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ANSWERS TO QUESTIONS - CHAPTER 3

1. Assets are used by a business to generate profits. One


measure of the profitability of a business is return on
assets, or how efficiently a business uses its assets.

2. Deferral is the recognition of revenue or expenses in a


period after the cash consequences are realized, i.e.,
cash is collected in advance of performing the service.

3. If cash is collected in advance for services, the revenue is


recognized when the services are rendered.

4. Salvage value is the expected value of an asset at the


end of its useful life.

5. If cash is collected in advance for services, a liability is


created (unearned revenue), increasing the claims side of
the accounting equation.

6. Unearned revenue is revenue that has been collected but


the service has not yet been performed.

7. Straight line depreciation is computed by taking the cost


of an asset minus the salvage value and dividing by the
number of years of useful life. Straight line depreciation
allocates an equal amount of depreciation to each
accounting period.

8. Depreciation expense is the process of recognizing the


used portion of a long-term tangible asset by allocating
its cost to expense over its useful life.

9. A contra asset account is an account that has a balance


opposite of the normal balance and has the effect of
reducing the asset to which it is associated.

Example of a contra asset account: Accumulated


Depreciation

3-1
10. The book value of an asset is the asset's historical cost
minus the accumulated depreciation.
11. $12,000 − $10,000 = $2,000 book value.

12. The concept of financial leverage is the practice of using


borrowed money to increase the return on owners'
equity. The business borrows money and invests it in
assets that will yield a return greater than the cost of the
borrowed money.

13. Cash paid for office equipment is shown in the cash flows
from investing activities section of the statement of cash
flows.

14. A cost can be either an asset or an expense. If the item


acquired has already been used in the process of earning
revenue, its cost represents an expense. If the item will
be used in the future to generate revenue, its cost
represents an asset.

15. A cost is held in the asset account until the item is used
to produce revenue. When the revenue is generated, the
asset is converted into an expense in order to match
revenues with related expenses. Not all costs become
expenses. If the value of an asset will not expire in the
revenue generating process, the asset will not become an
expense. For example, the cost of land will not become
an expense.

16. Supplies used during the accounting period are


recognized in a single adjusting entry at the end of the
period. The amount of supplies used is determined by
subtracting the amount of supplies on hand at the end of
the period from the amount of supplies that were
available for use (beginning supplies balance plus
supplies purchased).

17. The depreciation of office equipment is an example of an


asset whose cost is systematically allocated over several
accounting periods.

3-2
18. Expenses are matched to revenues by: (1) direct match;
(2) systematic allocation over several accounting periods;
and (3) match with period incurred.

19. Losses are decreases in assets or increases in liabilities


which result from peripheral or incidental transactions. For
example, when land purchased for $4,000 is sold for
$3,500, the loss is $500. This is a peripheral activity if the
company is not in the business of selling land.

20. Gains are increases in assets or decreases in liabilities


which result from peripheral or incidental transactions.
For example, when land purchased for $4,000 is sold for
$5,000, the gain is $1,000.

21. Income from operations is computed by subtracting


expenses from revenues. Gains and losses are not
included in the computation of income from operations.

22. A peripheral activity is an activity that does not arise


from normal or ordinary business operations.

23. Revenues $45,000


Oper. Exp. (36,000)
Income from Operations $9,000
Gain from Sale of Land 12,500
Net Income $21,500

24. The concept of materiality: If the decision of a reasonable


person would be influenced by the omission or
misstatement of accounting information, the omission or
misstatement is considered material.

25. Among the reasons a global GAAP has not been


established are:
• Different political structures
• Different economic structures

26. Return on Assets = Net Income


Total Assets

3-3
This ratio provides a common unit of measure that
enables comparisons between different size companies.

27. Debt-to- Assets = Total Debt


Total Assets

This ratio measures the level of risk of a company.

28. If a company can earn a ROA which is higher than the cost
of borrowed money (i.e. interest rate), the excess increases
ROE.

SOLUTIONS TO EXERCISES - SERIES A - CHAPTER 3

EXERCISE 3-1A

a. The owners invested cash in the business.

Cash revenue is earned.

b. Recorded accrued salaries.

Recorded accrued interest expense.

c. Paid cash dividends to stockholders.

Paid an expense with cash.

d. Paid cash for operating expenses previously purchased on

account.

Repaid a loan with cash.

e. Unearned revenue is earned and recognized.

f. The business invested cash by purchasing a building.

Collected accounts receivable.

3-4
g. Received cash in advance for services to be provided in

the future.

Borrowed cash from the bank.

3-5
EXERCISE 3-2A

a. accrual

b. accrual

c. deferral

d. deferral

e. accrual

f. neither

g. deferral

h. deferral

i. accrual

j. neither

3-6
EXERCISE 3-3A

a.
Even Assets = Liabiliti + Stockholders’ Equity
t es
Prepaid Common Retained
Cash Rent Stock + Earnings
1. (24,000 24,000
)
Adj. (10,000) (10,000)
*

*$24,000 x 5/12 = $10,000

b.
Even Assets = Stockholders’ Equity
t
Accumulate Common Retained
Cash Equipme d Stock + Earnings
nt Depreciatio
n
1. (22,000 22,000
)
Adj. (7,000)* (7,000)

*$22,000 − $1,000 = $21,000; $21,000 ÷ 3 = $7,000

c.
Even Assets = Liabilities + Stockholders’ Equity
t
Common Retained
Cash Unearned Stock Earnings
Revenue
1. 20,000 20,000
Adj. (10,000)* 10,000

*$20,000 x 3/6 = $10,000

3-7
EXERCISE 3-4A

Accounting Equation

Stock. Equity Income Statement


Type of Com. Ret. Net Cash
Event Event Assets = Liab. + Stock + Earn. Rev. − Exp. = Inc. Flows
a. AS I I NA NA NA NA NA I OA
b. AU D D NA NA NA NA NA D OA
c. AS I NA I NA NA NA NA I FA
d. AE I/D NA NA NA NA NA NA D IA
e. CE NA I NA D NA I D NA
f. AE I/D NA NA NA NA NA NA D OA
g. AS I NA NA I I NA I NA
h. AE I/D NA NA NA NA NA NA D OA
i. AU D NA NA D NA I D NA
j. AU D NA NA D NA I D D OA
k. AS I NA NA I I NA I I OA
l. AU D NA NA D NA NA NA D FA
m. CE NA I NA D NA I D NA
n. AE/AS I I NA NA NA NA NA D IA
o. AE I/D NA NA NA NA NA NA I OA
p. AU D NA NA D NA I D NA
q. AU D D NA NA NA NA NA D OA

3-8
EXERCISE 3-5A
a.
Management Consulting Services
Effect of Events on the Accounting Equation

Assets = Stockholders’ Equity


Prepaid Com. Retained
Event Cash Rent = Stock Earnings
1. Acq. Stock 12,000 12,000
2. Prepaid Rent (9,000) 9,000
3. Provided Service 18,000 18,000
4. Used Rent (8,250)* (8,250)
Totals 21,000 750 = 12,000 9,750

*$9,000 x 11/12 = $8,250

b.
Management Consulting Services
Income Statement
For the Year Ended December 31, 2007

Revenue $18,000
Expense (8,250)

Net Income $ 9,750

3-9
EXERCISE 3-5A b. (cont.)

Management Consulting Services


Statement of Cash Flows
For the Year Ended December 31, 2007

Cash Flows From Operating Activities:


Cash Receipt from Revenue $18,000
Cash Payment for Rent (9,000)
Net Cash Flow from Operating Activities $ 9,000

Cash Flow From Investing Activities -0-

Cash Flows From Financing Activities


Cash from Issue of Stock 12,000
Net Cash Flow from Financing Activities 12,000

Net Change in Cash 21,000


Plus: Beginning Cash Balance -0-
Ending Cash Balance $21,00
0

c. The difference of $750 ($9,750 − $9,000) is attributed to


recognizing rent expense of $8,250 in the income
statement, whereas the cash payment for rent is $9,000.

3-10
EXERCISE 3-6A
a.
Quick Printing
Effect of Events on Financial Statements for 2005

Assets = Liab. Stockholders’ Income Statement


Equity
Event Accts. Com. Retaine Net
No. Cash Supplie = Pay. + Stock d Rev. − Exp. = Incom
s Earnings e

Beg.
Bal. 5,000 -0- -0- 2,000 3,000
1. NA 7,200 7,200 NA NA NA NA NA
2. 15,000 NA NA NA 15,000 15,000 NA 15,000
3. (5,000 NA (5,000) NA NA NA NA NA
)
4. NA (5,800) NA NA (5,800) NA 5,800 (5,800
)
Totals 15,000 1,400 2,200 2,000 12,200 15,000 5,800 9,200

b. The difference in net income and cash flow from


operating activities of $800 ($9,200 − $10,000) is
attributed to recognizing supplies expense of $5,800 in
the income statement, whereas the cash payment on
accounts payable (for supplies) was only $5,000.

3-11
EXERCISE 3-7A
a.
Tasty Pizza
Accounting Equation for 2008

Assets = Stockholders’ Equity


Accum. Com. Retained
Event Cash Oven Depr. = Stock + Earnings
1. Issue Stk. 12,000 12,000
2. Pur. Oven (11,000) 11,000
3. Rev. 8,000 8,000
4. Paid Exp. (2,000) (2,000)
5. Depr. Exp. (2,000)* (2,000)
Totals 7,000 11,000 (2,000) = 12,000 + 4,000

*(11,000 − $1,000) ÷ 5=$2,000 depreciation per year

b. $2,000 each year.

c. 4,000 of accumulated depreciation ($2,000 for 2008 +


$2,000 for 2009).

d. No, because depreciation is a non-cash expense.


