Lesson 1

Problem 1-1

Respond briefly to the following questions:

A. Why is accounting sometimes referred to as the "language

Lesson 1 of business?"

Review of Accounting B. Financial accounting information is provided through general-

Environment and the purpose financial statements.
Basic Accounting Cycle i. What are the three general purpose financial statements
required under generally accepted accounting principles?

ii. What are the "notes to the financial statements?"

iii. Who uses financial statement information and why?

C. What is managerial accounting information and who uses it?

1 2

Problem 1-1 - Answer Problem 1-1 - Answer

B. Financial accounting information is provided through general-

A. Why is accounting sometimes referred to as the "language purpose financial statements.
of business?"

Answer: Language exists to provided a means of communication.

i. What are the three general purpose financial statements
Accounting is referred to as the "language of business" because its sole required under generally accepted accounting principles?
purpose is to communicate business information.
Answer:
Balance Sheet (sometimes referred to as a Statement of Financial
Position)

Income Statement (sometimes referred to as a Statement of Earnings,

Statement of Operations, Statement of Profits and Losses, or P&L
Statement)

Statement of Cash Flows

Although not required, most companies also provide a Statement of

Retained Earnings or a more complete Statement of Owners' Equity, which
provides information as to the causes of changes in retained earnings and
other elements of owners' equity over a period of time.

3 4

Problem 1-1 - Answer Problem 1-1 - Answer

B. Financial accounting information is provided through general

B. Financial accounting information is provided through general
purpose financial statements.
purpose financial statements.
iii. Who uses financial statement information and why?
ii. What are the "notes to the financial statements?"
Answer: The primary users of financial statement information are current
Answer: The notes to a company's financial statements provide
or potential investors and creditors, analysts providing investment advice
supplemental information that; (1) explains certain key accounting policies
and government regulatory bodies such as the Securities and Exchange
used in the preparation of the financial statements, (2) provides additional
Commission ("SEC") and Federal Trade Commission ("FTC"). In
detailed information in support of financial statement amounts and (3)
addition, employee unions, suppliers, prospective employees and the media
discloses other important information not reflected in the financial
are among other frequent users of financial statement information.
statements. Most notes to the financial statements are provided in
Although management personnel require much more detailed information
compliance with requirements under generally accepted accounting
in administering a company's day-to-day operations, the summarized results
principles.
provided through a company's financial statements can be helpful to
managers in evaluating progress in reaching a company's overall goals.
Managers are especially interested in financial statement results if bonuses
and raises are predicated on overall performance measures.

