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Chapter 4
Adjustments, Financial Statements, and the
Quality of Earnings
ANSWERS TO QUESTIONS
1. A trial balance is a list of the individual accounts, usually in financial statement
order, with their debit or credit balances. It is used to provide a check on the
equality of the debits and credits.
2. Adjusting entries are made at the end of the accounting period to record all
revenues and expenses that have not been recorded but belong in the current
period. They update the balance sheet and income statement accounts at the end
of the accounting period.
The four different types are adjustments for:
(1) Deferred revenues -- previously recorded liabilities that need to be adjusted at
the end of the period to reflect revenues that have been earned (e.g., Unearned
Ticket Revenue must be adjusted for the portion of ticket revenues earned in
the current period).
(2) Accrued revenues -- revenues that have been earned by the end of the
accounting period but which will be collected in a future accounting period (e.g.,
recording Interest Receivable for interest revenues not yet collected).
(3) Deferred expenses -- previously recorded assets that need to be adjusted at the
end of the period to reflect incurred expenses (e.g., Prepaid Insurance must be
adjusted for the portion of insurance expense incurred in the current period).
(4) Accrued expenses -- expenses that have been incurred by the end of the
accounting period but which will be paid in a future accounting period (e.g.,
recording Accrued Expenses Payable for utilities expense incurred during the
period that has not yet been paid).
3. A contra-asset is an account related to an asset that is an offset or reduction to the
asset's balance. Accumulated Depreciation is a contra-account to the equipment
and buildings accounts.
4. The net income on the income statement is included in determining ending retained
earnings on the statement of stockholders’ equity and the balance sheet. The
change in the cash account on the balance sheet is analyzed and categorized on
the statement of cash flows into cash from operating activities, investing activities,
and financing activities.
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5. (a) Income statement: (Revenues + Gains) - (Expenses + Losses) = Net Income
(b) Balance sheet: Assets = Liabilities + Stockholders' Equity
(c) Statement of cash flows: Changes in cash for the period = Cash from
Operations + Cash from Investing Activities + Cash from Financing Activities
(d) Statement of stockholders' equity: Ending Stockholders' Equity = (Beginning
Contributed Capital + Stock Issuances - Stock Repurchases) + (Beginning
Retained Earnings + Net Income - Dividends Declared)
6. Adjusting entries have no effect on cash.
For unearned revenues and
prepayments, cash was received or paid at some point in the past. For accruals,
cash will be received or paid in a future accounting period. At the time of the
adjusting entry, there is no cash being received or paid.
7. Earnings per share = Net Income ÷ weighted average number of shares of stock
outstanding during the period.
Earnings per share measures the average amount of net income for the year
attributable to one share of common stock.
8. Net profit margin = Net income ÷ net sales
The net profit margin measures how much of every sales dollar generated during
the period is profit.
9. An unadjusted trial balance is prepared after all current transactions have been
journalized and posted to the ledger. It does not include the effects of the adjusting
entries. The basic purpose of an unadjusted trial balance is to check the equalities
of the accounting model (particularly, Debits = Credits) and to provide the data in a
form convenient for further processing in the accounting information processing
cycle.
In contrast, an adjusted trial balance is prepared after the effects of all of the
adjusting entries have been applied to the corresponding (prior) unadjusted trial
balance amounts. The basic purpose of an adjusted trial balance is to insure that
accuracy has been attained in applying the effect of the adjusting entries. The
adjusted trial balance provides a second check in the model equalities (primarily
Debits = Credits). It also provides data in a form convenient for further processing.
10. Closing entries are made at the end of the accounting period to transfer the
balances in the temporary income statement accounts to retained earnings. The
closing entries reduce the revenue, gain, expense, and loss accounts to a zero
balance so that they can be used for the accumulation process during the next
period. Closing entries must be entered into the system through the journal and
posted to the ledger accounts to state properly the temporary and permanent
account balances (i.e., zero balances in the temporary accounts).
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Solutions Manual
11. (a) Permanent accounts -- balance sheet accounts; that is, the asset, liability, and
stockholders’ equity accounts (these are not closed at the end of each period).
(b) Temporary accounts -- income statement accounts; that is, revenues, gains,
expenses, and losses (these are closed at the end of each period).
(c) Real accounts -- another name for permanent accounts.
(d) Nominal accounts -- another name for temporary accounts.
12. The income statement accounts are closed at the end of the accounting period
because, in effect, they are temporary subaccounts to retained earnings (i.e., a part
of stockholders' equity). They are used only for accumulation during the accounting
period. When the period ends, these accumulated accounts must be transferred
(closed) to retained earnings. The closing process serves:
(1) to correctly state retained earnings, and
(2) to clear out the balances of the temporary accounts for the year just ended so
that these subaccounts can be used again during the next period for
accumulation and classification purposes.
Balance sheet accounts are not closed at the end of the period because they reflect
permanent accumulated balances of assets, liabilities, and stockholders' equity.
Permanent accounts show the entity's financial position at the end of the period and
are the beginning amounts for the next period.
13. A post-closing trial balance is a listing taken from the ledger after the adjusting and
closing entries have been journalized and posted. It is not a necessary part of the
accounting information processing cycle but it is useful because it demonstrates the
equality of the debits and credits in the ledger after the closing entries have been
journalized and posted.
ANSWERS TO MULTIPLE CHOICE
1. b)
6. d)
2. a)
7. a)
3. d)
8. c)
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4. c)
9. d)
5. d)
10. b)
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4-3
Authors' Recommended Solution Time
(Time in minutes)
Mini-exercises
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Alternate
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No.
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Cases and
Projects
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* Due to the nature of this project, it is very difficult to estimate the amount of time
students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by the
perceived difficulty of the task. You can reduce student frustration and anxiety by
making your expectations clear. For example, when our goal is to sharpen research
skills, we devote class time discussing research strategies. When we want the students
to focus on a real accounting issue, we offer suggestions about possible companies or
industries.
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Solutions Manual
MINI-EXERCISES
M4–1.
Puglisi Company
Adjusted Trial Balance
At June 30, 2007
Debit
Cash
Accounts receivable
Inventories
Prepaid expenses
Buildings and equipment
Accumulated depreciation
Land
Accounts payable
Accrued expenses payable
Income taxes payable
Unearned fees
Long-term debt
Contributed capital
Retained earnings
Sales revenue
Interest income
Cost of sales
Salaries expense
Rent expense
Depreciation expense
Interest expense
Income taxes expense
Totals
$
Credit
120
350
610
40
1,400
$
250
200
200
150
30
100
1,300
300
120
2,400
50
820
660
400
110
80
110
$ 4,900
$ 4,900
M4–2. (1) D; (2) B; (3) D; (4) C; (5) A; (6) C; (7) B; (8) A.
M4–3. (1) A; (2) B; (3) C; (4) D.
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M4–4.
(a) 1. Deferred revenue
200
2. Unearned rent revenue (L) .........................
Rent revenue (+R, +SE) ........................
200
To record one month of rent revenue earned ($800  4 months).
(b) 1. Deferred expense
900
2. Insurance expense (+E, SE).......................
900
Prepaid insurance (A) ..........................
To record six months of insurance expense ($3,600 x 6/24).
(c) 1. Deferred expense
2. Depreciation expense (+E, SE) ..................
Accumulated depreciation (+XA, A).....
To record annual depreciation expense.
3,000
3,000
M4–5.
Transaction
a.
b.
c.
Assets
NE
–900
–3,000
McGraw-Hill/Irwin
4-6
Balance Sheet
Stockholders’
Liabilities
Equity
–200
+200
NE
–900
NE
–3,000
Income Statement
Revenues Expenses
+200
NE
NE
+900
NE
+3,000
Net
Income
+200
–900
–3,000
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Solutions Manual
M4–6.
(a) 1. Accrued expense
320
2. Utilities expense (+E, SE) ...........................
Accrued utilities payable (+L) ................
To record utilities expense incurred but not yet paid.
320
(b) 1. Accrued expense
4,500
2. Wages expense (+E, SE) ...........................
Accrued wages payable (+L) .................
4,500
To record wages expense incurred but not yet paid,
calculated as 10 employees x 3 days x $150 each per day.
(c) 1. Accrued revenue
2. Interest receivable (+A) ................................
Interest revenue (+R, +SE) ....................
To record interest earned but not yet collected,
calculated as $5,000 x 12% x 4/12.
200
200
M4–7.
Transaction
a.
b.
c.
Assets
NE
NE
+200
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Financial Accounting, 5/e
Balance Sheet
Stockholders’
Liabilities
Equity
+320
–320
+4,500
–4,500
NE
+200
Income Statement
Revenues Expenses
NE
+320
NE
+4,500
+200
NE
Net
Income
–320
–4,500
+200
© The McGraw-Hill Companies, Inc., 2007
4-7
M4–8.
MORGAN COMPANY
Income Statement
For the Year Ended December 31, 2007
Revenues:
Sales revenue
Interest revenue
Rent revenue
Total revenues
Costs and expenses:
Wages expense
Depreciation expense
Utilities expense
Insurance expense
Rent expense
Total costs and expenses
Pretax income
Income tax expense
Net Income
$ 42,000
120
300
42,420
21,600
2,000
220
600
9,000
33,420
9,000
2,900
$ 6,100
$20.33
Earnings per share*
* calculated as $6,100  [(100 + 500)  2] = $6,100  300 = $20.33
Average number of shares
M4–9.
MORGAN COMPANY
Statement of Stockholders’ Equity
For the Year Ended December 31, 2007
Balance, January 1, 2007
Share issuance
Net income
Dividends
Balance, December 31, 2007
Contributed
Capital
$
400
2,000
$ 2,400
Total
Retained
Stockholders’
Earnings
Equity
$ 1,000*
$ 1,400
2,000
6,100
6,100
0
0
$ 7,100
$ 9,500
* From the trial balance.
Work backwards
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Solutions Manual
M4–10.
Req. 1
MORGAN COMPANY
Balance Sheet
At December 31, 2007
Assets
Current Assets:
Cash
Accounts receivable
Interest receivable
Prepaid insurance
Total current assets
Notes receivable
Equipment (net of accumulated depreciation, $2,000)
Total Assets
Liabilities
Current Liabilities:
Accounts payable
Accrued expenses payable
Income taxes payable
Unearned rent revenue
Total current liabilities
Stockholders’ Equity
Contributed Capital
Retained Earnings
Total Stockholders’ Equity
Total Liabilities and Stockholders’ Equity
$
1,500
2,000
120
1,800
5,420
3,000
10,000
$ 18,420
$ 1,600
3,820
2,900
600
8,920
2,400
7,100
9,500
$ 18,420
Req. 2
The adjustments in M4–4 and M4–6 have no effect on the operating, investing, and
financing activities on the statement of cash flows because no cash is paid or received
at the time of the adjusting entries.
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M4–11.
Revenues:
Sales revenue
Interest revenue
Rent revenue
Total revenues
Costs and expenses:
Wages expense
Depreciation expense
Utilities expense
Insurance expense
Rent expense
Income tax expense
Total costs and expenses
Net Income
$ 42,000
120
300
42,420
21,600
2,000
220
600
9,000
2,900
36,320
$ 6,100
Net profit margin = Net income  Operating Revenues = $6,100  $42,300 = 14.4%
The operating revenue sources for this company are from sales and rent revenue.
Interest revenue is not included in the denominator because it is a nonoperating
revenue source.
M4–12.
Sales revenue (R) ................................................
Interest revenue (R) .............................................
Rent revenue (R) ..................................................
Retained earnings (+SE) ..............................
Wages expense (E) ...................................
Depreciation expense (E) ..........................
Utilities expense (E) ...................................
Insurance expense (E) ..............................
Rent expense (E) ......................................
Income tax expense (E) ............................
McGraw-Hill/Irwin
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42,000
120
300
6,100
21,600
2,000
220
600
9,000
2,900
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
EXERCISES
E4–1.
Darius Consultants, Inc.
Unadjusted Trial Balance
At September 30, 2008
Debit
Cash
Accounts receivable
Supplies
Prepaid expenses
Investments
Building and equipment
Accumulated depreciation
Land
Accounts payable
Accrued expenses payable
Unearned consulting fees
Income taxes payable
Notes payable
Contributed capital
Retained earnings *
Consulting fees revenue
Investment income
Wages and benefits expense
Utilities expense
Travel expense
Rent expense
Professional development expense
Interest expense
Other operating expenses
General and administrative expenses
Gain on sale of land
Totals
Credit
$ 163,000
225,400
12,200
10,200
145,000
323,040
$
18,100
60,000
86,830
25,650
32,500
2,030
160,000
223,370
145,510
2,564,200
10,800
1,590,000
25,230
23,990
152,080
18,600
17,200
188,000
320,050
5,000
$3,273,990 $3,273,990
* Since debits are supposed to equal credits in a trial balance, the balance in Retained
Earnings is determined as the amount in the credit column necessary to make debits
equal credits (a “plugged” figure).