Depreciation is the systematic allocation of the cost of an
asset to expense. The cash payment occurred when the
oven was purchased.

3-12
EXERCISE 3-8A a.

a.
Kim Vanderbilt Personal Financial Planning
Horizontal Statements Model for 2003

Assets = Liabilities + Stk. Equity Income Statement


Unearned Retained Net
Event Cash = Revenue + Earnings Rev. − Exp. = Income
1. Advance Payment 72,000 72,000 NA NA NA 72
2. Revenue Earned (60,000)* 60,000 60,000 NA 60,000
Totals 72,000 = 12,000 60,000 60,000 60,000 72

*$72,000 x 10/12 = $60,000

b. Revenue that will be recognized in 2004 is $12,000, the


remainder of the unearned revenue.

c. $-0-, no cash is received. All cash was received in 2003.

3-13
EXERCISE 3-9A

IBC Enterprises
2004 Accounting Equation

Assets = Stockholders’ Equity


Common Retained
Event Cash Land = Stock + Earnings

a.1 +5,500 (6,000) = (500)

b.1 +7,000 (6,000) = 1,000

a. (1) See above.

a. (2) Loss of $500 ($5,500 sales price − $6,000 cost).

a. (3) Cash inflow from investing activities, $5,500.

b. (1) See above.

b. (2) Gain of $1,000 ($7,000 sales price − $6,000 cost).

b. (3) Cash inflow from investing activities, $7,000.

3-14
EXERCISE 3-10A

Cash Flow from


Net Income Operating Activities
Direction Amount of Direction Amount of
Event No. of Change Change of Change Change
a. Increase $12,000 Increase $10,000
b. Decrease 6001 Decrease 3,600
c. Decrease 6,000 No Effect
d. Decrease 4,0002 No Effect
e. Decrease 1,4003 Decrease 1,200
f. Increase 5,400 Increase 5,400
g. Decrease 2,000 Decrease 2,000
h. Increase 1,8004 Increase 2,400
i. No Effect No Effect
j. Increase 2,000 No Effect
1
$3,600 x 2/12 = $600
2
($20,000 − $4,000) ÷ 4=$4,000 depreciation expense per year.
3
$1,600 − $200 = $1,400
4
$2,400 x 9/12 = $1,800

3-15
EXERCISE 3-11A

R. Ross Attorney At Law


Effect of Transactions on the Financial Statements for 20
Balance Sheet Income Statement

Assets = Liabilities + S. Rev − Exp. = Ne


Equity
Acct. Unearn. Retaine
No. Cash + Supplie = Payabl + Revenu + d
s e e Earning
s
1. 15,000 + NA = NA + 15,000 + NA NA − NA =
2. NA + 900 = 900 + NA + NA NA − NA =
3. 35,300 + NA = NA + NA + 35,300 35,300 − NA = 35,
4. (21,400 + NA = NA + NA + (21,400 NA − 21,400 = (21
) )
5. (4,000) + NA = NA + NA + (4,000) NA − NA =
6. (700) + NA = (700) + NA + NA NA − NA =
7. NA + (825) = NA + NA + (825) NA − 825 = (
8. NA + NA = NA + (11,250 + 11,250 11,250 − NA = 11,
)*
Totals 24,200 + 75 = 200 + 3,750 + 20,325 46,550 − 22,225 = 24,

*$15,000 x 9/12 = $11,250

3-16
EXERCISE 3-12A

a. A cost is the value sacrificed for goods and services that


are expected to bring a current or future benefit to the
organization. A cost can be either an asset or expense.
Costs that are incurred to produce future benefits are
classified as assets. In a profit-making firm, future
benefits usually mean revenues. As costs are used up
in the production of revenues, they are said to expire.
Expired costs are called expenses. In each period,
expenses are deducted from revenues in the income
statement to determine the period’s profits. Once the
benefit has been obtained, the cost is classified as an
expense.
b.
Asset Expense
(1) X (Purchased
Equipment)
(2) X (Purchased
Supplies)
(3) X (Used Supplies)
(4) X (Purchased
Equipment)
(5) X (Accrued Interest)

3-17
EXERCISE 3-13A

Matched Matched with


Directly with the Period Systematicall
Cost Revenue Incurred y Matched
Rent 
Office 
Equipment
Land that has
been sold 
Utilities 
Sales 
Commissions
Furniture 
Advertising 

3-18
EXERCISE 3-14A
a.
Stotzy Corporation
Accounting Equation 2007

Assets = Liab. + Stockholders’ Equity


Prepaid Com. Retained
Event Cash Insurance = + Stock + Earnings
Pur. Insurance (7,200) +7,200
Adj. Ins Exp. (3,000) (3,000)
Totals (7,200) 4,200 = -0- + -0- + (3,000)

*$7,200 x 10/24 = $3,000

or: Decrease: Retained Earnings (Insurance


Expense) $3,000
Decrease: Prepaid Insurance
$3,000

b. The required entry would decrease assets by $3,000


[($7,200 ÷ 24) x 10] and decrease stockholders’ equity
by $3,000 (retained earnings). If this entry is not made,
assets and stockholders’ equity would both be
overstated on the balance sheet by $3,000. On the
income statement, expenses would be understated
causing net income to be overstated by $3,000.

3-19
EXERCISE 3-15A

Note: There are many examples of events that illustrate


the required effects. An example is given of each event.

a. Recognized revenue that had been received in advance


(unearned revenue).

b. Provided service for cash.

c. Recognized accrued interest expense.

d. Paid salaries expense.

3-20
EXERCISE 3-16A

Note: This exercise can be used to assess writing skills.

The tutoring fees of $600 received in advance by Jacob


Huron from Kev Saia should be reported as a liability.
Although the cash has been received by Jacob Huron, it
has not yet been earned. Huron has an obligation to
either perform the services for refund the cash advantage.
When the tutoring service is provided to Kev, the
unearned revenue should be recognized as revenue
earned by Huron.

3-21
SOLUTIONS TO PROBLEMS - SERIES A - CHAPTER 3

PROBLEM 3-17A

Midwest Company
Effect of Events on the Financial Statements

Balance Sheet Income Stat


Assets = Liabilities + Stock. Equity Rev. − Exp.

E Accts Accts. Unear Com. Ret.


vent Cash + Rec. + Supp = Pay. + n Rev. + Stock + Earn.
.
1. 8,000 + NA + NA = NA + NA + 8,00 + NA NA − NA
0
2. 2,000 + NA + NA = NA + NA + NA + 2,000 2,000 − NA
3. NA + 10,000 + NA = NA + NA + NA + 10,00 10,00 − NA
0 0
4. 7,500 + (7,500 + NA = NA + NA + NA + NA NA − NA
)
5. (800) + NA + 800 = NA + NA + NA + NA NA− NA
6. NA + NA + (650) = NA + NA + NA + (650) NA− 650
7. 3,000 + NA + NA = NA + 3,000 + NA + NA NA− NA
8. NA + NA + NA = NA + (500) + NA + 500 500− NA
9. (3,20 + NA + NA = NA + NA + NA + (3,200 NA− 3,20
0) ) 0
10. NA + NA + NA = 1,200 + NA + NA + (1,200 NA − 1,20
) 0
11. (1,00 + NA + NA = (1,00 + NA + NA + NA NA − NA
0) 0)
12. (800) + NA + NA = NA + NA + NA + (800) NA − NA
Bal. 14,70 + 2,500 + 150 = 200 + 2,500 + 8,00 + 6,650 12,50 − 5,05
0 0 0 0

3-22
PROBLEM 3-18A a.

Wax Made
Accounting Equation for 2005
Assets = Liabilities + Stockholders’ Equity
Event Cash Prepaid Com. Stock Retained
Date. Rent Earnings
3/1 50,000 NA NA 50,000 NA
5/1 (48,000) 48,000 NA NA NA
12/31 65,000 NA NA NA 65,000
12/31 NA (32,000)* NA NA (32,000)
Totals 67,000 16,000 = -0- + 50,000 33,000

*$48,000 x 8/12 = $32,000

Computation of net income:

Service Revenue $65,000

Expenses
Rent Expense $32,000
Total Expenses (32,000)

Net Income $33,000

Computation of Cash Flow from Operating Activities

Cash Flows From Operating Activities:


Cash Receipt from Revenue $65,000
Cash Payment for Expense (48,000)
Net Cash Flow from Operating Activities $17,000

3-23
PROBLEM 3-18A b. (cont.)
(For Instructor’s Use)
Copeland & Associates
Accounting Equation for 2001

Assets = Liabilities + Stockholders’ Equity


Event Unearned Common Retained
Date. Cash Revenue Stock Earnings
4/1 21,000 21,000 NA NA
12/31 NA (15,750)* NA 15,750
Totals 21,000 = 5,250 + -0- 15,750

*$21,000 x 9/12 = $15,750

Copeland & Associates


Financial Statements
For the Year Ended December 31, 2001

Income Statement

Consulting Revenue $15,750

Expenses -0-

Net Income $15,750

Statement of Changes in Stockholders’ Equity

Beginning Common Stock $ -0-


Plus, Stock Issued -0-
Ending Common Stock $ -0-

Beginning Retained Earnings -0-


Plus, Net Income 15,750
Ending Retained Earnings 15,750

Total Stockholders’ Equity $15,750

3-24
PROBLEM 3-18A b. (cont.)