5 6

1-1
 Problem 1-1 - Answer
C. What is managerial accounting information and who uses
it?
Answer: Managerial accounting information refers to all of the
various other kinds of information, above and beyond the
information found in a company's general purpose financial
statements, which may be used by managers and other company
employees in their efforts to successfully operate a company. This
information is generally restricted to use by company employees
and is not subject to public dissemination. Managerial accounting
often involves budgeting and the forecasting of future operations
as well as the use of historical data.
7 8
Problem 1-2 - Answer
A. What is the SEC and what is its role?
Answer: The SEC (Securities and Exchange Commission) is a federal
regulatory agency charged with the responsibility of regulating the stock
and bond ("securities") markets of the United States to insure their fairness
and integrity for purposes of protecting the investing public. The SEC's
authority extends only to larger businesses that seek capital from large
numbers of investors in the United States ("publicly-held businesses").
Many companies in the U.S. today are publicly-held and subject to the
SEC's regulations. The SEC seeks to guarantee that investors and
creditors have adequate and accurate information to make informed
decisions and that rules of fairness in the marketplace are enforced. It does
not guarantee that quality decisions are made or guarantee the ultimate
success of any business investment. SEC regulations and oversight extend
not only to publicly-held companies but to stock exchanges, broker-dealers,
investment advisers and others involved in the public capital markets.
9 10
Problem 1-2 - Answer
D. What is the FASB and what is its role?
Answer: The Financial Accounting Standards Board (FASB) is a private
non-profit organization currently responsible for the establishment of
GAAP in the United States. The SEC recognizes the pronouncements of the
FASB as authoritative. Funding for the organization's operations come
from donations from the accounting profession, industry and the financial
community along with revenues from the sale of its publications.
E. How do the SEC and the FASB relate to one another?
Answer: Because the SEC has the ultimate power to determine GAAP, the
FASB exists and functions at the SEC's pleasure. As a result, when the
SEC talks the FASB listens. The SEC has considerable influence over the
pronouncements issued by the FASB.
11
1-2
Problem 1-2 - Answer
Respond briefly to the following questions:
A. What is the SEC and what is its role?
B. What is GAAP and why is it important to financial statement
users?
C. Who is legally authorized to determine GAAP?
D. What is the FASB and what is its role?
E. How do the SEC and the FASB relate to one another?
F. What is the IASB and what is its role?
G. What is the current status of relations between the FASB and
the IASB and the development of a common set of accounting
standards?
H. What would be the benefit of a single set of accounting
standards accepted and used world-wide?
Problem 1-2 - Answer
B. What is GAAP and why is it important to financial statement
users?
Answer: Generally accepted accounting principles ("GAAP") are the
methods of accounting and the financial statement disclosures required
of SEC-regulated companies. The purpose of GAAP is to improve the
comparability and usefulness of financial statement information.
Although not required, companies not subject to SEC regulation will also
typically prepare financial statements in accordance with GAAP to add
credibility for current or potential investors and creditors.
C. Who is legally authorized to determine GAAP?
Answer: The SEC has the legal authority to determine GAAP for
companies required to file financial statements with the SEC; however,
the SEC currently allows the FASB to function in this capacity. (Note: In
November, 2007 the SEC changed their previous policy and now allows
foreign companies filing their financial statements in the United States to
use International Financial Reporting Standards (IFRS) established by
the International Accounting Standards Board (IASB) in lieu of U.S.
GAAP established by the FASB. U.S. companies must still use U.S.
GAAP but that is expected to change in the coming years.)
Problem 1-2 - Answer
F. What is the IASB and what is its role?
Answer: The International Accounting Standards Board (IASB) is a private
organization headquartered in London and committed to developing a
single set of high quality global accounting standards. In addition, the
Board cooperates with national accounting standard setters in an attempt to
achieve convergence in accounting standards around the world.
G. Why are international accounting standards not allowed for
companies whose securities trade in the United States and what
would be the benefit if they were allowed?
Answer: As noted in the previous answer to C. international accounting
standards are now allowed for foreign companies whose securities trade in
the United States. This simplifies and lowers the cost of foreign companies’
access to U.S. capital markets. In addition, in the future as U.S. companies
are allowed to use international standards and other countries adopt those
same standards the efficient and effective flow of capital to the best and
most competitive companies world-wide will improve, which should lift the
general standard of living for all people.
12
 Problem 1-2 - Answer
H. What would be the benefit of a single set of accounting standards
___accepted and used world-wide?
Answer: Common world-wide accounting standards would improve the
flow of capital to the best companies world-wide. In other words,
companies that do the best job of providing goods and services that people
really want and need at the most competitive prices available would have
improved access to capital regardless of their location. In the long-run this
will ultimately lift the standard of living of people throughout the world.
13
Problem 1-3 - Answer
A. Who is responsible for financial statement accuracy and
compliance with GAAP?
Answer: A company’s management is primarily responsible for financial
statement accuracy and compliance with GAAP. In fact, management
failure to provide accurate financial information may constitute a crime
under the Foreign Corrupt Practices Act. This act requires management
of public companies to safeguard company assets and maintain accurate
financial records through the implementation of adequate internal
controls. Public companies subject to SEC regulation must also have an
annual financial statement audit performed by an independent CPA firm
registered with the SEC. Such an audit, however, does not relieve
management of their primary reporting responsibilities. In fact, a
company’s CEO and CFO must sign a written certification as to the
accuracy of their company’s financial reports under the Sarbanes-Oxley
Act of 2002.
15
Problem 1-3 - Answer
C. How does a person become a CPA and what do CPAs do besides
audits of financial statements?
Answer: CPA certification is administered by each state. CPAs licensed to
practice in a state may be able to practice in other states if reciprocal
licensing agreements exist. All states require CPA candidates to be college
graduates with credit earned in designated accounting courses. Candidates
must also pass a uniform CPA exam administered by the American Institute
of Certified Public Accountants (AICPA). In addition, certain supervised
work experience with a licensed CPA firm is also required. Subsequent to
initial certification, a CPA must complete continuing professional education
(CPE) requirements to maintain the right to practice.
17
1-3
Problem 1-3
Respond briefly to the following questions:
A. Who is responsible for financial statement accuracy and
compliance with GAAP?
B. What are internal controls and provide examples of common
controls over a company's cash.
C. How does a person become a CPA and what do CPAs do besides
audits of financial statements?
D. What is the AICPA and what is its role?
E. Why aren't auditors completely independent in the
performance of an audit?
F. What risks does a CPA face if they knowingly misrepresent the
accuracy of a company's financial statements and its
compliance with GAAP or are negligent in their performance of
an audit.
14
Problem 1-3 - Answer
B. What are internal controls and provide examples of common
controls over a company's cash.
Answer: Internal controls are policies and procedures designed to
safeguard a company's assets, produce accurate accounting records,
and promote the effective and efficient operation of the company's
business. Some common controls designed to safeguard and improve
the management of cash are: (1) segregation of duties in the handling
of cash transactions, (2) the use of pre-numbered checks for all cash
expenditures, (3) dual-signatures required for all checks written over a
certain dollar amount, (4) the monthly preparation of a bank
reconciliation, and (5) the use of cash flow budgets to project future
cash needs.
16
Problem 1-3 - Answer
D. What is the AICPA and what is its role?
Answer: The AICPA is a private profession organization made up of CPAs
across the nation. In addition to the administration of the CPA exam, the
AICPA also determines standards of practice in the performance of audit,
tax, consulting, personal financial planning and other professional
services. (Note: In the area of audit services for publicly held companies
filing with the SEC, audit standards are now set by the Public Company
Accounting Oversight Board established by the Sarbanes-Oxley Act of 2002
rather than the AICPA).
18
 Problem 1-3 - Answer
E. Why aren't auditors completely independent in the performance of
an audit?
Answer: CPA firms conducting financial statement audits are paid by the
companies they audit creating an inherent conflict of interest. In most
cases, a company’s management team is motivated to prepare financial
statements that present the most favorable financial impression possible.
If management/auditor disagreements arise on financial statement
presentation, management may threaten to change auditors. As a result
auditors may be tempted to compromise the integrity of their audit work in
order to preserve the engagement and resulting fee income. (Note: In the
past, auditor conflicts also existed due to other profitable non-audit
consulting or other service arrangements with their audit clients. Now,
under Sarbanes-Oxley, auditors are generally prohibited from performing
such services for their audit clients.)
19
1-4
Problem 1-3 - Answer
F. What risks does a CPA face if they knowingly misrepresent the
accuracy of a company's financial statements and its compliance
with GAAP or are negligent in their performance of an audit.
Answer: CPAs who certify misleading financial statements expose
themselves to potential investor and creditor lawsuits that may result in the
payment of significant financial damages. In addition, the loss of license
and professional censure are probable consequences for CPAs who fail the
public’s trust. In the most serious cases of knowing misrepresentation or
willful neglect, criminal penalties may be imposed.
20
 Problem 1-4

In the "Introduction to Accounting: The Language of Business" a

financial practice set was provided for a fictional company referred to as
Hot Cars, Inc (HCI), a wholesale distributor of miniature model cars.
This review problem continues the HCI story for an additional year
through 20X3.

