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Chapter 3
Accrual Accounting & Income
Short Exercises
(10 min.) S 3-1
Millions
Sales revenue…………………………………………….
960
Cost of goods sold………………………………………
(270 )
All other expenses………………………………………
(300 )
Net income………………………………………………..
$ 390
Beginning cash…………………………………………..
$ 105
Collections ($700 $30)−………………………………..
935
Payments for: inventory……………………………….
(370 )
everything else……………………….
(285 )
Ending cash………………………………………………
$ 385
Chapter 3 Accrual Accounting & Income 162
(10 min.) S 3-2
Statement Reports (Amounts in millions)Income statement Interest
expense……………….$1.8
Balance sheet Notes payable($3.9 + $2.3 $2.0)−
………….$4.2
Interest payable………………..
0.1
(10 min.) S 3-3
At the end of each accounting period, the business reports its performance through the preparation of financial statements. In order to be useful to the various users of financial statements they must be up-to-date. Accounts such as cash, Equipment, Accounts Payable, Common Stock and Dividends are up-to date and require no adjustment at the end of the accounting period. Accounts such as Accounts Receivable, Supplies, Salary Expense and Salaries Payable may not be up to date as of the last day of the accounting period. Why? Because certain transactions that took place in the month may not have been recorded.
The accrued salaries, which are owed to the employees yet have not been paid, are an expense related to the current period. The salaries that are owed to the employees but are unpaid also represent a liability or debt that is owed by the business. The business must make an adjusting entry to record the accrued salary owed as both an increase in Salary Expense and an increase in Salaries Payable. If the business does not make this adjustment the expenses will be understated and net income will be overstated. In addition, liabilities will be understated.
Chapter 3 Accrual Accounting & Income 163
(10 min.) S 3-4
The large auto manufacturer should record sales
revenue when the revenue is earned by delivering
automobiles to Acme or Harris. The large auto
manufacturer should not record any revenue prior to
delivery of the vehicles because the large auto
manufacturer hasn’t earned the revenue yet. The revenue
principle governs this decision.
When the large auto manufacturer records the revenue
from the sale, at that time —not before or after — the
large auto manufacturer should also record cost of goods
sold, the expense. The matching principle tells when to
record expenses.
Chapter 3 Accrual Accounting & Income 164
(10 min.) S 3-5
Depreciation is the periodic allocation of the cost of a
tangible long- lived asset, less its estimated residual
value, over its estimated useful life. All long- lived or
plant assets, except for land decline in usefulness during
their life and this decline is an expense. Accountants
must allocate the cost of each plant asset, except for
land, over the asset’s useful life. Depreciation is the
process of allocating the cost of a plant asset to expense.
Depreciation also decreases the book value of the asset
to reflect its usage.
(10 min.) S 3-6 a. The Matching Principle
b. The Time Period Concept
c. The Revenue Principle
d. The Revenue Principle
e. The Matching Principle
Chapter 3 Accrual Accounting & Income 165
(10 min.) S 3-7
a.
Mar. 31 Rent Expense ($4,800 × 1/6)……..
800
Prepaid Rent……………………..
800
To record rent expense.
Prepaid Rent Rent ExpenseMar. 1
4,800 Mar. 31 800 Mar. 31
800
Bal. 4,000 Bal. 800
b.
Dec. 31 Supplies Expense ($900 −$700)….
200
Supplies…………………………….
200
To record supplies expense.
Supplies Supplies ExpenseDec. 1
900 Mar. 31
200 Marc. 31
200
Bal. 700 Bal. 200
Chapter 3 Accrual Accounting & Income 166
(10 min.) S 3-8
Req. 1
(a)Jan.
1Computer Equipment…………….…..
80,000
Cash…………………………………..
80,000
Purchased computer equipment.
(b)
Dec. 31
Depreciation Expense −
Computer Equipment ($80,000 / 4)…
20,000
Accumulated Depreciation −Computer
Equipment……………...20,00
0
Req. 2
Computer Equipment
Accumulated Depreciatio
n − Computer Equipment
DepreciationExpense −Computer Equipment
Jan. 80,000
Dec. 31
20,000
Dec. 31
20,000
Bal. 80,000
Bal. 20,000
Bal. 20,000
Req. 3
Computer equipment………………………………….