Copeland & Associates


Balance Sheet
As of December 31, 2001

Assets
Cash $21,000
Total Assets $21,000

Liabilities
Unearned Revenue $ 5,250
Total Liabilities $ 5,250

Stockholders’ Equity
Common Stock -0-
Retained Earnings 15,750
Total Stockholders’ Equity 15,750

Total Liabilities and Stockholders’ Equity $21,000

Statement of Cash Flows


For the Year Ended December 31, 2001

Cash Flows From Operating Activities:


Cash Receipt from Revenue $21,000
Net Cash Flow from Operating Activities $21,000

Net Cash Flow From Investing Activities: -0-

Net Cash Flow From Financing Activities: -0-

Net Change in Cash 21,000


Plus, Beginning Cash Balance -0-
Ending Cash Balance $21,000

3-25
PROBLEM 3-18A c. (cont.)

Fashion Cents
Accounting Equation for 2003
Assets = Liab. + Stock. Equity Income Statement
Event Accum. Comm. Retained
Date Cash Equip. Depr. Stock Earnings Rev. − Exp. =
1/1 35,000 NA NA NA 35,000 NA NA NA
1/1 (35,000) 35,000 NA NA NA NA NA NA
12/31 10,000 NA NA NA NA 10,000 10,000 NA 10
12/31 NA NA (6,000) NA NA (6,000)* NA 6,000 (6
Totals 10,000 35,000 (6,000) = -0- + 35,000 4,000 10,000 6,000 4

*($35,000 − $5,000) ÷ 5 = $6,000 depreciation per year

3-26
PROBLEM 3-19A

The Accounting Equation

Total Assets = Liabilities + Equity


Event/ Asset 1 Asset 2 Common Stock Retained
Adjust. (Cash) Earnings
a. (18,000) +18,000 NA NA NA
a. Adj.1 NA +450 NA NA +450

b. (4,200) +4,200 NA NA NA
b. Adj.2 NA (1,050) NA NA (1,050)

c. NA +2,000 +2,000 NA NA
c. Adj.3 NA (1,800) NA NA (1,800)

d. (9,000) +9,000 NA NA NA
d. Adj.4 NA (7,500) NA NA (7,500)

e. +10,000 NA +10,000 NA NA
e. Adj.5 NA NA +900 NA (900)

f. (19,000) +19,000 NA NA NA
f. Adj.6 NA (5,000) NA NA (5,000)

g. +6,000 NA +6,000 NA NA
g. Adj.7 NA NA (2,500) NA 2,500
1
$18,000 x 5% = $900; $900 x 6/12 = $450
2
$4,200 x 3/12 = $1,050
3
$2,000 − $200 = $1,800
4
$9,000 x 10/12 = $7,500
5
$10,000 x 12% = $1,200; $1,200 x 9/12 = $900
6
$19,000 − $4,000 = $15,000; $15,000 ÷ 3 = $5,000
7
$6,000 x 5/12 = $2,500

3-27
PROBLEM 3-20A
a.
Nevada Drilling Company
Accounting Equation for 2002

Assets = Liabilities
Type of Accts. Prepd. Office Acc. Accts. Accrued U
Event Event Cash Rec. Supp. Rent Land Equip. Depr. = Pay. Salaries
1. AS 40,000
2. AE (17,000) 17,000
3. AE (8,000) 8,000
4. AE (600) 600
5. AS 16,000
6. AU (7,200)
7. AE 10,000 (10,000)
8. CE 4,100
9. AU (500)
10. AU (3,200)*
Totals 17,200 6,000 100 -0- 8,000 17,000 (3,200) = -0- 4,100

*($17,000 − $1,000) ÷ 5 = $3,200 depreciation per year

3-28
PROBLEM 3-20A a. (cont.)

Nevada Drilling Company


Accounting Equation for 2003

Assets = Liabilities
Type of Accts. Prepd. Off. Acc. Accts. Accrued U
Event Event Cash Rec. Supp. Rent Land Equip. Depr. = Pay. Salaries Re
Bal. 17,200 6,000 100 -0- 8,000 17,000 (3,200) -0- 4,100
1. AS 6,000
2. AU (4,100) (4,100)
3. AE (2,100) 2,100
4. AE/AU 7,500 (8,000)
5. AS 4,800 4
6. AS 1,000 1,000
7. AS 12,000
8. AE 13,000 (13,000)
9. AU (1,000)
10. AU (1,400)1
11. CE (2
12. AU (980)
13. AU (3,200)3
14. CE 4,000
Totals 41,300 5,000 120 700 -0- 17,000 (6,400) = 1,000 4,000 2
1
$2,100 x 8/12 = $1,400
2
$4,800 x 5/12 = $2,000
3
($17,000 − $1,000) ÷ 5 = $3,200 depreciation per year

3-29
PROBLEM 3-20A (cont.)
b.
Nevada Drilling Company
Financial Statements
For the Years Ended December 31, 2002 and 2003

Income Statements

2002 2003

Service Revenue $ 16,000 $ 14,000

Expenses
Operating Expenses (7,200) -0-
Depreciation Expense (3,200) (3,200)
Supplies Expense (500) (980)
Salaries Expense (4,100) (4,000)
Rent Expense -0- (1,400)
Total Expenses (15,000) (9,580)
Net Operating Income 1,000 4,420
Less: Loss on Sale of Land -0- (500)
Net Income $ 1,000 $ 3,920

Statements of Changes in Stockholders’ Equity

Beginning Common Stock $ -0- $40,000


Plus: Stock Issued 40,000 6,000
Ending Common Stock 40,000 46,000

Beginning Retained Earnings -0- 1,000


Plus: Net Income 1,000 3,920
Less: Dividends -0- (1,000)
Ending Retained Earnings 1,000 3,920

Total Stockholders’ Equity $41,000 $49,920

3-30
PROBLEM 3-20A b. (cont.)

Nevada Drilling Company


Balance Sheets
As of December 31, 2002 and 2003

2002 2003
Assets
Cash $17,200 $41,300
Accounts Receivable 6,000 5,000
Supplies 100 120
Prepaid Rent -0- 700
Land 8,000 -0-
Office Equipment 17,000 17,000
Less: Accum. Depreciation (3,200) (6,400)
Total Assets $45,100 $57,720

Liabilities
Accounts Payable $ -0- $ 1,000
Accrued Salaries 4,100 4,000
Unearned Revenue -0- 2,800
Total Liabilities 4,100 7,800

Stockholders’ Equity
Common Stock 40,000 46,000
Retained Earnings 1,000 3,920
Total Stockholders’ Equity 41,000 49,920

Total Liab. and Stockholders’ Equity $45,100 $57,720

3-31
PROBLEM 3-20A b. (cont.)

Nevada Drilling Company


Statements of Cash Flows
For the Years Ended December 31, 2002 and 2003

2002 2003

Cash Flows From Operating Activities:


Cash Receipt from Revenue $10,000 $17,800
Cash Payment for Expense (7,800) (6,200)
Net Cash Flow from Operating Activities 2,200 11,600

Cash Flows From Investing Activities:


Cash Payment for Land (8,000) -0-
Cash Payment for Office Equipment (17,000) -0-
Cash Receipt from Sale of Land 7,500
Net Cash Flow From Investing Activities (25,000) 7,500

Cash Flows From Financing Activities:


Cash Receipts from Stock Issue 40,000 6,000
Cash Payment for Dividends -0- (1,000)
Net Cash Flow From Financing Activities 40,000 5,000

Net Change in Cash 17,200 24,100


Plus: Beginning Cash Balance -0- 17,200
Ending Cash Balance $17,200 $41,300

3-32
PROBLEM 3-21A (Prepared for Instructor's Use)

Accounting Equation
Assets Liabilities
Date Cash Acc Rec Pp. Supp. CD Int Van Acc Land Acc Sal. Note Int
Rent Rec Depr. Pay. Pay. Pay. Pay.
Bal. 70,000 41,000 40,000 44,000
1/1 10,000
1/1 (18,000) 18,000
3/1 8,000 8,000
5/1 (3,900) 3,900
6/1 (1,000)
7/1 (16,000) 16,000
8/1 (7,000) (7,000)
9/1 5,600
9/30 17,000 (20,000)
10/1 1,500 1,500
11/1 (10,000) 10,000
12/31 45,000
12/31 47,000 (47,000)
12/31 6,000
12/31 2,000
12/31 (1,400)
12/31a (5,000)1
12/31a 8002
12/31a (2,600) 3

12/31a
12/31a 1005
Bal. 101,700 39,000 1,300 100 10,000 100 18,000 (5,000) 36,000 44,500 2,000 8,000 800

(1) 12/31a Depreciation Expense ($18,000 − $3,000 = $15,000; $15,000 ÷ 3 = $5,000 per year.
(2) 12/31a Interest Expense ($8,000 x 12% = $960; $960 x 10/12 = $800)
(3) 12/31a Expired Rent ($3,900 x 8/12 = $2,600)
(4) 12/31a Unearned Revenue Earned ($5,600 x 4/8 = $2,800)
(5) 12/31a Interest Earned ($10,000 x 6% = $600; $600 x 2/12 = $100)