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E4–2.
Req. 1
The following deferred revenues and deferred expenses may need to be adjusted at the
end of the recent fiscal year:
Balance sheet account
Inventory
Related income statement account
Cost of products
Other current assets (may include
Various expense accounts (e.g.,
supplies and prepaid expenses such
supplies expense, insurance
as insurance)
expense, rent expense)
Property, plant, and equipment and
Accumulated depreciation
Depreciation expense
Intangible assets (depending on type)
Amortization expense
Deferred revenue
Product revenue or service revenue
Req. 2
The following accounts should be reviewed and may need to be adjusted to accrue
revenues and expenses at the end of the recent fiscal year:
Balance sheet account
Related income statement account
Other current assets (Interest receivable
on the short-term investments)
Investment income
Accounts receivable
Product revenue or service revenue
Other assets (may contain long-term
receivables)
Interest revenue
Accrued liabilities (Interest payable on
short-term note payable0
Interest expense
Accrued liabilities
Various expense accounts (e.g., wages
expense)
Income tax payable
Income tax expense
Req. 3
Temporary accounts that accumulate during the period are closed at the end of the
year to the permanent account Retained Earnings. These include: Product revenue,
service revenue, interest revenue, cost of products, cost of services, interest expense,
research and development expense, selling, general, and administrative expense, other
expenses, loss on investments, and income tax expense.
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E4–3.
Req. 1
The annual reporting period for this company is January 1 through December 31, 2008.
Req. 2 (Adjusting entries)
Both transactions are accruals because revenue has been earned and expenses
incurred but no cash has yet been received or paid.
(a)
December 31, 2008:
Wage expense (+E, SE) ...........................................
Wages payable (+L) ........................................
6,000
6,000
To record wages earned by employees during 2008, but not yet paid by the
company. This entry records the (a) 2008 expense, and (b) 2008 liability, which
is necessary to conform to accrual accounting and the matching principle.
(b)
December 31, 2008:
Interest receivable (+A) ..............................................
Interest revenue (+R, +SE) ..............................
3,000
3,000
To record interest revenue earned during 2008, but not yet collected. This entry
records the (a) 2008 revenue, and (b) 2008 receivable, which is necessary to
conform to accrual accounting and the revenue principle.
Req. 3
Adjusting entries are necessary at the end of the accounting period to ensure that all
revenues earned and expenses incurred and the related assets and liabilities are
measured properly. The entries above are accruals; entry (a) is an accrued expense
(incurred but not yet recorded) and entry (b) is an accrued revenue (earned but not yet
recorded). In applying the accrual basis of accounting, revenues should be recognized
when earned and measurable and expenses should be recognized when incurred in
generating revenues.
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E4–4.
Req. 1
2007 Income statement:
Insurance expense ($7,800 x 4/24) = $1,300 used.
Shipping supplies expense: ($14,000 + $72,000 - $11,000) = $75,000 used.
Req. 2
2007 Balance sheet:
Prepaid insurance ($7,800 x 20/24) = $6,500
Shipping supplies (given) = $11,000
or
$7,800 - $1,300 = $6,500
Req. 3
Adjusting entry (payment debited to Prepaid Insurance):
Prepaid Insurance
9/1
7,800
AJE 1,300
End.
6,500
Insurance Expense
AJE
End.
1,300
1,300
Insurance expense (+E, SE).....................................
1,300
Prepaid insurance (A) ....................................
1,300
To record the expiration of insurance for four months ($325 per month).
Req. 4
Adjusting entry (payment debited to Shipping Supplies):
Shipping Supplies
Beg. 14,000
Purch. 72,000 AJE 75,000
End. 11,000
Shipping Supplies Expense
AJE 75,000
End. 75,000
Shipping supplies expense (+E, SE) ........................
Shipping supplies (A) .....................................
To record the use of shipping supplies for the year.
McGraw-Hill/Irwin
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75,000
75,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E4–5.
Transaction Assets
E4–3 (a)
NE
E4–3 (b)
+3,000
E4–4 (a)
–1,300
E4–4 (b)
–75,000
Balance Sheet
Stockholders’
Liabilities
Equity
+6,000
–6,000
NE
+3,000
NE
–1,300
NE
–75,000
Income Statement
Net
Revenues Expenses Income
NE
+6,000
–6,000
+3,000
NE
+3,000
NE
+1,300
–1,300
NE
+75,000
–75,000
E4–6.
Req. 1 and 2
a.
Deferred expense -- cash paid before expense is incurred.
Office supplies expense (+E, SE)..............................
Office supplies (A) ...........................................
Supplies used in 2007 ($350 + 800 - 300 = $850).
b.
c.
d.
e.
f.
g.
Accrued expense -- expense incurred before cash is paid.
Wages expense (+E, SE) ..........................................
Wages payable (+L) ..........................................
Amount is given.
Deferred revenue -- cash received before revenue is earned.
Unearned rent revenue (L) ........................................
Rent revenue (+R, +SE) ....................................
Rent earned in 2007 ($9,000 x 2/6).
Accrued revenue -- revenue earned before cash is collected.
Rent receivable (+A)....................................................
Rent revenue (+R, +SE) ....................................
($820 x 2 months)
Deferred expense -- cash paid for equipment before being used.
Depreciation expense (+E, SE) .................................
Accumulated depreciation, delivery equipment (+XA, A)
Amount is given.
Deferred expense -- cash paid before expense is incurred.
Insurance expense (+E, SE) .....................................
Prepaid insurance (A) ......................................
($4,200 x 6/24 months)
Accrued revenue -- revenue earned before cash is received.
Repair accounts receivable (+A) .................................
Repair shop revenue (+R, +SE) ........................
Amount is given.
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850
850
3,700
3,700
3,000
3,000
1,640
1,640
5,000
5,000
1,050
1,050
750
750
© The McGraw-Hill Companies, Inc., 2007
4-15
E4–7.
Req. 1 and 2
a.
Accrued revenue -- revenue earned before cash is collected.
Accounts receivable (+A) ............................................
Service revenue (+R, +SE)................................
Amount is given.
b.
c.
d.
e.
f.
g.
Deferred revenue -- cash received before revenue is earned.
Unearned storage revenue (L) ..................................
Storage revenue (+R, +SE) ...............................
Storage revenue earned in fiscal year 2006 ($2,400 x 1/6)
Accrued expense -- expense incurred before cash is paid.
Wages expense (+E, SE) ..........................................
Wages payable (+L) ..........................................
Amount is given.
Deferred expense -- cash paid before expense is incurred.
Advertising expense (+E, SE)....................................
Prepaid advertising (A) ....................................
Advertising used in fiscal year 2006 ($600 x 9/12).
Deferred expense -- cash paid for equipment before being used.
Depreciation expense (+E, SE) .................................
Accumulated depreciation, equipment (+XA, A)
Amount is given.
Deferred expense -- cash paid before expense is incurred.
Supplies expense (+E, SE) .......................................
Supplies (A) .....................................................
Supplies used in 2006 ($15,600 + $47,500 - $12,200)
Accrued expense -- expense incurred before cash is paid.
Interest expense (+E, SE) ........................................
Interest payable (+L) .........................................
Interest incurred from October 1 to November 30, 2006
($150,000 principal x .10 x 2/12)
McGraw-Hill/Irwin
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2,100
2,100
400
400
2,900
2,900
450
450
23,000
23,000
50,900
50,900
2,500
2,500
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E4–8.
Assets
–850
NE
NE
+1,640
–5,000
–1,050
+750
Balance Sheet
Stockholders’
Liabilities
Equity
NE
–850
+3,700
–3,700
–3,000
+3,000
NE
+1,640
NE
–5,000
NE
–1,050
NE
+750
Transaction Assets
(a)
+2,100
(b)
NE
(c)
NE
(d)
–450
(e)
–23,000
(f)
–50,900
(g)
NE
Balance Sheet
Stockholders’
Liabilities
Equity
NE
+2,100
–400
+400
+2,900
–2,900
NE
–450
NE
–23,000
NE
–50,900
+2,500
–2,500
Transaction
(a)
(b)
(c)
(d)
(e)
(f)
(g)
Income Statement
Revenues Expenses
NE
+850
NE
+3,700
+3,000
NE
+1,640
NE
NE
+5,000
NE
+1,050
+750
NE
Net
Income
–850
–3,700
+3,000
+1,640
–5,000
–1,050
+750
E4–9.
Income Statement
Revenues Expenses
+2,100
NE
+400
NE
NE
+2,900
NE
+450
NE
+23,000
NE
+50,900
NE
+2,500
Net
Income
+2,100
+400
–2,900
–450
–23,000
–50,900
–2,500
E4–10.
a.
b.
c.
d.
e.
f.
g.
h.
i.
Code
N
A
K
O
C
Q
P
L
K
McGraw-Hill/Irwin
Financial Accounting, 5/e
Debit
Amount
$400
800
900
1,000
600
250
220
62,000
420
Credit
Code
Amount
G
$400
I
800
A
900
E
1,000
L
600
B
250
H
220
K
62,000
P
420
© The McGraw-Hill Companies, Inc., 2007
4-17
E4–11.
Selected Balance Sheet Amounts at December 31, 2007
Assets:
Equipment (recorded at cost per cost principle)
Accumulated depreciation (for one year, as given)
Carrying value of equipment (difference)
$12,000
(1,200)
10,800
Office supplies (on hand, as given)
400
Prepaid insurance (remaining coverage, $400 x 18/24 months)
300
Selected Income Statement Amounts for the Year Ended December 31, 2007
Expenses:
Depreciation expense (for one year, as given)
$ 1,200
Office supplies expense (used, $1,400 - $400 on hand)
1,000
Insurance expense (for 6 months, $400 x 6/24 months)
100
E4–12.
Date
Note 1:
April 1, 2008
December 31, 2008a
March 31, 2009b
Note 2:
August 1, 2008
December 31, 2008c
January 31, 2009d
Balance Sheet
Income Statement
Stockholders’
Net
Assets Liabilities
Equity
Revenues Expenses Income
+20,000/
NE
NE
NE
NE
NE
–20,000
+ 1,500
+22,000/
–21,500
NE
+ 1,500
+ 1,500
NE
+ 1,500
NE
+ 500
+500
NE
+ 500
NE
NE
NE
NE
+ 20,000 + 20,000
NE
+ 1,000
- 1,000
NE
+ 1,000
- 1,000
- 21,200
- 21,000
- 200
NE
+ 200
- 200
(a) $20,000 principal x .10 annual interest rate x 9/12 of a year = $1,500
(b) Additional interest revenue in 2009: $20,000 x .10 x 3/12 = $500. Cash
received was $22,000 ($20,000 principal + $2,000 interest for 12 months);
receivables decreased by the $20,000 note receivable and $1,500 interest
receivable accrued in 2008.
(c) $20,000 principal x .12 annual interest rate x 5/12 of a year = $1,000
(d) Additional interest expense in 2009: $20,000 x .12 x 1/12 = $200. Cash paid
was $21,200 ($20,000 principal + $1,200 interest for 6 months); payables
decreased by the $20,000 note payable and $1,000 interest payable accrued in
2008.
McGraw-Hill/Irwin
4-18
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E4–13.
Req. 1
(a)
(b)
(c)
(d)
(e)
(f)
Cash paid on accrued income taxes payable.
Accrual of additional income tax expense.
Cash paid on dividends payable.
Amount of dividends declared for the period.
Cash paid on accrued interest payable.
Accrual of additional interest expense.
Req. 2 Computations:
(a)
Beg. Bal. +
accrued income taxes
$71
+
332
-
cash paid
?
?
=
=
=
End. bal.
$80
$323 paid
(c)
Beg. Bal.
$43
dividends declared
176
-
cash paid
?
?
=
=
=
End. bal.
$48
$171 paid
accrued interest expense
?
?
-
cash paid
297
=
=
=
End. bal.
$51
$303 accrued
+
+
(f)
Beg. Bal. +
$45
+
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-19
E4–14.
Req. 1 Adjusting entries that were or should have been made at December 31:
(a) Should have been made.
Depreciation expense (+E, SE) ................................ 12,000
Accumulated depreciation - equipment (+XA, A)
Amount is given.
(b) Should have been made.
Unearned revenue (L) ..............................................
Fee revenue (+R, +SE) ....................................
Amount is given.
(c) Entry already made.
Interest expense (+E, SE) .......................................
Interest payable (+L) .......................................
($15,000 x 12% x 12/12 months)
Should have been made.
Interest expense (+E, SE) ........................................
Interest payable (+L) ........................................
($15,000 x 12% x 2/12 months)
(d) Should have been made.
Insurance expense (+E, SE).....................................
Prepaid insurance (A) ....................................
Amount is given.
(e) Should have been made.
Rent receivable (+A) ...................................................
Rent revenue (+R, +SE) ..................................
Amount is given.