$80,000
Less Accumulated depreciation…………………….
(20,000 )
Book $60,000
Chapter 3 Accrual Accounting & Income 167
value………………………………………………
Chapter 3 Accrual Accounting & Income 168
(10 min.) S 3-9
(Amounts in millions)
Income statement: 2010Salary expense ($38.3 + $2.8)
…..$41.1
Balance sheet: 2010Salary payable………………... $ 2.8
Chapter 3 Accrual Accounting & Income 169
(10 min.) S 3-10
Req. 1
Oct. 31 Interest Expense……………………………….
500
Interest Payable……………………………..
500
To accrue interest expense for October.
Nov. 30 Interest Expense……………………………….
500
Interest Payable……………………………..
500
To accrue interest expense for November.
Dec. 31
Interest Expense……………………………….
500
Interest Payable……………………………..
500
To accrue interest expense for December.
Req. 2
Interest PayableOct.
31500
Nov. 30
500
Dec. 31
500
Bal. 1,500
Chapter 3 Accrual Accounting & Income 170
Req. 3
Dec. 31
Interest Payable……………………………...
1,500
Cash…………………………………………
1,500
To pay interest.
Chapter 3 Accrual Accounting & Income 171
(10 min.) S 3-11
Req. 1
Oct. 31 Interest Receivable…………………………..
500
Interest Revenue…………………………..
500
To accrue interest revenue for October.
Nov. 30 Interest Receivable…………………………..
500
Interest Revenue……...…………………..
500
To accrue interest revenue for November.
Dec. 31 Interest Receivable…………………………..
500
Interest Revenue……...……………….…..
500
To accrue interest revenue for December.
Req. 2
Interest ReceivableOct. 31
500
Nov. 30 500Dec. 31 500Bal. 1,500
Req. 3
Dec. Cash……………………………………… 1,50
Chapter 3 Accrual Accounting & Income 172
31 …… 0Interest
Receivable………………………1,50
0To collect interest.
Chapter 3 Accrual Accounting & Income 173
(5- 10 min.) S 3-12
Unearned revenues are liabilities because The Globe and
Trail has received cash from subscribers in advance of
providing them with newspapers. Receiving the cash in
advance creates an obligation (a liability) for The Globe
and Trail. As The Globe and Trail delivers newspapers to
subscribers, The Globe and Trail earns the revenue, and
the dollar amount of the unearned revenue then goes into
the revenue account.
a. Cash…………………………………………
50,000
Unearned Subscription Revenue…...
50,000
Received cash for revenue in advance.
b. Unearned Subscription Revenue.............. ..
50,000
Subscription Revenue…………………….
50,000
To record the earning of subscriptionrevenue that was collected in advance.
Chapter 3 Accrual Accounting & Income 174
(5- 10 min.) S 3-13
Prepaid Rent at December 31:a. Unadjusted amount…………………………. $24,00
0b. Adjusted amount ($24,000 $8,000)−
……….16,000
Rent Expense at December 31:c. Unadjusted amount…………………………. $ 0d. Adjusted amount ($24,000 / 3)
……………….8,000
(10 min.) S 3-14
a. Accounts Receivable…………………….
60,000
Service Revenue……………………….
60,000
Cash…………………………………………
45,000
Accounts Receivable…………………
45,000
b. Cash…………………………………………
7,500
Unearned Service Revenue………….
7,500
Unearned Service Revenue…………….
3,500
Service Revenue……………………….
3,500
Chapter 3 Accrual Accounting & Income 175
(15- 30 min.) S 3-15
Vulture Sporting Goods CompanyIncome Statement
Year Ended March 31, 2010Thousands
Net revenues…………………………….
$ 174,000
Cost of goods sold…………………….
136,800
All other expenses……………………..
26,000
Net income………………………………
$ 11,200
Vulture Sporting Goods CompanyStatement of Retained Earnings
amount reported on the statement of retained earnings
and the balance sheet (in S 3-15).