3-33
PROBLEM 3-21A (cont.)

a. The five transactions that need adjusting entries are as follows:


1. Jan. 1, purchase of delivery van.
2. March 1, note payable issued.
3. May 1, prepaid rent.
4. Sept. 1, unearned revenue; cash was received in advance.
5. Nov. 1, purchase of CD.

b. $8,000 X 12% X 10/12=$800

c. $47,000 + $5,600 − $3,900 − $7,000 = $41,700

d. $3,900 X 8/12 = $2,600

e. $58,100 (see total of liabilities columns above; $44,500 + $2,000 + $8,000 + $800 + $2,800).

f. $1,500 − $100 = $1,400

g. $2,800=$5,600 − $2,800

h. $(27,000) = [$(18,000)+$(16,000)+$17,000+$(10,000)]

i. $8,000 x 12% x 10/12 = $800

j. Total expenses, $17,800 ($2,000+$6,000+$1,400+$2,600+$5,000+$800)

k. Ending retained earnings $53,100 (Beg. RE $27,000 + NI $27,100 − Dist. $1,000)

l. Total revenue $47,900=$45,000+$2,800 + $100

m. $17,000=$10,000+$8,000 − $1,000

n. ($3,000)= $17,000 − $20,000

o. $27,100 = (l) $47,900 − (j) $17,800 − (n) $3,000

3-33
PROBLEM 3-22A
Highpoint Company
Financial Statements
For the Year Ended 2005

Income Statement

Revenue
Service Revenue $50,000
Total Revenue $50,000

Expenses
Operating Expenses 10,000
Supplies Expense 850
Depreciation Expense 2,000
Insurance Expense 1,500
Total Expenses (14,350)

Net Income $35,650

Statement of Changes in Stockholders’ Equity

Beginning Common Stock $ 6,500


Plus: Stock Issued 28,000
Ending Common Stock $34,500

Beginning Retained Earnings 12,000


Plus: Net Income 35,650
Less: Dividends (2,500)
Ending Retained Earnings 45,150

Total Stockholders’ Equity $79,650

3-34
PROBLEM 3-22A (cont.)

Highpoint Company
Balance Sheet
As of the December 31, 2005

Assets
Cash $30,000
Accounts Receivable 18,000
Supplies 150
Prepaid Insurance 6,000
Office Equipment $28,000
Less: Accum. Depreciation (11,500) 16,500
Land 12,000
Total Assets $82,650

Liabilities
Accounts Payable $ 3,000
Total Liabilities $ 3,000

Stockholders’ Equity
Common Stock 34,500
Retained Earnings 45,150
Total Stockholders’ Equity 79,650

Total Liab. and Stockholders’ Equity $82,650

3-35
PROBLEM 3-22A (cont.)

Highpoint Company
Statement of Cash Flows
For the Year Ended December 31, 2005

Cash Flow From Operating Activities $15,000

Cash Flow From Investing Activities (20,000)

Cash Flow From Financing Activities 5,500

Net Change in Cash 500


Plus: Beginning Cash Balance 29,500*
Ending Cash Balance $30,000

*Not given in the problem.


Ending Cash Bal. − Increase in cash = Beg. Cash Balance
$30,000 − $500 = $29,500

3-36
PROBLEM 3-23A

Item/Account Statement Item/Account Statement

a. Total Assets BS t. Interest Receivable BS


b. Consulting Rev. IS u. Salary Expense IS
c. Depreciation Exp. IS v. Notes Receivable BS
d. Supplies Expense IS w. Unearned Revenue BS
e. Salaries Payable BS x. Cash Flow from CF
Investing Activities
f. Notes Payable BS y. Insurance Expense IS
g. Ending Common Stock BS,SE z. End. Retained Earn. SE,BS
h. Interest Payable BS aa. Accumulated Depr. BS
i. Office Equipment BS bb. Supplies BS
j. Interest Revenue IS cc. Beg. Retained Earn. SE
k. Land BS dd. Certificate of Deposit BS
l. Operating Expenses IS ee Cash Flow from CF
Financing Activities
m. Total Liabilities BS ff. Accounts Receivable BS
n. Debt-to-Equity Ratio NA gg. Prepaid Insurance BS
o. Salaries Expense IS hh. Cash BS/CF
p. Net Income IS/SE ii. Interest Expense IS
q. Service Revenue IS jj. Accounts Payable BS
r. Cash Flow from CF kk. Beg. Common Stock SE
Operating Activities
s. Return-on-Assets NA ll. Dividends SE,CF

3-37
PROBLEM 3-24A
For the instructor’s use.

Computation of income statement and cash flow amounts:


1. Beginning Accounts Receivable $ 45,000
Add: Services provided on account (IS) 128,000
Less: Accounts Receivable ending (28,000)
balance
Cash collected, 2004 (CF) $145,000

2. Unearned revenue 3/1; (for 24 months) $21,000


(CF)
Income earned (10 months) (IS) (8,750)
Unearned Revenue, 12/31/2004 $12,250

3. Interest earned on Certificate of


Deposit:
$30,000 x .15 x 4/12 (IS) $1,500

4. Depreciation Expense, 2004 (IS) $18,000

5. Salaries Expense, 2004 (IS) $25,000


Less, increase in Salaries Payable (3,500)
Salaries paid, 2004 (CF) $21,500

6. Operating expense accrued and paid $70,000


(IS/CF)

3-38
PROBLEM 3-24A (cont.)
a.
Cornell Corporation
Income Statement
For the Year Ended December 31, 2004

Revenue
Service Revenue $136,750
Interest Revenue 1,500
Total Revenue $138,250

Expenses
Operating Expenses 70,000
Salaries Expense 25,000
Depreciation Expense 18,000
Total Expenses (113,000)

Net Income $ 25,250

b.
Cornell Corporation

Cash Flows From Operating Activities:


Cash Receipts from Revenue $145,000
Cash Received from Unearned Rev. 21,000
Cash Paid for Salaries (21,500)
Cash Payments for Operating Expenses (70,000)
Net Cash Flow from Operating Activities $74,500

3-39
PROBLEM 3-25A

Note: This exercise can be used to evaluate both writing


and thinking skills. The student must understand the
differences in risk in order to write an answer.

a. Investment: Earnings ÷ Total Assets = Percent

Everhart $11,220 ÷ $185,000 = 6.1%


Harrison $ 900 ÷ $ 20,000 = 4.5%

b. Everhart’s investment in a small business produced a higher return than Harrison’s


deposit at the bank, but bank deposits carry much less risk than running a small
business. A business can have a high return one year, and a very low return the next
year due to a weak economy or a new competitor. Running a business also requires
management skills; the bank deposit does not.

3-40
SOLUTIONS TO EXERCISES - SERIES B - CHAPTER 3

EXERCISE 3-1B

a. The business invested cash by purchasing a building.

Collected accounts receivable.

b. Purchased land with a note.

Purchased supplies on account.

c. Paid accounts payable.

Paid notes payable.

d. Paid a cash dividend to owners.

Paid an expense with cash.

e. Recorded accrued salaries.

Recorded accrued interest expense.

f. The owners invested cash in the business.

Cash revenue is earned.

g. Unearned revenue is earned and recognized.

3-41
EXERCISE 3-2B

a. neither

b. deferral

c. accrual

d. accrual

e. neither

f. deferral

g. deferral

h. accrual

i. accrual

j. deferral

3-42
EXERCISE 3-3B

a.
Even Assets = Stockholders’ Equity
t
Accumulat Common Retained
Cash Equipme ed Stock + Earnings
nt Depreciatio
n
1. (12,400 12,400
)
Adj. (2,750)* (2,750)

*$12,400 − $1,400 = $11,000; $11,000 ÷ 4 = $2,750

b.
Even Assets = Stockholders’ Equity
t
Prepaid = Common Retained
Cash Rent Stock + Earnings
1. (15,000 15,000
)
Adj. (3,750)* (3,750)

*$15,000 x 3/12 = $3,750

c.
Even Assets = Liabilities + Stockholders’ Equity
t
Common Retained
Cash Unearned Stock Earnings
Revenue
1. 50,000 50,000
Adj. (12,500)* 12,500

*$50,000 x 2/8 = $12,500

3-43
EXERCISE 3-4B

Horizontal Statement Model

Stk. Equity Income


Statement
Type Com. Ret. Net Cash
of
E Event Asset = Liab. + Stoc + Earn Rev. − E = Inc. Flows
vent s k . xp.
a. AE I/D NA NA NA NA NA NA D IA
b. AS I NA I NA NA NA NA I FA
c. AU D D NA NA NA NA NA D OA
d. AS I I NA NA NA NA NA I OA
e. AE I/D NA NA NA NA NA NA I OA
f. AU D NA NA D NA I D D OA
g. CE NA I NA D NA I D NA
h. AE I/D NA NA NA NA NA NA D IA
i. AS I NA NA I I NA I NA
j. AE I/D NA NA NA NA NA NA D OA
k. AU D NA NA D NA I D NA
l. AS I NA NA I I NA I I OA
m. AE/AS I I NA NA NA NA NA D IA
n. AU D D NA NA NA NA NA D OA
o. AU D NA NA D NA NA NA D FA
p. AU D NA NA D NA I D NA
q. CE NA I NA D NA I D NA