HCI's income statement, statement of retained earnings and balance

sheet for the years 20X1 and 'X2 (a blank column is left for the 'X3
amounts to be determined in this problem), along with a simplified
general ledger reflecting balances in all of the company's accounts as of
1/1/X3 are provided herein for use in completing this problem. More
formal ledger formats, special journals and subsidiary ledgers used in
the previous Financial Practice Set will not be used in this review.
Problem Requirements:
1. On a blank sheet of paper record the following summarized 'X3 transactions for HCI
in basic general journal form as shown below:

Account Name XXX

Account Name XXX

A. Inventory purchased on account totaled $201,922.

B. Customer sales on account and the cost of inventory sold totaled $318,432 and
$206,145, respectively.
C. Cash purchases of office supplies totaled $4,677.
D. Cash payments of utility bills amounted to $7,607 of which $400 had been
previously recorded as an expense of the prior year.
E. Cash of $50,000 was paid down and a $250,000 mortgage note payable executed in
the purchase of land and a building on 10/1/X3. The 30-year fully amortizing
mortgage note bears 8% annual interest with monthly payments of $1,834.
Monthly cash payments on the note totaled $5,502 for the year of which $507 was
applied to principal and the rest to interest. The amount of principal due over the
next 12 months amounts to $2,130.
F. Paid off a $10,000 note payable (bank loan) plus interest of $1,500 of which $99
had been previously recorded as an expense in 20X2.
G. Paid off $4,000 of principal on a note payable (equipment loan) plus interest of
$1,440, of which $79 had been previously recorded as an expense in 20X2. The
remaining $8,000 of principal on this note is due in two equal $4,000 installments
over the next two years.
H. Cash payments of employee salaries totaled $53,409. (Ignore payroll withholdings
and employer payroll taxes for this problem.)
14
1-5
Continued...

I. Insurance premiums prepaid during the year totaled $4,313.

J. Cash collections of accounts receivable amounted to $310,406.
K. Paid the $6,408 of 20X2 income taxes payable at 1/1X3.
L. Cash payments on accounts payable totaled $163,407.
M. Cash dividends paid to stockholders amounted to $12,000.
N. Payments of miscellaneous expenses totaled $617.
O. Payments of postage expenses totaled $373.
P. Cash purchases of warehouse equipment totaled $13,456.
Q. Warehouse equipment having an original cost of $10,000 and associated
accumulated depreciation of $2,000 was sold for $10,000 cash.
2. Post the 20X3 summarized journal entries to the HCI general ledger.
3. Prepare the 12/31/X3 year-end adjusting entries given the following information:
a. Unpaid and unrecorded December, 20X3 salaries payable in January, 20X4
totaled $7,280.
b. Unpaid and unrecorded December 20X3 utility costs payable in January, 20X4
totaled $937.
c. Unearned rent revenue totaling $280 as of 12/31/X2 was earned in 20X3.
d. Unpaid and unrecorded 20X3 interest costs payable in the following year totaled
$53.
e. Prepaid insurance applicable to 20X4 operations totals $2,368 at 12/31/X3
f. Depreciation on warehouse equipment and the newly purchased building amount
to $6,985 for the year.
g. All 12/31/X2 prepaid rent expired in 20X3.
h. Unpaid and unrecorded 20X3 income taxes payable in the following year totaled
$4,747.
i. A physical count of office supplies on hand at 12/31/X3 totaled $1,962.
4. Post the 12/31/X3 adjusting entries to the HCI general ledger and determine the
12/31/X3 balance for each account.
5. Prepare a 12/31/X3 adjusted trial balance.
6. Extend the enclosed HCI income statements, statements of retained earnings and
balance sheets for the additional year ended 12/31/X3 so the statements reflect
comparative amounts for the last three years.
7. Prepare the required closing entries at 12/31/X3 and post the entries to the general
ledger.

15
1-6
 Problem 1-4

Hot Cars, Inc.

Income Statement
for the years ended December 31, 20X1, 20X2 and 20X3
20X1 20X2 20X3

Sales Revenues $ 185,043 $ 261,950

Cost of Goods Sold 111,026 164,026
Gross Margin 74,017 97,924
Operating Expenses:
Salaries Expense 49,500 53,600
Office Supplies Expense 3,893 3,958
Rent Expense 4,150 4,800
Utilities Expense 6,345 6,850
Depreciation Expense 1,436 1,640
Insurance Expense 1,055 1,105
Miscellaneous Expense 900 312
Postage Expense 298 321
Operating Expenses 67,577 72,586
Operating Income 6,440 25,338
Other Revenue and (Expense)
Rental Revenue 0 420
Interest Revenue 135 52
Interest Expense ( 0) (178)
Income Before Income Taxes 6,575 25,632
Income Tax Expense 1,644 6,408
Net Income $ 4,931 $ 19,224
Earnings Per Share $ 2.05 $ 4.52

Hot Cars, Inc.