12,000
2,000
2,000
1,800
1,800
300
300
600
600
850
850
Req. 2
Balance Sheet
Stockholders’
Transaction Assets
Liabilities
Equity
(a)
O 12,000
NE
O 12,000
(b)
NE
O 2,000
U 2,000
(c)
NE
O 1,500
U 1,500
(d)
O 600
NE
O 600
(e)
U 850
NE
U 850
McGraw-Hill/Irwin
4-20
Income Statement
Net
Revenues Expenses Income
NE
U 12,000 O 12,000
U 2,000
NE
U 2,000
NE
O 1,500
U 1,500
NE
U 600
O 600
U 850
NE
U 850
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E4–15.
Items
Balances reported
Effects of:
a. Depreciation
b. Wages
c. Rent revenue
Adjusted balances
d. Effect of
income taxes
Correct balances
Net
Income
$40,000
(9,000)
(17,000)
1,600
15,600
(4,680)
$ 10,920
Total
Assets
$80,000
Total
Liabilities
$30,000
(9,000)
71,000
$71,000
17,000
(1,600)
45,400
4,680
$50,080
Stockholders’
Equity
$50,000
(9,000)
(17,000)
1,600
25,600
(4,680)
$20,920
Computations:
a.
Given, $9,000 depreciation expense.
b.
Given, $17,000 accrued and unpaid.
c.
$4,800 x 1/3 = $1,600 rent revenue earned. The remaining $3,200 in unearned
revenue is a liability for two months of occupancy "owed'' to the renter.
d.
$15,600 income before taxes x 30% = $4,680.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-21
E4–16.
Req. 1
a.
b.
c.
Expenses (depreciation) (+E, SE) ............
Accumulated depreciation (+XA, A)...
5,000
Rent receivable (+A) ...................................
Revenues (rent) (+R, +SE) ..................
2,000
Income tax expense (+E, SE) ...................
Income taxes payable (+L) ..................
6,900
5,000
2,000
6,900
Req. 2
Effects of
Adjusting
Entries
As
Prepared
Income statement:
Revenues
Expenses
Income tax expense
Net income
Balance Sheet:
Assets
Cash
Accounts receivable
Rent receivable
Equipment
Accumulated depreciation
Liabilities
Accounts payable
Income taxes payable
Stockholders' Equity
Contributed capital
Retained earnings
McGraw-Hill/Irwin
4-22
$98,000
(72,000)
b
a
c
$26,000
$2,000
(5,000)
(6,900)
(9,900)
$20,000
22,000
50,000
(10,000)
$82,000
$100,000
(77,000)
(6,900)
$16,100
b
2,000
a
(5,000)
(3,000)
$20,000
22,000
2,000
50,000
(15,000)
$79,000
c
6,900
$10,000
6,900
(9,900)
(3,000)
40,000
22,100
$79,000
$10,000
40,000
32,000
$82,000
Corrected
Amounts
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E4–17.
Req. 1
a.
b.
c.
d.
Salaries and wages expense (+E, SE) ................
Salaries and wages payable (+L) ...................
310
Utilities expense (+E, SE)....................................
Accrued expenses payable (+L) .....................
400
Depreciation expense (+E, SE) ...........................
Accumulated depreciation (+XA, A) .............
23,000
Interest expense (+E, SE) ...................................
Interest payable (+L) ......................................
($20,000 x .10 x 3/12)
500
310
400
23,000
500
e.
No adjustment is needed because the revenue
will not be earned until January (next year).
f.
Maintenance expense (+E, SE)...........................
Maintenance supplies (A) .............................
1,000
Income tax expense (+E, SE)..............................
Income tax payable (+L) .................................
7,000
g.
McGraw-Hill/Irwin
Financial Accounting, 5/e
1,000
7,000
© The McGraw-Hill Companies, Inc., 2007
4-23
E4–17. (continued)
Req. 2
DEREK, INC.
Income Statement
For the Year Ended December 31, 2007
Rental revenue
Expenses:
Salaries and wages ($28,500 + $310)
Maintenance expense ($12,000 + $1,000)
Rent expense
Utilities expense ($4,000 + $400)
Gas and oil expense
Depreciation expense
Interest expense ($20,000 x 10% x 3/12)
Miscellaneous expenses
Total expenses
Pretax income
Income tax expense
Net income
Earnings per share: $24,290 ÷ 7,000 shares
$114,000
$28,810
13,000
9,000
4,400
3,000
23,000
500
1,000
82,710
31,290
7,000
$ 24,290
$3.47
Req. 3
Net profit margin = Net income  Net Sales = $24,290  $114,000 = 21.3%
The net profit margin indicates that, for every $1 of rental revenues, Derek earns
$0.213 (21.3%) in net income. This ratio is higher than the industry average net profit
margin of 18%, implying that Derek is more profitable and better able to manage its
business (in terms of sales price or costs) than the average company in the industry.
McGraw-Hill/Irwin
4-24
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E4–18.
Req. 1
(a)
(b)
(c)
(d)
Insurance expense (+E, SE) ....................................
Prepaid insurance (A) ....................................
5
Depreciation expense (+E, SE) ................................
Accumulated depreciation, machinery (+XA, A)
7
Wages expense (+E, SE) .........................................
Wages payable (+L) ........................................
5
Income tax expense (+E, SE) ...................................
Income tax payable (+L) ..................................
9
5
7
5
9
Req. 2
SENECA COMPANY
Trial Balance
December 31, 2007
(in thousands of dollars)
Cash
Accounts receivable
Prepaid insurance
Machinery
Accumulated depreciation
Accounts payable
Wages payable
Income taxes payable
Contributed capital
Retained earnings
Revenues (not detailed)
Expenses (not detailed)
Totals
McGraw-Hill/Irwin
Financial Accounting, 5/e
Unadjusted
Debit
Credit
38
9
6
80
Adjustments
Debit
Credit
a 5
b 7
9
c 5
d 9
76
4
84
32
169
a
b
c
d
169
5
7
5
9
26
26
Adjusted
Debit
Credit
38
9
1
80
7
9
5
9
76
4
84
58
190
190
© The McGraw-Hill Companies, Inc., 2007
4-25
E4–19.
SENECA COMPANY
Income Statement
For the Year Ended December 31, 2007
(in thousands of dollars)
Revenues (not detailed)
Expenses ($32 + 5 + 7 + 5)
Pretax income
Income tax expense
Net income
$84
49
35
9
$26
EPS ($26,000 ÷ 4,000 shares)
$6.50
SENECA COMPANY
Statement of Stockholders' Equity
For the Year Ended December 31, 2007
(in thousands of dollars)
Beginning balances, 1/1/2007
Stock issuance
Net income
Dividends declared
Ending balances, 12/31/2007
Contributed
Capital
$ 0
76
$ 76
Retained
Earnings
$ 0
26
(4) *
$ 22
Total
Stockholders'
Equity
$ 0
76
26
(4)
$ 98
* The amount of dividends declared can be inferred because the unadjusted trial
balance amount for retained earnings is a negative $4. Since this is the first year of
operations, we can assume the entire amount is due to a dividend declaration.
SENECA COMPANY
Balance Sheet
At December 31, 2007
(in thousands of dollars)
Assets
Current Assets:
Cash
Accounts receivable
Prepaid insurance ($6 - $5)
Total current assets
Machinery
Accumulated depreciation
Total assets
McGraw-Hill/Irwin
4-26
$ 38
9
1
48
80
(7)
$121
Liabilities
Current Liabilities:
Accounts payable
Wages payable
Income taxes payable
Total current liabilities
Stockholders' Equity
Contributed capital
Retained earnings
Total liabilities and
stockholders' equity
$
9
5
9
23
76
22
$121
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E4–20.
Req. 1
The purpose of “closing the books” at the end of the accounting period is to transfer the
balance in the temporary accounts to a permanent account (Retained Earnings). This
also creates a zero balance in each of the temporary accounts for accumulation of
activities in the next accounting period.
Req. 2
Revenues (R) ...........................................................
Expenses ($32 + $5 + $7 + $5 + $9) (E)........
Retained earnings (+SE) .................................
84
58
26
Req. 3
SENECA COMPANY
Post-closing Trial Balance
December 31, 2007
(in thousands of dollars)
Cash
Accounts receivable
Prepaid insurance
Machinery
Accumulated depreciation
Accounts payable
Wages payable
Income taxes payable
Contributed capital
Retained earnings
Revenues (not detailed)
Expenses (not detailed)
Totals
McGraw-Hill/Irwin
Financial Accounting, 5/e
Debit
38
9
1
80
Credit
7
9
5
9
76
22
0
0
128
128
© The McGraw-Hill Companies, Inc., 2007
4-27
PROBLEMS
P4–1.
Req. 1
Dell Computer Corporation
Adjusted Trial Balance
At January 31, 2006
(in millions of dollars)
Debit
Cash
Marketable securities
Accounts receivable
Inventories
Property, plant, and equipment
Accumulated depreciation
Other assets
Accounts payable
Accrued expenses payable
Long-term debt
Other liabilities
Contributed capital
Retained earnings (deficit)
Sales revenue
Cost of sales
Selling, general, and administrative expenses
Research and development expense
Other expenses
Income tax expense
Totals
$
Credit
520
2,661
2,094
273
775
$
252
806
2,397
1,298
512
349
1,781
844
18,243
14,137
1,788
272
38
624
$ 24,832
$ 24,832
Req. 2
Since debits are supposed to equal credits in a trial balance, the balance in Retained
Earnings is determined as the amount in the debit column necessary to make debits
equal credits (a “plugged” figure).
P4–2.
Req. 1
a.
b.
c.
d.
Deferred revenue
Accrued expense
Accrued revenue
Accrued expense
McGraw-Hill/Irwin
4-28
e.
f.
g.
h.
Deferred expense
Deferred expense
Deferred revenue
Accrued expense
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P4–2. (continued)
Req. 2
a.
4,800
Unearned rent revenue (L).........................................
Rent revenue (+R, +SE) ....................................
4,800
$7,200 ÷ 6 months = $1,200 per month x 4 months. This entry reduces (debits)
the liability for the amount earned and records a revenue.
b.
14,300
Wage expense (+E, SE) ............................................
Wages payable (+L) ..........................................
14,300
Wage expense is increased (debited) because this expense was incurred in
2007. A liability (wages payable) is credited because this amount is owed to the
employees.
c.
Accounts receivable (+A) .............................................
2,000
Service revenue (+R, +SE) ................................
2,000
This entry records an asset for the amount due from customers and recognizes
the revenue because it was earned in 2007.
d.
Interest expense (+E, SE) ..........................................
Interest payable (+L) ............................................
To accrue interest expense incurred but not paid,
$20,000 x 12% x 3/12 = $600.
600
600
e.
1,000
Insurance expense (+E, SE) ......................................
1,000
Prepaid insurance (A) .....................................
$6,000 ÷ 12 months = $500 per month x 2 months of coverage. This entry
reduces the asset (prepaid insurance) because part of it has been used and
only $5,000 represents future benefits (an asset) to the company.
f.
1,500
Depreciation expense (+E, SE) ..................................
1,500
Accumulated depreciation, service truck (+XA, A)
To record depreciation expense to recognize the use of the truck during the
year. Amount is given.
g.
400
Unearned service revenue (L) ....................................
Service revenue (+R, +SE)..................................
To recognize revenue earned during the year ($2,400 x 2/12).
400
Property tax expense (+E, SE) ...................................
Property tax payable (+L) .....................................
To record expense incurred but not paid.
400
h.
McGraw-Hill/Irwin
Financial Accounting, 5/e
400
© The McGraw-Hill Companies, Inc., 2007
4-29
P4–3.
Req. 1
a.
b.
c.
d.
Deferred expense
Deferred expense
Accrued expense
Accrued expense
e.
f.
g.
h.
Accrued revenue
Deferred expense
Accrued expense
Accrued expense
Req. 2
a.
200
Insurance expense (+E, SE) ......................................
200
Prepaid insurance (A) .....................................
$1,200 ÷ 36 months x 6 months of coverage. This entry reduces the asset
(prepaid insurance) because part of it has been used and only $1,000
represents future benefits (an asset) to the company.
b.
700
Supplies expense (+E, SE) ........................................
700
Supplies (A) .....................................................
Supplies inventory is decreased (credited) to record the use of supplies during
the year because this expense was incurred in 2008, calculated as
Beg. Inventory of $200 + Purchases $800 – Ending Inventory $300.
c.
800
Repairs and maintenance expense (+E, SE) .............
Accrued expenses payable (+L) ........................
800
Repairs and maintenance expense is increased (debited) because this expense
was incurred in 2008. A liability (accrued expenses payable) is credited
because this amount is owed but will not be paid until 2009.
d.
1,600
Property tax expense (+E, SE) ...................................
Property tax payable (+L) .....................................
1,600
Property tax expense is increased (debited) because this expense was
incurred in 2008. A liability (property tax payable) is credited because this
amount is owed but will not be paid until 2009.
e.
f.