3-44
EXERCISE 3-5B
a.
Belview Consulting Services
Effect of Events on the Accounting Equation

Assets = Stockholders’ Equity


Prepaid Common Retained
Event Cash Rent = Stock Earnings
1. Acq. Stock 25,000 25,000
2. Prepaid Rent (18,000) 18,000
3. Provided 28,000 28,000
Service
4. Used Rent (13,500)* (13,500)
Totals 35,000 4,500 = 25,000 14,500

*$18,000 x 9/12 = $13,500

b.
Belview Consulting Services
Balance Sheet
As of December 31, 2007

Assets
Cash $35,000
Prepaid Rent 4,500
Total Assets $39,500

Liabilities $ -0-
Stockholders’ Equity
Common Stock $25,000
Retained Earnings 14,500
Total Stockholders’ Equity 39,500
Total Liabilities and $39,500
Stockholders’ Equity

c. Rent Expense: $13,500

3-45
EXERCISE 3-5B (cont.)

d.
Cash Flow From Operating Activities:
Cash Revenue $28,000
Paid Rent (18,000)
Net Cash Flow from Operating $10,000
Activities

3-46
EXERCISE 3-6B
a.
A & I Express
Effect of Events on Financial Statements for 2003

Assets = Liab. Stockholders’ Income Statement


Equity
Event Accts. Com. Ret. Net
No. Cash Supplie = Pay. + Stock Earn. Rev. − Exp. = Incom
s e

Beg. 2,000 -0- -0- 1,200 800


Bal
1. NA 2,400 2,400 NA NA NA NA NA
2. 10,800 NA NA NA 10,800 10,800 NA 10,800
3. (1,800 NA (1,800) NA NA NA NA NA
)
4. NA (2,200) NA NA (2,200) NA 2,200 (2,200
)
Totals 11,000 200 600 1,200 9,400 10,800 2,200 8,600

b. The difference in net income and cash flow from operating


activities of $400 ($8,600 − $9,000) is attributed to
recognizing supplies expense of $2,200 in the income
statement, whereas the cash payment on accounts payable
(for supplies) was only $1,800.

3-47
EXERCISE 3-7B
a.
Papa’s Deli Delight
Accounting Equation for 2006

Assets = Stockholders’ Equity


Accum. Com. Retained
Event Cash Stove Depr. = Stock + Earnings
1. Acq. Cap. 30,000 30,000
2. Pur. Oven (22,000) 22,000
3. Rev. 21,000 21,000
4. Paid Exp. (4,000) (4,000)
5. Depr. Exp. (5,250)* (5,250)
Totals 25,000 22,000 (5,250) = 30,000 + 11,750

*(22,000 − $1,000) ÷ 4=$5,250 depreciation per year

Papa’s Deli Delight


Balance Sheet
As of December 31, 2006
Assets
Cash $25,000
Stove $22,000
Less: Accum. Depreciation (5,250) 16,750
Total Assets $41,750

Liabilities $
-0-
Stockholders’ Equity
Common Stock $30,000
Retained Earnings 11,750
Total Stockholders’ Equity 41,750
Total Liab. and Stockholders’ $41,750
Equity

3-48
EXERCISE 3-7B b. (cont.)

Papa’s Deli Delight


Statement of Cash Flows
For the Year Ended December 31, 2006
Cash Flows From Operating
Activities:
Cash Receipt from Revenue $21,000
Cash Payment for Salaries (4,000)
Net Cash Flow from Operating $17,00
Activities 0
Cash Flows From Investing
Activities:
Cash Outflow for Stove (22,000
)
Net Cash Flow from Investing (22,000
Activities )
Cash Flows From Financing
Activities:
Cash Receipts from Issue of Stock 30,000
Net Cash Flow from Financing 30,000
Activities
Net Change in Cash 25,000
Plus: Beginning Cash Balance -0-
Ending Cash Balance $25,00
0

c. Net Income: $11,750 (see the Retained Earnings column


above. There were no dividends paid.)

d. Depreciation expense for 2007: $5,250 (see computation


above; same as 2006)

e. Accumulated Depreciation on December 31, 2007: $10,500


($5,250 for 2006 + $5,250 for 2007)

3-49
f. No, depreciation is a non-cash expense. Depreciation is the
systematic allocation of the cost of an asset to expense.
The cash payment occurred when the stove was purchased.

3-50
EXERCISE 3-8B
a.
Holder Personal Financial Planning
Horizontal Statements Model for 2003

Assets = Liabilitie + Stk. Equity


s
Unearne Retained Net
Event Cash = d + Earnings Rev. − Exp. = Income
Revenue
1. Advance 30,000 30,000 NA NA NA
Payment
2. Revenue (22,500) 22,500 22,50 NA 22,500
Earned * 0
Totals 30,000 = 7,500 22,500 22,50 22,500
0

*$30,000 x 9/12 = $22,500

b. Revenue that will be recognized in 2004 is $7,500, the


remainder of the unearned revenue.

c. $-0-, no cash is received. All cash was received in 2003.

3-51
EXERCISE 3-9B

Mega Enterprises
2004 Accounting Equation

Assets = Stockholders’
Equity
Common Retained
Event Cash Land = Stock + Earnings

a.1 +15,000 (16,000) = (1,000)

Common Retained
Cash Land Stock Earnings
b.1 +18,000 (16,000) = +2,000

a. (1) See above.

a. (2) Loss of $1,000 ($15,000 sales price − $16,000 cost).

a. (3) Cash inflow from investing activities, $15,000.

b. (1) See above.

b. (2) Gain of $2,000 ($18,000 sales price − $16,000 cost).

b. (3) Cash inflow from investing activities, $18,000.

3-52
EXERCISE 3-10B

Cash Flow from


Net Income Operating Activities
Direction Amount of Direction Amount of
Event No. of Change Change of Change Change
a. Decrease $1,000 Decrease $6,000
b. Decrease 9001 Decrease $700
c. Decrease 7,5002 No Effect
d. Increase 8,000 Increase 8,000
e. Increase 1,2003 Increase 1,800
f. Decrease 3,200 No Effect
g. Increase 2,500 No Effect
h. No Effect No Effect
i. Increase 8,000 Increase 5,000
j. Decrease 3,000 Decrease 3,000
1
$1,000 − $100 = $900
2
($36,000 − $6,000) ÷ 4=$7,500 depreciation expense per year
3
$1,800 x 8/12 = $1,200

3-53
EXERCISE 3-11B

Moody Attorney At Law


Effect of Transactions on the Financial Statements for 20
Balance Sheet Income Statement

Assets = Liabilities + S. Rev − Exp. = Ne


Equity
Accts. Unearn. Retaine
No. Cash + Supplie = Payabl + Rev. + d
s e Earning
s
1. 24,000 + NA = NA + 24,000 + NA NA − NA =
2. 29,000 + NA = NA + NA + 29,000 29,000 − NA = 29,
3. NA + 1,400 = 1,400 + NA + NA NA − NA =
4. (1,000) + NA = (1,000) + NA + NA NA − NA =
5. (5,000) + NA = NA + NA + (5,000) NA − NA =
6. (16,200 + NA = NA + NA + (16,200 NA − 16,200 = (16
) )
7. NA + (1,250) = NA + NA + (1,250) NA − 1,250 = (1,
8. NA + NA = NA + (18,000 + 18,000 18,000 − NA = 18,
)*
Totals 30,800 + 150 = 400 + 6,000 + 24,550 47,000 − 17,450 = 29,

*$24,000 x 9/12 = $18,000

3-54
EXERCISE 3-12B

a. A cost that is an asset is the cost of resources that are


given up in acquiring some type of asset, such as an
automobile, office equipment, or land. A cost that is an
expense is the use of assets (depreciation) or the
payment for an expense that is incurred in the current
period (utilities, salaries, etc.)

b. Examples of costs that are assets:


1. Purchased land
2. Purchased equipment
3. Purchased supplies for future use.

c. Examples of costs that are expenses:


1. Paid monthly salary expense.
2. Paid monthly utilities expense.
3. Used supplies that had been previously purchased.

3-55
EXERCISE 3-13B

Matched Matched
Directly with the Systematica
Cost with Period lly Matched
Revenue Incurred
Delivery Van 
Office Manager’s 
salary
Office supplies 
Insurance 
Office Building 
Loss on sale of 
warehouse
Sales commissions 

3-56
EXERCISE 3-14B
a.
Black Corporation
Accounting Equation 2007
Assets = Liab. + Stockholders’
Equity
Prepaid Com. Retaine
Event Cash Insuranc = + Stock + d
e Earning
s
Paid rent in
advance (9,000) +9,000
Adj. Rent (6,000) (6,000)
exp.
Totals (9,000) 3,000 = -0- + -0- + (6,000)

*$9,000 x 8/12 = $6,000

or: Decrease:Retained Earnings (Rent Expense)


$6,000
Decrease: Prepaid Rent
$6,000

b. The required entry would decrease assets by $6,000


[($9,000 ÷ 12) x 8] and decrease stockholders’ equity by
$6,000 (retained earnings). If this entry is not made,
assets and stockholders’ equity would both be
overstated on the balance sheet by $6,000. On the
income statement, expenses would be understated
causing net income to be overstated by $6,000.

