prevent financial misstatement in all cases, do not necessarily prevent collusion by two or more people to circumvent internal controls, are more susceptible to fraud by top-level employees, and do not ensure a company’s success, or even survival.

Question 4-12 (LO 4-2) Collusion occurs when two or more people act in coordination to circumvent internal controls.

Question 4-13 (LO 4-2) Fraud is more likely to occur when it is being committed by top-level employees who have the ability to override internal control features. For example, managers may be required to obtain approval from the Chief Financial Officer (CFO) for all large purchases. However, if the CFO uses the company’s funds to purchase a boat for personal use at a lake home, fewer controls are in place to detect this misappropriation. Even if lower-level employees suspect wrongdoing, they may feel intimidated to confront the issue.

Chapter 4 - Cash and Internal Controls

Answers to Review Questions (continued) Question 4-14 (LO 4-3) Cash includes not only currency, coins, balances in checking accounts, and checks and money orders received from customers, but also cash equivalents, defined as investments that mature within three months from the date of purchase (such as money market funds, treasury bills, and certificates of deposit).

Question 4-15 (LO 4-3) A purchase with a check is recorded as an immediate cash payment.

Question 4-16 (LO 4-4) 1. Record all cash receipts as soon as possible. 2. Open mail each day, and make a list of checks received, including the amount and payor’s name. 3. Designate an employee to deposit cash and checks into the company’s bank account each day, different from the person who receives cash and checks. 4. Have another employee record cash receipts in the accounting records. Verify cash receipts by comparing the bank deposit slip with the accounting records.

Question 4-17 (LO 4-4) Credit cards extend credit (or lend money) to the cardholder each time the cardholder uses the credit card. The cardholder has a specified grace period before he or she has to pay the credit card balance in full. If the balance is not paid by the end of the grace period, the issuing company will charge a fee (interest). Credit card sales are recorded as a cash receipt by the seller.

Question 4-18 (LO 4-4) Like credit cards, debit cards offer customers a way to purchase goods and services without a physical exchange of cash. They differ, however, in that most debit cards (sometimes referred to as check cards) work just like a check and withdraw funds directly from the cardholder’s bank account at the time of use. Debit card sales are recorded as a cash receipt by the seller.

Question 4-19 (LO 4-4) 1. Make all disbursements, other than very small ones, by check, debit card, or credit card. 2. Authorize all expenditures before purchase and verify the accuracy of the purchase itself. The employee who authorizes payment should not also be the employee who prepares the check. 3. Make sure checks are serially numbered and signed only by authorized employees. Require two signatures for larger checks. 4. Periodically check amounts shown in the debit card and credit card statements against purchase receipts. The employee verifying the accuracy of the debit card and credit card statements should not also be the employee responsible for actual purchases. 5. Set maximum purchase limits on debit cards and credit cards. Give approval to purchase above these amounts only to upper-level employees. 6. Employees responsible for making cash disbursements should not also be in charge of cash receipts.

Chapter 4 - Cash and Internal Controls

Answers to Review Questions (continued) Question 4-20 (LO 4-4) Credit card purchases are recorded as purchases on account.

Question 4-21 (LO 4-5) A bank reconciliation matches the balance of cash in the bank account with the balance of cash in the company’s own records by reconciling timing differences and errors. It is the possibility of errors, or even outright fraudulent activities, that make the bank reconciliation a useful cash control tool.

Question 4-22 (LO 4-5) The two reasons are timing differences and errors. Timing differences arise when one party (the bank or the company) records a transaction at a different time than the other party. Errors are mistakes made by either the bank or the company.

Question 4-23 (LO 4-5) Examples include deposits outstanding, checks outstanding, notes collected by the bank, interest earned, service charges, and NSF checks.

Question 4-24 (LO 4-5) As a final step in the reconciliation process, the company must update the balance of cash for the items used to reconcile the company’s cash balance.

Question 4-25 (LO 4-6) Purchase cards are company-issued debit cards or credit cards that offer a convenient way for employees to make quick purchases for the company. The petty cash fund is cash kept on hand to pay for minor purchases.

Question 4-26 (LO 4-6) • • • •

•

Employees should be required to provide receipts and justification for those receipts on a timely basis. A separate employee reviews receipts and supporting documents to ensure all expenditures are made appropriately. Credit card receipts are reconciled to credit card statements, just like we reconciled checks and debit card transactions to the bank statement. Spending limits are placed on employees who are authorized to use a company credit card or have access to company cash. Lower limits are given to lower-level employees, while major expenditures require pre-approval through formal purchasing procedures. Only those employees that need to make timely business expenditures should receive authorization.

Question 4-27 (LO 4-7) In addition to the change in total cash which can be calculated using two consecutive balance sheets, the statement of cash flows provides details of inflows and outflows from operating, investing, and financing activities.

Chapter 4 - Cash and Internal Controls

Question 4-28 (LO 4-7) Operating activities include cash transactions involving revenue and expense events during the period. Investing activities include cash investments in long-term assets and investment securities. Financing activities include transactions designed to raise cash or finance the business.

Chapter 4 - Cash and Internal Controls

Answers to Review Questions (continued) Question 4-29 (LO 4-8)

To maintain normal operations, a company needs enough cash, or enough other assets that can quickly be converted to cash, to pay obligations as they become due. Having available cash also helps a company respond quickly to new, profitable opportunities. On the other hand, having too much cash represents idle resources that are not being used to produce revenues or that may be spent inefficiently. A company with too much cash may be a signal that management does not have additional opportunities for profitable expansion.

Question 4-30 (LO 4-8)

Cinemark has a higher ratio of cash to noncash assets than does Regal. The reasons include Cinemark having lower growth in investing activities, higher operating risk from international operations and paying fewer dividends.

Chapter 4 - Cash and Internal Controls

BRIEF EXERCISES Brief Exercise 4-1 (LO 4-1) 1. c. 2. a. 3. d. 4. b. 5. e.

Brief Exercise 4-2 (LO 4-2) 1. e. 2. d. 3. a. 4. c. 5. b.

Brief Exercise 4-3 (LO 4-2) 1. e. 2. a. 3. f. 4. c. 5. b. 6. d.

Chapter 4 - Cash and Internal Controls

Brief Exercise 4-4 (LO 4-3) 1. Yes 2. No 3. Yes 4. Yes 5. No 6. Yes

Brief Exercise 4-5 (LO 4-4) 1.

$ 500,000

350,000

582,000 (= $600,000 less 3% service fee)

198,000 (= $200,000 less 1% service fee) $1,630,000

Brief Exercise 4-6 (LO 4-4) 1. Salaries Expense Cash (Pay salaries by check) 2.

Debit

Credit

500 500

Equipment 1,000 Accounts Payable 1,000 (Purchase computer equipment with credit card) 3. Repairs and Maintenance Expense 400 Cash (Pay for vehicle maintenance with debit card)

400

Chapter 4 - Cash and Internal Controls

Brief Exercise 4-7 (LO 4-5) 1. d. 2. c. 3. f. 4. e. 5. a. 6. b.

Brief Exercise 4-8 (LO 4-5) Reconciliation items

Bank balance

Company balance

1. Checks outstanding

Subtract

No entry

2. NSF checks

No entry

Subtract

3. Deposit recorded twice by company

No entry

Subtract

4. Interest earned

No entry

Add

5. Deposits outstanding

Add

No entry

6. Bank service charges

No entry

Subtract

Brief Exercise 4-9 (LO 4-5) Bank balance

$2,000

Deposits outstanding

+4,200

Checks outstanding

−4,450

Reconciled bank balance

$1,750

Chapter 4 - Cash and Internal Controls

Brief Exercise 4-10 (LO 4-5) Company balance

$2,620

Service fees

−85

NSF check

−350

Note received

+1,000

Interest earned

+35

Reconciled company balance

$3,220

Brief Exercise 4-11 (LO 4-5) Debit Cash

Credit

1,035 Notes Receivable Interest Revenue (Record note and interest collected by bank)

1,000 35

Service Fee Expense 85 Accounts Receivable 350 Cash (Record bank service fee and NSF check)

435

Brief Exercise 4-12 (LO 4-5) Bank balance

$7,345

Company balance

Checks outstanding

−2,803

Service fees

−85

Interest earned

+34

Cash balance per reconciliation

$4,542

Cash balance per reconciliation

$4,542

$4,593

Chapter 4 - Cash and Internal Controls

Brief Exercise 4-13 (LO 4-6) Debit Postage Expense 60 Delivery Expense 85 Supplies Expense 50 Accounts Payable (Recognize expenditures from credit cards) Debit Entertainment Expense 25 Cash (Recognize expenditures from the petty cash fund)

Credit

195 Credit 25

Brief Exercise 4-14 (LO 4-7) 1.

Brief Exercise 4-15 (LO 4-7) Receipts for lessons in June

$4,500

Receipts for lessons in May

500

Total cash received

$5,000

Brief Exercise 4-16 (LO 4-7) Total investing cash flows =

$13,000

Chapter 4 - Cash and Internal Controls

Brief Exercise 4-17 (LO 4-7) Issuance of stock

$11,000

Borrowing from bank

35,000

Payment of dividends

(3,000) $43,000

Brief Exercise 4-18 (LO 4-8) Cash

Noncash Assets*

Ratio

Tuohy Incorporated

$4,200

$19,200

21.88%

Oher Corporation

$3,500

$22,200

15.77%

* Noncash assets = Total assets − Cash

Chapter 4 - Cash and Internal Controls

EXERCISES Exercise 4-1 (LO 4-1) 1. False 2. True 3. True 4. False 5. True 6. True

Exercise 4-2 (LO 4-1) 1. True 2. False 3. True 4. True 5. False 6. False

Exercise 4-3 (LO 4-2) 1. True 2. False 3. False 4. True 5. True 6. False 7. True 8. True 9. False

Exercise 4-4 (LO 4-2) 1. Performance reviews ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. Solutions Manual, Chapter 4 4-13

Chapter 4 - Cash and Internal Controls

2. Physical controls 3. Separation of duties 4. Reconciliations 5. None 6. Proper authorization

Exercise 4-5 (LO 4-3) Currency located at the company

$ 1,050

Short-term investments that mature within three months

1,950

Balance in savings account

8,500

Checks received from customers but not yet deposited

650

Coins located at the company

110

Balance in checking account

6,200

Total cash

$18,460

Exercise 4-6 (LO 4-4) Cash should be recorded and deposited more than once per week (on Friday). The employee recording cash receipts should not also be the employee making the deposit. The bank reconciliation should be prepared more than once each quarter.

Exercise 4-7 (LO 4-4) The petty cash fund of $10,000 is too large. Employees should not be allowed to both place a receipt in the fund and withdraw cash. Employees should obtain permission before writing a check. While it is good that checks over $5,000 must be signed by Goldie or Kate, this amount is too high. A more realistic amount may be $200.

Exercise 4-8 (LO 4-4) Jim should not deposit the checks and also record them.

Chapter 4 - Cash and Internal Controls

Exercise 4-9 (LO 4-5) Requirement 1

Spielberg Company Bank Reconciliation July 31, 2021 Bank’s Cash Balance Per bank statement $22,490 Deposits outstanding + 1,885 Checks outstanding − 1,460 Bank balance per reconciliation $22,915

Company’s Cash Balance Per general ledger $22,970 Service fees − 55 Company balance per reconciliation

$22,915

Requirement 2 Debit Service Fee Expense Cash (Record bank service fee)

Credit

55 55

Chapter 4 - Cash and Internal Controls

Exercise 4-10 (LO 4-5) Requirement 1

The Dean Acting Academy Bank Reconciliation August 31, 2021 Bank’s Cash Balance Per bank statement $6,042 Deposits outstanding + 3,338 Checks outstanding − 1,425 Bank balance per reconciliation $7,955

Company’s Cash Balance Per general ledger $7,944 Service fees − 35 Interest earned + 46 Company balance per reconciliation $7,955

Requirement 2 Debit Cash

Credit

46 Interest Revenue (Record note and interest collected by bank)

Service Fee Expense Cash (Record bank service fee)

35 35

Chapter 4 - Cash and Internal Controls

Exercise 4-11 (LO 4-5) Requirement 1

Damon Company Bank Reconciliation October 31, 2021 Bank’s Cash Balance Per bank statement $11,727 Deposits outstanding + 3,025 Checks outstanding − 1,485 Bank Error + 300 Bank balance per reconciliation $13,567

Company’s Cash Balance Per general ledger $ 8,397 Note received +5,000 Interest earned + 320 Service fees − 150 Company balance per reconciliation $13,567

Requirement 2 Debit Cash

Credit

5,320 Notes Receivable Interest Revenue (Record note and interest collected by bank)

Service Fee Expense Cash (Record bank service fee)

5,000 320

150 150

Chapter 4 - Cash and Internal Controls

Exercise 4-12 (LO 4-6) September 4 Petty Cash Cash (Establish the petty cash fund)

Debit

Credit

200 200

September 30 Debit Repairs and Maintenance Expense 420 Postage Expense 575 Delivery Expense 285 Accounts Payable (Recognize expenditures from credit cards)

Credit

September 30

Credit

Debit

Entertainment Expense 170 Cash (Recognize expenditures from the petty cash fund)

1,280

170

Exercise 4-13 (LO 4-6) April 3 Petty Cash Cash (Establish the petty cash fund) April 30

Debit 200

200 Debit

Utilities Expense 435 Repairs and Maintenance Expense 630 Cash ($435 + $630) (Recognize expenditures from credit cards) April 30

Credit

1,065

Debit

Credit

Entertainment Expense 44 Postage Expense 59 Cash (Recognize expenditures from the petty cash fund)

103

Chapter 4 - Cash and Internal Controls

Exercise 4-14 (LO 4-7) Transaction a. Borrow cash from the bank. b. Purchase supplies on account. c. Purchase equipment with cash. d. Provide services on account. e. Pay cash on account for transaction b above. f. Sell for cash a warehouse no longer in use. g. Receive cash on account for transaction d above. h. Pay cash to workers for salaries.

Cash If yes, is it involved? operating, investing, (yes or no) or financing? Yes Financing No N/A Yes Investing No N/A

Inflow or outflow? Inflow N/A Outflow N/A

Yes

Operating

Outflow

Yes

Investing

Inflow

Yes Yes

Operating Operating

Inflow Outflow

Exercise 4-15 (LO 4-7) Requirements 1 and 2 Transaction a. Issue common stock for cash, $60,000. b. Purchase building and land with cash, $45,000. c. Provide services to customers on account, $8,000. d. Pay utilities on building, $1,500. e. Collect $6,000 on account from customers. f. Pay employee salaries, $10,000. g. Pay dividends to stockholders $5,000. Net cash flows for the year

Cash Flows + $60,000 − $45,000 N/A − $1,500 + $6,000 − $10,000 − $5,000 + $4,500

Operating, investing, or financing? Financing Investing N/A Operating Operating Operating Financing

Requirement 3 December 31, 2021: $5,400 + $4,500 = $9,900

Chapter 4 - Cash and Internal Controls

Exercise 4-16 (LO 4-7) a. Cash used for purchase of office supplies

− $2,400

b. Cash provide from consulting to customers

+ $50,600

c. Cash used for purchase of mining equipment (Investing) d. Cash provided from long-term borrowing (Financing) e. Cash used for payment of employee salaries

− $25,000

f. Cash used for payment of office rent

− $13,000

g. Cash provided from sale of equipment purchased in c. above (Investing) h. Cash used to repay a portion of the long-term borrowing in d. above (Financing) − $5,300

i. Cash used to pay office utilities j. Purchase of company vehicle (Investing) Cash flows from operating activities

+ $4,900

Exercise 4-17 (LO 4-7) c. Cash used for purchase of mining equipment

− $83,000

g. Cash provided from sale of equipment purchased in c. above

+ $23,500

j. Purchase of company vehicle

− $11,000

Cash flows from investing activities

− $70,500

Exercise 4-18 (LO 4-7) d. Cash provided from long-term borrowing

+ $70,000

h. Cash used to repay a portion of the long-term borrowing in d. above

− $45,000

Cash flows from financing activities*

+ $25,000

Chapter 4 - Cash and Internal Controls

Exercise 4-19 (LO 4-7) Requirement 1 1. Cash collected from customers for services provided

+$70,000

2. Salaries paid for the year

−$35,000

3. Advertising paid for the year

−$10,000

4. Supplies paid for the year

5. Utilities paid for the year

−$11,000

6. Cash collected in advance from customers

+$2,000

Net operating cash flows

+$16,000

Requirement 2 1. Service Revenue for the year

+$80,000

2. Salaries Expense for the year

−$40,000

3. Advertising Expense for the year

−$10,000

4. Supplies Expense for the year

−$4,000

5. Utilities Expense for the year

−$12,000

6. Cash collected in advance from customers Net income

0 +$14,000

Requirement 3 Operating activities include cash transactions involving revenue and expense events during the period. In other words, operating activities include the cash effect of the same activities that are reported in the income statement to calculate net income.

Chapter 4 - Cash and Internal Controls

Exercise 4-20 (LO 4-8) All other things equal, Glasco likely has the higher ratio of cash to noncash assets. Based on the trend in operating cash flows, Glasco’s operations are more volatile and therefore riskier. Riskier companies are more likely to incur negative economic shocks to their operations. As a result, they tend to hold more cash to make sure they are able to make debt payments as they become due and to maintain normal operations. In addition, Glasco has foreign operations. Companies with foreign operations often keep cash located in other countries to avoid additional taxes in the United States. A company’s cash balance can also be affected by factors such as its dividend policy and growth opportunities.

Chapter 4 - Cash and Internal Controls

PROBLEMS: SET A Problem 4-1A (LO 4-4) Requirement 1 Internal controls include: - Tickets are serially numbered. - The person issuing the ticket at the box office is physically separated from the person taking the ticket for admission. - Half of the ticket is kept so that the number of tickets issued can be matched with the number of tickets received. - A turnstile is used to automatically count those entering the theatre. - The ticket stubs are stored in a locked box. Requirement 2 At the end of each day, the ticket manager can match the money received with the number of tickets issued. In addition, the number of tickets issued can be matched with the number of tickets in the locked box which can also be verified with the count of the turnstile. Requirement 3 and 4 Classroom discussion.

Chapter 4 - Cash and Internal Controls

Problem 4-2A (LO 4-5) Requirement 1 Oscar’s Red Carpet Store Bank Reconciliation February 28, 2021 Bank’s Cash Balance Per bank statement $13,145 Deposits outstanding + 1,600 Checks outstanding − 2,100

Bank balance per reconciliation

$ 12,645

Company’s Cash Balance Per general ledger $8,100 NSF check − 200 Company error − 300 EFT for rent −1,100 Interest on account + 20 Note collected +6,000 Interest on note + 250 Service fees − 125 Company balance per reconciliation $12,645

Requirement 2 Debit Cash

Credit

6,270 Notes Receivable Interest Revenue (Record note and interest collected by bank and interest earned on account balance)

Accounts Receivable 200 Advertising Expense 300 Rent Expense 1,100 Service Fee Expense 125 Cash (Record NSF check, recording error, automatic payment, and bank service fee)

6,000 270

1,725

Chapter 4 - Cash and Internal Controls

Problem 4-3A (LO 4-5) Requirement 1 Diaz Entertainment Bank Reconciliation May 31, 2021 Bank’s Cash Balance Per bank statement Deposits outstanding Checks outstanding (#475 and #476) Bank error Bank balance per reconciliation

$6,210 +3,180 −4,150 + 600 $5,840

Company’s Cash Balance Per general ledger $5,100 NSF check − 400 Interest earned + 90 Note collected +1,100 Service fees − 50 Company balance per reconciliation $5,840

Requirement 2 Debit Cash

Credit

1,190 Notes Receivable Interest Revenue (Record note and interest collected by bank and interest earned on account balance)

Accounts Receivable 400 Service Fee Expense 50 Cash (Record NSF check and bank service fee)

1,100 90

450

Chapter 4 - Cash and Internal Controls

Problem 4-4A (LO 4-7) Pixar Toy Manufacturing Statement of Cash Flows For the month ended August 31, 2021 Cash Flows from Operating Activities Cash inflows: From customers Cash outflows: For salaries For office rent For office utilities For materials to make toys Net cash flows from operating activities Cash Flows from Investing Activities Sale of unused warehouse Purchase of manufacturing equipment Net cash flows from investing activities Cash Flows from Financing Activities Bank borrowing Payment of dividends Net cash flows from financing activities Net decrease in cash Cash at the beginning of the month Cash at the end of the month

$93,500 (65,300) (19,000) (11,800) (27,700) ($30,300) 36,000 (46,000) (10,000) 26,000 (6,700) 19,300 (21,000) 25,500 $ 4,500

Chapter 4 - Cash and Internal Controls

Problem 4-5A (LO 4-7) Requirement 1 October 2 Cash

Debit

Credit

8,500 Service Revenue (Receive membership dues)

8,500

October 5

Debit

Cash

12,000 Common Stock (Issue common stock)

October 9

Credit 12,000

Debit

Credit

Equipment 9,600 Cash 4,800 Notes Payable 4,800 (Purchase boxing equipment: one-half paid for with cash on this date and issue a note payable for one-half, due by the end of the year) October 12

Debit

Advertising Expense Cash (Pay for current month advertising)

1,500

October 19

Debit

Dividends Cash (Pay dividends)

4,400

October 22

Debit

Prepaid Insurance Cash (Pay prepaid insurance)

6,900

Credit 1,500 Credit 4,400 Credit 6,900

Chapter 4 - Cash and Internal Controls

Problem 4-5A (continued) Requirement 1 (concluded) October 25

Debit

Cash

Credit

5,600 Deferred Revenue (Receive membership dues in advance)

5,600

October 30

Debit

Utilities Expense Utilities Payable (Receive current month utilities bill)

5,200

October 31

Debit

Salaries Expense Cash (Pay current month salaries)

7,300

Credit 5,200 Credit 7,300

Requirement 2 All transactions involve cash except for the utilities payable transaction on October 30.

Requirement 3 Cash October 1 October 2 October 5 October 25

Debits 16,600 8,500 12,000 5,600

Credits 4,800 1,500 4,400 6,900 7,300

October 9 October 12 October 19 October 22 October 31

17,800

Chapter 4 - Cash and Internal Controls

Problem 4-5A (continued) Requirement 4 Balboa’s Gym Statement of Cash Flows For the month ended October 31 Cash Flows from Operating Activities Cash inflows: From customers Cash outflows: For advertising For insurance For salaries Net cash flows from operating activities Cash Flows from Investing Activities Purchase of boxing equipment Net cash flows from investing activities Cash Flows from Financing Activities Issuance of common stock Payment of dividends Net cash flows from financing activities Net increase in cash Cash at the beginning of the month Cash at the end of the month

$14,100 (1,500) (6,900) (7,300) $ (1,600) (4,800) (4,800) 12,000 (4,400) 7,600 1,200 16,600 $17,800

Requirement 5 Net cash flows in statement of cash flows = $1,200 Change in cash balance for the month = $17,800 (ending) − $16,600 (beginning) = $1,200

Chapter 4 - Cash and Internal Controls

PROBLEMS: SET B Problem 4-1B (LO 4-4, 4-5) Requirement 1 Howard Productions Bank Reconciliation February 28 Bank’s Cash Balance Per bank statement $ 735 Deposits outstanding +7,692 Checks outstanding − 489 Bank error +1,350 Bank balance per reconciliation $9,288

Company’s Cash Balance Per general ledger $19,225 NSF check − 5,278 Service fees − 159 Petty cash fund − 4,500 Company balance per reconciliation $9,288

Requirement 2 The company has a large amount of NSF checks. This indicates that the company’s procedures related to acceptance of customers’ checks is not reliable. The company should tighten controls over the allowance of payment by check. Deposits outstanding are relatively high. The company should more frequently deposit cash to avoid theft or loss of cash. The amount established for the petty cash fund may be too high. Petty cash provides cash on hand for minor purchases. Having too much cash on hand creates the likelihood that a material amount of cash will be mishandled.

Chapter 4 - Cash and Internal Controls

Problem 4-2B (LO 4-5) Requirement 1 Blockwood Video Bank Reconciliation October 31, 2021 Bank’s Cash Balance Per bank statement $12,751 Deposits outstanding + 835 Checks outstanding − 1,280 Bank error − 577 Bank balance per reconciliation

$11,729

Company’s Cash Balance Per general ledger $12,381 Company error + 27 EFT for note − 560 Service fees − 34 NSF check − 85 Company balance per reconciliation $11,729

Requirement 2 Debit Cash

Credit

27 Utilities Expense (Record correction of recording error)

Note Payable 500 Interest Expense 60 Service Fee Expense 34 Accounts Receivable 85 Cash (Record EFT of note and interest, bank service fee, and NSF check )

679

Chapter 4 - Cash and Internal Controls

Problem 4-3B (LO 4-5) Requirement 1 Glover Incorporated Bank Reconciliation July 31, 2021 Bank’s Cash Balance Per bank statement $3,750 Deposits outstanding +2,820 Checks outstanding −2,400 (#534 and #535) Bank balance per reconciliation

$4,170

Company’s Cash Balance Per general ledger $5,670 Company error − 400 Interest earned + 60 NSF check − 500 Service fees − 60 Office supplies − 600 Company balance per reconciliation $4,170

Requirement 2 Debit Cash

Credit

60 Interest Revenue (Record interest earned on checking account)

Equipment 400 Accounts Receivable 500 Service Fee Expense 60 Supplies 600 Cash (Record correction of recording error, NSF check, bank service fee, and EFT)

1,560

Chapter 4 - Cash and Internal Controls

Problem 4-4B (LO 4-7) Dreamworks Bedding Supplies Statement of Cash Flows For the month ended August 31, 2021 Cash Flows from Operating Activities Cash inflows: From customers From interest Cash outflows: For salaries For advertising For office supplies For bedding material Net cash flows from operating activities Cash Flows from Investing Activities Sale of unused land Purchase of delivery truck Net cash flows from investing activities Cash Flows from Financing Activities Issuance of common stock Repayment of borrowing Net cash flows from financing activities Net increase in cash Cash at the beginning of the month Cash at the end of the month

$ 80,400 300 (47,100) (5,900) (3,800) (13,000) $ 10,900 15,700 (34,500) (18,800) 30,000 (9,000) 21,000 13,100 8,300 $ 21,400

Chapter 4 - Cash and Internal Controls

Problem 4-5B (LO 4-7) Requirement 1 June 2

Debit

Cash

19,000 Notes Payable (Borrow from the bank)

Credit 19,000

June 3

Debit

Rent Expense Cash (Pay current month rent)

1,200

June 7

Debit

Credit 1,200

Cash 5,200 Accounts Receivable 3,500 Service Revenue (Provide services for cash and on account) June 11

Debit

Equipment Cash (Purchase equipment)

8,400

June 17

Debit

Salaries Expense Cash (Pay salaries)

6,500

June 22

Debit

Dividends Cash (Pay dividends)

1,550

Credit

8,700 Credit 8,400 Credit 6,500 Credit 1,550

Chapter 4 - Cash and Internal Controls

Problem 4-5B (continued) Requirement 1 (concluded) June 25

Debit

Cash

Credit

2,100 Deferred Revenue (Receive cash in advance)

2,100

June 28

Debit

Utilities Expense Cash (Pay current month utilities bill)

3,300

June 30

Debit

Salaries Expense Salaries Payable (Owe current month’s salaries)

6,500

Credit 3,300 Credit 6,500

Requirement 2 All transactions involve cash except for the salaries payable transaction on June 30.

Requirement 3 Cash June 1 June 2 June 7 June 25

Debits 14,700 19,000 5,200 2,100

Credits 1,200 8,400 6,500 1,550 3,300

June 3 June 11 June 17 June 22 June 28

20,050

Chapter 4 - Cash and Internal Controls

Problem 4-5B (continued) Requirement 4 Homeward Bound Statement of Cash Flows For the month ended June 30 Cash Flows from Operating Activities Cash inflows: From customers Cash outflows: For rent For salaries For utilities Net cash flows from operating activities Cash Flows from Investing Activities Purchase equipment Net cash flows from investing activities Cash Flows from Financing Activities Borrow from bank Pay dividends Net cash flows from financing activities Net increase in cash Cash at the beginning of the month Cash at the end of the month

$ 7,300 (1,200) (6,500) (3,300) ($ 3,700) (8,400) (8,400) 19,000 (1,550) 17,450 5,350 14,700 $20,050

Requirement 5 Net cash flows in statement of cash flows = $5,350 Change in cash balance for the month = $20,050 (ending) − $14,700 (beginning) = $5,350

Chapter 4 - Cash and Internal Controls

ADDITIONAL PERSPECTIVES Additional Perspective 4-1 Requirement 1 Suzie should make deposits more often than once per month, such as each day or each time a major deposit is needed. Suzie should also reconcile the bank statement more than once every six months, such as once per month.

Requirement 2 Great Adventures, Inc. Bank Reconciliation December 31, 2021 Bank’s Cash Balance Per bank statement Deposits outstanding Checks outstanding Bank balance per reconciliation

$50,500 +20,000 − 6,000 $64,500

Dec. 31, 2021 Cash Interest Revenue (Record interest earned) Dec. 31, 2021 Service Fee Expense Cash (Record bank service fee)

Company’s Cash Balance Per general ledger $64,200 Interest earned + 500 Service fee − 200 Company balance per reconciliation $64,500 Debit 500

Credit 500

200 200

Requirement 3 Failure to record the interest revenue would cause assets and revenues to be understated by $500. Failure to record the service charge fee causes expenses to be understated and assets to be overstated by $200. The net effect of both transactions is an understatement of assets by $300 and an understatement of stockholders’ equity (retained earnings) and net income by $300.

Chapter 4 - Cash and Internal Controls

Additional Perspective 4-2 ($ in thousands) Requirement 1 We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of February 3, 2018, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 Framework) and our report dated March 16, 2018 expressed an unqualified opinion thereon. Requirement 2 The Company considers all highly liquid investments purchased with a remaining maturity of three months or less to be cash equivalents. Requirement 3 The amount of cash reported in the current year is $413,613, and the amount of cash reported in the previous year is $378,613. This is an increase of $35,000. Requirement 4 The amounts reported for operating, investing, and financing cash flows for continuing operations are $394,426, $(172,150), and $(188,772), respectively. The cash flows from continuing operations are $33,504. The difference of $1,496 is related to the effect of exchange rates on cash. Requirement 5 The amounts in requirement 3 and requirement 4 are equal. Requirement 6 The ratio of cash to noncash assets is $413,613/$1,402,700 = 29.5%.

Chapter 4 - Cash and Internal Controls

Additional Perspective 4-3 ($ in thousands) Requirement 1 We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of February 3, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated April 4, 2018, expressed an unqualified opinion on the Company’s internal control over financial reporting. Requirement 2 The Company considers all highly liquid debt instruments with an original maturity of three months or less when purchased to be cash equivalents. Requirement 3 The amount of cash reported in the current year is $165,086, and the amount of cash reported in the previous year is $196,536. This is an decrease of $31,450. Requirement 4 The amounts reported for operating, investing, and financing cash flows are $119,721, $(17,297), and $(133,874). Total cash flows are $(31,450). Requirement 5 The amounts in requirement 3 and requirement 4 are equal. Requirement 6 The ratio of cash to noncash assets is $165,086/$373,030 = 44.3%.

Chapter 4 - Cash and Internal Controls

Additional Perspective 4-4 ($ in thousands) Requirement 1 American Eagle’s ratio of cash to noncash assets is $413,613/$1,402,700 = 29.5%. Buckle’s ratio of cash to noncash assets is $165,086/$373,030 = 44.3%. Riskier companies are more likely to incur negative economic shocks to their operations. As a result, they tend to hold more cash to make sure they are able to make debt payments as they become due and to maintain normal operations. In addition, companies with foreign operations often keep cash located in other countries to avoid additional taxes in the United States. Only American Eagle operates in foreign countries. A company’s cash balance can also be affected by factors such as its dividend policy and growth opportunities. Requirement 2 American Eagle’s ratio of cash to current liabilities is $413,613/$485,221 = 85.2%. Buckle’s ratio of cash to current liabilities is $165,086/$97,906 = 168.6%. Based on this analysis alone, Buckle is more able to pay its current liabilities if they were all to be paid immediately. American Eagle would have to borrow short-term, or to collect on its receivables to pay all current liabilities immediately. It can be noted that Buckle has very minimal receivables and American Eagle has more than enough receivables to make up the shortage it would need to pay current liabilities. Therefore, on this analysis alone, receivables balances may be a factor in consideration of cash balances to have at a point in time. For example, it is unknown how cash might have been (legitimately) manipulated for the balance sheet date such that bills may or may not have been paid at the very end of the year to provide balances desired for balance sheet analysis pertaining to the year-end balance sheet date.

Chapter 4 - Cash and Internal Controls

Additional Perspective 4-5 1. Yes. The rules explicitly state that friends and family are not allowed to watch free movies, and full price is to be paid for all concession items. 2. Yes. While everyone else, including upper management, is breaking rules of written policy, Jack is still able to make the choice to follow policy. 3. Yes. Managers should consider the tone they are setting for the company. By violating the policies themselves, managers are not establishing a good control environment for an overall ethical tone by employees with respect to internal controls. 4. Yes. However, in such a situation, it would be easy for Jack to justify not following the policy and to feel pressure from others. Jack could believe that because many workers, including upper management, are violating policies in the employee handbook, it is less unethical to allow friends and family to see free movies and have free popcorn and beverages. Plus, Jack needs to save for college. Unethical actions seem to be easier to justify if one of the outcomes is achieving something positive, like a college education. By not engaging in these unethical actions, Jack also portrays a sense of ethical responsibility and trustworthiness among his peers and management. In the long-term, these characteristics could lead to Jack being promoted to higher positions because of management trust, receiving additional compensation, obtaining positive reference letters from management for college and scholarship applications, and other benefits.

Chapter 4 - Cash and Internal Controls

Additional Perspective 4-6 Requirement 1 The Kroger Company ($ in thousands) for January 28, 2017. Operating cash flows = Investing cash flows = Financing cash flows =

$ 4,272,000 (3,875,000) (352,000) $ 45,000

Requirement 2 Sprouts Farmers Market ($ in millions) for December 31, 2017. Operating cash flows = Investing cash flows = Financing cash flows =

$ 309,567 (198,594) (103,959) $ 7,014

Requirement 3 The Kroger Company: Cash (January 28, 2017) Cash (January 30, 2016)

$322,000 277,000 $ 45,000

Sprouts Farmers Market Cash (December 31, 2017) Cash (January 1, 2017)

$19,479 12,465 $ 7,014

Chapter 4 - Cash and Internal Controls

Additional Perspective 4-7 Some of the internal control weaknesses include: 1. - The employee who authorizes payment should not also be the employee who disburses cash. - The employee responsible for making cash disbursements should not also be the employee in charge of the cash receipts. - The fund balance should be verified by two or more employees. 2. - The employee who authorizes payment should not also be the employee who prepares the check. - The employee who authorizes the payment should not also be the employee who records the payment. - The employee who records the payment should not also be the employee who reconciles the bank statement. 3. - The employee who opens the mail should not also be the employee that makes a list of checks and cash received. - The employee who opens the mail should not also be the employee that makes the deposit at the bank. - The employee who makes deposits at the bank should not also be the employee that maintains a record of cash receipts.

Chapter 5 - Receivables and Sales

Chapter 5 Receivables and Sales REVIEW QUESTIONS Question 5-1 (LO 5-1) When recording a credit sale, we debit accounts receivable. Accounts receivable are reported as assets in the balance sheet.

Question 5-2 (LO 5-1) Trade receivables are amounts receivable from customers due to credit sales. Nontrade receivables are receivables from those other than customers and include tax refund claims, interest receivable, and loans by the company to other entities including stockholders and employees.

Question 5-3 (LO 5-2) Trade discounts represent a reduction in the listed price of a product or service. A sales discount represents a reduction, not in the selling price of a product or service, but in the amount to be paid by a credit customer if paid within a specified period of time. Sales discounts are reported as contra revenues in the income statement.

Question 5-4 (LO 5-2) Sales returns and allowances are contra revenue accounts and therefore have normal debit balances. Sales returns occur when a customer returns a product. Sales allowances occur when the seller reduces the customer’s balance owed or provides at least a partial refund because of some deficiency in the company’s product or service. Sales returns and allowances are reported as contra revenues in the income statement.

Question 5-5 (LO 5-2) An example of recognizing revenue at one point would be selling a car. An example of recognizing revenue over a period would be providing an annual magazine subscription.

Question 5-6 (LO 5-3) Companies should account for uncollectible accounts receivable using the allowance method. Under this method, a company estimates future bad debts and records those estimates as an expense and contra asset in the current period.

Question 5-7 (LO 5-3) The two purposes include reducing accounts receivable to the amount expected to be collected and reporting expenses (bad debts) typically in the same period as the revenue (credit sales) they helped generate.

Solutions Manual, Chapter 5

Answers to Review Questions (continued) Question 5-8 (LO 5-3) Allowing for uncollectible accounts involves recording a contra asset for the amount of receivables expected not to be collected. This contra account (Allowance for Uncollectible Accounts) is reported with Accounts Receivable in the balance sheet. The difference is net accounts receivable, which equals the net amount of cash expected to be collected.

Question 5-9 (LO 5-3) The two financial statement effects of establishing an allowance for uncollectible accounts are: (1) reducing assets and (2) increasing expenses (or reducing net income and ultimately retained earnings).

Question 5-10 (LO 5-3) The amount expected to be collected means that there is a possibility that not all accounts receivable will be collected and the balance sheet should not overstate assets without recognition of this possibility. Thus, accounts receivable are presented at a net amount which is equal to total accounts receivable minus the allowance for uncollectible accounts.

Question 5-11 (LO 5-4) The write-off of an account as uncollectible includes a debit to the Allowance for Uncollectible Accounts and a credit to Accounts Receivable for the amount being written off. The write-off has no effect on total assets or net income at the time of the write-off.

Question 5-12 (LO 5-4) A debit balance in the allowance for uncollectible accounts before adjustment could occur if actual bad debts in the current year exceed the previous year’s ending balance of allowance for uncollectible accounts, which is the beginning balance of the account in the current year.

Question 5-13 (LO 5-4) A credit balance occurs in Allowance for Uncollectible Accounts before adjustment when actual bad debts in the current year are less than the previous year’s ending balance of the account, which reflected an estimate of the amount of accounts receivable not expected to be collected.

Question 5-14 (LO 5-5) The age of accounts receivable refers to how far past due accounts are. The older the account, the less likely it is to be collected. The aging method estimates uncollectible accounts receivable by associating a percentage probability of uncollectibility to each account and multiplying that percentage by the account balance to determine the estimated uncollectible amount.

Question 5-15 (LO 5-5) The year-end adjustment to the allowance for uncollectible accounts normally includes a debit to bad debt expense and a credit to the allowance for uncollectible accounts. The amount of the adjustment is the amount needed to adjust the allowance for uncollectible accounts to its estimated ending balance when using the aging method or the percentage of receivables method. If the ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 5-2 Financial Accounting, 5e

Chapter 5 - Receivables and Sales

allowance account has a credit balance before adjustment, the amount of the adjustment is the yearend estimate of uncollectible accounts minus the existing credit balance. If the allowance account has a debit balance before adjustment, the amount of the adjustment is the year-end estimate of uncollectible accounts plus the existing debit balance.

Solutions Manual, Chapter 5

Answers to Review Questions (continued) Question 5-16 (LO 5-6) The allowance method requires companies to estimate future bad debts and to reflect those estimates in the current period as a balance in an allowance for uncollectible accounts as a contra account to accounts receivable. The amount required to adjust the allowance account is offset to bad debt expense. The direct write-off method makes no attempt to estimate future bad debts. Instead, the reduction in accounts receivable and increase in expense associated with bad debts is recorded only when the bad debt actually occurs. Only the allowance method is allowed by financial accounting rules.

Question 5-17 (LO 5-7) One common difference is that notes receivable require the borrower to pay interest. Also, notes receivable typically arise not from sales to customers, but from loans to other entities including affiliated companies, loans to stockholders and employees, and occasionally the sale of merchandise, other assets, or services.

Question 5-18 (LO 5-7) Face value – amount of the note. Annual interest rate – the interest charged by the lender to the borrower stated on an annual (twelve month) basis. Fraction of the year – the proportion of the year that the note is outstanding.

Question 5-19 (LO 5-7) Interest

Face value

Annual interest rate

Fraction of the year

$90

$2,000

9/12

Question 5-20 (LO 5-7) Recording interest earned but not yet received includes a debit to interest receivable and a credit to interest revenue. The amount is calculated as the face value of the note times the annual interest rate times the fraction of the year the note is outstanding.

Question 5-21 (LO 5-8) The receivables turnover ratio equals net credit sales divided by average accounts receivable. The ratio shows the number of times during a year that the average accounts receivable balance is collected (or “turns over”). Typically, a higher ratio is a good indicator of a company’s effectiveness in managing receivables.

Question 5-22 (LO 5-8) The average collection period equals 365 days divided by the receivables turnover ratio. The ratio shows the approximate number of days the average accounts receivable balance is outstanding. Typically, a lower number is a good indicator of a company’s effectiveness in managing receivables. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 5-4 Financial Accounting, 5e

Chapter 5 - Receivables and Sales

Answers to Review Questions (continued) Question 5-23 (LO 5-8) A company can attempt to boost sales, and thereby increase its value, by allowing customers to purchase products and services on account. Some customers may be unwilling or unable to purchase products and services in the current period if immediate cash payment is required. However, failure to recognize high-risk customers or to have a reliable collection policy can result in uncollectible accounts and lost resources, thereby lowering the value of a company. Having enough cash is important to running any business. The more quickly a company can collect on receivables, the more quickly it can use that cash to generate even more cash by reinvesting in the business and generating additional sales.

Question 5-24 (LO 5-9) The percentage of receivables method is commonly used in practice. Financial accounting rules require accounts receivable to be stated at the amount expected to be collected, and this is better accomplished through the percentage of receivables method. The percentage of credit sales method focuses on matching current period bad debt expense with current period credit sales, that is, the matching principle.

Question 5-25 (LO 5-9) The percentage of receivables method estimates future bad debts based on a balance sheet account – accounts receivable. The percentage of credit sales method estimates future bad debts based on an income statement account – credit sales. The current emphasis on better measurement of assets (balance sheet focus) outweighs the emphasis on better measurement of net income (income statement focus). This is why the percentage of receivables method (balance sheet method) is the preferable method, while the percentage of credit sales method (income statement method) is allowed only if amounts do not differ significantly from estimates using the percentage of receivables method.

Solutions Manual, Chapter 5

BRIEF EXERCISES Brief Exercise 5-1 (LO 5-2) Debit

Credit

Accounts Receivable 3,080 Service Revenue 3,080 (Provide services of $3,500 on account with 12% trade discount) Accounts Receivable Service Revenue (Provide services on account)

700 700

Brief Exercise 5-2 (LO 5-2) Total sales

$750,000

Less: Sales returns ($50 + $6)

(56,000)

Sales allowances ($30 + $4)

(34,000)

Sales discounts ($20 + $2)

(22,000)

Net sales

$638,000

Brief Exercise 5-3 (LO 5-3) Debit Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($20,000 x 10% = $2,000)

Credit

2,000 2,000

Chapter 5 - Receivables and Sales

Brief Exercise 5-4 (LO 5-4) Debit Allowance for Uncollectible Accounts Accounts Receivable (Write off uncollectible accounts)

Credit

17,000 17,000

Allowance for uncollectible accounts = $15,000 (beginning) − $17,000 (write-off) = −$2,000 or $2,000 debit

Brief Exercise 5-5 (LO 5-4) September 9

Debit

Accounts Receivable 7,000 Allowance for Uncollectible Accounts (Re-establish portion of account previously written off) Cash

Credit 7,000

7,000 Accounts Receivable (Cash collection on account)

Solutions Manual, Chapter 5

7,000

Brief Exercise 5-6 (LO 5-5) Debit Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($25,000 x 12% − $600 = $2,400)

Credit

2,400 2,400

Brief Exercise 5-7 (LO 5-5) Debit Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($25,000 x 12% + $600 = $3,600)

Credit

3,600 3,600

The amount in BE5-7 is greater because the balance of Allowance for Uncollectible Accounts before adjustment is a debit (or negative). This means that actual bad debts in the current year have been greater than expected, and the year-end adjustment accounts for the additional bad news.

Brief Exercise 5-8 (LO 5-5) Debit

Credit

Bad Debt Expense 12,000 Allowance for Uncollectible Accounts 12,000 (Estimate future bad debts) ($15,000 − $3,000 = $12,000)

Chapter 5 - Receivables and Sales

Brief Exercise 5-9 (LO 5-5) Debit Bad Debt Expense 18,000 Allowance for Uncollectible Accounts (Estimate future bad debts) ($15,000 + $3,000 = $18,000)

Credit 18,000

The amount in BE5-9 is greater because the balance of Allowance for Uncollectible Accounts before adjustment is a debit (or negative). This means that actual bad debts in the current year have been greater than expected, and the year-end adjustment accounts for the additional bad news.

Brief Exercise 5-10 (LO 5-5) Age Group Not yet due 1-30 days past due More than 30 days past due Total

Estimated Amount Percent Receivable Uncollectible $40,000 5% 11,000 20% 5,000 30% $56,000

Estimated Amount Uncollectible $2,000 2,200 1,500 $5,700

Estimated Amount Percent Receivable Uncollectible $25,000 4% 10,000 25% 5,000 50% $40,000

Estimated Amount Uncollectible $1,000 2,500 2,500 $6,000

Brief Exercise 5-11 (LO 5-5) Age Group Not yet due 1-60 days past due More than 60 days past due Total

Debit Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($6,000 − $1,000 = $5,000) Solutions Manual, Chapter 5

Credit

5,000 5,000

Brief Exercise 5-12 (LO 5-6) March 14, 2022

Debit

Bad Debt Expense 2,000 Accounts Receivable (Write off customer’s account using the direct write-off method)

Credit 2,000

Brief Exercise 5-13 (LO 5-6) December 31, 2021

Debit

Credit

Debit

Credit

No entry necessary During 2022

Bad Debt Expense 3,000 Accounts Receivable (Write off customers’ accounts using the direct write-off method)

3,000

Brief Exercise 5-14 (LO 5-6) If Brady uses the direct write-off method, then no adjustment is recorded at the end of 2021 to estimate future bad debts. Instead, if Brady uses the allowance method, the following adjustment would be recorded at the end of 2021: December 31, 2021

Debit

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts)

9,000

Credit 9,000

Brief Exercise 5-15 (LO 5-7) Face Value

Annual interest rate

Fraction of the year

Interest

Chapter 5 - Receivables and Sales

$11,000 $30,000 $35,000 $17,500

6% 5% 7% 8%

4 months 12 months 6 months 6 months

$220 $1,500 $1,225 $700

Brief Exercise 5-16 (LO 5-7) Interest Revenue 2021: $40,000 x 9% x 3/12 = $900 2022: $40,000 x 9% x 9/12 = $2,700

Brief Exercise 5-17 (LO 5-9) Debit Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($135,000 x 3% = $4,050)

Credit

4,050 4,050

Brief Exercise 5-18 (LO 5-9) Debit Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($135,000 x 3% = $4,050)

Solutions Manual, Chapter 5

Credit

4,050 4,050

Brief Exercise 5-19 (LO 5-1, 5-2, 5-3, 5-5, 5-6, 5-7) 1. C 2. E 3. A 4. H 5. B 6. D 7. G 8. F 9. I

Chapter 5 - Receivables and Sales

EXERCISES Exercise 5-1 (LO 5-1) May 7

Debit

Accounts Receivable Service Revenue (Provide services on account)

4,000

Credit 4,000

May 13 Cash

4,000 Accounts Receivable (Collect cash on account)

4,000

Exercise 5-2 (LO 5-2) May 1

Debit

Cash

270

Credit

Service Revenue 270 (Provide services of $300 with a 10% trade discount)

Exercise 5-3 (LO 5-1, 5-2) March 12

Debit

Accounts Receivable Service Revenue (Provide services on account)

11,000

Credit 11,000

March 20 Cash 10,780 Sales Discounts 220 Accounts Receivable 11,000 (Receive cash on account less a 2% sales discount) (Sales discount = $11,000 x 2%)

Solutions Manual, Chapter 5

Exercise 5-4 (LO 5-1, 5-2) March 12

Debit

Accounts Receivable Service Revenue (Provide services on account)

11,000

Credit 11,000

March 31 Cash

11,000 Accounts Receivable (Receive cash on account)

11,000

Exercise 5-5 (LO 5-1, 5-2) March 12

Debit

Service Fee Expense Accounts Payable (Receive services on account)

11,000

Credit 11,000

March 31 Accounts Payable Cash (Pay cash on account)

11,000 11,000

Chapter 5 - Receivables and Sales

Exercise 5-6 (LO 5-1, 5-2) Requirement 1 April 25

Debit

Accounts Receivable Service Revenue (Provide services on account) Requirement 2 April 27

Credit

3,500 3,500

Debit

Credit

Sales Allowances 600 Accounts Receivable (Record sales allowance for credit sale)

600

Requirement 3 April 30

Debit

Cash

Credit

2,900 Accounts Receivable 2,900 (Collect cash on account less sales allowance)

Requirement 4 Service revenue Less: Sales allowances Net sales

Solutions Manual, Chapter 5

$3,500 (600) $2,900

Exercise 5-7 (LO 5-3, 5-4) Requirement 1 December 31, 2021

Debit

Bad Debt Expense 12,500 Allowance for Uncollectible Accounts (Estimate future bad debts) ($12,500 = $50,000 x 25%) Requirement 2 During 2022

Debit

Allowance for Uncollectible Accounts Accounts Receivable (Write off uncollectible accounts)

Credit 12,500

Credit

10,000 10,000

Allowance for Uncollectible Accounts Beginning balance in 2022

$12,500 credit

Less: Write-offs during 2022

(10,000) debit

Ending balance in 2022 (before adjustment)

$ 2,500 credit

Requirement 3 During 2022

Debit

Allowance for Uncollectible Accounts Accounts Receivable (Write off uncollectible accounts)

Credit

15,000 15,000

Allowance for Uncollectible Accounts Beginning balance in 2022

$12,500 credit

Less: Write-offs during 2022

(15,000) debit

Ending balance in 2022 (before adjustment) $ 2,500 debit* * A debit balance in Allowance for Uncollectible Accounts indicates the account currently has a negative balance. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 5-16 Financial Accounting, 5e

Chapter 5 - Receivables and Sales

Exercise 5-8 (LO 5-5) Requirement 1 December 31, 2021

Debit

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($7,900 = $60,000 x 15% − $1,100)

Credit

7,900 7,900

Requirement 2 Bad debt expense

$7,900

Allowance for uncollectible accounts

$9,000*

*$9,000 = $7,900 credit adjustment + $1,100 credit balance before adjustment

Requirement 3 Total accounts receivable Less: Allowance for uncollectible accounts Net accounts receivable

Solutions Manual, Chapter 5

$ 60,000 (9,000) $ 51,000

Exercise 5-9 (LO 5-5) Requirement 1 December 31, 2021

Debit

Bad Debt Expense 28,100 Allowance for Uncollectible Accounts (Estimate future bad debts) [$28,100 =( $130,000 x 20%) + $2,100]

Credit 28,100

Requirement 2 Bad debt expense

$28,100

Allowance for uncollectible accounts

$26,000*

*$26,000 = $28,100 credit adjustment − $2,100 debit balance before adjustment

Requirement 3 Total accounts receivable

$130,000

Less: Allowance for uncollectible accounts

(26,000)

Net accounts receivable

$104,000

Chapter 5 - Receivables and Sales

Exercise 5-10 (LO 5-5) Requirement 1

Age Group Not yet due 0-30 days past due 31-90 days past due More than 90 days past due Total

Amount Receivable $50,000 11,000 8,000 1,000 $70,000

Estimated Percent Uncollectible 15% 20% 45% 85%

Requirement 2 December 31, 2021

Debit

Estimated Amount Uncollectible $ 7,500 2,200 3,600 850 $14,150 Credit

Bad Debt Expense 12,750 Allowance for Uncollectible Accounts 12,750 (Estimate future bad debts) ($12,750 = $14,150 − $1,400) Requirement 3 Total accounts receivable

$ 70,000

Less: Allowance for uncollectible accounts

(14,150)

Net accounts receivable

$ 55,850

Solutions Manual, Chapter 5

Exercise 5-11 (LO 5-5) Requirement 1

Age Group Not yet due 0-60 days past due 61-120 days past due More than 120 days past due Total

Amount Receivable $ 60,000 26,000 16,000 8,000 $110,000

Estimated Percent Uncollectible 4% 20% 30% 85%

Requirement 2 December 31, 2021

Debit

Estimated Amount Uncollectible $ 2,400 5,200 4,800 6,800 $19,200 Credit

Bad Debt Expense 23,200 Allowance for Uncollectible Accounts 23,200 (Estimate future bad debts) ($23,200 = $19,200 + $4,000) Requirement 3 Total accounts receivable

$110,000

Less: Allowance for uncollectible accounts

(19,200)

Net accounts receivable

$ 90,800

Exercise 5-12 (LO 5-3, 5-4, 5-5) Credit sales transaction cycle 1. Provide services on account 2. Estimate uncollectible accounts 3. Write off accounts as uncollectible 4. Collect on account previously written off

Stockholders’ Assets Liabilities equity Revenues Expenses I

Chapter 5 - Receivables and Sales

Exercise 5-13 (LO 5-6) Requirement 1 1.

Debit

Accounts Receivable Service Revenue (Provide service on account) 2.

190,000

Cash

185,000

Credit 190,000

Accounts Receivable (Collect cash on account)

185,000

3. Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($4,650 = $31,000 x 15%) 4.

4,650

Allowance for Uncollectible Accounts Accounts Receivable (Write off actual bad debts)

8,000

Requirement 2 1.

4,650

8,000

Debit

Accounts Receivable Service Revenue (Provide services on account) 2.

190,000

Cash

185,000

Credit 190,000

Accounts Receivable (Collect cash on account)

185,000

3. No entry 4. Bad Debt Expense Accounts Receivable (Write off actual bad debts) Solutions Manual, Chapter 5

8,000 8,000 © The McGraw-Hill Companies, Inc., 2019 5-21

Exercise 5-13 (concluded) Requirement 3 Bad Debt Expense

Allowance Method

Direct Write-off Method

2021:

$4,650

2022:

$8,000

Under the allowance method, we record bad debt expense in the period we estimate the bad debts (2021). In 2021, $4,650 would be recorded for bad debt expense under the allowance method only, so net income would be lower by $4,650 under the allowance method compared to the direct write-off method. Under the direct write-off method, we record bad debts when they actually occur (2022). In 2022, $8,000 would be recorded for bad debt expense under the direct write-off method only, so net income would be lower by $8,000 under the direct write-off method compared to the allowance method. The difference in expenses between years relates to the fact that bad debt estimates in 2021 did not prove to be the actual amount occurring in 2022.

Chapter 5 - Receivables and Sales

Exercise 5-14 (LO 5-7) 1. April 1

Debit

Notes Receivable Service Revenue (Provide services and accept note)

7,000

Credit 7,000

2. June 1 Notes Receivable Cash (Lend cash to vendor and accept note)

11,000 11,000

3. November 1 Notes Receivable 6,000 Accounts Receivable (Cancel accounts receivable and accept note)

6,000

Exercise 5-15 (LO 5-7) March 1

Debit

Credit

Notes Receivable 11,000 Service Revenue 11,000 (Provide legal services and accept note) September 1 Cash

11,495 Notes Receivable Interest Revenue (Receive cash on note receivable and interest) (Interest revenue = $11,000 x 9% x 6/12)

Solutions Manual, Chapter 5

11,000 495

Exercise 5-16 (LO 5-7) March 1

Debit

Legal Fees Expense Notes Payable (Receive legal services and sign note)

11,000

Credit 11,000

September 1 Notes Payable 11,000 Interest Expense 495 Cash 11,495 (Pay cash on note payable and interest) (Interest expense = $11,000 x 9% x 6/12)

Chapter 5 - Receivables and Sales

Exercise 5-17 (LO 5-7) Requirement 1 April 1, 2021

Debit

Credit

Notes Receivable 600,000 Cash 600,000 (Lend cash to supplier and accept note) Requirement 2 December 31, 2021

Debit

Credit

Interest Receivable 49,500 Interest Revenue 49,500 (Adjust interest receivable) (Interest revenue = $600,000 x 11% x 9/12) Requirement 3 April 1, 2022

Debit

Cash

666,000 Notes Receivable Interest Receivable Interest Revenue (Receive cash on note receivable and interest) (Interest revenue = $600,000 x 11% x 3/12)

Solutions Manual, Chapter 5

Credit 600,000 49,500 16,500

Exercise 5-18 (LO 5-8) Receivables turnover = ratio

Net sales Average accounts receivable

= Average collection period

= =

365 Receivables turnover ratio

WalCo

TarMart

CostGet

$322,427 ($1,815 + $2,762) /2

$67,878 ($6,166 + $6,694) /2

$68,963 ($629 + $665) /2

140.9 times

10.6 times

106.6 times

365 140.9

365 10.6

365 106.6

2.6 days

34.4 days

3.4 days

Of these three companies, WalCo appears to be collecting cash most efficiently from sales.

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Chapter 5 - Receivables and Sales

Exercise 5-19 (LO 5-9) Requirement 1 December 31, 2021

Debit

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) [$5,500 = ($55,000 x 12%) − $1,100]

5,500

Credit 5,500

Requirement 2 December 31, 2021

Debit

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($7,800 = $260,000 x 3%)

7,800

Credit 7,800

Requirement 3 Percentage of receivables method

Percentage of credit sales method

Total assets

−$5,500

−$7,800

Net income

−$5,500

−$7,800

In this example, the amount of the adjustment is greater under the percentage of credit sales approach. This means that both assets and net income will be lower in 2021 under this approach.

Solutions Manual, Chapter 5

Exercise 5-20 (LO 5-9) Requirement 1 December 31, 2021

Debit

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($7,700 = $55,000 x 12% + $1,100)

7,700

Credit 7,700

Requirement 2 December 31, 2021

Debit

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($7,800 = $260,000 x 3%)

7,800

Credit 7,800

Requirement 3 Percentage of receivables method

Percentage of credit sales method

Total assets

−$7,700

−$7,800

Net income

−$7,700

−$7,800

In this example, the amount of the adjustment is greater under the percentage of credit sales approach. This means that both assets and net income will be lower in 2021 under this approach.

Chapter 5 - Receivables and Sales

Exercise 5-21 (LO 5-1, 5-4, 5-5, 5-7, 5-9) Requirement 1 January 2 Cash Service Revenue (Provide services for cash) January 6 Accounts Receivable Service Revenue (Provide services on account) January 15 Allowance for Uncollectible Accounts Accounts Receivable (Write off uncollectible accounts) January 20 Salaries Expense Cash (Pay for salaries) January 22 Cash Accounts Receivable (Receive cash on account) January 25 Accounts Payable Cash (Pay cash on account) January 30 Utilities Expense Cash (Pay for utilities)

Solutions Manual, Chapter 5

Debit 35,100

Credit 35,100

Debit 72,400

Credit 72,400

Debit 1,000

Credit 1,000

Debit 31,400

Credit 31,400

Debit 70,000

Credit 70,000

Debit 5,500

Credit 5,500

Debit 13,700

Credit 13,700

Exercise 5-21 (continued) Requirement 2 (a) January 31 Debit Credit Bad Debt Expense 1,100 Allowance for Uncollectible Accounts 1,100 (Adjust uncollectible accounts) ($1,100 = ($5,000×20%)+($10,000a×5%)−$400b) a $10,000 =$13,600+$72,400−$70,000−$1,000−$5,000 b $400 = $1,400−$1,000 (b) January 31 Debit Credit Supplies Expense 1,800 Supplies 1,800 (Adjust supplies) ($1,800 = $2,500−$700) (c) January 31 Debit Credit Interest Receivable 100 Interest Revenue 100 (Adjust interest revenue) ($100 = $20,000×6%×1/12) (d) January 31 Debit Credit Salaries Expense 33,500 Salaries Payable 33,500 (Adjust salaries payable)

Chapter 5 - Receivables and Sales

Exercise 5-21 (continued) Requirement 3 3D Family Fireworks Adjusted Trial Balance January 31, 2021 Accounts Cash Accounts Receivable Interest Receivable Supplies Notes Receivable Land Allowance for Uncollectible Accounts Accounts Payable Salaries Payable Common Stock Retained Earnings Service Revenue Interest Revenue Supplies Expense Salaries Expense Utilities Expense Bad Debt Expense Totals

Solutions Manual, Chapter 5

Debit $ 78,400 15,000 100 700 20,000 77,000

Credit

$ 1,500 1,700 33,500 96,000 32,400 107,500 100 1,800 64,900 13,700 1,100 $272,700

$272,700

Exercise 5-21 (continued) Requirement 3 (continued) Ending Accounts Balance Cash 78,400 Accounts Receivable 15,000 Interest Receivable 100 Supplies 700 Notes Receivable 20,000 Land 77,000 Allowance for Uncollectible 1,500 Accounts Accounts Payable 1,700 Salaries Payable 33,500 Common Stock 96,000 Retained Earnings 32,400 Service Revenue 107,500 Interest Revenue 100 Supplies Expense 1,800 Salaries Expense 64,900 Utilities Expense 13,700 Bad Debt Expense 1,100

= = = = = = =

Beginning balance in bold, entries during January in blue, and adjusting entries in red. 23,900+35,100+70,000−31,400−5,500−13,700 13,600+72,400−1,000−70,000 100 2,500−1,800 20,000 77,000 1,400−1,000+1,100

= = = = = = = = = =

7,200−5,500 33,500 96,000 32,400 35,100+72,400 100 1,800 31,400+33,500 13,700 1,100

Chapter 5 - Receivables and Sales

Exercise 5-21 (continued) Requirement 4 3D Family Fireworks Income Statement For the year ended January 31, 2021 Revenues: Service revenue $107,500 Interest revenue 100 Total revenues 107,600 Expenses: Supplies expense 1,800 Salaries expense 64,900 Utilities expense 13,700 Bad debt expense 1,100 Total expenses 81,500 Net income

$ 26,100

Requirement 5 3D Family Fireworks Balance Sheet January 31, 2021 Assets Liabilities Cash $ 78,400 Accounts payable $ 1,700 Accounts receivable $15,000 Salaries payable 33,500 Less: Allowance (1,500) 13,500 Total current liabilities 35,200 Interest receivable 100 Supplies 700 Total current assets 92,700 Stockholders’ Equity Common stock 96,000 Notes receivable 20,000 Retained earnings 58,500 * Land 77,000 Total stockholders’ equity 154,500 Total liabilities and Total assets $189,700 stockholders’ equity $189,700 * Retained earnings = Beginning retained earnings + Net income − Dividends = $32,400 + $26,100 − $0 = $58,500

Solutions Manual, Chapter 5

Exercise 5-21 (concluded) Requirement 6 January 31, 2021 Service Revenue Interest Revenue Retained Earnings (Close revenue accounts)

Debit 107,500 100

Credit 107,600

Retained Earnings Supplies expense Salaries expense Utilities expense Bad debt expense (Close expense accounts)

81,500 1,800 64,900 13,700 1,100

Requirement 7 (a) The receivables turnover ratio is: Receivables Turnover Ratio

Net credit sales Average accounts receivable

$72,400 =

($13,600 + $15,000) / 2

5.1

A ratio of 5.1 suggests that credit sales are about five times the average balance of accounts receivable. Companies allow customers to purchase goods and services on account to boost revenues, but these credit sales also create a risk of the customer not paying, so a higher receivables turnover ratio typically is preferred. Compared to the industry average receivables turnover ratio of 4.2., 3D Family Fireworks is collecting cash more efficiently from customers on credit sales. (b) The ratio at the end of January is: Allowance for Uncollectible Accounts Accounts receivable

$1,500

= 10%

$15,000

In comparison, the ratio at the beginning of January was 10.3% (= $1,400 / $13,600). The allowance is lower in relation to accounts receivable at the end of the month indicating the company expects an improvement in cash collections from customers on credit sales. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 5-34 Financial Accounting, 5e

Chapter 5 - Receivables and Sales

Exercise 5-22 (LO 5-1, 5-2, 5-4, 5-5, 5-7) Requirement 1 1. Debit Accounts Receivable 7,000 Service Revenue (Provide services on account) 2. Debit Cash 4,900 Sales Discounts 100 Accounts Receivable (Receive cash on account with sales discount) ($100 = $5,000 × 2%) 3. Debit Allowance for Uncollectible Accounts 1,500 Accounts Receivable (Write off uncollectible accounts)

Credit 7,000 Credit 5,000 Credit 1,500

Requirement 2 (a) December 31 Debit Credit Bad Debt Expense 3,500 Allowance for Uncollectible Accounts 3,500 (Adjust uncollectible accounts) ($3,500 = [($41,500+$7,000−$5,000−$1,500)×10%]−$700a a $2,200 −$1,500 (c) December 31 Debit Credit Interest Receivable 200 Interest Revenue 200 (Adjust interest receivable) ($200 = $10,000×8%×3/12)

Solutions Manual, Chapter 5

Exercise 5-22 (continued) Requirement 3 Pop’s Fireworks Adjusted Trial Balance December 31, 2021 Accounts Cash Accounts Receivable Allowance for Uncollectible Accounts Interest Receivable Supplies Notes Receivable Land Accounts Payable Common Stock Retained Earnings Service Revenue Sales Discounts Interest Revenue Salaries Expense Utilities Expense Supplies Expense Bad Debt Expense Totals

Debit $ 26,100 42,000

Credit $ 4,200

200 6,700 10,000 85,000 12,300 106,000 29,900 131,800 100 200 70,900 24,200 15,700 3,500 $284,400

$284,400

Chapter 5 - Receivables and Sales

Exercise 5-22 (continued) Requirement 3 (continued) Accounts

Ending Balance

Cash Accounts Receivable Allowance for Uncollectible Accounts Interest Receivable Supplies Notes Receivable Land Accounts Payable Common Stock Retained Earnings Service Revenue Sales Discounts Interest Revenue Salaries Expense Utilities Expense Supplies Expense Bad Debt Expense

$26,100 42,000 4,200 200 6,700 10,000 85,000 12,300 106,000 29,900 131,800 100 200 70,900 24,200 15,700 3,500

Solutions Manual, Chapter 5

= = = = = = = = = = = = = = = = =

Given balance in bold, entries during the year in blue, and adjusting entries in red. 21,200+4,900 41,500+7,000−5,000−1,500 2,200−1,500+3,500 200 6,700 10,000 85,000 12,300 106,000 29,900 124,800+7,000 100 200 70,900 24,200 15,700 3,500

Exercise 5-22 (continued) Requirement 4 Pop’s Fireworks Income Statement For the year ended December 31, 2021 Revenues: Service revenue $131,800 Sales Discounts (100) Interest revenue 200 Net revenues 131,900 Expenses: Salaries Expense 70,900 Utilities Expense 24,200 Supplies Expense 15,700 Bad debt expense 3,500 Total expenses 114,300 Net income

$ 17,600

Requirement 5 Pop’s Fireworks Balance Sheet December 31, 2021 Assets Liabilities Cash $ 26,100 Accounts payable $ 12,300 Accounts receivable $42,000 Less: Allowance (4,200) 37,800 Total current liabilities 12,300 Interest receivable 200 Supplies 6,700 Total current assets 70,800 Stockholders’ Equity Common stock 106,000 Notes receivable 10,000 Retained earnings 47,500 * Land 85,000 Total stockholders’ equity 153,500 Total liabilities and Total assets $165,800 stockholders’ equity $165,800 * Retained earnings = Beginning retained earnings + Net income − Dividends = $29,900 + $17,600 − $0 = $45,700 ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education. 5-38 Financial Accounting, 5e

Chapter 5 - Receivables and Sales

Exercise 5-22 (concluded) Requirement 6 January 31, 2021 Service Revenue Interest Revenue Sales Discounts Retained Earnings (Close revenue accounts)

Debit 131,800 200

Credit 100 131,900

Retained Earnings Salaries Expense Utilities Expense Supplies Expense Bad debt expense (Close expense accounts)

114,300 70,900 24,200 15,700 3,500

Requirement 7 (a) Bad Debt Expense = $3,500 (b) Allowance for Uncollectible Accounts = $4,200 (c) Accounts Receivable Allowance for Uncollectible Amount expected to be collected

Solutions Manual, Chapter 5

$42,000 4,200 $37,800

PROBLEMS: SET A Problem 5-1A (LO 5-1) Revenue recognized in 2021 Scenario 1:

$11,000

Scenario 2:

$1,200

Scenario 3:

$450,000

Scenario 4:

$35,000

(= $1,600 x 75%)

Chapter 5 - Receivables and Sales

Problem 5-2A (LO 5-1, 5-2) Requirement 1 May 2

Debit

Credit

No entry May 7 Accounts Receivable Tour Revenue (Provide guided tour on account)

1,200 1,200

May 9 No entry May 15 Sales Allowances Accounts Receivable (Sales allowance for services on account) (Sales allowance = $1,200 x 30%)

360 360

May 20 Cash Sales Discounts Accounts Receivable (Receive cash on account) (Sales discount = $840 x 6%)

789.60 50.40 840

Requirement 2 Outdoor Expo Partial Income Statement Total tour revenues Less: Sales allowances Sales discounts Net tour revenues

Solutions Manual, Chapter 5

$1,200.00 (360.00) (50.40) $789.60

Problem 5-3A (LO 5-3, 5-4, 5-5) Requirement 1 June 12, 2021 Accounts Receivable Service Revenue (Provide services on account) September 17, 2021 Cash Accounts Receivable (Receive cash on account) December 31, 2021

Debit 41,000

41,000

25,000 25,000

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($16,000 x 45% = $7,200) March 4, 2022

7,200

Accounts Receivable Service Revenue (Provide services on account) May 20, 2022

56,000

Cash

10,000

7,200

56,000

Accounts Receivable (Receive cash on account) July 2, 2022

10,000

Allowance for Uncollectible Accounts Accounts Receivable (Write off actual bad debts) October 19, 2022

6,000

Cash

45,000

6,000

Accounts Receivable (Receive cash on account) December 31, 2022 Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) [($11,000 x 45%) − $1,200 = $3,750]

Credit

45,000

3,750 3,750

Chapter 5 - Receivables and Sales

Problem 5-3A (concluded) Requirement 2 Cash Dec. 31, 2021

25,000 25,000

Dec. 31, 2022

10,000 45,000 80,000

Accounts Receivable Dec. 31, 2021

Dec. 31, 2022

41,000 16,000

25,000

56,000

10,000 6,000 45,000

11,000

Allow. for Uncol. Accts.