Chapter 3 Accrual Accounting & Income 179
(5 min.) S 3-17
Req. 1
(Dollars in thousands)
Current ratio =
Total current assets
=
$71,700 = 1.3
5Total current liabilities
$53,000
Req. 2
Debt ratio =
Total liabilities
=
$65,500 = 0.6
2Total assets $105,700
These ratio values are neither strong nor weak. They are
middle- of-the- road values.
Chapter 3 Accrual Accounting & Income 180
(10 min.) S 3-18
1. Earned revenue of $8,000 on account:
a. Current ratio =
$71,700 + $8,000 = 1.50
$53,000
b. Debit ratio =
$65,500= 0.58$105,700 +
$8,000
2. Paid accounts payable of $8,000:
a. Current ratio =
$71,700 − $8,000 = 1.42$53,000 − $8,000
b. Debit ratio =
$65,500 − $8,000 = 0.59$105,700 − $8,000
Chapter 3 Accrual Accounting & Income 181
Exercises
Group A
(5- 10 min.) E 3-19A
Statement Reports1. Income statement Sales
revenue…………$4,10
0Operating expenses…
1,400
Balance sheet Accounts receivable…
$ 700
Accounts payable……
1,300
2. Cash basis would report only the cash collections of $4,900 from customers and the payment of operating expenses ($1,400). Their balance sheet should have included neither accounts receivable nor accounts payable.
(5- 10 min.) E 3-20A
a. Cash Basis b. Accrual Basis
Revenues…………………...
$590,000 $580,000
Expenses…………………...
460,000 480,000
Net income…………………
$130,000 $ 100,000
The accrual basis measures net income better because
its information on revenues and expenses is more
complete than the information provided by the cash basis.
Chapter 3 Accrual Accounting & Income 182
Chapter 3 Accrual Accounting & Income 183
(5- 10 min.) E 3-21A
Million
a. Revenue……………………………………………….
$800
The revenue principle says to record revenue when it has been earned , regardless of when cash is collected. Therefore, report the amount of revenue earned, regardless of when the company collects cash.
b. Total expense…………………………………….…..
$590
The matching principle governs accounting for expenses.
c. The income statement reports revenues and expenses.The statement of cash flows reports cash receipts and cash payments.
Chapter 3 Accrual Accounting & Income 184
(15- 20 min.) E 3-22A
Req. 1
Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT
a. Insurance Expense……………………………...
1,000
Prepaid Insurance ($500+$1,500−$1,000)..
1,000
b. Interest Receivable………………………...……
1,100
Interest Revenue…………………………......
1,100
c. Unearned Service Revenue ($1,200 −$400)..
800
Service Revenue……………………………
800
d. Depreciation Expense……………………..…..
4,900
Accumulated Depreciation………………...
4,900
e. Salary Expense ($14,000 × 3/5)………………
8,400
Salary Payable……………………….…..…..
8,400
f. Income Tax Expense ($22,000 × .25)……..…
5,500
Income Tax Payable…………………..…….
5,500
Chapter 3 Accrual Accounting & Income 185
(continued) E 3-22A
Req. 2
Net income understated by omission of:
Interest revenue……………………………..
$ 1,100
Service revenue……………………………...
800
Total understatement……………………….
$ 1,900
Net income overstated by omission of:Insurance
expense………………………….$1,000
Depreciation expense………………………
4,900
Salary expense………………………………
8,400
Income tax expense…………………………
5,500
Total overstatement…………………………
19,800
Overall effect — net income overstated by..
$17,90 0
Chapter 3 Accrual Accounting & Income 186
(10- 15 min.) E 3-23A
Missing amounts in italics .
1 2 3 4Beginning Supplies $ 100 $600 $
1,400$ 900
Add: Payments for supplies
during the year 1,300 600 800
700
Total amount to account for
1,400 1,200 2,200 1,600
Less: Ending Supplies (200 )
(200 )
(1,00 0 )
(300 )
Supplies Expense $ 1,200 $1,000 $ 1,200
$1,300
Journal entries:
Situation 1:
Supplies……………………………
1,300
Cash………………………….….
1,300
Situation 2:
Supplies Expense………………..
1,000
Supplies………………………...
1,000
Chapter 3 Accrual Accounting & Income 187
(10- 20 min.) E 3-24A
Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT
a. Interest Expense………………………………
9,500
Interest Payable…………………………….