3-57
EXERCISE 3-15B

Note: There are many examples of events that illustrate


the required effects. An example is given of each event.

a. Recognized revenue on account.

b. Recognized revenue that had been received in advance.

c. Recognized an expense on account.

d. Paid utilities expense.

3-58
EXERCISE 3-16B

Note: This exercise can be used to assess writing skills.

The fee that Matlock receives in advance is a liability at


the time of receipt. Matlock has the duty to either
perform the service or return the money received in
advance. When Matlock performs the service, the liability
will be satisfied and the revenue will be recognized.

3-59
PROBLEM 3-17B

Ice Land
Effect of Events on the Financial Statements

Balance Sheet Income Stat


Assets = Liabilities + Stkholders’ Rev. − Exp.
Equity
E Accts Pp. Accts. Unear Com. Ret.
vent Cash + Rec. + Rent = Pay. + n Rev. + Stock + Earn.
1. 8,000 + NA + NA = NA + NA + 8,000 + NA NA − NA
2. NA + 9,000 + NA = NA + NA + NA + 9,000 9,000 − NA
3. 3,000 + NA + NA = NA + NA + NA + 3,000 3,000 − NA
4. 2,500 + NA + NA = NA + 2,500 + NA + NA NA − NA
5. 5,600 + (5,60 + NA = NA + NA + NA + NA NA − NA
0)
6. (1,10 + NA + NA = NA + NA + NA + (1,100 NA − 1,10
0) ) 0
7. NA + NA + NA = NA + (1,400 + NA + 1,400 1,400 − NA
)
8. NA + NA + NA = 2,800 + NA + NA + (2,800 NA − 2,80
) 0
9. (2,40 + NA + 2,400 = NA + NA + NA + NA NA − NA
0)
10. (2,20 + NA + NA = (2,20 + NA + NA + NA NA − NA
0) 0)
11. (1,50 + NA + NA = NA + NA + NA + (1,500 NA − NA
0) )
12. NA + NA + (1,800 = NA + NA + NA + (1,800 NA − 1,80
)* ) 0
Bal. 11,90 + 3,400 + 600 = 600 + 1,100 + 8,000 + 6,200 13,40 − 5,70
0 0 0

*$2,400 x 9/12 = $1,800

3-60
PROBLEM 3-18B a.

Oliver Company
Accounting Equation for 2006
Assets = Liabiliti + Stockholders’
es Equity
Event Prepaid Commo Retaine
Date. Cash Rent n Stock d
Earning
s
2/1 10,000 NA NA 10,000 NA
6/1 (2,400) 2,400 NA NA NA
12/31 5,200 NA NA NA 5,200
12/31 NA (1,400)* NA NA (1,400)
Totals 12,800 1,000 = -0- + 10,000 3,800
*$2,400 x 7/12 = $1,400

Computation of Net Income:


Service Revenue $5,200
Expenses
Rent Expense $1,400
Total Expenses (1,400)
Net Income $3,800

Computation of Cash Flows from Operating Activities:


Cash Flows From Operating
Activities:
Cash Receipt from Revenue $5,200
Cash Payment for Expense (2,400)
Net Cash Flow from Operating $2,800
Activities

3-61
PROBLEM 3-18B b. (cont.)
(For Instructor’s Use)
Cooper & Associates
Accounting Equation for 2005
Assets = Liabilities + Stockholders’ Equity
Event Unearned Common Retained
Date. Cash Revenue Stock Earnings
9/1 12,000 12,000 NA NA
12/31 NA (4,000)* NA 4,000
Totals 12,000 = 8,000 + -0- 4,000
*$12,000 x 4/12 = $4,000

Cooper & Associates


Financial Statements
For the Year Ended December 31, 2005
Income Statement

Consulting Revenue $4,000


Expenses -0-
Net Income $4,000

Statement of Changes in Stockholders’ Equity


Beginning Common $ -0-
Stock
Plus, Stock Issued -0-
Ending Common Stock $ -0-
Beginning Retained -0-
Earnings
Plus, Net Income 4,000
Ending Retained 4,000
Earnings
Total Stockholders’ $4,000
Equity

3-62
PROBLEM 3-18B b. (cont.)

Cooper & Associates


Balance Sheet
As of December 31, 2005
Assets
Cash $12,000
Total Assets $12,000

Liabilities
Unearned Revenue $ 8,000
Total Liabilities $ 8,000
Stockholders’ Equity
Common Stock -0-
Retained Earnings 4,000
Total Stockholders’ Equity 4,000
Total Liab. and Stockholders’ $12,000
Equity

Statement of Cash Flows


For the Year Ended December 31, 2005
Cash Flows From Operating
Activities:
Cash Receipt from Revenue $12,000
Net Cash Flow from Operating $12,000
Activities
Net Cash Flow From Investing -0-
Activities:
Net Cash Flow From Financing -0-
Activities:
Net Change in Cash 12,000
Plus, Beginning Cash Balance -0-
Ending Cash Balance $12,000

3-63
PROBLEM 3-18B c. (cont.)

Eagle Company
Accounting Equation for 2004
Assets = Liab. + Stkholders’ Equity Income Statement
Event Cash Equip. Accum. Comm. Retained
Date Depr. Stock Earnings Rev. − Exp. =
1/1 10,000 NA NA NA 10,000 NA NA NA
1/1 (10,000) 10,000 NA NA NA NA NA NA
12/31 5,200 NA NA NA NA 5,200 5,200 NA 5
12/31 NA NA (2,000) NA NA (2,000)* NA 2,000 (2
Totals 5,200 10,000 (2,000) = -0- + 10,000 3,200 5,200 2,000 3

*($10,000 − $2,000) ÷ 4 = $2,000 depreciation per year

3-64
PROBLEM 3-19B

The Accounting Equation

Total Assets = Liabilitie + Stockholders’ Equity


s
Event/ Asset 1 Asset 2 Common Retaine
Adjust. (Cash) Stock d
Earnings
a. (3,600) +3,600 NA NA NA
a. Adj. NA (900) 1
NA NA (900)
b. +20,000 NA +20,000 NA NA
b. Adj. NA NA +1,3502 NA (1,350)
c. (19,000) +19,000 NA NA NA
c. Adj. NA (3,750)3 NA NA (3,750)
d. +1,800 NA 1,800 NA NA
d. Adj. NA NA (1,350)4 NA +1,350
e. NA +800 +800 NA NA
e. Adj. NA (660)5 NA NA (660)
f. (8,000) +8,000 NA NA NA
f. Adj. NA +3206 NA NA +320
g. (7,200) +7,200 NA NA NA
g. Adj. NA (3,000)7 NA NA (3,000)
1
$3,600 x 3/12 = $900
2
$20,000 x 9% = $1,800; $1,800 x 9/12 = $1,350
3
$19,000 − $4,000 = $15,000; $15,000 ÷ 4 = $3,750
4
$1,800 x 9/12 = $1,350
5
$800 − $140 = $660
6
$8,000 x 6% = $480; $480 x 8/12 = $320
7
$7,200 x 5/12 = $3,000

3-65
PROBLEM 3-20B
a.
Great Plains Company
Accounting Equation for 2005

Assets = Liabilities
Even Type Accts. Prep Com. Acc. Accts. Accrue U
t of Cash Rec. Supp. d. Land Equip. Depr. = Pay. d
Event Rent Salarie
s
1. AS 25,000

2. AE (6,000) 6,000
3. AE
(12,00 12,00
0) 0
4. AE (500) 500
5. AS 9,000
6. AU (2,400)
7. AE 7,000 (7,000)
8. CE 3,200
9. AU (400)
10. AU
(1,000)
*
Total 11,100 2,000 100 -0- 6,000 (1,000) = -0- 3,200
s 12,00
0

*($6,000 − $2,000) ÷ 4 = $1,000 depreciation per year

3-66
PROBLEM 3-20B a. (cont.)

Great Plains Company


Accounting Equation for 2006

Assets = Liabilities
Even Type Accts. Prepd. Off. Acc. Accts Accrue Un
t of Cash Rec. Supp. Rent Land Equip Depr. = . d
Event . Pay. Salari R
es
Bal. 2,000 100 -0- 12,000 6,000 -0- 3,200
11,10 (1,000
0 )
1. AS
12,00
0
2. AU
(3,200 (3,200
) )
3. AE 6,000
(6,000
)
4. AE/AS
18,00 (12,00
0 0)
5. AS 8,400 8,
6. AS 2,000
2,00
0
7. AS 11,000
8. AE 9,000 (9,000)
9. AU
(2,000
)
10. AU
(5,500)
1

11. CE
(2
0)
12. AU
(1,900)
3

13. AU
(1,000
)4

3-67
14. CE 6,000
Total 4,000 200 500 -0- 6,000 = 6,000 6,
s 47,30 (2,000 2,00
0 ) 0
1
$6,000 x 11/12 = $5,500
2
$8,400 x 3/12 = $2,100
3
$100 + $2,000 − $200 = $1,900
4
($6,000 − $2,000) ÷ 4 = $1,000 depreciation per year

3-68
PROBLEM 3-20B (cont.)
b.
Great Plains Company
Financial Statements
For the Years Ended December 31, 2005 and 2006
Income Statements
2005 2006
Service Revenue $9,000 $ 13,100
Expenses
Operating Expenses (2,400) -0-
Depreciation Expense (1,000) (1,000)
Supplies Expense (400) (1,900)
Salaries Expense (3,200) (6,000)
Rent Expense -0- (5,500)
Total Expenses (7,000) (14,400)
Net Operating Income 2,000 (1,300)
(Loss)
Plus: Gain on Sale of -0- 6,000
Land
Net Income $2,000 $ 4,700

Statements of Changes in Stockholders’ Equity


Beginning Common $ -0- $25,000
Stock
Plus, Stock Issued 25,000 12,000
Ending Common Stock 25,000 37,000
Beginning Retained -0- 2,000
Earnings
Plus, Net Income 2,000 4,700
Less, Dividends -0- (2,000)
Ending Retained 2,000 4,700
Earnings
Total Stockholders’ $27,000 $41,700
Equity

3-69
3-70
PROBLEM 3-20B b. (cont.)