Statement of Retained Earnings
for the years ended December 31, 20X1, 20X2 and 20X3
20X1 20X2 20X3

Balance at beginning of year $ 7,821 $ 11,502

Net Income for the year 4,931 19,224
Less: Dividends (1,250) (675)
Balance at end of year $ 11,502 $ 30,051

16
1-7
 Problem 1-4
Hot Cars, Inc.
Balance Sheet
December 31, 20X1, 20X2 and 20X3

12/31/X1 12/31/X2 12/31/X3

Assets
Current Assets:
Cash $ 12,665 $ 21,808
Accounts Receivable 11,750 34,315
Inventory 11,432 25,000
Office Supplies 470 750
Prepaid Insurance 350 400
Prepaid Rent 4,400 4,400
Notes Receivable 750 0
41,817 86,673
Building 0 0
Warehouse Equipment 18,466 42,800
Less: Accumulated Depreciation (3,766) (5,406)
Total Assets $ 56,517 $ 124,067

12/31/X1 12/31/X2 12/31/X3

Liabilities & Equity
Current Liabilities:
Accounts Payable $ 13,511 $ 22,250
Salaries Payable 4,125 0
Income Tax Payable 1,644 6,408
Dividend Payable 1,250 0
Unearned Rent Revenue 0 280
Utilities Payable 485 400
Interest Payable 0 178
Current Portion of Long-Term Debt 0 14,000
21,015 43,516
Equipment Note Payable 0 8,000
Mortgage Note Payable 0 0
Total Liabilities 21,015 51,516

Equity
Capital Stock (2,400 and
4,250 shares, respectively) 24,000 42,500
Retained Earnings 11,502 30,051
Total Equity 35,502 72,551
Total Liabilities & Equity $ 56,517 $ 124,067

17
1-8
 Cash Office Supplies
1/1/X3 21,808 1/1/X3 750

Prepaid Insurance
1/1/X3 400

Prepaid Rent
1/1/X3 4,400

Notes Receivable
1/1/X3 0
Accounts Receivable
1/1/X3 34,315

Land & Building

1/1/X3 0

Inventory
1/1/X3 25,000

Warehouse Equipment
1/1/X3 42,800

18

1-9
Accumulated Depreciation Utilities Payable
5,406 1/1/X3 400 1/1/X3

Accounts Payable Interest Payable

22,250 1/1/X3 178 1/1/X3

Salaries Payable
0 1/1/X3 Bank Note Payable
10,000 1/1/X3

Income Tax Payable

6,408 1/1/X3 Equipment Note Payable
12,000 1/1/X3

Dividend Payable
0 1/1/X3 Mortgage Note Payable
0 1/1/X3

Unearned Rent Revenue

280 1/1/X3

19

1-10
 Capital Stock Interest Revenue
42,500 1/1/X3 0 1/1/X3

Retained Earnings
Cost of Goods Sold
30,051 1/1/X3
1/1/X3 0

Dividends
Salaries Expense
1/1/X3 0
1/1/X3 0

Sales Revenues Office Supplies Expense

0 1/1/X3 1/1/X3 0

Rental Revenue Rent Expense

0 1/1/X3 1/1/X3 0

20

1-11
 Utilities Expense Interest Expense
1/1/X3 0 1/1/X3 0

Depreciation Expense
1/1/X3 0 Gain on Sale
0 1/1/X3

Miscellaneous Expense
1/1/X3 0 Income Tax Expense
1/1/X3 0

Insurance Expense
1/1/X3 0

Postage Expense
1/1/X3 0

21

1-12
 Problem 1-4 - Answer Problem 1-4 - Answer

1. DR CR 1. (continued) DR CR
A. Inventory 201,922 E. Land and Building 300,000
Accounts Payable 201,922 Cash 50,000
Mortgage Note Payable 250,000
B. Accounts Receivable 318,432
Sales Revenues 318,432 Interest Expense 4,995
Cost of Goods Sold 206,145 Mortgage Note Payable 507
Inventory 206,145 Cash 5,502
C. Office Supplies 4,677 F. Bank Note Payable 10,000
Cash 4,677 Cash 10,000
D. Utilities Payable 400 Interest Expense 1,401
Utilities Expense 7,207 Interest Payable 99
Cash 7,607 Cash 1,500

22 23

Problem 1-4 - Answer Problem 1-4 - Answer

1. (continued) DR CR 1. (continued) DR CR
G. Equipment Note Payable 4,000 L. Accounts Payable 163,407
Cash 4,000 Cash 163,407
Interest Expense 1,361 M. Dividends 12,000
Interest Payable 79 Cash 12,000
Cash 1,440
N. Miscellaneous Expense 617
H. Salaries Expense 53,409 Cash 617
Cash 53,409
O. Postage Expense 373
I. Prepaid Insurance 4,313 Cash 373
Cash 4,313
P. Warehouse Equipment 13,456
J. Cash 310,406 Cash 13,456
Accounts Receivable 310,406
Q. Cash 10,000
K. Income Tax Payable 6,408 Accumulated Depreciation 2,000
Cash 6,408 Warehouse Equipment 10,000
Gain on Sale 2,000

24 25

Problem 1-4 - Answer Problem 1-4 - Answer

2. 2. (continued)
Cash Accounts Receivable Prepaid Insurance Land & Building
1/1/X3 21,808 1/1/X3 34,315 1/1/X3 400 1/1/X3 0
J. 310,406 4,677 C. B. 318,432 310,406 J. I. 4,313 E. 300,000
Q. 10,000 7,607 D.
50,000 E.
5,502 E.
10,000 F. Inventory Prepaid Rent Warehouse Equipment
1,500 F. 1/1/X3 25,000 1/1/X3 4,400 1/1/X3 42,800
4,000 G. A. 201,922 206,145 B. P. 13,456 10,000 Q.
1,440 G.
53,409 H.
4,313 I.
6,408 K. Office Supplies Notes Receivable Accumulated Depreciation
163,407 L. 1/1/X3 0 5,406 1/1/X3
1/1/X3 750
12,000 M. Q. 2,000
C. 4,677
617 N.
373 O.
13,456 P.