Accounts receivable (+A) .............................................
8,000
Service revenue (+R, +SE) ................................
This entry records an asset for the amount due from the customer and
recognizes the revenue because it was earned in 2008.
8,000
1,100
Depreciation expense (+E, SE) ..................................
1,100
Accumulated depreciation, van (+XA, A)
To record depreciation expense to recognize the use of the van during the
year. Amount is given.
McGraw-Hill/Irwin
4-30
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P4–3. (continued)
g.
h.
Interest expense (+E, SE) ..........................................
Interest payable (+L) ............................................
To accrue interest expense incurred but not paid,
$10,000 x 12% x 3/12 = $300.
300
300
9,990
Income tax expense (+E, SE).....................................
Income tax payable (+L) .......................................
9,990
To accrue income tax expense incurred but not paid:
Income before adjustments (given)
$30,000
Effect of adjustments (a) through (g)
+3,300 (-200 - 700 - 800 -1,600
Income before income taxes
33,300
+8,000 -1,100 -300)
Income tax rate
x 30%
Income tax expense
$ 9,990
P4–4.
Req. 1
a.
b.
c.
d.
Deferred revenue
Accrued expense
Accrued revenue
Accrued expense
e.
f.
g.
h.
Deferred expense
Deferred expense
Deferred revenue
Accrued expense
Req. 2
Transaction
a.
b.
c.
d.
e.
f.
g.
h.
Assets
NE
NE
+2,000
NE
–1,000
–1,500
NE
NE
McGraw-Hill/Irwin
Financial Accounting, 5/e
Balance Sheet
Stockholders’
Liabilities
Equity
–4,800
+4,800
+14,300
–14,300
NE
+2,000
+600
–600
NE
–1,000
NE
–1,500
–400
+400
+400
–400
Income Statement
Net
Revenues Expenses Income
+4,800
NE
+4,800
NE
+14,300
–14,300
+2,000
NE
+2,000
NE
+600
–600
NE
+1,000
–1,000
NE
+1,500
–1,500
+400
NE
+400
NE
+400
–400
© The McGraw-Hill Companies, Inc., 2007
4-31
P4–5.
Req. 1
a.
b.
c.
d.
Deferred expense
Deferred expense
Accrued expense
Accrued expense
e.
f.
g.
h.
Accrued revenue
Deferred expense
Accrued expense
Accrued expense
Req. 2
Transaction
a.
b.
c.
d.
e.
f.
g.
h.
Assets
 200
 700
NE
NE
+ 8,000
 1,100
NE
NE
Balance Sheet
Stockholders’
Liabilities
Equity
NE
 200
NE
 700
+ 800
 800
+ 1,600
 1,600
NE
+ 8,000
NE
 1,100
+ 300
 300
+ 9,990
 9,990
Income Statement
Revenues Expenses
NE
+ 200
NE
+ 700
NE
+ 800
NE
+ 1,600
+ 8,000
NE
NE
+ 1,100
NE
+ 300
NE
+ 9,990
Net
Income
 200
– 700
 800
 1,600
+ 8,000
 1,100
 300
 9,990
Computations:
a.
Six months of expired insurance during 2008: $1,200 x 6/36 = $200.
b.
Supplies used during 2008: Beg. inventory, $200 + Purchases, $800 - Ending
inventory, $300 = $700 used for the period.
c.
Expense incurred during 2008 to be paid during January 2009.
d.
Property taxes incurred in 2008 to be paid in 2009.
e.
Accrued revenue: earned in 2008 but not yet collected or recorded; payable within
30 days.
f.
Depreciation is given.
g.
Interest expense accrued for 3 months: $10,000 x 12% x 3/12 = $300.
h.
Adjusted income = $30,000 - 200 - 700 - 800 -1,600 + 8,000 -1,100 - 300 =
$33,300 x 30% tax rate = $9,990 income tax expense.
McGraw-Hill/Irwin
4-32
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P4–6.
2007
Balance
$528,000
Financial
Statement
Income statement
65,000
Income statement
 62,000
9,300
Income statement
No effect
16,000
Balance sheet
No effect
5. Receivables from employees
1,500
Balance sheet
 1,500
6. Maintenance supplies
1,700
Balance sheet
 8,000
12,000
Balance sheet
+12,000
3,000
Balance sheet
 4,000
Account
1. Rent revenue
2. Salary expense
3. Maintenance supplies expense
4. Rent receivable
7. Unearned rent revenue
8. Salaries payable
(1)
Rent revenue
512,000 (a)
16,000 (b)
528,000
(4)
Rent receivable
(b) 16,000
(2)
Salary expense
(e) 62,000
(f)
3,000
65,000
(3) Maintenance
supplies expense
Used 9,300
9,300
(5) Receivables
from employees
(g)
1,500
16,000
(6) Maintenance
supplies
(h) 3,000
(i) 8,000 9,300 used
(j) 1,700
1,500
(7) Unearned
rent revenue
12,000 (c)
12,000
(8)
Salaries payable
(d)
4,000 4,000 Bal.
3,000 (f)
3,000
(a) from renters
(c) from renters
McGraw-Hill/Irwin
Financial Accounting, 5/e
Cash
512,000 4,000
12,000 62,000
1,500
8,000
Effect on
Cash Flows
+ $512,000
Inferred
(d) to employees
(e) to employees
(g) to employees
(i) to suppliers
© The McGraw-Hill Companies, Inc., 2007
4-33
P4–7.
Req. 1
(1)
(2)
(3)
(4)
December 31, 2006 Adjusting Entries
Accounts receivable (+A) .........................................
400
Service revenue (+R, +SE) ...........................
To record service fees earned, but not collected.
Insurance expense (+E, SE) .................................
Prepaid insurance (A) .................................
To record insurance expired as an expense.
400
(b)
(i)
200
(l)
(c)
8,500
(k)
(e)
4,700
(m)
(f)
200
Depreciation expense (+E, SE)..............................
Accumulated depreciation, equipment (+XA, A)
To record depreciation expense.
8,500
Income tax expense (+E, SE) ...............................
Income taxes payable (+L) ...........................
To record income taxes for 2006.
4,700
Req. 2
Amounts before
Adjusting Entries
Revenues:
Service revenue
Expenses:
Salary expense
Depreciation expense
Insurance expense
Income tax expense
Total expense
Net income (loss)
Amounts after
Adjusting Entries
$46,000
$46,400
41,700
41,700
8,500
200
4,700
41,700
$ 4,300
55,100
$ (8,700)
Net loss is $8,700 because this amount includes all revenues and all expenses (after
the adjusting entries). This amount is correct because it incorporates the effects of the
revenue and matching principles applied to all transactions whose effects extend
beyond the period in which the transactions occurred. Net income of $4,300 was not
correct because expenses of $13,400 and revenues of $400 were excluded that should
have been recorded in 2006.
Req. 3
Earnings (loss) per share = $(8,700) net loss  3,000 shares = $(2.90) per share
McGraw-Hill/Irwin
4-34
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P4–7. (continued)
Req. 4
Net profit margin = Net income  Net Sales = $(8,700) net loss  $46,400 = (18.8)%
The net profit margin indicates that, for every $1 of service revenues, Wagonblatt
actually lost $0.188 of net income. This ratio implies that Wagonblatt destroys
shareholder value in generating its sales and suggests that better management of its
business (in terms of sales price or costs) is required.
Req. 5
Service revenue (R) ...............................................
Retained earnings (SE) .........................................
Salary expense (E).........................................
Depreciation expense (E)...............................
Insurance expense (E) ...................................
Income tax expense (E) .................................
46,400
8,700
41,700
8,500
200
4,700
Req. 6
Cash
Wagonblatt Company
Post-closing Trial Balance
December 31, 2006
Debit
9,000
Accounts receivable
400
Prepaid insurance
400
Equipment
Credit
120,200
Accumulated depreciation, equipment
40,000
Income taxes payable
4,700
Contributed capital
80,000
Retained earnings
5,300
Service revenue
0
Salary expense
0
Depreciation expense
0
Insurance expense
0
Income tax expense
0
Totals
McGraw-Hill/Irwin
Financial Accounting, 5/e
130,000
130,000
© The McGraw-Hill Companies, Inc., 2007
4-35
P4–8.
Req. 1
December 31, 2007 Adjusting Entries:
(a)
(b)
(c)
(d)
(e)
Supplies expense (+E, SE) ......................................
Supplies (A) ..................................................
500
Insurance expense (+E, SE) ....................................
Prepaid insurance (A) ...................................
500
Depreciation expense (+E, SE) ...............................
Accumulated depreciation, service
trucks (+XA, A) ..............................................
4,000
Wages expense (+E, SE) .........................................
Wages payable (+L) .......................................
900
Income tax expense (+E, SE) ..................................
Income taxes payable (+L) .............................
7,350
500
500
4,000
900
7,350
Req. 2
ST. DENIS, INC.
Income Statement
For the Year Ended December 31, 2007
Service revenue
$77,000
Expenses:
Supplies expense ($800 - $300)
Insurance expense ($1,000 - $500)
Depreciation expense
Wages expense
Remaining expenses (not detailed)
Total expenses
Pretax income
Income tax expense
Net income
500
500
4,000
900
41,700
47,600
29,400
7,350
$22,050
Earnings per share ($22,050 ÷ 5,000 shares)
McGraw-Hill/Irwin
4-36
$4.41
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P4–8. (continued)
ST. DENIS, INC.
Balance Sheet
At December 31, 2007
Assets
Current Assets:
Cash
Accounts receivable
Supplies
Prepaid insurance
Total current assets
Service trucks
Accumulated depreciation,
service trucks
$60,000
13,000
300
500
73,800
20,000
Other assets (not detailed)
11,200
Total assets
Liabilities
Current Liabilities:
Accounts payable
Wages payable
Income taxes payable
Total current liabilities
Note payable, long term
Total liabilities
$ 3,000
900
7,350
11,250
20,000
31,250
(16,000)
$89,000
Stockholders' Equity
Contributed capital
Retained earnings*
Total stockholders' equity
Total liabilities and
stockholders' equity
28,200
29,550
57,750
$89,000
*Unadjusted balance, $7,500 + Net income, $22,050 = Ending balance, $29,550.
Req. 3
December 31, 2007 Closing Entry:
Service revenue (R) ..................................................
Retained earnings (+SE) ................................
Supplies expense (E) ....................................
Insurance expense (E) ..................................
Depreciation expense (E) .............................
Wages expense (E) ......................................
Remaining expenses (not detailed) (E)..........
Income tax expense (E) ................................
McGraw-Hill/Irwin
Financial Accounting, 5/e
77,000
22,050
500
500
4,000
900
41,700
7,350
© The McGraw-Hill Companies, Inc., 2007
4-37
P4–9.
Req. 1, 2, 3, and 5 T-accounts (in thousands)
Accounts
Cash
Receivable
Bal.
3 b
9
Bal.
5 f
24
a
10 e
70
c
40
c
120 g
10
d
3 h
13
f
24 k
17
Bal. 41
Bal. 21
b
Land
9
Bal.
Bal.
9
Bal.
Other Assets
Bal.
4
g
Bal.
Equipment
60
60
Wages Payable
o
12
Bal. 12
Interest Payable
n
1
Bal.
1
Contributed
Capital
Bal. 65
d
3
Bal. 68
Retained
Earnings
17 Bal.
CE
Bal.
Depreciation
Expense
m
6 CE
Bal.
0
Supplies
Expense
l
16 CE
Bal.
0
McGraw-Hill/Irwin
4-38
6
16
k
Bal.
Income Tax
Expense
p
8 CE
Bal.
0
Wages
Expense
o
12 CE
Bal.
0
16
14
Accumulated
Depreciation
Bal.
6
m
6
Bal. 12
Accounts Payable
h
13 Bal.
5
e
15
i
18
Bal. 25
10
14
Supplies
Bal. 12 l
i
18
8
32
23
8
12
Notes Payable
a
10
Bal.
10
Income Taxes
Payable
p
8
Bal.
8
CE
Service
Revenue
c
160
160
Bal.
0
Interest
Expense
n*
1 CE
1
Bal.
0
* $10,000 x .12 x 10/12
Remaining
Expenses
e
85 CE
85
Bal.
0
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P4–9. (continued)
Req. 2
a. Cash (+A) ..........................................................
Notes payable (+L) ..................................
Borrowed cash on 12% note, March 1, 2008.
b.
c.
d.
e.
f.
g.
h.
i.
10,000
10,000
Land (+A)...........................................................
Cash (A) ................................................
Purchased land for future building site.
9,000
Cash (+A) ..........................................................
Accounts receivable (+A)...................................
Service revenue (+R, +SE) ......................
Service revenues earned during 2008.
120,000
40,000
Cash (+A) ..........................................................
Contributed capital (+SE) ........................
Sold capital stock for cash.