Great Plains Company


Balance Sheets
As of December 31, 2005 and 2006
2005 2006
Assets
Cash $11,100 $47,300
Accounts Receivable 2,000 4,000
Supplies 100 200
Prepaid Rent -0- 500
Land 12,000 -0-
Communication 6,000 6,000
Equipment
Less: Accum. (1,000) (2,000)
Depreciation
Total Assets $30,200 $56,000

Liabilities
Accounts Payable $ -0- $ 2,000
Accrued Salaries 3,200 6,000
Unearned Revenue -0- 6,300
Total Liabilities 3,200 14,300
Stockholders’ Equity
Common Stock 25,000 37,000
Retained Earnings 2,000 4,700
Total Stockholders’ 27,000 41,700
Equity
Total Liab. and Stock. $30,200 $56,000
Equity

3-71
PROBLEM 3-20B b. (cont.)

Great Plains Company


Statements of Cash Flows
For the Years Ended December 31, 2005 and 2006
2005 2006
Cash Flows From Operating
Activities:
Cash Receipt from Revenue $7,000 $17,400
Cash Payment for Expense (2,900) (9,200)
Net Cash Flow from Operating 4,100 8,200
Activities
Cash Flows From Investing
Activities:
Cash Payment for Land (12,000) -0-
Cash Payment for Comm. (6,000) -0-
Equipment
Cash Receipt from Sale of Land 18,000
Net Cash Flow From Investing (18,000) 18,000
Activities

Cash Flows From Financing


Activities:
Cash Receipts from Stock Issue 25,000 12,000
Cash Payment for Dividends -0- (2,000)
Net Cash Flow From Financing 25,000 10,000
Activities
Net Change in Cash 11,100 36,200
Plus: Beginning Cash Balance -0- 11,100
Ending Cash Balance $11,100 $47,300

3-72
PROBLEM 3-21B Accounting Equation (Prepared for Instructor's Use)

Accounting Equation
Assets Liabilities
Pp. Int Acc Acc Sal. Note Int
Date Cash Acc Rec Rent Supp. CD Rec Truck Depr. Land Pay. Pay. Pay. Pay.
Bal. 23,000 7,000 42,000 5,000
1/1 12,000
1/1 (22,000) 22,000
2/1 10,000 10,000
2/1 (3,000) 3,000
3/1 (1,000)
4/1 (28,000) 28,000
5/1 (2,000) (2,000)
7/1 5,400
9/1 60,000 (42,000)
10/1 3,000 3,000
11/1 (50,000) 50,000
12/31 35,000
12/31 40,000 (40,000)
12/31 6,000
12/31 4,800
12/31 (2,950)
12/31a (5,000)1
12/31a 8252
12/31a (2,750)3
12/31a
12/31a 5005
Bal. 44,400 2,000 250 50 50,000 500 22,000 (5,000) 28,000 12,000 4,800 10,000 825

(1) 12/31a Depreciation Expense $22,000 − $2,000 = $20,000; $20,000 ÷ 4 = $5,000


(2) 12/31a Interest Expense $10,000 x 9% = $900; $900 x 11/12 = $825
(3) 12/31a Expired Rent $3,000 x 11/12 = $2,750
(4) 12/31a Unearned Revenue earned $5,400 x 6/12 = $2,700
(5) 12/31a Interest Earned $50,000 x 6% = $3,000; $3,000 x 2/12 = $500

3-73
PROBLEM 3-21B (cont.)

a. The five transactions that need adjusting entries are as


follows:
1. Jan. 1, purchase of truck.
2. Feb. 1, note payable issued.
3. Feb. 1, prepaid rent.
4. July 1, unearned revenue; cash was received in advance.
5. Nov. 1, purchase of CD.

b. $10,000 X 9% X 11/12=$825

c. $40,000 + $5,400 − $3,000 − $2,000 = $40,400

d. $3,000 X 11/12 = $2,750

e. $12,000 + $4,800 + $10,000 + $2,700 + 825 = $30,325

f. $3,000 − $50 = $2,950

g. $5,400 − $2,700 = $2,700

h. ($22,000) +($28,000) + $60,000+ ($50,000) = ($40,000)

i. $10,000 x 9% x 11/12 = $825

j. Total expenses, $22,325


($6,000+$4,800+$2,950+$2,750+$5,000+$825)

k. Ending retained earnings $75,875 (Beg. RE $43,000 + NI


$33,875 − Div. $1,000)

l. Total revenue $38,200=$35,000+$2,700 + $500

m. $21,000=$10,000+$12,000 − $1,000

n. $60,000 − $42,000 = $18,000

` 3-71
o. $33,875 = (l) $38,200 − (j) $22,325 + (n) $18,000

` 3-72
PROBLEM 3-22B

Johnson Company
Financial Statements
For the Year Ended December 31, 20--
Income Statement
Revenue
Service Revenue $45,450
Total Revenue $45,450
Expenses
Operating Expenses 35,000
Supplies Expense 750
Depreciation Expense 1,500
Insurance Expense 1,800
Total Expenses (39,050)
Net Income $ 6,400

Statement of Changes in Stockholders’ Equity


Beginning Common Stock $24,000
Plus: Stock Issued 6,000
Ending Common Stock $30,000
Beginning Retained 14,500
Earnings
Plus: Net Income 6,400
Less: Dividends (6,000)
Ending Retained Earnings 14,900
Total Stockholders’ $44,900
Equity

` 3-73
PROBLEM 3-22B (cont.)

Johnson Company
Balance Sheet
As of December 31, 20--
Assets
Cash $ 9,000
Accounts Receivable 7,000
Supplies 300
Prepaid Insurance 600
Office Equipment $16,000
Less: Accum. Depreciation (8,000) 8,000
Land 36,000
Total Assets $60,900

Liabilities
Accounts Payable $16,000
Total Liabilities $16,000
Stockholders’ Equity
Common Stock 30,000
Retained Earnings 14,900
Total Stockholders’ Equity 44,900
Total Liab. and Stockholders’ $60,900
Equity

` 3-74
PROBLEM 3-22B (cont.)

Johnson Company
Statement of Cash Flows
For the Year Ending December 31, 20--
Cash Flow From Operating Activities $10,450
Cash Flow From Investing Activities (7,800)
Cash Flow From Financing Activities -0-
Net Change in Cash 2,650
Plus: Beginning Cash Balance 6,350*
Ending Cash Balance $9,000
*Not given in the problem.

` 3-75
PROBLEM 3-23B

Item/Account Stateme Item/Account Stateme


nt nt
a. Depreciation Exp. IS t. Cash BS/CF
b. Interest BS u. Supplies BS
Receivable
c. Certificate of BS v. Cash Flow from CF
Deposit Financing Act.
d. Unearned BS w. Interest Revenue IS
Revenue
e. Service Revenue IS x. End Retained BS/SE
Earn.
f. Cash Flow from CF y. Net Income IS/SE
Investing
Activities
g. Consulting IS z. Dividends SE/CF
Revenue
h. Interest Expense IS aa. Office BS
Equipment
i. End. Common BS/SE bb. Debt-to-Equity NA
Stock Ratio
j. Total Liabilities BS cc.Land BS
k. Debt-to-Asset NA dd. Interest Payable BS
Ratio
l. Cash Flow from CF ee. Salaries Expense IS
Operating
Activities
m. Operating IS ff. Notes Receivable BS
Expenses
n. Supplies Expense IS gg. Accounts BS
Payable
o. Beg. Retained SE hh. Total Assets BS
Earn.
p. Beg. Common SE ii. Salaries Payable BS
Stock
q. Prepaid Insurance BS jj. Insurance IS
Expense

` 3-76
r. Salary Expense IS kk. Notes Payable BS
s. Accumulated BS ll. Accounts Rec. BS
Depr.

` 3-77
PROBLEM 3-24B a.
Not Required.
Deluxe Technology Company
Accounting Equation
Assets Liabilities
Stockholders’ Equity
Cash Computers Acct. Pay. Com. Ret.
Stock Earnings
Bal. 6,500 Bal. 35,000 Bal. 10,000 B 15,000 Bal. 22,150
al.
Coll. 84,000 C 38,600 I 10,000
hg. nv.
Rent (5,000) Pd. B 25,000 Dividends
(34,00 al.
0)
Sup. (1,000) Acc. Depr. Bal. 14,600 12/3 (700)
1
Exp. Bal. (7,000)
(34,000
)
Stk. 10,000 12/3 (3,500) Svc.
1 Revenue
Div. (700) Bal. (10,500) 12/3 93,000
1
Bal. 59,800
Rent
Expense
12/3 (6,000)
1
Acct. Rec.
Bal. 8,000 Supp.
Expense
Rev. 93,000 12/3 (1,100)
1
Coll.
(84,000
)
Bal. 17,000
Depr.
Expense
Supplies 12/3 (3,500)

` 3-78
1
Bal. 150
Pur. 1,000
Exp. (1,100) Oper.
Expense
Bal. 50 12/3
1
(38,600
)

Prepaid Rent
Bal. 4,500
Pd. 5,000
Exp. (6,000)
Bal. 3,500

` 3-79
PROBLEM 3-24B a. (cont.)