26 27

1-13
 Problem 1-4 - Answer Problem 1-4 - Answer
2. (continued) 2. (continued)
Accounts Payable Dividend Payable Interest Payable Mortgage Note Payable
22,250 1/1/X3 0 1/1/X3 178 1/1/X3 0 1/1/X3
L. 163,407 201,922 A. F. 99 250,000 E.
G. 79 E. 507

Unearned Rent Revenue

Salaries Payable 280 1/1/X3
0 1/1/X3 Bank Note Payable Capital Stock
10,000 1/1/X3 42,500 1/1/X3
F. 10,000

Utilities Payable
Income Tax Payable 400 1/1/X3 Retained Earnings
6,408 1/1/X3 Equipment Note Payable 30,051 1/1/X3
K. 6,408 12,000 1/1/X3
G. 4,000

28 29

Problem 1-4 - Answer Problem 1-4 - Answer

2. (continued) 2. (continued)
Dividends Rental Revenue Salaries Expense Rent Expense
1/1/X3 0 0 1/1/X3 1/1/X3 0 1/1/X3 0
M. 12,000 H. 53,409

Interest Revenue Utilities Expense

Sales Revenues 0 1/1/X3 Office Supplies Expense 1/1/X3 0
0 1/1/X3 1/1/X3 0 D. 7,207
318,432 B.

Cost of Goods Sold

1/1/X3 0
B. 206,145

30 31

Problem 1-4 - Answer Problem 1-4 - Answer

2. (continued) 2. (continued)
Depreciation Expense Postage Expense Gain on Sale Income Tax Expense
1/1/X3 0 1/1/X3 0 0 1/1/X3 1/1/X3 0
O. 373 2,000 Q.

Miscellaneous Expense Interest Expense

1/1/X3 0 1/1/X3 0
N. 617 E. 4,995
F. 1,401
G. 1,361

Insurance Expense
1/1/X3 0

32 33

1-14
 Problem 1-4 - Answer Problem 1-4 - Answer

3. DR CR 3. (continued) DR CR
a. Salaries Expense 7,280 f. Depreciation Expense 6,985
Salaries Payable 7,280 Accumulated Depreciation 6,985

b. Utilities Expense 937 g. Rent Expense 4,400

Utilities Payable 937 Prepaid Rent 4,400

c. Unearned Rent Revenue 280 h. Income Tax Expense 4,747

Rental Revenue 280 Income Tax Payable 4,747

d. Interest Expense 53 i. Office Supplies Expense 3,465

Interest Payable 53 Office Supplies 3,465

e. Insurance Expense 2,345

Prepaid Insurance 2,345

34 35

Problem 1-4 - Answer Problem 1-4 - Answer

4. 4. (continued)
Cash Accounts Receivable Prepaid Insurance Land & Building
1/1/X3 21,808 1/1/X3 34,315 1/1/X3 400 1/1/X3 0
J. 310,406 4,677 C. B. 318,432 310,406 J. I. 4,313 2,345 e. E. 300,000
Q. 10,000 7,607 D.
50,000 E. 12/31/X3 42,341 12/31/X3 2,368 12/31/X3 300,000
5,502 E.
10,000 F. Inventory Prepaid Rent Warehouse Equipment
1,500 F. 1/1/X3 25,000 1/1/X3 4,400 1/1/X3 42,800
4,000 G. A. 201,922 206,145 B. 4,400 g. P. 13,456 10,000 Q.
1,440 G.
53,409 H. 12/31/X3 20,777 12/31/X3 0 12/31/X3 46,256
4,313 I.
6,408 K. Office Supplies Notes Receivable Accumulated Depreciation
163,407 L. 1/1/X3 0 5,406 1/1/X3
1/1/X3 750
12,000 M. 3,465 i. Q. 2,000 6,985 f.
C. 4,677
617 N. 12/31/X3 0
373 O. 10,391 12/31/X3
12/31/X3 1,962
13,456 P.
12/31/X3 3,505

36 37

Problem 1-4 - Answer Problem 1-4 - Answer

4. (continued) 4. (continued)
Accounts Payable Dividend Payable Interest Payable Mortgage Note Payable
22,250 1/1/X3 0 1/1/X3 178 1/1/X3 0 1/1/X3
L. 163,407 201,922 A. F. 99 250,000 E.
0 12/31/X3 G. 79 53 d. E. 507
60,765 12/31/X3
Unearned Rent Revenue 53 12/31/X3 249,493 12/31/X3
Salaries Payable 280 1/1/X3
0 1/1/X3 c. 280 Bank Note Payable Capital Stock
7,280 a. 10,000 1/1/X3 42,500 1/1/X3
0 12/31/X3 F. 10,000
7,280 12/31/X3 42,500 12/31/X3
Utilities Payable 0 12/31/X3
Income Tax Payable 400 1/1/X3 Retained Earnings
6,408 1/1/X3 d. 400 937 b. Equipment Note Payable 30,051 1/1/X3
K. 6,408 4,747 h. 12,000 1/1/X3
937 12/31/X3 G. 4,000
4,747 12/31/X3
8,000 12/31/X3