3,000
Remaining expenses (+E, SE) ........................
Accounts payable (+L) .............................
Cash (A) ................................................
Remaining expenses incurred during 2008.
85,000
Cash (+A) ..........................................................
Accounts receivable (A).........................
Collected on customers' accounts.
24,000
Other assets (+A) ..............................................
Cash (A) ................................................
Purchased additional assets.
10,000
Accounts payable (L) .......................................
Cash (A) ................................................
Paid creditors.
13,000
Supplies (+A) .....................................................
Accounts payable (+L) .............................
Purchased supplies for future use.
18,000
j.
No entry required; no revenue earned in 2008.
k.
Retained earnings (SE) ...................................
Cash (A) ................................................
Declared and paid a cash dividend.
McGraw-Hill/Irwin
Financial Accounting, 5/e
9,000
160,000
3,000
15,000
70,000
24,000
10,000
13,000
18,000
17,000
17,000
© The McGraw-Hill Companies, Inc., 2007
4-39
P4–9. (continued)
Req. 3
l.
m.
n.
o.
p.
Supplies expense (+E, SE)..............................
Supplies (A) ............................................
To record supplies used ($30 - 14).
16,000
Depreciation expense (+E, SE) .......................
Accumulated depreciation (+XA, A)........
To record depreciation as given.
6,000
Interest expense (+E, SE) ...............................
Interest payable (+L) ................................
To accrue interest for March - December, 2008,
($10,000 x 12% x 10/12).
1,000
Wages expense (+E, SE) ................................
Wages payable (+L) .................................
To accrue wages incurred but not paid.
12,000
Income tax expense (+E, SE) ..........................
Income taxes payable (+L) .......................
To accrue income tax.
8,000
16,000
6,000
1,000
12,000
8,000
Req. 4
H & H TOOL, INC.
Income Statement
For the Year Ended December 31, 2008
Revenues:
Service revenue
Expenses:
Depreciation expense
Interest expense
Supplies expense
Wages expenses
Remaining expenses
Pretax income
Income tax expense
Net income
Earnings per share
[$32,000 ÷ 68,000]
McGraw-Hill/Irwin
4-40
$160,000
6,000
1,000
16,000
12,000
85,000
40,000
8,000
$32,000
$0.47
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P4–9. (continued)
H & H TOOL, INC.
Statement of Stockholders' Equity
For the Year Ended December 31, 2008
Balance, January 1, 2008
Additional stock issuance
Net income
Dividends declared
Balance, December 31, 2008
Contributed
Capital
$65,000
3,000
$68,000
Retained
Earnings
$ 8,000
32,000
(17,000)
$23,000
Total
Stockholders'
Equity
$73,000
3,000
32,000
(17,000)
$91,000
H & H TOOL, INC.
Balance Sheet
At December 31, 2008
Assets:
Current Assets:
Cash
Accounts receivable
Supplies
Total current assets
Land
Equipment
Less: Accumulated deprec.
Other assets
Total assets
McGraw-Hill/Irwin
Financial Accounting, 5/e
$ 41,000
21,000
14,000
76,000
9,000
60,000
(12,000)
14,000
$147,000
Liabilities:
Current Liabilities:
Accounts payable
Interest payable
Wages payable
Income taxes payable
Total current liabilities
Notes payable
Total liabilities
Stockholders' Equity:
Contributed capital
Retained earnings
Total stockholders'
equity
Total liabilities and
stockholders' equity
$ 25,000
1,000
12,000
8,000
46,000
10,000
56,000
68,000
23,000
91,000
$147,000
© The McGraw-Hill Companies, Inc., 2007
4-41
P4–9. (continued)
H & H TOOL, INC.
Statement of Cash Flows
For the Year Ended December 31, 2008
Cash from Operating Activities:
Cash collected from customers (c + f)
Cash paid to suppliers and employees (e +h)
Cash provided by operations
$144,000
(83,000)
61,000
Cash from Investing Activities:
Purchase of land (b)
Purchase of other assets (g)
Cash used for investing activities
(9,000)
(10,000)
(19,000)
Cash from Financing Activities:
Borrowing from bank (a)
Issuance of stock (d)
Payment of dividends (k)
Cash used for financing activities
Change in cash
Beginning cash balance, January 1, 2008
Ending cash balance, December 31, 2008
10,000
3,000
(17,000)
(4,000)
38,000
3,000
$ 41,000
Req. 5
1
December 31, 2008 Closing Entry
Service revenue (R) .........................................
Retained earnings (+SE) .........................
Depreciation expense (E) ......................
Interest expense (E) ..............................
Supplies expense (E) ............................
Wages expense (E) ...............................
Remaining expenses (E) .......................
Income tax expense (E) .........................
To close revenues and expenses (temporary
accounts).
McGraw-Hill/Irwin
4-42
160,000
32,000
6,000
1,000
16,000
12,000
85,000
8,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P4–9. (continued)
Req. 6
Post-closing trial balance:
H & H TOOL, INC.
Post-Closing Trial Balance
At December 31, 2008
Cash
Accounts receivable
Supplies
Land
Equipment
Accumulated depreciation (equipment)
Other assets (not detailed)
Accounts payable
Wages payable
Interest payable
Income taxes payable
Notes payable
Contributed capital (68,000 shares)
Retained earnings
Service revenue
Depreciation expense
Income tax expense
Interest expense
Supplies expense
Wages expense
Remaining expenses (not detailed)
Total
McGraw-Hill/Irwin
Financial Accounting, 5/e
Debit
$ 41,000
21,000
14,000
9,000
60,000
Credit
$ 12,000
14,000
25,000
12,000
1,000
8,000
10,000
68,000
23,000
0
0
0
0
0
0
0
$159,000
$159,000
© The McGraw-Hill Companies, Inc., 2007
4-43
P4–9. (continued)
Req. 7
(a)
Financial leverage
= Average total assets  Average stockholders’ equity
= [($78,000+$147,000)2] [($73,000+$91,000)2]
= $112,500  $82,000
= 1.37
This suggests that H & H Tool, Inc., finances its assets primarily with
stockholders’ equity. Approximately one-third of the assets are financed with
debt and the rest with stockholders’ equity.
(b)
Total asset turnover = Sales  Average total assets
= $160,000  $112,500
= 1.42
This suggests that H & H Tool, Inc., generates $1.42 for every dollar of assets.
(c)
Net profit margin
= Net income  Sales
= $32,000  $160,000
= 0.20 or 20%
This suggests that H & H Tool, Inc., earns $0.20 for every dollar in sales that it
generates.
For all of the ratios, a comparison across time and a comparison against an
industry average or competitors will need to be analyzed to determine how risky
(financial leverage ratio), how efficient (total asset turnover) and how effective
(net profit margin) H & H Tool’s management is.
McGraw-Hill/Irwin
4-44
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
ALTERNATE PROBLEMS
AP4–1.
Starbucks Corporation
Adjusted Trial Balance
At September 30, 2006
(in millions)
Cash
Short-term investments
Accounts receivable
Inventories
Prepaid expenses
Other current assets
Long-term investments
Property, plant, and equipment
Accumulated depreciation
Other long-lived assets
Accounts payable
Accrued liabilities
Short-term bank debt
Long-term liabilities
Contributed capital
Retained earnings
Net revenues
Interest income
Cost of sales
Store operating expenses
Other operating expenses
Depreciation expense
General and admin. expenses
Interest expense
Income tax expense
Totals
Debit
$
66
51
48
181
19
21
68
1,081
Credit
$
321
38
56
131
64
40
647
212
1,680
9
741
544
51
98
90
1
62
$ 3,160
$ 3,160
Req. 2
Since debits are supposed to equal credits in a trial balance, the balance in Retained
Earnings is determined as the amount in the credit column necessary to make debits
equal credits (a “plugged” figure).
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-45
AP4–2.
Req. 1
a.
b.
c.
d.
Deferred expense
Accrued expense
Deferred revenue
Deferred expense
e.
f.
g.
h.
Deferred revenue
Accrued expense
Accrued expense
Accrued revenue
Req. 2
a.
1,600
Insurance expense (+E, SE) ......................................
1,600
Prepaid insurance (A) .....................................
$3,200 ÷ 6 months x 3 months of coverage. This entry reduces the asset
(prepaid insurance) because part of it has been used and the remaining $1,600
represents future benefits (an asset) to the company.
b.
900
Wage expense (+E, SE) ............................................
Wages payable (+L) ..........................................
900
Wage expense is increased (debited) because this expense was incurred by
June 30, 2007. A liability (wages payable) is credited because this amount is
owed to the employees.
c.
225
Unearned maintenance revenue (L) ..........................
Maintenance revenue (+R, +SE) .......................
$450 ÷ 2 months x 1 month. This entry reduces (debits) the liability for the
amount earned and records a revenue.
d.
Depreciation expense (+E, SE) .................................
Accumulated depreciation, service truck (+XA, A)
Depreciation is given.
225
3,000
3,000
e.
700
Unearned service revenue (L) ...................................
Service revenue (+R, +SE) .................................
700
To recognize revenue earned during the year, $4,200 ÷ 12 months x 2 months.
f.
Interest expense (+E, SE)..........................................
Interest payable (+L) ............................................
To accrue interest expense incurred but not paid,
$16,000 x 9% ÷ 12 months x 5 months = $600.
600
Property tax expense (+E, SE) ..................................
Property tax payable (+L) ....................................
To record expense incurred but not paid.
500
g.
h.
600
500
Accounts receivable (+A) .............................................
2,000
Service revenue (+R, +SE) ................................
2,000
This entry records an asset for the amount due from customers and recognizes
the revenue because it was earned by June 30, 2007.
McGraw-Hill/Irwin
4-46
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP4–3.
Req. 1
a.
b.
c.
d.
Deferred expense
Accrued revenue
Accrued expense
Deferred expense
e.
f.
g.
h.
Deferred expense
Deferred expense
Accrued revenue
Accrued expense
Req. 2
a.
1,150
Supplies expense (+E, SE) ........................................
1,150
Supplies (A) .....................................................
Supplies is decreased (credited) to record the use of supplies during the year
because this expense was incurred in 2008, calculated as
Beg. Inventory of $350 + Purchases $1,200 – Ending Inventory $400.
b.
Accounts receivable (+A) .............................................
7,500
Catering revenue (+R, +SE) ..............................
7,500
This entry records an asset for the amount due from customers and recognizes
the revenue because it was earned in 2008.
c.
600
Repairs and maintenance expense (+E, SE) .............
Accrued expenses payable (+L) ........................
600
Repairs and maintenance expense is increased (debited) because this expense
was incurred in 2008. A liability (accrued expenses payable) is credited
because this amount is owed but will not be paid until 2009.
d.
200
Insurance expense (+E, SE) ......................................
200
Prepaid insurance (A) .....................................
$1,200 ÷ 12 months x 2 months of coverage. This entry reduces the asset
(prepaid insurance) because part of it has been used while $1,000 represents
future benefits (an asset) to the company.
e.
700
Rent expense (+E, SE)...............................................
700
Prepaid rent (A) ..................................................
$2,100 ÷ 3 months x 1 month of coverage. This entry reduces the asset
(prepaid rent) because part of it has been used while $1,400 represents future
benefits (an asset) to the company.
f.
1,600
Depreciation expense (+E, SE) ..................................
Accumulated depreciation, display counters (+XA, A)
Depreciation is given.
McGraw-Hill/Irwin
Financial Accounting, 5/e
1,600
© The McGraw-Hill Companies, Inc., 2007
4-47
AP4–3. (continued)
g.
h.
Interest receivable (+A) ................................................
Interest income (+R, +SE) ....................................
To accrue interest income earned but not yet received,
$4,000 x 12% x 2/12 = $80.
80
80
7,719
Income tax expense (+E, SE).....................................
Income tax payable (+L) .......................................
7,719
To accrue income tax expense incurred but not paid:
Income before adjustments (given)
$22,400
Effect of adjustments (a) through (g)
+3,330 (-1,150 +7,500 -600
Income before income taxes
25,730 -200 -700 -1,600 +80)
Income tax rate
x 30%
Income tax expense
$ 7,719
AP4–4.
Req. 1
a.
b.
c.
d.
Deferred expense
Accrued expense
Deferred revenue
Deferred expense
e.
f.
g.
h.
Deferred revenue
Accrued expense
Accrued expense
Accrued revenue
Req. 2
Transaction
a.
b.
c.
d.
e.
f.
g.
h.
Assets
–1,600
NE
NE
–3,000
NE
NE
NE
+2,000
McGraw-Hill/Irwin
4-48
Balance Sheet
Stockholders’
Liabilities
Equity
NE
–1,600
+900
–900
–225
+225
NE
–3,000
–700
+700
+600
–600
+500
–500
NE
+2,000
Income Statement
Revenues Expenses
NE
+1,600
NE
+900
+225
NE
NE
+3,000
+700
NE
NE
+600
NE
+500
+2,000
NE
Net
Income
–1,600
–900
+225
–3,000
+700
–600
–500
+2,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP4–5.