9,500
b. Interest Receivable……………………………
4,500
Interest Revenue…………………….……..
4,500
c. Unearned Rent Revenue ($13,600 / 2 × 6/12)
3,400
Rent Revenue……………………………….
3,400
d. Salary Expense ($1,800 × 3)………………....
5,400
Salary Payable………………………………
5,400
e. Supplies Expense……………………………..
2,100
Supplies ($3,300 1,200)−……………….….
2,100
f. Depreciation Expense ($100,000 / 5)………...
20,000
Accumulated Depreciation……………….
20,000
Book value = $80,000 ($100,000 $20,000)−
Chapter 3 Accrual Accounting & Income 188
(10- 20 min.) E 3-25A
Accounts Receivable Supplies1,600 600 (a) 500
(c) 800 Bal. 100Bal. 2,400
Salary Payable Unearned Service Revenue
(b) 300 (d) 200 900Bal. 300 Bal. 700
Service Revenue Salary Expense4,800 2,500
(c) 800 (b) 300(d) 200 Bal. 2800Bal. 5,800
Supplies Expense(a) 500Bal. 500
Chapter 3 Accrual Accounting & Income 189
(20- 30 min.) E 3-26A
Delicious Hams, Inc.Income Statement
Year Ended December 31, 2010Thousands
Revenues:Sales revenue………………...
$41,400
Expenses:Cost of goods
sold…………..$25,10
0Selling, administrative,
andgeneral
expense………….. 10,70
0Total
expenses……………. 35,80
0Income before tax………………
5,600
Income tax expense…………….
2,30 0
Net income……………………….
$ 3,300
Delicious Hams, Inc..Statement of Retained EarningsYear Ended December 31, 2010
ThousandsRetained earnings, December 31, 2009…
$4,700
Add: Net income ………………………….
3,300
8,000Less:
Dividends……………………………. (1,500 )
Retained earnings, December 31, 2010…
$6,500
Chapter 3 Accrual Accounting & Income 190
Chapter 3 Accrual Accounting & Income 191
(continued) E 3-26A
Delicious Hams, Inc.Balance Sheet
December 31, 2010Thousands
ASSETS LIABILITIESCash…………………………
….$
3,800 Accounts payable………
$ 7,600
Accounts receivable…………
1,500 Income tax payable……..
600
Inventories…………………….
1,100 Other liabilities…………..
2,20 0
Prepaid expenses…………….
1,700 Total liabilities…………...
10,400
Prop., plant, equip.
$ 6,500 STOCKHOLDERS’
Less: Accum. EQUITY deprec…… .
(2,300 )
4,200 Common stock…………..
4,700
Other assets…………………..
9,300 Retained earnings………
6,50 0
Total stockholders’ equity
11,20
Total liabilities and
Total assets……………………
$21,600
stockholders’ equity...
$21,600
Chapter 3 Accrual Accounting & Income 192
(10- 20 min.) E 3-27A
One mechanism for solving this exercise is to prepare the
relevant T-accounts, insert the given information, and
0Total stockholders’ equity………………… 33,600 Total liabilities and stockholders’ equity… $56,000
Chapter 3 Accrual Accounting & Income 200
(continued) E 3-32A
Req. 2
CurrentYear
PriorYear
Current ratio
=
Total current assets
=
$15,500 = 1.65 1.70Total current
liabilities$9,400
The ability to pay current liabilities with current assets deteriorated.
Debt ratio =
Total liabilities
=
$22,400 = 0.40 0.30Total assets $56,000
The overall ability to pay total liabilities deteriorated a little.
Chapter 3 Accrual Accounting & Income 201
(30 min.) E 3-33A
a. Current ratio =
$30= 1.6
7Debt ratio =
$30 + 8= 0.56$10 +
$8$60 + $8
The purchase of equipment on account hurts both ratios.
b. Current ratio =
$30 − $11 = .95 Debt
ratio =
$30 − $11 = 0.39$20 $60 − $11
The payment of long-term debit hurts the current ratio and improves the debt ratio.
c. Current ratio = $30 + $6 = 1.3
8Debt ratio = $30 + $6 = 0.55$20 + $6 $60 + $6
Collecting cash in advance hurts both ratios.
d. Current ratio = $30 = 1.3
0Debt ratio = $30 + $3 = 0.55$20 + $3 $60
Accruing an expense hurts both ratios.
e. Current ratio =
$30 + $11= 2.0
5 Debt ratio =$30
= .42$20 $60 + $11
A cash sale improves both ratios.