38 39

1-15
 Problem 1-4 - Answer Problem 1-4 - Answer
4. (continued) 4. (continued)
Dividends Rental Revenue Salaries Expense Rent Expense
1/1/X3 0 0 1/1/X3 1/1/X3 0 1/1/X3 0
M. 12,000 280 c. H. 53,409 g. 4,400
280 12/31/X3 a. 7,280 12/31/X3 4,400
12/31/X3 12,000 12/31/X3 60,689

Interest Revenue Utilities Expense

Sales Revenues 0 1/1/X3 Office Supplies Expense 1/1/X3 0
0 1/1/X3 0 12/31/X3 1/1/X3 0 D. 7,207
318,432 B. i. 3,465 b. 937
318,432 12/31/X3 12/31/X3 3,465 12/31/X3 8,144

Cost of Goods Sold

1/1/X3 0
B. 206,145
12/31/X3 206,145

40 41

Problem 1-4 - Answer Problem 1-4 - Answer

4. (continued) 4. (continued)
Depreciation Expense Postage Expense Gain on Sale Income Tax Expense
1/1/X3 0 1/1/X3 0 0 1/1/X3 1/1/X3 0
f. 6,985 O. 373 2,000 Q. h. 4,747
12/31/X3 6,985 12/31/X3 373 2,000 12/31/X3 12/31/X3 4,747

Miscellaneous Expense Interest Expense

1/1/X3 0 1/1/X3 0
N. 617 E. 4,995
12/31/X3 617 F. 1,401
G. 1,361
d. 53
12/31/X3 7,810
Insurance Expense
1/1/X3 0
e. 2,345
12/31/X3 2,345

42 43

Problem 1-4 - Answer Problem 1-4 - Answer

6. Hot Cars, Inc.
5.Adjusted Trial Balance Income Statement
for the years ended December 31, 20X1, 20X2 and 20X3
Accounts: DR CR Accounts (cont): DR CR
20X1 20X2 20X3
Cash 3,505 Sales Revenues 318,432
Accounts Receivable 42,341 Rental Revenue 280 Sales Revenues $ 185,043 $ 261,950 $ 318,432
Inventory 20,777 Interest Revenue 0 Cost of Goods Sold 111,026 164,026 206,145
Office Supplies 1,962 Cost of Goods Sold 206,145 Gross Margin 74,017 97,924 112,287
Prepaid Insurance 2,368 Salaries Expense 60,689 Operating Expenses:
Prepaid Rent 0 Office Supplies Expense 3,465 Salaries Expense 49,500 53,600 60,689
Notes Receivable 0 Rent Expense 4,400 Office Supplies Expense 3,893 3,958 3,465
Warehouse Equipment 46,256 Utilities Expense 8,144 Rent Expense 4,150 4,800 4,400
Land and Building 300,000 Depreciation Expense 6,985 Utilities Expense 6,345 6,850 8,144
Accumulated Depreciation 10,391 Misc. Expense 617 Depreciation Expense 1,436 1,640 6,985
Accounts Payable 60,765 Insurance Expense 2,345 Insurance Expense 1,055 1,105 2,345
Salaries Payable 7,280 Postage Expense 373 Miscellaneous Expense 900 312 617
Income Tax Payable 4,747 Interest Expense 7,810 Postage Expense 298 321 373
Dividend Payable 0 Gain on Sale 2,000 Operating Expenses 67,577 72,586 87,018
Unearned Rent Revenue 0 Income Tax Expense 4,747 Operating Income 6,440 25,338 25,269
Utilities Payable 937 Other Revenue and (Expense)
Totals 734,929 734,929
Interest Payable 53 Gain on Sale 0 0 2,000
Bank Note Payable 0 Rental Revenue 0 420 280
Equipment Note Payable 8,000 Interest Revenue 135 52 0
Mortgage Note Payable 249,493 Interest Expense ( 0) (178) (7,810)
Capital Stock 42,500 Income Before Income Taxes 6,575 25,632 19,739
Retained Earnings (1/1/X3) 30,051 Income Tax Expense 1,644 6,408 4,747
Dividends 12,000 Net Income $ 4,931 $ 19,224 $ 14,992
Earnings Per Share $ 2.05 $ 4.52 $ 3.53

44 45

1-16
 Problem 1-4 - Answer Problem 1-4 - Answer
6. (continued) Hot Cars, Inc. Hot Cars, Inc.
Statement of Retained Earnings Balance Sheet
for the years ended December 31, 20X1, 20X2 and 20X3 December 31, 20X1, 20X2 and 20X3
20X1 20X2 20X3 12/31/X1 12/31/X2 12/31/X3 12/31/X1 12/31/X2 12/31/X3
Assets Liabilities & Equity
Balance at beginning of year $ 7,821 $ 11,502 $ 30,051 Current Assets: Current Liabilities:
Net Income for the year 4,931 19,224 14,992 Cash $ 12,665 $ 21,808 $ 3,505 Accounts Payable $ 13,511 $ 22,250 $ 60,765
Less: Dividends (1,250) (675) (12,000) Accounts Receivable 11,750 34,315 42,341 Salaries Payable 4,125 0 7,280
Inventory 11,432 25,000 20,777 Income Tax Payable 1,644 6,408 4,747
Balance at end of year $ 11,502 $ 30,051 $ 33,043
Office Supplies 470 750 1,962 Dividend Payable 1,250 0 0
Prepaid Insurance 350 400 2,368 Unearned Rent Revenue 0 280 0
Prepaid Rent 4,400 4,400 0 Utilities Payable 485 400 937
Notes Receivable 750 0 0 Interest Payable 0 178 53
41,817 86,673 70,953 Current Portion of Long-Term Debt 0 14,000 6,130
Building 0 0 300,000 21,015 43,516 79,912
Warehouse Equipment 18,466 42,800 46,256 Equipment Note Payable 0 8,000 4,000
Less: Accumulated Depreciation (3,766) (5,406) (10,391) Mortgage Note Payable 0 0 247,363
Total Assets $ 56,517 $ 124,067 $ 406,818 Total Liabilities 21,015 51,516 331,275