6,000

7,200

Dec. 31, 2021

3,750 4,950

Dec. 31, 2022

Requirement 3 Total accounts receivable Less: Allowance for uncollectible accounts Net accounts receivable

Solutions Manual, Chapter 5

2021

2022

$16,000

$11,000

7,200

4,950

$ 8,800

$ 6,050

Problem 5-4A (LO 5-4, 5-5) Requirement 1

Age group Not yet due 0-90 days past due 91-180 days past due More than 180 days past due Total

Amount receivable $40,000 16,000 11,000 13,000 $80,000

Estimated percent uncollectible 4% 20% 25% 80%

Estimated amount uncollectible $ 1,600 3,200 2,750 10,400 $17,950

Requirement 2 December 31, 2021 Debit Credit Bad Debt Expense 12,950 Allowance for Uncollectible Accounts 12,950 (Estimate future bad debts) ($17,950 − $5,000 = $12,950) Requirement 3 July 19, 2022 Allowance for Uncollectible Accounts Accounts Receivable (Write off actual bad debts)

8,000 8,000

Requirement 4 September 30, 2022 Accounts Receivable 8,000 Allowance for Uncollectible Accounts (Re-establish account previously written off)

8,000

September 30, 2022 Cash

8,000 Accounts Receivable (Receive cash on account)

8,000

Chapter 5 - Receivables and Sales

Problem 5-5A (LO 5-3, 5-6) Requirement 1 Arnold should not use the direct write-off method. Even if no accounts are known to be uncollectible at the time, Arnold should estimate future bad debts and record those estimates as an expense (bad debt expense) and reduction in total assets (allowance for uncollectible accounts) in the current year. Requirement 2 Allowance for uncollectible accounts = $170,000 x 70% = $119,000. Requirement 3 If Arnold uses the direct write-off method, total assets will be overstated and total expenses will be understated by $119,000.

Solutions Manual, Chapter 5

Problem 5-6A (LO 5-5) Requirement 1 Debit 59,000

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) [($1,100,000 x 9%) − $40,000 = $59,000]

Credit 59,000

Requirement 2 Revised operating income = $260,000 − $59,000 (bad debt expense) = $201,000 Willie will not get his bonus because the revised operating income of $201,000 is less than the $210,000 bonus level. Requirement 3 Debit 26,000

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) [($1,100,000 x 6%) − $40,000 = $26,000]

Credit 26,000

Revised operating income = $260,000 − $26,000 (bad debt expense) = $234,000 Willie will get his bonus because the revised operating income of $234,000 is greater than the $210,000 bonus level. Requirement 4 Using 6% instead of 9% to estimate future bad debts causes total assets to be overstated and operating income to be overstated by $33,000 (= $234,000 − $201,000).

Chapter 5 - Receivables and Sales

Problem 5-7A (LO 5-3, 5-4) Requirement 1 December 31, 2021 Debit Credit Bad Debt Expense 455,000 Allowance for Uncollectible Accounts 455,000 (Estimate future bad debts) ($1,300,000 x 35% = $455,000) Requirement 2 Because actual bad debts in 2022 were only $300,000 when the company estimated bad debts to be $455,000, total assets will be understated and total expenses will be overstated by $155,000 (= $455,000 − $300,000) in 2021. Requirement 3 Humanity International should not prepare new financial statements for 2021. The fact that actual bad debts in 2022 turned out to be different than the amount estimated at the end of 2021 does not constitute a reason for re-issuing prior financial statements. Estimation error is an issue inherent in financial reporting.

Solutions Manual, Chapter 5

Problem 5-8A (LO 5-7) Requirement 1 December 1, 2021

Debit

Credit

Notes Receivable 90,000 Service Revenue 90,000 (Provide services in exchange for a note) Requirement 2 December 31, 2021

Debit

Interest Receivable (2021) 750 Interest Revenue (Adjust interest receivable) (Interest revenue = $90,000 x 10% x 1/12) December 1, 2022 Cash 9,000 Interest Receivable (2021) Interest Revenue (Receive annual interest) (Interest revenue = $90,000 x 10% x 11/12)

Credit 750

750 8,250

December 31, 2022 Interest Receivable (2022) 750 Interest Revenue (Adjust interest receivable) (Interest revenue = $90,000 x 10% x 1/12)

750

Chapter 5 - Receivables and Sales

Problem 5-8A (concluded) December 1, 2023 Cash

9,000 Interest Receivable (2022) Interest Revenue (Receive annual interest) (Interest revenue = $90,000 x 10% x 11/12)

750 8,250

December 31, 2023 Interest Receivable (2023) 750 Interest Revenue (Adjust interest receivable) (Interest revenue = $90,000 x 10% x 1/12)

750

Requirement 3 December 1, 2024

Debit

Cash

99,000 Notes Receivable Interest Receivable (2021) Interest Revenue (Receive cash on note and annual interest) (Interest revenue = $90,000 x 10% x 11/12)

Solutions Manual, Chapter 5

Credit 90,000 750 8,250

Problem 5-9A (LO 5-8) Requirement 1 Receivables Net sales turnover = Average accounts ratio receivable = Average collection period

= =

365 Receivables turnover ratio

Walmart

Target

$443,854 ($5,089 + $5,937) / 2

$68,466 ($6,153 + $5,927) / 2

80.5 times

11.3 times

365 80.5

365 11.3

4.5 days

32.3 days

Walmart has a higher receivables turnover ratio and a lower average collection period, which means it collects cash more quickly from its customers. The receivables turnover ratio and average collection period for Tenet Healthcare in the most recent year reported in the text are 7.7 times and 47.4 days. The receivables turnover ratio and average collection period for LifePoint Hospitals in the most recent year reported in the text are 8.7 times and 42.0 days. Companies in the healthcare industry will usually have a lower receivables turnover ratio because the amounts to be received are larger and customers are more often not able to pay in a timely manner. Requirement 2 Including cash sales in the numerator of the receivables turnover ratio is the same as suggesting that receivables turnover instantly (in other words, the average collection period is zero). Therefore, companies that are more likely to have cash sales will show a higher receivables turnover ratio and lower average collection period compared to a company with similar net sales that consist of a higher proportion of credit sales. The receivables turnover ratio remains useful for understanding how quickly a company generates cash from its customers, but the ratio will naturally vary with industry characteristics. Therefore, to determine the efficiency of management in collecting receivables, it is better to compare ratios among firms in the same industry.

Chapter 5 - Receivables and Sales

PROBLEMS: SET B Problem 5-1B (LO 5-1) Revenue recognized in 2021 Scenario 1:

$900,000

Scenario 2:

$68

Scenario 3:

$30,000

Scenario 4:

$260,000

Solutions Manual, Chapter 5

(= $80 x 85%)

Problem 5-2B (LO 5-1, 5-2) Requirement 1 June 10

Debit

Credit

No entry June 12 No entry June 13 No entry June 16 Accounts Receivable Service Revenue (Provide services of $3,000 on account with a 10% discount)

2,700 2,700

June 19 No entry June 20 Sales Allowances Accounts Receivable (Sales allowance for services on account)

810 810

June 30 Cash

1,890 Accounts Receivable (Receive cash on account)

1,890

Chapter 5 - Receivables and Sales

Problem 5-2B (concluded) Requirement 2 Data Recovery Services Partial Income Statement Total service revenues Less: Sales allowances Net service revenues

$2,700 (810) $1,890

Requirement 3 June 25 Cash Sales Discounts Accounts Receivable (Receive cash on account with 2% sales discount) (Sales discount = 1,890 x 2%)

1,852.2 37.8 1,890

Total Service Revenues

$2,700.00

Less: Sales Allowances

810.00

Sales Discounts

37.80

Net Service Revenues

$1,852.20

Solutions Manual, Chapter 5

Problem 5-3B (LO 5-3, 5-4, 5-5) Requirement 1 February 2, 2021 Accounts Receivable Service Revenue (Provide services on account) July 23, 2021 Cash Accounts Receivable (Receive cash on account) December 31, 2021

Debit 38,000

38,000

27,000 27,000

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($11,000 x 25% = $2,750) April 12, 2022

2,750

Accounts Receivable Service Revenue (Provide services on account) June 28, 2022

51,000

Cash

6,000

2,750

51,000

Accounts Receivable (Receive cash on account) September 13, 2022

6,000

Allowance for Uncollectible Accounts Accounts Receivable (Write off actual bad debts) October 5, 2022

5,000

Cash

45,000

5,000

Accounts Receivable (Receive cash on account) December 31, 2022 Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) [($6,000 x 25%) + $2,250 = $3,750]

Credit

45,000

3,750 3,750

Chapter 5 - Receivables and Sales

Problem 5-3B (concluded) Requirement 2 Cash Dec. 31, 2021

27,000 27,000

Dec. 31, 2022

6,000 45,000 78,000

Accounts Receivable Dec. 31, 2021

Dec. 31, 2022

38,000 11,000

27,000

51,000

6,000 5,000 45,000

6,000

Allow. for Uncol. Accts.

5,000

2,750

Dec. 31, 2021

3,750 1,500

Dec. 31, 2022

Requirement 3 Total accounts receivable Less: Allowance for uncollectible accounts Net accounts receivable

Solutions Manual, Chapter 5

2021

2022

$11,000

$6,000

2,750

1,500

$ 8,250

$4,500

Problem 5-4B (LO 5-4, 5-5) Requirement 1

Age group Not yet due 0-30 days past due 31-60 days past due More than 60 days past due Total

Amount receivable $40,000 11,000 8,000 1,000 $60,000

Estimated percent uncollectible 3% 4% 11% 25%

Estimated amount uncollectible $1,200 440 880 250 $2,770

Requirement 2 December 31, 2021 Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($2,770 + $400 = $3,170)

Debit 3,170

Credit 3,170

Requirement 3 April 3, 2022 Allowance for Uncollectible Accounts Accounts Receivable (Write off actual bad debts)

500 500

Requirement 4 July 17, 2022 Accounts Receivable 100 Allowance for Uncollectible Accounts (Re-establish portion of account previously written off)

100

July 17, 2022 Cash

100 Accounts Receivable (Receive cash on account)

100

Chapter 5 - Receivables and Sales

Problem 5-5B (LO 5-3, 5-6) Requirement 1 Letni should not use the direct write-off method. Even if no accounts are known to be uncollectible at the time, Paul should estimate future bad debts and record those estimates as an expense (bad debt expense) and reduction in total assets (allowance for uncollectible accounts) in the current year. Requirement 2 Allowance for uncollectible accounts = $330,000 x 25% = $82,500. Requirement 3 If Letni uses the direct write-off method, total assets will be overstated and total expenses will be understated by $82,500.

Solutions Manual, Chapter 5

Problem 5-6B (LO 5-5) Requirement 1 Debit 330,000

Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($11,000,000 x 4% − $110,000 = $330,000)

Credit 330,000

Requirement 2 Revised operating income = $2,900,000 − $330,000 (bad debt expense) = $2,570,000 Outlet Flooring will meet analysts’ expectations because the revised operating income of $2,570,000 is greater than the $2,200,000 expectations. Requirement 3 Revised operating income = $2,900,000 − $700,000 (bad debt expense) = $2,200,000 If Outlet Flooring records bad debt expense for $700,000 instead of $330,000, assets will be understated and operating income will be understated by $370,000. Requirement 4 By managing operating income downward, Wanda is “saving” reported income for the future. If bad debt expense is overestimated this year, then it can be understated next year. Understating bad debt expense next year will overstate operating income in that year.

Chapter 5 - Receivables and Sales

Problem 5-7B (LO 5-3, 5-4) Requirement 1 Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts) ($350,000 x 2% = $7,000)

Debit 7,000

Credit 7,000

Requirement 2 Previts underestimated uncollectible accounts by $80,500. Actual bad debts in the second year were $87,500 and the company estimated bad debts to be only $7,000. Because of this, total assets will be overstated and total expenses will be understated by $80,500 in the first year. Requirement 3 Previts should not prepare new financial statements for the first year. The fact that actual bad debts in the second year turned out to be different than the amount estimated at the end of the first year does not constitute a reason for re-issuing prior financial statements. Estimation error is an issue inherent in financial reporting.

Solutions Manual, Chapter 5

Problem 5-8B (LO 5-7) Requirement 1 April 15, 2021

Debit

Notes Receivable Service Revenue (Provide services and accept note)

110,000

Credit 110,000

Requirement 2 December 31, 2021

Debit

Interest Receivable (2021) 9,350 Interest Revenue (Adjust interest receivable) (Interest revenue = $110,000 x 12% x 8.5/12)

Credit 9,350

April 15, 2022 Cash

13,200 Interest Receivable (2021) Interest Revenue (Receive annual interest) (Interest revenue = $110,000 x 12% x 3.5/12)

9,350 3,850

December 31, 2022 Interest Receivable (2022) 9,350 Interest Revenue (Adjust interest receivable) (Interest revenue = $110,000 x 12% x 8.5/12)

9,350

Chapter 5 - Receivables and Sales

Problem 5-8B (concluded) April 15, 2023 Cash

13,200 Interest Receivable (2022) Interest Revenue (Receive annual interest) (Interest revenue = $110,000 x 12% x 3.5/12)

9,350 3,850

December 31, 2023 Interest Receivable (2023) 9,350 Interest Revenue (Adjust interest receivable) (Interest revenue = $110,000 x 12% x 8.5/12)

9,350

Requirement 3 April 15, 2024

Debit

Cash

123,200 Notes Receivable Interest Receivable (2023) Interest Revenue (Receive cash on note and annual interest) (Interest revenue = $110,000 x 12% x 3.5/12)

Solutions Manual, Chapter 5

Credit 110,000 9,350 3,850

Problem 5-9B (LO 5-8) Requirement 1 Receivables Net sales turnover = Average accounts ratio receivable = Average collection period

= =

365 Receivables turnover ratio

Sun Health Group

Select Medical

$1,930 ($215 + $202) / 2

$2,240 ($414 + $353) / 2

9.3 times

5.8 times

365 9.3

365 5.8

39.2 days

62.9 days

Compared to Select Medical, Sun Health has a higher receivables turnover ratio and a lower average collection period, which means it collects cash more quickly from its customers. The receivables turnover ratio and average collection period for Tenet Healthcare in the most recent year reported in the text are 7.7 times and 47.4 days. The receivables turnover ratio and average collection period for LifePoint Hospitals in the most recent year reported in the text are 8.7 times and 42.0 days. Sun Health has the most favorable (highest) receivables turnover ratio of the four companies. Requirement 2 The receivables turnover ratio and average collection period provide an indication of management’s ability to collect cash from customers in a timely manner. A high receivables ratio suggests that managers are selling to customers that have the ability to pay their accounts in a timely manner. The more quickly a company can collect its receivables, the more quickly it can use that cash to generate even more cash by reinvesting in the business and generating additional sales. Factors that could affect the receivables turnover ratio would be managers failing to recognize the financial situation of lower-quality customers, being too aggressive in selling to customers on account, or encountering weak business conditions in the industry which would affect all companies.

Chapter 5 - Receivables and Sales

ADDITIONAL PERSPECTIVES Additional Perspective 5-1 Requirement 1 Jan. 24, 2022 Debit Equipment 5,000 Cash (Pay cash for outdoor equipment) Feb. 25, 2022 Accounts Receivable 3,000 Service Revenue (Provide TEAM event) Feb. 28, 2022 Cash 2,850 Sales Discounts 150 Accounts Receivable (Receive cash on account less 5% discount) Mar. 19, 2022 Accounts Receivable 4,000 Service Revenue (Provide TEAM event) Mar. 27, 2022 Cash 3,800 Sales Discounts 200 Accounts Receivable (Receive cash on account less 5% discount) Apr. 7, 2022 Cash 7,500 Deferred Revenue (Received cash in advance for TEAM event) Apr. 14, 2022 Deferred Revenue 7,500 Service Revenue (Provide TEAM event) April 30, 2022 Accounts Receivable 6,000 Service Revenue (Provide TEAM event) Solutions Manual, Chapter 5

Credit 5,000

3,000

4,000

7,500

6,000

AP5-1 (continued) Requirement 1 (concluded) May 31, 2022 Notes Receivable Accounts Receivable (Accept note receivable) Jun. 15, 2022 Accounts Receivable Service Revenue (Provide TEAM event)

6,000 6,000

24,000 24,000

Requirement 2(a) Jun. 30, 2022 Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts)

Debit 2,400

Credit 2,400*

* Accounts Receivable × 10% = $24,000 × 10% = $2,400 Requirement 2(b) Jun. 30, 2022 Interest Receivable Interest Revenue (Accrue interest revenue) (Interest revenue = $6,000 × 8% × 1/12)

Debit 40

Credit 40

Chapter 5 - Receivables and Sales

AP5-1 (continued) Requirement 2(c) Great Adventures, Inc. Partial Balance Sheet June 30, 2022 Assets Current assets: Accounts receivable Less: Allowance for uncollectible accounts Net accounts receivable

Solutions Manual, Chapter 5

$24,000 (2,400) $21,600

Additional Perspective 5-1 (in General Ledger) Students will be given the following existing trial balance. Great Adventures, Inc. Trial Balance June 30, 2022 Accounts Cash Accounts Receivable Allowance for Uncollectible Accounts Interest Receivable Notes Receivable Prepaid Rent Equipment Accumulated Depreciation Accounts Payable Deferred Revenue Interest Payable Notes Payable Common Stock Retained Earnings Service Revenue Interest Revenue Sales Discounts Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Interest Expense Totals

Debit $ 38,500 -0-

Credit

-0-

-0-0400 40,000 16,000 2,800 -01,650 30,000 20,000 33,450 -0-0-08,000 2,400 1,200 12,000 500 -0900 $103,900

$103,900

Requirements 1, 2(a), and 2(b) will be completed as shown above.

Chapter 5 - Receivables and Sales

Additional Perspective 5-1 (in General Ledger, continued)

Great Adventures, Inc. Income Statement For the period ended June 30, 2022 Revenues: Service revenue Sales discounts Interest revenue Net revenues Expenses: Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Interest Expense Total expenses Net income

Solutions Manual, Chapter 5

$44,500 (350) 40 $44,190 8,000 2,400 1,200 12,000 500 2,400 900 27,400 $16,790

Additional Perspective 5-1 (in General Ledger, continued)

Great Adventures, Inc. Balance Sheet June 30, 2022 Assets Current assets: Cash $ 47,650 Accounts receivable 24,000 Allowance for (2,400) uncollectible accounts Interest receivable 40 Notes receivable 6,000 Prepaid Rent 400 Total current assets 75,690 Long-term assets: Equipment 45,000 Accumulated depreciation (16,000) Total assets

$104,690

Liabilities Current liabilities: Accounts payable Interest payable Total current liabilities Notes payable Total liabilities

$ 2,800 1,650 4,450 30,000 34,450

Stockholders’ Equity Common stock 20,000 Retained earnings 50,240 Total stockholders’ equity 70,240 Total liabilities and stockholders’ equity $104,690

Chapter 5 - Receivables and Sales

Additional Perspective 5-1 (in General Ledger, concluded) Jun. 30, 2021 Service Revenue Interest Revenue Sales Discounts Retained Earnings (Close revenue accounts) Jun. 30, 2021 Retained Earnings Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Interest Expense (Close expense accounts)

Solutions Manual, Chapter 5

Debit 44,500 40

Credit

350 44,190

27,400 8,000 2,400 1,200 12,000 500 2,400 900

Additional Perspective 5-2 Requirement 1 American Eagle shows an increasing trend in net sales for the past three years. Requirement 2 Accounts receivable are reported in the balance sheet in the current asset section. The receivables turnover ratio equals net credit sales divided by average accounts receivable. The net sales amount reported in the income statement includes not only credit sales, but also cash sales. When a company has a large amount of cash sales, net sales will not be a good measure of net credit sales. Therefore, using net sales (instead of net credit sales) to calculate the receivables turnover ratio will overstate a company’s ability to efficiently manage receivables. Requirement 3 Yes. American Eagle reports accounts receivable “net”, indicating the company likely has an allowance for uncollectible accounts.

Chapter 5 - Receivables and Sales

Additional Perspective 5-3 Requirement 1 Buckle shows a decreasing trend in net sales for the past three years. Requirement 2 Accounts receivable are reported in the balance sheet in the current asset section. The receivables turnover ratio equals net credit sales divided by average accounts receivable. The net sales amount reported in the income statement includes not only credit sales, but also cash sales. When a company has a large amount of cash sales, net sales will not be a good measure of net credit sales. Therefore, using net sales (instead of net credit sales) to calculate the receivables turnover ratio will overstate a company’s ability to efficiently manage receivables. Requirement 3 No. Buckle does not indicate that its accounts receivable balance is net of an allowance for uncollectible accounts.

Solutions Manual, Chapter 5

Additional Perspective 5-4 American Eagle’s ratio of total current receivables to current assets is 8.1%. Buckle’s ratio of total current receivables to current assets is 2.4%. Neither company has a relative large portion of its current assets as receivable. Therefore, there do not appear to be any problems with each company’s management of receivables.

Chapter 5 - Receivables and Sales

Additional Perspective 5-5 1. Increase income before taxes by $45,000. If the balance of the allowance for uncollectible accounts before adjustment is $20,000 and the year-end estimate of future uncollectible accounts is $180,000, then an adjustment of $160,000 is needed. This adjustment has the effect of increasing the allowance for uncollectible accounts, which increases bad debt expense and therefore reduces net income and eventually retained earnings (stockholders’ equity). By reducing the estimate of future bad debts to only $135,000, an adjustment of only $115,000 is needed. Therefore, the change requested by the controller has the effect of increasing income before taxes by $45,000. 2. Decrease total assets by $45,000. Allowance for Uncollectible Accounts is a contra-asset to the Accounts Receivable account. By reporting the Allowance account for $45,000 higher, total assets are reduced. 3. Yes. By making the change requested, net income and total assets will increase by $45,000. Overstating these amounts will make the company appear more profitable and less risky than it would have otherwise. This type of misreporting can fool investors and creditors into making suboptimal decisions. Preparing a new invoice does not change the age of the underlying account receivable, and the best estimate is the original amount estimated, $180,000. Next year, the large account may prove uncollectible and require a write off. When this occurs, investors and creditors (and potentially employees) could suffer financial damages because the company fails to receive cash that the receivables balances suggested it was going to collect. 4. No. However, you are new to the position. You might not be sure that it’s right for you to question any decision of your superior. It is clear that the superior is asking you to engage in fraudulent reporting. Upsetting your superior may reduce your compensation, reduce the likelihood of promotion, and increase your chance of being fired. You may feel that as long as your boss told you to do it, then your agreement to go along is technically the superior’s ethical dilemma; you are just following orders. However, you should agree that reporting inaccurate numbers is against your ethical standards. You would be partially responsible for any adverse outcomes to investors, creditors, employees, and others Solutions Manual, Chapter 5

relying on those reports. Both your superior and you could incur legal penalties for this fraudulent reporting.

Chapter 5 - Receivables and Sales

Additional Perspective 5-6 (Note to instructors: Answers are based on Avon’s annual report for the year ended December 31, 2016) Requirement 1 The balance of net accounts receivable is $458.9 million. By adding back the allowance of $131.1, total accounts receivable is computed to be $590.0 million. Requirement 2 Bad debt expense is reported on the statement of cash flows under provisions for doubtful accounts. The amount is $190.5 million. Requirement 3 The ending balance of the allowance account equals the beginning balance plus bad debt expense less actual write-offs. Using this formula, we calculate actual write-offs to be: ($ in millions)

Beginning allowance $86.7

+ +

Bad debt − expense $190.5 −

Actual Ending = write-offs allowance $X = $131.1 ($X = $146.1)

The estimate of bad debts at the beginning of the year was $86.7 million. Actual bad debts were $146.1 million, so the company underestimated and had approximately 70% more write-offs than it had provided for at the beginning of the year. Requirement 4 Receivables turnover ratio

Average collection period

Solutions Manual, Chapter 5

Net sales Average net accounts receivable

365 Receivables turnover ratio

$5,578.8 =

($458.9 + $443.0) / 2

12.4

29.4

365 =

12.4

Avon’s receivables turnover ratio and average collection period are better than the industry average.

Chapter 5 - Receivables and Sales

Additional Perspective 5-7 Students should communicate the following ideas. Under the allowance method, - Future bad debts are estimated. - The adjustments to total assets and net income as a result of bad debts are reported in the period the bad debts are estimated. - The adjustment normally involves a debit to bad debt expense and a credit to the allowance for uncollectible accounts. Under the direct write-off method, - Future bad debts are not estimated. - The reductions to total assets and net income as a result of bad debts are reported in the period the bad debts occur. - No adjustment is made. The difference between the two methods is in the timing of recording the bad debt (time of estimation vs. when actually occurring). Over an extended period of time, the two will approximately equal. However, in a given year, the difference can be large. The fact that uncollectible accounts have been stable across years indicates that the difference between the two has been relatively small. However, circumstances could change in any year and the allowance method would provide a better approximation of net accounts receivable and costs (bad debts expense) to generate current credit sales.

Solutions Manual, Chapter 5

Additional Perspective 5-8 Requirement 1 Bad Debt Expense Allowance for Uncollectible Accounts (Estimate future bad debts)

Debit 65,000

Credit 65,000*

* ($500,000 x 9%) + $20,000 = $65,000 Requirement 2 Revised operating income is $255,000 (= $320,000 − $65,000). Operating income decreases compared to the previous year’s amount of $275,000. Requirement 3 Using 4% instead of 9% of accounts receivable to estimate uncollectible accounts results in an adjustment of $40,000 [= ($500,000 x 4%) + $20,000] to bad debt expense. Now, operating income would be $280,000 (= $320,000 − $40,000), which is an increase compared to the previous year. Requirement 4 Total assets would be overstated and total expenses would be understated by $25,000 (= $65,000 − $40,000).

Chapter 6 - Inventory and Cost of Goods Sold

Chapter 6 Inventory and Cost of Goods Sold REVIEW QUESTIONS Question 6-1 (LO 6-1) Inventory includes items a company intends for sale to customers. Inventory also includes items that are not yet finished products. The cost of inventory that has not been sold by the end of the reporting period is reported in the balance sheet as an asset. The cost of inventory that has been sold during the reporting period is reported as an expense (cost of goods sold) in the income statement.

Question 6-2 (LO 6-1) Service companies generate revenues by providing services to their customers. Manufacturing or merchandising companies generate revenues by selling inventory rather than a service.

Question 6-3 (LO 6-1) Raw materials inventory includes the cost of components that will become part of the finished product but have not yet been used in production. Work-in-process inventory refers to the products that have started the production process but are not yet complete at the end of the period. The cost of work in process inventory includes the cost of raw materials used in production, the cost of direct labor that we can trace directly to the goods in process, and an allocated portion of other manufacturing costs, called overhead. Finished goods inventory is the cost of fully assembled but unshipped inventory at the end of the reporting period.

Question 6-4 (LO 6-2) The cost of goods (or inventory) available for sale equals the cost of beginning inventory plus additional purchases during the reporting period. By subtracting the cost of ending inventory at the end of the reporting period from the cost of goods available for sale, we calculate cost of goods sold during the reporting period.

Question 6-5 (LO 6-2) The balance of cost of goods sold in the income statement represents the cost of inventory sold during the period. For a company like Best Buy, this would include inventory sold such as phones, CD players, portable radios, cameras, camcorders, DVD players, computers, and other electronic devices and accessories. The balance of inventory in the balance sheet represents the cost of inventory not sold by the end of the reporting period.

Question 6-6 (LO 6-2) A multiple-step income statement reports multiple levels of profitability. Gross profit equals net sales minus cost of goods sold. Operating income equals gross profit minus operating expenses. Income before income taxes equals operating income plus non-operating revenues and minus nonoperating expenses. Net income equals all revenues minus all expenses. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Chapter 6 6-1

Chapter 6 - Inventory and Cost of Goods Sold

Answers to Review Questions (continued) Question 6-7 (LO 6-3) Because of the large number of inventory transactions for most companies and the high volatility in many inventory costs, it is not possible or cost effective to identify the cost of each item sold. Therefore, assumptions are made as to which units of inventory are sold.

Question 6-8 (LO 6-3) The three most common inventory cost flow assumptions are FIFO (first-in, first-out), LIFO (last-in, first-out), and weighted-average cost. These methods provide assumptions as to which inventory units are sold, whereas the specific identification method matches or identifies each unit of inventory with its actual cost.

Question 6-9 (LO 6-4) FIFO results in the highest reported amount for ending inventory when inventory costs are rising. The reason is that under the FIFO method, the oldest (or first) items are sold first and these are the lower-cost items, leaving the higher-cost items to be reported in ending inventory.

Question 6-10 (LO 6-4) FIFO results in the highest reported amount of net income when inventory costs are rising. The reason is that under the FIFO method, the oldest (or first) items are sold first and these are the lowercost items. Reporting cost of goods sold based on the lower-cost items results in net income being higher.

Question 6-11 (LO 6-4) Since FIFO assumes the first purchases sell first, the amount it reports for ending inventory (in the balance sheet), the last or most recent purchases, better approximates the current cost of inventory. LIFO assumes the last purchases are sold first, reporting the most recent inventory cost in cost of goods sold (in the income statement). Thus, LIFO more realistically matches the current costs of inventory needed to produce current revenues.

Question 6-12 (LO 6-4) LIFO generally results in lower income taxes payable when inventory costs are increasing because net income in this case is lower (than if FIFO were used). The LIFO conformity rule requires a company that uses LIFO for tax reporting to also use LIFO for financial reporting.

Question 6-13 (LO 6-5) The perpetual inventory system maintains a continual – or perpetual – record of inventory purchased and sold, while the periodic system periodically adjusts for purchases and sales of inventory at the end of the reporting period.

Question 6-14 (LO 6-5) Freight charges add to the cost of inventory, while purchase discounts and purchase returns reduce the cost of inventory. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 6-2 Financial Accounting, 5e

Chapter 6 - Inventory and Cost of Goods Sold

Answers to Review Questions (continued) Question 6-15 (LO 6-6) Cost of inventory is the net cost of purchases and freight, less purchase discounts, returns, and allowances. Net realizable value is normally selling price less cost of completion, disposal, and transportation costs. When net realizable value falls below cost, we adjust inventory down from cost to net realizable value. (For LIFO, we report inventory at lower of cost or replacement value.)

Question 6-16 (LO 6-6) The cost of inventory is determined using specific identification, FIFO, LIFO, or weighted-average cost. Net realizable value is determined using selling price less cost of completion, disposal, and transportation costs.

Question 6-17 (LO 6-6) The entry to adjust from cost to net realizable value for inventory write-downs includes a debit to cost of goods sold (increase to expenses) and a credit to inventory (decrease to assets). The adjustment has the following effects: (a) assets (inventory) = decrease (b) liabilities = no effect (c) stockholders’ equity (or retained earnings) = decrease (d) revenues = no effect (e) expenses (cost of goods sold) = increase (f) net income = decrease

Question 6-18 (LO 6-6) Firms are required to report the falling value of inventory but not allowed to report the increasing value of inventory. Conservative accounting implies that there is more potential harm to users of financial statements if estimated gains turn out to be wrong than if estimated losses turn out to be wrong. Therefore, companies typically do not report estimated gains.

Question 6-19 (LO 6-7) The inventory turnover ratio equals cost of goods sold divided by average inventory. The ratio shows the number of times the firm sells its average inventory balance during a reporting period. The more frequently a business is able to sell or “turn over” its average inventory balance, the less the company needs to invest in inventory for a given level of sales. Typically, a higher ratio indicates greater effectiveness of a company in managing its investment in inventory.

Chapter 6 - Inventory and Cost of Goods Sold

Answers to Review Questions (continued) Question 6-20 (LO 6-7) Gross profit equals net sales minus cost of goods sold. The gross profit ratio equals gross profit divided by net sales. The gross profit ratio measures the amount by which the sale price of inventory exceeds its cost per dollar of sales. The higher the ratio, the higher is the “markup” a company is able to achieve on its inventories.

Question 6-21 (LO 6-8) Under the periodic system, the sale of inventory is recorded by increasing an asset account (cash or accounts receivable) and increasing sales revenue. Under the perpetual system, two transactions are recorded. The first entry is the same as that under the periodic system. The second entry involves recording the cost of goods sold and decreasing inventory.

Question 6-22 (LO 6-8) The purposes of the period-end adjustment are to (1) update the balance of inventory for its ending amount, (2) record cost of goods sold, and (3) close the temporary purchases accounts to zero.

Question 6-23 (LO 6-9) Understating ending inventory in the current year will have the following effects in the current year: (a) assets (inventory) = understated (b) liabilities = no effect (c) stockholders’ equity (or retained earnings) = understated (d) revenues = no effect (e) expenses (cost of goods sold) = overstated (f) net income = understated

Question 6-24 (LO 6-9) Understating ending inventory in the current year will have the following effects in the following year: (a) assets (inventory) = no effect (b) liabilities = no effect (c) stockholders’ equity (or retained earnings) = no effect (d) revenues = no effect (e) expenses (cost of goods sold) = understated (f) net income = overstated

Chapter 6 - Inventory and Cost of Goods Sold

BRIEF EXERCISES Brief Exercise 6-1 (LO 6-1) 1. b. 2. a. 3. c.

Brief Exercise 6-2 (LO 6-1) 1. c. 2. a. 3. b.

Brief Exercise 6-3 (LO 6-2) Beginning inventory + Purchases Cost of goods available for sale − Ending inventory Cost of goods sold

$ 8,000 23,000 31,000 10,000 $21,000

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-4 (LO 6-2)

Company Lennon Harrison McCartney Starr a b

Sales Cost of revenue goods sold $18,000 (a) $10,000 20,000 11,000 13,000 9,000 16,000 6,000

Gross Operating Net a profit expenses incomeb $ 8,000 $3,500 $4,500 (b) 9,000 6,000 3,000 4,000 (c) 2,500 1,500 10,000 6,500 (d) 3,500

Gross profit = Sales revenue − Cost of goods sold Net income = Gross profit − Operating expenses

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-5 (LO 6-3) Date Nov. 3

Date Jan. 1 May 5 Nov. 3 a

Transaction Purchase

Transaction Beginning inventory Purchase Purchase

Number of units 40

Unit cost $90

Ending Inventory $3,600

Number of units 60 250 160 470a

Unit cost $82 85 90

Cost of Goods Sold $ 4,920 21,250 14,400 $40,570

Number of units 40

Unit cost $82

Ending Inventory $3,280

Number of units 20 250 200 470a

Unit cost $82 85 90

Cost of Goods Sold $ 1,640 21,250 18,000 $40,890

First 470 units purchased are assumed sold

Brief Exercise 6-6 (LO 6-3) Date Jan. 1

Date Jan. 1 May 5 Nov. 3 a

Transaction Beginning inventory

Transaction Beginning inventory Purchase Purchase

Last 470 units purchased are assumed sold

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-7 (LO 6-3) Date Jan. 1 May 5 Nov. 3

Transaction Beginning inventory Purchase Purchase

Number of units 60 250 200 510

Unit cost $82 85 90

Total Cost $ 4,920 21,250 18,000 $44,170

Weighted-average cost = $44,170 / 510 units = $86.6078 / unit Ending inventory = 40 × $86.6078 = $3,464.31 Cost of goods sold = 470 × $86.6078 = $40,705.69 (rounded)

Brief Exercise 6-8 (LO 6-3) Date May 5 Nov. 3

Date Jan. 1 May 5 Nov. 3

Transaction Purchase Purchase

Number of units 20 20 40

Unit cost $85 90

Ending Inventory $1,700 1,800 $3,500

Transaction Beginning inventory Purchase Purchase

Number of units 60 230 180 470

Unit cost $82 85 90

Cost of Goods Sold $ 4,920 19,550 16,200 $40,670

Brief Exercise 6-9 (LO 6-4) Inventory Costs Rising Declining

Higher total assets FIFO LIFO

Higher cost of goods sold LIFO FIFO

Higher net income FIFO LIFO

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-10 (LO 6-5) February 2

Debit

Inventory Accounts Payable (Purchase inventory on account)

40,000

March 17

Debit

Accounts Receivable Sales Revenue (Sell inventory on account)

60,000

Cost of Goods Sold Inventory (Cost of inventory sold)

40,000

Credit 40,000

Credit 60,000

40,000

Brief Exercise 6-11 (LO 6-5) February 2

Debit

Inventory Accounts Payable (Purchase inventory on account)

40,000

February 2

Debit

Inventory Cash (Pay freight charges)

Credit 40,000

Credit

600 600

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-12 (LO 6-5) February 2

Debit

Inventory Accounts Payable (Purchase inventory on account)

60,000

February 5

Debit

Credit 60,000

Accounts Payable 4,000 Inventory (Return inventory purchased on account) ($4,000 = 100 units × $40 unit cost)

Credit 4,000

Brief Exercise 6-13 (LO 6-5) February 2

Debit

Inventory Accounts Payable (Purchase inventory on account)

40,000

February 10

Debit

Accounts Payable Inventory Cash (Pay on account with 3% discount) ($1,200 = $40,000 × 3%)

40,000

Credit 40,000

Credit 1,200 38,800

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-14 (LO 6-6) Inventory Ski jackets Skis

Quantity 20 25

Lower of Cost and NRV per unit $ 95 300

Ending Inventory $1,900 7,500 $9,400

Brief Exercise 6-15 (LO 6-6) Inventory Optima cameras Inspire speakers

Quantity 110 50

Lower of Cost and NRV per unit $45 45

Ending Inventory $4,950 2,250 $7,200

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-16 (LO 6-7) Inventory turnover ratio

Average days in inventory

Gross profit ratio

Cost of goods sold Average inventory

3.6 times

$180,000 ($55,000 + $45,000) / 2

365 = Inventory turnover ratio

101.4 days

Gross profit Net sales

28%

365 3.6

($250,000 − $180,000) $250,000

Brief Exercise 6-17 (LO 6-8) February 2

Debit

Purchases Accounts Payable (Purchase inventory on account)

40,000

March 17

Debit

Accounts Receivable Sales Revenue (Sell inventory on account)

60,000

Credit 40,000

Credit 60,000

No entry for cost of goods sold

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-18 (LO 6-8) February 2

Debit

Purchases Accounts Payable (Purchase inventory on account)

40,000

February 2

Debit

Freight-In Cash (Pay freight charges)

Credit 40,000

Credit

600 600

Brief Exercise 6-19 (LO 6-8) February 2

Debit

Purchases Accounts Payable (Purchase inventory on account)

60,000

February 5

Debit

Credit 60,000

Accounts Payable 4,000 Purchase Returns (Return inventory purchased on account) ($4,000 = 100 units × $40 unit cost)

Credit 4,000

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-20 (LO 6-8) February 2

Debit

Purchase Accounts Payable (Purchase inventory on account)

40,000

February 10

Debit

Accounts Payable Purchase Discounts Cash (Pay on account with 3% discount) ($1,200 = $40,000 × 3%)

40,000

Credit 40,000

Credit 1,200 38,800

Brief Exercise 6-21 (LO 6-9) Overstating ending inventory by $15,000 has the following effects: Current year Cost of goods sold is understated by $15,000. Gross profit is overstated by $15,000. Following year Cost of goods sold is overstated by $15,000. Gross profit is understated by $15,000.

Chapter 6 - Inventory and Cost of Goods Sold

Brief Exercise 6-22 (LO 6-9) Overstating ending inventory by $15,000 has the following effects: Current year Inventory is overstated by $15,000. Retained earnings is overstated by $15,000. Following year Inventory is not affected. Retained earnings is not affected.

Chapter 6 - Inventory and Cost of Goods Sold

EXERCISES Exercise 6-1 (LO 6-2) Beginning inventory Add: Purchases Cost of goods available for sale

$ 55,000 910,000 965,000

Less: Ending inventory Cost of goods sold

(45,000) $920,000

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-2 (LO 6-2) Wayman Corporation Multiple-step Income Statement For the year ended December 31, 2021 Sales revenue $390,000 Cost of goods sold 130,000 Gross profit $260,000 Salaries expense 40,000 Utilities expense 50,000 Advertising expense 30,000 Total operating expenses 120,000 Operating income 140,000 Interest expense Income before income taxes

20,000 120,000

Income tax expense Net income

50,000 $ 70,000

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-3 (LO 6-2) Requirement 1 Tisdale Incorporated Multiple-step Income Statement For the year ended December 31, 2021 Net sales $300,000 Cost of goods sold 190,000 Gross profit $110,000 Selling expenses 60,000 General expenses 50,000 Administrative expenses 40,000 Total operating expenses 150,000 Operating income (loss) (40,000) Nonoperating revenue Income before income taxes

110,000 70,000

Income tax expense Net income

30,000 $ 40,000

Requirement 2 While Tisdale Incorporated is able to report positive net income ($40,000), the company does not appear to have much profit-generating potential. For its core operations, the company reports a negative operating income or loss (−$40,000). This means that normal operations are not profitable. These are the operations that continue into the next year. Investors should not count on nonoperating revenue ($110,000) to recur.

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-4

Chapter 6 - Inventory and Cost of Goods Sold

(LO 6-3)

Requirement 1 FIFO (a) Date Oct. 6

Transaction Purchase

Number of units 80

Unit cost $58

Ending Inventory $4,640

Number of units 60 140 210 40 450a

Unit cost $52 54 57 58

Cost of Goods Sold $ 3,120 7,560 11,970 2,320 $24,970

(b) Date Jan. 1 Apr. 7 Jul. 16 Oct. 6 a

Transaction Beginning inventory Purchase Purchase Purchase

First 450 units purchased are assumed sold

(c) Sales revenue = 450 units × $70 = $31,500 (d) Gross profit = Sales revenue − Cost of goods sold = $31,500 − $24,970 = $6,530

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-4 (continued) Requirement 2 LIFO (a) Date Jan. 1 Apr. 7

Transaction Beginning Inventory Purchase

Number of units 60 20 80

Unit cost $52 54

Ending Inventory $3,120 1,080 $4,200

Transaction Purchase Purchase Purchase

Number of units 120 210 120 440a

Unit cost $54 57 58

Cost of Goods Sold $ 6,480 11,970 6,960 $25,410

(b) Date Apr. 7 Jul. 16 Oct. 6 a

Last 440 units purchased are assumed sold

(c) Sales revenue = 450 units × $70 = $31,500 (d) Gross profit = Sales revenue − Cost of goods sold = $31,500 − $25,410 = $6,090

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-4 (concluded) Requirement 3 Weighted average Date Jan. 1 Apr. 7 Jul. 16 Oct. 6

Transaction Beginning Inventory Purchase Purchase Purchase

Number of units 60 140 210 120 530

Unit cost $52 54 57 58

Total cost $ 3,120 7,560 11,970 6,960 $29,610

Weighted-average cost = $29,610 / 530 units = $55.8679 (a) Ending inventory = 80 units × $55.8679 = $4,469 (b) Cost of goods sold = 450 units × $55.8679 = $25,141 (c) Sales revenue = 450 units × $70 = $31,500 (d) Gross profit = Sales revenue − Cost of goods sold = $31,500 − $25,141 = $6,359 Requirement 4

Gross profit

FIFO

LIFO

Weightedaverage

$6,530

$6,090

$6,359

FIFO results in higher profitability when inventory costs are rising.

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-5 (LO 6-3) Requirement 1 FIFO (a) Date Transaction Nov. 11 Purchase

Number of units 24

Unit cost $18

Ending Inventory $432

Number of units 20 25 30 6 81a

Unit cost $22 21 20 18

Cost of Goods Sold $ 440 525 600 108 $1,673

(b) Date Jan. 1 Mar. 4 Jun. 9 Nov. 11 a

Transaction Beginning inventory Purchase Purchase Purchase

First 81 units purchased are assumed sold

(c) Sales revenue = 81 units × $30 = $2,430 (d) Gross profit = Sales revenue − Cost of goods sold = $2,430 − $1,673 = $757

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-5 (continued) Requirement 2 LIFO (a) Date Jan. 1 Mar. 4

Transaction Beginning Inventory Purchase

Number of units 20 4 24

Unit cost $22 21

Ending Inventory $440 84 $524

Number of units 21 30 30 81*

Unit cost $21 20 18

Cost of Goods Sold $ 441 600 540 $1,581

(b) Date Transaction Mar. 4 Purchase Jun. 9 Purchase Nov. 11 Purchase

* Last 81 units purchased are assumed sold (c) Sales revenue = 81 units × $30 = $2,430 (d) Gross profit = Sales revenue − Cost of goods sold = $2,430 − $1,581 = $849

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-5 (concluded) Requirement 3 Weighted average Date Jan. 1 Mar. 4 Jun. 9 Nov. 11

Transaction Beginning Inventory Purchase Purchase Purchase

Number of units 20 25 30 30 105

Unit cost $22 21 20 18

Total Cost $ 440 525 600 540 $2,105

Weighted-average cost = $2,105 / 105 units = $20.04762 (a) Ending inventory = 24 units × $20.04762 = $481.14 (b) Cost of goods sold = 81 units × $20.04762 = $1,623.86 (c) Sales revenue = 81 units × $30 = $2,430 (d) Gross profit = Sales revenue − Cost of goods sold = $2,430 − $1,623.86 = $806.14 Requirement 4

Gross profit

FIFO

LIFO

Weightedaverage

$757

$849

$806.14

LIFO results in higher profitability when inventory costs are declining.

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-6 (LO 6-5) Debit Inventory Accounts Payable (Purchase inventory on account)

Credit

310,000 310,000

Debit Accounts Receivable Sales Revenue (Sell inventory on account)

520,000

Cost of Goods Sold Inventory (Cost of inventory sold)

335,000

Credit 520,000

335,000

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-7 (LO 6-5) June 5

Debit

Inventory Accounts Payable (Purchase inventory on account)

4,000

June 9

Debit

Credit 4,000

Accounts Payable 800 Inventory (Return inventory purchased on account) ($800 = 40 units × $20 unit cost) June 16

Debit

Accounts Receivable Sales Revenue (Sell inventory on account) ($5,600 = 160 units × $35 unit price)

5,600

Cost of Goods Sold Inventory (Record cost of inventory sold) ($3,200 = 160 units × $20 unit cost)

3,200

Credit 800

Credit 5,600

3,200

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-8 (LO 6-5) Requirement 1 June 5

Debit

Inventory Accounts Payable (Purchase inventory on account)

3,800

June 12

Debit

Accounts Payable Inventory Cash (Pay on account with 2% discount) ($76 = $3,800 × 2%)

3,800

Requirement 2 June 22 Accounts Payable Cash (Pay on account)

Credit 3,800

Credit 76 3,724

Debit

Credit

3,800 3,800

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-9 (LO 6-5) Requirement 1 May 2 Inventory Accounts Payable (Purchase inventory on account) May 3

Debit 3,300

3,300

Inventory Cash (Pay freight-in cost) May 5

200

Accounts Payable Inventory (Return inventory on account) May 10

400

Accounts Payable Inventory Cash (Pay on account with 1% discount) ($29 = $2,900 × 1%)

Credit

200

400

2,900 29 2,871

May 30

Accounts Receivable Sales Revenue (Sell inventory on account)

4,000

Cost of Goods Sold Inventory (Record cost of inventory sold)

3,071

4,000

3,071a

$3,300 (purchase) + $200 (freight-in) − $400 (return) − $29 (discount)

Requirement 2 May 24 Accounts Payable Cash

Debit

Credit

2,900 2,900

Chapter 6 - Inventory and Cost of Goods Sold

(Pay cash on account)

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-10 (LO 6-5) July 5

Debit

Inventory Accounts Payable (Purchase inventory on account) July 8

100,000

Accounts Payable Inventory (Return inventory on account) July 13

5,000

Accounts Payable Inventory Cash (Pay on account with 3% discount) ($2,850 = $95,000 × 3%)

95,000

Credit 100,000

5,000

2,850 92,150

July 28

Accounts Receivable Sales Revenue (Sell inventory on account)

114,000

Cost of Goods Sold Inventory (Record cost of inventory sold)

92,150

114,000

92,150a

$100,000 (purchase) − $5,000 (return) − $2,850 (discount)

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-11 (LO 6-5) August 6

Debit

Inventory Accounts Payable (Purchase inventory on account)

14,000

Credit 14,000

August 7 Inventory Cash (Pay freight-in cost)

400 400

August 10 Accounts Payable Inventory (Return inventory on account)

1,200 1,200

August 14 Accounts Payable 12,800 Inventory Cash (Pay cash on account with 1% discount) ($128 = $12,800 × 1%)

128 12,672

August 23 Accounts Receivable Sales Revenue (Sell inventory on account) Cost of Goods Sold Inventory (Record cost of inventory sold)

11,000 11,000 10,212.50 10,212.50

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-12 (LO 6-5) August 6 Accounts Receivable Sales Revenue (Sell inventory on account)

14,000

Cost of Goods Sold Inventory (Record cost of inventory sold)

12,600

14,000

12,600

August 10 Sales Returns Accounts Receivable (Receive return on account)

1,200 1,200

August 14 Cash 12,672 Sales Discounts 128 Accounts Receivable (Receive cash on account with 1% discount) ($128 = $12,800 × 1%)

12,800

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-13 (LO 6-6) Requirement 1

Inventory Furniture Electronics

Quantity 200 50

Unit Cost $ 85 400

Quantity 200 50

Lower of Cost and NRV per unit $ 85 300

Total Recorded Cost $17,000 20,000 $37,000

Requirement 2

Inventory Furniture Electronics

Ending Inventory $17,000 15,000 $32,000

Requirement 3 Debit Cost of Goods Sold 5,000 Inventory (Adjust inventory down to net realizable value) (50 units of electronics × $100)

Credit 5,000

Requirement 4 The write-down of inventory has the effect of reducing total assets (inventory), increasing expenses (cost of goods sold), decreasing net income, and decreasing retained earnings.

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-14 (LO 6-6) Requirement 1

Inventory Shirts MegaDriver MegaDriver II

Quantity 35 15 30

Unit Cost $ 60 360 350

Total Recorded Cost $ 2,100 5,400 10,500 $18,000

Requirement 2

Inventory Shirts MegaDriver MegaDriver II

Lower of Cost and NRV Quantity per unit 35 $ 60 15 250 30 350

Ending Inventory $ 2,100 3,750 10,500 $16,350

Requirement 3 Debit Cost of Goods Sold 1,650 Inventory (Adjust inventory down to net realizable value) (15 units of MegaDriver × $110)

Credit 1,650

Requirement 4 The write-down of inventory has the effect of reducing total assets (inventory), increasing expenses (cost of goods sold), decreasing net income, and decreasing retained earnings.

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-15 (LO 6-2, 6-7) Requirement 1 Beginning inventory Add: Purchases Less: Purchase returns Cost of goods available for sale

Lewis $ 24,000 261,000 (15,000) 270,000

Clark $ 50,000 235,000 (60,000) 225,000

Less: Ending inventory Cost of goods sold

(18,000) $252,000

(60,000) $165,000

Requirement 2 Lewis Inventory $252,000 turnover = Cost of goods sold Average inventory ($24,000 + $18,000) /2 ratio =

Clark $165,000 ($50,000 + $60,000) /2

12.0 times

3.0 times

Lewis

Clark

365 12.0

365 3.0

30.4 days

121.7 days

Requirement 3 Average 365 days in = Inventory turnover inventory ratio =

Requirement 4 Lewis seems to be managing its inventory more efficiently. For Lewis, inventory turns over 12 times per year. In other words, inventory sells every 30.4 days. For Clark, its inventory turns over only three times per year or every 121.7 days.

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-16 (LO 6-2, 6-7) Requirement 1 Gross Profita $27,200 10,500 15,200

Henry Grace James

Operating Incomeb $22,200 (2,600) 12,200

Income Before Income Taxesc $20,200 (9,600) 12,200

Net Incomed $18,200 (9,600) 9,200

Gross profit = Sales revenue − Cost of goods sold Operating income = Gross profit − Operating expenses c Income before income taxes = Operating income − Nonoperating expenses d Net income = Income before income taxes − Income tax expense b

Requirement 2 Gross profit ratio

= =

Gross profit Net sales

Henry

Grace

James

$27,200 $32,000

$10,500 $35,000

$15,200 $40,000

0.85

0.30

0.38

Henry has the most favorable gross profit ratio.

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-17 (LO 6-8) Requirement 1 May 2

Debit

Purchases Accounts Payable (Purchase inventory on account) May 3

3,300 3,300

Freight-In Cash (Pay freight-in cost) May 5

200

Accounts Payable Purchase Returns (Return inventory on account) May 10

400

200

400

Accounts Payable 2,900 Purchase Discounts Cash (Pay cash on account with 1% discount) (Purchase discount = $2,900 × 1%) May 30 Accounts Receivable Sales Revenue (Sell inventory on account) Requirement 2 May 31 Cost of Goods Sold Purchase Returns Purchase Discounts Purchases Freight-In (Record period-end adjustment)

Credit

29 2,871

4,000 4,000

Debit 3,071 400 29

Credit

3,300 200

Note: Beginning and ending inventory amounts are zero; no entry required. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 6-38 Financial Accounting, 5e

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-18 (LO 6-8) Requirement 1 July 5

Debit

Purchases Accounts Payable (Purchase inventory on account) July 8

100,000

Accounts Payable Purchase Returns (Return inventory on account) July 13

5,000

100,000

5,000

Accounts Payable 95,000 Purchase Discounts Cash (Pay cash on account with 3% discount) ($2,850 = $95,000 × 3%) July 28 Accounts Receivable Sales Revenue (Sell inventory on account) Requirement 2 July 31 Cost of Goods Sold Purchase Returns Purchase Discounts Purchases (Record period-end adjustment)

Credit

2,850 92,150

114,000 114,000

Debit 92,150 5,000 2,850

Credit

100,000

Note: Beginning and ending inventory amounts are zero; no entry required.

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-19 (LO 6-9) August 6

Debit

Purchases Accounts Payable (Purchase inventory on account) August 7

14,000 14,000

Freight-In Cash (Pay freight-in cost) August 10

400 400

Accounts Payable Purchase Returns (Return inventory on account) August 14

1,200 1,200

Accounts Payable 12,800 Purchase Discounts Cash (Pay cash on account with 1% discount) ($128 = $12,800 × 1%) August 23 Accounts Receivable Sales Revenue (Sell inventory on account)

128 12,672

11,000 11,000

Requirement 2 August 31 Inventory (ending) Cost of Goods Sold Purchase Returns Purchase Discounts Purchases Freight-In (Record period-end adjustment)

Credit

Debit

Credit

2,859.50 10,212.50 1,200.00 128.00 14,000 400

Note: Beginning inventory was zero; no entry required. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 6-40 Financial Accounting, 5e

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-20 (LO 6-9) Requirement 1 When goods are shipped FOB shipping point, title transfers from the seller to the buyer at the time of shipment. This means that Mulligan Corporation (buyer) receives title to the inventory when it is shipped on December 30, 2021. By not including this inventory in its 2021 ending inventory count, the company has made an error.

Requirement 2 Balance Sheet Year

Income Statement

Stockholders’ Cost of Assets Liabilities Equity Revenues Goods Sold

Gross Profit

Current

Following

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-21 Requirement 1 January 3 Debit Inventory 126,000 Accounts Payable (Purchase inventory on account) January 8 Debit Inventory 143,000 Accounts Payable (Purchase inventory on account) January 12 Debit Inventory 161,000 Accounts Payable (Purchase inventory on account) January 15 Debit Accounts Payable 11,500 Inventory (Return defective inventory) ($11,500 = $115×100 units) January 19 Debit Accounts Receivable 600,000 Sales Revenue (Sell inventory on account) Cost of Goods Sold 437,000 Inventory (Record cost of inventory sold) ($437,000 = [$100×300 units]+[$105×1,200 units]+ [$110×1,300 units]+[$115×1,200 units]) January 22 Debit Cash 580,000 Accounts Receivable (Receive cash on account) January 24 Debit Accounts Payable 410,000 Cash (Pay cash on account)

Credit 126,000 Credit 143,000 Credit 161,000 Credit 11,500 Credit 600,000 437,000

Credit 580,000 Credit 410,000

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-21 (continued) Requirement 1 (concluded) January 27 Allowance for Uncollectible Accounts Accounts Receivable (Write off uncollectible accounts) January 31 Salaries Expense Cash (Pay salaries for the current period)

Debit 2,500

Credit 2,500

Debit 128,000

Requirement 2 (a) January 31 Debit Cost of Goods Sold 1,500 Inventory (Adjust inventory for net realizable value) ($1,500 = ($115−$100)×100 units (b) January 31 Debit Bad Debt Expense 3,000 Allowance for Uncollectible Accounts (Adjust uncollectible accounts) $3,000 = ($4,000×40%)+($50,000a×4%)−$600b a $50,000 = $36,500+$600,000−$580,000−$2,500−$4,000 b $600 = $3,100−$2,500 (c) January 31 Debit Interest Expense 200 Interest Payable (Adjust interest expense) ($200 = $30,000 × 8% × 1/12) (d) January 31 Debit Income Tax Expense 12,300 Income Tax Payable (Adjust income taxes)

Credit 128,000

Credit 1,500 Credit 3,000

Credit 200 Credit 12,300

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-21 (continued) Requirement 3 Big Blast Fireworks Adjusted Trial Balance January 31, 2021 Accounts Debit Cash $ 63,900 Accounts Receivable 54,000 Inventory 10,000 Land 61,600 Allowance for Uncollectible Accounts Accounts Payable Interest Payable Income Tax Payable Notes Payable Common Stock Retained Earnings Sales Revenue Cost of Goods Sold 438,500 Salaries Expense 128,000 Bad Debt Expense 3,000 Interest Expense 200 Income Tax Expense 12,300 Totals $771,500

Credit

$ 3,600 40,900 200 12,300 30,000 56,000 28,500 600,000

$771,500

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-21 (continued) Requirement 3 (concluded) Accounts Cash Accounts Receivable Inventory Land Allow for Uncoll Accts Accounts Payable Interest Payable Income Tax Payable Notes Payable Common Stock Retained Earnings Sales Revenue Cost of Goods Sold Salaries Expense Bad Debt Expense Interest Expense Income Tax Expense

Ending Balance $ 63,900 54,000 10,000 61,600 3,600 40,900 200 12,300 30,000 56,000 28,500 600,000 438,500 128,000 3,000 200 12,300

= = = = = = = = = = = = = = = = =

Beginning balance in bold, entries during January in blue, and adjusting entries in red. 21,900+580,000−410,000−128,000 36,500+600,000−580,000−2,500 30,000+126,000+143,000+161,000−437,000−11,500−1,500 61,600 3,100−2,500+3,000 32,400+126,000+143,000+161,000−410,000−11,500 200 12,300 30,000 56,000 28,500 600,000 437,000+1,500 128,000 3,000 200 12,300

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-21 (continued) Requirement 4 Big Blast Fireworks Multiple-Step Income Statement For the year ended January 31, 2021 Sales revenue $600,000 Cost of goods sold 438,500 Gross profit $161,500 Salaries expense Bad debt expense Total operating expenses Operating income

128,000 3,000 131,000 30,500

Interest expense Income before taxes Income tax expense Net income

200 30,300 12,300 $ 18,000

Requirement 5 Big Blast Fireworks Classified Balance Sheet January 31, 2021 Assets Cash $ 63,900 Accounts receivable 54,000 Less: Allowance (3,600) 50,400 Inventory 10,000 Total current assets 124,300 Land

Total assets *

61,600

$185,900

Liabilities Accounts payable $ 40,900 Interest payable 200 Income tax payable 12,300 Total current liabilities 53,400 Notes payable 30,000 Total liabilities 83,400 Stockholders’ Equity Common stock 56,000 Retained earnings 46,500 * Total stockholders’ eq. 102,500 Total liabilities and stockholders’ equity $185,900

Retained earnings = Beginning retained earnings + Net income − Dividends = $28,500 + $18,000 − $0 = $46,500

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-21 (continued) Requirement 6 January 31, 2021 Sales Revenue Retained Earnings (Close revenue accounts)

Debit 600,000

Retained Earnings Cost of Goods Sold Salaries Expense Bad Debt Expense Interest Expense Income Tax Expense (Close expense accounts)

582,000

Credit 600,000

438,500 128,000 3,000 200 12,300

Chapter 6 - Inventory and Cost of Goods Sold

Exercise 6-21 (concluded) Requirement 7 (a) The inventory turnover ratio is: Inventory Turnover Ratio

Cost of Goods Sold =

Average Inventory

$438,500 =

($30,000 + $10,000)/2

21.9

A ratio of 21.9 suggests that the average inventory balance is sold 21.9 times over the period. Typically, a higher ratio is good. Therefore, Big Blast Fireworks appears to be managing its inventory more efficiently than the average company in the same industry. (b) The gross profit ratio is: Gross Profit Ratio

(Sales − Cost of Goods Sold) ($600,000 − $438,500) = = 26.9% Sales $600,000

A ratio of 26.9% suggests that for every $1 of sales, the company spends just over $0.73 on inventory ($1.00 − $0.269), resulting in a gross profit of almost $0.27. The industry average gross profit ratio, however, is higher at 33%, so Big Blast Fireworks is less profitable per dollar of sales than the average company in the same industry. (c) Based on the inventory turnover ratio and the gross profit ratio, Big Blast Fireworks’ business strategy appears to be selling a higher volume of less expensive items. In general, lower priced items sell more frequently.