Req. 1
a.
b.
c.
d.
Deferred expense
Accrued revenue
Accrued expense
Deferred expense
e.
f.
g.
h.
Deferred expense
Deferred expense
Accrued revenue
Accrued expense
Req. 2
Transaction
a.
b.
c.
d.
e.
f.
g.
h.
Assets
–1,150
+7,500
NE
–200
–700
–1,600
+80
NE
Balance Sheet
Stockholders’
Liabilities
Equity
NE
–1,150
NE
+7,500
+600
–600
NE
–200
NE
–700
NE
–1,600
NE
+80
+7,719
–7,719
Income Statement
Revenues Expenses
NE
+1,150
+7,500
NE
NE
+600
NE
+200
NE
+700
NE
+1,600
+80
NE
NE
+7,719
Net
Income
–1,150
+7,500
–600
–200
–700
–1,600
+80
–7,719
Computations:
a.
Supplies used during 2008: Beg. Inventory of $350 + Purchases $1,200 – Ending
Inventory $400 = $1,150 used for the period.
b.
Accrued revenue: earned in 2008 but not yet collected or recorded; payable within
30 days.
c.
Expense incurred during 2008 to be paid during January 2009.
d.
Two months of expired insurance during 2008: $1,200 x 2/12 = $200.
e.
One month of expired rent during 2008: $2,100 x 1/3 = $700.
f.
Depreciation is given.
g.
Interest expense accrued for 2 months: $4,000 x 12% x 2/12 = $80.
h.
Adjusted income = $22,400 - 1,150 + 7,500 - 600 -200 - 700 - 1,600 + 80 =
$25,730 x 30% tax rate = $7,719 income tax expense.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-49
AP4–6.
Req. 1
(1)
(2)
(3)
(4)
(5)
December 31, 2006 Adjusting Entries
Accounts receivable (+A) ........................................
1,500
Service revenue (+R, +SE) ...........................
To record service fees earned, but not collected.
Rent expense (+E, SE) .........................................
Prepaid rent (A)............................................
To record rent expired as an expense.
400
Depreciation expense (+E, SE) .............................
Accumulated depreciation (+XA, A)
To record depreciation expense.
17,500
Deferred revenue (L) .............................................
Service revenue (+R, +SE) ...........................
To record service fees earned.
8,000
Income tax expense (+E, SE) ...............................
Income taxes payable (+L) ...........................
To record income taxes for 2006.
6,500
1,500
(b)
(j)
400
(m)
(c)
17,500
(l)
(e)
8,000
(g)
(j)
6,500
(n)
(f)
Req. 2
Amounts before
Adjusting Entries
Revenues:
Service revenue
Expenses:
Salary expense
Depreciation expense
Rent expense
Income tax expense
Total expense
Net income
Amounts after
Adjusting Entries
$83,000
$92,500
54,000
54,000
17,500
400
6,500
78,400
$ 14,100
54,000
$ 29,000
Net income is $14,100 because this amount includes all revenues and all expenses
(after the adjusting entries). This amount is correct because it incorporates the effects
of the revenue and matching principles applied to all transactions whose effects extend
beyond the period in which the transactions occurred. Net income of $29,000 was not
correct because expenses of $24,400 and revenues of $9,500 were excluded that
should have been recorded in 2006.
McGraw-Hill/Irwin
4-50
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP4–6. (continued)
Req. 3
Earnings per share = $14,100 net income  5,000 shares = $2.82 per share
Req. 4
Net profit margin = Net income  Net Sales = $14,100  $92,500 = 15.2%
The net profit margin indicates that, for every $1 of service revenues, Abraham made
$0.152 (15.2%) of net income. This ratio suggests that Abraham is generally profitable.
Req. 5
Service revenue (R) ...............................................
Retained earnings (+SE) ..................................
Salary expense (E).........................................
Depreciation expense (E)...............................
Rent expense (E) ...........................................
Income tax expense (E) .................................
92,500
14,100
54,000
17,500
400
6,500
Req. 6
Abraham Company
Post-closing Trial Balance
December 31, 2006
Debit
Cash
18,000
Accounts receivable
1,500
Prepaid rent
800
Property, plant, and equipment
210,000
Accumulated depreciation
Income taxes payable
Deferred revenue
Contributed capital
Retained earnings
Service revenue
Salary expense
0
Depreciation expense
0
Rent expense
0
Income tax expense
0
Totals
230,300
McGraw-Hill/Irwin
Financial Accounting, 5/e
Credit
70,000
6,500
8,000
110,000
35,800
0
230,300
© The McGraw-Hill Companies, Inc., 2007
4-51
AP4–7.
Req. 1
December 31, 2007 Adjusting Entries:
(a)
(b)
(c)
(d)
(e)
Depreciation expense (+E, SE) ...............................
3,000
Accumulated depreciation, equipment (+XA, A)
Insurance expense (+E, SE) ....................................
Prepaid insurance (A) ...................................
450
Wages expense (+E, SE) .........................................
Wages payable (+L) .......................................
1,100
Supplies expense (+E, SE) ......................................
Supplies (A) ..................................................
700
Income tax expense (+E, SE) ..................................
Income tax payable (+L) .................................
2,950
3,000
450
1,100
700
2,950
Req. 2
AUSTIN CO.
Income Statement
For the Year Ended December 31, 2007
Service revenue
$48,000
Expenses:
Supplies expense ($1,300 balance - $600 on hand)
Insurance expense
Depreciation expense
Wages expense
Remaining expenses (not detailed)
Total expenses
Pretax income
Income tax expense
Net income
Earnings per share ($6,900 ÷ 4,000 shares)
McGraw-Hill/Irwin
4-52
700
450
3,000
1,100
32,900
38,150
9,850
2,950
$6,900
$1.73
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP4–7. (continued)
AUSTIN CO.
Balance Sheet
At December 31, 2007
Assets
Current Assets:
Cash
Accounts receivable
Supplies
Prepaid insurance
Total current assets
Equipment
Accumulated depreciation
Other assets (not detailed)
$19,600
7,000
600
450
27,650
27,000
(15,000)
5,100
Total assets
$44,750
Liabilities
Current Liabilities:
Accounts payable
Wages payable
Income tax payable
Total current liabilities
Note payable, long term
Total liabilities
Stockholders' Equity
Contributed capital
Retained earnings*
Total stockholders' equity
Total liabilities and
stockholders' equity
$ 2,500
1,100
2,950
6,550
5,000
11,550
16,000
17,200
33,200
$44,750
*Unadjusted balance, $10,300 + Net income, $6,900 = Ending balance, $17,200.
Req. 3
December 31, 2007 Closing Entry:
Service revenue (R) ..................................................
Retained earnings (+SE) ................................
Supplies expense (E) ....................................
Insurance expense (E) ..................................
Depreciation expense (E) .............................
Wages expense (E) ......................................
Remaining expenses (not detailed) (E)..........
Income tax expense (E) ................................
McGraw-Hill/Irwin
Financial Accounting, 5/e
48,000
6,900
700
450
3,000
1,100
32,900
2,950
© The McGraw-Hill Companies, Inc., 2007
4-53
AP4–8.
Req. 1, 2, 3, and 5 T-accounts (in thousands)
Accounts
Cash
Receivable
Bal.
5 b
18
Bal.
4 g
8
a
20 e
28
d
9
c
5 f
3
d
56 h
11
g
8 k
10
j
3
Bal. 27
Bal.
5
Small Tools
Bal.
6 l
1
f
3
Bal.
8
Other Assets
Bal.
9
Bal.
b
Bal.
Bal.
8
4
Accumulated
Depreciation
m
2
Equipment
18
18
Bal.
Accounts Payable
h
11 Bal.
7
e
7
i
10
Bal. 13
9
Supplies
Bal.
2 l
i
10
2
Notes Payable
a
20
Bal.
20
Wages Payable
o
3
Bal.
3
Interest Payable
n
1
Bal.
1
Income Taxes
Payable
p
4
Bal.
4
Unearned Revenue
j
3
3
Contributed Capital
Bal. 15
c
5
Bal. 20
Retained Earnings
k
10 Bal.
4
CE 11
Bal.
5
Service Revenue
d
65
CE
65
Bal.
0
Income Tax Expense
p
4
CE
4
Bal.
0
Interest Expense
n
1
CE
1
Bal.
0
Bal.
Depreciation Expense
m
2
CE
Bal.
0
McGraw-Hill/Irwin
4-54
o
Wages Expense
3
2
CE
Bal.
0
3
Remaining Expenses
e
35
l
9
CE
44
Bal.
0
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP4–8. (continued)
Req. 2
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
Cash (+A) ..........................................................
Notes payable (+L) ..................................
Borrowed cash on 10% note, July 1, 2008.
20,000
Equipment (+A) .................................................
Cash (A) ................................................
Purchased equipment, July 1, 2008
18,000
Cash (+A) ..........................................................
Contributed capital (+SE) ........................
Sold capital stock for cash.
5,000
Cash (+A) ..........................................................
Accounts receivable (+A)...................................
Service revenue (+R, +SE) ......................
Service revenues earned during 2008.
56,000
9,000
Remaining expenses (+E, SE) ........................
Accounts payable (+L) .............................
Cash (A) ................................................
Remaining expenses incurred during 2008.
35,000
Small tools (+A) .................................................
Cash (A) ................................................
Purchased additional small tools.
3,000
Cash (+A) ..........................................................
Accounts receivable (A).........................
Collected on customers' accounts.
8,000
Accounts payable (L) .......................................
Cash (A) ...............................................
Paid on accounts payable to suppliers.
11,000
Supplies (+A) .....................................................
Accounts payable (+L) .............................
Purchased supplies for future use.
10,000
Cash (+A) ..........................................................
Unearned revenue (+L) ..........................
Deposit received for revenue not yet earned.
3,000
McGraw-Hill/Irwin
Financial Accounting, 5/e
20,000
18,000
5,000
65,000
7,000
28,000
3,000
8,000
11,000
10,000
3,000
© The McGraw-Hill Companies, Inc., 2007
4-55
AP4–8. (continued)
k.
Retained earnings (SE) ...................................
Cash (A) ................................................
Declared and paid a cash dividend.
10,000
Remaining expenses (+E, SE) ........................
Supplies (A) ............................................
Small tools (A) ........................................
To record supplies used ($12 – 4) and small
tools used ($9 – 8).
9,000
Depreciation expense (+E, SE) .......................
Accumulated depreciation (+XA, A)........
To record depreciation as given.
2,000
Interest expense (+E, SE) ...............................
Interest payable (+L) ................................
To accrue interest for July - December, 2008,
($20,000 x 10% x 6/12).
1,000
Wages expense (+E, SE) ................................
Wages payable (+L) .................................
To accrue wages incurred but not paid.
3,000
Income tax expense (+E, SE) ..........................
Income taxes payable (+L) .......................
To accrue income tax.
4,000
10,000
Req. 3
l.
m.
n.
o.
p.
McGraw-Hill/Irwin
4-56
8,000
1,000
2,000
1,000
3,000
4,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP4–8. (continued)
Req. 4
NEW AGAIN FURNITURE, INC.
Income Statement
For the Year Ended December 31, 2008
Revenues:
Service revenue
Expenses:
Depreciation expense
Interest expense
Wages expense
Remaining expenses
Pretax income
Income tax expense
Net income
$65 000
2,000
1,000
3,000
44,000
15,000
4,000
$11,000
Earnings per share
[$11,000 ÷ [(15,000+20,000)2]
$0.63
NEW AGAIN FURNITURE, INC.
Statement of Stockholders' Equity
For the Year Ended December 31, 2008
Balance, January 1, 2008
Additional stock issuance
Net income
Dividends declared
Balance, December 31, 2008
McGraw-Hill/Irwin
Financial Accounting, 5/e
Contributed
Capital
$15,000
5,000
$20,000
Retained
Earnings
$ 4,000
11,000
(10,000)
$ 5,000
Total
Stockholders'
Equity
$19,000
5,000
11,000
(10,000)
$25,000
© The McGraw-Hill Companies, Inc., 2007
4-57
AP4–8. (continued)
NEW AGAIN FURNITURE, INC.
Balance Sheet
At December 31, 2008
Assets:
Current Assets:
Cash
Accounts receivable
Supplies
Small tools
Total current assets
Equipment
Less: Accum. depr.
Other assets
$27,000
5,000
4,000
8,000
44,000
18,000
(2,000)
9,000
Total assets
$69,000
Liabilities:
Current Liabilities:
Accounts payable
$13,000
Notes payable
20,000
Wages payable
3,000
Interest payable
1,000
Income taxes payable
4,000
Unearned revenue
3,000
Total current liabilities
44,000
Stockholders' Equity:
Contributed capital
20,000
Retained earnings
5,000
Total stockholders' equity
25,000
Total liabilities and
stockholders' equity
$69,000
NEW AGAIN FURNITURE, INC.