Chapter 3 Accrual Accounting & Income 202
Exercises
Group B
(5- 10 min.) E 3-34B
Statement Reports1. Income statement Sales
revenue…………$4,80
0Operating expenses…
1,100
Balance sheet Accounts receivable…
$ 300
Accounts payable……
500
2. Cash basis would report only the cash collections of $4,900 from customers and the payment of operating expenses ($1,100).The balance sheet would include neither accounts receivable nor accounts payable.
(5- 10 min.) E 3-35B
a. Cash Basis b. Accrual Basis
Revenues…………………...
$580,000 $510,000
Expenses…………………...
440,000 470,000
Net income…………………
$140,000 $ 40,000
The accrual basis measures net income better because
its information on revenues and expenses is more
complete than the information provided by the cash basis.
Chapter 3 Accrual Accounting & Income 203
(5- 10 min.) E 3-36B
Million
a. Revenue……………………………………………….
$740
The revenue principle says to record revenue when it has been earned , regardless of when cash is collected. Therefore, report the amount of revenue earned, regardless of when the company collects cash.
b. Total expense…………………………………….…..
$560
The matching principle governs accounting for expenses.
c. The income statement reports revenues and expenses.The statement of cash flows reports cash receipts and cash payments.
Chapter 3 Accrual Accounting & Income 204
(15- 20 min.) E 3-37B
Req. 1
Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT
a. Insurance Expense……………………………...
1,600
Prepaid Insurance ($800+$2,400-$1,600)…
1,600
b. Interest Receivable…………………..…………
1,000
Interest Revenue……………………..……...
1,000
c. Unearned Service Revenue ($1,500 −$400)..
1,100
Service Revenue……………………..………
1,100
d. Depreciation Expense…………………..……..
4,600
Accumulated Depreciation…………..…….
4,600
e. Salary Expense ($16,000 × 3/5)………….……
9,600
Salary Payable……………………….…..…...
9,600
f. Income Tax Expense ($21,000 × .25)…………
5,250
Chapter 3 Accrual Accounting & Income 205
Income Tax Payable………………………….
5,250
Chapter 3 Accrual Accounting & Income 206
(continued) E 3-37B
Req. 2
Net income understated by omission of:
Interest revenue……………………………..
$ 1,000
Service revenue……………………………...
1,100
Total understatement……………………….
$ 2,100
Net income overstated by omission of:Insurance
expense………………………….$1,600
Depreciation expense………………………
4,600
Salary expense………………………………
9,600
Income tax expense…………………………
5,250
Total overstatement…………………………
21,050
Overall effect — net income overstated by..
$18,95 0
Chapter 3 Accrual Accounting & Income 207
(10- 15 min.) E 3-38B
Missing amounts in italics .
1 2 3 4Beginning Supplies $ 100 $400 $
1,200$ 800
Add: Payments for supplies
during the year 1,400 1,000 800 800 Total amount to account for
1,500 1,400 2,000 1,600
Less: Ending Supplies (400 )
(500 )
(700 ) (500 )
Supplies Expense $ 1,100
$ 900 $ 1,300 $1,100
Journal entries:
Situation 1:
Supplies……………………………
1,400
Cash………………………….….
1,400
Situation 2:
Supplies Expense………………..
900
Supplies………………………...
900
Chapter 3 Accrual Accounting & Income 208
Chapter 3 Accrual Accounting & Income 209
(10- 20 min.) E 3-39B
Adjusting EntriesDATE ACCOUNT TITLES DEBIT CREDIT
a. Interest Expense………………………………
9,200
Interest Payable…………………………….
9,200
b. Interest Receivable……………………………
4,200
Interest Revenue…………………….……..
4,200
c. Unearned Rent Revenue ($12,600 / 2 × 6/12)
3,150
Rent Revenue……………………………….
3,150
d. Salary Expense ($1,900 × 3)………………....