Chapter 6 - Inventory and Cost of Goods Sold

PROBLEMS: SET A Problem 6-1A (LO 6-3) Requirement 1 Specific identification Date Oct. 1 Oct. 30

Transaction Beginning inventory Purchase

Number of units 1 7 8

Unit cost $900 930

Ending Inventory $ 900 6,510 $7,410

Number Unit Cost of Date Transaction of units cost Goods Sold a Oct. 1 Beginning inventory 4 $900 $ 3,600 b Oct. 1 Beginning inventory 1 900 900 b Oct. 10 Purchase 2 910 1,820 c Oct. 10 Purchase 3 910 2,730 c Oct. 20 Purchase 4 920 3,680 14 $12,730 a b c From the October 4 sale; From the October 13 sale; From the October 28 sale. Requirement 2 FIFO Date Oct. 20 Oct. 30

Date Oct. 1 Oct. 10 Oct. 20 a

Transaction Purchase Purchase

Number of units 1 7 8

Unit cost $920 930

Ending Inventory $ 920 6,510 $7,430

Transaction Beginning inventory Purchase Purchase

Number of units 6 5 3 14a

Unit cost $900 910 920

Cost of Goods Sold $ 5,400 4,550 2,760 $12,710

First 14 units purchased are assumed sold

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-1A (concluded) Requirement 3 LIFO Date Oct. 1 Oct. 10

Date Oct. 10 Oct. 20 Oct. 30 a

Transaction Beginning inventory Purchase

Number of units 6 2 8

Unit Cost $900 910

Ending Inventory $5,400 1,820 $7,220

Transaction Purchase Purchase Purchase

Number of units 3 4 7 14a

Unit Cost $910 920 930

Cost of Goods Sold $ 2,730 3,680 6,510 $12,920

Unit cost $900 910 920 930

Total Cost $ 5,400 4,550 3,680 6,510 $20,140

Last 14 units purchased are assumed sold

Requirement 4 Weighted average Date Oct. 1 Oct. 10 Oct. 20 Oct. 30

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 6 5 4 7 22

Weighted-average cost = $20,140 / 22 units = $915.45 (rounded) Ending inventory = 8 units × $915.45 = $7,323.60 Cost of goods sold = 14 units × $915.45 = $12,816.30

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-2A (LO 6-3, 6-4, 6-5) Requirement 1 Specific identification Date Mar. 1 Mar. 9 Mar. 22 Mar. 30

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 1 2 2 9 14

Unit cost $250 270 280 300

Ending Inventory $ 250 540 560 2,700 $4,050

Number Unit Cost of Date Transaction of units cost Goods Sold a Mar. 1 Beginning inventory 15 $250 $3,750 b Mar. 9 Purchase 8 270 2,160 c Mar. 1 Beginning inventory 4 250 1,000 c Mar. 22 Purchase 8 280 2,240 35 $9,150 a b c From the March 5 sale; From the March 17 sale; From the March 27 sale. Requirement 2 FIFO Date Transaction Mar. 22 Purchase Mar. 30 Purchase

Number of units 5 9 14

Unit cost $280 300

Ending Inventory $1,400 2,700 $4,100

Date Transaction Mar. 1 Beginning inventory Mar. 9 Purchase Mar. 22 Purchase

Number of units 20 10 5 35a

Unit cost $250 270 280

Cost of Goods Sold $5,000 2,700 1,400 $9,100

First 35 units purchased are assumed sold

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-2A (continued) Requirement 3 LIFO Date Mar. 1

Date Mar. 1 Mar. 9 Mar. 22 Mar. 30 a

Transaction Beginning inventory

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 14

Unit cost $250

Ending Inventory $3,500

Number of units 6 10 10 9 35a

Unit cost $250 270 280 300

Cost of Goods Sold $1,500 2,700 2,800 2,700 $9,700

Unit cost $250 270 280 300

Total Cost $ 5,000 2,700 2,800 2,700 $13,200

Last 35 units purchased are assumed sold

Requirement 4 Weighted average Date Mar. 1 Mar. 9 Mar. 22 Mar. 30

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 20 10 10 9 49

Weighted-average cost = $13,200 / 49 units = $269.3878 (rounded) Ending inventory = 14 units × $269.3878 = $3,771.43 Cost of goods sold = 35 units × $269.3878 = $9,428.57

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-2A (concluded) Requirement 5

Sales revenue Cost of goods sold Gross profit

Specific Identification $15,300 9,150 $ 6,150

FIFO $15,300 9,100 $ 6,200

LIFO $15,300 9,700 $ 5,600

Weightedaverage Cost $15,300.00 9,428.57 $ 5,871.43

Requirement 6 FIFO provides the more meaningful measure of ending inventory. The amount of ending inventory reported using FIFO ($4,100) compared to LIFO ($3,500) better approximates the current cost of inventory at the end of the period ($300 per unit × 14 units = $4,200). Requirement 7 March 31 Cost of Goods Sold Inventory (Record the LIFO adjustment)

Debit

Credit

600 600*

* The LIFO adjustment equals the difference in inventory reported using FIFO ($4,100) versus using LIFO ($3,500). The LIFO adjustment equals $600.

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-3A (LO 6-2, 6-5) Requirement 1 July 3

Debit

Inventory Accounts Payable (Purchase inventory on account) July 4

2,300 2,300

Inventory Cash (Pay freight-in) July 9

110

Accounts Payable Inventory (Return inventory on account) July 11

200

110

200

Accounts Payable Inventory Cash (Pay on account less 1% discount) ($21 = $2,100 × 1%) July 12

2,100

Accounts Receivable Sales Revenue (Sell inventory on account)

5,800

Cost of Goods Sold Inventory (Record cost of inventory sold) July 15

3,000

Cash

5,800 Accounts Receivable (Receive cash on account)

Credit

21 2,079

5,800

3,000

5,800

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-3A (concluded) Requirement 1 (continued) July 18

Debit

Inventory Accounts Payable (Purchase inventory on account) July 22

3,100

Cash

4,200

3,100

Sales Revenue (Sell inventory for cash)

4,200

Cost of Goods Sold Inventory (Record cost of inventory sold) July 28

2,500

Accounts Payable Inventory (Return inventory on account) July 30

300

Accounts Payable Cash (Pay cash on account)

Credit

2,500

300

2,800 2,800

Requirement 2 CD City Multiple-step Income Statement (partial) For the month of July Net sales Cost of goods sold Gross profit

$10,000 5,500 $ 4,500

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-4A (LO 6-6) Requirement 1 Inventory items Vans Trucks 2-door sedans 4-door sedans Sports cars SUVs

Quantity 4 7 3 5 1 6

Unit Cost $27,000 18,000 13,000 17,000 37,000 30,000

Total Cost $108,000 126,000 39,000 85,000 37,000 180,000 $575,000

Requirement 2

Inventory items Vans Trucks 2-door sedans 4-door sedans Sports cars SUVs Total

Quantity 4 7 3 5 1 6

Unit Cost $27,000 18,000 13,000 17,000 37,000 30,000

Unit NRV $25,000 17,000 15,000 20,000 40,000 28,000

Lower of Cost and NRV per unit Total $25,000 $100,000 17,000 119,000 13,000 39,000 17,000 85,000 37,000 37,000 28,000 168,000 $548,000

Requirement 3 Because the total of lower of cost and net realizable value ($548,000) is less than total cost ($575,000), inventory is written down for the difference ($27,000). Debit

Credit

Cost of Goods Sold 27,000 Inventory 27,000 (Write down inventory to net realizable value) Requirement 4 The write-down of inventory from cost to net realizable value reduces total assets and increases total expenses, leading to lower net income and lower retained earnings. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Chapter 6 6-57

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-5A (LO 6-3, 6-6) Requirement 1 FIFO Unit cost $16 9

Ending Inventory $ 640 540 $1,180

Number Unit Date Transaction of units Cost Jan. 1 Beginning inventory 120 $21 Mar. 12 Purchase 50 16 a 170 a First 170 units purchased are assumed sold

Cost of Goods Sold $2,520 800 $3,320

Date Transaction Mar. 12 Purchase Sep. 17 Purchase

Number of units 40 60 100

Requirement 2 LIFO Unit cost $21

Ending Inventory $2,100

Number Unit Date Transaction of units cost Jan. 1 Beginning inventory 20 $21 Mar. 12 Purchase 90 16 Sep. 17 Purchase 60 9 a 170 a Last 170 units purchased are assumed sold

Cost of Goods Sold $ 420 1,440 540 $2,400

Date Jan. 1

Transaction Beginning inventory

Number of units 100

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-5A (concluded) Requirement 3 Ending Inventory

FIFO a

Cost

NRV

Lower of Cost and NRV

$ 1,180a

$500

Ending inventory from Requirement 1 above.

FIFO Cost of Goods Sold Inventory (Adjust inventory to net realizable value)

Debit

Credit

680 680

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-6A (LO 6-2, 6-3, 6-4, 6-5, 6-6) Requirement 1 October 4 Inventory Accounts Payable (Purchase inventory on account) October 5

Debit 6,500

6,500

Inventory Cash (Pay freight-in) October 9

600

Accounts Payable Inventory (Return inventory on account) October 12

500

600

500

Accounts Payable Inventory Cash (Pay on account less 2% discount) ($120 = $6,000 × 2%) October 15

6,000

Accounts Receivable Sales Revenue (Sell inventory on account)

12,800

120 5,880

12,800

Cost of Goods Sold 8,440 Inventory (Record cost of inventory sold) ($8,440 = ($50 × 50 units) + ($54 × 110 units)) October 19 Cash

Credit

8,440

12,800 Accounts Receivable (Receive cash on account)

12,800

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-6A (continued) Requirement 1 (continued) October 20

Debit

Inventory Accounts Payable (Purchase inventory on account) October 22

7,000

Cash

8,000

Credit 7,000

Sales Revenue (Sell inventory for cash) Cost of Goods Sold 6,840 Inventory (Record cost of inventory sold) ($6,840 = ($54 × 10 units) + ($70 × 90 units))

8,000

6,840

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-6A (concluded) Requirement 2 October 31

Debit

Credit

Cost of Goods Sold 350 Inventory (Adjust inventory down to net realizable value)

350*

* The net realizable value of ending inventory ($350 = $35 net realizable value × 10 units) is $350 less than FIFO ending inventory ($700 from Requirement 1).

Requirement 3 Bowser Co. Multiple-step Income Statement (partial) For the month of October Net sales Cost of goods sold* Gross profit

$20,800 15,630 $ 5,170

* Cost of goods sold equals the cost of the units sold ($15,280) + write down to net realizable value ($350).

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-7A (LO 6-2, 6-7) Requirement 1 Baskin-Robbins Multiple-step Income Statement For the month of July, 2021 Net sales: Total sales revenue Less: Sales returns Net sales revenue Cost of goods sold Gross profit Operating expenses: Salaries Utilities Rent Total Operating income Non-operating items: Interest income Interest expense Total Income before income taxes Income tax expense Net income

$69,800 (1,100) $68,700 28,700 40,000 13,700 3,600 6,700 24,000 16,000 3,300 (400) 2,900 18,900 6,000 $12,900

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-7A (concluded) Requirement 2 Inventory turnover ratio

Cost of goods sold Average inventory

$28,700 ($1,100 + $2,300) /2

16.9 times

This ratio will likely be lower in December when inventory is being sold at a much slower pace due to ice cream sales being less popular in colder months. Requirement 3 Gross profit ratio

Gross profit Net sales

$40,000 $68,700 0.58

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-8A (LO 6-7) Requirement 1 Inventory turnover ratio

Cost of goods sold Average inventory

Company 1

Company 2

$180,000 $40,000

$330,000 $30,000

4.5

Company 1

Company 2

$220,000 $400,000

$70,000 $400,000

0.55

0.175

Requirement 2 Gross profit ratio

Gross profit Net sales

Requirement 3 Company 1 is likely St. Jude and Company 2 is likely Wawa. The reason is that convenience stores are likely to sell their inventory quickly, resulting in a higher inventory turnover ratio. In addition, competition among common goods (such as grocery-related items) reduces gross profit. Selling highly specialized medical equipment is likely to result in a higher gross profit ratio but lower inventory turnover.

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-9A (LO 6-8) Requirement 1 July 3 Purchases Accounts Payable (Purchase inventory on account) July 4

Debit 2,300

2,300

Freight-In Cash (Pay freight-in) July 9

110

Accounts Payable Purchase Returns (Return inventory on account) July 11

200

110

200

Accounts Payable Purchase Discounts Cash (Pay on account less 1% discount) ($21 = $2,100 × 1%) July 12

2,100

Accounts Receivable Sales Revenue (Sell inventory on account) July 15

5,800

Cash

5,800

21 2,079

5,800

Accounts Receivable (Receive cash on account) July 18 Purchases Accounts Payable (Purchase inventory on account)

Credit

5,800

3,100 3,100

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-9A (continued) Requirement 1 (concluded) July 22 Cash

Debit 4,200

Sales Revenue (Sell inventory for cash) July 28 Accounts Payable Purchase Returns (Return inventory on account) July 30 Accounts Payable Cash (Pay cash on account) Requirement 2 July 31 Inventory (ending) Cost of Goods Sold Purchase Returns Purchase Discounts Purchases Freight-In Inventory (beginning) (Record period-end adjustment)

Credit 4,200

300 300

2,800 2,800

Debit

Credit

2,889 5,500 500 21 5,400 110 3,400

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Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-9A (concluded) Requirement 3 CD City Multiple-step Income Statement (partial) For the month of July Net sales Cost of goods sold: Beginning inventory Add: Purchases Freight-in Less: Purchase returns Purchase discounts Cost of goods available for sale Less: Ending inventory Cost of goods sold Gross profit

$10,000 $3,400 5,400 110 (500) (21) 8,389 (2,889) 5,500 $4,500

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-10A (LO 6-7. 6-9) Requirement 1 Gross profit ratio

2018

2019

2020

2021

= Gross profit = $28,000 $60,000 Net sales

$20,000 $66,000

$46,000 $74,000

$42,000 $90,000

0.47

0.30

0.62

0.47

2018

2019

2020

2021

$31,000a $66,000

$35,000a $74,000

$42,000 $90,000

0.47

= Requirement 2 Gross profit ratio

= Gross profit = $28,000 $60,000 Net sales =

0.47

These amounts represent amounts that would have been reported had the $11,000 inventory error not occurred. The understatement of inventory in 2019 has the effect of understating gross profit in 2019 and overstating gross profit in 2020 by $11,000.

Using the corrected amounts, the trend in gross profit is much more stable over time, which is to be expected for most companies. Requirement 3 Corrected gross profit from 2018-2021 = $28,000 + $31,000 + $35,000 + $42,000 = $136,000 The cumulative gross profit over the four-year period is unaffected by the inventory error. That’s because inventory errors have the effect of reversing in the year following the error.

Chapter 6 - Inventory and Cost of Goods Sold

PROBLEMS: SET B Problem 6-1B (LO 6-3) Requirement 1 Specific identification Date Jun. 1 Jun. 12 Jun. 24 Jun. 29

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 1 1 3 9 14

Unit cost $ 350 340 330 320

Ending Inventory $ 350 340 990 2,880 $4,560

Number Unit Cost of Date Transaction of units cost Goods Sold a Jun. 1 Beginning inventory 11 $350 $ 3,850 b Jun. 1 Beginning inventory 3 350 1,050 b Jun. 12 Purchase 9 340 3,060 c Jun. 1 Beginning inventory 1 350 350 c Jun. 24 Purchase 7 330 2,310 31 $10,620 a From the June 7 sale; b From the June 15 sale; c From the June 27 sale. Requirement 2 FIFO Date Jun. 24 Jun. 29

Date Jun. 1 Jun. 12 Jun. 24 a

Transaction Purchase Purchase

Number of units 5 9 14

Unit cost $330 320

Ending Inventory $1,650 2,880 $4,530

Transaction Beginning inventory Purchase Purchase

Number of units 16 10 5 31a

Unit cost $350 340 330

Cost of Goods Sold $ 5,600 3,400 1,650 $10,650

First 31 units purchased are assumed sold

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-1B (concluded) Requirement 3 LIFO Date Jun. 1

Date Jun. 1 Jun. 12 Jun. 24 Jun. 29

Transaction Beginning inventory

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 14

Unit cost $350

Ending Inventory $4,900

Number of units 2 10 10 9 31*

Unit cost $350 340 330 320

Cost of Goods Sold $ 700 3,400 3,300 2,880 $10,280

Unit cost $350 340 330 320

Total Cost $ 5,600 3,400 3,300 2,880 $15,180

* Last 31 units purchased are assumed sold Requirement 4 Weighted average Date Jun. 1 Jun. 12 Jun. 24 Jun. 29

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 16 10 10 9 45

Weighted-average cost = $15,180 / 45 units = $337.3333 (rounded) Ending inventory = 14 units × $337.3333 = $4,722.67 Cost of goods sold = 31 units × $337.3333 = $10,457.33

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-2B (LO 6-3, 6-4, 6-5) Requirement 1 Specific identification Date Transaction Aug. 1 Beginning inventory Aug. 11 Purchase Aug. 29 Purchase

Number of units 2 2 11 15

Unit cost $160 150 130

Ending Inventory $ 320 300 1,430 $2,050

Number Unit Cost of Date Transaction of units cost Goods Sold a Aug. 1 Beginning inventory 5 $160 $ 800 b Aug. 11 Purchase 8 150 1,200 c Aug. 1 Beginning inventory 1 160 160 c Aug. 20 Purchase 10 140 1,400 24 $3,560 a b c From the August 4 sale; From the August 13 sale; From the August 26 sale. Requirement 2 FIFO Date Transaction Aug. 20 Purchase Aug. 29 Purchase

Number of units 4 11 15

Unit cost $140 130

Ending Inventory $ 560 1,430 $1,990

Date Transaction Aug. 1 Beginning inventory Aug. 11 Purchase Aug. 20 Purchase

Number of units 8 10 6 24*

Unit cost $160 150 140

Cost of Goods Sold $1,280 1,500 840 $3,620

* First 24 units purchased are assumed sold

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-2B (continued) Requirement 3 LIFO Date Transaction Aug. 1 Beginning inventory Aug. 11 Purchase

Number of units 8 7 15

Unit cost $160 150

Ending Inventory $1,280 1,050 $2,330

Date Transaction Aug. 11 Purchase Aug. 20 Purchase Aug. 29 Purchase

Number of units 3 10 11 24*

Unit cost $150 140 130

Cost of Goods Sold $ 450 1,400 1,430 $3,280

Unit cost $160 150 140 130

Total Cost $1,280 1,500 1,400 1,430 $5,610

* Last 24 units purchased are assumed sold Requirement 4 Weighted average Date Aug. 1 Aug. 11 Aug. 20 Aug. 29

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 8 10 10 11 39

Weighted-average cost = $5,610 / 39 units = $143.8462 (rounded) Ending inventory = 15 units × $143.8462 = $2,157.69 Cost of goods sold = 24 units × $143.8462 = $3,452.31

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-2B (concluded) Requirement 5

Sales revenue Cost of goods sold Gross profit

Specific Identification $5,795 3,560 $2,235

FIFO $5,795 3,620 $2,175

Weightedaverage Cost $5,795.00 3,452.31 $2,342.69

LIFO $5,795 3,280 $2,515

Requirement 6 FIFO provides the more meaningful measure of ending inventory. The amount of ending inventory reported using FIFO ($1,990) compared to LIFO ($2,330) better approximates the current cost of inventory at the end of the period ($130 per unit × 15 units = $1,950). Requirement 7 August 31 Inventory Cost of Goods Sold (Record the LIFO adjustment)

Debit

Credit

340 340*

The LIFO reserve equals the difference in inventory reported using FIFO ($1,990) versus using LIFO ($2,330). The LIFO reserve equals −$340.

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-3B (LO 6-2, 6-5) Requirement 1 June 2

Debit

Inventory Accounts Payable (Purchase inventory on account) June 4

2,700 2,700

Inventory Cash (Pay freight-in) June 8

400

Accounts Payable Inventory (Return inventory on account) June 10

400

Accounts Payable Inventory Cash (Pay on account less 1% discount) ($23 = $2,300 × 1%) June 11

2,300

Accounts Receivable Sales Revenue (Sell inventory on account)

5,000

Cost of Goods Sold Inventory (Record cost of inventory sold) June 18

3,200

Cash

4,000 Accounts Receivable (Receive cash on account)

Credit

23 2,277

5,000

3,200

4,000

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-3B (concluded) Requirement 1 (continued) June 20

Debit

Inventory Accounts Payable (Purchase inventory on account) June 23

3,800

Cash

5,300

3,800

Sales Revenue (Sell inventory for cash)

5,300

Cost of Goods Sold Inventory (Record cost of inventory sold) June 26

3,600

Accounts Payable Inventory (Return inventory on account) June 28

500

Accounts Payable Cash Inventory (Pay cash on account) ($99 = $3,300 × 3%)

Credit

3,600

500

3,300 3,201 99

Requirement 2 Circuit Country Multiple-step Income Statement (partial) For the month of June Net sales Cost of goods sold Gross profit

$10,300 6,800 $ 3,500

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-4B (LO 6-6) Requirement 1 Inventory items Hammers Saws Screwdrivers Drills 1-gallon paint cans Paint brushes

Quantity 110 60 140 50 170 190

Unit Cost $ 8.00 11.00 3.00 26.00 6.50 7.00

Total Cost $ 880 660 420 1,300 1,105 1,330 $5,695

Requirement 2

Unit Inventory items Quantity Cost Hammers 110 $ 8.00 Saws 60 11.00 Screwdrivers 140 3.00 Drills 50 26.00 1-gallon paint cans 170 6.50 Paint brushes 190 7.00 Total

Unit NRV $ 8.50 10.00 3.60 24.00 6.00 7.50

Lower of Cost and NRV per unit $ 8.00 10.00 3.00 24.00 6.00 7.00

Total $ 880 600 420 1,200 1,020 1,330 $5,450

Requirement 3 Because the total of lower of cost and net realizable value ($5,450) is less than total cost ($5,695), inventory is written down for the difference ($245). Debit

Credit

Cost of Goods Sold 245 Inventory (Write down inventory to net realizable value)

245

Requirement 4 The write-down of inventory from cost to net realizable value reduces total assets and ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 6-78 Financial Accounting, 5e

Chapter 6 - Inventory and Cost of Goods Sold

increases total expenses, leading to lower net income and lower retained earnings.

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-5B (LO 6-3, 6-6) Requirement 1 FIFO Unit cost $550

Ending Inventory $4,950

Number Unit Date Transaction of units cost Jan. 1 Beginning inventory 20 $500 Apr. 9 Purchase 30 520 Oct. 4 Purchase 2 550 a 52 a First 52 units purchased are assumed sold

Cost of Goods Sold $10,000 15,600 1,100 $26,700

Date Oct. 4

Transaction Purchase

Number of units 9

Requirement 2 LIFO Unit cost $500

Ending Inventory $4,500

Number Unit Date Transaction of units cost Jan. 1 Beginning inventory 11 $500 Apr. 9 Purchase 30 520 Oct. 4 Purchase 11 550 a 52 a Last 52 units purchased are assumed sold

Cost of Goods Sold $ 5,500 15,600 6,050 $27,150

Date Jan. 1

Transaction Beginning inventory

Number of units 9

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-5B (concluded) Requirement 3 Ending Inventory

FIFO a

Cost

NRV

Lower of Cost and NRV

$4,950a

$3,150

Ending inventory from Requirement 1 above.

FIFO

Debit

Credit

Cost of Goods Sold 1,800 Inventory (Adjust inventory to net realizable value)

1,800

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-6B (LO 6-2, 6-3, 6-4, 6-5, 6-6) Requirement 1 November 2 Inventory Accounts Payable (Purchase inventory on account) November 3 Inventory Cash (Pay freight-in) November 9

Debit 9,000

9,000

231 231

Accounts Payable Inventory (Return inventory on account) November 11

1,300

Accounts Payable Inventory Cash (Pay on account less 3% discount) ($231 = $7,700 × 3%) November 16

7,700

Accounts Receivable Sales Revenue (Sell inventory on account)

14,000

1,300

231 7,469

14,000

Cost of Goods Sold 9,640 Inventory (Cost of inventory sold) ($9,640 = ($94 × 60 units) + ($100 × 40 units)) November 20 Cash

Credit

9,640

14,000 Accounts Receivable (Receive cash on account)

14,000

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-6B (continued) Requirement 1 (continued) November 21

Debit

Inventory Accounts Payable (Purchase inventory on account) November 24

7,280

Cash

12,600

Credit 7,280

Sales Revenue (Sell inventory for cash) Cost of Goods Sold 9,212 Inventory (Record cost of inventory sold) [$9,160 = ($100 × 37 units) + ($104 × 53 units)]

12,600

9,212

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-6B (concluded) Requirement 2 November 30

Debit

Credit

Cost of Goods Sold 391 Inventory (Adjust inventory down to net realizable value)

391*

* The net realizable value of ending inventory ($1,377 = $81 net realizable value × 17 units) is $391 less than FIFO ending inventory ($1,768 from Requirement 1).

Requirement 3 Yoshi Inc. Multiple-step Income Statement (partial) For the month of November Net sales Cost of goods sold* Gross profit

$26,600 19,243 $ 7,357

* Cost of goods sold equals the cost of the units sold ($18,852) + write down to net realizable value ($391).

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-7B (LO 6-2, 6-7) Requirement 1 Toys “R” Us Multiple-step Income Statement For the month of March, 2021 Net sales: Total sales revenue Less: Sales discounts Net sales revenue Cost of goods sold Gross profit Operating expenses: Advertising Rent Insurance Salaries Total Operating income Non-operating items: Gain on sale of building Income before income taxes Income tax expense Net income

$77,300 (3,000) $74,300 35,800 38,500 6,400 4,300 2,300 9,400 22,400 16,100 7,500 23,600 4,200 $19,400

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-7B (concluded) Requirement 2 Inventory turnover ratio

Cost of goods sold Average inventory

$35,800 ($2,800 + $1,000) /2

18.8

This ratio will likely be higher in December when inventory is being sold at a much faster pace due to the holiday season. Requirement 3 Gross profit ratio

Gross profit Net sales

$38,500 $74,300 0.52

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-8B (LO 6-7) Requirement 1 Inventory turnover ratio

Cost of goods sold Average inventory

Company 1

Company 2

$130,000 $35,000

$165,000 $20,000

3.71

8.25

Company 1

Company 2

$70,000 $200,000

$35,000 $200,000

0.35

0.175

Requirement 2 Gross profit ratio

Gross profit Net sales

Requirement 3 Company 1 is likely Dillard’s and Company 2 is likely Payless. The reason is that common, lower-to-middle priced footwear is likely to sell more quickly than is more specialized, higher-end footwear. In addition, higher-end footwear is likely to be more profitable due to less competition.

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-9B (LO 6-8) Requirement 1 June 2

Debit

Purchases Accounts Payable (Purchase inventory on account) June 4

2,700 2,700

Freight-In Cash (Pay freight-in) June 8

400

Accounts Payable Purchase Returns (Return inventory on account) June 10

400

Accounts Payable Purchase Discounts Cash (Pay on account less 1% discount) ($23 = $2,300 × 1%) June 11

2,300

Accounts Receivable Sales Revenue (Sell inventory on account) June 18

5,000

Cash

4,000 Accounts Receivable (Receive cash on account)

Credit

23 2,277

5,000

4,000

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-9B (concluded) Requirement 1 (continued) June 20

Debit

Purchases Accounts Payable (Purchase inventory on account) June 23

3,800

Cash

5,300

3,800

Sales Revenue (Sell inventory for cash) June 26 Accounts Payable Purchase Returns (Return inventory on account) June 28 Accounts Payable Cash Purchase Discounts (Pay on account less 3% discount) ($99 = $3,300 × 3%)

Requirement 2 June 30 Inventory (ending) Cost of Goods Sold Purchase Returns Purchase Discounts Purchases Freight-In Inventory (beginning) (Record period-end adjustment)

Credit

5,300

500 500

3,300 3,201 99

Debit

Credit

2,078 6,800 900 122 6,500 400 3,000

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-9B (concluded) Requirement 3 Circuit Country Multiple-step Income Statement (partial) For the month of June Net sales Cost of goods sold: Beginning inventory Add: Purchases Freight-in Less: Purchase returns Purchase discounts Cost of goods available for sale Less: Ending inventory Cost of goods sold Gross profit

$10,300 $3,000 6,500 400 (900) (122) 8,878 (2,078) 6,800 $ 3,500

Chapter 6 - Inventory and Cost of Goods Sold

Problem 6-10B (LO 6-3, 6-9) Requirement 1 Date Oct. 29

Date Jan. 1 Apr. 14 Aug. 22 Oct. 29 a

Transaction Purchase

Transaction Beginning inventory Purchase Purchase Purchase

Number of units 60

Unit cost $46

Ending Inventory $2,760

Number of units 35 80 130 35 280a

Unit cost $40 42 44 46

Cost of Goods Sold $ 1,400 3,360 5,720 1,610 $12,090

Number of units 50

Unit cost $46

Ending Inventory $2,300

Number of units 35 80 130 45 290*

Unit cost $40 42 44 46

Cost of Goods Sold $ 1,400 3,360 5,720 2,070 $12,550

First 280 units purchased are assumed sold

Requirement 2 Date Oct. 29

Date Jan. 1 Apr. 14 Aug. 22 Oct. 29

Transaction Purchase

Transaction Beginning inventory Purchase Purchase Purchase

* First 290 units purchased are assumed sold (including the 10 lost units) Requirements 3 and 4 (a) ending inventory (b) retained earnings (c) cost of goods sold (d) net income

2021 Overstate Overstate Understate Overstate

2022 No Effect No Effect Overstate Understate

Chapter 6 - Inventory and Cost of Goods Sold

ADDITIONAL PERSPECTIVES AP6-1 Requirement 1 (a)

Sales Revenue Date Jul. 31 Aug. 22 Nov. 20 Dec. 8 Total

Number of units 40 30 90 40 200

Sale price $500 500 500 500

Total sales $20,000 15,000 45,000 20,000 $100,000

Cost of Goods Sold* Date Jul. 17 Aug. 12 Oct. 27 Dec. 4 Total

Number of units 50 40 80 30** 200a

Unit cost $150 160 170 180

Total cost $ 7,500 6,400 13,600 5,400 $32,900

First 200 units purchased are assumed sold. Only 30 of the 100 units purchased on December 4 are sold, as this makes the total number of units sold equal 200. The remaining 70 units are in ending inventory.

Ending Inventory Date Dec. 4

Number of units 70

Unit cost $180

Total cost $12,600

Chapter 6 - Inventory and Cost of Goods Sold

AP6-1 (continued) Requirement 1 (b) Great Adventures, Inc. Partial Income Statement For the year ended December 31, 2022 Sales revenue $100,000 Cost of goods sold (32,900) Gross profit $ 67,100

Requirement 2 (a)

Inventory items MU watches

Cost per unit

NRV per unit

Lower of Cost and NRV per unit

$180

$100

Dec. 31, 2022 Debit Cost of Goods Sold 5,600 Inventory (Adjust inventory down to net realizable value) a

Quantity

Lower of Cost and NRV

$7,000

Credit 5,600a

The amount of the inventory write-down equals the difference between the cost of the 70 MU watches ($12,600) and their net realizable value ($7,000)

Requirement 2 (b) Great Adventures reports its inventory in the balance sheet at the lower of cost and net realizable value, which equals $7,000, as demonstrated in requirement 2(a).

Chapter 6 - Inventory and Cost of Goods Sold

AP6-1 (concluded) Requirement 2 (c) Great Adventures, Inc. Partial Income Statement For the year ended December 31, 2022 Sales revenue $100,000 Cost of goods sold (38,500) a Gross profit $ 61,500

Cost of goods sold includes the write-down of inventory of $5,600 calculated in requirement 2(a). This amount is added to the original cost of goods sold of $32,900. The additional cost of goods sold reduces gross profit by $5,600.

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-1 (in General Ledger) Students will be given the following existing trial balance. Great Adventures, Inc. Trial Balance December 31, 2022 Accounts Cash Accounts Receivable Allowance for Uncollectible Accounts Inventory Equipment Accumulated Depreciation Accounts Payable Interest Payable Income Tax Payable Notes Payable Common Stock Retained Earnings Service Revenue Sales Revenue Interest Revenue Sales Discounts Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Interest Expense Income Tax Expense Totals

Debit $ 36,770 24,000

Credit

$ 2,400 -045,000 24,000 2,800 750 14,500 30,000 20,000 33,450 44,500 -0120 350 -016,000 4,800 2,400 24,000 500 2,400 1,800 14,500 $172,520

$172,520

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-1 (in General Ledger, continued) Jul. 17, 2022

Debit

Inventory Accounts Payable (Purchase inventory on account) Jul. 31, 2022

7,500

Cash

20,000

7,500

Sales Revenue (Sell inventory on account)

20,000

Cost of Goods Sold Inventory (Record cost of inventory sold) ($6,000 = 40 watches × $150) Aug. 12, 2022

6,000

Inventory Cash (Purchase inventory with cash) Aug. 22, 2022

6,400

Accounts Receivable Sales Revenue (Sell inventory on account)

15,000

6,000

6,400

15,000

Cost of Goods Sold 4,700 Inventory (Record cost of inventory sold) [$4,700 = (10 watches × $150) + (20 watches × $160)] Sep. 19, 2022 Accounts Payable Cash (Pay on account) Sep. 27, 2022

7,500

Cash

9,000 Accounts Receivable (Receive on account)

Credit

4,700

7,500

9,000

Chapter 6 - Inventory and Cost of Goods Sold

Oct. 27, 2022 Inventory Cash (Purchase inventory with cash) Nov. 20, 2022

13,600

Cash

45,000

13,600

Sales Revenue (Sell inventory for cash)

45,000

Cost of Goods Sold 15,100 Inventory 15,100 (Record cost of inventory sold) [$15,100 = (20 watches × $160) + (70 watches × $170)] Dec. 4, 2022 Inventory Accounts Payable (Purchase inventory on account) Dec. 8, 2022

18,000

Accounts Receivable Sales Revenue (Sell inventory on account)

20,000

18,000

Cost of Goods Sold 7,100 Inventory (Record cost of inventory sold) [$7,100 = (10 watches × $170) + (30 watches × $180)] Dec. 31, 2022 Cost of Goods Sold 5,600 Inventory (Adjust inventory down to net realizable value)

20,000

7,100

5,600a

The amount of the inventory write-down equals the difference between the cost of the 70 MU watches ($12,600) and their net realizable value ($7,000)

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-1 (in General Ledger, continued)

$ 44,500 100,000 (350) 144,150 38,500 $105,650 16,000 4,800 2,400 24,000 500 2,400 50,100 55,550

Interest revenue Interest expense Income before income taxes

120 (1,800) 53,870

Income tax expense Net income

14,500 $ 39,370

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-1 (in General Ledger, continued)

Great Adventures, Inc. Balance Sheet December 31, 2022 Assets Current assets: Cash Accounts receivable Allow for Uncoll Accts Inventory Total current assets

$ 83,270 50,000 (2,400) 7,000 137,870

Long-term assets: Equipment Accumulated depreciation

45,000 (24,000)

Total assets

$158,870

Liabilities Current liabilities: Accounts payable Interest payable Income tax payable Total current liabilities Notes payable Total liabilities

$ 20,800 750 14,500 36,050 30,000 66,050

Stockholders’ Equity Common stock 20,000 Retained earnings 72,820 Total stockholders’ equity 92,820 Total liabilities and stockholders’ equity $158,870

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-1 (in General Ledger, concluded) Dec. 31, 2022 Service Revenue Sales Revenue Interest Revenue Sales Discounts Retained Earnings (Close revenue accounts) Dec. 31, 2022 Retained Earnings Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Interest Expense Income Tax Expense (Close expense accounts)

Debit 44,500 100,000 120

Credit

350 144,270

104,900 38,500 16,000 4,800 2,400 24,000 500 2,400 1,800 14,500

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-2 ($ in thousands) Requirement 1 The amount of inventory reported in the balance sheet is $398,213. This amount represents the cost, less any write-downs, of inventory that has not been sold by the end of the year. Requirement 2 The company refers to cost of goods sold as cost of sales. Requirement 3 The amount of cost of goods sold reported in the income statement is $2,425,044. This amount represents the cost of inventory sold during the year. Requirement 4 Inventory turnover = ratio

Cost of goods sold Average inventory

$2,425,044 $378,329.5

365 6.4

= 57.0

2018

2017

2016

36.1%

37.9%

37.0%

365 Average days = = in inventory Inventory turnover ratio

6.4

Requirement 5 Gross profit Gross profit = = ratio Net sales There is no trend across the three years. Requirement 6 Operating expenses Net sales

$1,067,717 = $3,795,549

28.1%

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-3 ($ in thousands) Requirement 1 The amount of inventory reported in the balance sheet is $118,007. This amount represents the cost, less any write-downs, of inventory that has not been sold by the end of the year. Requirement 2 The company refers to cost of goods sold as cost of sales. Requirement 3 The amount of cost of goods sold reported in the income statement is $533,357. This amount represents the cost of inventory sold during the year. Requirement 4 Inventory = turnover ratio

Cost of goods sold Average inventory

$533,357 $121,850.5

= 4.4

365 4.4

= 83.0

2018

2017

2016

41.6%

40.7%

43.0%

$245,945 $913,380

365 Average days = = in inventory Inventory turnover ratio Requirement 5 Gross profit ratio

Gross profit Net sales

There is no trend over the three years.

Requirement 6 Operating expenses Net sales

26.9%

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-4 Requirement 1 American Eagle’s percentage of inventory to total assets is 21.9%. Buckle’s percentage of inventory to total assets is 21.9%. Requirement 2 American Eagle

Buckle

6.4

4.4

365 Average days = = in inventory Inventory turnover ratio

57.0

83.0

Inventory = turnover ratio

Cost of goods sold Average inventory

American Eagle has a higher inventory turnover ratio and lower days in inventory. Requirement 3

Gross profit ratio

Gross profit Net sales

American Eagle

Buckle

36.1%

41.6%

American Eagle

Buckle

28.1%

26.9%

Buckle shows greater profitability. Requirement 4

Operating expenses Net sales

No. From Requirement 3, Buckle shows greater profitability. From Requirement 4, Buckle shows a lower expense ratio, which again supports its greater profitability.

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-5 1. Increase in income before taxes. By recording the fictitious sale, income before taxes will increase by the amount of the selling price above the cost of the inventory. In addition, the company avoids reporting a loss that would further reduce income. When the net realizable value of inventory falls below its cost, companies are required to write down inventory, resulting in a loss being reported in the income statement. 2. Decrease in total assets and decrease in income before taxes. The company’s assets (inventory) will be reported for lower amounts and a loss will be reported. 3. Yes. Reporting the sale would lead to misstated financial statements. Even if creditors are fooled for a short while, the company’s lack of profitability will eventually be discovered and likely lead to bankruptcy. The longer the company stays in business, the more money it could lose and the less creditors would be paid in bankruptcy proceedings. Therefore, not reporting accurately in 2021 could easily cause larger losses to creditors in the future. New investors could potentially suffer as well if their decision to invest in the business is based on financial reports prepared using misstated amounts. 4. No. Under generally accepted accounting principles, the sale does not transfer control or risk of ownership of the inventory, so it should not be recorded. However, the decision is difficult. If profits are too low, Jim will lose his job and so will all of his coworkers. Jim doesn’t want to be the one to blame for everyone losing their job. If he allows the “fake” sale to be reported, he and his coworkers will have time to start looking for other jobs. He will also please his boss, and if the company somehow is able to continue its existence, this could mean promotions and pay raises. However, as the person responsible for preparing financial statements, Jim has an ethical responsibility to investors and creditors to accurately report the financial position of the company. Jim may face legal penalties for fraudulent reporting. In addition, by refusing to issue misleading financial statements, Jim sends a strong signal to upper management that he is someone who can be trusted. This could prove useful if the company maintains its business or in his career with another employer. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Chapter 6 6-105

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-6 (Note to instructor: Amounts are based on annual reports filed December 31, 2016) Requirement 1 ($ in millions)

Gross profit ratio

Gross profit Net sales

= =

Inventory turnover ratio

Coca-Cola $25,398 $41,863

PepsiCo $34,590 $62,799

60.7%

55.1%

Coca-Cola Cost of goods sold $16,465 = Average inventory = ($2,625+$2,902)/2

PepsiCo $28,209 ($2,723+$2,720)/2

10.4 times

6.0 times

365 Average days = = in inventory Inventory turnover ratio =

365 6.0

365 10.4

60.8 days

35.1 days

Requirement 2 As indicated by the higher gross profit ratio, Coca-Cola is able to generate more profit selling its inventory (beverages) than PepsiCo is selling its inventory (beverages and snack foods). However, PepsiCo’s inventory turns over much faster. On average, PepsiCo sell its inventory 10.4 times per year compared to only 6.0 times per year for Coca-Cola. This is an average difference of about 26 days, which likely reflects the shorter shelf-life of snack foods compared to beverages.

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-7 Students should discuss the following issues. For FIFO, - FIFO assumes that the first units purchased are sold first. - It is likely that FIFO more closely matches the actual flow of inventory. - By more closely matching actual flow, FIFO results in a better approximate value of inventory being reported in the balance sheet. - If inventory costs are rising, which is typically the case for most businesses, FIFO results in a higher amount being reported for assets and net income. For LIFO, - LIFO assumes that the last units purchased are sold first. - LIFO may better match current inventory costs with current inventory sales, resulting in a more accurate measure of profitability in the income statement. - If inventory costs are rising, which is typically the case for most businesses, LIFO generally results in a lower amount being reported for assets and net income. The lower amount being reported for net income will reduce the amount of income taxes payable. - If inventory costs are declining, LIFO results in a higher amount being reported for assets and net income.

Chapter 6 - Inventory and Cost of Goods Sold

Additional Perspective 6-8 Requirement 1 Date Transaction Aug. 22 Purchase Oct. 29 Purchase

Number of units 30 80 110

Unit cost $600 640

Ending Inventory $18,000 51,200 $69,200

Date Transaction Jan. 1 Beginning inventory Mar. 8 Purchase Aug. 22 Purchase

Number of units 150 120 70 340*

Unit cost $540 570 600

Cost of Goods Sold $ 81,000 68,400 42,000 $191,400

* First 340 units purchased are assumed sold Requirement 2 Date Oct. 29 Date Jan. 1 Mar. 8 Aug. 22 Oct. 29

Transaction Purchase Transaction Beginning inventory Purchase Purchase Purchase

Number of units 50

Unit cost $640

Ending Inventory $32,000

Number of units 150 120 100 30 400*

Unit cost $540 570 600 640

Cost of Goods Sold $ 81,000 68,400 60,000 19,200 $228,600

* First 400 units purchased are assumed sold Requirements 3 and 4 (a) ending inventory (b) retained earnings (c) cost of goods sold (d) net income

2021 Overstatement Overstatement Understatement Overstatement

2022 No Effect No Effect Overstatement Understatement

Chapter 7 Long-Term Assets REVIEW QUESTIONS Question 7-1 (LO 7-1)

WorldCom recorded assets on the balance sheet that should have been recorded as expenses on the income statement. When WorldCom uses the telecommunication lines of another company, it pays a fee. This fee is part of normal operating costs, and should be recorded as an expense of the current period to properly match the expense with the revenues it helped to generate. Instead, WorldCom recorded these operating expenses as long-term assets on the balance sheet.

Question 7-2 (LO 7-1)

The two major categories for long-term assets are (1) property, plant, and equipment and (2) intangible assets. Property, plant, and equipment include land, land improvements, buildings, equipment, and natural resources. Intangible assets include patents, trademarks, copyrights, franchises, and goodwill. The two categories differ by their physical substance. Property, plant, and equipment consist of items that you can actually see, while intangible assets lack physical substance. The existence of intangible assets is often based on a legal contract.

Question 7-3 (LO 7-1) We initially record a long-term asset at its cost plus all expenditures necessary to get the asset ready for use. Thus, the initial cost of a long-term asset might be more than just its purchase price; it also will include any additional amounts the firm paid to bring the asset to its desired condition and location for use.

Question 7-4 (LO 7-1)

Recording an expense incorrectly as an asset will overstate net income on the income statement. If University Hero initially records an expense incorrectly as an asset, expenses are understated or too small. Since expenses are subtracted from revenues in arriving at net income, understating expenses will overstate net income reported on the income statement. Similarly, recording an expense as an asset will overstate assets on the balance sheet. Retained earnings on the balance sheet will also be overstated due to the overstatement of net income.

Question 7-5 (LO 7-1) Costs Little King might incur to make the land ready for its intended use include the purchase price plus closing costs such as fees for the attorney, real estate agent commissions, title, title search, and recording. Little King also includes the cost of removing the old building as an additional cost in making the land ready for its intended use. If any cash is received from selling salvaged materials from the old building, the cost of land is reduced by that amount. If the property is subject to back taxes or other obligations, these amounts are included as well. In fact, any additional expenditure such as clearing, filling, and draining the land, to prepare the land for its intended use, becomes part of the land’s capitalized cost.

Answers to Review Questions (continued) Question 7-6 (LO 7-1)

We don’t depreciate land because its service life never ends. Land improvements are additional amounts spent to improve the land such as a parking lot, paving, temporary landscaping, lighting systems, fences, sprinkler systems, and similar additions. We record land improvements separately from land because, unlike land, these assets are subject to depreciation.

Question 7-7 (LO 7-1)

Costs we might incur to get equipment ready for use include sales tax, shipping, delivery, insurance, assembly, installation, testing, and even legal fees incurred to establish title.

Question 7-8 (LO 7-1) We report natural resources on the balance sheet as part of property, plant, and equipment. Examples of natural resources include oil, natural gas, timber, and salt.

Question 7-9 (LO 7-2)

We value purchased intangible assets at their original cost plus all other costs, such as legal and filing fees, necessary to get the asset ready for use. Reporting intangible assets developed internally is quite different. Rather than recording these as an intangible asset on the balance sheet, we expense most of the costs for internally developed intangible assets to the income statement as we incur them.

Question 7-10 (LO 7-2)

A patent is an exclusive right to manufacture a product or to use a process. A copyright is an exclusive right of protection given to the creator of a published work, such as a song, film, painting, photograph, book, or computer software. A trademark, is a word, slogan, or symbol that distinctively identifies a company, product, or service.

Question 7-11 (LO 7-2) Goodwill is an intangible asset on the balance sheet that is recorded only when one company acquires another company. The acquiring company records goodwill equal to the purchase price less the fair value of the identifiable net assets acquired. The fair value of the identifiable net assets is the fair value of all identifiable assets acquired, minus the fair value of all liabilities assumed. We cannot sell goodwill separately. While most long-term assets can be separated from the company and individually sold, goodwill cannot.

Question 7-12 (LO 7-3) We capitalize a particular cost as an asset if it increases future benefits, whereas we expense a cost if it benefits only the current period.

Answers to Review Questions (continued) Question 7-13 (LO 7-3)

We expense repairs and maintenance expenditures which maintain a given level of benefits, in the period incurred. We capitalize as assets more extensive repairs that increase the future benefits, such as a new transmission or an engine overhaul of a delivery truck. An addition occurs when we add a new major component to an existing asset. An improvement is the cost of replacing a major component of an asset. We should capitalize the cost of additions and improvements because they increase the future benefits from the expenditure.

Question 7-14 (LO 7-3)

If a firm successfully defends an intangible right, it should capitalize the litigation costs and amortize them over the remaining service life of the related intangible. If the defense of an intangible right is unsuccessful, then the firm should expense the litigation costs as incurred because they provide no future benefit.

Question 7-15 (LO 7-4) The dictionary definition of depreciation is a decrease in value of an asset, whereas the accounting definition of depreciation is an allocation of an asset’s cost to an expense over time.

Question 7-16 (LO 7-4) We must estimate the service life (also called useful life) of the asset as well as its residual value (also called salvage value) at the end of that life.

Question 7-17 (LO 7-4)

The service life tells how long the company expects to obtain benefits from the asset before disposing of it. Under the straight-line method we determine service life in units of time. Under the activity-based method we determine service life in units of activity. For example, the estimated service life of a delivery truck might be either five years or 100,000 miles.

Question 7-18 (LO 7-4)

Residual value, also referred to as salvage value, is the amount the company expects to receive from selling the asset at the end of its service life. The depreciable cost is the asset’s cost minus its estimated residual value. In calculating depreciation under the straight-line method, we simply divide the depreciable cost by the number of years in the asset’s life.

Question 7-19 (LO 7-4)

Straight-line creates an equal amount of depreciation each year. Double-declining-balance creates more depreciation in earlier years and less depreciation in later years. Activity-based depreciation varies depending on the use of the asset each year.

Answers to Review Questions (continued) Question 7-20 (LO 7-4) Little King Sandwiches uses straight-line depreciation that creates an equal amount of depreciation each year. In contrast, University Hero uses double-declining balance depreciation that takes more depreciation in earlier years and less depreciation in later years. By taking more depreciation in earlier years, University Hero will report lower income on the income statement and lower assets and retained earnings on the balance sheet. The use of different depreciation methods makes it more difficult to compare financial results across companies.

Question 7-21 (LO 7-4) University Hero depreciates over a shorter service life (20 years) and therefore will take more depreciation expense per year. By taking more depreciation expense per year, University Hero will report lower income on the income statement and lower assets and retained earnings on the balance sheet. Even when both companies use the same depreciation method, comparisons can be hindered if the companies estimate different service lives.

Question 7-22 (LO 7-4)

Most companies use the straight-line method for financial reporting and the Internal Revenue Service’s prescribed accelerated method (called MACRS) for income tax purposes. Companies choose straight-line for financial reporting for several reasons. Many probably believe they realize benefits from their plant assets approximately evenly over these assets’ service lives. Another contributing factor is that straight-line is the easiest method to understand and apply. One more important motivation is the positive effect on reported income. Straight-line produces a higher net income than accelerated methods in the earlier years of an asset’s life. Most companies choose MACRS for tax reporting to reduce taxable income. MACRS combines declining-balance methods in earlier years with straight-line in later years to allow for a more advantageous tax depreciation deduction.

Question 7-23 (LO 7-5)

No. Just as we don’t depreciate land because it has an unlimited life, we don’t amortize intangible assets with unlimited service lives such as goodwill and most trademarks. For most other intangible assets that have a finite service life, we allocate the asset’s cost less any estimated residual value over the period in which we expect the intangible asset to contribute to the company’s revenue-generating activities. This period is called service life and is either equal to or, in many cases, less than an asset’s legal life. For example, the legal life of a patent is 20 years. However, the estimated service life of a patent often is less than 20 years if the benefits are not expected to continue for the entire legal life. Apple’s iPod Nano is amortized over fewer than 20 years, since new technology will cause the Nano to become outdated in a much shorter period.

Question 7-24 (LO 7-6)

Book value is the cost of the asset minus accumulated depreciation. We record a gain if we sell the asset for more than book value. Similarly, we record a loss if we sell the asset for less than book value.

Answers to Review Questions (continued) Question 7-25 (LO 7-7)

Return on assets equals net income divided by average total assets. Return on assets indicates the amount of net income generated for each dollar invested in assets. Profit margin equals net income divided by net sales. This ratio provides an indication of the earnings per dollar of sales. Asset turnover equals net sales divided by average total assets. In contrast to profit margin, this ratio measures the sales per dollar of assets invested.

Question 7-26 (LO 7-7)

Examples of high profit margin include companies that pursue a higher profit margin through product differentiation and premium pricing. Apple and Saks Fifth Avenue are possible examples. Examples of high asset turnover include companies that pursue a high sales volume by charging lower prices. Dell and Ross Dress for Less are possible examples.

Question 7-27 (LO 7-8)

An asset impairment occurs when the future cash flows (future benefits) that we estimate a longterm asset will generate, fall below its book value (cost minus accumulated depreciation). Impairment is a two-step process. Step 1: Test for Impairment – the long-term asset is impaired if future cash flows are less than book value. Step 2: If Impaired, Record Impairment Loss – the impairment loss is the amount by which book value exceeds fair value. Recording an impairment loss will negatively affect the income statement through lower net income and negatively affect the balance sheet through lower long-term assets and retained earnings.

Question 7-28 (LO 7-8)

A big bath is when a company records all losses in one year to make a bad current year even worse. By recording additional expenses in the current year, management is able to report higher earnings in future years. Future earnings are higher because the write-down of assets in this year results in lower depreciation and amortization charges in the future.

BRIEF EXERCISES Brief Exercise 7-1 (LO 7-1) Purchase price of land (and warehouse to be removed) Broker’s commission Title insurance Closing costs Cost of removing the warehouse Total cost of the land

Brief Exercise 7-2 (LO 7-1)

Purchase price Freight Installation Testing Total cost of the bread machine

$490,000 29,000 1,900 6,000 29,000 $555,900

$30,000 2,000 4,000 1,500 $37,500

The $600 property tax is a recurring cost that benefits the company in the current year. The Whole Grain Bakery will report the $600 as property tax expense over the first year.

Brief Exercise 7-3 (LO 7-1)

Building

Estimated Allocation Fair Percentage Value $400,000 $400,000/$480,000 = 83.33% (= 5/6)

Equipment

80,000 $80,000/$480,000 = 16.67% (=1/6)

Total

$480,000

Amount of Recorded Basket Amount Purchase × $450,000 $375,000 × $450,000

75,000 $450,000

Brief Exercise 7-4 (LO 7-2)

(in millions) Purchase price Less: Fair value of assets acquired Less: fair value of liabilities assumed Fair value of identifiable net assets Amount paid for goodwill

$19.0 $14.3 (2.5) 11.8 $ 7.2

Brief Exercise 7-5 (LO 7-2) Salaries for R&D Depreciation on R&D facilities and equipment Utilities incurred for the R&D facilities Payment to another company for part of the development work Total research and development expense

$540,000 145,000 7,000 13,000 $705,000

The $27,000 in patent filing and related legal costs are recorded to the patent intangible asset account.

Brief Exercise 7-6 (LO 7-3) (1)

Expense in the period incurred.

(2)

Capitalize and depreciate over the service life of the asset.

(3)

Capitalize and depreciate over the service life of the asset.

(4)

Capitalize and depreciate over the service life of the asset.

Brief Exercise 7-7 (LO 7-3) $240,000 Betty Foods can capitalize legal fees only for the successful defense.

Brief Exercise 7-8 (LO 7-4) The company controller’s approach to measuring depreciation is based on the dictionary definition of depreciation – decrease in value of an asset. Depreciation in accounting is different. Depreciation in accounting is allocating the cost of an asset to an expense over its service life. For example, the controller could allocate the $40,000 cost of the vehicle over a 5-year service life, recording $8,000 in depreciation expense each year.

Brief Exercise 7-9 (LO 7-4) Year 2021 2022

($45,000 – $6,000) 10

= 3,900 x 4/12

($45,000 – $6,000) 10

$1,300

$3,900

Brief Exercise 7-10 (LO 7-4) 1. Straight-line Depreciation expense

$30,000 – $3,000 4 years

$6,750

$15,000

2. Double-declining-balance Depreciation expense

$30,000 x 2/4

3. Activity-based Depreciation expense

$30,000 – $3,000 20,000 hours

$1.35 per hour x 3,100 hours = $4,185

Brief Exercise 7-11 (LO 7-4) Straight-line Depreciation expense

$50,000 – $10,000 8 years

$5,000

Depreciation after 6 years = $5,000 × 6 = $30,000 Book value after 6 years = $50,000 – $30,000 = $20,000 Depreciation Expense in the seventh year

$20,000 – $10,000 4 years

$2,500

Brief Exercise 7-12 (LO 7-5) Amortization expense

$4,000,000 5 years

$800,000

The $5 million trademark and the $6 million goodwill are not amortized, because they have indefinite service lives.

Brief Exercise 7-13 (LO 7-6)

Sale amount Less: Cost of the ice cream equipment Less: Accumulated depreciation Book value Loss (on sale of the equipment)

$16,000 $90,000 (71,000) 19,000 ($ 3,000)

Brief Exercise 7-14 (LO 7-6)

Sale amount Less: Cost of the ice cream equipment Less: Accumulated depreciation Book value Gain (on sale of the equipment)

$25,000 $72,000 (51,000) 21,000 $ 4,000

Brief Exercise 7-15 (LO 7-6) Loss Accumulated Depreciation Building

Debit 8,000 12,000

Credit 20,000

Accumulated depreciation = ($20,000/5 years) × 3 years = $12,000

Brief Exercise 7-16 (LO 7-6) Equipment (Delivery Truck) Accumulated Depreciation Cash Equipment Gain

Brief Exercise 7-17 (LO 7-6) Equipment Accumulated Depreciation Loss Cash Equipment (Delivery Truck)

Debit 31,000 33,000

Credit

Debit 22,000 4,400 1,600 9,000

Credit

9,000 45,000 10,000

37,000

Brief Exercise 7-18 (LO 7-7) Net income ($840,000 + $930,000)  2 Net income $885,000

20%

Net income = 20% x $885,000 = $177,000

Brief Exercise 7-19 (LO 7-8) Step 1: Test for Impairment The long-term asset is not impaired since future cash flows ($38 million) are greater than book value ($33.5 million). Step 2: If Impaired, Record Loss Since the asset does not meet the first test for impairment, no impairment loss is recorded.

Brief Exercise 7-20 (LO 7-8)

Step 1: Test for Impairment The long-term asset is impaired since future cash flows ($32 million) are less than book value ($33.5 million). Step 2: If Impaired, Record Loss The impairment loss is $3.5 million, calculated as the amount by which book value ($33.5 million) exceeds fair value ($30 million).

EXERCISES Exercise 7-1 (LO 7-1) Purchase price of land (and building to be removed) Title insurance Back property taxes Cost of removing the building Less: Salvaged materials Level the land Total cost of the land

$1,000,000 3,000 9,000 50,000 (5,000) 11,000 $1,068,000

For property taxes, $5,000 relates only to the current period and we expense it in the current period. All of the other costs, including the $9,000 in back property taxes, are necessary to acquire the land so we capitalize them. Note that the salvaged materials that were sold for $5,000 reduce the overall cost of the land.

Exercise 7-2 (LO 7-1) Purchase price Sales tax Shipping Installation Total cost

$75,000 6,000 1,000 2,000 $84,000

With the exception of the $700 annual insurance, each of the expenditures described is necessary to bring the machine to its condition and location for use. Orion will initially report the $700 insurance amount as prepaid insurance and expense it over the first year of coverage. Debit Equipment Prepaid Insurance Cash Accounts Payable (Purchase of equipment)

Credit

84,000 700 3,700 81,000

Exercise 7-3 (LO 7-1) Land

Estimated Allocation Fair Value Percentage $175,000 $175,000/$700,000 = 25%

Amount of Basket Purchase X $600,000

Recorded Amount $150,000

Building

455,000 $455,000/$700,000 = 65%

X $600,000

390,000

Equipment

70,000 $70,000/$700,000 = 10%

X $600,000

60,000

Total

$700,000

$600,000

Exercise 7-4 (LO 7-1, 7-4) 1. Land is not depreciated. However, depreciation on the building is taxdeductible. If management allocates less of the purchase price to land and more of the purchase price to building, the company will enjoy a larger overall depreciation deduction for tax purposes. 2. If the true allocation should have been 20% to land and 80% to building, then the allocation of 10% to land and 90% to building, for the express purpose of reducing taxes, is not ethical. Who is harmed? The government is clearly harmed as it will collect lower taxes. The general public is also affected as less tax revenue means fewer public resources are available. If the incorrect allocation is later detected, then investors and management will be harmed as well. Not only will the company be required to pay the additional tax, it could also be subject to additional penalties and suffer negative reputational effects from the unethical behavior.

Exercise 7-5 (LO 7-2) Debit Legal Fees Expense Patents Advertising Expense Cash (Record cash expenditures)

Credit

9,000 42,500 80,000 131,500

Exercise 7-6 (LO 7-2)

(amounts in millions) Purchase price Less: Fair value of assets acquired Less: fair value of liabilities assumed Fair value of identifiable net assets Goodwill

$30 $45 (20) 25 $ 5

Exercise 7-7 (LO 7-2)

1. Patent costs capitalized Legal fees for patent application Legal fees for successful defense Total costs capitalized 2. Expense items on income statement Basic research to develop the technology Engineering design work Development of prototype device Testing and modification of the prototype Total R&D expense

$ 79,000 39,000 $118,000

$3,900,000 1,180,000 590,000 390,000 $6,060,000

3. Purchased intangible assets are usually capitalized. Internally developed intangible assets are usually expensed.

Exercise 7-8 (LO 7-2, 7-4) List A

List B

__f_ 1. Depreciation __e_ 2. Goodwill __g_ 3. Amortization __d_ 4. Natural resources __c_ 5. Intangible assets __b_ 6. Copyright __a_ 7. Trademark

a. Exclusive right to display a word, a symbol, or an emblem. b. Exclusive right to benefit from a creative work. c. Assets that represent contractual rights. d. Oil and gas deposits, timber tracts, and mineral deposits. e. Purchase price less fair value of net identifiable assets. f. The allocation of cost for plant and equipment. g. The allocation of cost for intangible assets.

Exercise 7-9 (LO 7-3) 1. 2. 3. 4. 5. 6.

Equipment Building Repairs and Maintenance Expense Prepaid Insurance Equipment Land Improvements

$250,000 $750,000 $24,000 $8,800 $9,900 $65,000

Exercise 7-10 (LO 7-4) 1. Straight-line Depreciation expense

$29,500 – $3,500 10 years

$2,600

$5,900

2. Double-declining-balance Depreciation expense

$29,500 x 2/10

3. Activity-based Depreciation expense

$29,500 – $3,500 13,000 hours

$2.00 per hour x 1,700 hours = $3,400

Exercise 7-11 (LO 7-4) Requirement 1 Straight-line Depreciation expense

$36,000 − $6,400 4 years

$7,400 per year

Requirement 2 Double-declining-balance Calculation End-of-Year Amounts Beginning Depreciation Depreciation Accumulated Book X = Year Book Value Rate* Expense Depreciation Value** 1 36,000 0.50 18,000 18,000 18,000 2 18,000 0.50 9,000 27,000 9,000 * 2 / 4 years = 0.50 per year ** $36,000 cost minus accumulated depreciation Requirement 3 Activity-based Calculation End-of-Year Amounts Miles Depreciation Depreciation Accumulated Book X = Year Used Rate* Expense Depreciation Value** 1 40,000 x $0.20 8,000 8,000 28,000 2 46,000 x $0.20 9,200 17,200 18,800 * ($36,000 – $6,400)/ 148,000 miles = $0.20/mile ** $36,000 cost minus accumulated depreciation

Exercise 7-12 (LO 7-4) Year 2021 2022

($18,000 – $2,000) 5 years

$3,200 x 9/12

$2,400

$3,200

Exercise 7-13 (LO 7-4) Year 2021 2022

($21,600 – $1,200) 6 years

$3,400 x 3/12

$850

$3,400

Exercise 7-14 (LO 7-4) Cost of the equipment $19,000 Less: Accumulated depreciation (Years 1 and 2) (8,000)* Book value, end of year 2 11,000 Less: New residual value (1,200) New depreciable cost 9,800  Remaining service life 4 Annual depreciation in years 3 to 6 $2,450 * ($19,000 – $3,000) / 4 years = $4,000 per year x 2 years = $8,000

Exercise 7-15 (LO 7-4) ($21,500 – $2,500) = $0.19/mile 100,000 Year 2021 2022

5,000 miles 19,000 miles

x $0.19 $ 950 x $0.19 $3,610

Exercise 7-16 (LO 7-5) Requirement 1 January 1, 2021 Patents Cash

Debit 237,000

December 31, 2021 Amortization Expense Patents

39,500

December 31, 2022 Amortization Expense Patents

39,500

January, 2023 Patents Cash

57,000

December 31, 2023 Amortization Expense* Patents

53,750

Credit 237,000

39,500

57,000

53,750

*($237,000 – $39,500 – $39,500 + $57,000)/4 remaining years = $53,750 Requirement 2 Balance in the Patents account Patents 237,000 39,500 57,000 39,500 53,750 161,250

Exercise 7-17 (LO 7-6) Requirement 1 Debit 21,600 23,400*

Credit

Debit 13,600 23,400 5,000

Credit

Cash Accumulated Depreciation Equipment 42,000 Gain 3,000 (Sell equipment for a gain) * ($42,000 – $3,000) / 5 = $7,800 per year x 3 years = $23,400 Requirement 2 Cash Accumulated Depreciation Loss Equipment (Sell equipment for a loss)

42,000

Exercise 7-18 (LO 7-6) Requirement 1 Fair value of the old land Cash paid to complete the purchase Fair value of the new land Requirement 2

$132,000 19,000 $151,000 Debit 151,000

Land, New Land, Old Cash Gain

Credit 70,000 19,000 62,000

Exercise 7-19 (LO 7-7) Net Income $28,000 Net Income $28,000 Sales $735,000

÷ ÷

Average Total Assets ($389,000 + $496,000)/2

÷ ÷

Sales $735,000

÷ ÷

Average Total Assets ($389,000 + $496,000)/2

= =

Return on Assets 6.3%

= =

Profit Margin 3.8%

= =

Asset Turnover 1.7 times

Exercise 7-20 (LO 7-8) Requirement 1 Step 1: Test for Impairment The long-term asset is impaired since future cash flows ($7.1 million) are less than book value ($8.6 million). Step 2: If Impaired, Record Loss The impairment loss is $2.7 million calculated as the amount by which book value ($8.6 million) exceeds fair value ($5.9 million). Requirement 2 Step 1: Test for Impairment The long-term asset is not impaired since future cash flows ($10 million) exceed book value ($8.6 million). Step 2: If Impaired, Record Loss Since the asset does not meet the first test for impairment, no impairment loss is recorded.