Statement of Cash Flows
For the Period Ended December 31, 2008
Cash from Operating Activities:
Cash collected from customers (d + g + j)
Cash paid to suppliers and employees (e + h)
Cash provided by operations
Cash from Investing Activities:
Purchase of equipment (b)
Purchase of small tools (f)
Cash used in investing activities
Cash from Financing Activities:
Borrowing from bank (a)
Issuance of stock (c)
Payment of dividends (k)
Cash provided by financing activities
Change in cash
Beginning cash balance, January 1, 2008
Ending cash balance, December 31, 2008
McGraw-Hill/Irwin
4-58
$ 67,000
(39,000)
28,000
(18,000)
(3,000)
(21,000)
20,000
5,000
(10,000)
15,000
22,000
5,000
$ 27,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP4–8. (continued)
Req. 5
December 31, 2008 Closing Entry
Service revenue (R) .........................................
Retained earnings (+SE) .........................
Depreciation expense (E) ......................
Interest expense (E) ..............................
Wages expense (E) ...............................
Remaining expenses (E) .......................
Income tax expense (E) .........................
To close revenues and expenses.
65,000
11,000
2,000
1,000
3,000
44,000
4,000
Req. 6
NEW AGAIN FURNITURE, INC.
Post-Closing Trial Balance
At December 31, 2008
Account Titles
Cash
Accounts receivable
Supplies
Small tools
Equipment
Accumulated depreciation
Other assets (not detailed)
Accounts payable
Notes payable
Wages payable
Interest payable
Income taxes payable
Unearned revenue
Contributed capital (20,000 shares)
Retained earnings
Service revenue
Depreciation expense
Wages expense
Income tax expense
Interest expense
Remaining expenses (not detailed)
Totals
McGraw-Hill/Irwin
Financial Accounting, 5/e
Debit
$27,000
5,000
4,000
8,000
18,000
Credit
$ 2,000
9,000
13,000
20,000
3,000
1,000
4,000
3,000
20,000
5,000
0
0
0
0
0
0
$71,000
$71,000
© The McGraw-Hill Companies, Inc., 2007
4-59
AP4–8. (continued)
Req. 7
(a)
Financial leverage
= Average total assets  Average stockholders’ equity
= [($26,000+$69,000)2] [($19,000+$25,000)2]
= $47,500  $22,000
= 2.16
This result suggests that New Again Furniture, Inc., finances its assets more with
debt than stockholders’ equity. The company borrowed $1.16 and utilized $1 of
stockholders’ equity to acquire every dollar of assets.
(b)
Total asset turnover = Sales  Average total assets
= $65,000  $47,500
= 1.37
This suggests that New Again Furniture, Inc., generates $1.37 for every dollar of
assets.
(c)
Net profit margin
= Net income  Sales
= $11,000  $65,000
= 0.17 or 17%
This suggests that New Again Furniture, Inc., earns $0.17 for every dollar in
sales that it generates.
For all of the ratios, a comparison across time and a comparison against an
industry average or competitors will need to be analyzed to determine how risky
(financial leverage ratio), how efficient (total asset turnover) and how effective
(net profit margin) New Again Furniture’s management is.
McGraw-Hill/Irwin
4-60
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CASES AND PROJECTS
FINANCIAL REPORTING AND ANALYSIS CASES
CP4–1.
1. At the end the 2004 fiscal year, Prepaid Expenses were $19,943 thousand. Of that
amount, $12,476 thousand was prepaid rent. This information is disclosed on the
balance sheet.
2. The company reported $26,826 thousand for unearned (deferred) revenue. This
information is disclosed on the balance sheet.
3. Prepaid rent represents rent that Pacific Sunwear of California has paid in advance
to its landlords. It is an asset. Pacific Sunwear also rents property to tenants.
Deferred rent represents rent that it has collected in advance for which PacSun has
an obligation to allow a tenant to use PacSun’s property.
4. Accrued Liabilities would consist of costs that have been incurred by the end of the
accounting period but which have not yet been paid.
5. The company owed $6,647 thousand in currently payable sales taxes at the end of
the 2004 fiscal year. This information is disclosed in Note 5 regarding accrued
liabilities.
6. Interest Income is related to the company’s short-term investments.
7. The company’s income statement accounts (revenues, expense, gains, and losses)
would not have balances on a post-closing trial balance. These accounts are
temporary accounts that have been closed to Retained Earnings.
8. Prepaid Expenses is an asset account. As such, it is a permanent account that
carries its ending balance into the next accounting period. It is not closed at the end
of the period.
9. The company reported basic earnings per share of $1.41 for fiscal year 2004, $1.05
for 2003, and $0.67 for 2002.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-61
CP4–1. (continued)
10. Fiscal year
2002:
(dollars in thousands)
Net Profit Margin
= Net Income = $49,666 = 0.059
Sales
2003:
Net Profit Margin
= Net Income = $80,200 = 0.077
Sales
2004:
Net Profit Margin
847,150
1,041,456
= Net Income = $106,904 = 0.087
Sales
1,229,762
Over the past three years, the company’s net profit margin has increased. Pacific
Sunwear of California is becoming progressively more profitable each year.
Management appears to be controlling costs, generating greater sales, or both.
CP4–2.
1. American Eagle paid $121,138 thousand in income taxes in its 2004 fiscal year, as
disclosed in note 2 under “Supplemental Disclosures of Cash Flow Information.”
2. The quarter ended January 29, 2005, was its best quarter in terms of sales at
$674,024,000 (this quarter covered Christmas, the biggest part of the year for
retailers). The worst quarter ended May 1, 2004 (the quarter following Christmas),
and most likely this is because most people have very little money to spend on extra
clothing in that period. Note 15 discloses quarterly information.
3. Other income (net) is an aggregate of many accounts, but a summary entry for them
all would be:
Other income (net) ...................
Retained Earnings ..........
McGraw-Hill/Irwin
4-62
4,129
4,129
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP4–2. (continued)
4. As disclosed in Note 4, Accounts and Note Receivable consists of (in thousands):
Fabric
Construction allowances
Sell-offs to non-related parties
Taxes
Distribution services
Sale of Bluenotes
Other
Total
5. Fiscal year
5.
2002:
2,871
6,801
6,657
2,584
2,015
2,707
2,797
$26,432
(dollars are in thousands)
Net Profit Margin
= Net Income = $88,108 = 0.064
Sales
2003:
Net Profit Margin
= Net Income = $59,622 = 0.042
Sales
2004:
Net Profit Margin
1,382,923
1,435,436
= Net Income = $213,343 = 0.113
Sales
1,881,241
Over the past three years, the company’s net profit margin at first decreased and then
the most recent year’s profit margin was almost double that during the 2002 fiscal
year. In 2004, management appears to be controlling costs, generating greater
sales, or both.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-63
CP4–3.
1. American Eagle Outfitters reported an advertising expense of $41.4 million for fiscal
2004 (Note 2 under Advertising Costs). Pacific Sunwear of California reported
$11.4 million of advertising costs during fiscal 2004. (See Note 1 under Advertising
Costs).
2.
Fiscal
Year
2004
2003
2002
American Eagle Outfitters
Advertising
Expense /
Net Sales
41,400 / 1,881,241
2.2%
44,800 / 1,435,436
3.1%
44,400 /1,382,923
3.2%
Pacific Sunwear of California
Advertising
Expense /
Net Sales
11,400 / 1,229,762
.9%
10,400 / 1,041,456
1.0%
8,900 / 847,150
1.1%
American Eagle Outfitters incurred the higher percentage for fiscal year 2004. Both
firms had a steadily declining balance of advertising costs as a percentage of net
sales.
3.
Advertising/Sales =
Industry
Average
3.03%
American Eagle
Outfitters
2.2%
Pacific Sunwear of
California
.9%
Both American Eagle Outfitters and Pacific Sunwear of California are spending less
on advertising as a percentage of sales than the average company in their industry.
This might imply that they are more effective, as they are generating more sales per
dollar spent on advertising. Another interpretation is that they are not supporting
their brand, and sales will eventually decline as their brands lose value.
4. Both accounting policies are similar indicating that advertising costs are expensed
when the marketing campaigns become publicly available. American Eagle
allocates advertising costs for television campaigns over the life of the campaign.
PacSun expenses its television costs when the advertising becomes publicly
available. (The policies are disclosed in note 1 of Pacific Sunwear of California’s
annual report, and note 2 of American Eagle’s annual report).
McGraw-Hill/Irwin
4-64
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP4–3. (continued)
American Eagle
Outfitters
5.
Pacific Sunwear of
California
2002: Net Profit = Net Income
Margin
Sales
$88,108 = 0.064
1,382,923
$49,666
$847,150
= 0.059
2003: Net Profit = Net Income
Margin
Sales
$59,622 = 0.042
1,435,436
$80,200 = 0.077
$1,041,456
2004: Net Profit = Net Income
Margin
Sales
$213,343 = 0.113
1,881,241
$106,904 = 0.087
$1,229,762
Both companies show an increase in their profit margins over the 2002-2004 time
period. Pacific Sunwear of California shows steadily increasing profit margins over
time; whereas American Eagle showed a dip in its profit margin in 2003. With the
exception of 2003, American Eagle has been able to attain a greater profit margin
than that for Pacific Sunwear of California, suggesting a better overall performance.
6.
Net Profit Margin =
Industry
Average
4.52%
American Eagle
Outfitters
11.3%
Pacific Sunwear of
California
8.7%
Both companies, American Eagle Outfitters and Pacific Sunwear of California have
higher Net Profit Margins than the average company in their industry. This is likely
due to the strategy that these two companies have pursued, which is to differentiate
their clothing in terms of style and quality and appeal to a particular niche market,
therefore being able to charge a higher price.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-65
CP4–4
Req. 1
The author suggests that the root cause of accounting scandals is “a widespread
obsession with earnings that drives companies to push accounting standards to the limit
and, in extreme cases, to engage in outright fraud.” This causes managers to make
decisions to meet short-term earnings expectations, often at the expense of long-term
shareholder value.
Req. 2
The uncertainties that the author believes are problems in current financial reporting are
related to the subjective assumptions about the future (accruals) – revenue recognition
and expense matching. Examples include uncertainties as to how much revenue a
company will generate from current-period expenditures for research and development,
employee training, brand building, or additions to production capacity. There is also
subjectivity in matching expenses with revenues. Examples include the various
depreciation methods available to managers and expensing research and development.
According to the author, these uncertainties about the future combined with historical
information produce financial statements, and net income in particular, that do not tell
users what they need to know to make investing and lending decisions.
McGraw-Hill/Irwin
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© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP4–5.
Req. 1
Account
Cash
Maintenance supplies
Service equipment
Accumulated depreciation,
service equipment
Remaining assets
Note payable, 8%
Interest payable
Income taxes payable
Wages payable
Unearned revenue
Contributed capital
Retained earnings
Service revenue
Expenses
Unadjusted
Trial Balance
Debit
Credit
20,000
500
90,000
Adjusted
Trial Balance
Debit
Credit
20,000
200
90,000
18,000
42,500
27,000
42,500
10,000
313,000
27,000
42,500
10,000
800
13,020
500
6,000
56,000
9,000
214,000
56,000
9,000
220,000
160,000
313,000
Post-Closing
Trial Balance
Debit
Credit
20,000
200
90,000
183,620
336,320
336,320
10,000
800
13,020
500
6,000
56,000
39,380
0
0
152,700
152,700
Ending Retained Earnings = Beg., $9,000 + Net income, ($214,000 - 183,620)
Req. 2
(a)
To record the amount of supplies used during 2007, $300, and to reduce the
supplies account to the amount remaining on hand at the end of 2007.
(b)
To accrue interest expense for 2007 (the interest is payable in 2008, computed
as $10,000 x 8% = $800) and to record interest payable.
(c)
To reduce service revenue for cash collected in advance of being earned and to
record the liability for those services yet to be performed, $6,000.
(d)
To record depreciation expense for 2007, $9,000.
(e)
To record 2007 wages of $500 that will be paid in 2008.
(f)
To record 2007 income tax and the related liability, $13,020.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-67
CP4–5. (continued)
Req. 3
Closing Entry on December 31, 2007:
Service revenue (from the adjusted trial balance) (R) .........
214,000
Retained earnings (+SE) ............................................
30,380
Expenses (from the adjusted trial balance) (E) ........
183,620
Req. 4
Pretax income
x
($214,000 - 170,600) x
$43,400
x
Average income tax rate = Income tax expense
?
=
$13,020
?
=
$13,020
?
=
30%
Req. 5
Number of shares issued x
8,000
x
McGraw-Hill/Irwin
4-68
Average issue price = Total issue amount
?
=
$56,000
?
=
$7.00 per share
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP4–6.
Transaction (a):
1. This transaction will affect Shirley’s financial statements for 10 years (from 2006 to
2015) in conformity with the matching principle.