5700
Salary Payable………………………………
5,700
e. Supplies Expense……………………………..
1,400
Supplies ($2,600 1,200)−……………….….
1,400
f. Depreciation Expense ($160,000 / 5)………...
32,000
Accumulated Depreciation……………….
32,000
Book value = $128,000 ($160,000 $32,000)−
Chapter 3 Accrual Accounting & Income 210
Chapter 3 Accrual Accounting & Income 211
(10- 20 min.) E 3-40B
Accounts Receivable Supplies1,200 300 (a) 100
(c) 800 Bal. 200Bal. 2,000
Salary Payable Unearned Service Revenue
(b) 600 (d) 100 800Bal. 600 Bal. 700
Service Revenue Salary Expense4,400 1,900
(c) 800 (b) 600(d) 100 Bal. 2,500Bal. 5,300
Supplies Expense(a) 100Bal. 100
Chapter 3 Accrual Accounting & Income 212
(20- 30 min.) E 3-41B
Holiday Hams, Inc.Income Statement
Year Ended December 31, 2010Thousands
Revenues:Sales revenue………………...
$39,900
Expenses:Cost of goods
sold…………..$25,40
0Selling, administrative,
andgeneral
expense………….. 10,40
0Total
expenses……………. 35,80
0Income before tax………………
4,100
Income tax expense…………….
2,40 0
Net income……………………….
$ 1,700
Holiday Hams, Inc.Statement of Retained EarningsYear Ended December 31, 2010
ThousandsRetained earnings, December 31, 2009…
$4,700
Add: Net income ………………………….
1,700
6,400Less:
Dividends……………………………. (1,200 )
Retained earnings, December 31, 2010…
$5,200
Chapter 3 Accrual Accounting & Income 213
Chapter 3 Accrual Accounting & Income 214
(continued) E 3-41B
Holiday Hams, Inc.Balance Sheet
December 31, 2010Thousands
ASSETS LIABILITIESCash…………………………
….$
3,500 Accounts payable………
$ 7,900
Accounts receivable…………
1,700 Income tax payable……..
900
Inventories…………………….
1,200 Other liabilities…………..
2,70 0
Prepaid expenses…………….
1,600 Total liabilities…………...
11,500
Prop., plant, equip.
$ 6,700 STOCKHOLDERS’
Less: Accum. EQUITY deprec…… .
(2,700 )
4,000 Common stock…………..
4,800
Other assets…………………..
9,500 Retained earnings………
5,20 0
Total stockholders’ equity
10,00
Total liabilities and
Total assets……………………
$21,500
stockholders’ equity...
$21,500
Chapter 3 Accrual Accounting & Income 215
(10- 20 min.) E 3-42B
One mechanism for solving this exercise is to prepare the
relevant T-accounts, insert the given information, and
solve for the unknown amounts, shown in italics .
Amounts in millions
ReceivablesBeg. bal. 250Sales revenue 20,68
0Collections 20,60
0End. bal. 330
Prepaid InsuranceBeg. bal. 130
Payment 450Insurance expense 44
0End. bal. 140
Accrued Liabilities PayableBeg. bal. 600
Payments 4,100Other operating
expenses 4,260End. bal. 760
Chapter 3 Accrual Accounting & Income 216
(10 min.) E 3-43B
Req. 1
Mother Elizabeth’s income statement:Service revenue ($9,600 × 1/2)
………………….....$4,800
Mother Elizabeth’s balance sheet:Unearned service revenue ($9,600 × 1/2)
………..$4,800
Req. 2
Portland’s income statement:Medical expense ($9,600 × 1/2)
……………………$4,800
Boston’s balance sheet:Prepaid medical expense ($9,600 × 1/2)
…………$4,800
Chapter 3 Accrual Accounting & Income 217
(10 min.) E 3-44B
Req. 1
Millions
Income statementService revenue (£400 £105)−
……………………£295
Balance sheetUnearned service
revenue………………………...£105
Req. 2
Income statementService revenue (£95 + £400 £105)−
…………….£390
Balance sheetUnearned service
revenue………………………...£105
Service revenue is greater in (2) because Direct began
the year owing more phone service to customers. With
collections for the year and the amount of the ending
liability unchanged, Direct must have earned more
revenue in situation 2 than in situation 1.