Exercise 7-21

Requirement 1 January 1 Equipment Cash (Purchase equipment for cash)

Debit 19,500

January 4 Accounts Payable Cash (Pay cash on account)

Debit 9,500

January 8 Inventory Accounts Payable (Purchase inventory on account)

Debit 82,900

January 15 Cash Accounts Receivable (Receive cash on account)

Debit 22,000

January 19 Salaries Expense Cash (Pay for salaries)

Debit 29,800

January 28 Utilities Expense Cash (Pay for utilities)

Debit 16,500

January 30 Accounts Receivable Sales Revenue (Sell inventory on account) Cost of Goods Sold Inventory (Record cost of inventory sold)

Debit 220,000

Credit 19,500 Credit 9,500 Credit 82,900 Credit 22,000 Credit 29,800 Credit 16,500 Credit 220,000

115,000 115,000

Exercise 7-21 (continued) Requirement 2 (a) January 31 Depreciation Expense Accumulated Depreciation (Record depreciation) ($300 = [$19,500−$1,500] / 60 months)

Debit 300

Credit 300

(b) January 31 Debit Bad Debt Expense 5,900 Allowance for Uncollectible Accounts (Adjust uncollectible accounts) ($5,900 = ($3,000×50%)+($220,000a×3%)−$2,200 a $220,000 = $25,000−$22,000+$220,000−$3,000

Credit

Debit 50

Credit

(d) January 31 Salaries Expense Salaries Payable (Adjust salaries payable)

Debit 32,600

(e) January 31 Income Tax Expense Income Tax Payable (Adjust income taxes)

Debit 9,000

5,900

Credit 32,600 Credit 9,000

Exercise 7-21 (continued) Requirement 3 TNT Fireworks Adjusted Trial Balance January 31, 2021 Accounts Debit Cash $ 5,400 Accounts Receivable 223,000 Allowance for Uncollectible Accounts Interest Receivable 50 Inventory 4,200 Notes Receivable 12,000 Land 155,000 Equipment 19,500 Accumulated Depreciation Accounts Payable Salaries Payable Income Tax Payable Common Stock Retained Earnings Sales Revenue Interest Revenue Cost of Goods Sold 115,000 Salaries Expense 62,400 Utilities Expense 16,500 Bad Debt Expense 5,900 Depreciation Expense 300 Income Tax Expense 9,000 Totals $628,250

Credit $

8,100

300 88,200 32,600 9,000 220,000 50,000 220,000 50

$628,250

Exercise 7-21 (continued) Requirement 3 (continued) Accounts

Ending Balance Cash 5,400 Accounts Receivable 223,000 Allowance for Uncollectible Accounts 8,100 Interest Receivable 50 Inventory 4,200 Notes Receivable 12,000 Land 155,000 Equipment 19,500 Accumulated Depreciation 300 Accounts Payable 88,200 Salaries Payable 32,600 Income Tax Payable 9,000 Common Stock 220,000 Retained Earnings 50,000 Sales Revenue 220,000 Interest Revenue 50 Cost of Goods Sold 115,000 Salaries Expense 62,400 Utilities Expense 16,500 Bad Debt Expense 5,900 Depreciation Expense 300 Income Tax Expense 9,000

Beginning balance in bold, entries during January in blue, and adjusting entries in red. = 58,700−19,500−9,500+22,000−29,800−16,500 = 25,000−22,000+220,000 = 2,200+5,900 = 50 = 36,300+82,900−115,000 = 12,000 = 155,000 = 19,500 = 300 = 14,800−9,500+82,900 = 32,600 = 9,000 = 220,000 = 50,000 = 220,000 = 50 = 115,000 = 29,800+32,600 = 16,500 = 5,900 = 300 = 9,000

Exercise 7-21 (continued) Requirement 4 TNT Fireworks Multiple-Step Income Statement For the month ended January 31, 2021 Sales revenue $220,000 Cost of goods sold 115,000 Gross profit $105,000 Salaries expense Utilities expense Bad debt expense Depreciation expense Total operating expenses Operating income

62,400 16,500 5,900 300 85,100 19,900

Interest revenue Income before taxes

50 19,950

Income tax expense Net income Requirement 5

9,000 $ 10,950

Assets Current assets: Cash Accounts receivable 223,000 Less: Allowance (8,100) Interest receivable Inventory Total current assets

TNT Fireworks Balance Sheet January 31, 2021 Liabilities Current liabilities: $ 5,400 Accounts payable Salaries payable 214,900 Income tax payable 50 Total current liabilities 4,200 224,550

Long-term assets: Notes receivable Land Equipment Less: Accumulated depreciation

12,000 155,000 19,500 (300)

Total assets *

$410,750

Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

88,200 32,600 9,000 129,800

220,000 60,950 * 280,950 $410,750

Retained earnings = Beginning retained earnings + Net income − Dividends = $50,000 + $10,950 − $0 = $60,950

Exercise 7-21 (concluded) Requirement 6

January 31, 2021 Sales Revenue Interest Revenue Retained Earnings (Close revenue accounts)

Debit 220,000 50

Retained Earnings Cost of goods sold Salaries expense Utilities expense Bad debt expense Depreciation expense Income tax expense (Close expense accounts)

209,100

Credit 220,050

115,000 62,400 16,500 5,900 300 9,000

Requirement 7 (a) The return on assets ratio is: Return on Assets Ratio

Net income Average total assets

$10,950 ($284,800 + $410,750) / 2

3.1%

Compared to the industry average of 2%, TNT Fireworks is more profitable than other companies in the same industry. Note these are monthly, rather than annual, return on asset calculations. A consistent monthly return on assets of 1% results in a 12% return on assets for the entire year. (b) The profit margin is: Profit Margin

Net income Net sales

$10,950 $220,000

5.0%

Compared to the industry average profit margin of 4%, TNT Fireworks is more efficient at converting sales to profit than other companies in the same industry. (c) The asset turnover ratio is: Asset Turnover Ratio

Net sales Average total assets

$220,000 ($284,800 + $410,750) / 2

0.63 times

Compared to the industry average asset turnover of 0.5 times per month, TNT Fireworks is also more efficient at producing revenues with their assets.

PROBLEMS: SET A Problem 7-1A (LO 7-1) Purchase price of land Demolition of old building Sale of salvaged materials Architect fees (for new building) Legal fees (for title investigation of land) Building construction costs Interest costs related to the construction Totals

Land $70,000 9,000 (1,100) 3,000 $80,900

Building

$ 20,000 600,000 23,000 $643,000

The property taxes on the land of $4,000 will be recorded as property tax expense over the first year.

Problem 7-2A (LO 7-1) Requirement 1 The ovens should be recorded in the Great Harvest equipment account as detailed in the following schedule: Purchase price Freight costs Electrical connections Labor costs Bread dough used in testing ovens Safety guards Total equipment

$700,000 35,000 5,000 37,800 900 1,500 $780,200

Requirement 2 The repair costs of $4,000 for the oven damaged during installation should not be included in the equipment account as this is not a normal cost to get the asset ready for use. The repair costs of $4,000 should be recorded as repairs expense on the income statement.

Problem 7-3A (LO 7-2) 1. The amount Fresh Cut paid for goodwill is $1.5 million, calculated as follows: (in millions) Purchase price $12.0 Less: Fair value of assets acquired 13.2 Less: fair value of liabilities assumed (2.7) Fair value of identifiable net assets 10.5 Goodwill $ 1.5

2. (in millions) Accounts Receivable (at fair value) Equipment (at fair value) Patents (at fair value) Goodwill (remaining purchase price) Notes Payable (at fair value) Cash (at purchase price)

Debit 1.6 9.9 1.7 1.5

Credit

2.7 12.0

Problem 7-4A (LO 7-3) 1. Capitalize 2. Expense 3. Capitalize 4. Capitalize 5. Expense 6. Expense Health Services could increase reported earnings by improperly recording expenses as assets. For example, Health Services could record maintenance and repair expense to the Equipment asset account. This would lower expenses and increase earnings reported in the current year.

Problem 7-5A (LO 7-4) Requirement 1 Straight-Line University Car Wash

Year 1 2 3 4 5 6 Total

Calculation End of Year Amounts Depreciable Depreciation Depreciation Accumulated Book X = Cost* Rate Expense Depreciation Value** $246,000 1/6 $41,000 $ 41,000 $229,000 246,000 1/6 41,000 82,000 188,000 246,000 1/6 41,000 123,000 147,000 246,000 1/6 41,000 164,000 106,000 246,000 1/6 41,000 205,000 65,000 246,000 1/6 41,000 246,000 24,000 $246,000

* $270,000 – $24,000 = $246,000 ** $270,000 cost minus accumulated depreciation Requirement 2 Double-declining-balance University Car Wash Calculation End of Year Amounts Beginning Depreciation Depreciation Accumulated Book X = Year Book Value Rate* Expense Depreciation Value** 1 $270,000 1/3 $90,000 $ 90,000 $180,000 2 180,000 1/3 60,000 150,000 120,000 3 120,000 1/3 40,000 190,000 80,000 4 80,000 1/3 26,667 216,667 53,333 5 53,333 1/3 17,778 234,445 35,555 6 35,555 11,555*** 246,000 24,000 Total $246,000 * 2 / 6 years = 1/3 per year ** $270,000 cost minus accumulated depreciation *** Amount needed to reduce book value to residual value.

Requirement 3 Activity-based University Car Wash Calculation End of Year Amounts Hours Depreciation Depreciation Accumulated Book X = Year Used Rate* Expense Depreciation Value** 1 3,100 $20.50 $63,550 $ 63,550 $206,450 2 1,100 $20.50 22,550 86,100 183,900 3 1,200 $20.50 24,600 110,700 159,300 4 2,800 $20.50 57,400 168,100 101,900 5 2,600 $20.50 53,300 221,400 48,600 6 1,200 $20.50 24,600 246,000 24,000 Total 12,000 $246,000 * $246,000 / 12,000 hours = $20.50/hour ** $270,000 cost minus accumulated depreciation *** Amount needed to reduce book value to residual value.

Problem 7-6A (LO 7-5) Requirement 1 a. Goodwill is not amortized.

b. Amortization Expense. . . . . .. .. . . . Patents . . . . . . . . .. . . . . . . . . . (Amortize patent) * $82,250 / 7 years

Debit 11,750*

c. Amortization Expense. .. . . . . . . . . 18,500* Franchises. . .. . . . . . . . . . . . . (Amortize franchise) * ($333,000 / 9 years) x ½ year

Credit 11,750

18,500

Requirement 2 University Testing Services Balance Sheet December 31, 2021 (Intangible Assets section) Intangible Assets Goodwill Patents ($82,250 – $11,750) Franchises ($333,000 – $18,500) Total intangible assets

$310,000 70,500 314,500 $695,000

Problem 7-7A (LO 7-4, 7-5) Requirement 1 Depreciation Expense Accumulated Depreciation (Depreciate building) * $294,400 x 2/10 Depreciation Expense Accumulated Depreciation (Depreciate equipment) * ($235,000 – $10,000)/9

Debit 58,880*

25,000*

Credit 58,880

25,000

Requirement 2 Amortization Expense Patent (Amortize patent) * $250,000/5

Debit 50,000*

Credit 50,000

Requirement 3

Land Building Equipment Patent

Solich Sandwich Shop December 31, 2021 Accumulated Cost Depreciation $ 95,000 – 460,000 $(224,480) 235,000 (75,000) 250,000 (150,000)

Book Value $ 95,000 235,520 160,000 100,000

Problem 7-8A (LO 7-6) Requirement 1 $170,000 =

$910,000 – $60,000 10

x 2 years

Requirement 2 Cost of the oven Less: Accumulated depreciation Book value at the end of year 2

$910,000 (170,000) $740,000

Requirement 3 Sale amount Less: Cost of the oven Less: Accumulated depreciation Book value at the end of year 2 Loss

$700,000 $910,000 (170,000) 740,000 $ (40,000)

Requirement 4 Cash Accumulated Depreciation Loss Equipment (Sell equipment for a loss)

Debit 700,000 170,000 40,000

Credit

910,000

Problem 7-9A (LO 7-7) Requirement 1 Sub Station

Net Income $25,922

Average ÷ Total Assets = ÷ ($75,183 + $116,371)/2 =

Return on Assets 27.1%

Net Income $25,922

÷ ÷

= =

Profit Margin 23.9%

Sales $108,249

Average ÷ Total Assets = ÷ ($75,183 + $116,371)/2 =

Asset Turnover 1.1 times

Net Income $3,492

Average ÷ Total Assets ÷ ($38,599 + $44,533)/2

= =

Return on Assets 8.4%

Net Income $3,492

÷ ÷

= =

Profit Margin 5.6%

Sales $62,071

Average ÷ Total Assets ÷ ($38,599 + $44,533)/2

= =

Asset Turnover 1.5 times

Sales $108,249

Requirement 2 Planet Sub

Sales $62,071

Requirement 3 Sub Station has the higher profit margin, while Planet Sub has the higher asset turnover. This is consistent with their primary business strategies. Sub Station uses the highest quality ingredients to obtain higher profit margins, while Planet Sub emphasizes high sales turnover by selling at lower prices.

Problem 7-10A (LO 7-7) Requirement 1 Sandwiches Only Net Income $170,000 Net Income $170,000 Sales $900,000

÷ ÷

Average Total Assets $500,000

= =

Return on Assets 34.0%

= =

Profit Margin 18.9%

÷ ÷

Sales $900,000

÷ ÷

Average Total Assets $500,000

= =

Asset Turnover 1.8 times

Requirement 2 Sandwiches and Smoothies Net Income $260,000

÷ ÷

Average Total Assets $900,000

= =

Return on Assets 28.9%

Net Income $260,00

÷ ÷

Sales $1,500,000

= =

Profit Margin 17.3%

÷ ÷

Average Total Assets $900,000

= =

Asset Turnover 1.67 times

Sales $1,500,000

Requirement 3 Do not go forward with the expansion plans. The return on assets, profit margin, and asset turnover are all lower with the addition of smoothies. Even though net income increases from $170,000 to $260,000, it comes at too great a cost. University Hero would be better off focusing on the more profitable sandwich line.

PROBLEMS: SET B Problem 7-1B (LO 7-1) Purchase price of land Land clearing costs Sale of firewood to a worker Architect fees (for new building) Legal fees (for title investigation of land) Building construction costs Totals

Land $90,000 5,000 (400) 3,500 $98,100

Building

$ 30,000 400,000 $430,000

The property taxes on the land of $3,000 will be recorded as property tax expense over the first year.

Problem 7-2B (LO 7-1) Requirement 1 The ovens should be recorded in the Sicily Pizza equipment account as detailed in the following schedule: Purchase price Shipping costs Labor costs Electrical work Pizza dough for testing ovens New timers Total equipment

$341,000 16,000 17,000 3,800 1,300 800 $379,900

Requirement 2 All amounts were included in the Equipment account.

Problem 7-3B (LO 7-2) 1.

Purchase price Less: Fair value of assets acquired Less: Fair value of liabilities assumed Fair value of identifiable net assets Goodwill

$5,600,000 $5,650,000 (750,000) 4,900,000 $ 700,000

2. Accounts Receivable (at fair value) Buildings (at fair value) Equipment (at fair value) Goodwill (remaining purchase price) Accounts Payable (at fair value) Cash (at purchase price) (Acquire Pioneer Equipment Rental)

Debit 650,000 4,800,000 200,000 700,000

Credit

750,000 5,600,000

Problem 7-4B (LO 7-3) 1. Expense 2. Capitalize 3. Capitalize 4. Expense 5. Expense 6. Capitalize SYP could increase reported earnings by improperly recording expenses as assets. For example, SYP could record maintenance and repair expense to the Equipment asset account. This would lower expenses and increase earnings reported in the current year.

Problem 7-5B (LO 7-4) Requirement 1 Straight-line Cheetah Copy

Year 1 2 3 4 Total

Calculation End of Year Amounts Depreciable Depreciation Depreciation Accumulated Book X = Cost* Rate Expense Depreciation Value** $105,000 0.25 $26,250 $ 26,250 $113,750 105,000 0.25 26,250 52,500 87,500 105,000 0.25 26,250 78,750 61,250 105,000 0.25 26,250 105,000 35,000 $105,000

* $140,000 – $35,000 = $105,000 ** $140,000 cost minus accumulated depreciation Requirement 2 Double-declining-balance Cheetah Copy Calculation End of Year Amounts Beginning Depreciation Depreciation Accumulated Book X = Year Book Value Rate* Expense Depreciation Value** 1 $140,000 0.50 $70,000 $ 70,000 $70,000 2 70,000 0.50 35,000 105,000 35,000 3 35,000 0.50 0*** 105,000 35,000 4 35,000 0.50 0*** 105,000 35,000 Total $105,000 * 2 / 4 years = 0.50 per year ** $140,000 cost minus accumulated depreciation *** Asset is fully depreciated after two years.

Requirement 3 Activity-based Cheetah Copy Calculation Hours Depreciation X = Year Used Rate* 1 3,000 $13.125 2 2,000 $13.125 3 2,000 $13.125 4 2,000 $13.125 Total 9,000

End of Year Amounts Depreciation Accumulated Book Expense Depreciation Value** $39,375 $ 39,375 $100,625 26,250 65,625 74,375 26,250 91,875 48,125 13,125*** 105,000 35,000 $105,000

* $105,000 / 8,000 hours = $13.125/hour ** $140,000 cost minus accumulated depreciation *** Amount needed to reduce book value to residual value.

Problem 7-6B (LO 7-5) Requirement 1 a. Goodwill is not amortized.

b. Amortization Expense Patents (Amortize patent) * $49,500 / 9 years

Debit 5,500*

c. Amortization Expense 13,500* Franchises (Amortize franchise) * ($216,000 / 8 years) x 1/2 year

Credit 5,500

13,500

Requirement 2 Lettuce Express Balance Sheet December 31, 2021 (Intangible Assets section) Intangible Assets Goodwill Patents ($49,500 – $5,500) Franchises ($216,000 – $13,500) Total intangible assets

$160,000 44,000 202,500 $406,500

Problem 7-7B (LO 7-4, 7-5) Requirement 1 Depreciation Expense Accumulated Depreciation (Depreciate building) * ($358,400) x 2/10 Depreciation Expense Accumulated Depreciation (Depreciate equipment) *($145,000 – $10,000)/9 Requirement 2

Debit 71,680*

15,000*

Debit

Amortization Expense Patent (Amortize patent) * $125,000/5

Credit 71,680

15,000

Credit

25,000* 25,000

Requirement 3

Land Building Equipment Patent

Togo’s Sandwich Shop December 31, 2021 Accumulated Cost Depreciation $ 85,000 – 560,000 $(273,280) 145,000 (45,000) 125,000 (75,000)

Book Value $ 85,000 286,720 100,000 50,000

Problem 7-8B (LO 7-6) Requirement 1 $127,500

$455,000 – $30,000 10

x 3 years

Requirement 2 Cost of the oven Less: Accumulated depreciation Book value at the end of year 3

$455,000 (127,500) $327,500

Requirement 3 Sale amount Less: Cost of the oven Less: Accumulated depreciation Book value at the end of year 3 Gain

$341,000 $455,000 (127,500) 327,500 $ 13,500

Requirement 4 Cash Accumulated Depreciation Gain Equipment (Sell equipment for a gain)

Debit 341,000 127,500

Credit 13,500 455,000

Problem 7-9B (LO 7-7) Requirement 1 Papa’s Pizza Net Income $2,223 Net Income $2,223 Sales $24,128 Requirement 2 Pizza Prince Net Income $129 Net Income $129 Sales $1,835

÷ ÷

Average Total Assets ($14,998 + $15,465)/2

÷ ÷

Sales $24,128

÷ ÷

Average Total Assets ($14,998 + $15,465)/2

÷ ÷

Average Total Assets ($919 + $1,157)/2

÷ ÷

Sales $1,835

÷ ÷

Average Total Assets ($919 + $1,157)/2

= =

Return on Assets 14.6%

= =

Profit Margin 9.2%

= =

Asset Turnover 1.6 times

= =

Return on Assets 12.4%

= =

Profit Margin 7.0%

= =

Asset Turnover 1.8 times

Requirement 3 Papa’s Pizza has a higher profit margin than Pizza Prince (9.2% vs. 7.0%), while Pizza Prince has a slightly higher asset turnover (1.8 times vs. 1.6 times). Overall, Papa’s Pizza has a return on assets of 14.6% compared to 12.4% for Pizza Prince.

Problem 7-10B (LO 7-7) Requirement 1 Cars Only

Net Income $500,000 Net Income $500,000

÷ ÷

Average Total Assets $1,700,000

= =

Return on Assets 29.4%

= =

Profit Margin 7.7%

÷ ÷

Sales $6,500,000

÷ ÷

Average Total Assets $1,700,000

= =

Asset Turnover 3.8 times

Net Income $700,000

÷ ÷

Average Total Assets $1,900,000

= =

Return on Assets 36.8%

Net Income $700,00

÷ ÷

Sales $7,700,000

= =

Profit Margin 9.1%

÷ ÷

Average Total Assets $1,900,000

= =

Asset Turnover 4.1 times

Sales $6,500,000 Requirement 2 Cars and Boats

Sales $7,700,000

Requirement 3 Go forward with the expansion plans to include the sale of recreational boats. The return on assets, profit margin, and asset turnover are all higher with the additional sale of boats.

ADDITIONAL PERSPECTIVES Continuing Problem: Great Adventures AP7-1 Requirement 1 Jul. 1, 2022

Debit

Equipment

17,000

Credit

Prepaid Insurance 1,800 Cash 18,800 (Purchase new vehicle and prepay insurance) Purchase price Painting and new logo Deluxe roof rack and trailer hitch Total

$12,000 3,000 2,000 $17,000

Requirement 2 Oct. 22, 2022 Repairs and Maintenance Expense Cash (Pay vehicle maintenance)

400 400

Requirement 3

Year 2022 2023 2024 2025 2026 2027 Total

Great Adventures

Calculation End of Year Amounts Allocation Depreciation Depreciation Accumulated Book × = Base* Rate Expense Depreciation Value** $12,500 0.20 × 1/2 $1,250 $ 1,250 $15,750 12,500 0.20 2,500 3,750 13,250 12,500 0.20 2,500 6,250 10,750 12,500 0.20 2,500 8,750 8,250 12,500 0.20 2,500 11,250 5,750 12,500 0.20 × 1/2 1,250 12,500 4,500 $12,500

* $17,000 – $4,500 = $12,500 ** $17,000 cost minus accumulated depreciation Depreciation expense in 2022 is only six months of the company’s accounting year ($2,500 × 6/12 = $1,250). The final year of depreciation goes from January 1, 2027 to June 30, 2027. Requirement 4 Dec. 31, 2022 Depreciation Expense Accumulated Depreciation (Depreciate vehicle) [$1,250 = ($17,000−$4,500)/5 × 6/12] Dec. 31, 2022 Insurance Expense Prepaid Insurance (Expiration of prepaid insurance) ($900 = $1,800 × 6/12)

1,250 1,250

900 900

Requirement 5 July 1, 2024 Debit Credit Cash 10,000 Accumulated Depreciation 5,000 Loss 2,000 Equipment 17,000 (Sell equipment for a loss) Note that 2024 in the schedule goes from January 1, 2024 to December 31, 2024. Depreciation expense in 2024 is only six months of the company’s accounting year ($2,500 × 6/12 = $1,250) because the vehicle is sold. Thus, when the vehicle is sold, there are two full years of depreciation across three accounting years ($1,250 in 2022 + $2,500 in 2023 + $1,250 in 2024).

Additional Perspective 7-1 (in General Ledger) Students will be given the following existing trial balance. Great Adventures, Inc. Trial Balance December 31, 2022 Accounts Cash Accounts Receivable Allowance for Uncollectible Accounts Inventory Equipment Accumulated Depreciation Accounts Payable Interest Payable Income Tax Payable Notes Payable Common Stock Retained Earnings Service Revenue Sales Revenue Interest Revenue Sales Discounts Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Interest Expense Income Tax Expense Totals

Debit $ 83,270 50,000

Credit

$ 2,400 7,000 45,000 24,000 20,800 750 14,500 30,000 20,000 33,450 44,500 100,000 120 350 38,500 16,000 4,800 2,400 24,000 500 2,400 -01,800 14,500 $290,520

$290,520

Additional Perspective 7-1 (in General Ledger, continued) Jul. 1, 2022

Debit

Equipment

17,000

Credit

Prepaid Insurance 1,800 Cash 18,800 (Purchase new vehicle and prepay insurance) Oct. 22, 2022 Repairs and Maintenance Expense Cash (Pay vehicle maintenance) Dec. 31, 2022 Depreciation Expense Accumulated Depreciation (Depreciate vehicle) [$1,250 = ($17,000−$4,500)/5 × 6/12] Dec. 31, 2022 Insurance Expense Prepaid Insurance (Expiration of prepaid insurance) ($900 = $1,800 × 6/12)

400 400

1,250 1,250

900 900

Additional Perspective 7-1 (in General Ledger, continued)

Great Adventures, Inc. Income Statement For the period ended December 31, 2022 Service revenue Sales revenue Sales discounts Net sales Cost of goods sold Gross profit Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Total operating expenses Operating income (loss)

$ 44,500 100,000 (350) 144,150 38,500 $105,650 17,250 5,700 2,400 24,000 500 2,400 400 52,650 53,000

Interest revenue Interest expense Income before income taxes

120 (1,800) 51,320

Income tax expense Net income

14,500 $36,820

Additional Perspective 7-1 (in General Ledger, continued)

Great Adventures, Inc. Balance Sheet December 31, 2022 Assets

Current assets: Cash Accounts receivable Allow for Uncoll Accts Inventory Prepaid Insurance Total current assets

$ 64,070 50,000 (2,400) 7,000 900 119,570

Long-term assets: Equipment Accumulated depreciation

62,000 (25,250)

Total assets

$156,320

Liabilities Current liabilities: Accounts payable Interest payable Income tax payable

$ 20,800 750 14,500

Total current liabilities Notes payable Total liabilities

26,050 30,000 66,050

Stockholders’ Equity Common stock 20,000 Retained earnings 70,270 Total stockholders’ equity 90,270 Total liabilities and stockholders’ equity $156,320

Additional Perspective 7-1 (in General Ledger, concluded) Dec. 31, 2022 Service Revenue Sales Revenue Interest Revenue Sales Discounts Retained Earnings (Close revenue accounts) Dec. 31, 2022 Retained Earnings Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Interest Expense Income Tax Expense (Close expense accounts)

Debit 44,500 100,000 120

Credit

350 144,270 107,450 38,500 17,250 5,700 2,400 24,000 500 2,400 400 1,800 14,500

Financial Analysis: American Eagle AP7-2 ($ in thousands) Requirement 1 The straight-line method is used. The estimated useful lives are as follows: Buildings Fixtures and equipment

25 years 5 years

Requirement 2 The cost of property and equipment is $2,023,875 and the book value is $724,239. Book value is the same as “Property and equipment, net”. The trend in depreciation expense is increasing. Requirement 3 The intangible asset listed is trademarks. The cost is $70,322 and the book value is $46,666. The trend in amortization expense is increasing.

Financial Analysis: The Buckle AP7-3 ($ in thousands) Requirement 1 Buckle uses a combination of accelerated and straight-line depreciation methods. The estimated useful lives are as follows: Property and equipment Buildings

5 to 10 years 31.5 to 39 years

Requirement 2 The cost of property and equipment is $459,043. The trend in property is decreasing. Requirement 3 The other types of long-term assets listed are Long-term investments and Other assets.

Comparative Analysis: American Eagle vs. The Buckle AP7-4

Requirement 1 American Eagle ($ in thousands) Net Income $204,163 Net Income $204,163

Average ÷ Total Assets ÷ ($1,816,313 + 1,782,660)/2 ÷ ÷

Sales $3,795,549

÷ ÷

Return on Assets 11.3%

= =

Profit Margin 5.4%

= =

Average Total Assets ($1,816,313 + 1,782,660)/2

= =

Asset Turnover 2.1 times

Requirement 2 Buckle ($ in thousands) Net Income $89,707 Net Income $89,707

÷ ÷ ÷ ÷

Sales $913,380

Average Total Assets ($538,116 + $579,847)/2 Sales $913,380

= =

Return on Assets 16.0%

= =

Profit Margin 9.8%

Average Asset ÷ Total Assets = Turnover ÷ ($538,116 + $579,847)/2 = 1.6 times

Requirement 3 Buckle has a higher return on assets and profit margin. American Eagle has a higher asset turnover.

Ethics AP7-5 1. Yes. Depreciation is affected by management’s choice of depreciation method (such as straight-line, double-declining-balance, or activity-based) and by management’s estimate of the asset’s useful service life and residual value. Depreciation expense is reported as an expense in the income statement. Accumulated Depreciation is reported as a contra asset in the balance sheet. 2. (a) Straight-line. A company could increase earnings by changing from double-declining-balance to straight-line in the early years of an asset’s life. Double-declining-balance depreciation will be higher than straight-line depreciation in earlier years, but lower in later years. Since expenses decrease net income, the higher depreciation expense under double-declining-balance will result in lower reported net income. (b) Longer service life. A company could increase earnings by lengthening the estimated service lives of depreciable assets. A longer service life reduces the amount of depreciation in each particular year, resulting in higher reported net income. (c) Higher residual value. A company could increase earnings by increasing the estimated residual value of depreciable assets. A larger residual value results in a lower depreciable cost of the asset and therefore less depreciation expense being recorded each year. Lower depreciation expense, in turn, results in higher reported net income. 3. Yes. Many amounts reported in financial statements are based on estimates by management, and these estimates are a crucial part of the information set used by investors and creditors to make decisions. To the extent that these estimates are materially misstated by management, financial reporting provides misleading information. 4. No. Even though Wall Street analysts place extensive pressure on companies to meet earnings expectations, management and the company’s auditors have a legal and ethical responsibility to fairly report all estimates, including those for depreciation. A successful defense for misreporting financial performance cannot include pressure from external decision makers. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Chapter 7 7-61

Internet Research AP7-6 This case provides an opportunity for students to learn how to locate annual reports available on company websites. It also allows students to learn more about how longterm assets are reported in the annual report. Answers to the assignment will vary depending on the company chosen.

Written Communication AP7-7 The dictionary definition of depreciation is a decrease in value of an asset. The accounting concept of depreciation is different. Depreciation in accounting is the process of allocating to an expense the cost of an asset over its service life. An asset provides benefits (revenues) to a company in future periods. To properly match the cost (expense) with the revenues it helps to generate, we allocate a portion of the asset’s cost to an expense in each year that the asset provides a benefit.

Earnings Management AP7-8 Requirement 1 Depreciation expense = ($4,200,000 − $600,000) / 12 years = $300,000 Requirement 2 Option 1: Depreciation expense = ($4,200,000 − $600,000) / 6 years = $600,000. The higher amount of depreciation expense would lower net income in the current year. Option 2: Depreciation expense = ($4,200,000 − $0) / 12 years = $350,000. The higher amount of depreciation expense would lower net income in the current year. Option 3: Depreciation expense = ($4,200,000 − $0) / 6 years = $700,000. The higher amount of depreciation expense would lower net income in the current year. Requirement 3 Option 3 results in the biggest decrease in net income.

Chapter 8 Current Liabilities QUESTIONS Question 8-1 Liabilities have three essential characteristics. Liabilities are: (1) probable future sacrifices of economic benefits; (2) arising from present obligations to other entities; (3) resulting from past transactions or events. The definition of liabilities touches on the present, the future, and the past. A liability is a present responsibility to sacrifice assets in the future due to a transaction or other event that happened in the past.

Question 8-2 In most cases, current liabilities are payable within one year from the date of the balance sheet and long-term liabilities are payable in more than one year. Current liabilities are usually, but not always, due within one year. For example, if a company has an operating cycle longer than one year (a winery, for example), its current liabilities are defined by the operating cycle rather than by the length of a year.

Question 8-3 Distinguishing between current and long-term liabilities is important in helping investors and creditors assess the riskiness of a business’ obligations. Given a choice, most companies would prefer to report a liability as long-term rather than current because it may cause the firm to appear less risky. In turn, less risky firms may enjoy lower interest rates on borrowing and command higher stock prices for new stock listings.

Question 8-4 Current liabilities common to the airline industry include payroll liabilities, deferred revenue in the form of advance ticket sales, and contingent liabilities due to litigation.

Question 8-5 The accrual basis requires expenses to be recorded when incurred. The cash basis requires expenses to be recorded when the cash is paid. Financial accounting requires use of the accrual basis rather than the cash basis as this best reflects the timing of the expense in the same period as the associated benefits.

Question 8-6 A line of credit is an informal agreement that permits a company to borrow up to a prearranged limit without having to follow formal loan procedures and paperwork. The line of credit works like a note payable except the company is able to borrow without having to go through a formal loan approval process each time it borrows money.

answers to Questions (continued) Question 8-7 If a company borrows from another company rather than from a bank, the note is referred to as commercial paper. The interest rate is often lower for commercial paper than a bank loan as the company is effectively bypassing the additional mark-up in interest rates by the bank.

Question 8-8 Four items commonly withheld from employee payroll checks include (1) federal and state income taxes, (2) Social Security and Medicare (FICA), (3) health, dental, disability, and life insurance premiums, and (4) employee investments to retirement or savings plans. The first two are required by law and the second two are voluntary.

Question 8-9

Four common employer costs in addition to the employee’s salary include (1) federal and state unemployment taxes, (2) the employer portion of Social Security and Medicare (FICA), (3) employer contributions for health, dental, disability, and life insurance, and (4) employer contributions to retirement or savings plans. The first two are required by law and the last two are voluntary benefits paid by a company on behalf of its employees.

Question 8-10 Both the employer and the employee pay equal portions of social security taxes. Employers withhold from employee paychecks a 6.2% Social Security tax up to a maximum base amount and a 1.45% Medicare tax with no maximum. Therefore, the total FICA tax is 7.65% (6.2% + 1.45%) on income up to a base amount for Social Security ($128,400 in 2018) and 1.45% on all income above the base amount. Employers then pay an additional (matching) amount equal to the amount withheld from employee paychecks so the government actually is collecting 15.3% (7.65% employee + 7.65% employer) on each employee’s salary.

Question 8-11 When a company receives cash in advance through the sale of gift cards, it debits cash and credits a current liability account called deferred revenue. When it provides the goods or services already paid for, the company debits deferred revenue and credits revenue.

Question 8-12

(a) When Sports Illustrated sells magazine subscriptions, the company will debit cash and credit deferred revenue. (b) As the subscription is provided through the distribution of magazines, the company debits deferred revenue and credits revenue.

answers to Questions (continued) Question 8-13 The sales tax rate for Hollister is 6.5% calculated as $325 in sales taxes divided by sales of $5,000. The journal entry to record the transaction would debit cash for $5,325, credit sales for $5,000, and credit sales taxes payable for $325.

Question 8-14 Dell will include $10 million as a current note payable and the remaining $120 million as part of long-term notes payable.

Question 8-15 A contingent liability is an existing, uncertain situation that might result in a loss. Examples include lawsuits, product warranties, environmental problems, and premium offers.

Question 8-16 The likelihood of the loss occurring can be probable, reasonably possible, or remote. Probable means likely to occur while remote means the chance is slight. Reasonably possible fits somewhere in between—more than remote but less than probable.

Question 8-17 A loss contingency is recorded only if a loss is probable and the amount is reasonably estimable.

Question 8-18 If the likelihood of loss is reasonably possible rather than probable, we record no entry but make full disclosure in a disclosure note to the financial statements to describe the contingency. Finally, if the likelihood of loss is remote, disclosure is usually not required.

Question 8-19 If one amount within a range of potential losses appears more likely than other amounts within the range, we record that amount. When no amount within the range appears more likely than others, we record the minimum amount and disclose information about the potential loss including the potential range of loss.

answers to Questions (continued) Question 8-20 In a pending lawsuit, one side—the defendant—faces a loss contingency, while the other side— the plaintiff—has a gain contingency. The $2 million is a gain contingency and the outcome, while promising, is not yet certain. We do not record gain contingencies of this type until the gain is certain. Though firms do not record gain contingencies in the accounts, they sometimes disclose them in notes to the financial statements.

Question 8-21 Liquidity measures the ability of a company to pay current liabilities as they come due. Liquidity can be evaluated by examining the current ratio or the more specific acid-test ratio.

Question 8-22 Working capital is simply the difference between current assets and current liabilities. The current ratio is calculated by dividing current assets by current liabilities. The acid-test ratio is similar to the current ratio but is based on a more conservative measure of current assets available to pay current liabilities. We calculate the acid-test ratio by dividing “quick assets” by current liabilities. Quick assets include only cash, short-term investments, and accounts receivable. By eliminating current assets such as inventories and prepaid expenses that are less readily convertible into cash, the acid-test ratio may provide a better indication of a company’s liquidity than does the current ratio.

Question 8-23 (a) The purchase of inventory with cash would have no effect on the current ratio as one current asset (inventory) would increase while another current asset (cash) would decrease. The purchase of inventory with cash would decrease the acid-test ratio due to the decrease in cash. (b) The sale of inventory for more than its cost would increase the current ratio because the increase in cash or accounts receivable from the sale would more than offset the reduction of inventory at its cost. The sale of inventory for more than its cost would also increase the acid-test ratio due to the increase in cash or accounts receivable from the sale.

BRIEF EXERCISES Brief Exercise 8-1 November 1 Cash Notes Payable

Debit 4,000,000

December 31 Interest Expense (4,000,000 × 0.06 × 2/12) Interest Payable

Brief Exercise 8-2 November 1 Notes Receivable Cash

Credit 4,000,000

40,000

Debit 4,000,000

Credit 4,000,000

December 31 Interest Receivable 40,000 Interest Revenue (4,000,000 × 0.06 × 2/12)

40,000

Brief Exercise 8-3 Interest Expense $4,800

= =

Face value $160,000

× ×

Annual interest rate 6%

× ×

Fraction of the year 6/12

Brief Exercise 8-4

April 1 Cash Notes Payable - Commercial Paper

Debit 13,000,000

Credit 13,000,000

December 31 Notes Payable - Commercial Paper Interest Expense ($13,000,000 × 0.09 × 9/12) Cash

13,000,000 877,500

13,877,500

Brief Exercise 8-5 Total withheld for: Social Security $128,400 × 0.062 Medicare $652,800 × 0.0145 Total

= =

$ 7,961 9,466 $17,427

The employer will contribute an additional (matching) $17,427.

Brief Exercise 8-6 December 18 Cash Deferred Revenue (to record advance receipt of cash) January 23 Cash Deferred Revenue Sales Revenue Cost of Goods Sold Inventory (to complete the sale)

Debit 260,000

2,340,000 260,000 1,600,000

Credit 260,000

2,600,000 1,600,000

Brief Exercise 8-7 ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 8-6 Financial Accounting, 5e

June July August

$1,200 2,100 1,700*

* Includes gift cards redeemed ($1,400) and gift cards unlikely to be redeemed ($300).

Brief Exercise 8-8 Accounts Receivable Sales Revenue Sales Taxes Payable (0.085 × $3,200)

Debit 3,472

Credit 3,200 272

Brief Exercise 8-9 Southwest Airlines Partial Balance Sheet December 31, 2021 Current Liabilities: Current portion of long-term debt Long-Term Liabilities: Notes payable Total Liabilities

Brief Exercise 8-10 Warranty Expense ($31,000,000 x 3%) Warranty Liability Warranty Liability Cash

$ 10,000,000 31,000,000 $41,000,000

Debit 930,000

Credit 930,000

300,000 300,000

The Warranty Liability at the end of the year is $630,000, calculated using a Taccount as follows: Warranty Liability 300,000 930,000 630,000 balance

Brief Exercise 8-11 The loss contingency is probable and reasonably estimable, so a loss and a liability for $8 million must be recorded. The entry will reduce income before taxes on the income statement and increase total liabilities on the balance sheet by $8 million.

Brief Exercise 8-12 Electronic Innovators has a contingent liability that is probable, and reasonably estimable within a range between $6 and $10 million. Electronic Innovators should record a loss and a liability for the minimum amount ($6 million) and disclose the range between $6 and $10 million in the notes to the financial statements.

Brief Exercise 8-13 Aviation Systems has a contingent gain that is probable and reasonably estimable, within a range between $6 and $10 million. Contingent gains are not recorded until the gain is certain. Though firms do not record contingent gains in the accounts, they sometimes disclose them in the notes to the financial statements.

Brief Exercise 8-14 Northwest Forest Products has a contingent liability that is reasonably possible and reasonably estimable, within a range between $20 and $30 million. Since the loss is reasonably possible, but not probable, we will carefully disclose the situation, but not record the potential loss and liability in the financial records. Details regarding the investigation by the EPA, the reasonable possibility of an assessment, and the range of settlements should be included in the disclosure.

Brief Exercise 8-15 (1) Not recorded (disclosure only) as the loss is reasonably possible, but not probable. (2) Not recorded (disclosure only) as the loss is not reasonably estimable. (3) Recorded because the warranty costs are probable and reasonably estimable.

Brief Exercise 8-16

Current Assets ÷ ($112 + 104 + 192 + 28) ÷

Current Liabilities ($118 + 45)

= =

Current Ratio 2.67

÷ ÷

Current Liabilities ($118 + 45)

= =

Acid-Test Ratio 1.33

Quick Assets ($112 + 104)

Brief Exercise 8-17 1. Provide services to customers on account. 2. Borrow cash from the bank by signing a long-term note payable. 3. Purchase office supplies with cash 4. Pay rent for the current period.

Current Ratio Increase Increase

Acid-Test Ratio Increase Increase

No change Decrease

Decrease Decrease

EXERCISES Exercise 8-1 Reporting Method C. Current liability L. Long-term liability D. Disclosure note only N. Not reported Item __C__ __C__ __C__ __C__ __L__ __C__ __C__ __D__ __C__ __D__

1. Accounts payable. 2. Current portion of long-term debt. 3. Sales tax collected from customers. 4. Notes payable due next year. 5. Notes payable due in two years. 6. Advance payments from customer. 7. Commercial paper. 8. Unused line of credit. 9. A contingent liability with a probable likelihood of occurring within the next year and can be estimated. 10. A loss contingency with a reasonably possible likelihood of occurring within the next year and can be estimated.

Exercise 8-2 1. November 1, 2021 Cash Notes Payable (Issuance of notes payable)

Debit 60,000

2. December 31, 2021 Interest Expense ($60,000 × 7% × 2/12) 700 Interest Payable (Interest expense incurred, but not paid) 3. January 31, 2022 Notes Payable 60,000 Interest Payable ($60,000 × 7% × 2/12) 700 Interest Expense ($60,000 × 7% × 1/12) 350 Cash (Payment of notes payable and interest)

Credit 60,000

700

61,050

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Exercise 8-3 1. August 1, 2021 Cash Notes Payable (Issuance of notes payable)

Debit 21,000,000

2. December 31, 2021 Interest Expense ($21 million × 9% × 5/12) 787,500 Interest Payable (Interest expense incurred, but not paid) 3. January 31, 2022 Notes Payable 21,000,000 Interest Payable ($21 million × 9% × 5/12) 787,500 Interest Expense ($21 million × 9% × 1/12) 157,500 Cash (Payment of notes payable and interest)

Credit 21,000,000

787,500

21,945,000

Exercise 8-4 1. August 1, 2021 Notes Receivable Cash (Issuance of notes receivable)

Debit 21,000,000

2. December 31, 2021 Interest Receivable ($21 × 9% × 5/12) 787,500 Interest Revenue (Interest revenue earned, but not received) 3. January 31, 2022 Cash 21,945,000 Notes Receivable Interest Receivable ($21 × 9% × 5/12) Interest Revenue ($21 × 9% × 1/12) (Collection of notes receivable and interest)

Credit 21,000,000

787,500

21,000,000 787,500 157,500

Exercise 8-5 1. 2. 3. 4.

$6,000,000 $6,000,000 $6,000,000 $6,000,000

× 0.11 × 0.09 × 0.10 × 0.07

× 6/12 = × 3/12 = × 4/12 = × 7/12 =

$330,000 $135,000 $200,000 $245,000

Exercise 8-6 January 13 No Entry February 1 Cash

Notes Payable

May 1 Notes Payable Interest Expense ($5,000,000 × 0.07 × 3/12) Cash

5,000,000

5,000,000 87,500

5,087,500

Exercise 8-7 Requirement 1 Total Salary Expense Less: Withholdings Federal Income Taxes State Income Taxes FICA Taxes Total Withholdings Actual Direct Deposit

Requirement 2 FICA Taxes Unemployment Taxes Total Payroll Tax Expense

(100 × 40 hours × $20) ($80,000 × 0.15) ($80,000 × 0.05) ($80,000 × 0.0765)

$80,000 $12,000 4,000 6,120 22,120 $57,880

($80,000 × 0.0765) ($80,000 × 0.062)

$ 6,120 4,960 $11,080

Requirement 3 The company does not make an accounting entry to record the free skiing given to employees on their days off; no additional costs are directly incurred by the company to provide this benefit.

Exercise 8-8 Requirement 1 January 31 3,000,000 Salaries Expense Income Tax Payable 637,500 FICA Tax Payable 229,500 Accounts Payable (to Blue Cross/Blue Shield) 30,000 Salaries Payable (to balance) 2,103,000 (Employee salary expense and withholdings) Requirement 2 January 31 90,000 Salaries Expense (fringe benefits) Accounts Payable (to Blue Cross/Blue Shield) (Employer-provided fringe benefits) Requirement 3 January 31 Payroll Tax Expense FICA Tax Payable Unemployment Tax Payable (Employer payroll taxes)

90,000

415,500 229,500 186,000

Exercise 8-9 January 31 600,000 Salaries Expense Income Tax Payable FICA Tax Payable ($600,000 × 0.0765) Salaries Payable (to balance) (Employee salary expense) January 31 83,100 Payroll Tax Expense (total) FICA Tax Payable ($600,000 × 0.0765) Unemployment Tax Payable ($600,000 × 0.062) (Employer payroll tax expense)

120,000 45,900 434,100

45,900 37,200

Exercise 8-10 Requirement 1 November 30 Cash 21,000,000 Deferred Revenue (Advance collection for gift cards)

21,000,000

Requirement 2 December 31 Deferred Revenue 14,000,000 Sales Revenue 14,000,000 (Revenue recognized when gift cards are redeemed) Requirement 3 The ending balance in Deferred Revenue is $7,000,000. Deferred Revenue 14,000,000 21,000,000 7,000,000 Ending balance

Exercise 8-11 Requirement 1 October 1, 2021 Cash Deferred Revenue (Sale of gift cards)

100,000

Requirement 2 December 31, 2021 Deferred Revenue 20,000 Sales Revenue 20,000 (Revenue recognized when gift cards are redeemed) ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 8-18 Financial Accounting, 5e

Requirement 3 March 31, 2022 Deferred Revenue 70,000 Sales Revenue 70,000 (Revenue recognized when gift cards are redeemed) ($70,000 = $30,000 + $25,000 + $15,000) Requirement 4 April 1, 2022 Deferred Revenue 10,000 Sales Revenue (Revenue expiration of gift cards) ($10,000 = $100,000 − $20,000 − $70,000)

10,000

Exercise 8-12 Requirement 1 The contingent liability is probable and reasonably estimable, so it must be reported. Requirement 2 A $4 million loss should be reported in its 2021 income statement. Requirement 3 A $4 million liability should be reported in its 2021 balance sheet. Requirement 4 Loss

Contingent Liability (Record the contingent liability)

4,000,000

Exercise 8-13 Requirement 1 The contingent liability is probable and reasonably estimable, so it must be recorded as follows: Loss

Contingent Liability (Record the contingent liability)

1,300,000

Requirement 2 Pacific Cruise Lines should record a loss and a liability for the minimum amount ($1.1 million) and disclose the nature of the contingency in the disclosure notes to the financial statements. The journal entry is as follows: Loss

Contingent Liability (Record the contingent liability)

1,100,000

Requirement 3 If the likelihood of loss is reasonably possible rather than probable, we record no entry but make full disclosure in a note to the financial statements to describe the contingency. Requirement 4 If the likelihood of loss is remote, disclosure is usually not required.

Exercise 8-14 Requirement 1 Yes, it’s probable that costs for warranties will be incurred and based on previous experience the amount is reasonably estimable. Requirement 2 December 31 Warranty Expense ($600,000 × 6%) Warranty Liability (Record contingent liability for warranties)

36,000

Requirement 3 January 31 Warranty Liability Cash (Record actual warranty expenditures)

13,000

36,000

13,000

Requirement 4 Warranty Liability 36,000 Expense Payment 13,000 23,000 Balance

Exercise 8-15 Requirement 1 December 31, 2021 Warranty Expense ($1,600,000 × 2%) Warranty Liability (Record contingent liability for warranties)

32,000

Requirement 2 Summary entry in 2022 Warranty Liability Cash (Record actual warranty expenditures)

25,000

Requirement 3 December 31, 2022 Warranty Expense 29,000 Warranty Liability (Record contingent liability for warranties) ($36,000 = $2,400,000 × 1.5%) ($29,000 = $36,000 − $7,000 current balance in Warranty Liability)

32,000

25,000

29,000

Requirement 4 Warranty Liability 0 32,000 Adjusting entry 32,000 Balance in 2021 Payment in 2022 25,000 7,000 29,000 Adjusting entry 36,000 Balance in 2022

Exercise 8-16 Requirement 1 Yes, a contingent liability is an existing, uncertain situation that might result in a loss. The environmental remediation and restoration costs represent an existing uncertain situation that will likely result in a loss to the company. Requirement 2 Dow would record a contingency if the loss is probable and is reasonably estimable. Requirement 3 Loss

Contingent Liability (Record the contingent liability)

381,000,000

Exercise 8-17 Requirement 1 Current Assets $875

÷ ÷

Current Liabilities $2,638

= =

Current Ratio 0.33

Quick Assets $331 + 63 + 230

÷ ÷

Current Liabilities $2,638

= =

Acid-Test Ratio 0.24

Requirement 2 Queen’s Line has a lower current ratio and a lower acid-test ratio than either United Airlines or American Airlines reported in the text. Queen’s Line appears more likely to have difficulty paying its currently maturing debts.

Exercise 8-18

Requirement 1 Transactions during January, 2021 January 2 Cash Deferred Revenue (Sell gift cards for cash)

Debit 8,000

Credit

January 6 Inventory Accounts Payable (Purchase inventory on account)

Debit 147,000

Credit

January 15 Accounts Receivable Sales Revenue (Sell inventory on account) Cost of Goods Sold Inventory (Record cost of inventory sold) January 23 Cash Accounts Receivable (Receive cash on account)

Debit 135,000

January 25 Accounts Payable Cash (Pay cash on account)

Debit 90,000

January 28 Allowance for Uncollectible Accounts Accounts Receivable (Write off uncollectible accounts)

Debit 4,800

8,000

147,000

73,800 Debit 125,400

Credit 135,000 73,800 Credit 125,400 Credit 90,000 Credit 4,800

January 30 Cash Accounts Receivable Sales Revenue (Sell inventory for cash and on account) Cost of Goods Sold Inventory (Record cost of inventory sold)

Debit 11,000 132,000

January 31 Salaries Expense Cash (Pay monthly salaries)

Debit 52,000

79,500

Credit 143,000 79,500 Credit 52,000

Exercise 8-18 (continued)

Requirement 2 Adjusting entries at end of January, 2021 (a) January 31 Depreciation Expense Accumulated Depreciation (Record depreciation for January) ($500 = [$15,000−$3,000] / 24 months)

Debit 500

Credit 500

(b) January 31 Debit Credit Bad Debt Expense 12,500 Allowance for Uncollectible Accounts 12,500 (Adjust uncollectible accounts) ($12,500 = [$11,000×30%]+[$172,000a×5%]+$600b) a $172,000 = $46,200+$135,000−$125,400−$4,800+$132,000−$11,000 b $600 = $4,800−$4,200 (c) January 31 Interest Expense Interest Payable (Adjust interest expense) ($250 = $50,000 × 6% × 1/12)

Debit 250

(d) January 31 Income Tax Expense Income Tax Payable (Adjust income taxes)

Debit 13,000

(e) January 31 Deferred Revenue Sales Revenue (Adjust revenue for gift cards redeemed)

Debit 3,000

Credit 250

Credit 13,000 Credit 3,000

Exercise 8-18 (continued) Requirement 3 ACME Fireworks Adjusted Trial Balance January 31, 2021 Accounts Cash Accounts Receivable Inventory Land Equipment Allowance for Uncollectible Accounts Accumulated Depreciation Accounts Payable Deferred Revenue (gift cards liability) Interest Payable Income Tax Payable Notes Payable Common Stock Retained Earnings Sales Revenue Cost of Goods Sold Salaries Expense Bad Debt Expense Depreciation Expense Interest Expense Income Tax Expense Totals

Debit $ 27,500 183,000 13,700 46,000 15,000

153,300 52,000 12,500 500 250 13,000 $516,750

Credit

$ 11,900 2,000 85,500 5,000 250 13,000 50,000 35,000 33,100 281,000

$516,750

Exercise 8-18 (continued) Requirement 3 (concluded) Accounts

Ending Balance Cash $ 27,500 Accounts Receivable 183,000 Inventory 13,700 Land 46,000 Equipment 15,000 Allow for Unc. Accounts 11,900 Accumulated Depreciation 2,000 Accounts Payable 85,500 Deferred Revenue 5,000 Interest Payable 250 Income Tax Payable 13,000 Notes Payable 50,000 Common Stock 35,000 Retained Earnings 33,100 Sales Revenue 281,000 Cost of Goods Sold 153,300 Salaries Expense 52,000 Bad Debt Expense 12,500 Depreciation Expense 500 Interest Expense 250 Income Tax Expense 13,000

= = = = = = = = = = = = = = = = = = = = =

Beginning balance in bold, entries during January in blue, and adjusting entries in red. 25,100+8,000+125,400−90,000+11,000−52,000 46,200+135,000−125,400−4,800+132,000 20,000+147,000−73,800−79,500 46,000 15,000 4,200−4,800+12,500 1,500+500 28,500+147,000−90,000 8,000−3,000 250 13,000 50,000 35,000 33,100 135,000+143,000+3,000 73,800+79,500 52,000 12,500 500 250 13,000

Exercise 8-18 (continued) Requirement 4 ACME Fireworks Multiple-Step Income Statement For the year ended January 31, 2021 Sales revenue $281,000 Cost of goods sold 153,300 Gross profit $127,700 Salaries expense Bad debt expense Depreciation expense Total operating expenses Operating income Interest expense Income before taxes Income tax expense Net income

52,000 12,500 500 65,000 62,700 250 62,450 13,000 $ 49,450

Requirement 5 ACME Fireworks Classified Balance Sheet January 31, 2021 Assets Liabilities Accounts payable Cash $ 27,500 Deferred revenue Accounts receivable 183,000 Interest payable Less: Allowance (11,900) 171,100 Income tax payable Inventory 13,700 Total current liabilities Total current assets 212,300 Notes payable Total liabilities Land 46,000 Stockholders’ Equity Equipment 15,000 Common stock Less: Accumulated Depreciation (2,000) Retained earnings Total stockholders’ equity Total liabilities and Total assets $271,300 stockholders’ equity *

$ 85,500 5,000 250 13,000 103,750 50,000 153,750 35,000 82,550 * 117,550 $271,300

Retained earnings = Beginning retained earnings + Net income − Dividends = $33,100 + $49,450 − $0 = $82,550

Exercise 8-18 (concluded) Requirement 6

January 31, 2021 Sales Revenue Retained Earnings (Close revenue accounts)

Debit 281,000

Retained Earnings Cost of Goods Sold Salaries Expense Bad Debt Expense Depreciation Expense Interest Expense Income Tax Expense (Close expense accounts)

231,550

Credit 281,000

153,300 52,000 12,500 500 250 13,000

Requirement 7 (a) The current ratio is: Current Ratio

Current Assets Current Liabilities

$212,300 $103,750

2.05

ACME Fireworks is more liquid than the industry average. ACME Fireworks has a greater proportion of current assets to pay current liabilities compared to the industry average of 1.8. (b) The acid-test ratio is: Acid-Test Ratio =

Quick Assets* Current Liabilities

$27,500 + $0 + $171,100 $103,750

1.91

*Quick Assets = Cash + Current Investments + Accounts Receivable ACME Fireworks is less likely to have difficulty paying its currently maturing debts. ACME Fireworks has a greater proportion of quick assets to pay current liabilities compared to the industry average of 1.5. (c) The current ratio, assuming the notes payable are current liabilities, is: Current Ratio

Current Assets Current Liabilities

$212,300 $153,750

1.38

Assuming the notes payable were due on April 1, 2021, they would be included in total current liabilities. This would increase current liabilities and decrease the current ratio, since dividing by a larger number reduces the ratio.

PROBLEMS: SET A Problem 8-1A List B a. Recording of a contingent liability b. Deferred revenue

_j__

List A 1. An IOU promising to repay the amount borrowed plus interest. 2. Payment amount is reasonably possible and is reasonably estimable. 3. Mixture of liabilities and equity a business uses. 4. Payment amount is probable and is reasonably estimable. 5. A liability that requires the sacrifice of something other than cash. 6. Long-term debt maturing within one year.

_f__

7. FICA and FUTA.

g. Line of credit

_g__

8. Informal agreement that permits a company to borrow up to a prearranged limit 9. Classifying liabilities as either current or longterm helps investors and creditors assess this. 10. Amount of note payable x annual interest rate x fraction of the year.

h. Capital structure

_i__ _d__ _h__ _a__ _b__

_c__ _e__

c. The riskiness of a business’s obligations d. Disclosure of a contingent liability e. Interest on debt f. Payroll taxes

i. Notes payable j. Current portion of long-term debt

Problem 8-2A Requirement 1 (a). October 1, 2021 Cash Notes Payable (Issuance of notes payable)

41,000,000

(b). October 1, 2021 Notes Receivable Cash (Acceptance of notes receivable)

41,000,000

Requirement 2 (a). December 31, 2021 Interest Expense ($41 million × 9% × 3/12) 922,500 Interest Payable (Interest expense incurred, but not paid) (b). December 31, 2021 Interest Receivable 922,500 Interest Revenue (Interest revenue earned, but not received)

41,000,000

922,500

Requirement 3 (a) September 30, 2022 Notes Payable 41,000,000 Interest Payable ($41 million × 9% × 3/12) 922,500 Interest Expense ($41 million × 9% × 9/12) 2,767,500 Cash (Payment of notes payable and interest)

(b). September 30, 2022 Cash 44,690,000 Interest Receivable ($41 million × 9% × 3/12) Interest Revenue ($41 million × 9% × 9/12) Notes Receivable (Collection of notes receivable and interest)

44,690,000

922,500 2,767,500 41,000,000

Problem 8-3A Requirement 1 January 31 600,000 Salaries Expense Income Tax Payable FICA Tax Payable Salaries Payable (to balance) (Employee salary expense and withholdings) Requirement 2 January 31 Salaries Expense (fringe benefits) Accounts Payable (to Blue Cross) Accounts Payable (to Fidelity) (Employer-provided fringe benefits) Requirement 3 January 31 Payroll Tax Expense (total) FICA Tax Payable Unemployment Tax Payable (Employer payroll taxes)

60,000 45,900 494,100

34,800 10,800 24,000

83,100 45,900 37,200

Problem 8-4A Requirement 1 February 14 1,500,000 Salaries Expense Income Tax Payable FICA Tax Payable Accounts Payable (Retirement Plan) Salaries Payable (to balance) (Employee salary expense and withholdings) Requirement 2 February 14 Salaries Expense (fringe benefits) Accounts Payable (Medical Insurance) Accounts Payable (Life Insurance) Accounts Payable (Retirement Plan) (Employer-provided fringe benefits) Requirement 3 February 14 Payroll Tax Expense (total) FICA Tax Payable Unemployment Tax Payable (Employer payroll taxes)

375,000 114,750 63,000 947,250

100,500 31,500 6,000 63,000

207,750 114,750 93,000

Problem 8-5A Requirement 1 $102,600,000 = 114,000 $900 = 6 games

$900 per season ticket $150 per individual game ticket

Requirement 2 Cash 102,600,000 Deferred Revenue (Advance collection of ticket sales) Requirement 3 Deferred Revenue 17,100,000 Sales Revenue ($102,600,000/6) (Revenue recognized after first home game)

102,600,000

17,100,000

Problem 8-6A Requirement 1 Cash Deferred Revenue (Sale of gift cards)

3,500 3,500

Requirement 2 Deferred Revenue Sales Revenue ($728 / 1.04) Sales Taxes Payable (Redemption of gift certificates) Requirement 3 Deferred Revenue 3,500 728 2,772

728

700 28

Balance

Problem 8-7A Requirement 1 The likelihood of loss is reasonably possible rather than probable, so no journal entry is recorded. However, full disclosure of the contingent liability is made in a note to the financial statements.

Requirement 2 Environmental Printing has a contingent gain that is probable, and is reasonably estimable within a range between $6.5 and $9 million. Contingent gains are not recorded until the gain is certain. Though firms do not record contingent gains in the accounts, they sometimes disclose them in notes to the financial statements.

Requirement 3 Environmental Printing should record a loss and a liability for the minimum amount ($500,000) and disclose the range between $500,000 and $900,000 in the notes to the financial statements. The entry is as follows: Loss Contingent Liability (Record the contingent liability)

500,000 500,000

Problem 8-8A Requirement 1 The reporting for this situation depends on the likelihood of loss occurring. If the likelihood of loss is reasonably possible rather than probable, no journal entry is recorded. However, if the likelihood of loss is probable, the following entry would be recorded: Loss

Contingent Liability (Record the contingent liability)

130,000,000

Requirement 2 The contingent loss is probable and reasonably estimable, so it would be recorded as follows: Loss

Contingent Liability (Record the contingent liability)

150,000,000

Requirement 3 Dinoco has a contingent gain that is probable, and is reasonably estimable at $150 million. Contingent gains are not recorded until the gain is certain. Though firms do not record contingent gains in the accounts, they sometimes disclose them in notes to the financial statements.

Problem 8-9A Requirement 1 ($ in millions)

Total Total Current ÷ Current = Assets Liabilities

ACME Corporation Wayne Enterprises

$15,372 ÷ $9,784 ÷

$11,462 $7,708

= =

Current Ratio 1.34 1.27

ACME Corporation has a better current ratio than Wayne Enterprises. Requirement 2 Total ÷ Current = Liabilities

($ in millions)

Quick Assets

ACME Corporation Wayne Enterprises

$3,889 ÷ $883 ÷

$11,462 $7,708

= =

Acid-Test Ratio 0.34 0.11

ACME Corporation also has a higher acid-test ratio than Wayne Enterprises. Requirement 3 The purchase of additional inventory on credit would increase current assets (inventory) and current liabilities (accounts payable) by the same amount. This transaction would cause the current ratios for ACME Corporation and Wayne Enterprises to decrease towards 1.0. This transaction would also cause the acid-test ratios to decrease as quick assets would remain the same, but current liabilities would increase.

PROBLEMS: SET B Problem 8-1B _i__ _d__ _h__ _c__ _j__ _b__ _f__ _g__ _a__ _e__

List A 1. Interest expense is recorded in the period interest is incurred rather than in the period interest is paid. 2. Payment is reasonably possible and is reasonably estimable. 3. Cash, current investments, and accounts receivable all divided by current liabilities. 4. Payment is probable and is reasonably estimable. 5. Gift cards. 6. Long-term debt maturing within one year. 7. Social Security and Medicare. 8. Unsecured notes sold in minimum denominations of $25,000 with maturities up to 270 days. 9. Classifying liabilities as either current or longterm helps investors and creditors assess this. 10. Incurred on a notes payable.

List B a. The riskiness of a business’s obligations b. Current portion of longterm debt c. Recording a contingent liability d. Disclosure of a contingent liability e. Interest expense f. FICA g. Commercial paper h. Acid-test ratio i. Accrual accounting j. Deferred revenue

Problem 8-2B Requirement 1 (a). November 1, 2021 Cash Notes Payable (Issuance of notes payable)

21,000,000

(b). November 1, 2021 Notes Receivable Cash (Acceptance of notes receivable)

21,000,000

Requirement 2 (a). December 31, 2021 Interest Expense ($21 million × 7% × 2/12) 245,000 Interest Payable (To record interest expense incurred, but not paid) (b). December 31, 2021 Interest Receivable ($21 million × 7% × 2/12) 245,000 Interest Revenue (Interest revenue earned, but not received)

21,000,000

245,000

Requirement 3 (a). April 30, 2022 Notes Payable 21,000,000 Interest Payable ($21 million × 7% × 2/12) 245,000 Interest Expense ($21 million × 7% × 4/12) 490,000 Cash (Payment of notes payable and interest)

(b). April 30, 2022 Cash 21,735,000 Notes Receivable Interest Receivable ($21 million × 7% × 2/12) Interest Revenue ($21 million × 7% × 4/12) (Collection of notes receivable and interest)

21,735,000

21,000,000 245,000 490,000

Problem 8-3B Requirement 1 January 31 500,000 Salaries Expense Income Tax Payable FICA Tax Payable Salaries Payable (to balance) (Employee salary expense and withholdings) Requirement 2 January 31 Salaries Expense (fringe benefits) Accounts Payable (to Blue Cross) Accounts Payable (to Fidelity) (Employer-provided fringe benefits) Requirement 3 January 31 Payroll Tax Expense (total) FICA Tax Payable Unemployment Tax Payable (Employer payroll taxes)

135,000 38,250 326,750

73,000 13,000 60,000

69,250 38,250 31,000

Problem 8-4B Requirement 1 January 24 2,500,000 Salaries Expense Income Tax Payable 537,500 FICA Tax Payable 191,250 Accounts Payable (Retirement Plan) 125,000 Salaries Payable (to balance) 1,646,250 (Employee salary expense and withholdings) Requirement 2 January 24 201,250 Salaries Expense (fringe benefits) Accounts Payable (Medical Insurance) Accounts Payable (Dental Insurance) Accounts Payable (Life Insurance) Accounts Payable (Retirement Plan) (Employer-provided fringe benefits) Requirement 3 January 24 Payroll Tax Expense (total) FICA Tax Payable Unemployment Tax Payable (Employer payroll taxes)

50,000 17,500 8,750 125,000

346,250 191,250 155,000

Problem 8-5B Requirement 1 $9,128,000 16,300 $560 16 games

$560 per season ticket

$35 per individual game ticket

Requirement 2 Cash 9,128,000 Deferred Revenue (Advance collection of ticket sales) Requirement 3 Deferred Revenue 570,500 Sales Revenue ($9,128,000/16) (Revenue recognized after first home game)

9,128,000

570,500

Problem 8-6B Requirement 1 Cash Deferred Revenue (Sale of gift cards)

2,300 2,300

Requirement 2 Deferred Revenue Sales Revenue ($742/1.06) Sales Taxes Payable (Redemption of gift certificates) Requirement 3 Deferred Revenue 2,300 742 1,558

742

700 42

Balance

Problem 8-7B Requirement 1 Bad Debt Expense ($29 million × 3%) Allowance for Uncollectible Accounts (Estimated uncollectible accounts)

870,000

Requirement 2 Compact Electronics has a contingent gain that is probable and reasonably estimable. Contingent gains are not recorded until the gain is certain. Though firms do not record contingent gains in the accounts, they sometimes disclose them in notes to the financial statements. Requirement 3 Loss Contingent Liability (Record the loss contingency)

600,000

Requirement 4 The likelihood of loss is reasonably possible rather than probable, so no journal entry is recorded. However, full disclosure of the contingent liability and the estimated range of loss between $2.5 and $3.5 million is disclosed in notes to the financial statements.

Problem 8-8B Requirement 1 The contingent liability is reasonably possible and can be reasonably estimated within a range. Because the loss is not probable, no journal entry for a loss and liability is required. Authors Academic Press must disclose a description of the loss contingency in its notes to the financial statements.