Equity
Capital Stock (2,400 and
4,250 shares, respectively) 24,000 42,500 42,500
Retained Earnings 11,502 30,051 33,043
Total Equity 35,502 72,551 75,543
Total Liabilities & Equity $ 56,517 $ 124,067 $ 406,818

46 47

Problem 1-4 - Answer Problem 1-4 - Answer

7. (continued)
7. Closing Entires: DR CR Cash Accounts Receivable
Sales Revenues 318,432 1/1/X3 21,808 1/1/X3 34,315
Rental Revenue 280 J. 310,406 4,677 C. B. 318,432 310,406 J.
Gain on Sale 2,000 Q. 10,000 7,607 D.

Cost of Goods Sold 206,145 50,000 E. 12/31/X3 42,341

Salaries Expense 60,689 5,502 E.

Office Supplies Expense 3,465 10,000 F. Inventory

1,500 F.
Rent Expense 4,400 1/1/X3 25,000
4,000 G.
Utilities Expense 8,144 A. 201,922 206,145 B.
1,440 G.
Depreciation Expense 6,985
53,409 H.
Misc. Expense 617 12/31/X3 20,777
4,313 I.
Insurance Expense 2,345
6,408 K. Office Supplies
Postage Expense 373
163,407 L.
Interest Expense 7,810 1/1/X3 750
12,000 M.
Income Tax Expense 4,747 C. 4,677 3,465 i.
617 N.
Retained Earnings 14,992
373 O.
12/31/X3 1,962
Retained Earnings 12,000 13,456 P.
Dividends 12,000 12/31/X3 3,505

48 49

Problem 1-4 - Answer Problem 1-4 - Answer

7. (continued) 7. (continued)
Prepaid Insurance Land & Building Accounts Payable Dividend Payable
1/1/X3 400 1/1/X3 0 22,250 1/1/X3 0 1/1/X3
I. 4,313 2,345 e. E. 300,000 L. 163,407 201,922 A.
0 12/31/X3
12/31/X3 2,368 12/31/X3 300,000 60,765 12/31/X3
Unearned Rent Revenue
Prepaid Rent Warehouse Equipment Salaries Payable 280 1/1/X3
1/1/X3 4,400 1/1/X3 42,800 0 1/1/X3 c. 280
4,400 g. P. 13,456 10,000 Q. 7,280 a.
0 12/31/X3
12/31/X3 0 12/31/X3 46,256 7,280 12/31/X3
Utilities Payable
Notes Receivable Accumulated Depreciation Income Tax Payable 400 1/1/X3
1/1/X3 0 5,406 1/1/X3 6,408 1/1/X3 d. 400 937 b.
Q. 2,000 6,985 f. K. 6,408 4,747 h.
12/31/X3 0 937 12/31/X3
10,391 12/31/X3 4,747 12/31/X3

50 51

1-17
 Problem 1-4 - Answer Problem 1-4 - Answer
7. (continued) 7. (continued)
Interest Payable Mortgage Note Payable Dividends Rental Revenue
178 1/1/X3 0 1/1/X3 1/1/X3 0 0 1/1/X3
F. 99 250,000 E. M. 12,000 280 c.
G. 79 53 d. E. 507 280 12/31/X3
12/31/X3 12,000 close 280
53 12/31/X3 249,493 12/31/X3 12,000 close 0 1/1/X4
1/1/X4 0
Bank Note Payable Capital Stock Interest Revenue
Sales Revenues 0 1/1/X3
10,000 1/1/X3 42,500 1/1/X3
F. 10,000 0 1/1/X3 0 12/31/X3
318,432 B. close 0
42,500 12/31/X3
0 12/31/X3 318,432 12/31/X3 0 1/1/X4
Retained Earnings close 318,432
0 1/1/X4 Cost of Goods Sold
Equipment Note Payable 30,051 1/1/X3
1/1/X3 0
12,000 1/1/X3 14,992 close
B. 206,145
G. 4,000 Dividends 12,000
12/31/X3 206,145
33,043 12/31/X3
206,145 close
8,000 12/31/X3
1/1/X4 0

52 53

Problem 1-4 - Answer Problem 1-4 - Answer

7. (continued) 7. (continued)
Salaries Expense Rent Expense Depreciation Expense Postage Expense
1/1/X3 0 1/1/X3 0 1/1/X3 0 1/1/X3 0
H. 53,409 g. 4,400 f. 6,985 O. 373
a. 7,280 12/31/X3 4,400 12/31/X3 6,985 12/31/X3 373
12/31/X3 60,689 4,400 close 6,985 close 373 close
60,689 close 1/1/X4 0 1/1/X4 0 1/1/X4 0
1/1/X4 0
Miscellaneous Expense Interest Expense
Utilities Expense
Office Supplies Expense 1/1/X3 0 1/1/X3 0
1/1/X3 0
N. 617 E. 4,995
1/1/X3 0 D. 7,207
12/31/X3 617 F. 1,401
i. 3,465 b. 937
617 close G. 1,361
12/31/X3 3,465 12/31/X3 8,144
1/1/X4 0 d. 53
3,465 close 8,144 close
12/31/X3 7,810
1/1/X4 0 1/1/X4 0 Insurance Expense
7,810 close
1/1/X3 0
1/1/X4 0
e. 2,345
12/31/X3 2,345
2,345 close
1/1/X4 0