Beginning Retained Earnings: $22,150


($6,500 + $8,000 + $4,500 + $150 + $35,000 − $7,000 −
$10,000 − $15,000)

b.
Deluxe Technology Company
Income Statement
For the Year Ended December 31, 20--
Revenue
Service Revenue $93,000
Total Revenue $93,000
Expenses
Operating Expenses 38,600
Supplies Expense 1,100
Depreciation Expense 3,500
Rent Expense 6,000
Total Expenses (49,200)
Net Income $43,800

Deluxe Technology Company


Statement of Changes in Stockholders’ Equity
For the Year Ended December 31, 20--
Beginning Common Stock $15,000
Plus: Stock Issued 10,000
Ending Common Stock $25,000
Beginning Retained 22,150
Earnings
Plus: Net Income 43,800
Less: Dividends (700)
Ending Retained Earnings 65,250
Total Stockholders’ $90,250
Equity

` 3-80
PROBLEM 3-24B b. (cont.)

Deluxe Technology Company


Balance Sheet
As of December 31, 20--
Assets
Cash $59,800
Accounts Receivable 17,000
Supplies 50
Prepaid Rent 3,500
Office Equipment $35,000
Less: Accum. Depreciation (10,500) 24,500
Total Assets $104,85
0

Liabilities
Accounts Payable $14,600
Total Liabilities $14,600
Stockholders’ Equity
Common Stock 25,000
Retained Earnings 65,250
Total Stockholders’ Equity 90,250
Total Liab. and Stockholders’ $104,85
Equity 0

` 3-81
PROBLEM 3-24B b. (cont.)

Deluxe Technology Company


Statement of Cash Flows
For the Year Ended December 31, 20--
Cash Flows from Operating
Activities:
Cash Receipts from Revenue $84,000
Cash Payments for Expenses (40,000)
Net Cash Flow from Operating $44,000
Activities
Net Cash Flow from Investing -0-
Activities
Cash Flows from Financing Activities:
Cash Receipts from Stock Issue 10,000
Cash Payments for Dividends (700)
Net Cash Flow from Financing 9,300
Activities
Net Change in Cash 53,300
Plus Beginning Cash Balance 6,500
Ending Cash Balances $59,800

` 3-82
PROBLEM 3-25B

Note: This exercise can be used to evaluate both


writing and thinking skills. The student must
understand the difference between retained earnings
and cash in order to write an answer.

Marty’s assessment of his father’s cash position is


invalid. Retained earnings is the net income
accumulated over the life of the business and
retained in the business and not distributed to the
owners.

Marty can gain more information about his father’s


cash position by observing the balance of the cash
account on the balance sheet and by examining the
statement of cash flows.

` 3-83
ATC 3-1

Financial Statement Analysis

a. Debt-to-assets: $7,813 ÷ $13,435 = 58.2%

b. Return-on-assets: $2,177 ÷ $13,435 = 16.2%

c. Return-on-equity: $2,177 ÷ $5,622 = 38.7%

d. Dell’s return on equity is more than double its return


on assets due to financial leverage.

` 3-84
ATC 3-2

a.1
Compute the amount of season 2003 2004 2005
ticket sales:
Deferred revenue, 12/31 (4 $127,000 $249,000 $275,000
months)
Season ticket sales revenue 127,000 249,000 275,000
earned, 12/31
Total season ticket sales $254,000 $498,000 $550,000

2.
Compute the amount of door 2003 2004 2005
sales:
Total Revenue $450,000 $575,000 $625,000
Less, previous year deferred
revenue earned -0- (127,000 (249,000)
)
Less, current year season ticket
sales earned (127,000 (249,000 (275,000)
) )
Door sales $323,000 $199,000 $101,000

3.
Net Income 2003 2004 2005
Total Revenue $450,000 $575,000 $625,000
Operating Expense (231,000 (326,000 (428,000
) ) )
Net Income $219,000 $249,000 $197,000

4. No instructor response required.

b. Students should notice that season ticket sales are


increasing while door sales are decreasing. One
explanation for this would be that the company may be
discounting the season ticket prices. It appears that
the company is stressing season ticket sales more than

` 3-85
door sales. This would be more desirable for the
company because the season ticket sales are collected
in advance. Thus, the funds are available to pay
production expenses that are incurred prior to the
actual performances.
ATC 3-3

a. Assessing risk involves more than computing a


company’s debt-to-assets ratio. Some industries are
inherently riskier than others. The construction
industry is very sensitive to changes in the economy,
and is a relatively unregulated industry. Banks, while
sensitive to changing interest rates, are generally
viewed as more stable than home construction.
Perhaps the biggest difference between banks and
construction companies is the very high level of
regulation and oversight to which banks are
subjected. When a bank gets into financial trouble,
government agencies probably will intervene to
prevent this failure. Such is not the case for
construction companies.
b. Ryland is more highly leveraged than Pulte. Ryland is
using this additional leverage to increase its return-
on-equity compared to its return on assets.
Though not covered in the text to avoid undue
confusion, instructors may wish to show students the
following mathematical relationship between the two
companies’ debt-to assets, return-on-assets, and
return-on-equity ratios.
Except for rounding and assorted “weird stuff” that
sometimes occur, the following relationship holds:
Return-on-assets
(1.0 − Debt-to-assets) = Return-on-equity
Ryland: 6.0%

` 3-86
(1.0 − .67) = 18.2% (rounding is the
reason for 18.2%
vs. 18.1%)

Pulte: 6.5%
(1.0 − .57) = 15.1%

` 3-87
ATC 3-4
a.
Total Total Common
Company Debt ÷ Assets = Unit
of Measure
%
Men’s Clothier $58,000 ÷ $215,00 = 27.0%
0

Women’s $256,50 ÷ $675,00 = 38.0%


Fashions 0 0

b. Based only on the debt-to-assets ratio, Women’s Fashions


has more financial risk than Men’s Clothier because it is
financing more of its assets with borrowed money.

3-88
ATC 3-5

a. Debt-to-Assets Ratio: Total debt ÷ Total assets

El Greco $ 93,000 ÷ $127,000 = 73.2%


Athenian: $452,000 ÷ $753,000 = 60.0%

Return-on-Equity Ratio: Net income ÷ Equity

El Greco $ 8,000 ÷ $ 34,000 = 23.5%


Athenian $45,000 ÷ $301,000 = 15.0%

b. El Greco 100% − 73.2% = 26.8%


Athenian 100% − 60.0% = 40.0%

c. Based only on the information available, El Greco appears to have


the greatest financial risk.

d. El Greco has the highest profitability.

e. Yes, companies with higher percentages of assets financed by debt


have lower percentages of assets financed by owners. If a company
can achieve about the same level of earnings with less investment by
the owners, the ROE ratio will be higher.

3-89
ATC 3-6

The following information should be contained in the memo:

a.
Present Return on Assets:
$425,000 ÷ $3,500,000 = 12.14%

If the asset is sold for $1,500,000:


Assets: $3,500,000 + ($1,500,000 − $900,000) =
$4,100,000
Net Income: $425,000 + $600,000 = $1,025,000

New Return on Assets:


$1,025,000 ÷ $4,100,000= 25%

An increase of both denominator and numerator by the


same amount will cause the rate of return to increase.

b.
If the asset is sold for $600,000:
Assets: $3,500,000 − ($600,000 − $900,000) = $3,200,000
Net Income: $425,000 − $300,000 = $125,000

New Return on Assets:


$125,000 ÷ $3,200,000 = 3.91%

A decrease In both the denominator and numerator by the


same amount will cause the rate of return to decrease.

3-90
ATC 3-7
a.
Income Statement Balance Sheet

Service $120,00 Assets: $167,000


Revenue 0
Operating (40,000
Exp. )
Net Income $ Liabilities: $ 5,000
80,000
Stockholders’
Equity:
Common Stock 82,000
Retained 80,000
Earnings
Total Liab. 162,000
Total Liab. and
Stk. Equity $167,000

Computations for Income Statement Items:

Revenue: $38,000+$82,000 = $120,000


Operating Expense: $70,000 − $30,000 = $40,000

Computations for Balance Sheet Items:

Assets: $85,000+$82,000 = $167,000


Liabilities: $35,000 − $30,000 = $5,000
Retained Earnings: ($32,000) + $82,000 + $30,000 =
$80,000

b. Willful deception is an act of fraud and punishable under


the law. Good intentions are not sufficient justification
for breaking the law. Students should learn to avoid
operating under an ends justifies the means philosophy.
Suppose the unexpected happens in this case. Glenn

3-91
fails to obtain the contract and is forced to declare
bankruptcy after having manipulated the statements. He
would not only stand to lose the friend that he deceived,
but also may become a convicted felon on charges of
fraudulent reporting.

3-92