Requirement 2 The contingent liability is probable and reasonably estimable, so it must be reported. Because the estimate of the loss is a range where no amount within the range is a better estimate than any other amount, the minimum amount of the range will be recorded as follows: Loss

1,500,000 Contingent Liability (Record the loss contingency)

1,500,000

The range of the potential loss (from $1.5 to $2.25 million) should also be disclosed.

Requirement 3 Authors Academic Press has a contingent gain that is probable and can be reasonably estimated at $3 million. Contingent gains are not recorded until the gain is certain. Though firms do not record contingent gains in the accounts, they sometimes disclose them in notes to the financial statements.

Problem 8-9B Requirement 1 ($ in millions)

Total Total Current ÷ Current = Assets Liabilities

Ferris Air Oceanic Airlines

$4,227 $8,272

÷ ÷

$4,650 $13,270

Current Ratio

= =

0.91 0.62

Ferris Air has a better current ratio than Oceanic Airlines. Requirement 2 ($ in millions)

Quick Assets

Total ÷ Current = Liabilities

Ferris Air Oceanic Airlines

$3,548 $5,905

÷ ÷

$4,650 $13,270

= =

Acid-Test Ratio 0.76 0.44

Ferris Air also has a better acid-test ratio than Oceanic Airlines. Requirement 3 The purchase of additional inventory with cash would not affect the current ratio as total current assets would remain unchanged. One current asset (inventory) would increase while another current asset (cash) would decrease by the same amount. The purchase of additional inventory with cash would decrease the acid-test ratio due to the decrease in cash. Recall that inventory is excluded from the acid-test ratio.

ADDITIONAL PERSPECTIVES Continuing Problem: Great Adventures AP8-1 Requirement 1 Interest Expense Interest Payable (Accrue interest on note) ($750 = $30,000 × 6% × 5/12)

750 750

Notes Payable (long-term) Notes Payable (current) (Reclassify portion of long-term debt as current)

10,000

Deferred Revenue Sales Revenue (Record gift cards redeemed)

20,000

Loss

12,000

10,000

20,000

Contingent Liability (Record a contingent liability)

Warranty Expense Warranty Liability (Estimate future warranty costs)

12,000 4,000 4,000

Requirement 2 No entry would be required.

Additional Perspective 8-1 (in General Ledger) Students will be given the following existing trial balance. Great Adventures, Inc. Trial Balance December 31, 2022 Accounts Cash Accounts Receivable Allowance for Uncollectible Accounts Inventory Prepaid Insurance Equipment Accumulated Depreciation Accounts Payable Deferred Revenue Warranty Liability Contingent Liability Income Tax Payable Interest Payable Notes Payable (current) Notes Payable (long-term) Common Stock Retained Earnings Service Revenue Sales Revenue Interest Revenue Sales Discounts Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Warranty Expense Loss

Debit $ 89,070 50,000

Credit

$ 2,400 7,000 900 62,000 25,250 20,800 25,000 -0-014,500 -0-030,000 20,000 33,450 44,500 100,000 120 350 38,500 17,250 5,700 2,400 24,000 500 2,400 400 -0-0-

Interest Expense Income Tax Expense Totals

1,050 14,500 $316,020

$316,020

Additional Perspective 8-1 (in General Ledger, continued) Interest Expense Interest Payable (Accrue interest on note) ($750 = $30,000 × 6% × 5/12)

750 750

Notes Payable (long-term) Notes Payable (current) (Reclassify portion of long-term debt as current)

10,000

Deferred Revenue Sales Revenue (Record gift cards redeemed)

20,000

Loss

12,000

10,000

20,000

Contingent Liability (Record a contingent liability)

Warranty Expense Warranty Liability (Estimate future warranty costs)

12,000 4,000 4,000

Additional Perspective 8-1 (in General Ledger, continued)

$ 44,500 120,000 (350) 164,150 38,500 $125,650 17,250 5,700 2,400 24,000 500 2,400 400 4,000 12,000 68,650 57,000 120 (1,800) 55,320 14,500 $ 40,820

Additional Perspective 8-1 (in General Ledger, continued)

Great Adventures, Inc. Balance Sheet December 31, 2022 Assets

Current assets: Cash Accounts receivable Allow for Uncoll Accts Inventory Prepaid Insurance Total current assets

$ 89,070 50,000 (2,400) 7,000 900 144,570

Long-term assets: Equipment Accumulated depreciation

62,000 (25,250)

Total assets

$181,320

Liabilities Current liabilities: Accounts payable Deferred Revenue Warranty Liability Contingent Liability Income tax payable Interest payable Notes Payable (current) Total current liabilities Notes payable (long-term) Total liabilities

$ 20,800 5,000 4,000 12,000 14,500 750 10,000 67,050 20,000 87,050

Stockholders’ Equity Common stock 20,000 Retained earnings 74,270 Total stockholders’ equity 94,270 Total liabilities and stockholders’ equity $181,320

Additional Perspective 8-1 (in General Ledger, concluded) Dec. 31, 2022 Service Revenue Sales Revenue Interest Revenue Sales Discounts Retained Earnings (Close revenue accounts) Dec. 31, 2022 Retained Earnings Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Warranty Expense Loss Interest Expense Income Tax Expense (Close expense accounts)

Debit 44,500 120,000 120

Credit

350 164,270 123,450 38,500 17,250 5,700 2,400 24,000 500 2,400 400 4,000 12,000 1,800 14,500

Financial Analysis: American Eagle AP8-2

($ in thousands) Requirement 1 Total Current Total Current Assets ÷ Liabilities 2018 $968,530 ÷ $485,221 2017 $901,229 ÷ $493,783 The current ratio improved in the more recent year.

= = =

Current Ratio 2.00 1.83

= = =

Acid-Test Ratio 1.01 0.94

Requirement 2

Quick Total Current Assets ÷ Liabilities 2018 $491,917 ÷ $485,221 2017 $465,247 ÷ $493,783 The acid-test ratio also improved in the more recent year.

Requirement 3 If American Eagle used $100 million in cash to pay $100 million in accounts payable, its current ratio and acid-test ratio will improve since they are greater than 1. The calculations are provided as follows:

Before After

Total Current Assets $968,530 $968,530 − $100,000

Before After

Quick Assets ÷ $491,917 ÷ $491,917 − $100,000 ÷

÷ ÷ ÷

Total Current Liabilities $485,221 $485,221 − $100,000 Total Current Liabilities $485,221 $485,221 − $100,000

= = =

Current Ratio 2.00 2.25

Acid-Test Ratio 1.01 1.02

Financial Analysis: The Buckle AP8-3

($ in thousands) Requirement 1 Total Current Total Current Assets ÷ Liabilities 2018 $360,584 ÷ $97,906 2017 $386,457 ÷ $98,616 The current ratio weakens in the more recent year.

= = =

Current Ratio 3.68 3.92

= = =

Acid-Test Ratio 2.29 2.58

Requirement 2

Quick Total Current Assets ÷ Liabilities 2018 $224,507 ÷ $97,906 2017 $254,740 ÷ $98,616 The acid-test ratio also weakens in the more recent year.

Requirement 3 If Buckle purchased $50 million of inventory by debiting inventory and crediting accounts payable, its current ratio and acid-test ratio would weaken. The calculations are provided as follows:

Before After

Total Current Total Current Assets ÷ Liabilities = $360,584 ÷ $97,906 = $360,584 + $50,000 ÷ $97,906 + $50,000 =

Current Ratio 3.68 2.78

Before After

Quick Assets ÷ $224,507 ÷ $224,507 + $50,000 ÷

Acid-Test Ratio 2.29 1.86

Total Current Liabilities $97,906 $97,906 + 50,000

= = =

Comparative Analysis: American Eagle vs. The Buckle AP8-4

($ in thousands) Requirement 1 Total Current Assets

Total Current Liabilities

Current Ratio

American Eagle $968,530 ÷ $485,221 = 2.00 Buckle $360,584 ÷ $97,906 = 3.68 Buckle has a better current ratio. Both American Eagle and Buckle have better ratios than United and American Airlines. The clothing industry maintains a higher current ratio. Requirement 2 Quick Assets

Total Current Liabilities

Acid-Test Ratio

American Eagle $491,917 ÷ $485,221 = 1.01 Buckle $224,507 ÷ $97,906 = 2.29 Buckle also has a better acid-test ratio. Both American Eagle and Buckle have better ratios than United and American Airlines. The clothing industry maintains a higher acid-test ratio. Requirement 3 The purchase of additional inventory with accounts payable will decrease the current ratio for American Eagle and Buckle because their current ratio is above 1.0.

Ethics AP8-5 1. Eugene’s decision will have no effect on current assets but will understate current liabilities. Under either assumption, cash (current asset) is collected. Deferred revenue is a liability. Eugene’s decision not to record the deferred revenue will understate current liabilities. 2. ($ in millions) Treatment Service Revenue Deferred Revenue

Total Current Assets

Total Current Liabilities

Current Ratio

$10.1

$10

1.01

$10.1

$10 + $1

0.92

3. Yes. By recording the cash received as revenue, the reported current ratio remains above 1.0. First Federal Bank will not consider Caribbean Cruise Lines to be in violation of its debt covenant. 4. No. Receiving cash in advance from customers is considered a liability. While Caribbean Cruise Line has received the cash, it remains obligated to provide services to customers in the following year. By not recording this obligation, the company provides the false appearance of adequate liquidity. Eugene may justify his decision based on the company’s history and the fact that cash has been received. These factors may suggest a high likelihood that the bank will be fully repaid. However, at this point there are no guarantees that the economy will not worsen further, preventing loan repayment by even the most well-meaning borrowers.

Internet Research AP8-6 This case provides an opportunity for students to research stock price and accounting information on a publicly traded company of their choice. This case also allows students to access key statistics on companies and compare accounting information with competitors in the same industry. Answers to the assignment will vary depending on the company chosen.

Written Communication AP8-7 a. In order to record a contingent liability, the loss must be probable and the amount must be reasonably estimable. A loss and liability will not be recorded for the employee strikes, even though the likelihood of loss is probable (virtually certain), because the loss cannot be reasonably estimated. However, careful disclosure of the situation should be provided in the notes to the financial statements. b. Western should record warranty expense of $40,000 (2% x $2 million in sales) rather than just the $25,000 in warranty expense recorded for expenditures incurred so far. It is probable that costs for warranties will be incurred and, based on their experience with previous product introductions, the company can reasonably estimate the amount. Therefore, the following additional amount should be recorded: Warranty Expense Warranty Liability (Loss contingency for warranties)

15,000

c. The likelihood of loss is reasonably possible rather than probable, so a contingent liability is not recorded. However, full disclosure of the contingent liability is made in a note to the financial statements.

Earnings Management AP8-8 Requirement 1 Yes. Quattro can use the estimate for warranty expense to manage the reported amount of net income. Quattro can report lower net income in 2021 by recording more warranty expense and building up the warranty liability in that year. The company can then run down the warranty liability in 2022 and record less warranty expense, boosting net income in that year. Total net income over the two-year period is unaffected, but the reported amount of net income in each year is affected. Requirement 2 ($ in millions) 2021 2022

Net Income Before Warranty Expense $210 $210

−

Warranty Expense

Net Income

− −

$50 $30

= =

$160 $180

Requirement 3 Yes. By recording $50 million in warranty expense in 2021 and $30 million in warranty expense in 2022, rather than $40 million each year, Quattro is able to report steadier growth in net income. Net income increases by $20 million each year over the four year period ($120, $140, $160, and $180 million). Using $40 million in warranty expense in 2021 and 2022 would have resulted in reported net income of $120, $140, $170, and $170 million over the four-year period, which provides a less stable, upward pattern.

Chapter 9 - Long-Term Liabilities

Chapter 9 Long-Term Liabilities REVIEW QUESTIONS Question 9-1 (LO 9-1)

Capital structure is the mixture of liabilities and stockholders’ equity a business uses. Companies in the auto industry, like Ford, typically lean more toward liabilities for their financing, while companies in the computer industry, like Microsoft, use stockholders’ equity to a greater extent in financing their asset growth.

Question 9-2 (LO 9-1)

One of the primary reasons a company chooses to borrow money rather than issue additional stock relates to taxes. Interest expense incurred when borrowing money is tax deductible, while dividends paid to stockholders is not tax deductible. Therefore, debt can be a less costly form of financing. A second reason relates to control. If a company issues additional shares to investors, control in the company is shared with the new shareholders. If a company borrows funds, voting control in the company is retained.

Question 9-3 (LO 9-2)

Both interest expense and the carrying value of the note decrease over time. Interest expense decreases with each installment payment. In each of the following periods, the amount that goes to interest expense becomes less and the amount that goes to decreasing the carrying value becomes more. Interest expense decreases over time because the carrying value decreases over time, and interest is a constant percentage of carrying value.

Question 9-4 (LO 9-3)

A lease is a contractual arrangement by which the lessor (owner) provides the lessee (user) the right to use an asset for a specified period of time. In the balance sheet, a lease asset is reported for the right to use an asset, and a lease liability is reported for the obligation to make lease payments. The amount to report at the beginning of the lease is the present value of the lease payments.

Question 9-5 (LO 9-4) Bond issue costs include underwriting services, legal, accounting, registration, and printing fees incurred to complete the bond issue. An underwriter is the investment house through which the bonds are sold like JPMorgan Chase, Citigroup, and Bank of America.

Chapter 9 - Long-Term Liabilities

Answers to Review Questions (continued) Question 9-6 (LO 9-4)

A company that borrows by issuing bonds is effectively by-passing the bank and borrowing directly from the investing public, usually at a lower interest rate than from a bank loan. However, issuing bonds entails significant bond issue costs that often exceed 5% of the amount borrowed. For smaller loans, the additional bond issue costs exceed the savings from a lower interest rate, making it more economical to borrow from a bank. For loans of $20 million or more, the interest rate savings often exceed the additional bond issuance costs, making a bond issue more attractive.

Question 9-7 (LO 9-4)

(a) Secured bonds are supported by assets pledged as collateral. Unsecured bonds, also referred to as debentures, are not backed by a specific asset. (b) Term bonds require payment of the full principal amount of the bond at a single maturity date. Serial bonds require payments in installments over a series of years. (c) Callable bonds allow the issuer to repay the bonds before their scheduled maturity date at a specified call price. Convertible bonds allow the investor to convert each bond into a specified number of shares of common stock.

Question 9-8 (LO 9-4)

Convertible bonds allow the investor to convert each bond into a specified number of shares of common stock. The investor benefits from the conversion feature if share prices rise above the fixed conversion rate. For instance, assume a $1,000 bond is convertible into 40 shares of common stock, when the stock is trading at $23 per share. If the stock rises above $25 ($1,000/40), the shareholder will benefit by converting the bond into 40 common shares of stock. The borrower also benefits. Convertible bonds sell at a higher price and require a lower interest rate than bonds without a conversion feature.

Question 9-9 (LO 9-5)

(a) The face amount is the amount that will be repaid at maturity. The carrying value is the balance in the Bonds Payable account minus any discount or plus any premium. For example a $100,000 bond that issues for $93,205 has a face value of $100,000 and a carrying value of $93,205 on the date of issue calculated as Bonds Payable of $100,000 less Discount on Bonds Payable of $6,795. The carrying value will increase from $93,205 to $100,000 over the life of the bond issue. (b) The stated interest rate is the rate used to determine the periodic interest payments paid by the borrower. The market interest rate represents the true interest rate used by investors to value the bond issue.

Chapter 9 - Long-Term Liabilities

Answers to Review Questions (continued) Question 9-10 (LO 9-5)

The bonds issue at a discount when the stated interest rate is less than the market interest rate. The bonds are paying less than the going rate and, therefore, issue at a discount.

Question 9-11 (LO 9-5)

The bonds issue at a premium when the stated interest rate is more than the market interest rate. The bonds are paying more than the going rate and, therefore, issue at a premium.

Question 9-12 (LO 9-5)

If bonds issue at a discount, the carrying value of the bonds and interest expense will increase over time. Recall that interest expense is calculated as the carrying value of the bond times the market interest rate. As carrying value increases, interest expense also increases.

Question 9-13 (LO 9-5)

If bonds issue at a premium, the carrying value of the bonds and interest expense will decrease over time. Recall that interest expense is calculated as the carrying value of the bond times the market interest rate. As carrying value decreases, interest expense also decreases.

Question 9-14 (LO 9-5) Cash paid is calculated as the face amount of the bonds times the stated interest rate. Interest expense is the carrying value times the market rate. The difference between interest expense and the cash paid increases the carrying value of the bonds. At the maturity date, the carrying value will equal the face amount. The amortization schedule is similar when bonds are issued at a premium, except that the difference between interest expense and the cash paid decreases, rather than increases, the carrying value of the bonds over time.

Question 9-15 (LO 9-6) If interest rates decrease, a company may choose to buy back high interest rate bonds and reissue bonds at a lower interest rate. A company can help protect itself from decreases in interest rates by including a call feature allowing the company to repurchase bonds at a fixed price (like 2% over face amount). When interest rates decrease, companies with a call provision are more likely to repurchase higher-cost debt and then reissue debt at new lower interest rates. Another incentive to repay debt early is to improve the company's debt and profitability ratios. Repurchasing debt can improve debt ratios. It can also improve profitability. If interest rates increase, bond prices go down and a company repurchasing the lower priced debt can report a gain on the income statement.

Chapter 9 - Long-Term Liabilities

Answers to Review Questions (continued) Question 9-16 (LO 9-6) A loss of $50,000 is recorded by the issuer retiring the bonds as follows:

Bonds Payable Premium on Bonds Payable Loss Cash (Retire bonds before maturity)

250,000 30,000 50,000 330,000

Question 9-17 (LO 9-7)

We calculate the issue price of a bond as the present value of the principal (the face amount on the bond due at maturity) plus the present value of the periodic interest payments. It is not solely the present value of the principal; rather it is the present value of the principal plus the present value of the interest payments.

Question 9-18 (LO 9-7) The cash payment every six months is $15,000 ($500,000 × .06 × 6/12). There will be 40 interest payments over the 20 years – one every six months.

Question 9-19 (LO 9-7) (a) $562,757 (b) $500,000 (c) $446,612 (Note: These answers are based on a calculator/Excel. Answers using the present value tables may differ just a little due to rounding.)

Question 9-20 (LO 9-8)

Additional debt increases risk. Failure to repay debt or the interest associated with the debt on a timely basis may result in default and perhaps even bankruptcy. Other things being equal, the higher the debt, the higher the risk of bankruptcy. Additional debt also offers potential rewards. If a company earns a return in excess of the cost of borrowing the funds, shareholders are provided with a total return greater than what could have been earned with equity funds alone. Unfortunately, borrowing is not always favorable. Sometimes the cost of borrowing the funds exceeds the returns they generate.

Chapter 9 - Long-Term Liabilities

BRIEF EXERCISES Brief Exercise 9-1 (LO 9-2) January 1, 2021 Equipment Notes Payable (Issue a note payable) January 31, 2021 Interest Expense ($30,000 × 5% × 1/12) Notes Payable (difference) Cash (monthly payment) (Pay monthly installment on note)

30,000 30,000

125.00 441.14

566.14

Brief Exercise 9-2 (LO 9-2) January 1, 2021 Building Notes Payable (Issue a note payable) January 31, 2021 Interest Expense ($600,000 × 6% × 1/12) Notes Payable (difference) Cash (monthly payment) (Pay monthly installment on note)

600,000

3,000.00 597.30

600,000

3,597.30

Brief Exercise 9-3 (LO 9-3) January 1, 2021 Lease Asset Lease Payable (Sign a lease)

100,000

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-4 (LO 9-3) Balance before: Effect of lease: Balance after:

Assets $600,000 + 40,000 $640,000

Liabilities $400,000 + 40,000 $440,000

Stockholders’ Equity $200,000 $200,000

Exercise 9-5 (LO 9-4) Terms __e___ 1. Sinking fund. __g___ 2. Secured bond. __c___ 3. Unsecured bond. __f___ 4. Term bond. __b___ 5. Serial bond. __a___ 6. Callable bond. __d___ 7. Convertible bond. __h___ 8. Bond issue costs. Definitions a. Allows the issuer to pay off the bonds early at a fixed price. b. Matures in installments. c. Secured only by the “full faith and credit” of the issuing corporation. d. Allows the investor to transfer each bond into shares of common stock. e. Money set aside to pay debts as they come due. f. Matures on a single date. g. Supported by specific assets pledged as collateral by the issuer. h. Includes underwriting, legal, accounting, registration, and printing fees.

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-6 (LO 9-5) 1. January 1, 2021 Cash Bonds Payable (Issue bonds at face amount)

70,000

2. June 30, 2021 Interest Expense Cash ($70,000 × 7% × ½) (Pay semiannual interest)

2,450

70,000

2,450

Brief Exercise 9-7 (LO 9-5) 1. January 1, 2021 Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) 2. June 30, 2021 Interest Expense ($63,948 × 8% × ½) Discount on Bonds Payable (difference) Cash ($70,000 × 7% × ½) (Pay semiannual interest)

63,948 6,052

2,558

70,000

108 2,450

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-8 (LO 9-5) 1. January 1, 2021 Cash Bonds Payable Premium on Bonds Payable (Issue bonds at a premium) 2. June 30, 2021 Interest Expense ($76,860 × 6% × ½) Premium on Bonds Payable (difference) Cash ($70,000 × 7% × ½) (Pay semiannual interest)

76,860

2,306 144

70,000 6,860

2,450

Brief Exercise 9-9 (LO 9-5) 1. January 1, 2021 Cash Bonds Payable (Issue bonds at face amount)

70,000

2. December 31, 2021 Interest Expense Cash ($70,000 × 7%) (Pay annual interest)

4,900

70,000

4,900

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-10 (LO 9-5) 1. January 1, 2021 Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) 2. December 31, 2021 Interest Expense ($64,008 × 8%) Discount on Bonds Payable (difference) Cash ($70,000 x7% ) (Pay annual interest)

64,008 5,992 70,000

5,121

221 4,900

Brief Exercise 9-11 (LO 9-5)

1. January 1, 2021 Cash Bonds Payable Premium on Bonds Payable (Issue bonds at a premium) 2. December 31, 2021 Interest Expense ($76,799 × 6%) Premium on Bonds Payable (difference) Cash ($70,000 × 7%) (Pay annual interest)

76,799

4,608 292

70,000 6,799

4,900

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-12 (LO 9-5) $2,653 ($88,443 × 6% × ½).

Brief Exercise 9-13 (LO 9-5) Interest expense for the year ended December 31, 2021 would be $4,157. Interest expense for the first six months ended June 30, 2021 is $2,075 ($82,985 × 5% × ½). Interest expense for the next six months ended December 31, 2021 is $2,082 ([$82,985 + ($2,075 – $1,800)] × 5% × ½). Thus, the total interest expense for the year is $2,075 + $2,082 = $4,157.

Brief Exercise 9-14 (LO 9-5) 1. Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) 2. Interest Expense Discount on Bonds Payable Cash (Pay semiannual interest)

63,948 6,052

2,558

70,000

108 2,450

3. Interest expense increases each period because the carrying value of the debt issued at a discount increases over time.

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-15 (LO 9-5) 1. Cash

Bonds Payable Premium on Bonds Payable (Issue bonds at a premium)

2. Interest Expense Premium on Bonds Payable Cash (Pay semi-annual interest)

76,860

2,306 144

70,000 6,860

2,450

3. Interest expense decreases each period because the carrying value of the debt issued at a premium decreases over time.

Brief Exercise 9-16 (LO 9-6) Bonds Payable Loss Discount on Bonds Payable Cash (Retire bonds before maturity)

70,000 3,832 5,832 68,000

Brief Exercise 9-17 (LO 9-6) Bonds Payable Premium on Bonds Payable Gain Cash (Retire bonds before maturity)

70,000 6,567

4,567 72,000

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-18 (LO 9-7) If the market rate is 7%, the bonds will issue at $60,000 (face amount).

Calculator Input Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $60,000 $2,100 = $60,000 × 7% × ½ year 20 = 10 years × 2 periods each year 3.5% = 7% / 2 periods each year

Calculator Output Issue price

$60,000

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-19 (LO 9-7) If the market rate is 8%, the bonds will issue at $54,812 (a discount).

Calculator Input Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $60,000 $2,100 = $60,000 × 7% × ½ year 30 = 15 years × 2 periods each year 4% = 8% / 2 periods each year

Calculator Output Issue price

$54,812

Brief Exercise 9-20 (LO 9-7) If the market rate is 6%, the bonds will issue at $66,934 (a premium).

Calculator Input Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $60,000 $2,100 = $60,000 × 7% × ½ year 40 = 20 years × 2 periods each year 3% = 6% / 2 periods each year

Calculator Output Issue price

$66,934

Chapter 9 - Long-Term Liabilities

Brief Exercise 9-21 (LO 9-8) 1.

Total Liabilities $628

÷ ÷

Net Income ÷ $66 ÷ *($718 + $727) / 2 3. Net Income + Interest + Taxes ÷ $125 ÷

Stockholders’ Equity $99

= =

Average Total Assets $722.5*

= =

Return on Assets Ratio 9.1%

= =

Times Interest Earned Ratio 8.3

Interest $15

Debt to Equity Ratio 6.34

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Chapter 9 - Long-Term Liabilities

EXERCISES Exercise 9-1 (LO 9-1) Requirement 1 Operating income Interest expense (note only) Income before tax Income tax expense (35%) Net income # of shares Earnings per share (Net income / # of shares)

Issue Note $11,000,000 2,450,000 8,550,000 2,992,500 $ 5,557,500

Issue Stock $11,000,000

4,000,000

5,000,000

$1.39

$1.43

11,000,000 3,850,000 $ 7,150,000

Requirement 2 Issuing stock results in higher earnings per share. Issuing the note results in earnings per share of $1.39 compared with $1.43 for issuing stock.

Chapter 9 - Long-Term Liabilities

Exercise 9-2 (LO 9-2) January 1, 2021 Cash Notes Payable (Issue a note payable) January 31, 2021 Interest Expense ($50,000 × 6% × 1/12) Notes Payable (difference) Cash (monthly payment) (Pay monthly installment on note) February 28, 2021 Interest Expense ([$50,000-578.64] × 6% × 1/12) Notes Payable (difference) Cash (monthly payment) (Pay monthly installment on note)

50,000

250.00 578.64

50,000

828.64

247.11 581.53 828.64

Chapter 9 - Long-Term Liabilities

Exercise 9-3 (LO 9-2) Requirement 1 January 1, 2021 Land Notes Payable (Issue a note payable for land) Requirement 2 June 30, 2021 Interest Expense ($800,000 × 6% × 6/12) Notes Payable (difference) Cash (semiannual payment) (Pay annual installment on note) December 31, 2021 Interest Expense ([$800,000−191,221.64] × 6% × 6/12) Notes Payable (difference) Cash (annual payment) (Pay annual installment on note)

800,000

24,000.00 191,221.64 215,221.64

18,263.35 196,958.29

215,221.64

Requirement 3 Notes Payable = $800,000 − $191,221.64 − $196,958.29 = $411,820.07 Interest Expense = $24,000.00 + $18,263.35 = $42,263.35

Chapter 9 - Long-Term Liabilities

Exercise 9-4 (LO 9-3, LO 9-8) Requirement 1 Assets $25 million

Liabilities $15 million

Stockholders’ Equity ?

Stockholders’ equity must be $10 million ($25 million − $15 million). Requirement 2 Total Liabilities $15 million Requirement 3 Total Liabilities $15 + $2 = $17 million

÷ ÷

Stockholders’ Equity $10 million

Stockholders’ Equity

$10 million

= =

Debt to Equity Ratio 1.50

Debt to Equity Ratio 1.70

Requirement 4 Yes. A higher ratio typically indicates greater risk.

Exercise 9-5 (LO 9-3) Requirement 1 PV of lease payments = $3,618.18 × 22.110544* = $80,000 (rounded) * Present value of an annuity; n = 24; i = 8%/12 Requirement 2 June 1, 2021 Lease Asset Lease Payable (Record a 24-month lease)

80,000

Chapter 9 - Long-Term Liabilities

Exercise 9-6 (LO 9-3) Requirement 1 PV of lease payments = $29,122.87 × 17.16864* = $500,000 (rounded) * Present value of an annuity; n = 20; i = 6%/4 (Table 4) Requirement 2 June 30, 2021 Lease Asset Lease Payable (Record a 20-quarter lease)

500,000

Exercise 9-7 (LO 9-5) January 1, 2021 Cash Bonds Payable (Issue bonds at face amount) June 30, 2021 Interest Expense Cash ($500,000 × 9% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense Cash ($500,000 × 9% × ½) (Pay semiannual interest)

500,000

22,500

500,000

22,500

Chapter 9 - Long-Term Liabilities

Exercise 9-8 (LO 9-5) Requirement 1 (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

(2)

(3)

Cash Paid Face Amount x 4.5% Stated Rate

Interest Expense Carrying Value x 5% Market Rate

$ 22,500 22,500

$ 22,855 22,873

Requirement 2 January 1, 2021 Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) June 30, 2021 Interest Expense Discount on Bonds Payable (difference) Cash ($500,000 × 9% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense Discount on Bonds Payable (difference) Cash ($500,000 × 9% × ½) (Pay semiannual interest)

(4) Increase in Carrying Value

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$ 355 373

$ 457,102 457,457 457,830

457,102 42,898

22,855

500,000

355 22,500

22,873 373 22,500

Chapter 9 - Long-Term Liabilities

Exercise 9-9 (LO 9-5) Requirement 1 (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

(2)

(3)

Cash Paid Face Amount x 4.5% Stated Rate

Interest Expense Carrying Value x 4% Market Rate

$ 22,500 22,500

$ 21,979 21,958

Requirement 2 January 1, 2021 Cash Bonds Payable Premium on Bonds Payable (Issue bonds at a premium) June 30, 2021 Interest Expense Premium on Bonds Payable (difference) Cash ($500,000 × 9% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense Premium on Bonds Payable (difference) Cash ($500,000 × 9% × ½) (Pay semiannual interest)

(4) Decrease in Carrying Value

(5)

(2) – (3)

Carrying Value Prior Carrying Value – (4)

$ 521 542

$ 549,482 548,961 548,419

549,482

500,000 49,482

21,979 521 22,500

21,958 542

22,500

Chapter 9 - Long-Term Liabilities

Exercise 9-10 (LO 9-5) January 1, 2021 Cash Bonds Payable (Issue bonds at face amount) June 30, 2021 Interest Expense Cash ($600,000 × 7% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense Cash ($600,000 × 7% × ½) (Pay semiannual interest)

600,000

21,000

600,000

21,000

Chapter 9 - Long-Term Liabilities

Exercise 9-11 (LO 9-5) Requirement 1 (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

(2)

(3)

Cash Paid Face Amount x 3.5% Stated Rate

Interest Expense Carrying Value x 4% Market Rate

$ 21,000 21,000

$ 22,369 22,424

Requirement 2 January 1, 2021 Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) June 30, 2021 Interest Expense Discount on Bonds Payable (difference) Cash ($600,000 x7% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense Discount on Bonds Payable (difference) Cash ($600,000 × 7% × ½) (Pay semiannual interest)

(4) Increase in Carrying Value

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$ 1,369 1,424

$ 559,229 560,598 562,022

559,229 40,771

22,369

600,000

1,369 21,000

22,424 1,424 21,000

Chapter 9 - Long-Term Liabilities

Exercise 9-12 (LO 9-5) Requirement 1 (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

(2)

(3)

Cash Paid Face Amount x 3.5% Stated Rate

Interest Expense Carrying Value x 3% Market Rate

$ 21,000 21,000

$ 19,339 19,289

Requirement 2 January 1, 2021 Cash Bonds Payable Premium on Bonds Payable (Issue bonds at a premium) June 30, 2021 Interest Expense Premium on Bonds Payable (difference) Cash ($600,000 × 7% × ½) (Pay semi-annual interest) December 31, 2021 Interest Expense Premium on Bonds Payable (difference) Cash ($600,000 × 7% × ½) (Pay semi-annual interest)

(4) Decrease in Carrying Value

(5)

(2) – (3)

Carrying Value Prior Carrying Value – (4)

$ 1,661 1,711

$ 644,632 642,971 641,260

644,632

600,000 44,632

19,339 1,661 21,000

19,289 1,711

21,000

Chapter 9 - Long-Term Liabilities

Exercise 9-13 (LO 9-5) January 1, 2021 Cash Bonds Payable (Issue bonds at face amount) December 31, 2021 Interest Expense Cash ($600,000 × 7%) (Pay annual interest) December 31, 2022 Interest Expense Cash ($600,000 × 7%) (Pay annual interest)

600,000

42,000

600,000

42,000

Chapter 9 - Long-Term Liabilities

Exercise 9-14 (LO 9-5) Requirement 1 (1) Date

1/ 1 /2021 12/31/2021 12/31/2022

(2)

(3)

Cash Paid Face Amount x 7% Stated Rate

Interest Expense Carrying Value x 8% Market Rate

$ 42,000 42,000

$ 44,779 45,002

Requirement 2 January 1, 2021 Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) December 31, 2021 Interest Expense Discount on Bonds Payable (difference) Cash ($600,000 × 7%) (Pay annual interest) December 31, 2022 Interest Expense Discount on Bonds Payable (difference) Cash ($600,000 × 7%) (Pay annual interest)

(4) Increase in Carrying Value

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$ 2,779 3,002

$ 559,740 562,519 565,521

559,740 40,260

44,779

600,000

2,779 42,000

45,002 3,002 42,000

Chapter 9 - Long-Term Liabilities

Exercise 9-15 (LO 9-5) Requirement 1 (1) Date

1/ 1 /2021 12/31/2021 12/31/2022

(2)

(3)

Cash Paid Face Amount x 7% Stated Rate

Interest Expense Carrying Value x 6% Market Rate

$ 42,000 42,000

$ 38,650 38,449

Requirement 2 January 1, 2021 Cash Bonds Payable Premium on Bonds Payable (Issue bonds at a premium) December 31, 2021 Interest Expense Premium on Bonds Payable (difference) Cash ($600,000 × 7%) (Pay annual interest) December 31, 2022 Interest Expense Premium on Bonds Payable (difference) Cash ($600,000 × 7%) (Pay annual interest)

(4) Decrease in Carrying Value

(5)

(2) – (3)

Carrying Value Prior Carrying Value – (4)

$ 3,350 3,551

$ 644,161 640,811 637,260

644,161

600,000 44,161

38,650 3,350 42,000

38,449 3,551

42,000

Chapter 9 - Long-Term Liabilities

Exercise 9-16 (LO 9-6) Requirement 1 (1) Date

1/ 1 /2021 6/30/2021 12/31/2021 6/30/2022 12/31/2022

(2)

(3)

Cash Paid Face Amount x 4.5% Stated Rate

Interest Expense Carrying Value x 5% Market Rate

$ 22,500 22,500 22,500 22,500

$ 22,855 22,873 22,892 22,911

(4) Increase in Carrying Value

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$ 355 373 392 411

$ 457,102 457,457 457,830 458,222 458,633

Requirement 2 If the market rate drops to 7%, it will cost $601,452 to retire the bonds.

Calculator Input Bond characteristics 1. Face amount 2. Interest payment each period 3. Periods to maturity 4. Market interest rate each period

Key

Amount

FV PMT N I

$500,000 $22,500 = $500,000 × 9% × ½ year 36 = 18 years × 2 periods each year 3.5% = 7% / 2 periods each year

Calculator Output Issue price

$601,452

December 31, 2022 Bonds Payable Loss Discount on Bonds Payable Cash (Retire bonds before maturity)

500,000 142,819

41,367 601,452

Chapter 9 - Long-Term Liabilities

Exercise 9-17 (LO 9-6) Requirement 1 (1) Date

1/ 1 /2021 6/30/2021 12/31/2021 6/30/2022 12/31/2022 6/30/2023 12/31/2023

(2)

(3)

Cash Paid Face Amount x 3.5% Stated Rate

Interest Expense Carrying Value x 3% Market Rate

$ 21,000 21,000 21,000 21,000 21,000 21,000

$ 19,339 19,289 19,238 19,185 19,130 19,074

(4) Decrease in Carrying Value

(5)

(2) – (3)

Carrying Value Prior Carrying Value – (4)

$ 1,661 1,711 1,762 1,815 1,870 1,926

$ 644,632 642,971 641,260 639,498 637,683 635,813 633,887

Requirement 2 If the market rate increases to 8%, it will cost $568,311 to retire the bonds.

Calculator Input Bond Characteristics 1. Face amount 2. Interest payment each period 3. Periods to maturity 4. Market interest rate each period

Key

Amount

FV PMT N I

$600,000 $21,000 = $600,000 × 7% × ½ year 14 = 7 years × 2 periods each year 4% = 8% / 2 periods each year

Calculator Output Issue price

$568,311

December 31, 2023 Bonds Payable Premium on Bonds Payable Gain Cash (Retire bonds before maturity)

600,000 33,887

65,576 568,311

Chapter 9 - Long-Term Liabilities

Exercise 9-18 (LO 9-7) Requirement 1 Premium. The issue price is $45,057,519

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $41,000,000 $1,845,000 = $41,000,000 × 9% × ½ year 40 = 20 years × 2 periods each year 4% = 8% / 2 periods each year

Calculator Output Issue price

$45,057,519

Requirement 2 Face amount. The issue price is $41,000,000.

Calculator Input Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $41,000,000 $1,845,000 = $41,000,000 × 9% × ½ year 40 = 20 years × 2 periods each year 4.5% = 9% / 2 periods each year

Calculator Output Issue price

$41,000,000

Chapter 9 - Long-Term Liabilities

Requirement 3 Discount. The issue price is $37,482,387

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $41,000,000 $1,845,000 = $41,000,000 × 9% × ½ year 40 = 20 years × 2 periods each year 5% = 10% / 2 periods each year

Calculator Output Issue price

$37,482,387

Chapter 9 - Long-Term Liabilities

Exercise 9-19 (LO 9-7) Requirement 1 Premium. The issue price is $27,934,072.

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $26,000,000 $910,000 = $26,000,000 x7% × ½ year 20 = 10 years × 2 periods each year 3% = 6% / 2 periods each year

Calculator Output Issue price

$27,934,072

Requirement 2 Face amount. The issue price is $26,000,000.

Calculator Input Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $26,000,000 $910,000 = $26,000,000 × 7% × ½ year 20 = 10 years × 2 periods each year 3.5% = 7% / 2 periods each year

Calculator Output Issue price

$26,000,000

Chapter 9 - Long-Term Liabilities

Requirement 3 Discount. The issue price is $24,233,258.

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $26,000,000 $910,000 = $26,000,000 × 7% × ½ year 20 = 10 years × 2 periods each year 4% = 8% / 2 periods each year

Calculator Output Issue price

$24,233,258

Chapter 9 - Long-Term Liabilities

Exercise 9-20 (LO 9-8) Requirement 1

E-Travel Pricecheck

Total Liabilities

Stockholders’ Equity =

$4,254,475 $486,610

÷ ÷

$3,182,681 $1,607,614

= =

Debt to Equity Ratio 1.34 0.30

E-Travel has a higher debt to equity ratio than Pricecheck. Requirement 2

E-Travel Pricecheck

Net Income + Interest + Taxes ÷

Interest

Times Interest Earned Ratio

$588,159 $600,724

$94,233 $34,084

= =

6.2 17.6

÷ ÷

Pricecheck, with a times interest earned ratio of 17.6, is better able to meet interest payments as they become due than E-Travel with a ratio of only 6.2.

Chapter 9 - Long-Term Liabilities

Exercise 9-21 (LO 9-2, LO 9-8)

Requirement 1 January 1 Cash Notes Payable (Long-term) (Issue a long-term note payable)

Debit 100,000

100,000

January 4 Cash Accounts Receivable (Receive cash on account)

Debit 31,000

January 11 Accounts Payable Cash (Pay cash on account)

Debit 11,000

January 15 Salaries Expense Cash (Pay for salaries)

Debit 28,900

January 30 Cash Accounts Receivable Sales Revenue (Sell inventory for cash and on account) Cost of Goods Sold Inventory (Record cost of inventory sold)

Debit 65,000 130,000

January 31 Interest Expense Notes Payable (Long-term) Cash (Pay monthly installment on long-term note) ($583 = $100,000 × 7% × 1/12)

Credit

Credit 31,000 Credit 11,000 Credit 28,900 Credit 195,000

112,500 112,500 Debit 583 1,397

Credit 1,980

Chapter 9 - Long-Term Liabilities

Exercise 9-21 (continued)

Requirement 2 (a) January 31 Depreciation Expense Accumulated Depreciation (Record depreciation for January) ($800 = [$120,000−$24,000] / 120 months)

Debit 800

Credit 800

(b) January 31 Debit Bad Debt Expense 2,300 Allowance for Uncollectible Accounts (Adjust uncollectible accounts) ($2,300 = [$3,000×50%]+[$130,000a×2%]−$1,800) a $130,000 = $34,000−$31,000+$130,000−$3,000

Credit

Debit 26,100

Credit

(d) January 31 Income Tax Expense Income Tax Payable (Adjust income taxes)

Debit 8,000

(e) January 31 Notes Payable (Long-term) Notes Payable (Current) (Reclassify current portion of note payable)

Debit 17,411

2,300

26,100 Credit 8,000 Credit 17,411

Chapter 9 - Long-Term Liabilities

Exercise 9-21 (continued) Requirement 3 Freedom Fireworks Adjusted Trial Balance January 31, 2021 Accounts Debit Cash $165,320 Accounts Receivable 133,000 Allowance for Uncollectible Accounts Inventory 39,500 Land 67,300 Buildings 120,000 Accumulated Depreciation Accounts Payable Salaries Payable Income Tax Payable Notes Payable (Current) Notes Payable (Long-term) Common Stock Retained Earnings Sales Revenue Cost of Goods Sold 112,500 Salaries Expense 55,000 Bad Debt Expense 2,300 Depreciation Expense 800 Interest Expense 583 Income Tax Expense 8,000 Totals $704,303

Credit $ 4,100

10,400 6,700 26,100 8,000 17,411 81,192 200,000 155,400 195,000

$704,303

Chapter 9 - Long-Term Liabilities

Exercise 9-21 (continued) Requirement 3 (continued) Ending Accounts Balance Cash $165,320 Accounts Receivable 133,000 Allow for Uncoll Accts 4,100 Inventory 39,500 Land 67,300 Buildings 120,000 Accumulated Depreciation 10,400 Accounts Payable 6,700 Salaries Payable 26,100 Income Tax Payable 8,000 Notes Payable (Current) 17,411 Notes Payable (Long-term) 81,192 Common Stock 200,000 Retained Earnings 155,400 Sales Revenue 195,000 Cost of Goods Sold 112,500 Salaries Expense 55,000 Bad Debt Expense 2,300 Depreciation Expense 800 Interest Expense 583 Income Tax Expense 8,000

= = = = = = = = = = = = = = = = = = = = =

Beginning balance in bold, entries during January in blue, and adjusting entries in red. 11,200+100,000+31,000−11,000−28,900+65,000−1,980 34,000−31,000+130,000 1,800+2,300 152,000−112,500 67,300 120,000 9,600+800 17,700−11,000 26,100 8,000 17,411 100,000 – 1,397 -17,411 200,000 155,400 195,000 112,500 28,900+26,100 2,300 800 583 8,000

Chapter 9 - Long-Term Liabilities

Exercise 9-21 (continued) Requirement 4 Freedom Fireworks Multiple-Step Income Statement For the year month ended January 31, 2021 Sales revenue $195,000 Cost of goods sold 112,500 Gross profit $ 82,500 Salaries expense Bad debt expense Depreciation expense Total operating expenses Operating income

55,000 2,300 800 58,100 24,400

Interest expense Income before taxes

583 23,817

Income tax expense Net income

8,000 $ 15,817

Requirement 5

Assets

Freedom Fireworks Classified Balance Sheet January 31, 2021 Liabilities

Cash $165,320 Accounts receivable 133,000 Less: Allowance (4,100) 128,900 Inventory 39,500 Total current assets 333,720 Land Buildings Less: Accumulated Depreciation Total assets *

67,300 120,000 (10,400) $510,620

Accounts payable Salaries payable Income tax payable Notes payable (Current) Total current liabilities Notes payable (Long-term) Total liabilities Stockholders’ Equity Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity

$ 6,700 26,100 8,000 17,411 58,211 81,192 139,403 200,000 171,217 * 371,217 $510,620

Retained earnings = Beginning retained earnings + Net income − Dividends = $155,400 + $15,817 − $0 = $171,217

Chapter 9 - Long-Term Liabilities

Exercise 9-21 (concluded) Requirement 6

January 31, 2021 Sales Revenue Retained Earnings (Close revenue accounts)

Debit 195,000

Retained Earnings Cost of Goods Sold Salaries Expense Bad Debt Expense Depreciation Expense Interest Expense Income Tax Expense (Close expense accounts)

179,183

Credit 195,000

112,500 55,000 2,300 800 583 8,000

Requirement 7 (a) The debt to equity ratio is: Debt to Equity Ratio

Total Liabilities Stockholders’ Equity

$139,403 $371,217

0.38

Freedom Fireworks is less leveraged than the industry average. Freedom Fireworks has a lower proportion of liabilities in relation to stockholders’ equity than the industry average of 1.0. (b) The times interest earned ratio is: Net Income +Interest Expense + Tax Expense $15,817 +$583 +$8,000 = 41.9 = Interest Expense $583 Compared to the industry average of 20 times, Freedom Fireworks is more able to meet interest payments than other companies in the same industry. Times Interest Earned Ratio

(c) Based on the debt to equity ratio and the times interest earned ratio, ratio, Freedom Fireworks would more likely receive a lower interest rate than the average borrowing rate in the industry. Freedom Fireworks carries less debt than the industry average and is better able to meet interest payments than the average company in the industry.

Chapter 9 - Long-Term Liabilities

PROBLEMS: SET A Problem 9-1A (LO 9-2) Requirement 1 January 1, 2021 Building Cash Notes Payable (Issue a mortgage note payable)

360,000 60,000 300,000

Requirement 2 (1)

(2)

(3)

(4)

(5)

Date

Cash Paid

Interest Expense

Carrying Value

Monthly Payment

Carrying Value x 0.07 × 1/12

Decrease in Carrying Value

$3,483.25 3,483.25

$ 1,750.00 1,739.89

1/1/2021 1/31/2021 2/28/2021

Requirement 3 January 31, 2021 Interest Expense ($300,000 × 7% × 1/12) Notes Payable (difference) Cash (monthly payment) (Pay monthly installment on note )

(2) – (3) $ 1,733.25 1,743.36

Prior Carrying Value – (4) $ 300,000.00 298,266.75 296,523.39

1,750.00 1,733.25 3,483.25

In the first monthly payment, $1,750.00 goes to interest expense and $1,733.25 goes to reducing the carrying value of the loan. Requirement 4 Total payments on the loan are $417,990. Since actual payments on the loan are $300,000, the remainder of $117,990 is the amount paid for interest expense.

Chapter 9 - Long-Term Liabilities

Problem 9-2A (LO 9-2) Requirement 1 January 1, 2021 Cash Notes Payable (Issue a note payable)

2,000,000

Requirement 2 Date

Cash Paid

Interest Expense

Decrease in Carrying Value

12/31/2021 12/31/2022 12/31/2023

776,067 776,067 776,067

160,000 110,715 57,486

616,067 665,352 718,581

Carrying Value 2,000,000 1,383,933 718,581 0

Requirement 3 December 31, 2021 Interest Expense Notes Payable Cash (Pay annual installment on note)

160,000 616,067

December 31, 2022 Interest Expense Notes Payable Cash (Pay annual installment on note)

110,715 665,352

December 31, 2023 Interest Expense Notes Payable Cash (Pay annual installment on note)

57,486 718,581

776,067

Chapter 9 - Long-Term Liabilities

Problem 9-3A (LO 9-3, 9-8) Requirement 1 Assets $81 million

Liabilities $11 + $41 = $52 million

Stockholders’ Equity ?

Stockholders’ equity must be $29 million ($81 million - $52 million). Requirement 2 Total Liabilities $52 million

÷ ÷

Requirement 3 ($ in millions) Lease Asset Lease Payable (Record a lease)

Stockholders’ Equity $29 million

= =

Debt to Equity Ratio 1.79

Requirement 4 Yes. The revised debt to equity ratio of 2.34 is greater than the 2.0 ratio required in the bond agreement. Total Stockholders’ Debt to Equity Liabilities ÷ Equity = Ratio $52 + 16 = 68 million ÷ $29 million = 2.34

Chapter 9 - Long-Term Liabilities

Problem 9-4A (LO 9-5) Requirement 1 January 1, 2021 Cash Bonds Payable (Issue bonds at face amount) June 30, 2021 Interest Expense Cash ($600,000 × 8% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense Cash ($600,000 × 8% × ½) (Pay semiannual interest) Requirement 2 January 1, 2021 Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) June 30, 2021 Interest Expense ($544,795 × 9% × ½) Discount on Bonds Payable (difference) Cash ($600,000 × 8% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense ([$544,795+$516] × 9% × ½) Discount on Bonds Payable (difference) Cash ($600,000 × 8% × ½) (Pay semiannual interest)

600,000

24,000

544,795 55,205

24,516

24,539

600,000

24,000

600,000

516 24,000

539 24,000

Chapter 9 - Long-Term Liabilities

Requirement 3 January 1, 2021 Cash Bonds Payable Premium on Bonds Payable (Issue bonds at a premium) June 30, 2021 Interest Expense ($664,065 × 7% × ½) Premium on Bonds Payable (difference) Cash ($600,000 × 8% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense ([$664,065 – $758] × 7% × ½) Premium on Bonds Payable (difference) Cash ($600,000 × 8% × ½) (Pay semiannual interest)

664,065

23,242 758

600,000 64,065

24,000

23,216 784 24,000

Chapter 9 - Long-Term Liabilities

Problem 9-5A (LO 9-5) 1. Discount 2. $37,281,935 3. $40,000,000 4. 7% ($1,400,000 cash paid ÷ $40,000,000 face value) × 2 5. 8% ($1,491,277 interest expense ÷ $37,281,935 carrying value) × 2 6. $28,000,000 ($1,400,000 × 20 payments)

Chapter 9 - Long-Term Liabilities

Problem 9-6A (LO 9-5) Requirement 1 (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

(2)

(3)

Cash Paid Face Amount x 4% Stated Rate

Interest Expense Carrying Value x 4.5% Market Rate

$ 36,000 36,000

$ 37,866 37,950

Requirement 2 January 1, 2021 Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) Requirement 3 June 30, 2021 Interest Expense ($841,464 × 9% × ½) Discount on Bonds Payable (difference) Cash ($900,000 × 8% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense ($843,330 × 9% × ½) Discount on Bonds Payable (difference) Cash ($900,000 × 8% × ½) (Pay semiannual interest)

(4) Increase in Carrying Value

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$ 1,866 1,950

$ 841,464 843,330 845,280

841,464 58,536

900,000

37,866 1,866 36,000 37,950 1,950 36,000

Chapter 9 - Long-Term Liabilities

Problem 9-7A (LO 9-5, 9-7) Requirement 1 Face amount. The issue price is $1,300,000.

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $1,300,000 $45,500 = $1,300,000 × 7% × ½ year 30 = 15 years × 2 periods each year 3.5% = 7% / 2 periods each year

Calculator Output Issue price (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

$1,300,000

(2)

(3)

Cash Paid Face Amount x 3.5% Stated Rate

Interest Expense Carrying Value x 3.5% Market Rate

$ 45,500 45,500

(4) Increase in Carrying Value

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$0 0

$ 1,300,000 1,300,000 1,300,000

Chapter 9 - Long-Term Liabilities

Requirement 2 Discount. The issue price is $1,187,602.

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $1,300,000 $45,500 = $1,300,000 × 7% × ½ year 30 = 15 years × 2 periods each year 4% = 8% / 2 periods each year

Calculator Output Issue price

(1) Date

$1,187,602

(2)

(3)

Cash Paid Face Amount x 3.5% Stated Rate

Interest Expense Carrying Value x 4% Market Rate

1/ 1 /2021 6/30/2021 12/31/2021

$ 45,500 45,500

(4) Increase in Carrying Value

$ 47,504 47,584

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$ 2,004 2,084

$ 1,187,602 1,189,606 1,191,690

Requirement 3 Premium. The issue price is $1,427,403.

Calculator Input Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $1,300,000 $45,500 = $1,300,000 × 7% × ½ year 30 = 15 years × 2 periods each year 3% = 6% / 2 periods each year

Calculator Output Issue price

$1,427,403

Chapter 9 - Long-Term Liabilities

(1) Date

1/ 1 /2021 6/30/2021 12/31/2021

(2)

(3)

Cash Paid Face Amount x 3.5% Stated Rate

Interest Expense Carrying Value x 3% Market Rate

$ 45,500 45,500

$ 42,822 42,742

(4) Decrease in Carrying Value

(5)

(2) – (3)

Carrying Value Prior Carrying Value – (4)

$ 2,678 2,758

$ 1,427,403 1,424,725 1,421,967

Chapter 9 - Long-Term Liabilities

Problem 9-8A (LO 9-8) Requirement 1 ($ in millions)

Total Liabilities

Bahama Bay Caribbean Key

$5,724 $2,819

Stockholders’ ÷ Equity = ÷ ÷

$3,137 $4,821

= =

Debt to Equity Ratio 1.82 0.58

Bahama Bay has a higher debt to equity ratio than Caribbean Key. Requirement 2 ($ in millions)

Net Income

Bahama Bay $562 Caribbean Key $88 *($8,861 + $9,560) / 2 **($7,640 + $7,507) / 2

Average Total Assets

÷ ÷

$9,210.5* = $7,573.5** =

Return on Assets Ratio 6.1% 1.2%

Bahama Bay is more profitable than Caribbean Key. Requirement 3 ($ in millions)

Net Income + Interest + Taxes

Interest

Times Interest Earned Ratio

Bahama Bay Caribbean Key

$880 $166

÷ ÷

$170 $70

= =

5.2 2.4

Bahama Bay, with a times interest earned ratio of 5.2, is better able to meet interest payments as they become due than Caribbean Key with a ratio of only 2.4.

Chapter 9 - Long-Term Liabilities

PROBLEMS: SET B Problem 9-1B (LO 9-2) Requirement 1 January 1, 2021 Building Cash Notes Payable (Issue a mortgage note payable)

610,000

110,000 500,000

Requirement 2 (1)

(2)

(3)

(4)

(5)

Date

Cash Paid

Interest Expense

Carrying Value

Monthly Payment

Carrying Value x 0.09 × 1/12

Decrease in Carrying Value

1/1/2021 1/31/2021 2/28/2021

$ 5,071.33 5,071.33

$ 3,750.00 3,740.09

Requirement 3 January 31, 2021 Interest Expense ($500,000 × 9% × 1/12) Notes Payable (difference) Cash (monthly payment) (Pay monthly installment on note )

(2) – (3)

Prior Carrying Value – (4)

$ 1,321.33 1,331.24

$ 500,000.00 498,678.67 497,347.43

3,750.00 1,321.33

5,071.33

In the first monthly payment, $3,750.00 goes to interest expense and only $1,321.33 goes to reducing the carrying value of the loan. Requirement 4 Over the 15 year mortgage, $412,839 is interest expense and $500,000 goes to reducing the carrying value of the loan. Interest expense over the 15 year mortgage is calculated as the total payments of $912,839 minus the $500,000 carrying value of the loan.

Chapter 9 - Long-Term Liabilities

Problem 9-2B (LO 9-2) Requirement 1 January 1, 2021 Cash Notes Payable (Issue a note payable)

9,000,000

Requirement 2 Date

Cash Paid

Interest Expense

Decrease in Carrying Value

12/31/2021 12/31/2022 12/31/2023 12/31/2023

2,657,053 2,657,053 2,657,053 2,657,053

630,000 488,106 336,280 173,826

2,027,053 2,168,947 2,320,773 2,483,227

Carrying Value 9,000,000 6,972,947 4,804,000 2,483,227 0

Requirement 3 December 31, 2021 Interest Expense Notes Payable Cash (Pay annual installment on note)

630,000 2,027,053

December 31, 2022 Interest Expense Notes Payable Cash (Pay annual installment on note)

488,106 2,168,947

December 31, 2023 Interest Expense Notes Payable Cash (Pay annual installment on note)

336,280 2,320,773

December 31, 2024 Interest Expense Notes Payable Cash (Pay annual installment on note)

173,826 2,483,227

2,657,053

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Chapter 9 - Long-Term Liabilities

Problem 9-3B (LO 9-3, 9-8) Requirement 1 Assets $201 million

Stockholders’ Equity ?

Liabilities + $91 + $61 = $152 million

Stockholders’ equity must be $49 million ($201 million - $152 million). Requirement 2 Total Liabilities $152 million

÷ ÷

Stockholders’ Equity $49 million

Requirement 3 ($ in millions) Lease Asset Lease Payable (Record a lease agreement)

= =

Debt to Equity Ratio 3.10

Requirement 4 Yes. The revised debt to equity ratio of 3.63 is greater than the 3.25 ratio required in the bond agreement. Total Stockholders’ Debt to Equity Liabilities ÷ Equity = Ratio $152 + 26 = 178 million ÷ $49 million = 3.63

Chapter 9 - Long-Term Liabilities

Problem 9-4B (LO 9-5) Requirement 1 January 1, 2021 Cash Bonds Payable (Issue bonds at face amount) June 30, 2021 Interest Expense Cash ($3,000,000 × 9% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense Cash ($3,000,000 × 9% × ½) (Pay semiannual interest) Requirement 2 January 1, 2021 Cash Discount on Bonds Payable Bonds Payable (Issue bonds at a discount) June 30, 2021 Interest Expense ($2,813,067 × 10% × ½) Discount on Bonds Payable (difference) Cash ($3,000,000 × 9% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense ([$2,813,067+$5,653] x10% × ½) Discount on Bonds Payable (difference) Cash ($3,000,000 × 9% × ½) (Pay semiannual interest)

3,000,000

135,000

2,813,067 186,933

140,653

140,936

3,000,000

135,000

3,000,000

5,653 135,000

5,936 135,000

Chapter 9 - Long-Term Liabilities

Requirement 3 January 1, 2021 Cash Bonds Payable Premium on Bonds Payable (Issue bonds at a premium) June 30, 2021 Interest Expense ($3,203,855 × 8% × ½) Premium on Bonds Payable (difference) Cash ($3,000,000 × 9% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense ([$3,203,855 – $6,846] × 8% × ½) Premium on Bonds Payable (difference) Cash ($3,000,000 × 9% × ½) (Pay semiannual interest)

3,203,855

128,154 6,846

3,000,000 203,855

135,000

127,880 7,120 135,000

Problem 9-5B (LO 9-5) 1. Premium 2. $66,934,432 3. $60,000,000 4. 7% ($2,100,000 cash paid ÷ $60,000,000 face value) × 2 5. 6% ($2,008,033 interest expense ÷ $66,934,432 carrying value) × 2 6. $84,000,000 ($2,100,000 × 40 payments)

Chapter 9 - Long-Term Liabilities

Problem 9-6B (LO 9-5) Requirement 1 (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

(2)

(3)

Cash Paid Face Amount x 3.5% Stated Rate

Interest Expense Carrying Value x 3% Market Rate

$ 35,000 35,000

$ 32,940 32,878

Requirement 2 January 1, 2021 Cash Bonds Payable Premium on Bonds Payable (Issue bonds at a premium) Requirement 3 June 30, 2021 Interest Expense ($1,098,002 × 6% × ½) Premium on Bonds Payable (difference) Cash ($1,000,000 × 7% × ½) (Pay semiannual interest) December 31, 2021 Interest Expense ($1,095,942 × 6% × ½) Premium on Bonds Payable (difference) Cash ($1,000,000 × 7% × ½) (Pay semiannual interest)

(4) Decrease in Carrying Value

(5)

(2) – (3)

Carrying Value Prior Carrying Value – (4)

$ 2,060 2,122

$ 1,098,002 1,095,942 1,093,820

1,098,002 1,000,000 98,002

32,940 2,060

32,878 2,122

35,000

Chapter 9 - Long-Term Liabilities

Problem 9-7B (LO 9-5, 9-7) Requirement 1 Face amount. The issue price is $850,000.

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $850,000 $25,500 = $850,000 × 6% × ½ year 20 = 10 years × 2 periods each year 3% = 6% / 2 periods each year

Calculator Output Issue price (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

$850,000

(2)

(3)

Cash Paid Face Amount x 3% Stated Rate

Interest Expense Carrying Value x 3% Market Rate

$ 25,500 25,500

(4) Increase in Carrying Value

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$0 0

$ 850,000 850,000 850,000

Chapter 9 - Long-Term Liabilities

Requirement 2 Discount. The issue price is $789,597.

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $850,000 $25,500 = $850,000 × 6% × ½ year 20 = 10 years × 2 periods each year 3.5% = 7% / 2 periods each year

Calculator Output Issue price

(1) Date

1/ 1 /2021 6/30/2021 12/31/2021

$789,597

(2)

(3)

Cash Paid Face Amount x 3% Stated Rate

Interest Expense Carrying Value x 3.5% Market Rate

$ 25,500 25,500

$ 27,636 27,711

(4) Increase in Carrying Value

(5)

(3) – (2)

Carrying Value Prior Carrying Value + (4)

$ 2,136 2,211

$ 789,597 791,733 793,944

Chapter 9 - Long-Term Liabilities

Requirement 3 Premium. The issue price is $916,254.

Calculator Input

Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $850,000 $25,500 = $850,000 × 6% × ½ year 20 = 10 years × 2 periods each year 2.5% = 5% / 2 periods each year

Calculator Output Issue price (1) Date

1/ 1 /2021 6/30/2021 12/31/2021

$916,254

(2)

(3)

Cash Paid Face Amount x 3% Stated Rate

Interest Expense Carrying Value x 2.5% Market Rate

$ 25,500 25,500

$ 22,906 22,842

(4) Decrease in Carrying Value

(5)

(2) – (3)

Carrying Value Prior Carrying Value – (4)

$ 2,594 2,658

$ 916,254 913,660 911,002

Chapter 9 - Long-Term Liabilities

Problem 9-8B (LO 9-8) Requirement 1 ($ in millions)

Total Liabilities

Stockholders’ ÷ Equity =

Surf City Paradise Falls

$11,519 $15,232

÷ ÷

$8,309 $23,929

Debt to Equity Ratio

= =

1.39 0.64

Surf City has a higher debt to equity ratio than Paradise Falls. Requirement 2 ($ in millions)

Net Income

Surf City $18 Paradise Falls $1,298 *($19,828 + $19,804) / 2 **($39,161 + $38,637) / 2

Average Total Assets

Return on Assets Ratio

÷ ÷

$19,816* $38,899**

= =

0.1% 3.3%

Paradise Falls is more profitable than Surf City. Requirement 3 ($ in millions) Surf City Paradise Falls

Net Income + Interest + Taxes ÷ $374 $1,638

÷ ÷

Interest

Times Interest Earned Ratio

$356 $336

= =

1.1 4.9

Paradise Falls, with a times interest earned ratio of 4.9, is better able to meet interest payments as they become due than Surf City with a ratio of only 1.1.

Chapter 9 - Long-Term Liabilities

ADDITIONAL PERSPECTIVES Continuing Problem: Great Adventures AP9-1 Requirement 1 (1) Date 11/ 1 /2022 11/30/2022 12/31/2022

(2)

(3)

Cash Paid Monthly Payment

Interest Expense Carrying Value × 6% × 1/12

$ 5,551 5,551

$ 2,500 2,485

(4) Decrease in Carrying Value (2) – (3) $ 3,051 3,066

(5) Carrying Value Prior Carrying Value – (4) $ 500,000 496,949 493,883

Chapter 9 - Long-Term Liabilities

Requirement 2 November 1, 2022 Land Notes Payable (long-term) (Purchase land by issuing a note payable)

500,000

Requirement 3 November 30, 2022 Interest Expense ($500,000 × 6% × 1/12) Notes Payable (difference) Cash (monthly payment) (Pay monthly installment on note )

2,500 3,051

December 31, 2022 Interest Expense ($496,949 × 6% × 1/12) Notes Payable (difference) Cash (monthly payment) (Pay monthly installment on note ) Balance as of December 31, 2022: November 1 – Issuance November 30 – First payment December 31 – Second payment Balance

500,000

5,551

2,485 3,066 5,551

$500,000 (3,051) (3,066) $493,883

Requirement 4 Current liability* Long-term liability

$ 38,014 455,869 $493,883

* Portion of note that will be paid within one year of the balance sheet date.