54 55

Problem 1-4 - Answer

7. (continued) Accounting for Adjustments of
Gain on Sale Income Tax Expense
0 1/1/X3 1/1/X3 0
Prepaid Expenses and Unearned Revenues
2,000 Q. h. 4,747
2,000 12/31/X3 12/31/X3 4,747 Example: Assume on 10/1/X1, Berry, Inc. prepays a $1,200 insurance
close 2,000 4,747 close premium providing fire insurance coverage through 9/30/X2.
0 1/1/X4 1/1/X4 0
Previously discussed accounting:

10/1/X1 Original Entry:

Prepaid Insurance Expense 1,200
Cash 1,200

12/31/X1 Adjusting Entry:

Insurance Expense 300
Prepaid Insurance Expense 300
$300 Insurance Expense $900 Prepaid Insurance

56 57

1-18
Now, assume that the original entry made on October 1st to record Example: Assume Jones Real Estate Company receives $24,000 rent in
the $1,200 prepayment was made to insurance expense rather than advance from a tenant on a one year lease beginning at the
to the asset, prepaid insurance. time of the rent receipt, 8/1/X1.

10/1/X1 Original Entry: 8/1/X1 Original Entry:

Insurance Expense 1,200 Cash 24,000
Cash 1,200 Unearned Rent Revenue 24,000

In this case what adjusting entry could be made on 12/31, three 12/31/X1 Adjusting Entry:
months later, to properly adjust the books and accurately reflect the
company's expenses for the year and prepaid insurance at the end of Unearned Rent Revenue 10,000
the year? Rent Revenue 10,000
$10,000 Rent Revenues $14,000 Unearned Revenues
12/31/X1 Adjusting Entry:
Prepaid Insurance Expense 900
Insurance Expense 900
$300 Insurance Expense $900 Prepaid Insurance

58 59

Problem 1-5 Problem 1-5

A. Cobb Industries prepays 3-month warehouse rental costs on
12/1/X1 amounting to $15,000.
1. Prepare the original and 12/31/X1 adjusting entries assuming
the payment is originally recorded as an asset.
2. Prepare the original and 12/31/X1 adjusting entries assuming
the payment is originally recorded as an expense.
3. Assuming the original entry was made to an expense what would
be the effect on Cobb's financial position if no adjusting entry
was made? What principle of accounting mandates an
adjusting entry in this case? Which approach to the original
entry and resulting adjustment is preferred?
B. On 12/15/X1 Cobb collects $10,000 in advance on a customer order
for goods to be shipped as soon as possible. Assume that 30% of the
ordered goods are actually shipped by Cobb on 12/31/X1 with the
remainder to be shipped the first week of January.
1. Prepare the original and 12/31/X1 adjusting entries assuming
the cash receipt is originally recorded as unearned revenue.
2. Prepare the original and 12/31/X1 adjusting entries assuming
the payment is originally recorded as revenue.
3. What principle of accounting mandates an adjusting entry in
this case?

60 61

Problem 1-5 - Answer Problem 1-5 - Answer

A. Cobb Industries prepays 3-month warehouse rental costs on 2. Prepare the original and 12/31/X1 adjusting entries assuming
12/1/X1 amounting to $15,000. the payment is originally recorded as an expense.

1. Prepare the original and 12/31/X1 adjusting entries assuming

the payment is originally recorded as an asset. 12/1/X1 Original Entry:
Rent Expense 15,000
Cash 15,000
12/1/X1 Original Entry:
Prepaid Rent Expense 15,000 12/31/X1 Adjusting Entry:
Cash 15,000 Prepaid Rent Expense 10,000
Rent Expense 10,000
12/31/X1 Adjusting Entry:
Rent Expense 5,000
Prepaid Rent Expense 5,000

62 63

1-19
 Problem 1-5 - Answer Problem 1-5 - Answer

3. Assuming the original entry was made to an expense, what B. On 12/15/X1 Cobb collects $10,000 in advance on a customer order
would be the effect on Cobb's financial position if no adjusting for goods to be shipped as soon as possible. Assume that 30% of the
entry was made? ordered goods are actually shipped by Cobb on 12/31/X1 with the
remainder to be shipped the first week of January.
Expenses Overstated
Net Income Understated
1. Prepare the original and 12/31/X1 adjusting entries assuming
Retained Earnings Understated
Owners' Equity Understated
the cash receipt is originally recorded as unearned revenue.
Assets Understated 12/15/X1 Original Entry:
What principle of accounting mandates an adjusting entry in Cash 10,000
this case? Unearned Sales Revenue 10,000
Answer: The matching principle of accrual basis accounting
mandates the year-end adjusting entry to properly record 12/31/X1 Adjusting Entry:
expenses in both 'X1 and 'X2.
Unearned Sales Revenue 3,000
Which approach to the original entry and resulting adjustment Sales Revenue 3,000
is preferred?
Answer: Both approaches produce the same financial statement Cost of Goods Sold ?
results at year-end…..no preference. Inventory ?

64 65

Problem 1-5 - Answer

2. Prepare the original and 12/31/X1 adjusting entries assuming

the payment is originally recorded as revenue.
12/15/X1 Original Entry:
Cash 10,000
Sales Revenue 10,000

12/31/X1 Adjusting Entry:

Sales Revenue 7,000
Unearned Sales Revenue 7,000

Cost of Goods Sold ?

Inventory ?

3. What principle of accounting mandates an adjusting entry in

this case?
Answer: The revenue recognition principle mandates the
adjusting entry in this case.

66

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