Not required but helpful:
Unearned Service RevenueBeg. bal. 95
Earned revenue
390
Collected cash
400
End. bal. 105 Chapter 3 Accrual Accounting & Income 218
(10- 20 min.) E 3-45B
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Closing EntriesDec.
31 Service Revenue…………………………
24,100
Other Revenue……………………………
500
Retained Earnings…………………….
24,600
31 Retained Earnings……………………….
22,500
Cost of Services Sold………………...
11,200
Selling, General, and Administrative
Expense……………………………...
6,100
Depreciation Expense………………..
4,800
Income Tax Expense………………….
400
31 Retained Earnings……………………….
900
Dividends…………………………….…
900
Net income for 2010 was $2,100 ($24,600 $22,500).−
Retained EarningsDec. 31, 2009 2,400
Dividends
900 Net income 2,100
Dec. 31, 2010 3,600
Chapter 3 Accrual Accounting & Income 219
Chapter 3 Accrual Accounting & Income 220
(15- 25 min.) E 3-46B
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
Adjusting EntriesDec. 31 Unearned Service
Revenue……………….6,500
Service Revenue ($19,900 −$13,400)...
6,500
31 Salary Expense ($4,900 $4,500)−………...
400
Salary Payable……………………….…...
400
31 Rent Expense ($1,400 $900)−…………..
500
Prepaid Rent………………………………
500
31 Depreciation Expense ($600 $0)−………..
600
Accumulated Depreciation……………..
600
31 Income Tax Expense ($1,700 $0)−……….
1,700
Income Tax Payable……………………..
1,700
Closing Entries31 Service
Revenue…………………………….19,90
0Retained
Earnings……………………….19,90
0
31 Retained Earnings…………………………..
8,600
Salary Expense…………………………...
4,900
Rent 1,400
Chapter 3 Accrual Accounting & Income 221
Expense……………………………..Depreciation
Expense…………………...600
Income Tax Expense…………………….
1,700
31 Retained Earnings…………………………..
1,000
Dividends…………………………….……
1,000
Chapter 3 Accrual Accounting & Income 222
(20- 30 min.) E 3-47B
Req. 1
Wallace Production CompanyBalance Sheet
December 31, 2009ASSETS
Current:Cash…………………………………………………..
….$13,600
Prepaid rent ($1,100 $500)−………………………....
600
Total current assets………………………………..
14,200
Plant:
Equipment…………………………………..
$48,000
Less accumulated depreciation($3,800 + $300)…………………….
$225,000 for the business. His asking price is $308,000
so you are starting out quite far apart. If Williams
appears especially eager to sell out, you may be able to
buy the firm for closer to your highest price of $240,000.
However, if he is not so eager to sell and if you want the
business badly enough, you may have to pay somewhere
between $240,000 and $308,000. It might pay to hire an
expert to value the business’s assets. You may find that
Williams’ price is inflated based on the value of its
assets. You can always raise your offer, but you cannot
decrease it, so start the negotiating process with an offer
around $225,000.
Chapter 3 Accrual Accounting & Income 297
Ethical Issues
Ethical Issue 1
1. The journal entry to record the revenue is:
Dec. Accounts Receivable………...
XXX
Sales Revenue……………..
XXX
The debit to Accounts Receivable will increase total current assets and, as a result, increase (improve) the current ratio.
The credit to Sales Revenue will increase total owner equity and, as a result, decrease (improve) the debt ratio.
2. a. – c. The issue is whether it is ethical to record the revenue in the current year. The contract has been signed, but the implication is that the company will not have done everything it needs to do in order to earn the revenue in the current year. The stakeholders are the company, the bank, the stockholders, and the company’s other creditors. From an economic standpoint, the entry would obviously improve the company’s short term financial position. However, the advantage would probably be short- lived. When the bank finds out about this entry, they will likely protest, and demand immediate payment, so the longer- term economic impact will likely be negative. From a “legal” standpoint, to record this transaction in December violates GAAP by violating the revenue principle . In this case Cross Timbers has not made the sale (has not delivered the merchandise) to the customer and, therefore, has not earned the revenue prior to December 31 of the current year. From an ethical standpoint, recording this revenue violates the bank’s rights for proper disclosure of the company’s income and assets. Revenue should be recorded no earlier than when it is earned. Cross Timbers expects to earn Chapter 3 Accrual Accounting & Income 298
the revenue in January of next year. Cross Timbers clearly cannot record this revenue until it is earned. To do so is not in their best economic, legal (GAAP) or ethical best interests.