Chapter 9 - Long-Term Liabilities

Additional Perspective 9-1 (in General Ledger) Students will be given the following existing trial balance. Great Adventures, Inc. Trial Balance December 31, 2022 (Prior to transactions in AP9-1) Accounts Cash Accounts Receivable Allowance for Uncollectible Accounts Inventory Prepaid Insurance Land Equipment Accumulated Depreciation Accounts Payable Deferred Revenue Warranty Liability Contingent Liability Income Tax Payable Interest Payable Notes Payable (current) Notes Payable (long-term) Common Stock Retained Earnings Service Revenue Sales Revenue Interest Revenue Sales Discounts Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Warranty Expense

Debit $ 89,070 50,000

Credit

$ 2,400 7,000 900 -062,000 25,250 20,800 5,000 4,000 12,000 14,500 750 10,000 20,000 20,000 33,450 44,500 120,000 120 350 38,500 17,250 5,700 2,400 24,000 500 2,400 400 4,000

Chapter 9 - Long-Term Liabilities

Loss Interest Expense Income Tax Expense Totals

12,000 1,800 14,500 $332,770

$332,770

Chapter 9 - Long-Term Liabilities

Additional Perspective 9-1 (in General Ledger, continued) November 1, 2022 Land Notes Payable (long-term) (Purchase land by issuing a note payable) November 30, 2022 Interest Expense ($500,000 × 6% × 1/12) Notes Payable (long-term) Cash (monthly payment) (Pay monthly installment on note ) December 31, 2022 Interest Expense ($496,949 × 6% × 1/12) Notes Payable (long-term) Cash (monthly payment) (Pay monthly installment on note ) December 31, 2022 Notes Payable (long-term) Notes Payable (current) (Reclassify portion of long-term note payable as current)

500,000

2,500 3,051

500,000

5,551

2,485 3,066 5,551

38,014 38,014

Chapter 9 - Long-Term Liabilities

Additional Perspective 9-1 (in General Ledger, continued)

$ 44,500 120,000 (350) 164,150 38,500 $125,650 17,250 5,700 2,400 24,000 500 2,400 400 4,000 12,000 68,650 57,000 120 (6,785) 50,335 14,500 $ 35,835

Chapter 9 - Long-Term Liabilities

Additional Perspective 9-1 (in General Ledger, continued)

Great Adventures, Inc. Balance Sheet December 31, 2022 Assets

Current assets: Cash Accounts receivable Allow for Uncoll Accts Inventory Prepaid Insurance Total current assets

$ 77,968 50,000 (2,400) 7,000 900 133,468

Long-term assets: Land Equipment Accumulated depreciation

500,000 62,000 (25,250)

Total assets

$670,218

$ 20,800 5,000 4,000 12,000 14,500 750 48,014 105,064 475,869 580,933

Stockholders’ Equity Common stock 20,000 Retained earnings 69,285 Total stockholders’ equity 89,285 Total liabilities and stockholders’ equity $670,218

Chapter 9 - Long-Term Liabilities

Additional Perspective 9-1 (in General Ledger, concluded) Dec. 31, 2022 Service Revenue Sales Revenue Interest Revenue Sales Discounts Retained Earnings (Close revenue accounts) Dec. 31, 2022 Retained Earnings Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Warranty Expense Loss Interest Expense Income Tax Expense (Close expense accounts)

Debit 44,500 120,000 120

Credit

350 164,270 128,435 38,500 17,250 5,700 2,400 24,000 500 2,400 400 4,000 12,000 6,785 14,500

Chapter 9 - Long-Term Liabilities

Financial Analysis: American Eagle AP9-2 ($ in thousands) Requirement 1

Total Liabilities

2018 $569,522 ÷ 2017 $578,091 ÷ The ratio decreased in the more recent year. Requirement 2

2018

Net Income $204,163

Stockholders’ Equity

Debt to Equity Ratio

$1,246,791 $1,204,569

= =

0.46 0.48

Average Total Assets =

÷ ($1,816,313 + = 1,782,660)/2

Return on Assets 11.3%

This rate exceeds the approximate cost of borrowing. Requirement 3 The bankruptcy risk of American Eagle is low. The company carries very little debt and has several large lines of credit that it could use to borrow in the future if necessary.

Chapter 9 - Long-Term Liabilities

Financial Analysis: Buckle AP9-3 ($ in thousands) Requirement 1

Total Liabilities

2018 $146,868 ÷ 2017 $149,308 ÷ The ratio increased in the more recent year. Requirement 2

2018

Net Income $89,707

Stockholders’ Equity

Debt to Equity Ratio

$391,248 $430,539

= =

0.38 0.35

Average Total Assets

Return on Assets

($538,116 + $579,847)/2

16.0%

This rate exceeds the approximate cost of borrowing. Requirement 3 The bankruptcy risk of The Buckle is low. The company carries no bank borrowings and has an unsecured line of credit that it could use to borrow in the future if necessary.

Chapter 9 - Long-Term Liabilities

Comparative Analysis: American Eagle vs. Buckle AP9-4 ($ in thousands) Requirement 1

American Eagle Buckle

Total Liabilities $569,522 $146,868

Stockholders’ Equity

Debt to Equity Ratio

÷ ÷

$1,246,791 $391,248

= =

0.46 0.38

American Eagle has a riskier (higher) debt to equity ratio. The ratios are both much lower than those for Coca-Cola and Pepsi reported in the chapter. The soft-drink industry maintains a higher debt to equity ratio than the retail clothing industry. Requirement 2

American Eagle Buckle

Net Income $204,163 $89,707

Average Total Assets

Return on Assets Ratio

÷ ÷

($1,816,313 + 1,782,660)/2 ($538,116 + $579,847)/2

= =

11.3% 16.0%

Buckle appears more profitable.

Chapter 9 - Long-Term Liabilities

Ethics AP9-5

1. Current liabilities are understated and long-term liabilities are overstated by $447,116. Current liabilities are defined as debt that is due within one year of the balance sheet date. Because $447,116 of the principal will be paid in the following year, this portion of the long-term note should be classified as current. 2.

Current Ratio Current Assets/ Current Liabilities

Debt to Equity Ratio Total Liabilities / Total Equity

With Jim’s suggestion

$3,100,000 / $2,700,000

= 1.15

$5,283,026 / $4,000,000

= 1.32

Without Jim’s suggestion

$3,100,000 / $3,147,116

= 0.99

$5,283,026 / $4,000,000

= 1.32

3. Yes. By misclassifying the current portion of the note as part of long-term liabilities, the current ratio is overstated. Thus, the company’s ability to pay its debt in the following year is overstated. Lenders may not understand the company’s true ability to pay debt. The expectation of using long-term profits to pay long-term debt is not a justification for the misclassification. There are no guarantees that those profits will exist, and to the extent the company cannot pay its debt in the following year, longer-term profits are not helpful. The debt to equity ratio does not reveal this misclassification because the numerator is total liabilities. Whether the debt is classified as current or long-term has no effect on the reported amount of total liabilities. 4. No. The portion of the note that is due within one year of the balance sheet date ($447,116) should be reported as a current liability. The portion of the note due in more than one year should be classified as a long-term liability ($2,135,910 = $2,583,026 − $447,116).

Chapter 9 - Long-Term Liabilities

Internet Research AP9-6 This case provides an opportunity for students to learn more about credit ratings at Standard & Poor’s. This case also allows students to access current items in the business press. Answers to the assignment will vary depending on the news items chosen.

Chapter 9 - Long-Term Liabilities

Written Communication AP9-7 Requirement 1 A company that borrows by issuing bonds is effectively by-passing the bank and borrowing directly from the investing public, usually at a lower interest rate than it would in a bank loan. However, issuing bonds entails significant bond issue costs for the underwriter, legal fees, and accounting costs. For smaller loans, the additional bond issuance costs exceed the savings from a lower interest rate, making it more economical to borrow from a bank. For loans of $20 million or more, the interest rate savings often exceed the additional bond issuance costs, making a bond issue more attractive. Requirement 2 One of the primary reasons for issuing bonds over issuing common stock relates to taxes. Interest expense incurred when borrowing money is tax deductible, while dividends paid to stockholders are not tax deductible. Therefore, debt can be a less costly form of financing. Requirement 3 The price of a bond is calculated as the present value of the principal (the face amount on the bond due at maturity) plus the present value of the periodic interest payments. The stated rate is used to calculate the periodic interest payment each period. The market rate is used to calculate the present value of the principal and periodic interest payments.

Chapter 9 - Long-Term Liabilities

Earnings Management AP9-8 Requirement 1 Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Calculator Input Key FV PMT N I

Amount $100,000,000 $3,000,000 = $100,000,000 × 6% × ½ year 30 = 15 years × 2 periods each year 2.5% = 5% / 2 periods each year

Calculator Output Issue price

$110,465,146

Requirement 2

Calculator Input Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Key FV PMT N I

Amount $100,000,000 $3,000,000 = $100,000,000 × 6% × ½ year 20 = 10 years × 2 periods each year 2.5% = 5% / 2 periods each year

Calculator Output Issue price

$107,794,581

Chapter 9 - Long-Term Liabilities

Requirement 3 Bond Characteristics 1. Face amount 2. Interest payment 3. Periods to maturity 4. Market interest rate

Calculator Input Key FV PMT N I

Amount $100,000,000 $3,000,000 = $100,000,000 × 6% × ½ year 20 = 10 years × 2 periods each year 4.5% = 9% / 2 periods each year

Calculator Output Issue price

$80,488,095

Requirement 4 December 31, 2021 Bonds Payable 100,000,000 Premium on Bonds Payable 7,794,581 Gain 27,306,486 Cash 80,488,095 (Retire bonds before maturity) The transaction increases net income by the amount of the gain, $27,306,486. Requirement 5 No. Investors likely would not agree with David Plesko’s plan. To report the $27 million gain on repurchase, the company must give up bonds costing only $6 million ($100 million times 6%) in interest each year and reissue new bonds requiring the payment of $9 million ($100 million times 9%) in interest each year. The additional interest cost of $3 million each year will reduce the company’s cash flows.

Chapter 10 Stockholders’ Equity REVIEW QUESTIONS Question 10-1 (LO 10-1)

Most corporations first raise money by selling stock to the founders of the business and their friends and family. As the equity financing needs of the corporation grow, companies prepare a business plan and seek outside investment from “angel” investors and venture capital firms. Angel investors are wealthy individuals in the business community willing to risk investment funds on a promising business venture. Venture capital firms provide additional financing, often in the millions, for a percentage ownership in the company. Many venture capital firms look to invest in promising companies to which they can add value through business contacts, financial expertise, or marketing channels. Most corporations do not consider issuing stock to the general public (going public) until their equity financing needs exceed $20 million dollars.

Question 10-2 (LO 10-1) The stock of a publicly held corporation trades on the New York Stock Exchange (NYSE), National Association of Securities Dealers Automated Quotations (NASDAQ), or by over-thecounter (OTC) trading. Examples include Walmart, General Motors, and General Electric. A privately held corporation does not allow investment by the general public and normally has fewer stockholders. Three of the largest private corporations in the United States are Cargill (agricultural commodities), Koch Industries (oil and gas), and Mars (candy).

Question 10-3 (LO 10-1)

The basic ownership rights of common stockholders are (1) the right to vote, (2) the right to receive dividends, and (3) the right to share in the distribution of assets.

Question 10-4 (LO 10-1) Sole proprietorships are the most common form of business. However, corporations are larger in terms of total sales, total assets, earnings, or number of employees.

Question 10-5 (LO 10-1) A corporation offers two primary advantages over sole proprietorships and partnerships. These are (1) limited liability and (2) ability to raise capital and transfer ownership. Because of limited liability, even in the event of bankruptcy, stockholders in a corporation can lose no more than the amount they invested in the company. Because corporations sell ownership interest in the form of shares of stock, ownership rights are easily transferred. An investor can sell his or her ownership interest (shares of stock) at any time and without affecting the structure of the corporation or its operations. A corporation has two primary disadvantages relative to sole proprietorships and partnerships. These are (1) additional taxes and (2) more paperwork. Corporations have double taxation. Corporate income is taxed once on earnings at the corporate level and again on dividends at the ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Vol.1, Chapter 10 10-1

individual level. Corporations also have more paperwork as federal and state governments impose extensive reporting requirements on the company.

Question 10-6 (LO 10-1)

An LLC or an S Corporation allows a company to enjoy limited liability as a corporation, but avoid the double taxation of traditional corporations.

Question 10-7 (LO 10-2)

Authorized stock is the total number of shares available to sell, stated in the company’s articles of incorporation. Issued stock is the number of shares that have been sold to investors. A company usually does not issue all its authorized stock. Outstanding stock is the number of shares held by investors. Issued and outstanding are the same amounts as long as the corporation has not purchased any of its shares. Purchased shares, called treasury stock, are included as part of shares issued, but excluded from shares outstanding.

Question 10-8 (LO 10-2)

One million shares are authorized, 100,000 shares are issued, and 90,000 shares are outstanding.

Question 10-9 (LO 10-2)

Par value is the legal capital per share of stock that’s assigned when the corporation is first established. Par value has no relationship to the market value of the common stock. We credit the common stock account for the number of shares issued times the par value per share and we credit additional paid-in capital for the portion of the cash proceeds above par value.

Question 10-10 (LO 10-3)

The three potential features of preferred stock are convertible, redeemable, and cumulative. Convertible makes it appear more like stockholders’ equity, while redeemable and cumulative make it appear more like long-term liabilities.

Question 10-11 (LO 10-3)

Investors in common stock are the owners of the corporation. Investors in bonds are creditors who have loaned money to the corporation. Preferred stock fits somewhere between common stock and bonds. For example, the risk and expected return are greatest for investments in common stock followed by preferred stock and then bonds. In contrast, preference for payments of interest and dividends are given first to bonds, then preferred stock, and then common stock. Illustration 10-7 provides a summary.

Question 10-12 (LO 10-4)

A company may buy back its own stock to boost under-priced stock. When a company’s management feels the market price of its stock is too low, it may attempt to support the price by decreasing the supply of stock in the marketplace. Other reasons why a company might buy back its own stock are to distribute surplus cash in the company without paying dividends, to boost earnings per share, and to offset issuance of shares under stock-based compensation plans.

Question 10-13 (LO 10-4)

When a corporation purchases its own stock, it increases, or debits treasury stock reported in the balance sheet as a reduction in stockholders’ equity. When a corporation purchases stock in another ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 3-2 Financial Accounting, 5e

corporation, it increases, or debits an investment account reported in the balance sheet as an increase in assets.

Question 10-14 (LO 10-5)

Many companies that are unprofitable choose not to pay dividends. Management of these companies may instead need to use that cash for strategic purposes to keep the company from bankruptcy. However, many profitable companies also choose not to pay cash dividends. Companies with large expansion plans, called “growth companies,” prefer to reinvest earnings in the growth of the company rather than distribute earnings back to investors in the form of cash dividends. Investors purchase stock in companies that do not pay dividends because they expect share prices to increase. Investors hope a company’s share price increases and then they can sell the stock for a profit. Profitable companies that reinvest earnings, rather than pay dividends, should see their share price increase.

Question 10-15 (LO 10-5) The declaration date is the date the board of directors announces the next dividend to be paid. The record date is the date on which a company looks at its records to determine who the stockholders of the company are. Finally, the payment date is the date of the actual cash distribution.

Question 10-16 (LO 10-6)

Total assets, total liabilities, and total stockholders’ equity do not change as a result of a 100% stock dividend or a 2-for-1 stock split.

Question 10-17 (LO 10-6)

Declaration and payment of a cash dividend reduces total assets and total stockholders’ equity. Declaration and payment of a stock dividend has no effect on total assets, total liabilities, and total stockholders’ equity.

Question 10-18 (LO 10-6)

In a 2-for-1 stock split the number of shares outstanding doubles, while the par value and share price drop by one-half.

Question 10-19 (LO 10-7)

The correct order in the stockholders’ equity section of the balance sheet is Preferred Stock, Common Stock, Additional Paid-in Capital, Retained Earnings, and Treasury Stock.

Question 10-20 (LO 10-7)

The stockholders’ equity section of the balance sheet shows the balance in each equity account at a point in time. In contrast, the statement of stockholders’ equity summarizes the changes in the balance in each stockholders’ equity account over a period of time.

Question 10-21 (LO 10-7)

Total stockholders’ equity is equal to assets minus liabilities. An asset usually equals its market value on the date it’s purchased. However, the two aren’t necessarily the same after that. For instance, many buildings increase in value over time, but continue to be reported in the balance sheet ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Vol.1, Chapter 10 10-3

at historical cost minus accumulated depreciation. Other activities, such as research and development, might increase the long-term profit generating ability of the company, but under accounting rules, they are expensed. This causes the true market value of assets and stockholders’ equity to be greater than the amount recorded for assets and stockholders’ equity in the accounting records. Even when investors see the increase in a company’s value and its stock price moves higher, common stock in the company’s balance sheet continues to be reported at its original issue price rather than its higher market value.

Question 10-22 (LO 10-8)

Earnings per share is not comparable between companies because companies do not have the same number of shares. By simply declaring a 2-for-1 stock split, a company will immediately double the number of shares, thereby reducing its earnings per share in half. Even in comparing earnings per share for the same company over time, it is important to adjust for changes in the number of shares due to stock dividends or stock splits during the comparison period.

Question 10-23 (LO 10-8)

PE stands for price-earnings. Investors use the PE ratio to evaluate the price of a stock in relation to the current earnings generated. A high PE ratio indicates that the market has high hopes for a company’s stock and has bid up the price. They are priced high in relation to current earnings because investors expect future earnings to be higher. On the other hand, a low PE ratio might indicate a lack of confidence by the market, or it might suggest an underpriced “sleeper” or value stock.

BRIEF EXERCISES Brief Exercise 10-1 (LO 10-1) ADVANTAGES OF A CORPORATION • Limited Liability—Even in the event of bankruptcy, stockholders in a corporation can lose no more than the amount they invested in the company. In contrast, owners in a sole proprietorship or a partnership can be held personally liable for debts the company has incurred, over and beyond the investment they have made. • Raising Capital—A corporation is better suited to raising capital than is a sole proprietorship or a partnership. DISADVANTAGES OF A CORPORATION • Additional Taxes—Owners of sole-proprietorships and partnerships are taxed once, when they include their share of earnings in their personal income tax returns. However, corporations have double taxation. • More Paperwork—To protect the rights of those who buy a corporation’s stock or who loan money to a corporation, the state and federal governments impose extensive reporting requirements on the company.

Brief Exercise 10-2 (LO 10-1) An S Corporation allows a company to enjoy limited liability as a corporation, but tax treatment as a partnership. Because of these benefits, many companies that qualify choose to incorporate as an S Corporation. One of the major restrictions is that the corporation cannot have more than 100 stockholders, so S Corporations appeal more to smaller, less widely held businesses.

Brief Exercise 10-3 (LO 10-2)

Cash (3,000 shares x $11) Common Stock (3,000 shares x $0.01) Additional Paid-in Capital (difference) (Issue common stock above par)

33,000 30 32,970

Brief Exercise 10-4 (LO 10-2)

Cash (1,000 shares x $30) Common Stock (1,000 shares x $1.00) Additional Paid-in Capital (difference) (Issue common stock above par)

30,000

Cash (1,000 shares x $30) Common Stock (Issue no-par value common stock)

30,000

Brief Exercise 10-5 (LO 10-3)

Cash (1,000 shares x $32) Preferred Stock (1,000 shares x $0.01) Additional Paid-in Capital (difference) (Issue preferred stock above par)

Brief Exercise 10-6 (LO 10-3) Preferred Stock Features __c___ 1. Convertible __b___ 2. Redeemable __a___ 3. Cumulative

32,000

1,000 29,000

30,000

10 31,990

Description a. Prior unpaid dividends receive priority. b. Shares can be sold at a predetermined price. c. Shares can be exchanged for common stock.

Brief Exercise 10-7 (LO 10-3) Preferred dividends in arrears for 2019 and 2020 ($7,000 x 2 years) Preferred dividends for 2021 (2,000 shares x 7% x $50 par value) Remaining dividends to common stockholders Total dividends

Brief Exercise 10-8 (LO 10-4)

Treasury Stock (100 shares x $38) Cash (Purchase treasury stock)

Brief Exercise 10-9 (LO 10-4)

3,800

Cash (100 shares x $40) Treasury Stock (100 shares x $38) Additional Paid-in Capital (100 shares x $2) (Resell treasury stock above cost)

4,000

$14,000 7,000 2,000 $23,000

3,800

3,800 200

Brief Exercise 10-10 (LO 10-5)

October 1 Dividends (4,000 shares x $0.75) Dividends Payable (Declare cash dividends)

3,000

October 15 No Entry October 31 Dividends Payable (4,000 shares x $0.75) Cash (Pay cash dividends)

3,000

Brief Exercise 10-11 (LO 10-6)

June 30 Stock Dividends (30,000 shares x $1.00) Common Stock (Record 100% [large] stock dividend)

30,000 30,000

Brief Exercise 10-12 (LO 10-6) • No entry is recorded for a 2-for-1 stock split, because the balance in all of the accounts remain the same before and after a stock split. • Number of shares: 30,000 x 2 = 60,000 • Par value per share: $1.00 ÷ 2 = $0.50 • Market price per share: $35.00 ÷ 2 = $17.50

Brief Exercise 10-13 (LO 10-7) Transaction Issue common stock Issue preferred stock Purchase treasury stock Resell treasury stock

Total Assets + + − +

Total Liabilities NE NE NE NE

Total Stockholders’ Equity + + − +

Brief Exercise 10-14 (LO 10-7) Summit Apparel Balance Sheet (Stockholders’ Equity Section) December 31 Stockholders’ equity: Common stock, $1.00 par value Additional paid-in capital Total paid-in capital Retained earnings Treasury stock, 60,000 shares Total stockholders’ equity

Brief Exercise 10-15 (LO 10-8) ($ in millions)

Net Income

Colorado Outfitters

$320

$ 2,000,000 18,000,000 20,000,000 11,000,000 (1,320,000) $29,680,000

Average Stockholders’ Equity

($3,219 + 2,374) / 2 =

Return on Equity 11.4%

EXERCISES Exercise 10-1 (LO 10-1) Terms __f___ __d___ __h___ __a___ __g___ __b___ __e___ __c___

1. Publicly held corporation. 2. Organization chart. 3. Articles of incorporation. 4. Limited liability. 5. Initial public offering. 6. Double taxation. 7. S corporation. 8. Limited liability company.

Definitions a. Shareholders can lose no more than the amount they invested in the company. b. Corporate earnings are taxed twice - at the corporate level and individual shareholder level. c. Like an S corporation, but there are no limitations on the number of owners as in an S corporation. d. Traces the line of authority within the corporation. e. Allows for legal treatment as a corporation, but tax treatment as a partnership. f. Has stock traded on a stock exchange such as the New York Stock Exchange (NYSE). g. The first time a corporation issues stock to the public. h. Describes (a) the nature of the firm’s business activities, (b) the shares to be issued, and (c) the composition of the initial board of directors.

Exercise 10-2 (LO 10-2, 10-3, 10-4) Authorized stock is the total number of shares available to sell, stated in the company’s articles of incorporation. Issued stock is the number of shares that have been sold to investors. Outstanding stock is the number of shares held by investors. Issued and outstanding are the same amounts as long as the corporation has not purchased any of its shares. Preferred stock is “preferred” over common stock in two ways. Preferred stockholders usually have first rights to a specified amount of dividend and receive preference over common stockholders in the distribution of assets in the event the corporation is dissolved. Treasury stock is the company’s own stock that it has purchased.

Exercise 10-3 (LO 10-2) Requirement 1 January 1 Cash (700 shares x $50) Common Stock (Issue no-par value common stock) April 1 Cash (110 shares x $54) Common Stock (Issue no-par value common stock) Requirement 2 January 1 Cash (700 shares x $50) Common Stock (700 shares x $1.00) Additional Paid-in Capital (difference) (Issue common stock above par or stated value) April 1 Cash (110 shares x $54) Common Stock (110 shares x $1.00) Additional Paid-in Capital (difference) (Issue common stock above par or stated value)

35,000 35,000

5,940

35,000

5,940

700 34,300

110 5,830

Exercise 10-4 (LO 10-3) Requirement 1 Preferred dividends in arrears for 2020 Preferred dividends for 2021 (2,000 shares x 5% x $100 par value) Remaining dividends to common stockholders Total dividends

Requirement 2 Preferred dividends in arrears for 2020 Preferred dividends for 2021 (2,000 shares x 5% x $100 par value) Remaining dividends to common stockholders Total dividends

$10,000 10,000 2,000 $22,000

0 10,000 12,000 $22,000

Exercise 10-5 (LO 10-2, 10-3, 10-5)

February 1 Cash (6,000 x $16) Common Stock (6,000 x $16) (Issue common stock no-par value)) May 15 Cash (700 x $13) Preferred Stock (700 x $10) Additional Paid-in Capital (Issue preferred stock above par) October 1 Dividends (6,700 shares x $1.25) Dividends Payable (Declare cash dividends)

Debit 96,000

Credit 96,000

9,100 7,000 2,100

8,375

October 15 No Entry October 31 Dividends Payable (6,700 shares x $1.25) Cash (Pay cash dividends)

8,375

Exercise 10-6 (LO 10-2, 10-3, 10-4) January 2, 2021 Cash (100,000 x $35) Common Stock (100,000 x $1) Additional Paid-in Capital (difference) (Issue common stock above par) February 6, 2021 Cash (3,000 x $11) Preferred Stock (3,000 x $10) Additional Paid-in Capital (difference) (Issue preferred stock above par) September 10, 2021 Treasury Stock (11,000 shares x $40) Cash (Purchase treasury stock) December 15, 2021 Cash (5,500 shares x $45) Treasury Stock (5,500 shares x $40) Additional Paid-in Capital (5,500 x $5) (Resell treasury stock above cost)

Debit 3,500,000

33,000

440,000

247,500

Credit 100,000 3,400,000

30,000 3,000

440,000

220,000 27,500

Exercise 10-7 (LO 10-7) Finishing Touches Balance Sheet (Stockholders’ Equity Section) December 31, 2021 Stockholders’ equity: Preferred stock, $10 par value Common stock, $1.00 par value Additional paid-in capital Total paid-in capital Retained earnings Treasury stock, 5,500 shares Total stockholders’ equity * $160,000 – ($94,500 + $2,400)

Exercise 10-8 (LO 10-5)

March 15 Dividends (210 million shares x $0.125) Dividends Payable (Declare cash dividends)

30,000 100,000 3,430,500 3,560,500 63,100 * (220,000) $3,403,600

Debit 26,250,000

Credit 26,250,000

March 30 No Entry April 13 Dividends Payable (210 million shares x $0.125) Cash (Pay cash dividends)

26,250,000

Exercise 10-9 (LO 10-2, 10-4, 10-5) March 1, 2021 Debit Cash (65,000 x $62) 4,030,000 Common Stock (65,000 x $1) Additional Paid-in Capital (difference) (Issue common stock above par) May 10, 2021 Treasury Stock (6,000 shares x $65) Cash (Purchase treasury stock) June 1, 2021 Dividends (159,000 shares x $2.00) Dividends Payable (Declare cash dividends) July 1, 2021 Dividends Payable (159,000 shares x $2.00) Cash (Pay cash dividends) October 21, 2021 Cash (3,000 shares x $70) Treasury Stock (3,000 shares x $65) Additional Paid-in Capital (3,000 x $5) (Resell treasury stock)

390,000

318,000

210,000

Credit 65,000 3,965,000

390,000

318,000

195,000 15,000

Exercise 10-10 (LO 10-6) Requirement 1 September 1 Stock Dividends (10,000 x 10% x $30) 30,000 Common Stock (10,000 x 10% x $1) Additional Paid-in Capital (difference) (Record 10% stock dividend, small stock dividend)

Requirement 2 September 1 Stock Dividends (10,000 shares x $1) 10,000 Common Stock (Record 100% stock dividend, large stock dividend)

1,000 29,000

10,000

Requirement 3 • No entry is recorded for a 2-for-1 stock split, because the balance in all of the accounts remains the same before and after a stock split.

Exercise 10-11 (LO 10-7) Power Drive Corporation Balance Sheet (Stockholders’ Equity Section) December 31, 2021 Stockholders’ equity: Common stock, $1.00 par value Additional paid-in capital Total paid-in capital Retained earnings Treasury stock, 3,000 shares Total stockholders’ equity

$ 165,000 9,480,000 9,645,000 3,382,000 * (195,000) $12,832,000

* $3,000,000 + $700,000 – $318,000

Exercise 10-12 (LO 10-7) Power Drive Corporation Statement of Stockholders’ Equity For the Year Ended December 31, 2021 Additional Common Paid-in Retained Treasury Stock Capital Earnings Stock Balance, January 1 Issue common stock Purchase treasury stock Declare dividends Resell treasury stock Net income Balance, December 31

$100,000 5,500,000 3,000,000 65,000 3,965,000

Total Stockholders’ Equity

-0-

$ 8,600,000 4,030,000 (390,000) (390,000) (318,000) (318,000) 15,000 195,000 210,000 700,000 700,000 $165,000 9,480,000 3,382,000 (195,000) $12,832,000

Exercise 10-13 (LO 10-7) Transaction Issue common stock Issue preferred stock Purchase treasury stock Resell treasury stock Declare cash dividend Pay cash dividend 100% stock dividend 2-for-1 stock split

Total Assets + + − + NE − NE NE

Total Liabilities NE NE NE NE + − NE NE

Total Stockholders’ Equity + + − + − NE NE NE

Exercise 10-14 (LO 10-7) United Apparel Balance Sheet (Stockholders’ Equity Section) December 31, 2021 Stockholders’ equity: Preferred stock Common stock Additional paid-in capital Total paid-in capital Retained earnings Treasury stock Total stockholders’ equity

$ 3,600,000 600,000 8,800,000 13,000,000 2,200,000 (850,000) $14,350,000

Exercise 10-15 (LO 10-8) Requirement 1

($ in millions) Friendly Fashions

Net Income $312

Average ÷ Stockholders’ Equity = ÷ ($2,310 + 1,850) / 2 =

Return on Equity 15.0%

Requirement 2

($ in millions) Friendly Fashions

Requirement 3 ($ in millions) Friendly Fashions

Dividends Per Share $0.31

Net Income $312

÷ ÷

Stock Price $6.20

Shares Outstanding 675

= =

Dividend Yield 5.0%

= Earnings per Share = $0.46

Requirement 4 ($ in millions) Friendly Fashions

Stock Price $6.20

÷ ÷

Earnings Per Share $0.46

= =

Price-Earnings Ratio 13.5

Exercise 10-16 (LO 10-8) Requirement 1 ($ in millions) 2020 2021

Net Income Minus Preferred Dividends ($308 − $15) ($129 − $20)

÷ ÷ ÷

Average Shares Outstanding = Earnings per Share 400 = $0.7325 150 = $0.7267

Earnings per share (EPS) is calculated as net income minus preferred dividends, divided by average shares outstanding. In 2020, EPS = ($308 − $15)/400 = $0.7325. In 2021, EPS = ($129 - $20)/150 = $0.7267. EPS did not increase in 2021. Requirement 2 ($ in millions) 2020 2021

Stock Price ÷ $10.97 ÷ $12.02 ÷

Earnings Per Share $0.7325 $0.7267

= = =

Price-Earnings Ratio $14.98 $16.54

The price-earnings ratio is calculated as stock price divided by earnings per share. In 2020, the price-earnings ratio = $10.97/$$0.7325 = $14.98. In 2021, the price-earnings ratio = $12.02/$0.7267 = $16.54. The stock price in relation to earnings is lower in 2020.

Exercise 10-17

Requirement 1 January 2 Cash Common Stock Additional Paid-in Capital (Issue common stock)

Debit 40,000

January 9 Accounts Receivable Service Revenue (Provide services on account)

Debit 14,300

January 10 Supplies Accounts Payable (Purchase supplies on account)

Debit 4,900

January 12 Treasury Stock Cash (Purchase treasury stock)

Debit 18,000

January 15 Accounts Payable Cash (Pay cash on account)

Debit 16,500

January 21 Cash Service Revenue (Provide services for cash)

Debit 49,100

January 22 Cash Accounts Receivable (Receive cash on account)

Debit 16,600

Credit 2,000 38,000 Credit 14,300 Credit 4,900 Credit 18,000 Credit 16,500 Credit 49,100 Credit 16,600

Exercise 10-17 (continued) Requirement 1 (concluded)

January 29 Dividends Dividends Payable (Declare cash dividends) ($3,300=[10,000+2,000−1,000]×$0.30)

Debit 3,300

January 30 Cash Treasury Stock Additional Paid-in Capital (Resell treasury stock)

Debit 12,000

January 31 Salaries Expense Cash (Pay monthly salaries)

Debit 42,000

Credit 3,300

Credit 10,800 1,200 Credit 42,000

Exercise 10-17 (continued) Requirement 2 (a) January 31 Utilities Expense Utilities Payable (Adjust utilities)

Debit 6,200

Credit 6,200

(b) January 31 Supplies Expense Supplies (Adjust supplies) ($7,300 = $7,500+$4,900−$5,100)

Debit 7,300

Credit

(c) January 31 Depreciation Expense Accumulated Depreciation (Record depreciation for January) ($1,500 = [$64,000−$10,000] / 36 months)

Debit 1,500

Credit

(d) January 31 Income Tax Expense Income Tax Payable (Adjust income taxes)

Debit 2,000

Credit

7,300

1,500

2,000

Exercise 10-17 (continued) Requirement 3 Grand Finale Fireworks Adjusted Trial Balance January 31, 2021 Accounts Debit Cash $ 83,900 Accounts Receivable 42,200 Supplies 5,100 Equipment 64,000 Accumulated Depreciation Accounts Payable Utilities Payable Dividends Payable Income Tax Payable Common Stock Additional Paid-in Capital Retained Earnings Dividends 3,300 Treasury Stock 7,200 Service Revenue Salaries Expense 42,000 Utilities Expense 6,200 Supplies Expense 7,300 Depreciation Expense 1,500 Income Tax Expense 2,000 Totals $264,700

Credit

$ 10,500 3,000 6,200 3,300 2,000 12,000 119,200 45,100 63,400

$264,700

Exercise 10-17 (continued) Requirement 3 (continued) Accounts

Ending Balance Cash 83,900 Accounts Receivable 42,200 Supplies 5,100 Equipment 64,000 Accumulated Depreciation 10,500 Accounts Payable 3,000 Utilities Payable 6,200 Dividends Payable 3,300 Income Tax Payable 2,000 Common Stock 12,000 Additional Paid-in Capital 119,200 Retained Earnings 45,100 Dividends 3,300 Treasury Stock 7,200 Service Revenue 63,400 Salaries Expense 42,000 Utilities Expense 8,200 Supplies Expense 7,300 Depreciation Expense 1,500 Income Tax Expense 2,000

= = = = = = = = = = = = = = = = = = = =

Beginning balance in bold, entries during January in blue, and adjusting entries in red. 42,700+40,000−18,000−16,500+49,100+16,600+12,000−42,000 44,500+14,300−16,600 7,500+4,900−7,300 64,000 9,000+1,500 14,600+4,900−16,500 6,200 3,300 2,000 10,000+2,000 80,000+38,000+1,200 45,100 3,300 18,000−10,800 14,300+49,100 42,000 8,200 7,300 1,500 2,000

Exercise 10-17 (continued) Requirement 4 Grand Finale Fireworks Income Statement For the month ended January 31, 2021 Service revenue $63,400 Salaries expense Utilities expense Supplies expense Depreciation expense Income before taxes Income tax expense Net income

42,000 6,200 7,300 1,500 6,400 2,000 $ 4,400

Requirement 5

Grand Finale Fireworks Balance Sheet January 31, 2021 Assets Liabilities Cash $ 83,900 Accounts payable Accounts receivable 42,200 Utilities payable Supplies 5,100 Dividends payable Total current assets 131,200 Income tax payable Total current liabilities Stockholders’ Equity Common stock Additional paid-in capital Retained earnings Equipment 64,000 Treasury stock Less: Accumulated Depreciation (10,500) Total stockholders’ equity Total liabilities and Total assets $184,700 stockholders’ equity *

3,000 6,200 3,300 2,000 14,500 12,000 119,200 46,200 * (7,200) 170,200

$184,700

Retained earnings = Beginning retained earnings + Net income − Dividends = $45,100 + $4,400 − $3,300 = $46,200

Exercise 10-17 (concluded) Requirement 6

January 31, 2021 Service Revenue Retained Earnings (Close revenue accounts)

Debit 63,400

Retained Earnings Salaries Expense Utilities Expense Supplies Expense Depreciation Expense Income Tax Expense (Close expense accounts)

59,000

Retained Earnings Dividends (Close dividend account)

3,300

Credit 63,400

42,000 6,200 7,300 1,500 2,000

3,300

Requirement 7 (a) The return on equity is: Return on Equity Ratio

Net Income Average Stockholders’ Equity

$4,400 =

($135,100 + $170,200) / 2

2.9%

Compared to the industry average of 2.5%, Grand Finale Fireworks is more profitable than other companies in the same industry. Note these are monthly, rather than annual, return on equity calculations. A consistent monthly return on equity of 2.5% results in a 30% annual return on equity. (b) The number of common shares outstanding as of January 31, 2021 is 11,600. The company had 10,000 shares at the beginning of January, issued 2,000 additional shares on January 2, purchased 1,000 shares on January 12, and resold 600 shares on January 30. (11,600 = 10,000+2,000−1,000+600) (c) Earnings per share is: Earnings Per Share

Net Income = Average Shares Outstanding

$4,400 (10,000 + 11,600) / 2

0.41

Compared to an average earnings per share of $0.30 per month last year, earnings per share for January 2021 is better than last year’s average earnings per share. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Vol.1, Chapter 10 10-29

PROBLEMS: SET A Problem 10-1A (LO 10-1) Terms __f___ 1. Cumulative. __d__ 2. Retained earnings. __g__ 3. Outstanding stock. __h__ 4. Limited liability. __j__ 5. Treasury stock. __e__ 6. Issued stock. __i__ 7. Angel investors. __a__ 8. Paid-in capital. __b__ 9. Authorized stock. __c__ 10. Redeemable. Definitions a. The amount invested by stockholders. b. Shares available to sell. c. Shares can be returned to the corporation at a predetermined price. d. The earnings not paid out in dividends. e. Shares actually sold. f. Shares receive priority for future dividends if dividends are not paid in a given year. g. Shares held by investors. h. Shareholders can lose no more than the amount they invested in the company. i. Wealthy individuals in the business community willing to risk investment funds on a promising business venture. j. The corporation’s own stock that it acquired.

Problem 10-2A (LO 10-2, 10-3, 10-4, 10-5) Requirement 1 March 1, 2021 Cash (1,100 x $42) Common Stock (1,100 x $0.01) Additional Paid-in Capital (difference) (Issue common stock) May 15, 2021 Treasury Stock (400 shares x $35) Cash (Purchase treasury stock) July 10, 2021 Cash (200 shares x $40) Treasury Stock (200 shares x $35) Additional Paid-in Capital (200 x $5) (Resell treasury stock above cost) October 15, 2021 Cash (200 x $45) Preferred Stock (200 x $1) Additional Paid-in Capital (difference) (Issue preferred stock) December 1, 2021 Dividends (5,400 shares x $0.50) Dividends Payable (Declare cash dividends) December 31. 2021 Dividends Payable (5,400 shares x $0.50) Cash (Pay cash dividends)

Debit 46,200

14,000

8,000

9,000

2,700

Credit 11 46,189

14,000

7,000 1,000

200 8,800

2,700

Requirement 2 Transaction Issue common stock Purchase treasury stock Resell treasury stock Issue preferred stock Declare cash dividends Pay cash dividends

Total Assets + + + NE -

Total Liabilities NE NE NE NE + -

Total Stockholders’ Equity + + + NE

Problem 10-3A (LO 10-6) Requirement 1 Common stock, $1 par value Additional paid-in capital Total paid-in capital Retained earnings Total stockholders’ equity Shares outstanding Par value per share Share price

Before $ 1,100 59,000 60,100 23,850 $83,950

After 100% Stock Dividend $ 2,200 59,000 61,200 22,750 $83,950

After 2-for-1 Stock Split $ 1,100 59,000 60,100 23,850 $83,950

1,100 $1.00 $130

2,200 $1.00 $65

2,200 $0.50 $65

Requirement 2 The primary reason companies declare a large stock dividend or a stock split is to lower the trading price of the stock to a more acceptable trading range, making it attractive to a larger number of potential investors.

Problem 10-4A (LO 10-7)

Requirement 1 6,000,000 shares = ($6,000 / $1 par value per share) in thousands (x 1,000). Requirement 2 30,000,000 shares = ($30,000 / $1 par value per share) in thousands (x 1,000). Requirement 3 $50 per share. The total paid-in capital for common stock is $900,000 (30,000 x $30). Therefore, the total paid-in capital for preferred stock must be $300,000 ($1,200,000 – $900,000). $300,000 divided by 6,000 shares indicates an issue price of $50 per share. Requirement 4 (in millions) Retained earnings, beginning

$250

+ Net income

– Dividends

(30)

= Retained earnings, ending

$288

Net income for the year was $68 million. Requirement 5 $32 per share ($352,000 / 11,000 shares).

Problem 10-5A (LO 10-7) Requirement 1

Donnie Hilfiger Balance Sheet (Stockholders’ Equity Section) December 31, 2021 Stockholders’ equity: Preferred stock, $1 par value Common stock, $0.01 par value Additional paid-in capital Total paid-in capital Retained earnings Treasury stock, 200 shares Total stockholders’ equity

500 51 131,989 132,540 38,600 (7,000) $164,140

Requirement 2 Donnie Hilfiger Statement of Stockholders’ Equity For the Year Ended December 31, 2021 Additional Total Preferred Common Paid-in Retained Treasury Stockholders’ Stock Stock Capital Earnings Stock Equity Balance, January 1 Issue common stock Purchase treasury stock Resell treasury stock Issue preferred stock Declare cash dividends Net income Balance, December 31

$300

$40 11

1,000 8,800

200 $500

$ 76,000 46,189

$51

$131,989

$30,500

-0-

(14,000) 7,000 (2,700) 10,800 $38,600 $(7,000)

$106,840 46,200 (14,000) 8,000 9,000 (2,700) 10,800 $164,140

Requirement 3 Items 1 and 2 are similar in that item 1 shows the equity balances in a column format and item 2 shows these same balances across the bottom row. However, items 1 and 2 serve different purposes. The stockholders’ equity section of the balance sheet in item 1 presents the balance of each equity account at a point in time. The statement of stockholders’ equity in item 2 shows the change in each equity account balance over time.

Problem 10-6A (LO 10-2, 10-3, 10-4, 10-5, 10-7) Requirement 1 January 2, 2021 Cash (110,000 x $70) Common Stock (110,000 x $1) Additional Paid-in Capital (difference) (Issue common stock above par) February 14, 2021 Cash (60,000 x $12) Preferred Stock (60,000 x $10) Additional Paid-in Capital (difference) (Issue preferred stock above par) May 8, 2021 Treasury Stock (11,000 shares x $60) Cash (Purchase treasury stock) May 31, 2021 Cash (5,500 shares x $65) Treasury Stock (5,500 shares x $60) Additional Paid-in Capital (5,500 shares x $5) (Resell treasury stock above cost) December 1, 2021 Dividends [(104,500 shares x $0.25) + $36,000] Dividends Payable (Declare cash dividends) December 30, 2021 Dividends Payable Cash (Pay cash dividends)

Debit 7,700,000

720,000

660,000

357,500

62,125

Credit 110,000 7,590,000

600,000 120,000

660,000

330,000 27,500

62,125

Requirement 2 Major League Apparel Balance Sheet (Stockholders’ Equity Section) December 31, 2021 Stockholders’ equity: Preferred stock, $10 par value Common stock, $1 par value Additional paid-in capital Total paid-in capital Retained earnings Treasury stock, 5,500 shares Total stockholders’ equity

$ 600,000 110,000 7,737,500 8,447,500 427,875* (330,000) $8,545,375

*$490,000 net income – $62,125 in dividends

Problem 10-7A (LO 10-8) Requirement 1 ($ in millions) Khaki Republic

Net Income $144

Average = Stockholders’ Equity ÷ ($1,890 + 1,931) / 2 = ÷

Return on Equity 7.5%

Khaki Republic has a much lower return on equity than both Facebook and IBM. Requirement 2

Khaki Republic

Dividends Per Share $0.75

÷ ÷

Stock Price $47.23

= =

Dividend Yield 1.6%

Khaki Republic has a higher dividend yield than Facebook because Facebook does not pay dividends, and Khaki Republic has a lower dividend yield than IBM. Requirement 3 ($ in millions) Khaki Republic

Stock Price $47.23

÷ Earnings Per Share = ÷

($144 / 85.6)

Price-Earnings Ratio 28.1

Khaki Republic has a lower price-earnings ratio than Facebook, but a higher priceearnings ratio than IBM.

PROBLEMS: SET B Problem 10-1B (LO 10-1 to 10-8) Terms __e___ 1. PE ratio. __i___ 2. Stockholders’ equity section of the balance sheet. __a___ 3. Accumulated deficit. __b___ 4. Growth stocks. __c___ 5. 100% stock dividend. __f___ 6. Statement of stockholders’ equity. __j___ 7. Treasury stock. __g___ 8. Value stocks. __h___ 9. Return on equity. __d___ 10. Retained earnings, Definitions a. A debit balance in retained earnings. b. Priced high in relation to current earnings as investors expect future earnings to be higher. c. Effectively the same as a 2-for-1 stock split. d. The earnings not paid out in dividends. e. The stock price divided by earnings per share. f. Summarizes the changes in the balance in each stockholders’ equity account over a period of time. g. Priced low in relation to current earnings. h. Measures the ability of company management to generate earnings from the resources that owners provide. i. Shows the balance in each equity account at a point in time. j. The corporation’s own stock that it acquired.

Problem 10-2B (LO 10-2, 10-3, 10-4, 10-5) Requirement 1 March 1, 2021 Cash (3,000 x $10) Common Stock (3,000 x $1.00) Additional Paid-in Capital (difference) (Issue common stock) April 1, 2021 Cash (175 shares x $40) Preferred Stock (175 shares x $10) Additional Paid-in Capital (difference) (Issue preferred stock) June 1, 2021 Dividends (6,300 shares x $0.25) Dividends Payable (Declare cash dividends) June 30, 2021 Dividends Payable (6,300 shares x $0.25) Cash (Pay cash dividends) August 1, 2021 Treasury Stock (175 shares x $7) Cash (Purchase treasury stock) October 1, 2021 Cash (125 shares x $9) Treasury Stock (125 shares x $7) Additional Paid-in Capital (125 shares x $2) (Resell treasury stock above cost)

Debit 30,000

7,000

1,575

1,225

1,125

Credit 3,000 27,000

1,750 5,250

1,575

1,225

875 250

Requirement 2 Transaction Issue common stock Issue preferred stock Declare cash dividends Pay cash dividends Purchase treasury stock Resell treasury stock

Total Assets + + NE +

Total Liabilities NE NE + NE NE

Total Stockholders’ Equity + + NE +

Problem 10-3B (LO 10-6)

Common stock, $0.01 par value Additional paid-in capital Total paid-in capital Retained earnings Total stockholders’ equity Shares outstanding Par value per share Share price

Before $ 11 34,990 35,001 16,000 $51,001

After 100% Stock Dividend $ 22 34,990 35,012 15,989 $51,001

After 2-for-1 Stock Split $ 11 34,990 35,001 16,000 $51,001

1,100 $0.01 $102

2,200 $0.01 $51

2,200 $0.005 $51

Problem 10-4B (LO 10-7) Requirement 1 No preferred stock has been issued. Requirement 2 4,000,000 shares = ($20,000 / $5 par value per share) in thousands (x 1,000). Requirement 3 $30 per share. The total paid-in capital for common stock is $120 million. $120 million divided by 4 million shares indicates an issue price of $30 per share. Requirement 4 Retained earnings, beginning

$45,000,000

+ Net income

9,907,500

– Dividends

= Retained earnings, ending

$53,000,000

Dividends paid for the year were $1,907,500. Requirement 5 185,000 shares = ($3,700 / $20 per share) in thousands (x 1,000). Requirement 6 $1,907,500 / (4,000,000 – 185,000) = $0.50 dividend per share.

Problem 10-5B (LO 10-7) Requirement 1

Nautical Balance Sheet (Stockholders’ Equity Section) December 31, 2021 Stockholders’ equity: Preferred stock, $10 par value Common stock, $1.00 par value Additional paid-in capital Total paid-in capital Retained earnings Treasury stock, 100 shares Total stockholders’ equity

$ 3,000 6,000 52,000 61,000 17,575 (350) $78,225

Requirement 2 Nautical Statement of Stockholders’ Equity For the Year Ended December 31, 2021 Additional Preferred Common Paid-in Retained Stock Stock Capital Earnings Balance, January 1 Issue common stock Issue preferred stock Declare dividends Purchase treasury stock Resell treasury stock Net income Balance, December 31

$1,250

$3,000 3,000

1,750

$19,500 27,000 5,250

$11,500

$6,000

$52,000

-0-

(1,575) (1,225) 875

250 $3,000

Treasury Stock

7,650 $17,575

$ (350)

Total Stockholders’ Equity $35,250 30,000 7,000 (1,575) (1,225) 1,125 7,650 $78,225

Problem 10-6B (LO 10-2, 10-3, 10-4, 10-5, 10-7) Requirement 1 February 2, 2021 Cash (1,500,000 x $35) Common Stock (1,500,000 x $5) Additional Paid-in Capital (difference) (Issue common stock above par) February 4, 2021 Cash (600,000 x $23) Preferred Stock (600,000 x $20) Additional Paid-in Capital (difference) (Issue preferred stock above par) June 15, 2021 Treasury Stock (150,000 shares x $30) Cash (Purchase treasury stock) August 15, 2021 Cash (112,500 shares x $45) Treasury Stock (112,500 shares x $30) Additional Paid-in Capital (112,500 x $15) (Resell treasury stock above cost) November 1, 2021 Dividends (1,462,500 shares x $1.50) + $480,000) Dividends Payable (Declare cash dividends) November 30, 2021 Dividends Payable Cash (Pay cash dividends)

Debit 52,500,000

13,800,000

4,500,000

5,062,500

2,673,750

Credit 7,500,000 45,000,000

12,000,000 1,800,000

4,500,000

3,375,000 1,687,500

2,673,750

Problem 10-6B (Continued) Requirement 2 National League Gear Balance Sheet (Stockholders’ Equity Section) December 31, 2021 Stockholders’ equity: Preferred stock, $20 par value Common stock, $5 par value Additional paid-in capital Total paid-in capital Retained earnings* Treasury stock, 37,500 shares Total stockholders’ equity

$12,000,000 7,500,000 48,487,500 67,987,500 2,226,250 (1,125,000) $69,088,750

* $4,900,000 net income – $2,673,750 in dividends

Problem 10-7B (LO 10-8) Requirement 1 ($ in millions) DC Menswear

Net Income $833

Average ÷ Stockholders’ Equity = ÷

($4,080 + 2,755) / 2

Return on Equity 24.4%

DC Menswear has a higher return on equity than Facebook but a lower return on equity than IBM. Requirement 2

DC Menswear

Dividends Per Share $1.00

÷ ÷

Stock Price $18.93

= =

Dividend Yield 5.3%

DC Menswear has a higher dividend yield than either Facebook or IBM. Facebook does not have a dividend yield because it does not pay dividends. Requirement 3 ($ in millions) DC Menswear

Stock Price ÷ $18.93 ÷

Earnings Per Share ($833 / 485)

= =

Price-Earnings Ratio 11.0

DC Menswear has a lower price-earnings ratio than either Facebook or IBM. In other words, DC Menswear is trading at a lower price per dollar of earnings. Looks like a great buy. Unfortunately, it’s a fictional company name from a video game.

ADDITIONAL PERSPECTIVES Continuing Problem: Great Adventures AP10-1 Requirement 1 November 5, 2022 Cash (100,000 x $12) Common Stock (100,000 x $1) Additional Paid-in Capital (difference) (Issue common stock above par) November 16, 2022 Treasury Stock (10,000 shares x $15) Cash (Purchase treasury stock) November 24, 2022 Cash (4,000 shares x $16) Treasury Stock (4,000 shares x $15) Additional Paid-in Capital (4,000 shares x $1) (Resell treasury stock above cost) December 1, 2022 Dividends Dividends Payable (Declare cash dividends) December 20, 2022 Dividends Payable Cash (Pay cash dividends) December 31, 2022 Building Cash (Purchase buildings)

Debit 1,000,000

Credit 100,000 900,000

150,000

64,000

11,400

800,000

150,000

60,000 4,000

11,400

800,000

Requirement 2 Great Adventures, Inc. Balance Sheet (Stockholders’ Equity Section) December 31, 2022 Stockholders’ equity: Common stock, $1 par value Additional paid-in capital Total paid-in capital Retained earnings* Treasury stock, 6,000 shares Total stockholders’ equity

$ 120,000 904,000 1,024,000 57,885 (90,000) $ 991,885

* $33,450 beginning balance in retained earnings + $35,835 net income – $11,400 in dividends

Additional Perspective 10-1 (in General Ledger) Students will be given the following existing trial balance. Great Adventures, Inc. Trial Balance December 31, 2022 (Prior to transactions in AP10-1) Accounts Debit Credit Cash $ 77,968 Accounts Receivable 50,000 Allowance for Uncollectible Accounts $ 2,400 Inventory 7,000 Prepaid Insurance 900 Land 500,000 Buildings -0Equipment 62,000 Accumulated Depreciation 25,250 Accounts Payable 20,800 Deferred Revenue 5,000 Warranty Liability 4,000 Contingent Liability 12,000 Income Tax Payable 14,500 Interest Payable 750 Notes Payable (current) 48,014 Notes Payable (long-term) 475,869 Common Stock 20,000 Retained Earnings 33,450 Service Revenue 44,500 Sales Revenue 120,000 Interest Revenue 120 Sales Discounts 350 Cost of Goods Sold 38,500 Depreciation Expense 17,250 Insurance Expense 5,700 Rent Expense 2,400 Salaries Expense 24,000 Supplies Expense 500 Bad Debt Expense 2,400 Repairs and Maintenance Expense 400 Warranty Expense 4,000 ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 3-50 Financial Accounting, 5e

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Loss Interest Expense Income Tax Expense Totals

12,000 6,785 14,500 $826,653

$826,653

Additional Perspective 10-1 (in General Ledger, continued) November 5, 2022 Cash (100,000 x $12) Common Stock (100,000 x $1) Additional Paid-in Capital (difference) (Issue common stock above par) November 16, 2022 Treasury Stock (10,000 shares x $15) Cash (Purchase treasury stock) November 16, 2022 Cash (4,000 shares x $16) Treasury Stock (4,000 shares x $15) Additional Paid-in Capital (4,000 shares x $1) (Resell treasury stock above cost) December 1, 2022 Dividends Dividends Payable (Declare cash dividends) December 20, 2022 Dividends Payable Cash (Pay cash dividends) December 30, 2022 Building Cash (Purchase buildings)

Debit 1,000,000

150,000

64,000

11,400

800,000

Credit 100,000 900,000

150,000

60,000 4,000

11,400

800,000

Additional Perspective 10-1 (in General Ledger, continued)

Great Adventures, Inc. Income Statement For the period ended December 31, 2022 Service revenue Sales revenue Sales Discounts Net sales Cost of goods sold Gross profit Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Warranty Expense Loss Total operating expenses Operating income (loss) Interest revenue Interest expense Income before income taxes Income tax expense Net income

$ 44,500 120,000 (350) 164,150 38,500 $125,650 17,250 5,700 2,400 24,000 500 2,400 400 4,000 12,000 68,650 57,000 120 (6,785) 50,335 14,500 $ 35,835

Additional Perspective 10-1 (in General Ledger, continued)

Great Adventures, Inc. Balance Sheet December 31, 2022 Assets

Current assets: Cash Accounts receivable Allow for Uncoll Accts Inventory Prepaid Insurance Total current assets

$180,568 50,000 (2,400) 7,000 900 236,068

Long-term assets: Land Buildings Equipment Accumulated depreciation

500,000 800,000 62,000 (25,250)

Total assets

$1,572,818

$ 20,800 5,000 4,000 12,000 14,500 750 48,014 105,064 475,869 580,933

Stockholders’ Equity Common stock 120,000 Additional Paid-in Capital 904,000 Retained earnings 57,885 Treasury Stock (90,000) Total stockholders’ equity 991,885 Total liabilities and stockholders’ equity $1,572,818

Additional Perspective 10-1 (in General Ledger, concluded) Dec. 31, 2022 Service Revenue Sales Revenue Interest Revenue Sales Discounts Retained Earnings (Close revenue accounts) Dec. 31, 2022 Retained Earnings Cost of Goods Sold Depreciation Expense Insurance Expense Rent Expense Salaries Expense Supplies Expense Bad Debt Expense Repairs and Maintenance Expense Warranty Expense Loss Interest Expense Income Tax Expense (Close expense accounts) Dec. 31, 2022 Retained Earnings Dividends (Close dividends account)

Debit 44,500 120,000 120

Credit

350 164,270 128,435 38,500 17,250 5,700 2,400 24,000 500 2,400 400 4,000 12,000 6,785 14,500

11,400 11,400

Financial Analysis: American Eagle AP10-2

Requirement 1 $0.01 par value per share. The par value per share is listed in the stockholders’ equity section of the balance sheet. Requirement 2 249,566 shares (in thousands). The number of shares issued is listed in the stockholders’ equity section of the balance sheet. This is the exact number. In the text, we estimated the number of shares outstanding as 249,600 which is the common stock amount of $2,496 (rounded to the nearest thousand) divided by the $0.01 par value. Requirement 3 Yes, 72,250 shares (in thousands). The number of shares of treasury stock (in thousands) is listed in the stockholders’ equity section of the balance sheet. Requirement 4 $90,858 ($ in thousands). The cash dividends paid is listed in the retained earnings column of the statement of stockholders’ equity. Be sure to find the cash dividends for the most recent year.

Financial Analysis: Buckle AP10-3

Requirement 1 $0.01 par value per share. The par value per share is listed in the stockholders’ equity section of the balance sheet. Requirement 2 48,816,170 shares. The number of shares issued is listed in the stockholders’ equity section of the balance sheet. Requirement 3 No. There is no treasury stock reported in the stockholders’ equity section of the balance sheet. Requirement 4 $133,874 ($ in thousands). The cash dividends paid is listed in the retained earnings column of the statement of stockholders’ equity. Be sure to find the cash dividends for the most recent year.

Comparative Analysis: American Eagle vs. Buckle AP10-4 ($ in thousands) Requirement 1

American Eagle Buckle

Return = on Equity

Net Income

Average Stockholders’ Equity

$204,163 $89,707

÷ ($1,246,791 + $1,204,569) / 2 = 16.7% ÷ ($391,248 + $430,539) / 2 = 21.8%

Buckle has a higher return on equity. Requirement 2

American Eagle Buckle

Dividends Per Share

Stock Price

$90,858 / 177,316 $133,874/ 48,816.170

÷ ÷

$17.56 $19.60

Dividend = Yield = =

3.0% 14.0%

Buckle also has a higher dividend yield. Requirement 3

American Eagle Buckle

Stock Price

Earnings Per Share*

Price-Earnings Ratio

$17.56 $19.60

÷ ÷

$1.15 $1.86

= =

15.27 10.54

*Basic earnings per share is found near the bottom of the income statement. Buckle is trading at a much lower price per dollar of earnings.

Ethics AP10-5

1. Yes. With the gain included, pretax income will be $3,330,000 (= $3,250,000 + $80,000 gain). This represents an 11% increase over prior year’s pretax income of $300,000. To receive the bonus, she needed to increase pretax income by only 10%. 2. As an increase to additional paid-in capital. For treasury stock, any gain of the sale is reported as additional equity rather than a gain in calculating pretax income. 3. Yes. By misclassifying the gain on the sale of treasury stock as part of pretax income, Brooke will receive a bonus equal to 15% of her salary. That’s a bonus of $60,000 (= $400,000 × 15%). This is cash taken inappropriately from the company, reducing its ability to pay debt, pay salaries to other employees, pay dividends to shareholders, and purchase productive assets to ensure the company’s future profitability. 4. No. Even though Brooke feels it was her decision to buy the stock at $42 and sell at $50, this belief does not justify falsely reporting the transaction. Brooke could have used her own cash to make that investment, but she instead used the company’s cash. As CEO, she is a steward of the company’s resources, but she is not the owner. To the extent she uses the company’s resources, then any gains are those of the company. Brooke also should not justify her decision based on her many years of devotion to the company and good decisions. To the extent she believes higher compensation is needed, then she should make that claim to the board.

Internet Research AP10-6 This case provides an opportunity for students to learn more about Form 10-K, containing the annual report for publicly traded companies. It also introduces students to EDGAR, one of the largest sources of accounting information available on the internet. Finally, students gain an understanding of transactions that affect the statement of stockholders’ equity. Answers to the assignment will vary depending on the 10-K filing chosen.

Written Communication AP10-7 Requirement 1 Liabilities are the creditors’ claims to resources. Stockholders’ equity are the owners’ claim to resources. Requirement 2 The balance sheet has always distinguished between liabilities and stockholders’ equity. Financial accounting information is designed to provide information useful to its two primary user groups, investors and creditors. Therefore, it makes sense to separate the owners’ claim to resources from the creditors’ claim to resources. Requirement 3 Arguments in support of eliminating the distinction relate to the difficulty, in certain cases, in distinguishing between liabilities and stockholders’ equity. For instance, preferred stock can be structured so that it is nearly identical to common stock by giving preferred stock voting rights and making it convertible to common stock at the option of the investor. On the other hand, preferred stock can also be structured so that it is like a bond with a fixed dividend payment and a mandatory redemption date similar to the interest payment and maturity date on bonds payable. Since preferred stock can fall anywhere along the line between common stock and bonds, it becomes difficult to maintain a distinction between liabilities and stockholders’ equity. Requirement 4 While answers to this question will vary, students should be able to defend their position.

Earnings Management AP10-8 Requirement 1 ÷

Shares outstanding 950,000

Earnings Per Share = $0.92 =

Before Purchase

Net Income $878,000 ÷

Before Purchase

Average Return on ÷ = Net Income Stockholders’ Equity Equity $878,000 ÷ ($4,425,000 + 4,000,000) / 2 = 20.8%

Requirement 2 ÷

Shares outstanding (950,000 + 850,000) / 2

Earnings Per Share = $0.98 =

After Purchase

Net Income $878,000 ÷

After Purchase

Average Return on = Net Income Stockholders’ Equity Equity $878,000 ÷ ($4,425,000 + 3,000,000) / 2 = 23.6% ÷

Requirement 3 Yes. The purchase of stock near year-end improves earnings per share by reducing the number of outstanding shares used to calculate earnings per share. It also improves the return on equity by reducing the ending balance in stockholders’ equity. Note that it will be difficult to maintain next year as the reduction in shares outstanding and average stockholders’ equity comes at a cost—the increase in interest expense beginning next year due to the $1 million loan at year-end. The loan also increases company risk.

Chapter 11 - Statement of Cash Flows

Chapter 11 Statement of Cash Flows REVIEW QUESTIONS Question 11-1 (LO 11-1) The three categories of cash flows are operating activities, investing activities, and financing activities. Operating activities include cash receipts and cash payments for transactions relating to revenue and expense activities, essentially the very same activities reported on the income statement. Investing activities include cash transactions involving the purchase and sale of long-term assets and current investments. Financing activities are cash flows resulting from the external financing of a business.

Question 11-2 (LO 11-1)

Changes in long-term asset accounts and current investment accounts are used in determining net cash flows from investing activities. Changes in long-term liability and stockholders’ equity accounts are used in determining net cash flows from financing activities.

Question 11-3 (LO 11-1) Noncash activities are investing and financing activities that do not result in the transfer of cash. Examples of significant noncash investing and financing activities include: 1. 2. 3. 4.

Purchase of long-term assets by issuing debt. Purchase of long-term assets by issuing stock. Conversion of bonds payable into common stock. Exchange of long-term assets.

Question 11-4 (LO 11-1)

The income statement provides important information in determining cash flows from operating activities. The balance sheet provides changes in asset, liability, and stockholders’ equity accounts from the end of last period to the end of this period to find cash flows from operating, investing, and financing activities. Sometimes we need additional information from the accounting records to determine specific cash inflows or cash outflows for the period.

Question 11-5 (LO 11-2) The heading includes the company name, the title statement of cash flows, and the period covered. Like the income statement, the statement of cash flows is over a period of time. The three major categories are operating activities, investing activities, and financing activities, in that order. The last three lines of the statement of cash flows include amounts for the net increase or decrease in cash, cash at the beginning of the period, and cash at the end of the period.

Question 11-6 (LO 11-2)

The four steps are to calculate net cash flows from operating activities using information from the income statement and changes in current assets and current liabilities, determine the net cash ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Vol.1, Chapter 11 11-1

Chapter 11 - Statement of Cash Flows

flows from investing activities by analyzing changes in long-term asset accounts, determine the net cash flows from financing activities by analyzing changes in long-term liabilities and stockholders’ equity accounts, and finally, combine the operating, investing, and financing activities and make sure the total agrees with the net increase (decrease) in cash.

Question 11-7 (LO 11-2)

Using the indirect method, we begin with net income and then list adjustments to net income in order to arrive at operating cash flows. Using the direct method we adjust the items on the income statement to directly show the cash inflows and outflows from operations such as cash received from customers and cash paid for inventory, salaries, rent, interest and taxes. The indirect method is more common in practice, while the direct method provides a more logical presentation of cash flows.

Question 11-8 (LO 11-3)

The most common adjustments to convert net income to net cash flows are adjustments for noncash items such as depreciation expense, nonoperating items such as a gain or loss on sale of long-term assets, and adjustments for changes in current assets and current liabilities from the beginning to the end of the period examined.

Question 11-9 (LO 11-3)

It is possible to report a loss and still have positive operating cash flows. For example, if depreciation expense was $500,000, a company could have a loss of $200,000 and positive operating cash flows of $300,000. Other adjustments that cause net income to be lower than operating cash flows are decreases in current assets and increases in current liabilities.

Question 11-10 (LO 11-3)

Depreciation expense is an addition to net income in arriving at net operating cash flows. Depreciation expense reduces net income. Remember, though, this expense does not correspond to a cash outflow in the current period. Since we deducted depreciation expense in the determination of net income, we need to add it back in order to eliminate it from our calculation of net operating cash flows.

Question 11-11 (LO 11-3) We subtract a gain on sale of assets and add a loss on sale of assets to net income in arriving at net cash flows from operating activities. The sale of an asset is an investing activity, not an operating activity. However, a gain on sale of assets increases net income, so we need to subtract it from net income to eliminate it. Similarly, a loss on sale of assets decreases net income, so we need to add it to net income.

Question 11-12 (LO 11-3)

We (a) subtract an increase in current assets, (b) add a decrease in current assets, (c) add an increase in current liabilities, and (d) subtract a decrease in current liabilities from net income under the indirect method.

Question 11-13 (LO 11-3)

An increase in accounts receivable indicates sales were more than cash collections from customers during the period. Therefore, an increase in accounts receivable indicates net income is more than operating cash flows. A decrease in accounts receivable indicates sales were less than ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 11-2 Financial Accounting, 5e

Chapter 11 - Statement of Cash Flows

cash collections from customers during the period. Therefore, a decrease in accounts receivable indicates net income is less than operating cash flows.

Question 11-14 (LO 11-3, 11-4) The $1,000 loss on sale of the investment (selling price $9,000 less book value $10,000) is added back to net income in arriving at net operating cash flows. The sale of the investment is also reported as a $9,000 increase to cash from investing activities. This transaction has no effect on financing activities.

Question 11-15 (LO 11-5)

Financing activities are related to changes in short-term debt, long-term debt, and stockholders’ equity items other than net income. Common financing activities are borrowing and repaying debt, issuing and buying back the company’s stock, and paying dividends.

Question 11-16 (LO 11-1, 11-4, 11-5)

The purchase of land by issuing its own common stock is a noncash activity. Transactions like this that don’t increase or decrease cash, but that result in significant investing and financing activities, are reported directly after the cash flow statement or in a separate note to the financial statements.

Question 11-17 (LO 11-6)

Return on assets has net income in the numerator while cash return on assets has cash flows from operations in the numerator. Both ratios divide by average total assets. Analysts often supplement their investigation of income statement and balance sheet amounts with cash flow ratios. Some cash flow ratios are derived by substituting net cash flows from operating activities in place of net income, not to replace those ratios but to complement them. Cash flow ratios offer additional insight in the evaluation of a company’s profitability and financial strength.

Question 11-18 (LO 11-6)

Companies have two primary strategies for increasing their cash return on assets. One strategy is to produce highly innovative products that yield very high cash inflows from customers in relationship to the cash outflows to produce and then sell the products. Another strategy is to pursue high asset turnover by efficiently using assets to generate sales (typically selling at lower prices than the competition).

Chapter 11 - Statement of Cash Flows

Question 11-19 (LO 11-7)

The primary cash inflows under the direct method are cash received from customers and cash received from interest and dividends. The primary cash outflows are cash paid to suppliers, cash paid for operating expenses, cash paid for interest, and cash paid for income taxes.

Question 11-20 (LO 11-7)

Depreciation expense has no effect on cash flows. It is merely an allocation in the current period of a prior cash expenditure (to purchase the depreciable asset). Therefore, depreciation expense is not reported on the statement of cash flows under the direct method. The gain or loss on sale of land is also not reported because it, too, has no effect on operating cash flows.

Chapter 11 - Statement of Cash Flows

BRIEF EXERCISES Brief Exercise 11-1 (LO 11-1) 1. Financing activity. 2. Financing activity. 3. Operating activity. 4. Investing activity. 5. Operating activity.

Brief Exercise 11-2 (LO 11-1) 1. Financing activity. 2. Operating activity. 3. Financing activity. 4. Investing activity.

Brief Exercise 11-3 (LO 11-2) Operating activities Investing activities Financing activities Net increase (decrease) in cash Beginning cash balance Ending cash balance

Brief Exercise 11-4 (LO 11-3) Cash Flows from Operating Activities ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Vol.1, Chapter 11 11-5

Chapter 11 - Statement of Cash Flows

Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Increase in accounts receivable Decrease in accounts payable Net cash flows from operating activities

$650,000 50,000 (11,000) (30,000) $659,000

Brief Exercise 11-5 (LO 11-3) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Increase in prepaid rent Increase in accounts payable Increase in income tax payable Net cash flows from operating activities

$75,000 90,000 (70,000) 10,000 23,000 $128,000

Brief Exercise 11-6 (LO 11-3) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Loss (on sale of equipment) Increase in accounts receivable Increase in inventory Increase in accounts payable Net cash flows from operating activities

$70 6 2 (3) (5) 4 $74

Brief Exercise 11-7 (LO 11-3) Cash Flows from Operating Activities Net income

$70

Chapter 11 - Statement of Cash Flows

Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Gain (on sale of land) Decrease in accounts receivable Decrease in inventory Decrease in accounts payable Net cash flows from operating activities

6 (2) 3 5 (4) $78

Brief Exercise 11-8 (LO 11-4) Cash Flows from Investing Activities Sale of investments Sale of land Purchase equipment Purchase a patent Net cash flows from investing activities

$40 16 (26) (13) $17

Brief Exercise 11-9 (LO 11-4) Cash Flows from Investing Activities Collection of note receivable

$100,000*

*Interest of $10,000 (= $100,000 × 10%) is reported as an operating cash inflow.

Chapter 11 - Statement of Cash Flows

Brief Exercise 11-10 (LO 11-4) If purchased for $850,000: Cash Flows from Investing Activities Sale of land

$900,000

If purchased for $950,000: Cash Flows from Investing Activities Sale of land

$900,000

Brief Exercise 11-11 (LO 11-5) Cash Flows from Financing Activities Issuance of common stock Purchase of treasury stock Net cash flows from financing activities

$42 (22) $20

Brief Exercise 11-12 (LO 11-5) Cash Flows from Financing Activities Repayment of note payable

$(100,000)*

*Interest of $10,000 (= $100,000 × 10%) is reported as an operating cash outflow.

Brief Exercise 11-13 (LO 11-1, 11-4, 11-5) a. b. c.

Investing activities -0-0-0-

Financing activities $250,000 -0-0-

Chapter 11 - Statement of Cash Flows

Brief Exercise 11-14 (LO 11-6) Operating Cash Flow $60,000

Average Cash Return ÷ Total Assets = on Assets ÷ ($500,000 + $800,000)/2 = 9.2%

Operating Cash Flow $60,000

÷ ÷

= =

Cash Flow to Sales 2.9%

Sales $2,100,000

Average ÷ Total Assets = ÷ ($500,000 + $800,000)/2 =

Asset Turnover 3.2 times

Sales $2,100,000

Brief Exercise 11-15 (LO 11-6) Operating Cash Flow ($620,000 + $820,000)/2 = Operating Cash Flow $720,000

0.25

Operating Cash Flow = 0.25 x ($720,000) = $180,000

Brief Exercise 11-16 (LO 11-7) Net sales + Decrease in accounts receivable Cash received from customers

$73 9 $82

Chapter 11 - Statement of Cash Flows

Brief Exercise 11-17 (LO 11-7) Cost of goods sold + Increase in inventory = Purchases − Increase in accounts payable = Cash paid to suppliers

$45 5 50 (7) $43

Brief Exercise 11-18 (LO 11-7) Operating expenses + Increase in prepaid rent − Increase in salaries payable = Cash paid for operating expenses

$985,000 30,000 (20,000) $995,000

Brief Exercise 11-19 (LO 11-7) Income tax expense − Increase in income taxes payable Cash paid for income taxes

$340,000 (15,000) $325,000

Brief Exercise 11-20 (LO 11-5, 11-7) Net income − Increase in retained earnings Cash paid for dividends

$220,000 (120,000) $100,000

Chapter 11 - Statement of Cash Flows

EXERCISES Exercise 11-1 (LO 11-1, 11-2, 11-3, 11-4, 11-5, 11-6) Items __e__ __f__ __d__ __g__ __a__ __h__ __b__ __c__

1. Operating activities 2. Investing activities 3. Financing activities 4. Noncash activities 5. Indirect method 6. Direct method 7. Depreciation expense 8. Cash return on assets

Descriptions a. Begins with net income and then lists adjustments to net income in order to arrive at operating cash flows. b. Item included in net income, but excluded from net operating cash flows. c. Net cash flows from operating activities divided by average total assets. d. Cash transactions involving lenders and investors. e. Cash transactions involving net income. f. Cash transactions for the purchase and sale of long-term assets. g. Purchase of long-term assets by issuing stock to seller. h. Shows the cash inflows and outflows from operations such as cash received from customers and cash paid for inventory, salaries, rent, interest and taxes.

Chapter 11 - Statement of Cash Flows

Exercise 11-2 (LO 11-1) The $25,000 increase in notes payable should be properly recorded as an increase in cash from financing activities. While most changes in current assets and current liabilities are included in operating activities, borrowing money from a bank is clearly a financing activity. Ethics come into play because, by recording the increase in notes payable as an operating rather than a financing activity, operating cash flows increase to $210,000 ($185,000 + $25,000) and Justin Lake receives a $100,000 bonus. Nicole should insist that the $25,000 increase in notes payable be recorded as an increase in cash from financing activities. Classroom discussion might consider what additional actions Nicole should take if Justin Lake does not accept her opinion.

Exercise 11-3 (LO 11-1) 1. Investing activities 2. Operating activities 3. Operating activities 4. Financing activities 5. Operating activities 6. Investing activities 7. Investing activities 8. Noncash activities 9. Operating activities 10. Financing activities

Chapter 11 - Statement of Cash Flows

Exercise 11-4 (LO 11-1) 1. Financing activities 2. Investing activities 3. Operating activities 4. Operating activities 5. Noncash activities 6. Financing activities 7. Investing activities 8. Operating activities

Exercise 11-5 (LO 11-1) 1. Investing activities, Operating activities (Gain on sale of land) 2. Financing activities 3. Investing activities 4. Operating activities

Chapter 11 - Statement of Cash Flows

Exercise 11-6 (LO 11-1) 1. Investing activities 2. Investing activities 3. Financing activities 4. Financing activities

Chapter 11 - Statement of Cash Flows

Exercise 11-7 (LO 11-2) Technology Solutions Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: List of items adjusting net income to operating cash flows Net cash flows from operating activities

$$$

Cash Flows from Investing Activities List of cash inflows and outflows from investing activities Net cash flows from investing activities

$$$

Cash Flows from Financing Activities List of cash inflows and outflows from financing activities Net cash flows from financing activities

$$$

Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period

$$$ $$$ $$$

Note: Noncash Activities List of noncash transactions

$$$

Chapter 11 - Statement of Cash Flows

Exercise 11-8 (LO 11-3) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Gain (on sale of land) Increase in accounts receivable Increase in inventory Decrease in accounts payable Net cash flows from operating activities

$165,000 (20,000) (35,000) (20,000) (55,000) $35,000

All of the adjustments are subtracted from net income in arriving at net operating cash flows. This could be a natural occurrence in the data, or it could imply that management may be using some of these items to overstate net income.

Exercise 11-9 (LO 11-3) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Loss (on sale of land) Decrease in accounts receivable Decrease in inventory Increase in accounts payable Net cash flows from operating activities

$65,000 15,000 6,000 28,000 37,000 45,000 $196,000

All of the adjustments are added to net income in arriving at net operating cash flows. This could be a natural occurrence in the data, or it could imply that management may be using some of these items to minimize net income.

Chapter 11 - Statement of Cash Flows

Exercise 11-10 (LO 11-2, 11-3, 11-4, 11-5) Plasma Screens Corporation Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Decrease in accounts receivable Increase in inventory Increase in prepaid rent Increase in accounts payable Decrease in interest payable Increase in income tax payable Net cash flows from operating activities Cash Flows from Investing Activities Purchase of equipment Net cash flows from investing activities Cash Flows from Financing Activities Payment of notes payable Payment of cash dividends Net cash flows from financing activities Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period

$ 79,000 150,000 15,000 (16,000) (3,000) 15,000 (6,900) 4,000 $237,100 (110,000) (110,000) (115,000) (30,000) (145,000) (17,900) 126,800 $108,900

Chapter 11 - Statement of Cash Flows

Exercise 11-11 (LO 11-3) Peach Computer Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Decrease in accounts receivable Increase in inventory Decrease in prepaid rent Increase in accounts payable Decrease in income tax payable Net cash flows from operating activities

$130,000 60,000 8,000 (25,000) 3,000 13,000 (9,000) $180,000

Chapter 11 - Statement of Cash Flows

Exercise 11-12 (LO 11-4) Sale of building Investment in Fleet’s common stock Purchase of equipment Loan to supplier (note receivable)

$ 500,000 (120,000) (65,000) (100,000) $ 215,000

Exercise 11-13 (LO 11-5) Issuance of common stock Purchase treasury stock Payment of dividend Repay notes payable

$ 160,000 (75,000) (40,000) (90,000) $(45,000)

Chapter 11 - Statement of Cash Flows

Exercise 11-14 (LO 11-6) Requirement 1 ($ in millions) Zoogle Requirement 2 ($ in millions) Zoogle Requirement 3

Net Income $6,620

Average ÷ Total Assets ÷ ($41,768 + $50,497)/2

= =

Return on Assets 14.3%

Operating Cash Flows $9,326

Average ÷ Total Assets ÷ ($41,768 + $50,497)/2

= =

Cash Return on Assets 20.2%

= =

Cash Flow to Sales 37.8%

= =

Asset Turnover 0.5 times

($ in millions) Zoogle

Operating Cash Flows $9,326

÷ ÷

($ in millions) Zoogle

Net Sales $24,651

Average ÷ Total Assets ÷ ($41,768 + $50,497)/2

Net Sales $24,651

Chapter 11 - Statement of Cash Flows

Exercise 11-15 (LO 11-7) Peach Computer Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Cash received from customers Cash paid to suppliers Cash paid for operating expenses Cash paid for income taxes Net cash flows from operating activities

$2,058,000 (1,162,000) (657,000) (59,000)

Net sales + Decrease in accounts receivable = Cash received from customers

$2,050,000 8,000 $2,058,000

Cost of goods sold + Increase in inventory = Purchases − Increase in accounts payable = Cash paid to suppliers

$1,150,000 25,000 1,175,000 (13,000) $1,162,000

$180,000

Operating expenses − Decrease in prepaid rent = Cash paid for operating expenses

$660,000 (3,000) $657,000

Income tax expense + Decrease in income tax payable = Cash paid for income taxes

$50,000 9,000 $59,000

Chapter 11 - Statement of Cash Flows

Exercise 11-16 (LO 11-7) Net sales − Increase in accounts receivable = Cash received from customers

$3,200,000 (55,000) $3,145,000

Cost of goods sold − Decrease in inventory = Purchases + Decrease in accounts payable = Cash paid to suppliers

$2,000,000 (40,000) 1,960,000 17,000 $1,977,000

Income tax expense − Increase in income tax payable = Cash paid for income taxes

$150,000 (9,000) $141,000

Exercise 11-17 (LO 11-7) 1. ($ in millions) Net sales − Increase in accounts receivable = Cash received from customers

$91,758 (1,733) $90,025

2. Cost of goods sold + Increase in inventory = Purchases + Decrease in accounts payable = Cash paid to suppliers

$69,278 883 70,161 1,967 $72,128

Chapter 11 - Statement of Cash Flows

Exercise 11-18 (LO 11-7) Requirement 1 Situation 1. 2. 3.

Sale Revenue 200 200 200

Accounts Receivable Increase (Decrease) -030 (30)

Cash Received from Customers* 200 170 230

* Cash received from customers = Sales revenue + Decrease in Accounts Receivable − Increase in Accounts Receivable

Requirement 2 1. Cash Sales Revenue 2.

200 200

Cash Accounts Receivable Sales Revenue

170 30

Cash Accounts Receivable Sales Revenue

230

200 30 200

Chapter 11 - Statement of Cash Flows

Exercise 11-19 (LO 11-7) Requirement 1 Cost of Sit. Goods Sold 1. 150 2. 150 3. 150 4. 150

Inventory Increase (Decrease) 25 (25) 25 (25)

Accounts Payable Increase (Decrease) 20 20 (20) (20)

Cash Paid to Suppliers 155 105 195 145

* Cash paid to suppliers = Cost of goods sold + Increase in Inventory − Decrease in Inventory + Decrease in Accounts Payable − Increase in Accounts Payable

Requirement 2 1. Cost of Goods Sold Inventory Accounts Payable Cash 2.

150 25 20 155

Cost of Goods Sold Inventory Accounts Payable Cash

150

Cost of Goods Sold Inventory Accounts Payable Cash

150 25 20

Cost of Goods Sold Accounts Payable Inventory Cash

150 20

25 20 105

195

25 145

Chapter 11 - Statement of Cash Flows

Exercise 11-20 (LO 11-7) Requirement 1 Operating Sit. Expenses 1. 100 2. 100 3. 100 4. 100

Prepaid Insurance Increase (Decrease) 15 (15) 15 (15)

Salaries Payable Increase (Decrease) 10 10 (10) (10)

Cash Paid for Operating Expenses 105 75 125 95

* Cash paid for operating expenses = Operating expenses + Increase in Prepaid Insurance − Decrease in Prepaid Insurance + Decrease in Salaries Payable − Increase in Salaries Payable

Requirement 2 1. Operating Expenses Prepaid Insurance Salaries Payable Cash 2.

100 15 10 105

Operating Expenses Prepaid Insurance Salaries Payable Cash

100

Operating Expenses Prepaid Insurance Salaries Payable Cash

100 15 10

Operating Expenses Salaries Payable Prepaid Insurance Cash

100 10

15 10 75

125

15 95

Chapter 11 - Statement of Cash Flows

PROBLEMS: SET A Problem 11-1A (LO 11-1) Type of Activity O I O O F O I O NC F I F F O I

Cash Inflow or Outflow CO CI CO CI CI CO CI CO NE CI CO CO CO CO CI

Transaction 1. Payment of employee salaries. 2. Sale of land for cash. 3. Purchase of rent in advance. 4. Collection of an account receivable. 5. Issuance of common stock. 6. Purchase of inventory. 7. Collection of notes receivable. 8. Payment of income taxes. 9. Sale of equipment for a note receivable. 10. Issuance of bonds. 11. Loan to another company. 12. Payment of a long-term note payable. 13. Purchase of treasury stock. 14. Payment of an account payable. 15. Sale of equipment for cash.

Chapter 11 - Statement of Cash Flows

Problem 11-2A (LO 11-1, 11-3, 11-4, 11-5) ATM Software Developers Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Increase in accounts receivable Decrease in inventory Decrease in prepaid rent Decrease in accounts payable Net cash flows from operating activities Cash Flows from Investing Activities Cash received from sale of land Purchase of equipment Net cash flows from investing activities Cash Flows from Financing Activities Issuance of common stock Issuance of long-term notes payable Payment of dividends Purchase of treasury stock Net cash flows from financing activities Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period

$12,400 5,465 (4,090) 1,475 905 (1,760) $14,395 8,650 (39,865) (31,215) 13,075 16,495 (6,370) (2,615) 20,585 3,765 7,510 $11,275

Chapter 11 - Statement of Cash Flows

Problem 11-3A (LO 11-4) Alliance Technologies Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Decrease in accounts receivable Increase in inventory Decrease in prepaid rent Increase in salaries payable Decrease in accounts payable Increase in income tax payable Net cash flows from operating activities

$56,000 17,000 7,000 (14,000) 10,000 6,000 (9,000) 24,000 $97,000

Chapter 11 - Statement of Cash Flows

Problem 11-4A (LO 11-2, 11-3, 11-4, 11-5) Video Phones, Inc. Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Loss (on sale of land) Increase in accounts receivable Decrease in inventory Increase in prepaid rent Decrease in accounts payable Decrease in interest payable Increase in income tax payable Net cash flows from operating activities Cash Flows from Investing Activities Purchase investment in bonds Proceeds from sale of land Net cash flows from investing activities Cash Flows from Financing Activities Payment of cash dividends Net cash flows from financing activities Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period Note: Noncash Activities Purchase equipment issuing a note payable

$104,000 37,000 9,000 (22,000) 40,000 (7,200) (16,000) (5,000) 1,000 $140,800 (115,000) 31,000 (84,000) (30,000) (30,000) 26,800 227,800 $254,600 $70,000

Chapter 11 - Statement of Cash Flows

Problem 11-5A (LO 11-6) Requirement 1 ($ in millions) Cyberdyne Virtucon

Requirement 2 ($ in millions) Cyberdyne Virtucon Requirement 3 ($ in millions) Cyberdyne Virtucon

($ in millions) Cyberdyne Virtucon

Net Income $9,737 $1,049

Average ÷ Total Assets ÷ ($57,851 + $72,574)/2 ($14,928 + $14,783)/2

Operating Cash Flows $14,565 $1,324

Average ÷ Total Assets ÷ ($57,851 + $72,574)/2 ÷ ($14,928 + $14,783)/2

Operating Cash Flows $14,565 $1,324

÷ ÷ ÷

Net Sales $37,905 $4,984

Average ÷ Total Assets ÷ ($57,851 + $72,574)/2 ÷ ($14,928 + $14,783)/2

Net Sales $37,905 $4,984

= = =

Return on Assets 14.9% 7.1%

= = =

Cash Return on Assets 22.3% 8.9%

= = =

Cash Flow to Sales 38.4% 26.6%

= = =

Asset Turnover 0.6 times 0.3 times

Requirement 4 Cyberdyne has a better return on assets, cash return on assets, cash flow to sales, and asset turnover.

Chapter 11 - Statement of Cash Flows

*Problem 11-6A (LO 11-7) Alliance Technologies Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Cash received from customers Cash paid to suppliers Cash paid for operating expenses Cash paid for income taxes Net cash flows from operating activities

$412,000 (258,000) (54,000) (3,000)

Net sales + Decrease in accounts receivable = Cash received from customers

$405,000 7,000 $412,000

Cost of goods sold + Increase in inventory = Purchases + Decrease in accounts payable = Cash paid to suppliers

$235,000 14,000 249,000 9,000 $258,000

Operating expenses − Decrease in prepaid rent − Increase in salaries payable = Cash paid for operating expenses

$70,000 (10,000) (6,000) $54,000

Income tax expense − Increase in income tax payable = Cash paid for income taxes

$27,000 (24,000) $ 3,000

$97,000

Chapter 11 - Statement of Cash Flows

*Problem 11-7A (LO 11-7) Video Phones, Inc. Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Cash received from customers Cash paid to suppliers Cash paid for operating expenses Cash paid for interest Cash paid for income taxes Net cash flows from operating activities

$3,614,000 (2,426,000) (965,200) (25,000) (57,000)

Cash Flows from Investing Activities Purchase investment in bonds Proceeds from sale of land Net cash flows from investing activities

(115,000) 31,000

Cash Flows from Financing Activities Payment of cash dividends Net cash flows from financing activities Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period Note: Noncash Activities Purchase equipment issuing a note payable

$140,800

(84,000) (30,000) (30,000) 26,800 227,800 $254,600 $70,000

Chapter 11 - Statement of Cash Flows

Net sales − Increase in accounts receivable = Cash received from customers

$3,636,000 (22,000) $3,614,000

Cost of goods sold − Decrease in inventory = Purchases + Decrease in accounts payable = Cash paid to suppliers

$2,450,000 (40,000) 2,410,000 16,000 $2,426,000

Operating expenses + Increase in prepaid rent = Cash paid for operating expenses

$958,000 7,200 $965,200

Interest expense + Decrease in interest payable = Cash paid for interest

$20,000 5,000 $25,000

Income tax expense − Increase in income tax payable = Cash paid for income taxes

$58,000 (1,000) $57,000

Chapter 11 - Statement of Cash Flows

*Problem 11-8A (LO 11-3, 1-7) Reverse Logic Income Statement For the Year Ended December 31, 2021 Net sales Expenses: Cost of goods sold Operating expenses Depreciation expense Income tax expense Total expenses Net Income

$4,108 $2,624 1,158 62 90 3,934 $ 174

Net sales − Increase in accounts receivable = Cash received from customers

$4,108 (38) $4,070

Cost of goods sold − Decrease in inventory = Purchases + Decrease in accounts payable = Cash paid to suppliers

$2,624 (50) 2,574 11 $2,585

Operating expenses + Increase in prepaid rent = Cash paid for operating expenses

$1,158 5 $1,163

Income tax expense + Decrease in income tax payable = Cash paid for income taxes

$90 9 $99

Chapter 11 - Statement of Cash Flows

PROBLEMS: SET B Problem 11-1B (LO 11-1) Type of Activity F I F O F O F O NC F I O F I I

Cash Inflow or Outflow CI CI CO CI CI CO CO CO NE CI CO CO CO CO CI

Transaction 1. Issue common stock. 2. Sale of land for cash. 3. Purchase of treasury stock. 4. Collection of an account receivable. 5. Issuance of a note payable. 6. Purchase of inventory. 7. Repayment of note payable. 8. Payment of employee salaries. 9. Sale of equipment for a note receivable. 10. Issuance of bonds. 11. Investment in bonds. 12. Payment of interest on bonds payable. 13. Payment of a cash dividend. 14. Purchase of a building. 15. Collection of a note receivable.

Chapter 11 - Statement of Cash Flows

Problem 11-2B (LO 11-1, 11-3, 11-4, 11-5) CPU Hardware Designers Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Loss (on sale of land) Increase in accounts receivable Increase in inventory Increase in prepaid rent Increase in accounts payable Net cash flows from operating activities Cash Flows from Investing Activities Cash received from sale of land Purchase of equipment Net cash flows from investing activities Cash Flows from Financing Activities Issuance of common stock Payment of dividends Repayment of notes payable Net cash flows from financing activities Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period

$ 80,000 30,000 8,000 (70,000) (40,000) (11,000) 11,000 $

8,000

4,000 (230,000) (226,000) 300,000 (50,000) (60,000) 190,000 (28,000) 90,000 $ 62,000

Chapter 11 - Statement of Cash Flows

Problem 11-3B (LO 11-3) Software Associates Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Decrease in accounts receivable Decrease in inventory Increase in prepaid rent Decrease in salaries payable Increase in accounts payable Increase in income tax payable Net cash flows from operating activities

$78,000 33,000 10,000 13,000 (3,000) (4,000) 7,000 8,000 $142,000

Chapter 11 - Statement of Cash Flows

Problem 11-4B (LO 11-2, 11-3, 11-4, 11-5) Virtual Gaming Systems Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Gain (on sale of land) Decrease in accounts receivable Increase in inventory Decrease in prepaid rent Decrease in accounts payable Increase in interest payable Decrease in income tax payable Net cash flows from operating activities Cash Flows from Investing Activities Purchase investment in stock Proceeds from sale of land Net cash flows from investing activities Cash Flows from Financing Activities Issue common stock Payment of cash dividends Net cash flows from financing activities Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period Note: Noncash Activities Purchase equipment issuing a note payable

$195,000 33,000 (7,000) 16,000 (15,000) 2,600 (63,000) 1,100 (4,000) $158,700 (95,000) 62,000 (33,000) 60,000 (120,000) (60,000) 65,700 343,800 $409,500 $30,000

Chapter 11 - Statement of Cash Flows

Problem 11-5B (LO 11-6) Requirement 1 ($ in millions) InGen RDA

Requirement 2 ($ in millions) InGen RDA Requirement 3 ($ in millions) InGen RDA

($ in millions) InGen RDA

Average Net Income ÷ Total Assets $7,074 ÷ ($124,503 + $129,517)/2 $15,855 ÷ ($113,452 + $116,433)/2

= = =

Operating Average Cash Flows ÷ Total Assets $12,639 ÷ ($124,503 + $129,517)/2 $19,846 ÷ ($113,452 + $116,433)/2

Cash Return = on Assets = 10.0% = 17.3%

Operating Cash Flows ÷ $12,639 ÷ $19,846 ÷

Net Sales $127,245 $106,916

Average ÷ Total Assets ÷ ($124,503 + $129,517)/2 ÷ ($113,452 + $116,433)/2

Return on Assets 5.6% 13.8%

= = =

Cash Flow to Sales 9.9% 18.6%

= = =

Asset Turnover 1.0 times 0.9 times

Requirement 4 RDA has a higher return on assets, cash return on assets, and cash flow to sales ratio. However, InGen has a slightly higher asset turnover ratio.

Chapter 11 - Statement of Cash Flows

*Problem 11-6B (LO 11-7) Software Associates Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Cash received from customers Cash paid to suppliers Cash paid for operating expenses Cash paid for income taxes Net cash flows from operating activities

$720,000 (400,000) (137,000) (41,000)

Net sales + Decrease in accounts receivable = Cash received from customers

$710,000 10,000 $720,000

Cost of goods sold − Decrease in inventory = Purchases − Increase in accounts payable = Cash paid to suppliers

$420,000 (13,000) 407,000 (7,000) $400,000

Operating expenses + Increase in prepaid rent + Decrease in salaries payable = Cash paid for operating expenses

$130,000 3,000 4,000 $137,000

Income tax expense − Increase in income tax payable = Cash paid for income taxes

$49,000 (8,000) $41,000

$142,000

Chapter 11 - Statement of Cash Flows

*Problem 11-7B (LO 11-7) Virtual Gaming Systems Statement of Cash Flows For the Year Ended December 31, 2021 Cash Flows from Operating Activities Cash received from customers Cash paid to suppliers Cash paid for operating expenses Cash paid for interest Cash paid for income taxes Net cash flows from operating activities

$2,616,000 (1,728,000) (612,400) (32,900) (84,000)

Cash Flows from Investing Activities Purchase investment in stock Proceeds from sale of land Net cash flows from investing activities

(95,000) 62,000

Cash Flows from Financing Activities Issue common stock Payment of cash dividends Net cash flows from financing activities Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period Note: Noncash Activities Purchase equipment issuing a note payable

$158,700

(33,000) 60,000 (120,000) (60,000) 65,700 343,800 $409,500 $30,000

Chapter 11 - Statement of Cash Flows

Net sales + Decrease in accounts receivable = Cash received from customers

$2,600,000 16,000 $2,616,000

Cost of goods sold + Increase in inventory = Purchases + Decrease in accounts payable = Cash paid to suppliers

$1,650,000 15,000 1,665,000 63,000 $1,728,000

Operating expenses − Decrease in prepaid rent = Cash paid for operating expenses

$615,000 (2,600) $612,400

Interest expense − Increase in interest payable = Cash paid for interest

$34,000 (1,100) $32,900

Income tax expense + Decrease in income tax payable = Cash paid for income taxes

$80,000 4,000 $84,000

Chapter 11 - Statement of Cash Flows

*Problem 11-8B (LO 11-3, 11-7) Electronic Transformations Income Statement For the Year Ended December 31, 2021 Net sales Expenses: Operating expenses Depreciation expense Income tax expense Total expenses Net Income

$96,000 $34,000 9,000 17,000 60,000 $36,000

Net sales − Increase in accounts receivable = Cash received from customers

$96,000 (13,000) $83,000

Operating expenses − Increase in accounts payable = Cash paid for operating expenses

$34,000 (8,000) $26,000

Income tax expense − Increase in income tax payable = Cash paid for income taxes

$17,000 (6,000) $11,000

Chapter 11 - Statement of Cash Flows

ADDITIONAL PERSPECTIVES Continuing Problem: Great Adventures AP11-1 Great Adventures, Inc. Statement of Cash Flows For the Year Ended December 31, 2022 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Increase in accounts receivable Increase in inventory Decrease in other current assets Increase in accounts payable Increase in income tax payable Increase in other current liabilities Net cash flows from operating activities Cash Flows from Investing Activities Purchase of buildings Purchase of equipment Net cash flows from investing activities Cash Flows from Financing Activities Repayment of notes payable Issued common stock Purchased treasury stock Sale of treasury stock Payment of dividends Net cash flows from financing activities Net increase (decrease) in cash Cash at the beginning of the period Cash at the end of the period Note: Noncash Activities Purchase land issuing a note payable

$ 35,835 17,250 (47,600) (7,000) 3,600 18,000 500 21,000 $ 41,585 (800,000) (22,000) (822,000) (6,117) 1,000,000 (150,000) 64,000 (11,400) 896,483 116,068 64,500 $180,568 $500,000

Chapter 11 - Statement of Cash Flows

Financial Analysis: American Eagle AP11-2 ($ in thousands) 1. $35,000 increase. 2. $394,426. Yes. Net cash flows from operating activities increased in the most recent year. The largest reconciling item between net income and net operating cash flows in the most recent year is depreciation and amortization of $169,473. 3. $(172,150) . The largest investment activity during the most recent year is capital expenditures for property and equipment of $(169,469). 4. $(188,772). The largest financing activity during the most recent year is the payment of cash dividends of $88,548.

Chapter 11 - Statement of Cash Flows

Financial Analysis: Buckle AP11-3 ($ in thousands) 1. $31,450 decrease. 2. $119,721. No. Net cash flows from operating activities decreased in the most recent year. The largest reconciling item between net income and net operating cash flows in the most recent year is depreciation and amortization of $30,745. 3. $(17,297). The largest investment activity during the most recent year is purchases of investments for $56,631. 4. $(133,874). The largest financing activity during the most recent year is the payment of dividends of $133,874.

Chapter 11 - Statement of Cash Flows

Comparative Analysis: American Eagle vs. Buckle AP11-4 ($ in thousands) 1. American Eagle

American Eagle

American Eagle 2. Buckle

Buckle

Operating Cash Flow $394,426

Average Cash Return ÷ Total Assets = on Assets ÷ ($1,816,313 + 1,782,660)/2 = 21.9%

Operating Cash Flow $394,426

Sales $3,795,549 Operating Cash Flow $119,721

÷ ÷

Sales $3,795,549

= =

Average Total Assets ($1,816,313 + 1,782,660)/2

Average ÷ Total Assets = ÷ ($538,616 + $579,847)/2 =

Operating Cash Flow $119,721

÷ ÷

Sales $913,380

Average ÷ Total Assets ÷ ($538,616 + $579,847)/2

Sales $913,380

Cash Flow to Sales 10.4%

= =

Asset Turnover 2.1 times

Cash Return on Assets 21.4% Cash Flow to Sales 13.1%

= =

Asset Turnover 1.6 times

3. American has a higher cash return on assets (21.9% vs. 21.4%), a lower cash flow to sales (10.4% vs. 13.1%), and a higher asset turnover (2.1 times vs. 1.6 times) compared to Buckle.

Chapter 11 - Statement of Cash Flows

Ethics AP11-5 Requirement 1 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Increase in accounts payable Increase in interest payable Net cash flows from operating activities

$65,000 10,000 25,000 10,000 $110,000

Requirement 2 Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Increase in accounts receivable Increase in inventory Increase in accounts payable Increase in interest payable Net cash flows from operating activities

$ 30,000a 10,000 (60,000)b (40,000)c 25,000 10,000 $(25,000)

Chapter 11 - Statement of Cash Flows

$65,000 as reported − $35,000 profit on assumed sale of inventory ($75,000 − $40,000) b Increase in accounts receivable = $60,000 actual ending balance − $0 beginning balance (first year of operations). c Increase in inventory = $40,000 actual ending balance − $0 beginning balance (first year of operations). Requirement 3 Yes. The company is reporting a positive net income of $65,000 and positive operating cash flows of $110,000. Both amounts are overstated. Net income is overstated by $35,000, the assumed sale of inventory. Operating cash flows are overstated by $135,000 (= $60,000 assumed cash to be collected from current accounts receivable + $75,000 assumed cash to be collected from the sale of inventory). The company has actual negative operating cash flows of $25,000 this year, and its ending cash balance is actually only $15,000. If the negative operating cash flows continue, it will be difficult for Larry to pay back the loan. If Matt instead uses Larry’s assumptions, operating cash flows are highly positive, indicating the company’s likely ability to pay back the loan. Requirement 4 No. Without additional information, it’s not possible for Matt to determine the likelihood that customer accounts will be collected or for what amount the inventory will be sold. Matt should not use the personal gain from potential future employment in his decision to put the bank’s cash at risk. Larry likely mentioned the potential employment position as it could influence Matt’s decision regarding the approval of the $100,000 loan increase. It is important that Matt consider the loan application from the perspective of what is best for the bank. Matt may wish to obtain the opinion of another bank employee, especially if he has difficulty making an unbiased decision under these circumstances.

Chapter 11 - Statement of Cash Flows

Internet Research AP11-6 This case provides an opportunity for students to learn more about Form 10-K, containing the annual report for publicly traded companies. It also introduces students to EDGAR, one of the largest sources of accounting information available on the internet. Answers to the assignment will vary depending on the 10-K filing chosen.

Chapter 11 - Statement of Cash Flows

Written Communication AP11-7 Polar Opposites Statement of Cash Flows For the Year Ended December 31, 2021

($ in millions) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation expense Increase in accounts receivable Increase in inventory Increase in accounts payable Increase in accrued expenses payable Net cash flows from operating activities

$ 5 4 (16) (14) 7 9 $ (5)

As the operating activities section under the indirect method indicates, net income is $5 million, yet cash flow from operating activities is a negative $5 million. This is primarily due to the large increase in accounts receivable and inventory during the first year of operations.

Chapter 11 - Statement of Cash Flows

Earnings Management AP11-8 Requirement 1 Increase. The increase in accounts receivable is likely caused by the company’s more relaxed credit policy and longer collection periods. The company may be having greater difficulty collecting their accounts receivable. Yes. An increase in accounts receivable affects net income differently than operating cash flows. An increase in accounts receivable is related to an increase in sales revenue which increases net income. However, an increase in accounts receivable has a negative effect on cash flows as this represents sales that have not been collected. In summary, an increase in accounts receivable increases net income, but decreases operating cash flows. Requirement 2 Yes. Salary arrangements for officers that are tied to reported net income might increase the risk of earnings management. For instance, the CEO and CFO may have an incentive to increase earnings in order to receive higher compensation. Executive compensation tied to accounting numbers is used in practice, but users of accounting information need to be aware that this increases the risk of earnings management. Requirement 3 The positive trend in operating income compared to the negative trend in cash flows from operations. The trends combined with the two additional events may lead Bryan to suspect the possibility of earnings management. First, the large increase in accounts receivable can help explain the difference in trends between operating income and cash flows from operations. An increase in credit sales would explain the increase in net income. If those additional sales are not collected, supported by the large increase in accounts receivable, cash flows from operations will be lower than operating income. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education 11-52 Financial Accounting, 5e

Chapter 11 - Statement of Cash Flows

The second event provides the motive. Several of the company’s salary arrangements, including that of the CEO and CFO, are based on reported net income. These company executives have a direct salary incentive to overstate income.

Chapter 12 - Financial Statement Analysis

Chapter 12 Financial Statement Analysis REVIEW QUESTIONS Question 12-1 (LO 12-1, 12-2) The three types of comparisons commonly used in financial statement analysis are comparisons between companies, comparisons over time, and comparisons to industry.

Question 12-2 (LO 12-1, 12-2)

For vertical analysis, we express each item as a percentage of the same base amount, such as a percentage of sales in the income statement or as a percentage of total assets in the balance sheet. We use horizontal analysis to analyze trends in financial statement data, such as the amount of change and the percentage change, for one company over time.

Question 12-3 (LO 12-1) Sales are commonly used as a base amount for income statement accounts. Total assets are commonly used as a base amount for balance sheet accounts.

Question 12-4 (LO 12-1)

The company that has most of its equity balance in retained earnings is likely an older and more established company. The retained earnings balance of a profitable company that pays little dividends will grow substantially over the years. Walmart, Starbucks, and Facebook are all good examples.

Question 12-5 (LO 12-2)

If the dollar amount of the change is small, it may not be all that important even if the percentage change is very large. For example, in a large company, a $100 change is probably not important even if it increased 1,000% from $10 to $110.

Question 12-6 (LO 12-3)

We measure income statement accounts over a period of time (like a video), while we measure balance sheet accounts at a point in time (like a photograph). Therefore, ratios that compare an income statement account with a balance sheet account should express the balance sheet account as an average of the beginning and ending balances.

Question 12-7 (LO 12-3)

Liquidity refers to a company’s ability to pay its current liabilities. The accounts used to calculate liquidity ratios are current assets and current liabilities. Solvency refers to a company’s ability to pay its long-term liabilities.

Chapter 12 - Financial Statement Analysis

Question 12-8 (LO 12-3)

(a) Receivable turnover ratio and average collection period. (b) Inventory turnover ratio and average days in inventory. (c) Times interest earned ratio

Question 12-9 (LO 12-3) (a) Good news. (b) Bad news. (c) Good news. (d) Bad news.

Question 12-10 (LO 12-3)

A $100,000 purchase of inventory on account will increase current assets and current liabilities by $100,000. The new current ratio will increase to 0.92, calculated as current assets ($550,000) divided by current liabilities ($600,000).

Question 12-11 (LO 12-4) (a) Return on assets. (b) Profit margin. (c) Asset turnover.

Question 12-12 (LO 12-4) (a) Good news. (b) Bad news. (c) Bad news. (d) Good news.

Question 12-13 (LO 12-4)

The return on assets and the return on equity differ due to financial leverage – the amount of debt each company carries. If a company earns a return on investment above the interest cost of borrowing, then the additional debt will benefit investors in the company. The result, as is the case for Hash Mark, Inc., is that the return on equity will exceed the return on assets.

Question 12-14 (LO 12-5)

Earnings persistence is the ability of current earnings to continue or persist into future years. Items that are not expected to persist, like discontinued operations, are reported separately near the bottom of the income statement.

Question 12-15 (LO 12-6) The trend in earnings per share is favorable. Companies report discontinued operations separately near the bottom of the income statement to allow investors to see that these are one-time items that should be excluded in estimating income that will persist into future periods. Therefore, excluding the discontinued operations, earnings per share increased from $1.30 last year to $1.50 this year.

Chapter 12 - Financial Statement Analysis

Question 12-16 (LO 12-6)

Conservative accounting practices are those that result in reporting lower income, lower assets, and higher liabilities. In contrast, aggressive accounting practices result in reporting higher income, higher assets, and lower liabilities.

Question 12-17 (LO 12-6)

A larger estimation of the allowance for uncollectible accounts, the write-down of overvalued inventory, the use of a shorter useful life for depreciation, and the recording of a contingent litigation loss are all examples of conservative accounting. They are conservative because all of these practices report lower net income.

Question 12-18 (LO 12-6)

A lower estimation of the allowance for uncollectible accounts, waiting to report an inventory write-down, choosing a longer useful life for depreciation, and waiting to record a litigation loss all are examples of more aggressive accounting. They are aggressive because all of these practices report higher net income.

Question 12-19 (LO 12-6)

All of these adjustments are conservative resulting in a lower reported net income.

Question 12-20 (LO 12-6)

All of the changes proposed near the end of the chapter improve the income statement and the balance sheet, but have no effect on cash flows. They include reducing the estimate of bad debts, eliminating a write-down of inventory, increasing the useful life or the salvage value used in calculating depreciation expense, and the elimination of the litigation liability.

Chapter 12 - Financial Statement Analysis

BRIEF EXERCISES Brief Exercise 12-1 (LO 12-1)

Cash Accounts receivable Inventory Long-term assets Total assets

2021 Amount $ 420,000 660,000 1,020,000 3,900,000 $6,000,000

% 7.0 11.0 17.0 65.0 100.0

2020 Amount $ 1,050,000 300,000 925,000 2,725,000 $5,000,000

% 21.0 6.0 18.5 54.5 100.0

Brief Exercise 12-2 (LO 12-2) Year Cash Accounts receivable Inventory Long-term assets Total assets

2021 $ 420,000 660,000 1,020,000 3,900,000 $6,000,000

2020 $ 1,050,000 300,000 925,000 2,725,000 $5,000,000

Increase (Decrease) Amount % $ (630,000) (60.0) 360,000 120.0 95,000 10.3 1,175,000 43.1 $1,000,000 20.0

Brief Exercise 12-3 (LO 12-1) Athletic World’s income before tax as a percentage of sales increased. Income before tax was 17% of sales in 2021 [100% – (48% + 35%)] compared to only 14% of sales in 2020 [100% – (56% + 30%)]. If net income as a percentage of sales increases, that does not mean that net income also increases. For example, if sales decrease 10% and net income decreases 5%, net income as a percentage of sales will increase, even though net income decreases.

Chapter 12 - Financial Statement Analysis

Brief Exercise 12-4 (LO 12-2) Percentage change from 2020 to 2021 = 3.8% increase Percentage change from 2021 to 2022 = 7.4% decrease

Brief Exercise 12-5 (LO 12-2) $1,150,000 = 1.15 x Sales in 2021 Sales in 2021 = $1,150,000 / 1.15 = $1,000,000

Brief Exercise 12-6 (LO 12-3) Receivables turnover ratio

$750,000 ($200,000 + $220,000) / 2

= 3.6 times

$500,000* ($65,000 + $75,000) / 2

= 7.1 times

Brief Exercise 12-7 (LO12-3) Inventory turnover ratio

*$750,000 sales minus $250,000 gross profit = $500,000 COGS

Chapter 12 - Financial Statement Analysis

Brief Exercise 12-8 (LO12-3) COGS must equal $980,000 to complete the inventory turnover ratio. COGS $200,000

Inventory turnover ratio

= 4.9 times

Given sales of $1,140,000 and calculating COGS of $980,000, gross profit is $160,000. Sales – Cost of goods sold = Gross profit

$1,140,000 980,000 $ 160,000

Brief Exercise 12-9 (LO12-3) Current ratio before purchase of inventory $3,430,000 $4,900,000

= 0.70 to 1

Current ratio after $900,000 cash purchase of inventory $3,430,000 + $900,000 inventory − $900,000 cash $4,900,000

= 0.70 to 1

Current ratio after $900,000 purchase of inventory on account $3,430,000 + $900,000 inventory $4,900,000 + $900,000 accounts payable

= 0.75 to 1

Chapter 12 - Financial Statement Analysis

Brief Exercise 12-10 (LO12-4) Return on assets

$15 ($96 + $104) / 2

= 15.0%

Profit margin

$15 $130

= 11.5%

Asset turnover

$130 ($96 + $104) / 2

= 1.3 times

Return on assets

$130,000 $700,000

= 18.6%

Return on equity

$130,000 $700,000 − $340,000

= 36.1%

Brief Exercise 12-11 (LO12-4)

Brief Exercise 12-12 (LO12-5) Income from continuing operations Discontinued operation: Loss from sale of the career counseling division, net of tax Net income

$32,000,000 (7,500,000) $24,500,000

Brief Exercise 12-13 (LO12-5) ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Chapter 12 12-7

Chapter 12 - Financial Statement Analysis

1. Other expenses 2. Other expenses 3. Discontinued operations 4. Other revenues

Brief Exercise 12-14 (LO12-6) 1. Conservative 2. Aggressive 3. Aggressive

Brief Exercise 12-15 (LO12-6) 1. Conservative 2. Conservative 3. Conservative

Chapter 12 - Financial Statement Analysis

EXERCISES Exercise 12-1 (LO12-1, 12-2, 12-3, 12-4, 12-5, 12-6) Items g e a h f d b c

1. Vertical analysis 2. Horizontal analysis 3. Liquidity 4. Solvency 5. Discontinued operation 6. Quality of earnings 7. Conservative accounting practices 8. Aggressive accounting practices

Descriptions a. A company’s ability to pay its current liabilities. b. Accounting choices that result in reporting lower income, lower assets, and higher liabilities. c. Accounting choices that result in reporting higher income, higher assets, and lower liabilities. d. The ability of reported earnings to reflect the company’s true earnings as well as the usefulness of reported earnings to help investors predict future earnings. e. A tool to analyze trends in financial statement data for a single company over time. f. The sale or disposal of a significant component of a company’s operations. g. A means to express each item in a financial statement as a percentage of a base amount. h. A company’s ability to pay its long-term liabilities.

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Chapter 12 - Financial Statement Analysis

Exercise 12-2 (LO12-1) Federer Sports Apparel Income Statement For the Years Ended December 31 2022 2021 Amount % Amount Net sales $ 18,800,000 100.0 $ 15,500,000 Cost of goods sold 13,200,000 70.2 7,000,000 Gross profit 5,600,000 29.8 8,500,000 Operating expenses 1,600,000 8.5 1,200,000 Depreciation expense 1,000,000 5.3 1,000,000 Inventory write-down 200,000 1.1 0 Litigation expense 1,500,000 8.0 300,000 Income before tax 1,300,000 6.9 6,000,000 Income tax expense 450,000 2.4 2,000,000 Net income $ 850,000 4.5 $ 4,000,000

% 100.0 45.2 54.8 7.7 6.5 0.0 1.9 38.7 12.9 25.8

Chapter 12 - Financial Statement Analysis

Exercise 12-3 (LO12-2) Federer Sports Apparel Income Statement For the Years Ended December 31 Year Increase (Decrease) 2022 2021 Amount % Revenues $ 18,800,000 $ 15,500,000 $3,300,000 21.3 Cost of goods sold 13,200,000 7,000,000 6,200,000 88.6 Gross profit 5,600,000 8,500,000 (2,900,000) (34.1) Operating expenses 1,600,000 1,200,000 400,000 33.3 Depreciation expense 1,000,000 1,000,000 0 0 Inventory write-down 200,000 0 200,000 N/A Litigation expense 1,500,000 300,000 1,200,000 400 Income before tax 1,300,000 6,000,000 (4,700,000) (78.3) Income tax expense 450,000 2,000,000 (1,550,000) (77.5) Net income $ 850,000 $ 4,000,000 $(3,150,000) (78.8)

Chapter 12 - Financial Statement Analysis

Exercise 12-4 (LO12-1, 12-2) Requirement 1 Federer Sports Apparel Balance Sheet December 31 2022 Assets Amount % Cash $ 2,300,000 14.7 Accounts receivable 1,500,000 9.6 Inventory 2,800,000 18.0 Buildings 11,000,000 70.5 Less: Accumulated depreciation (2,000,000) (12.8) Total assets $15,600,000 100.0 Accounts payable Litigation liability Common stock Retained earnings Total liabilities and stockholders’ equity

2021 Amount $ 800,000 1,200,000 1,700,000 11,000,000 (1,000,000) $13,700,000

% 5.8 8.8 12.4 80.3 (7.3) 100.0

$ 1,450,000 1,500,000 8,000,000 4,650,000

9.3 9.6 51.3 29.8

$ 1,700,000 0 8,000,000 4,000,000

12.4 0.0 58.4 29.2

$15,600,000

100.0

$13,700,000

100.0

Chapter 12 - Financial Statement Analysis

Requirement 2

Assets Cash Accounts receivable Inventory Buildings Less: Accumulated depreciation Total assets Accounts payable Litigation liability Common stock Retained earnings Total liabilities and stockholders’ equity

Federer Sports Apparel Balance Sheet December 31 Year 2022 2021 $ 2,300,000 $ 800,000 1,500,000 1,200,000 2,800,000 1,700,000 11,000,000 11,000,000

Increase (Decrease) Amount % $1,500,000 187.5 300,000 25.0 1,100,000 64.7 0 0

(2,000,000) $15,600,000

(1,000,000) $13,700,000

(1,000,000) $1,900,000

100.0 13.9

$ 1,450,000 1,500,000 8,000,000 4,650,000

$ 1,700,000 0 8,000,000 4,000,000

$ (250,000) 1,500,000 0 650,000

(14.7) N/A 0 16.3

$15,600,000

$13,700,000

$1,900,000

13.9

Chapter 12 - Financial Statement Analysis

Exercise 12-5 (LO12-3) Requirement 1 Risk Ratios

Calculations

Receivables turnover ratio

$19,310,000 ($1,100,000 + $1,600,000) / 2

= 14.3 times

Average collection period

365 14.3

= 25.5 days

Inventory turnover ratio

$12,250,000 ($1,500,000 + $2,000,000) / 2

= 7.0 times

Average days in inventory

365 7.0

= 52.1 days

Current ratio

$4,300,000 $1,920,000

= 2.2 to 1

Debt to equity ratio

$4,320,000 $4,880,000

= 88.5%

Requirement 2 Based on the above ratios, Adrian Express is more risky than the industry average. The receivable turnover, inventory turnover, and current ratios are close to the industry averages. However, the debt to equity ratio at 88.5% is much worse than the industry average of 50%.

Chapter 12 - Financial Statement Analysis

Exercise 12-6 (LO12-4) Requirement 1 Profitability Ratios

Calculations

Gross profit ratio

($19,310,000 – $12,250,000) $19,310,000

= 36.6%

Return on assets

$1,700,000 ($7,800,000 + $9,200,000) / 2

= 20.0%

Profit margin

$1,700,000 $19,310,000

= 8.8%

Asset turnover

$19,310,000 ($7,800,000 + $9,200,000) / 2

= 2.3 times

Return on equity

$1,700,000 ($3,540,000 + $4,880,000) / 2

= 40.4%

Requirement 2 Adrian Express is less profitable than the industry average. The gross profit ratio, return on assets, profit margin, and asset turnover are all below the industry average. Return on equity of 40% is an exception, exceeding the industry average of 35%.

Chapter 12 - Financial Statement Analysis

Exercise 12-7 (LO12-3) Requirement 1 Risk Ratios

Calculations

a. Receivables turnover ratio

$1,890,000 ($102,000 + $98,000) / 2

= 18.9 times

b. Inventory turnover ratio

$1,394,250 ($90,000 + $105,000) / 2

= 14.3 times

c. Current ratio

$450,000 $125,000

= 3.6 to 1

d. Acid-test ratio

$242,000 + $98,000 + $5,000 $125,000

= 2.8 to 1

$235,000 $1,157,000

= 20.3%

e. Debt to equity ratio

Requirement 2 One company can have a higher current ratio while the other has a higher acid-test ratio. The company may have a higher current ratio due to higher inventory and prepaid expenses. Inventory and prepaid expenses are less liquid than other current assets and therefore, are excluded in the calculation of the acid-test ratio. Note that, for the same company, the current ratio will always be higher than the acidtest ratio. This is true because the current ratio includes all current assets in the numerator, while the acid-test ratio includes only cash, accounts receivable, and current investments.

Chapter 12 - Financial Statement Analysis

Exercise 12-8 (LO12-4) Requirement 1 <

Profitability Ratios

Calculations

a. Gross profit ratio

$495,750 $1,890,000

= 26.2%

b. Return on assets

$184,000 ($1,307,000 + $1,392,000) / 2

= 13.6%

c. Profit margin

$184,000 $1,890,000

= 9.7%

d. Asset turnover

$1,890,000 ($1,307,000 + $1,392,000) / 2

= 1.4 times

e. Return on equity

$184,000 ($973,000 + $1,157,000) / 2

= 17.3%

Requirement 2 One company can have a higher return on assets while the other company has a higher return on equity. The return on equity takes into consideration leverage – the amount of debt the company has assumed. The return on assets does not consider the effects of leverage.

Chapter 12 - Financial Statement Analysis

Exercise 12-9 (LO12-4) Requirement 1 Profitability Ratios

Calculations

a. Gross profit ratio

$14,820,000 – $9,544,080 $14,820,000

= 35.6%

b. Return on assets

$418,000 ($3,600,000 + $4,000,000) / 2

= 11.0%

c. Profit margin

$418,000 $14,820,000

= 2.8%

d. Asset turnover

$14,820,000 ($3,600,000 + $4,000,000) / 2

= 3.9 times

e. Return on equity

$418,000 ($1,200,000 + $1,300,000) / 2

= 33.4%

Requirement 2 Dividends paid to shareholders in 2021 were $318,000. This amount can be determined by analyzing the changes to retained earnings as follows:

Retained earnings, 2020

$300,000

+ Net income

418,000

– Dividends paid

(318,000)

= Retained earnings, 2021

$400,000

Chapter 12 - Financial Statement Analysis

Exercise 12-10 (LO12-4) Profitability Ratios

Calculations

Return on assets

$65,700 $900,000

= 7.3%

Profit margin

$65,700 $540,000

= 12.2%

Asset turnover

$540,000 $900,000

= 0.6 times

Return on equity

$65,700 ($600,000 + $635,700) / 2

= 10.6%

Stockholders’ equity, beginning

$600,000

+ Net income

65,700

– Dividends paid

(30,000)

= Stockholders’ equity, ending

$635,700

Chapter 12 - Financial Statement Analysis

Exercise 12-11 (LO12-5) a. Other expenses b. Discontinued operations c. Other expenses d. Other expenses e. Other revenues

Chapter 12 - Financial Statement Analysis

Exercise 12-12 (LO12-5) LeBron’s Bookstores Income Statement For the Year Ended December 31, 2021 Net sales Cost of goods sold Gross profit Operating expenses Income before tax Income tax expense Income from continuing operations Discontinued operation: Loss from disposal of book division, net of tax Net income

$ 11,000,000 6,500,000 4,500,000 3,000,000 1,500,000 375,000 1,125,000 (675,000) $ 450,000

Chapter 12 - Financial Statement Analysis

Exercise 12-13 (LO12-5) Shaquille Corporation Income Statement For the Year Ended December 31, 2021 Operating income Inventory write-down Income before tax Income tax expense Income from continuing operations Discontinued operation: Gain from disposal of operating segment, net of tax Net income

$ 1,700,000 200,000 1,500,000 425,000 1,075,000 275,000 $ 1,350,000

Chapter 12 - Financial Statement Analysis

Exercise 12-14 (LO12-6) a. Conservative (lower income, lower assets) b. Aggressive

(higher income, higher assets)

c. Conservative (lower income, lower assets) d. Aggressive

(higher income, lower liabilities)

Chapter 12 - Financial Statement Analysis

Exercise 12-15 (LO12-6) Requirement 1 (a) Aggressive (b) Conservative (c) Aggressive (d) Aggressive (e) Aggressive Note: Changes resulting in higher revenues or lower expenses are considered aggressive. Changes resulting in lower revenues or higher expenses are considered conservative. Requirement 2 The total effect is neutral because net income is the same before and after the proposed changes. The conservative change of $400,000 exactly offsets the four aggressive changes totaling $400,000.

Chapter 12 - Financial Statement Analysis

PROBLEMS: SET A Problem 12-1A (LO12-1) Requirement 1 Sports Emporium Income Statements For the Year Ended December 31, 2021 Sporting Goods Sports Apparel Amount % Amount % Net sales $1,800,000 100.0 $970,000 100.0 Cost of goods sold 1,040,000 57.8 440,000 45.4 Gross profit 760,000 42.2 530,000 54.6 Operating expenses 450,000 25.0 340,000 35.1 Operating income 310,000 17.2 190,000 19.5 Other income (expense) 20,000 1.1 (15,000) (1.5) Income before tax 330,000 18.3 175,000 18.0 Income tax expense 80,000 4.4 70,000 7.2 Net income $ 250,000 13.9 $105,000 10.8

Requirement 2 The sporting goods segment has a higher net income ($250,000) than the sports apparel segment ($105,000). Vertical analysis further indicates the sporting goods segment is more profitable since net income is 13.9% of sales in that segment compared to only 10.8% of sales in the sports apparel segment. If these results continue, Sports Emporium may want to place greater focus on the expansion of the more profitable sporting goods segment.

Chapter 12 - Financial Statement Analysis

Problem 12-2A (LO12-2) Requirement 1 Anything Tennis Income Statements For the Years Ended December 31 Net sales Cost of goods sold Gross profit Operating expenses Operating income Other income (expense) Income before tax Income tax expense Net income

2021 $ 3,500,000 2,150,000 1,350,000 810,000 540,000 10,000 550,000 100,000 $ 450,000

2020 $ 2,620,000 1,380,000 1,240,000 630,000 610,000 6,000 616,000 140,000 $ 476,000

Increase (Decrease) Amount % $ 880,000 33.6 770,000 55.8 110,000 8.9 180,000 28.6 (70,000) (11.5) 4,000 66.7 (66,000) (10.7) (40,000) (28.6) $ (26,000) (5.5)

Requirement 2 Sales increased $880,000 (33.6%), but cost of goods sold increased $770,000 (55.8%), resulting in a gross profit just slightly higher than the prior year. Operating expenses increased 28.6%, which explains why operating income, income before tax, and net income fell short of the prior year.

Chapter 12 - Financial Statement Analysis

Problem 12-3A (LO12-1, 12-2) Requirement 1

Assets Current assets: Cash Accounts receivable Inventory Prepaid rent Long-term assets: Investment in bonds Land Equipment Accumulated depreciation Total assets

Sports Unlimited Balance Sheet December 31, 2021 2021 Amount %

2020 Amount

$ 103,500 46,800 44,550 7,200

23.0 10.4 9.9 1.6

$ 70,400 32,000 71,200 3,600

17.6 8.0 17.8 0.9

54,900 117,450 106,200 (30,600) $ 450,000

12.2 26.1 23.6 (6.8) 100.0

0 141,600 102,000 (20,800) $ 400,000

0.0 35.4 25.5 (5.2) 100.0

6.7 1.6 2.7

$ 46,800 3,600 10,000

11.7 0.9 2.5

30.7

127,600

31.9

32.0 26.3 100.0

144,000 68,000 $400,000

36.0 17.0 100.0

Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 30,150 Interest payable 7,200 Income tax payable 12,150 Long-term liabilities: Notes payable 138,150 Stockholders’ equity: Common stock 144,000 Retained earnings 118,350 Total liabilities and equity $450,000

Chapter 12 - Financial Statement Analysis

Requirement 2

Assets Current assets: Cash Accounts receivable Inventory Prepaid rent Long-term assets: Investment in bonds Land Equipment Accumulated depreciation Total assets

Sports Unlimited Balance Sheet December 31, 2021 Year 2021 2020

Increase (Decrease) Amount %

$ 103,500 46,800 44,550 7,200

$ 70,400 32,000 71,200 3,600

$ 33,100 14,800 (26,650) 3,600

47.0 46.3 (37.4) 100.0

54,900 117,450 106,200 (30,600) $ 450,000

0 141,600 102,000 (20,800) $ 400,000

54,900 (24,150) 4,200 (9,800) $50,000

N/A (17.1) 4.1 (47.1) 12.5

$ 46,800 3,600 10,000

$(16,650) 3,600 2,150

(35.6) 100.0 21.5

127,600

10,550

8.3

144,000 68,000 $400,000

0 50,350 $50,000

0 74.0 12.5

Chapter 12 - Financial Statement Analysis

Problem 12-4A (LO12-3) Risk Ratios

Calculations

1. Receivables turnover ratio

$3,086,000 ($70,000 + $91,000) / 2

= 38.3 times

2. Average collection period

365 38.3

= 9.5 days

3. Inventory turnover ratio

$1,960,000 ($145,000 + $115,000) / 2

= 15.1 times

4. Average days in inventory

365 15.1

= 24.2 days

5. Current ratio

$415,000 $104,000

= 4.0 to 1

6. Acid-test ratio

$196,000 + $91,000 $104,000

= 2.8 to 1

$399,000 $547,000

= 72.9%

7. Debt to equity ratio 8. Times interest earned ratio

$139,000 + $20,000 + $58,000 $20,000

= 10.9 times

Chapter 12 - Financial Statement Analysis

Problem 12-5A (LO12-4) Profitability Ratios

Calculations

1. Gross profit ratio

$1,126,000 $3,086,000

= 36.5%

2. Return on assets

$139,000 ($794,200 + $946,000) / 2

= 16.0%

3. Profit margin

$139,000 $3,086,000

= 4.5%

4. Asset turnover

$3,086,000 ($794,200 + $946,000) / 2

= 3.5 times

5. Return on equity

$139,000 ($449,200 + $547,000) / 2

= 27.9%

6. Price-earnings ratio

$28.30 $1.40

= 20.2

Chapter 12 - Financial Statement Analysis

Problem 12-6A (LO12-3, 12-4) Requirement 1 Risk Ratios Receivables turnover ratio

Calculations

2021

$3,086,000 ($70,000 + $91,000) / 2

= 38.3 times

2022

$3,560,000 ($91,000 + $90,000) / 2

= 39.3 times

2021

$1,960,000 ($145,000 + $115,000) / 2

= 15.1 times

2022

$2,490,000 ($115,000 + $140,000) / 2

= 19.5 times

2021

$415,000 $104,000

= 4.0 to 1

2022

$461,000 $186,000

= 2.5 to 1

2021

$399,000 $547,000

= 72.9%

2022

$636,000 $436,000

= 145.9%

Inventory turnover ratio

Current ratio

Debt to equity ratio

Chapter 12 - Financial Statement Analysis

Requirement 2 Profitability Ratios Gross profit ratio

Calculations

2021

$1,126,000 $3,086,000

= 36.5%

2022

$1,070,000 $3,560,000

= 30.1%

2021

$139,000 ($794,200 + $946,000) / 2

= 16.0%

2022

$33,000 ($946,000 + $1,072,000) / 2

= 3.3%

2021

$139,000 $3,086,000

= 4.5%

2022

$33,000 $3,560,000

= 0.9%

Return on assets

Profit margin

Asset turnover 2021

$3,086,000 ($794,200 + $946,000) / 2

= 3.5 times

2022

$3,560,000 ($946,000 + $1,072,000) / 2

= 3.5 times

Requirement 3 The risk ratios are mixed. The receivables and inventory turnover ratios improved in 2022, while the current ratio and debt to equity ratio indicate greater risk in 2022. Profitability decreased as indicated by the lower gross profit ratio and return on assets in 2022. It appears that the lower return on assets in 2022 is due to lower profit margins rather than to a decrease in asset turnover.

Chapter 12 - Financial Statement Analysis

PROBLEMS: SET B Problem 12-1B (LO12-1) Requirement 1 Game-On Sports Income Statements For the Year Ended December 31, 2021 Athletic Equipment Accessories Amount % Amount % Net sales $3,050,000 100.0 $3,500,000 100.0 Cost of goods sold 1,350,000 44.3 1,670,000 47.7 Gross profit 1,700,000 55.7 1,830,000 52.3 Operating expenses 750,000 24.6 800,000 22.9 Operating income 950,000 31.1 1,030,000 29.4 Other income (expense) 80,000 2.6 (15,000) (0.4) Income before tax 1,030,000 33.7 1,015,000 29.0 Income tax expense 235,000 7.7 210,000 6.0 Net income $ 795,000 26.0 $ 805,000 23.0

Requirement 2 The athletic equipment segment is more profitable. Net income is 26.0% of sales in that segment compared to only 23.0% of sales in the accessories segment. If these results continue, Game-On Sports may want to place greater focus on the expansion of the more profitable athletic equipment segment.

Chapter 12 - Financial Statement Analysis

Problem 12-2B (LO12-2) Requirement 1 Galaxy Tennis Income Statements For the Years Ended December 31 Net sales Cost of goods sold Gross profit Operating expenses Operating income Other income (expense) Income before tax Income tax expense Net income

2021 2020 $ 6,150,000 $ 6,250,000 2,850,000 2,920,000 3,300,000 3,330,000 1,510,000 1,390,000 1,790,000 1,940,000 60,000 85,000 1,850,000 2,025,000 390,000 435,000 $ 1,460,000 $ 1,590,000

Increase (Decrease) Amount % $ (100,000) (1.6) (70,000) (2.4) (30,000) (0.9) 120,000 8.6 (150,000) (7.7) (25,000) (29.4) (175,000) (8.6) (45,000) (10.3) $(130,000) (8.2)

Requirement 2 Sales and gross profit decreased 1.6% and 0.9% respectively. However, even though sales decreased, operating expenses increased 8.6%. This resulted in decreases to operating income, income before tax, and net income around 8%.