3. The authors would suggest either of two actions. Cross Timbers can either:
a. Report the current ratio of 1.47 and the debt ratio of .51 because these are the true values. Then tell the bank of the signed contract for additional work and the hope for a better set of ratio values next year. In some cases, banks will agree to sign a waiver of the terms of loan covenants, meaning that, although the company is in violation, the bank will not move to enforce the covenant. They may give Cross Timbers a “grace period” to cure the violation in the covenant.
b. Pay off some current liabilities before year end. This will improve both the current ratio and the debt ratio. This may enable Cross Timbers to bring its ratio values into compliance with the bank’s requirements.
Chapter 3 Accrual Accounting & Income 299
Ethical Issue 2
1. These transactions — recorded as directed by Almond
— overstate the reported income of the company by
$21,000 ($10,000 + $10,000 + $1,000).
2. It appears that Almond wants to improve the company’s
reported income in order to borrow on favorable terms.
Her action is unethical and probably illegal as well
because she is deliberately overstating the company’s
reported income.
Almond appears to be letting the potential short term
economic advantage of these deliberate misstatements
take precedence. She needs to remember that these
misstatements violate GAAP, and that, depending on
what use is made of the financial statements, could
subject the company to civil or criminal legal
proceedings. If this happens, the short term economic
gains ($21,000) would not even come close to the long-
term economic costs associated with the legal actions,
not to mention the negative publicity. The business
will need a bank loan, and perhaps the money would be
used to pay bills, expand the business, and so on.
However, based on Almond’s lack of integrity, the
money may be destined for her own use. Regardless of
its use, the money is obtained under false pretenses
and cannot be headed for a good outcome.
The bank is harmed by Almond’s and Lail’s actions.
Lending money to Almond under false pretenses may
Chapter 3 Accrual Accounting & Income 300
lead the bank to charge an unrealistically low interest
rate that robs the bank’s owners of interest revenue. In
the extreme, the public is robbed if taxpayers wind up
financing the bailout of a failed institution.
3. Personal advice will vary from student to student. The
purpose of asking this question is to challenge students
to take the high road of ethical conduct by having
nothing to do with Almond’s scheme. The authors would
advise Lail, the accountant, to take these actions, in
order:
a. Refuse to take any part in Almond’s scheme,
explaining that the result is overstatement of reported
income. This is both illegal and unethical, and will
ultimately have a negative economic impact on the
company, as well. Accountants are bound to
standards of ethical conduct that these actions
violate. The can go to prison when caught falsifying
financial statements.
b. To remain ethical, the accountant must be willing to
lose his/her job. It is better to protect one’s
reputation even if that causes a short- term hardship.
Chapter 3 Accrual Accounting & Income 301
Focus on Financials: Amazon.com, Inc.
(15- 20 min.)
Req. 1
Accrued expenses are expenses that have been incurred
but that have not yet been paid as of the balance sheet
date. The accrual and matching concepts require that all
expenses be recognized during the period in which they
are incurred in order to earn revenue, regardless of when
they are paid.
Req. 2 and Req. 4 (balances in millions at December 31, 2008)
Accrued expenses and other Cash
Beg. Bal. $902
(a) 902
(a) 902
(b) 1,093 (b) 2,335
End. Bal. $1,093
Operating expenses
(b) 3,428
Chapter 3 Accrual Accounting & Income 302
(continued) Focus on Financials: Amazon.com, Inc.
Req. 3 (amounts in millions)
JournalDATE ACCOUNT TITLES AND EXPLANATION DEBIT CREDIT
a. Accrued expenses and other…….…
902
Cash………………….. 902
b. Operating expenses….……………….
3,428
Cash……………………..………... 2,335 Accrued expenses and other…
1,093
The balance of accrued expenses and other agrees with