Chapter 12 - Financial Statement Analysis

Problem 12-3B (LO12-1, 12-2) Requirement 1

Assets Current assets: Cash Accounts receivable Inventory Supplies Long-term assets: Equipment Accumulated depreciation Total assets

Fantasy Football Balance Sheet December 31 2021 Amount

2020 Amount

$ 208,000 856,000 1,900,000 124,000

5.2 21.4 47.5 3.1

$ 262,200 999,400 1,349,000 87,400

6.9 26.3 35.5 2.3

1,292,000 (380,000) $4,000,000

32.3 1,292,000 (9.5) (190,000) 100.0 $3,800,000

34.0 (5.0) 100.0

4.2 $ 129,200 0.0 3,800 1.9 76,000

3.4 0.1 2.0

19.0

760,000

20.0

19.7 786,600 55.2 2,044,400 100.0 $3,800,000

20.7 53.8 100.0

Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 168,000 Interest payable 0 Income tax payable 76,000 Long-term liabilities: Notes payable 760,000 Stockholders’ equity: Common stock 786,600 Retained earnings 2,209,400 Total liabilities and equity $4,000,000

Chapter 12 - Financial Statement Analysis

Requirement 2

Assets Current assets: Cash Accounts receivable Inventory Supplies Long-term assets: Equipment Accumulated depreciation Total assets

Fantasy Football Balance Sheet December 31 Year 2021 2020 $ 208,000 856,000 1,900,000 124,000

$ 262,200 999,400 1,349,000 87,400

1,292,000 1,292,000 (380,000) (190,000) $4,000,000 $3,800,000

Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 168,000 $ 129,200 Interest payable 0 3,800 Income tax payable 76,000 76,000 Long-term liabilities: Notes payable 760,000 760,000 Stockholders’ equity: Common stock 786,600 786,600 Retained earnings 2,209,400 2,044,400 Total liabilities and equity $4,000,000 $3,800,000

Increase (Decrease) Amount % $ (54,200) (143,400) 551,000 36,600

(20.7) (14.3) 40.8 41.9

0 0 (190,000) (100.0) $200,000 5.3

$ 38,800 30.0 (3,800) (100.0) 0 0 0

0 165,000 $200,000

0 8.1 5.3

Chapter 12 - Financial Statement Analysis

Problem 12-4B Risk Ratios

Calculations

1. Receivables turnover ratio

$8,900,000 ($810,000 + $790,000) / 2

= 11.1 times

2. Average collection period

365 11.1

= 32.9 days

3. Inventory turnover ratio

$5,450,000 ($1,075,000 + $1,405,000) / 2

= 4.4 times

4. Average days in inventory

365 4.4

= 83.0 days

5. Current ratio

$2,469,000 $155,000

= 15.9 to 1

6. Acid-test ratio

$164,000 + $790,000 $155,000

= 6.2 to 1

$755,000 $2,444,000

= 30.9%

7. Debt to equity ratio

8. Times interest earned ratio

$1,230,000 + $50,000 + $360,000 $50,000

= 32.8 times

Chapter 12 - Financial Statement Analysis

Problem 12-5B (LO12-4) Profitability Ratios

Calculations

1. Gross profit ratio

$3,450,000 $8,900,000

= 38.8%

2. Return on assets

$1,230,000 ($3,124,000 + $3,199,000) / 2

= 38.9%

3. Profit margin

$1,230,000 $8,900,000

= 13.8%

4. Asset turnover

$8,900,000 ($3,124,000 + $3,199,000) / 2

= 2.8 times

5. Return on equity

$1,230,000 ($2,397,000 + $2,444,000) / 2

= 50.8%

6. Price-earnings ratio

$22.42 $1.36

= 16.5 times

Chapter 12 - Financial Statement Analysis

Problem 12-6B (LO12-3, 12-4) Requirement 1 Risk Ratios Receivables turnover ratio

Calculations

2021

$8,900,000 ($810,000 + $790,000) / 2

= 11.1 times

2022

$10,400,000 ($790,000 + $990,000) / 2

= 11.7 times

2021

$5,450,000 ($1,075,000 + $1,405,000) / 2

= 4.4 times

2022

$6,800,000 ($1,405,000 + $1,725,000) / 2

= 4.3 times

2021

$2,469,000 $155,000

= 15.9 to 1

2022

$3,070,000 $219,000

= 14.0 to 1

2021

$755,000 $2,444,000

= 30.9%

2022

$719,000 $2,851,000

= 25.2%

Inventory turnover ratio

Current ratio

Debt to equity ratio

Chapter 12 - Financial Statement Analysis

Requirement 2 Profitability Ratios Gross profit ratio

Calculations

2021

$3,450,000 $8,900,000

= 38.8%

2022

$3,600,000 $10,400,000

= 34.6%

2021

$1,230,000 ($3,124,000 + $3,199,000) / 2

= 38.9%

2022

$1,360,000 ($3,199,000 + $3,570,000) / 2

= 40.2%

2021

$1,230,000 $8,900,000

= 13.8%

2022

$1,360,000 $10,400,000

= 13.1%

2021

$8,900,000 ($3,124,000 + $3,199,000) / 2

= 2.8 times

2022

$10,400,000 ($3,199,000 + $3,570,000) / 2

= 3.1 times

Return on assets

Profit margin

Asset turnover

Requirement 3 Regarding risk, the receivables turnover slightly improved and the debt to equity ratio declined, which are both positive signs. However, the inventory turnover ratio and current ratio both declined in 2022. Profitability ratios are mixed. While net income increased $130,000 in 2022, the gross profit ratio declined from 38.8% to 34.6%. Return on assets increased, profit margin declined, and asset turnover improved.

Chapter 12 - Financial Statement Analysis

ADDITIONAL PERSPECTIVES Continuing Problem: Great Adventures AP12-1 Requirement 1 Note: Assume all sales and services are on credit. Risk Ratios Calculations a. Receivables turnover ratio

$164,150 ($47,600 + $0) / 2

= 6.9 times

b. Average collection period

365 6.9

= 52.9 days

c. Inventory turnover ratio

$38,500 ($7,000 + $0) / 2

= 11.0 times

d. Average days in inventory

365 11.0

= 33.2 days

e. Current ratio

$236,068 $105,064

= 2.2 to 1

f. Acid-test ratio

$180,568 + $47,600 $105,064

= 2.2 to 1

$580,933 $991,885

= 58.6%

$35,835 + $6,785 + $14,500 $6,785

= 8.4 times

g. Debt to equity ratio h. Times interest earned ratio

Chapter 12 - Financial Statement Analysis

Requirement 2 Profitability Ratios

Calculations

a. Gross profit ratio

$164,150 − $38,500 $164,150

= 76.5%

b. Return on assets

$35,835 ($1,572,818 + $101,000) / 2

= 4.3%

c. Profit margin

$35,835 $164,150

= 21.8%

d. Asset turnover

$164,150 ($1,572,818 + $101,000) / 2

= 0.2 times

e. Return on equity

$35,835 ($991,885 + $53,450) / 2

= 6.9%

Chapter 12 - Financial Statement Analysis

Financial Analysis: American Eagle AP12-2 ($ in thousands) Requirement 1 Calculations

Risk Ratios a. Receivable turnover ratio

$3,795,549 ($78,304 + $86,634) / 2

= 46.0 times

b. Average collection period

365 46.0

= 7.9 days

c. Inventory turnover ratio

$2,425,044 ($398,213 + $358,446) / 2

= 6.4 times

d. Average days in inventory

365 6.4

= 57.0 days

e. Current ratio

$968,530 $485,221

= 2.0

f. Acid-test ratio

$413,613 + $0 +$78,304 $485,221

= 1.0

g. Debt to equity ratio

$569,522 $1,246,791

= 45.7%

Chapter 12 - Financial Statement Analysis

Requirement 2 Profitability Ratios

Calculations

a. Gross profit ratio

$1,370,505 $3,795,549

= 36.1%

b. Return on assets

$204,163 ($1,816,313 + 1,782,660) / 2

= 11.3%

c. Profit margin

$204,163 $3,795,549

= 5.4%

d. Asset turnover

$3,795,549 ($1,816,313 + 1,782,660) / 2

= 2.1 times

e. Return on equity

$204,163 ($1,246,791 + $1,204,569) / 2

= 16.7%

Chapter 12 - Financial Statement Analysis

Financial Analysis: The Buckle AP12-3 ($ in thousands) Requirement 1 Calculations

Risk Ratios a. Receivable turnover ratio

$913,380 ($8,588 + $8,210) / 2

= 108.7 times

b. Average collection period

365 108.7

= 3.4 days

c. Inventory turnover ratio

$533,357 ($118,007 + $125,694) / 2

= 4.4 times

d. Average days in inventory

365 4.4

= 83.0 days

e. Current ratio

$360,584 $97,906

= 3.7

f. Acid-test ratio

$165,086 + $50,833 +$8,588 $97,906

= 2.3

g. Debt to equity ratio

$146,868 $391,248

= 37.5%

Chapter 12 - Financial Statement Analysis

Requirement 2 Profitability Ratios

Calculations

a. Gross profit ratio

$380,023 $913,380

= 41.6%

b. Return on assets

$89,707 ($538,116 + $579,847) / 2

= 16.0%

c. Profit margin

$89,707 $913,380

= 9.8%

d. Asset turnover

$913,380 ($538,116 + $579,847) / 2

= 1.6 times

e. Return on equity

$89,707 ($391,248 + $430,539) / 2

= 21.8%

Chapter 12 - Financial Statement Analysis

Comparative Analysis: American Eagle vs. The Buckle AP12-4

($ in thousands) Requirement 1 American Eagle Calculations

Risk Ratios a. Receivable turnover ratio

$3,795,549 ($78,304 + $86,634) / 2

= 46.0 times

b. Average collection period

365 46.0

= 7.9 days

c. Inventory turnover ratio

$2,425,044 ($398,213 + $358,446) / 2

= 6.4 times

d. Average days in inventory

365 6.4

= 57.0 days

e. Current ratio

$968,530 $485,221

= 2.0

f. Acid-test ratio

$413,613 + $0 +$78,304 $485,221

= 1.0

g. Debt to equity ratio

$569,522 $1,246,791

= 45.7%

Chapter 12 - Financial Statement Analysis

The Buckle Calculations

Risk Ratios a. Receivable turnover ratio

$913,380 ($8,588 + $8,210) / 2

= 108.7 times

b. Average collection period

365 108.7

= 3.4 days

c. Inventory turnover ratio

$533,357 ($118,007 + $125,694) / 2

= 4.4 times

d. Average days in inventory

365 4.4

= 83.0 days

e. Current ratio

$360,584 $97,906

= 3.7

f. Acid-test ratio

$165,086 + $50,833 +$8,588 $97,906

= 2.3

g. Debt to equity ratio

$146,868 $391,248

= 37.5%

Buckle appears more risky based on the inventory turnover and average days in inventory. American Eagle appears more risky based on the receivable turnover ratio, average collection period, current ratio, acid-test ratio, and debt to equity ratio.

Chapter 12 - Financial Statement Analysis

Requirement 2 American Eagle Profitability Ratios

Calculations

a. Gross profit ratio

$1,370,505 $3,795,549

= 36.1%

b. Return on assets

$204,163 ($1,816,313 + 1,782,660) / 2

= 11.3%

c. Profit margin

$204,163 $3,795,549

= 5.4%

d. Asset turnover

$3,795,549 ($1,816,313 + 1,782,660) / 2

= 2.1 times

e. Return on equity

$204,163 ($1,246,791 + $1,204,569) / 2

= 16.7%

Chapter 12 - Financial Statement Analysis

The Buckle Profitability Ratios

Calculations

a. Gross profit ratio

$380,023 $913,380

= 41.6%

b. Return on assets

$89,707 ($538,116 + $579,847) / 2

= 16.0%

c. Profit margin

$89,707 $913,380

= 9.8%

d. Asset turnover

$913,380 ($538,116 + $579,847) / 2

= 1.6 times

e. Return on equity

$89,707 ($391,248 + $430,539) / 2

= 21.8%

American Eagle appears more profitable based on the asset turnover ratio. Buckle appears more profitable based on the gross profit ratio, return on assets, profit margin, and return on equity.

Chapter 12 - Financial Statement Analysis

Ethics AP12-5

1. The debt to equity ratio would be lower. The debt to equity ratio is the ratio of total liabilities to total equity. The warranty adjustment causes liabilities to increase and expenses to increase (and therefore equity to decrease). By not making the adjustment, the numerator (total liabilities) is lower, and the denominator (total equity) is higher. The result is the debt to equity ratio would be lower if the adjustment is not made. The gross profit ratio would be higher. The gross profit ratio is the ratio of gross profit to net sales. Gross profit is net sales revenue minus cost of goods sold. The inventory adjustment causes cost of goods sold to increase (and therefore gross profit to decrease) and total assets to decrease. By not making the adjustment, the numerator (gross profit) is higher, and the denominator (net sales) is unaffected. The result is the gross profit ratio would be higher if the adjustment is not made. The profit margin would be higher. Profit margin is the ratio of net income to net sales. The depreciation adjustment causes expenses to increase (and therefore net income to decrease) and total assets to decrease. By extending the estimated service life, the numerator (net income) is higher, and the denominator (net sales) is unaffected. The result is the profit margin would be higher if the adjustment is not made. 2. The company will appear riskier and less profitable if the adjustments are kept. The warranty adjustment increases the debt to equity ratio, indicating greater risk. The inventory adjustment decreases the gross profit ratio, and the shorter useful life used for the depreciable asset decreases the profit margin. Both of these lower ratios indicate lower profitability. 3. Yes. By not making the adjustments, stockholders may perceive the company as too profitable, and lenders may perceive the company as having too little risk. Management is affected by possibly now being able to receive their bonuses. 4. No. Each of these adjustments is required and appropriate. Estimated amounts are reasonable and consistent with prior practices.

Chapter 12 - Financial Statement Analysis

Internet Research AP12-6 This case provides an opportunity for students to examine ratios calculated for a company of their choice and a competitor in the same industry. It also allows students to evaluate risk and profitability ratios between two competing companies. Answers to the assignment will vary depending on the companies chosen.

Chapter 12 - Financial Statement Analysis

Written Communication AP12-7 Roseburg Corporation sells timber tracts for $30 million in 2021 that were purchased for $20 million in 2017. The $10 million gain on sale is recorded as: Cash Timber tracts Gain (To record gain on sale)

Debit 30,000,000

Credit 20,000,000 10,000,000

The issue is whether to record the $10 million gain on sale in the income statement as part of operating income, “other revenues and expenses,” or discontinued operations. Roseburg might prefer to report the large gain as part of operating income as it would make their operations appear more profitable. However, the sale of the timber tracts is not part of their ordinary operations of manufacturing cardboard containers. The sale or disposal of most long-term assets is reported as other revenues and expenses. This seems to be the best alternative as the sale of timber tracts is not part of ordinary operations. If the sale of the timber tracts qualified as a significant separate business segment having a major impact on the company’s operations and financial results, the $10 million gain would be reported at the bottom of the income statement as discontinued operations. This does not appear to be the case, as the timber tracts appear to be an asset investment more than a separate business operation. In summary, the $10 million gain might be reported as part of operating income, “other revenues and expenses,” or discontinued operations. However, the best alternative in this situation is to report the $10 million gain as part of “other revenues and expenses.”

Chapter 12 - Financial Statement Analysis

Earnings Management AP 12-8 Requirement 1 (a) Aggressive (b) Aggressive (c) Aggressive (d) Aggressive Requirement 2 Decrease. All four adjustments decrease expenses in the current year which, in turn, increases net income. Requirement 3 None. Each of the four adjustments improves the appearance of amounts reported in the income statement and the balance sheet, but none of the adjustments affects the cash balance. Requirement 4 Yes. All four of the year-end adjustments increase income. It may be that all four adjustments are perfectly legitimate, but it also may be an indication management is inflating earnings. Year-end adjustments, especially those with an increasing or decreasing pattern, should be investigated with greater skepticism.

Appendix C Time Value of Money REVIEW QUESTIONS Question C-1 (LO C-1)

Interest is the cost of borrowing money. Simple interest is interest we earn on the initial investment only. Compound interest is the interest we earn on the initial investment plus previous interest. We use compound interest in calculating the time value of money.

Question C-2 (LO C-2) To compute a future value, you need to know three amounts: (1) initial investment, (2) the interest rate per period and (3) the number of periods.

Question C-3 (LO C-2) Present value tells us the value today of receiving some larger amount in the future. The discount rate is the rate at which we would be willing to give up current dollars for future dollars.

Question C-4 (LO C-3)

An annuity represents cash payments of equal amounts over time periods of equal length.

Question C-5 (LO C-3)

The present value of an annuity is the sum of the present values of the single payments that make up the annuity. This means that the present value of an annuity can be calculated as the present value of each individual payment in the annuity, and then summing those present values. It’s also the case that, because annuities are cash payments of equal amounts over time periods of equal length, the present value of an annuity factor is simply the sum of the present value factors of the single payments that make up the annuity.

BRIEF EXERCISES Brief Exercise C-1 (LO C-1) Oprah should choose the second option, the investment on which interest is compounded semiannually. The more frequent the rate of compounding, the more interest we earn on previous interest, resulting in a higher future value.

Brief Exercise C-2 (LO C-2) Initial Annual Interest Period investment rate compounded invested $15,000 9% Annually 6 years a $15,000 × Future value of $1; n = 6; i = 9% Dusty will have enough to buy a car with the Turbo engine.

Future Value $25,156.50a

Brief Exercise C-3 (LO C-2) Initial Annual Interest investment rate compounded $27,000 7% Annually a $27,000 × Future value of $1; n = 2; i = 7%

Period invested 2 years

Future Value $30,912.30a

Arnold and Helene will not be able to pay for their trip.

Brief Exercise C-4 (LO C-2) Initial Annual Interest investment rate compounded 1. $8,000 10% Annually 2. 6,000 12 Semiannually 3. 9,000 8 Quarterly a $8,000 × Future value of $1; n = 7; i = 10% b $6,000 × Future value of $1; n = 8; i = 6% c $9,000 × Future value of $1; n = 12; i = 2%

Period invested 7 years 4 years 3 years

Future Value $15,589.74a 9,563.09b 11,414.18c

Brief Exercise C-5 (LO C-2) Future Annual Interest Period value Rate compounded invested $6,000 8% Annually 5 years a $6,000 × Present value of $1; n = 5; i = 8%

Present Value $4,083.50a

Brief Exercise C-6 (LO C-2) Future Annual Interest Period value Rate compounded invested $55,000 6% Annually 3 years a $55,000 × Present value of $1; n = 3; i = 6%

Present Value $46,179.06a

Brief Exercise C-7 (LO C-2) Future Annual Interest Period value Rate compounded invested 1. $10,000 6% Annually 5 years 2. 7,000 8 Semiannually 8 years 3. 6,000 12 Quarterly 4 years a $10,000 × Present value of $1; n = 5; i = 6% b $7,000 × Present value of $1; n = 16; i = 4% c $6,000 × Present value of $1; n = 16; i = 3%

Present value $7,472.58a 3,737.36b 3,739.00c

Brief Exercise C-8 (LO C-3) Annuity Annual Interest Period payment Rate compounded invested $4,000 8% Annually 7 years a $4,000 × Future value of annuity; n = 7; i = 8%

Future value of annuity $35,691.21a

Tom and Suri will reach their goal.

Brief Exercise C-9 (LO C-3) Annuity Annual Interest Period payment Rate compounded invested $3,000 10% Semiannually 5 years a $3,000 × Future value of annuity; n = 10; i = 5%

Future value of annuity $37,733.68a

Brief Exercise C-10 (LO C-3) Annuity Annual Interest Period payment Rate compounded invested 1. $3,000 7% Annually Six years 2. 6,000 8 Semiannually Nine years 3. 5,000 12 Quarterly Five years a $3,000 × Future value of annuity; n = 6; i = 7% b $6,000 × Future value of annuity; n = 18; i = 4% c $5,000 × Future value of annuity; n = 20; i = 3%

Future value of annuity $ 21,459.87a 153,872.48b 134,351.87c

Brief Exercise C-11 (LO C-3) Annuity Annual Interest Period Present value Payment Rate compounded invested of annuity $8,000 6% Annually Four years $27,720.88a a $8,000 × Present value of annuity; n = 4; i = 6% The four $8,000 payments (a total of $32,000 received) are worth $27,720.88 today.

Brief Exercise C-12 (LO C-3) Annuity Annual Interest Period Payment Rate compounded invested $5,000 10% Annually Ten years a $5,000 × Present value of annuity; n = 10; i = 10%

Present value of annuity $30,722.84a

Since the present value of revenue expected to be received ($30,722.84) is less than the cost today ($35,000), Monroe should not make the purchase.

Brief Exercise C-13 (LO C-3) Annuity Annual Interest Period Present value Payment rate compounded invested of annuity 1. $4,000 7% Annually Five years $16,400.79a 2. 9,000 8 Semiannually Three years 47,179.23b 3. 3,000 8 Quarterly Two years 21,976.44c a $4,000 × Present value of annuity; n = 5; i = 7% b $9,000 × Present value of annuity; n = 6; i = 4% c $3,000 × Present value of annuity; n = 8; i = 2%

EXERCISES Exercise C-1 (LO C-2) Investment Interest amount rate Compounding Jerry $13,000 12% Quarterly Elaine 16,000 6 Semiannually George 23,000 8 Annually Kramer 19,000 10 Annually a $13,000 × Future value of $1; n = 24; i = 3% b $16,000 × Future value of $1; n = 12; i = 3% c $23,000 × Future value of $1; n = 6; i = 8% d $19,000 × Future value of $1; n = 6; i = 10%

Period invested 6 years 6 years 6 years 6 years

Future Value $26,426.32a 22,812.17b 36,498.11c 33,659.66d

George will have the greatest investment accumulation.

Exercise C-2 (LO C-2) Initial Annual Interest investment rate compounded $2,000 13% Annually a $2,000 × Future value of $1; n = 30; i = 13%

Period invested 30 years

Future Value $78,231.80a

Exercise C-3 (LO C-2) Contract Discount amount rate Compounding Derek $600,000 9% Annually Isabel 640,000 9 Annually Meredith 500,000 9 Annually George 500,000 9 Annually a $600,000 × Present value of $1; n = 2; i = 9% b $640,000 × Present value of $1; n = 3; i = 9% c $500,000 × Present value of $1; n = 0; i = 9% d $500,000 × Present value of $1; n = 1; i = 9%

Period invested 2 years 3 years Today 1 year

Present Value $505,008.00a 494,197.43b 500,000.00c 458,715.60d

Derek is being paid the most in present value terms. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education C-6 Financial Accounting, 5e

Exercise C-4 (LO C-2) Purchase Discount amount rate Compounding Store 1 $3,500 9% Annually Store 2 3,700 9 Annually a $3,500 × Present value of $1; n = 0; i = 9% b $3,700 × present value of $1; n = 1; i = 9%

Period due Today One year

Present Value $3,500.00a 3,394.50b

Ray and Rachel should buy their ovens from Store 2.

Exercise C-5 (LO C-2) Present Total Payment value of present in one Discount payment in Payment value (or year rate Compounding one year today total cost)d Option 1 $ 0 11% Annually $ 0a $150,000 $150,000.00 Option 2 82,500 11 Annually 74,324.32b 75,000 149,324.32 c Option 3 172,500 11 Annually 155,405.41 0 155,405.41 a $0 × Present value of $1; n = 1; i = 11% b $82,500 × present value of $1; n = 1; i = 11% c $172,500 × present value of $1; n = 1; i = 11% d Total present value (or total cost) = present value of payment in one year + payment today Option 2’s cost has the lowest present value.

Exercise C-6 (LO C-3) Annuity Annual Interest Period payment Rate compounded invested $60,000 7% Annually 3 years 60,000 9 Annually 3 years 60,000 11 Annually 3 years a $60,000 × Future value of annuity; n = 3; i = 7% b $60,000 × Future value of annuity; n = 3; i = 9% c $60,000 × Future value of annuity; n = 3; i = 11%

Future value of annuity $192,894.00a 196,686.00b 200,526.00c

Exercise C-7 (LO C-3) Annuity Annual Interest Period payment Rate compounded invested $2,000 13% Annually 30 years a $2,000 × Future value of annuity; n = 30; i = 13%

Future value of annuity $586,398.43a

Exercise C-8 (LO C-3) Annuity Annual Interest Period payment Rate compounded invested Option 1 $35,000 12% Annually Today Option 2 4,000 12% Quarterly 3 years a $35,000 × Present value of annuity; n = 0; i = 12% b $4,000 × Present value of annuity; n = 12; i = 3%

Present value of annuity $35,000.00a 39,816.02b

Since the present value of payments ($39,816.02) is more than the cost today ($35,000), Denzel should choose option 1.

PROBLEMS: SET A Problem C-1A (LO C-2) Accumulated investment by retirement (age 65)

Person

Age

Initial investment

Alec

$11,000

$28,531.17a

Daniel

$11,000

$74,002.50b

William

$11,000

$191,943.42c

Stephen

$11,000

$497,851.81d

$11,000 × Future value of $1; n = 10; i = 10% $11,000 × Future value of $1; n = 20; i = 10% c $11,000 × Future value of $1; n = 30; i = 10% d $11,000 × Future value of $1; n = 40; i = 10% b

Problem C-2A (LO C-2, C-3) Annuity Discount Interest Period payment Rate compounded invested Years 1-6 $100,000 11% Annually 6 years a $100,000 × Present value of annuity; n = 6; i = 11%

Present value of annuity $423,053.79a

Future value Year 7 $110,000 Year 8 120,000 Year 9 130,000 Year 10 140,000 Year 10 1,300,000

Present Value $ 52,982.43a 52,071.18d 50,820.22c 49,305.83d 457,839.82e $663,019.48

Discount rate 11% 11% 11% 11% 11%

Interest compounded Annually Annually Annually Annually Annually

Period invested 7 years 8 years 9 years 10 years 10 years

$110,000 × Present value of $1; n = 7; i = 11% $120,000 × Present value of $1; n = 8; i = 11% c $130,000 × Present value of $1; n = 9; i = 11% d $140,000 × Present value of $1; n = 10; i = 11% a $1,300,000 × Present value of $1; n = 10; i = 11% b

Total present value = $423,053.79 + $663,019.48 = $1,086,073.27 Bruce should purchase the restaurant. With a discount rate of 11%, the current cost of the restaurant ($1,000,000) is less than the present value of future cash flows ($1,086,073.27).

Problem C-3A (LO C-2, C-3) Camera 1: Annuity Discount Interest payment Rate compounded Years 1-8 $300 9% Annually a $300 × Present value of annuity; n = 8; i = 9%

Period invested 8 years

Present value of annuity $1,660.45a

Future Discount Interest value rate compounded Year 8 $300 9% Annually a $300 × Present value of $1; n = 8; i = 9%

Period invested 8 years

Present Value $150.56a

Total cost of camera 1

= + −

$6,000.00 (purchase price) 1,660.45 (maintenance) 150.56 (sale price) $7,509.89

Camera 2: Year 3 Year 5 Year 7

Future payment $ 900 900 1,000

Discount rate 9% 9% 9%

Interest compounded Annually Annually Annually

Period invested 3 years 5 years 7 years

Present Value $ 694.97a 584.94b 547.03c $1,826.94

$900 × Present value of $1; n = 3; i = 9% $900 × Present value of $1; n = 5; i = 9% c $1,000 × Present value of $1; n = 7; i = 9% b

Total cost of camera 2

= + −

$5,500.00 (purchase price) 1,826.94 (maintenance) 0.00 (sale price) $7,326.94

By comparing the total cost of camera 1 ($7,509.89) to the total cost of camera 2 ($7,326.94), Hollywood Tabloid should purchase camera 2. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Appendix C C-11

PROBLEMS: SET B Problem C-1B (LO C-3) Requirements 1 and 2 Person

Annuity Payment

Type of account

Expected Annual Return

Four-year accumulated investment

Maximum home purchasee

Mary Kate

$4,000

Savings

$16,486.43a

$65,945.72

Ashley

$5,000

CDs

$21,232.32b

$84,929.28

Dakota

$6,000

Bonds

$26,639.66c

$106,558.64

Elle $6,000 Stocks 11% $28,258.39d $113,033.56 a $4,000 × Future value of annuity; n = 4; i = 2% b $5,000 × Future value of annuity; n = 4; i = 4% c $6,000 × Future value of annuity; n = 4; i = 7% d $6,000 × Future value of annuity; n = 4; i = 11% e Maximum home purchase = Four-year accumulated investment / 25%

Problem C-2B (LO C-2, C-3) Annuity Discount Interest Period payment Rate compounded invested Years 1-20 $60,000 9% Annually 20 years a $60,000 × Present value of annuity; n = 20; i = 9%

Present value of annuity $547,712.74a

Future Discount Interest value rate compounded Year 20 $600,000 9% Annually a $600,000 × Present value of $1; n = 20; i = 9%

Present Value $107,058.53a

Period invested 20 years

Present value of future cash flows = $547,712.74 + $107,058.53 = $654,771.27 If Woody wants to make at least 9% on his investment, the most he would pay for the toy store is $654,771.27, the total present value of future cash flows.

Problem C-3B (LO C-2, C-3) Option 1: Present value = $1,600,000 Option 2: Annuity Discount Interest Period payment Rate compounded invested Years 1-10 $150,000 8% Annually 10 years a $150,000 × Present value of annuity; n = 10; i = 8%

Present value of annuity $1,006,512.21a

Present value = $600,000 + $1,006,512.21 = $1,606,512.21 Option 3: Annuity Discount Interest Period payment Rate compounded invested Years 1-10 $250,000 8% Annually 10 years a $250,000 × Present value of annuity; n = 10; i = 8%

Present value of annuity $1,677,520.35a

Present value = $1,677,520.35 Option 4: Future Discount Interest payment rate compounded Year 5 $2,300,000 8% Annually a $2,300,000 × Present value of $1; n = 5; i = 8%

Period invested 5 years

Present Value $1,565,341.35a

Present value = $1,565,341.35 The lowest cost alternative for Star Studios is option 4.

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Appendix D - Investments

Appendix D Investments REVIEW QUESTIONS Question D-1 (LO D-1) A company might invest in another company to (1) receive dividends, earn interest, and gain from the increase in the value of their investment, (2) temporarily invest excess cash created by operating in seasonable industries, or (3) build strategic alliances, increase market share, or enter new industries.

Question D-2 (LO D-1)

Companies can gain from the increase in the value of their investment. Even without receiving dividends, investors still benefit when companies reinvest earnings, leading to even more profits in the future and eventually higher stock prices. Many companies also make investments for strategic purposes to develop closer business ties, increase market share, or expand into new industries.

Question D-3 (LO D-1) Companies in seasonal industries often invest excess funds generated during the busy season and draw on these funds in the slow season.

Question D-4 (LO D-1) PepsiCo purchased Tropicana in order to diversify beyond soft drinks.

Question D-5 (LO D-1)

The flip side of an investment in equity securities is the issuance of stock.

Question D-6 (LO D-1) The method depends on the level of influence, generally by ownership percentage of voting common stock of the investee company . An insignificant level of influence, generally less than 20% ownership, results in the use of the fair value method. A significant, but not controlling, level of influence, presumed at 20% to 50% ownership, results in the use of the equity method. A controlling level of influence at more than 50% ownership requires preparation of consolidated financial statements.

Question D-7 (LO D-2)

Fair value is the amount for which the investment could be bought or sold in a current transaction between willing parties.

Question D-8 (LO D-2)

Dividends received are accounted for as dividend revenue under the fair value method.

Question D-9 (LO D-2)

An unrealized holding gain is the gain in value while holding the investment, while a realized gain is recognized in cash (or the right to receive cash) at the time the investment is sold. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education Solutions Manual, Appendix D D-1

Appendix D - Investments

Question D-10 (LO D-2) Fair value increases are reported in the income statement as unrealized holding gains. Fair value decreases are reported in the income statement as unrealized holding losses. Unrealized holding gains and losses are reported in the income statement as part of nonoperating items. .

Question D-11 (LO D-2)

At the end of the year, the investment’s carrying amount is adjusted upward for fair value increases and adjusted downward for fair value decreases. The investment is reported in the balance sheet at its fair value.

Question D-12 (LO D-3)

The equity method is used when an investor can’t control but can “significantly influence” the investee. For example, if effective control is absent, the investor still might be able to exercise significant influence over the operating and financial policies of the investee if the investor owns a large percentage of the outstanding shares relative to other shareholders. By voting those shares as a block, the investor often can sway decisions in the direction desired. We presume, in the absence of evidence to the contrary, that the investor exercises significant influence over the investee when it owns between 20% and 50% of the investee’s voting shares.

Question D-13 (LO D-3) The investor should account for dividends from the investee as a reduction in the investment account. Since investment revenue is recognized as the investee earns it, it would be inappropriate to recognize revenue again when earnings are distributed as dividends.

Question D-14 (LO D-4)

These statements combine the parent’s and subsidiary’s operating activities as if the two companies were a single reporting company, even though both companies continue to operate as separate legal entities.

Question D-15 (LO D-4)

It is appropriate to consolidate financial statements of two companies when the parent company owns a controlling interest (more than 50%) in the voting stock of the subsidiary.

Question D-16 (LO D-5) The flip side of an investment in debt securities is the issuance of debt, such as bonds.

Question D-17 (LO D-5)

If bonds are purchased at a discount, the amortized cost of the investment in bonds and the amount recorded for interest revenue will increase over time. Recall that interest revenue is calculated as the amortized cost of the bond times the market interest rate. As amortized cost increases, interest revenue also increases.

Question D-18 (LO D-5)

If bonds are purchased at a premium, the amortized cost of the investment in bonds and the amount recorded for interest revenue will decrease over time. Recall that interest revenue is calculated as the amortized cost of the bond times the market interest rate. As amortized cost decreases, interest revenue also decreases.

Appendix D - Investments

Question D-19 (LO D-5) When interest rates go down, the value of a bond with fixed interest payments goes up because the fixed interest payments are now more attractive to investors.

Question D-20 (LO D-5)

Investments in debt securities are classified as “held-to-maturity,” “trading,” or “available-forsale” securities. Held-to-maturity securities are debt securities that the company expects to hold until they mature, which means until they become payable. Trading securities are securities that the investor expects to sell in the near future. These investments are adjusted to fair value with the unrealized gain or loss included in net income. Available-for-sale securities are investments that do not fit the other two categories; they are not expected to be sold in the near future, yet they are not expected to be held to maturity either. These investments are adjusted to fair value with the unrealized gain or loss included in comprehensive income.

Appendix D - Investments

BRIEF EXERCISES Brief Exercise D-1 (LO D-1) X

1. To invest excess cash created by operating in seasonal industries. 2. To increase employees’ morale.

3. To build strategic alliances. 4. To reduce government regulation.

5. To receive interest and dividends.

Brief Exercise D-2 (LO D-2) September 1 Investments (150 shares × $13) Cash (Purchase common stock) November 1 Cash (150 shares × $17) Investments (150 shares × $13) Gain (difference) (Sell investments above recorded amount)

Debit 1,950

2,550

Credit 1,950

1,950 600

Appendix D - Investments

Brief Exercise D-3 (LO D-2) December 28 Investments Cash (Purchase common stock) December 31 Unrealized Holding Loss—Net Income Investments (Adjust investments to fair value)

Debit 485,000

2,000

Credit 485,000

2,000

Brief Exercise D-4 (LO D-2) December 28 Investments Cash (Purchase common stock) December 31 Investments Unrealized Holding Gain—Net Income (Adjust investments to fair value)

Debit 485,000

2,000

Credit 485,000

2,000

Appendix D - Investments

Brief Exercise D-5 (LO D-2) December 29, 2021 Investments Cash (Purchase common stock) December 31, 2021 Investments

Debit 19,000

1,000

Unrealized Holding Gain—Net Income

(Adjust investments to fair value) January 24, 2022 Cash

Investments Gain (Sell investment for realized gain)

Brief Exercise D-6 (LO D-2) December 29, 2021 Investments Cash (Purchase common stock) December 31, 2021 Investments

22,000

Debit 19,000

1,000

Unrealized Holding Gain—Net Income

(Adjust investments to fair value)

Credit 19,000

1,000

20,000 2,000

Credit 19,000

1,000

January 24, 2022 Cash Loss

Investments (Sell investment for realized loss)

16,000 4,000

20,000

Brief Exercise D-7 (LO D-3) ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education D-6 Financial Accounting, 5e

Appendix D - Investments

An investor should account for net income from an equity method investee as an increase in its investments account and an increase in equity income. Therefore, Strong String’s reported net income of $20 million will increase investments and equity income for Wendy Day Kite Company by $8 million (= $20 million × 40%).

Brief Exercise D-8 (LO D-3) An investor should account for dividends from an equity method investee as a reduction in its investment account. Since investment revenue is recognized as the investee earns it, it would be inappropriate to recognize revenue again when earnings are distributed as dividends. Instead, the dividend distribution is considered to be a reduction of the investee’s net assets, reflecting the fact that the investor’s ownership interest in those net assets declined proportionately. Wendy Day’s cash increased by $4 million (= $10 million × 40%). Its investment account declined by the same amount. There is no effect on the income statement.

Brief Exercise D-9 (LO D-4) Wendy Day would report total inventory of $22,000 in the consolidated financial statements. Since Wendy Day owns all of the outstanding stock in Strong String Company, Wendy Day will combine its total inventory of $14,000 with Strong String’s total inventory of $8,000 in Wendy Day’s consolidated financial statements.

Brief Exercise D-10 (LO D-5) 1.

January 1 Investments Cash (Purchase bonds) 2. June 30 Cash Interest Revenue (Receive semiannual interest revenue) ($1,400 = $40,000 × 7% × ½)

Debit 40,000

Credit 40,000

1,400 1,400

Appendix D - Investments

Brief Exercise D-11(LO D-5) 1. January 1 Investments Cash (Purchase bonds) 2. June 30 Cash ($40,000 × 7% × ½) Investments (difference) Interest Revenue ($37,282 × 8% × ½) (Receive semiannual interest revenue)

Debit

Credit

37,282 37,282

1,400 91

1,491

Brief Exercise D-12 (LO D-5) 1. January 1 Investments Cash (Purchase bonds) 2. June 30 Cash ($40,000 × 7% × ½) Investments (difference) Interest Revenue ($42,975 × 6% × ½) (Receive semiannual interest revenue)

Debit 42,975

1,400

Credit 42,975

111 1,289

Appendix D - Investments

EXERCISES Exercise D-1 (LO D-1) __T__ 1. A reason companies invest in other companies is to build strategic alliances. __F__ 2. All companies are required to pay dividends to their investors. __F__ 3. When market interest rates increase, the market value of a bonds increases as well. __T__ 4. One way for a company to expand operations into a new industry is to acquire the majority of another company’s common stock that already operates in that industry. __T__ 5. Stocks typically have greater upside potential, providing a higher average return to their investors over the long-run than do bonds. __F__ 6. Companies purchase debt securities primarily for the dividend revenue they provide.

Appendix D - Investments

Exercise D-2 (LO D-2) Requirement 1 December 20 Investments Cash (Purchase common stock) December 28 Cash Dividend Revenue (Receive cash dividends) December 31 Unrealized Holding Loss—Net Income Investments (300,000 shares × $0.20 per share) (Adjust investments to fair value)

Debit 1,500,000

6,000

60,000

Credit 1,500,000

6,000

60,000

The investments decreased in value $0.20 per share from $5.00 per share to $4.80 per share. Unrealized holding losses are included in net income. Requirement 2 Balance of the investments account on December 31: $1,500,000 − $60,000 = $1,440,000.

Appendix D - Investments

Exercise D-3 (LO D-2) Requirement 1 February 1 Investments Cash (Purchase common stock) June 15 Cash (50 shares × $14) Loss (difference) Investments (50 shares × $16) (Sell investments below recorded amount) October 31 Cash (100 shares × $0.50 per share) Dividend Revenue (Receive cash dividends)

Debit 2,400

Credit 2,400

700 100 800

50 50

December 31 Unrealized Holding Loss–Net Income Investments (100 shares × [$16 − $12])

(Adjust investments to fair value)

400 400

Requirement 2 The balance of the investment account on December 31 is $1,200, equal to the 100 remaining shares times $12 per share fair value. The balance of the investment account can be verified by posting all journal entries to a T-account. Investments 2,400 800 400 1,200

Appendix D - Investments

Exercise D-4 (LO D-2) Requirement 1 March 1, 2021 Investments (3,000 shares × $62) Cash (Purchase common stock) July 1, 2021 Cash ($1.25 × 3,000 shares) Dividend Revenue (Receive cash dividends) December 31, 2021 Investments (3,000 shares × $13) Unrealized Holding Gain–Net Income (Adjust investments to fair value) Requirement 2 February 1, 2022 Cash (1,000 shares × $70) Loss (difference) Investments [1,000 shares × ($62 + $13)] (Sell investments for a realized loss)

Debit 186,000

Credit 186,000

3,750 3,750

39,000 39,000

70,000 5,000

75,000

At the time of the sale, the shares have a balance of $75 per share, which equals the purchase price ($62 per share) plus the increase in fair value ($13 per share) recorded at the end of 2021.

Appendix D - Investments

Exercise D-5 (LO D-2)

Requirement 1 March 1, 2021 Investments (3,000 shares × $62) Cash (Purchase common stock) July 1, 2021 Cash ($1.25 × 3,000 shares) Dividend Revenue (Receive cash dividends) December 31, 2021 Investments (3,000 shares × $13) Unrealized Holding Gain–Net Income (Adjust investments to fair value) Requirement 2 February 1, 2022 Cash (1,000 shares × $80) Investments [1,000 shares × ($62 + $13)] Gain (difference) (Sell investments for a realized gain)

Debit 186,000

3,750

39,000

80,000

Credit 186,000

3,750

39,000

75,000 5,000

At the time of the sale, the shares have a balance of $75 per share, which equals the purchase price ($62 per share) plus the increase in fair value ($13 per share) recorded at the end of 2021.

Appendix D - Investments

Exercise D-6 (LO D-3) January 1 Investments Cash (Purchase common stock) December 31 Investments Equity Income (Earn equity income) ($40,000 = $160,000 × 25%) December 31 Cash Investments (Receive cash dividends) ($15,000 = $60,000 × 25%)

Debit 700,000

40,000

15,000

Credit 700,000

40,000

15,000

Appendix D - Investments

Exercise D-7 (LO D-3) January 1 Investments Cash (Purchase common stock) December 31 Investments Equity Income (Earn equity income) ($45,500 = $130,000 × 35%) December 31 Cash Investments (Receive cash dividends) ($14,000 = $40,000 × 35%)

Debit 600,000

Credit 600,000

45,500

14,000

45,500

14,000

Under the equity method, no adjustment is made to fair value.

Appendix D - Investments

Exercise D-8 (LO D-2, D-3) Requirement 1 Purchase: Investments Cash (Purchase common stock)

Debit 360,000

Credit 360,000

Net income: No entry for Midlin’s net income Dividends: Cash Dividend Revenue (Receive cash dividends) ($15,000 = $0.25 × 300,000 shares × 20%) Fair value adjustment: Investments Unrealized Holding Gain–Net Income (Adjust investments to fair value) ($15,000 = $375,000 − $360,000)

15,000

Appendix D - Investments

Exercise D-8 (concluded) Requirement 2 Purchase: Investments Cash (Purchase common stock)

Debit 360,000

Net income: Investments Equity Income (Earn equity income) ($27,000 = $135,000 × 20%)

27,000

Dividends: Cash 15,000 Investments (Receive cash dividends) ($15,000 = $0.25 × 300,000 shares × 20%)

Credit 360,000

27,000

15,000

Fair value adjustment: No adjustment is made under the equity method

Appendix D - Investments

Exercise D-9 (LO D-4)

1. 10% of the common stock of Beta. 2. 40% of the bonds of Gamma. 3. 75% of the common stock of Delta. 4. 15% of the bonds of Epsilon. 5. 25% of the common stock of Zeta. 6. 60% of the bonds of Eta. 7. 100% of the common stock of Theta.

Appendix D - Investments

Exercise D-10 (LO D-5) Requirement 1 (1) (2) Date 1/ 1 6/30 12/31

(3)

(4)

(5)

Cash Received Face Amount × Stated Rate

Interest Revenue Amortized Cost × Market Rate

Amortization of Discount

$ 6,125 6,125

$ 6,395 6,406

$ 270 281

Amortized Cost Prior Amortized Cost + (4) $159,869 160,139 160,420

Requirement 2 January 1 Investments Cash (Purchase bonds) June 30 Cash ($175,000 × 7% × ½) Investments (difference) Interest Revenue ($159,869 × 8% × ½) (Receive semiannual interest revenue) December 31 Cash ($175,000 × 7% × ½) Investments (difference) Interest Revenue ($160,139 × 8% × ½) (Receive semiannual interest revenue)

(3) – (2)

159,869

6,125 270

159,869

6,395

6,125 281 6,395

Appendix D - Investments

Exercise D-11 (LO D-5) Requirement 1 (1) Date 1/ 1 6/30 12/31

(2)

(3)

(4)

(5)

Cash Received Face Amount × Stated Rate

Interest Revenue Amortized Cost × Market Rate

Amortization of Premium

$ 17,500 17,500

$ 16,470 16,439

$ 1,030 1,061

Amortized Cost Prior Amortized Cost − (4) $ 549,001 547,971 546,910

Requirement 2 January 1 Investments Cash (Purchase bonds) June 30 Cash ($500,000 × 7% × ½) Investments (difference) Interest Revenue ($549,001 × 6% × ½) (Receive semiannual interest revenue) December 31 Cash ($500,000 × 7% × ½) Investments (difference) Interest Revenue ($547,971 × 6% × ½) (Receive semiannual interest revenue)

(2) − (3)

549,001

17,500

549,001

1,030 16,470

1,061 16,439

Appendix D - Investments

Exercise D-12 (LO D-5) Requirement 1 (1) Date 1/ 1 6/30 12/31

(2)

(3)

(4)

(5)

Cash Received Face Amount × Stated Rate

Interest Revenue Amortized Cost × Market Rate

Amortization of Discount

$ 32,000 32,000

$ 33,659 33,733

$ 1,659 1,733

Amortized Cost Prior Amortized Cost − (4) $ 747,968 749,627 751,360

Requirement 2 January 1 Investments Cash (Purchase bonds) June 30 Cash ($800,000 × 8% × ½) Investments (difference) Interest Revenue ($747,968 × 9% × ½) (Receive semiannual interest revenue) December 31 Cash ($800,000 × 8% × ½) Investments (difference) Interest Revenue ($749,627 × 9% × ½) (Receive semiannual interest revenue)

(3) − (2)

747,968

32,000 1,659

747,968

33,659

32,000 1,733 33,733

Requirement 3 December 31 Unrealized Holding Loss–Other Comprehensive Income Investments ($751,360 − $750,000) (Adjust investments to fair value)

1,360

Appendix D - Investments

Requirement 4 Sales Revenue Operating expenses Interest revenue* Net income Other comprehensive income: Unrealized holding loss Comprehensive income

$ 2,600,000 (1,400,000) 67,392 1,267,392 (1,360) $ 1,266,032

*$33,659 + $33,733

Appendix D - Investments

PROBLEMS: SET A Problem D-1A (LO D-2) Requirement 1 January 2 Investments Cash (Purchase 1,500 shares common stock) February 14 Investments Cash (Purchase 600 shares preferred stock) May 15 Cash (300 shares × $62) Loss (difference) Investments (300 shares × $70) (Sell 300 shares common stock below original cost amount) December 30 Cash Dividend Revenue (Receive cash dividends) (1,200 common shares × $0.50) + (600 preferred shares × $0.50)

Debit 105,000

7,200

18,600 2,400

900

Credit 105,000

7,200

21,000

900

Appendix D - Investments

Problem D-1A (concluded) Requirement 1 (concluded) December 31 Investments 3,600 Unrealized Holding Gain–Net Income (Adjust investments in common stock to fair value) ($3,600 = 1,200 shares × $3)

3,600

December 31 Investments 1,200 Unrealized Holding Gain–Net Income (Adjust investments in preferred stock to fair value) ($1,200 = 600 shares × $2)

1,200

Requirement 2 The balance of the Investments account on December 31 is $96,000, equal to the 1,200 remaining common shares times $73 per share fair value plus the 600 preferred shares times $14 per share fair value.

Appendix D - Investments

Problem D-2A (LO D-3) ($ in millions) Purchase: Investments Cash (Purchase common stock; 25% of 34 million shares) Net income: Investments Equity Income (Earn equity income) ($32.50 = $130 × 25%) Dividends: Cash Investments (Receive cash dividends) ($9.35 = $1.10 × 34 million shares × 25%)

Debit 178

Credit 178

32.50

9.35

32.50

9.35

Appendix D - Investments

Problem D-3A (LO D-5) Requirement 1 (1) Date 1/ 1 6/30 12/31

(2)

(3)

(4)

(5)

Cash Received Face Amount × Stated Rate

Interest Revenue Amortized Cost × Market Rate

Amortization of Discount

$ 4,500 4,500

$ 4,689 4,696

$ 189 196

Amortized Cost Prior Amortized Cost + (4) $ 133,984 134,173 134,369

Requirement 2 January 1 Investments Cash (Purchase bonds)

(3) − (2)

133,984

June 30 Cash ($150,000 × 6% × ½) 4,500 Investments (difference) 189 Interest Revenue ($133,984 × 7% × ½) (Receive semiannual interest revenue) December 31 Cash ($150,000 × 6% × ½) 4,500 Investments (difference) 196 Interest Revenue ($134,173 × 7% × ½) (Receive semiannual interest revenue)

133,984

4,689

4,696

Appendix D - Investments

Requirement 3 December 31 Cash Gain (difference) Investments (Sell bonds before maturity)

145,000

10,631 134,369

Requirement 4 Bond prices move in the opposite direction of market interest rates. Since bond prices went up between the beginning and end of the year, market interest rates must have decreased.

Appendix D - Investments

Problem D-4A (LO D-5) Requirement 1 Investments ........................................................ Cash ................................................................ (Purchase bonds) Requirement 2 Cash ($180,000 × 8% × ½)................................ Investments ........................................................ Interest revenue ($152,000 × 10% × ½)....... (Receive semiannual interest revenue) Requirement 3 Cash ($180,000 × 8% × ½)................................ Investment.......................................................... Interest revenue ([$152,000 + 400] × 10% × ½) (Receive semiannual interest revenue)

152,000 152,000

7,200 400 7,600

7,200 420 7,620

Requirement 4 Since these are held-to-maturity securities, Justin Investor reports its investment in the December 31, balance sheet at its amortized cost – that is, its book value: Investments: $152,000 + 400 + 420 = $152,820 Increases and decreases in the fair value between the time a debt security is acquired and the day it matures are relatively unimportant if sale before maturity isn’t an alternative. For this reason, if an investor has the intent to hold the securities to maturity, investments in debt securities are classified as “held-to-maturity” and reported at amortized cost rather than fair value in the balance sheet. Requirement 5 Investments ($160,000 − $152,820) 7,180 Unrealized Holding Gain–Other Comprehensive Income (Adjust investments to fair value)

7,180

Debt securities that management intends neither to hold to maturity or to sell in the near term are classified as available-for-sale. These securities are reported in the balance sheet at fair value, with unrealized holding gains and losses from fair value changes reported as part of other comprehensive income.

Appendix D - Investments

PROBLEMS: SET B Problem D-1B (LO D-2) Requirement 1 February 2 Investments Cash (Purchase 1,500 shares common stock) February 4 Investments Cash (Purchase 600 shares preferred stock) July 15 Cash (400 shares ×$40) Investments (400 shares × $35) Gain (difference) (Sell 400 shares common stock above original cost amount) November 30 Cash Dividend Revenue (Receive cash dividends) (1,100 common shares × $1.10) + (600 preferred shares × $1.80)

Debit 52,500

19,200

16,000

2,290

Credit 52,500

19,200

14,000 2,000

2,290

Appendix D - Investments

Problem D-1B (concluded) Requirement 1 (concluded) December 31 Unrealized Holding Loss–Net Income Investments

4,400 4,400

(Adjust investments in common stock to fair value) ($4,400 = 1,100 shares × $4 decrease per share)

December 31 Unrealized Holding Loss–Net Income Investments

(Adjust investments in preferred stock to fair value) ($1,200 = 600 shares × $2 decrease per share)

1,200 1,200

Requirement 2 The balance of the Investments account on December 31 is $52,100, equal to the 1,100 remaining common shares times $31 per share fair value plus the 600 preferred shares times $30 per share fair value.

Appendix D - Investments

Problem D-2B (LO D-3) ($ in millions) Purchase: Investments Cash (Purchase 30% of 10 million shares common stock) Net income: Investments Equity Income (Earn equity income) ($2.7 = $9 × 30%) Dividends: Cash Investments (Receive cash dividends) ($1.5 = $0.50 × 10 million shares × 30%)

Debit 52

Credit 52

2.7

1.5

2.7

1.5

Appendix D - Investments

Problem D-3B (LO D-5) Requirement 1 (1) Date 1/1 6/30 12/31

(2)

(3)

(4)

(5)

Cash Received Face Amount × Stated Rate

Interest Revenue Amortized Cost × Market Rate

Amortization of Discount

$ 15,750 15,750

$ 16,777 16,818

$ 1,027 1,068

Amortized Cost Prior Amortized Cost + (4) $ 419,422 420,449 421,517

Requirement 2 January 1 Investments Cash (Purchase bonds) June 30 Cash ($450,000 × 7% × ½) Investments (difference) Interest Revenue ($419,422 × 8% × ½) (Receive semiannual interest revenue) December 31 Cash ($450,000 × 7% × ½) Investments (difference) Interest Revenue ($420,449 × 8% × ½) (Receive semiannual interest revenue)

(3) − (2)

419,422 419,422

15,750 1,027

15,750 1,068

16,777

16,818

Appendix D - Investments

Requirement 3 December 31 Cash Loss (difference) Investments (Sell bonds before maturity)

415,000 6,517

421,517

Requirement 4 Bond prices move in the opposite direction of market interest rates. Since bond prices went down between the beginning and end of the year, market interest rates must have increased.

Appendix D - Investments

Problem D-4B (LO D-5) Requirement 1 Investments ........................................................ Cash ................................................................ (Purchase bonds) Requirement 2 Cash ($130,000 × 7% × ½)................................ Investments ........................................................ Interest revenue ($124,728 × 8% × ½)......... (Receive semiannual interest revenue) Requirement 3 Cash ($130,000 × 7% × ½)................................ Investments ........................................................ Interest revenue ([$124,728 + 439] × 8% × ½) (Receive semiannual interest revenue)

124,728 124,728

4,550 439 4,989

4,550 457 5,007

Requirement 4 Since these are held-to-maturity securities, Tsunami Sushi reports its investment in the December 31, balance sheet at its amortized cost – that is, its book value: Investments: $124,728 + 439 + 457 = $125,624 Increases and decreases in the fair value between the time a debt security is acquired and the day it matures are relatively unimportant if sale before maturity isn’t an alternative. For this reason, if an investor has the intent to hold the securities to maturity, investments in debt securities are classified as “held-to-maturity” and reported at amortized cost rather than fair value in the balance sheet. Requirement 5 Unrealized Holding Loss–Net Income Investments ($125,624 − $124,000) (Adjust investments to fair value)

1,624

Debt securities that management intends to sell in the near term are classified as trading securities. These securities are reported in the balance sheet at fair value, with unrealized holding gains and losses from fair value changes reported as part of net income. ©2019 McGraw-Hill Education. All rights reserved. Authorized only for instructor use in the classroom. No reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education D-34 Financial Accounting, 5e

Appendix E - International Financial Reporting Standards

Appendix E International Financial Reporting Standards REVIEW QUESTIONS Question E-1 (LOE-1) Convergence refers to the process by which U.S. GAAP and IFRS will eventually merge to become a single set of accounting standards.

Question E-2 (LOE-1) Financial accounting standards and practices differ from country to country for many reasons, including different legal systems, the influence of tax laws, sources of financing, inflation, culture, political influence of other countries, and the level of economic development. See Illustration D-1 in the textbook for further details.

Question E-3 (LOE-1) Legal system (common law vs. code law) is often used as a way to describe overall differences in accounting practices between countries. Common law countries such as the U.S., U.K., Australia, and Canada have separate rules for financial accounting and tax accounting, rely more on equity financing, and have political and economic ties with Britain. Code law countries such as those in Central Europe and Japan, have similar rules for financial accounting and tax accounting, rely more on debt financing, and many have political and economic ties with Germany.

Question E-4 (LOE-1) Differences in accounting standards cause problems for investors in comparing companies whose financial statements are prepared under different accounting rules. Investors unfamiliar with the accounting practices of a particular country are less likely to invest in firms from that country because of this uncertainty.

Question E-5 (LOE-1) Differences in accounting standards make it more difficult and more costly for multinational corporations to comply with multiple sets of accounting rules.

Question E-6 (LOE-2) The IASB’s main objective is to develop a single set of high-quality, understandable, and enforceable global accounting standards to help participants in the world’s capital markets and other users make economic decisions.

Appendix E - International Financial Reporting Standards

Question E-7 (LOE-2) Principles-based accounting standards emphasize broad principles of accounting with relatively less emphasis on detailed implementation rules. In comparison, rules-based accounting standards provide additional detailed guidance to help users implement the standards.

Question E-8 (LOE-2) The Norwalk Agreement formalized the commitment to convergence of U.S. GAAP and IFRS. Under this agreement, the two boards pledged to remove existing differences between their standards and to coordinate their future standard-setting agendas so that major issues are worked on together. The agreement is significant because it was a major step in the convergence of U.S. accounting with international accounting standards.

Question E-9 (LOE-2) One argument against convergence between U.S. GAAP and IFRS is that U.S. GAAP is necessary to meet the specific legal and regulatory requirements of the U.S. business environment. A one-size-fits-all approach taken by international accounting standards may not always work. Another argument for maintaining the two sets of standards is that competition between alternative standardsetting regimes is healthy and can lead to improved standards.

Question E-10 (LOE-3) A conceptual framework in accounting is a common structure useful in setting accounting standards. It is important that the FASB and the IASB work together in developing a common conceptual framework as this framework will be relied upon in developing future accounting standards.

Question E-11 (LOE-3) Revenues and expenses that relate to a company’s primary operating activities such as sales revenue, cost of goods sold, and operating expenses would be included in operating activities. Revenues and expenses from investing such as interest revenue or a loss on sale of an investment would be included as investing activities. Revenues and expenses from financing such as interest expense incurred on borrowing or a gain on repurchase of long-term debt would be included in a separate section labeled financing activities.

Question E-12 (LOE-3) LIFO is allowed under U.S. GAAP, but not under IFRS. U.S. companies currently using LIFO will lobby to keep this method because a switch from LIFO would greatly increase taxes for many U.S. companies.

Question E-13 (LOE-3) An inventory write-down causes total assets and net income to decrease. The reversal of an inventory write-down causes just the opposite: total assets and net income increase.

Appendix E - International Financial Reporting Standards

Question E-14 (LOE-3) To revalue a long-term asset is to periodically adjust the asset to fair value. Under U.S. GAAP, companies are not allowed to revalue long-term assets to fair value for financial reporting purposes. IFRS allows, but does not require, revaluation of long-term assets to fair value.

Question E-15 (LOE-3) U.S. GAAP requires all research and development expenditures to be expensed in the period incurred. IFRS draws a distinction between research activities and development activities. Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset. U.S. GAAP is more conservative as it requires all research and development costs to be expensed as incurred.

Question E-16 (LOE-3) A company would be more likely to report a contingent liability under IFRS. We accrue a contingent liability under U.S. GAAP if it’s both probable and can be reasonably estimated. IFRS are similar, but the threshold is “more likely than not.” This is a lower threshold than “probable.” IFRS is more conservative in the reporting of contingent liabilities. Companies are more likely under IFRS to report a contingent liability resulting in lower net income.

Question E-17 (LOE-3) Under U.S. GAAP, preferred stock is usually recorded as stockholders’ equity with dividends reported as a reduction of retained earnings. Under IFRS, most preferred stock is reported as debt with the dividends reported in the income statement as interest expense. As we learned in Chapter 10, preferred stock has characteristics of both liabilities and stockholders’ equity. Preferred stock can have characteristics nearly identical to bonds or characteristics nearly identical to common stock.

Appendix E - International Financial Reporting Standards

EXERCISES Exercise E-1 (LOE-1) Reason

Description

1. _c__ Legal system

a. More developed economies have more complex business transactions.

2. _e__ Tax laws

b. The extent of public disclosure depends on the secretiveness of society.

3. _g__ Sources of financing

c. Common law countries rely more heavily on public information.

4. _f__

Inflation

d. Countries share business activities and have political connections.

5. _b__ Culture

e. Alignment between financial reporting and tax reporting rules.

6. _d__ Political and economic ties

f. In some countries, asset values increase rapidly because of the general price level changes.

7. _a__ Economic development g. Some countries rely more heavily on debt capital than on equity capital to fund operations.

Appendix E - International Financial Reporting Standards

Exercise E-2 (LOE-1) Requirement 1 Austria’s accounting is very similar to that of Germany.

1. Legal system

(b) Code law

2. Tax laws

(b) Similar tax and financial accounting rules

3. Sources of financing

(b) More debt financing

4. Inflation

(a) Low inflation

5. Culture

(b) Secretive

6. Political and economic ties (b) German ties 7. Economic development

(a) Developed economy

Requirement 2 Australia’s accounting is very similar to that of the United Kingdom.

1. Legal system

(a) Common law

2. Tax laws

(a) Different tax and financial accounting rules

3. Sources of financing

(a) More equity financing

4. Inflation

(a) Low inflation

5. Culture

(a) Transparent

6. Political and economic ties (a) British ties 7. Economic development

(a) Developed economy

Appendix E - International Financial Reporting Standards

Exercise E-3 (LOE-2) For the idea There are several reasons to allow U.S. companies the choice of reporting under either U.S. GAAP or IFRS. It is important to allow U.S. companies the opportunity to report under IFRS because the rest of the world is moving to IFRS. A single set of global standards can improve comparability of financial reporting across countries and facilitate access to capital. Without the ability to report under IFRS, U.S. companies may be at a competitive disadvantage in raising debt and equity capital in international markets. Against the idea There are also several reasons to not allow U.S. companies the choice of reporting under either U.S. GAAP or IFRS. U.S. GAAP is customized to fit the stringent legal and regulatory requirements of the U.S. business environment. U.S. GAAP provides a better fit and should therefore be required for U.S. companies. Furthermore, allowing the choice of reporting either U.S. GAAP or IFRS could create confusion for users of financial accounting information. Investors and creditors have to compare a company using U.S. GAAP to another company using IFRS. This emphasizes the continuing need for convergence of accounting standards between U.S. GAAP and IFRS.

Appendix E - International Financial Reporting Standards

Exercise E-4 (LOE-3) Requirement 1 Principles-based accounting standards emphasize broad principles of accounting with relatively less emphasis on detailed implementation rules. Rules-based accounting standards provide additional detailed guidance to help users implement the standard. Requirement 2 Principles-based standards are more concise, allowing preparers and users of accounting information to focus on the key issues. Requirement 3 Rules-based standards are more precise, providing additional guidance to preparers and users on an issue. Requirement 4 Most people agree that, in order to reduce the volume of accounting rules internationally, future international accounting standards will need to more principlesbased.

Appendix E - International Financial Reporting Standards

Exercise E-5 (LOE-3) Requirement 1 Operating activities include transactions relating to the primary operating activities of the business. Investing activities include transactions involving the purchase and sale of long-term assets and current investments. Financing activities include transactions relating to long-term debt and stockholders’ equity. Requirement 2 (a) Sales, cost of goods sold, and operating expenses would be classified as an operating activity. (b) Interest revenue, dividend income, and a gain or loss on sale of an investment would be classified as an investing activity. (c) Interest expense, bond issue costs, stock issue costs, and the gain or loss on the repurchase of long-term debt would be classified as a financing activity. Requirement 3 (a) Most current assets and current liabilities would be classified as an operating activity. (b) Long-term assets and current investments would be classified as an investing activity. (c) Long-term debt and stockholders’ equity would be classified as a financing activity.

Appendix E - International Financial Reporting Standards

Exercise E-6 (LOE-3) Requirement 1 Date Jan. 1 Apr. 7

Date Apr. 7 Oct. 9 a

Transaction Beginning Inventory Purchase

Number of units 70 10 80

Unit cost $83 85

Ending Inventory $5,810 850 $6,660

Transaction Purchase Purchase

Number of units 180 90 270a

Unit cost $85 87

Cost of Goods Sold $15,300 7,830 $23,130

Last 270 units purchased are assumed sold

Sales revenue = 270 units X $100 = $27,000 Gross profit = Sales revenue − Cost of goods sold = $27,000 − $23,130 = $3,870

Appendix E - International Financial Reporting Standards

Requirement 2 Date Oct. 9

Date Jan. 1 Apr. 7 Oct. 9 a

Transaction Purchase

Transaction Beginning inventory Purchase Purchase

Number of units 80

Unit cost $87

Ending Inventory $6,960

Number of units 70 190 10 270a

Unit cost $83 85 87

Cost of Goods Sold $ 5,810 16,150 870 $22,830

First 270 units purchased are assumed sold

Sales revenue = 270 units X $100 = $27,000 Gross profit = Sales revenue − Cost of goods sold = $27,000 − $22,830 = $4,170

Requirement 3 FIFO will result in a higher income of $300 (gross profit of $4,170 vs. $3,870) reported on the income statement. FIFO will also result in higher assets of $300 (ending inventory of $6,960 vs. $6,660) reported on the balance sheet.

Appendix E - International Financial Reporting Standards

Exercise E-7 (LOE-3) Requirement 1 U.S. GAAP requires all research and development expenditures to be expensed in the period incurred. Therefore, all $700,000 would be expensed. Requirement 2 IFRS draws a distinction between research activities and development activities. Research expenditures are expensed in the period incurred. However, development expenditures that meet specified criteria are capitalized as an intangible asset. Therefore, $200,000 in research costs would be expensed, and the $500,000 in development costs would be capitalized as an intangible asset. Requirement 3 Income under IFRS would be $500,000 higher than under U.S. GAAP. Total assets and stockholders’ equity on the balance sheet would also be $500,000 higher under IFRS than under U.S. GAAP.

Appendix E - International Financial Reporting Standards

Exercise E-8 (LOE-3) Requirement 1 A liability is an amount owed to a creditor. Stockholders’ equity is the owners’ claims to company resources. Requirement 2 Under the IFRS position, preferred stock is a liability. The true owners of the business are the common shareholders as they control the company through voting rights. Preferred shareholders usually do not have voting rights. Preferred shareholders receive preference in the payment of dividends similar to an interest payment to a creditor. Requirement 3 Under the U.S. GAAP position, preferred stock is usually part of stockholders’ equity. Unlike long-term debt, preferred stock usually does not have a maturity date. The lack of a maturity date makes preferred stock more like stockholders’ equity than a liability on the balance sheet. Requirement 4 The classification of preferred stock depends on the characteristics of the preferred stock issue. Non-voting, mandatorily redeemable preferred stock with a fixed annual dividend is similar to bonds and should be reported as a liability. Preferred stock with voting rights or convertible to common stock and lacking a dividend preference is similar to common stock and probably should be reported as part of stockholders’ equity.

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