2. Income statement:
Depreciation expense, as given
3. Balance sheet at December 31, 2008:
Assets:
Office equipment
Less: Accumulated depreciation*
Carrying (book) value
*$1,400 x 3 years = $4,200.
$1,400 each year
$14,000
4,200
$ 9,800
4. An adjusting entry each year over the life of the asset would be recorded to reflect
the allocation of the cost of the asset when used to generate revenues:
1,400
Depreciation expense (+E, SE)
1,400
Accumulated depreciation (+XA, A)
Transaction (b):
1. This transaction will affect Shirley’s financial statements for 2 years--2008 and
2009--because four month’s rent revenue was earned in 2008, and two months'
rent revenue will be earned in 2009.
2. The 2008 income statement should report rent revenue earned of $16,000
($24,000 x 4/6). Occupancy was provided for only 4 months in 2008. This is in
conformity with the revenue principle.
3. This transaction created an $8,000 liability ($24,000 - $16,000 = $8,000) as of
December 31, 2008, because at that date Shirley "owes'' the renter two more
months' occupancy for which it has already collected the cash.
4. Yes, an adjusting entry must be made to (a) increase the rent revenue account by
$16,000, and (b) to decrease the liability to $8,000 representing the future
occupancy owed (in conformity with the revenue principle).
December 31, 2008--Adjusting entry:
Unearned rent revenue (L) ........................... 16,000
Rent revenue (+R, +SE) ........................
16,000
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-69
CP4–6. (continued)
Transaction (c):
1. This transaction will directly affect Shirley’s financial statements for two years, with
the expense incurred in 2008 and the cash payment in 2009.
2. The $7,500 should be reported as wage expense in the 2008 income statement
and as a liability on the 2008 balance sheet. On January 5, 2009, the liability will
be paid. Therefore, the 2009 balance sheet will reflect a reduced cash balance and
reduced liability balance. The transaction will not directly affect the 2009 income
statement (unless the adjusting entry was not made).
3. Yes, an adjusting entry must be made to (a) record the $7,500 as an expense in
2008 (matching principle) and (b) to record the liability which will be paid in 2009.
December 31, 2008--Adjusting entry:
Wage expense (+E, SE) ...............................
7,500
Wages payable (+L) .............................
7,500
Note: On January 5, 2009, the liability, Wages Payable, $7,500, will be paid. Wage
expense for 2009 will not include this $7,500. The 2009 related entry will debit
(decrease) wages payable, and credit (decrease) cash, $7,500.
Transaction (d):
1. Yes, service revenue of $45,000 (i.e., $60,000 x 3/4) should be recorded as earned
by Shirley in conformity with the revenue principle. Service revenue is recognized
as the service is performed.
2. Recognition of revenue earned but not collected by the end of 2008 requires an
adjusting entry. This adjusting entry is necessary to (a) record the revenue earned
(to be reported on the 2008 income statement) and (b) record the related account
receivable (an asset to be reported on the 2008 balance sheet). The adjusting
entry on December 31, 2008 is:
Accounts receivable (+A)............................................ 45,000
Service revenue (+R, +SE) ..............................
45,000
($60,000 total price x 3/4 completed)
3. February 15, 2009--Completion of the last phase of the service contract and cash
collected in full:
Cash (+A) .................................................................. 60,000
Accounts receivable (A) .................................
45,000
Service revenue (+R, +SE) ..............................
15,000
McGraw-Hill/Irwin
4-70
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP4–7.
Req. 1
Adjusting entries:
(a) Expenses (insurance) (+E, SE) .......................................
Prepaid insurance (A) ...........................................
To adjust for expired insurance.
(b)
(c)
(d)
(e)
(f)
Rent receivable (+A) .........................................................
Revenues (rent) (+R, +SE) ......................................
To adjust for rent revenue earned but not yet collected.
Expenses (depreciation) (+E, SE) ...................................
Accumulated depreciation, long-lived assets (+XA, A)
To adjust for annual depreciation.
1
1
2
2
11
11
Expenses (wages) (+E, SE) ............................................
Wages payable (+L) ................................................
To adjust for wages earned but not recorded or paid.
3
Income tax expense (+E, SE) .........................................
Income taxes payable (+L) .....................................
To adjust for income tax expense.
5
Unearned rent revenue (L)...............................................
Revenues (rent) (+R, +SE) ......................................
To adjust for rent revenue collected but unearned.
3
3
5
3
Req. 2
Closing entry (from the adjusted trial balance):
Revenues (R) ...................................................................
Retained earnings (+SE) ..............................................
Expenses (E)...............................................................
Income tax expense (E) ..............................................
To close the temporary accounts to Retained Earnings for
2006.
McGraw-Hill/Irwin
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15
83
5
© The McGraw-Hill Companies, Inc., 2007
4-71
CP4–7. (continued)
Req. 3
(a) Shares outstanding: 1,000 shares (given).
(b) Interest expense: $20,000 x 10% = $2,000.
(c) Ending balance in retained earnings:
Unadjusted balance, $(3,000) + Net income, $15,000 = $12,000.
(d) Average income tax rate: $5,000 income tax expense ÷ ($103,000 revenues $83,000 total expenses) = 25%.
(e) Rent receivable -- report on the balance sheet as an asset.
Unearned rent revenue -- report on the balance sheet as a liability (for future
occupancy "owed'').
(f) Net income of $15,000 was computed on the basis of accrual accounting
concepts. Revenue is recognized when earned and expenses recorded when
incurred regardless of the timing of the respective cash flows. Cash inflows, in
addition to certain revenues, were from numerous sources such as the issuance of
capital stock, borrowing, and revenue collected in advance. Similarly, cash
outflows were, in addition to certain expenses, due to numerous transactions such
as the purchase of operational and other assets, prepaid insurance, and dividends
to stockholders.
(g) EPS: $15,000 ÷ 1,000 shares (per (a) above) =$15.00 per share.
(h) Selling price per share: $30,000 contributed capital ÷ 1,000 shares = $30 per
share.
(i) The prepaid insurance account reflected a $2,000 balance before the adjustment
(decrease) of $1,000. Therefore, it appears that the policy premium was paid on
January 1, 2006, and it was prepaid for two years (2006 and 2007). Other
possibilities might be (a) a 12-month policy purchased on July 1, 2006, or (b) a 2month policy purchased on December 1, 2006. In any case, one-half of the
premium has expired.
(j) Net profit margin: $15,000 net income ÷ $103,000 revenues = 0.146 (14.6%).
McGraw-Hill/Irwin
4-72
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP4–8.
Req. 1
CRYSTAL’S DAY SPA AND SALON, INC.
Income Statement
For the Year Ended December 31, 2008
Items
Revenues:
Spa fees
Expenses:
Office rent
Utilities
Telephone
Salaries
Supplies
Miscellaneous
Depreciation
Total expenses
Net income
*
**
Cash
Basis Per
Crystal’s
Statement
Explanation of Changes
Corrected
Basis
$1,115,000 See * below.
$1,012,000
130,000
43,600
12,200
522,000
31,900
12,400
0
752,100
$ 362,900
120,000
43,600
11,800
523,500
29,825
12,400
20,500
761,625
$ 250,375
Exclude rent for Jan. 2009 ($130,000 ÷ 13) (g)
No change
See ** below.
Add December 2008 salary ($18,000 ÷ 12) (e)
See *** below.
No change
Given for 2008 (c)
Cash collected for spa fees
Fees earned in prior years (a)
Fees earned in 2008 but not yet collected (b)
Fees earned in 2008
$1,115,000
-132,000
+ 29,000
$1,012,000
Add December 2008 bill of $1,400 (f) and subtract the December 2007 bill of
$1,800 paid in 2008 ($12,200 + $1,400 - $1,800 = $11,800).
***
Beg.
Purchases
End.
McGraw-Hill/Irwin
Financial Accounting, 5/e
Supplies (d)
3,125
31,900 29,825
5,200
Used
© The McGraw-Hill Companies, Inc., 2007
4-73
CP4–8. (continued)
Req. 2
Memo to Crystal Mullinex should include the following:
(1) Net income was overstated by $112,525 because of inappropriate recognition of
revenue (overstated by $103,000) and expenses (understated by $9,525).
Revenue should be recognized when earned, not when the cash is collected.
Similarly, expenses should be matched against revenue in the period when the
services or materials were used (including depreciation expense).
(2) Some other items the parties should consider in the pricing decision:
(a) A correct balance sheet at December 31, 2008.
(b) Collectibility of any receivables (if they are to be sold with the business).
(c) Any liabilities of the spa to be assumed by the purchaser.
(d) Current employees -- how will they be affected?
(e) Adequacy of the rented space -- is there a long-term noncancellable lease?
(f) Characteristics of Crystal’s spa practices.
(g) Expected future cash flows of the business. What is the present value of
those expectations?
McGraw-Hill/Irwin
4-74
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CRITICAL THINKING CASES
CP4–9.
Req. 1
2007
12/31
(a)
(b)
(c)
(d)
(e)
(f)
Adjusting Entries
Debit
Supplies expense (+E, SE)…………………
Supplies (A)……………………………….
To record supplies used ($6,000 - $1,800 = $4,200).
4,200
Insurance expense (+E, SE)…………………….
Prepaid insurance (A)……………………
To record expired insurance at December 31, 2007.
2,000
Depreciation expense (+E, SE)…………………
Accumulated depreciation (+XA, A)…….
To record depreciation for one year.
8,000
Salaries expense (+E, SE)…………………………
Salaries payable (+L)………………………
To record salaries earned but not paid.
2,200
Transportation revenue (R, +SE) ………
Unearned transportation revenue (+L)……
To record transportation revenue earned but
collected in advance.
7,000
Income tax expense (+E, SE)…………………...
Income tax payable (+L)……………………
To record 2007 income tax computation:
Transportation revenue: $85,000  7,000 = $78,000
Expenses:
$47,000 + 4,200 + 2,000
+ 8,000 + 2,200 = 63,400
Pretax income
$14,600
Income tax expense: $14,600 x 25% = $ 3,650
3,650
McGraw-Hill/Irwin
Financial Accounting, 5/e
Credit
4,200
2,000
8,000
2,200
7,000
3,650
© The McGraw-Hill Companies, Inc., 2007
4-75
CP4–9. (continued)
Req. 2
MAGLIOCHETTI MOVING CORPORATION
Corrections to 2007 Financial Statements
Amounts
Reported
2007 Income Statement:
Revenue:
Transportation revenue
Expenses:
Salaries expense
Supplies expense
Other expenses
Insurance expense
Depreciation expense
Income tax expense
Total expenses
Net income
December 31, 2007 Balance Sheet
Assets:
Current Assets:
Cash
Receivables
Supplies
Prepaid insurance
Total current assets
Equipment
Less: Accumulated deprec.
Remaining assets
Total assets
Liabilities:
Current Liabilities:
Accounts payable
Salaries payable
Unearned transportation revenue
Income tax payable
Total current liabilities
Stockholders' Equity
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders'
equity
McGraw-Hill/Irwin
4-76
Changes
Plus Minus
$ 85,000
e
17,000
12,000
18,000
0
0
0
47,000
$ 38,000
d
a
2,200
4,200
b
c
f
2,000
8,000
3,650
$
2,000
3,000
6,000
4,000
15,000
40,000
0
27,000
$82,000
$ 9,000
0
0
0
9,000
35,000
38,000
73,000
$82,000
7,000
a
b
c
d
e
f
2,200
7,000
3,650
$ 78,000
19,200
16,200
18,000
2,000
8,000
3,650
67,050
$ 10,950
4,200
2,000
8,000
Corrected
Amounts
$ 2,000
3,000
1,800
2,000
8,800
40,000
(8,000)
27,000
$67,800
$ 9,000
2,200
7,000
3,650
21,850
35,000
10,950
45,950
$67,800
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP4–9. (continued)
Req. 3
Omission of the adjusting entries caused:
(a) Net income to be overstated by $27,050.
(b) Total assets to be overstated by $14,200.
Req. 4
(a) Earnings per share:
Unadjusted -- $38,000 net income  10,000 shares = $3.80 per share
Adjusted -- $10,950 net income  10,000 shares = $1.095 per share
(b) Net profit margin:
Unadjusted -- $38,000 net income  85,000 sales = 44.7%
Adjusted -- $10,950 net income  78,000 sales = 14.0%
Each of the ratios was affected by inclusion of the adjustments with revenues
decreasing and expenses increasing resulting in a lower net income. For earnings per
share, the numerator net income decreased while the denominator did not, resulting in
a significantly lower figure. For the net profit margin, the denominator sales was lower
but did not decrease more than the reduction in the numerator net income causing a
significantly lower percentage.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-77
CP4–9. (continued)
Req. 5
(today’s date)
To the Stockholders of Magliochetti Moving Corporation:
We regret to inform you that your request for a $20,000 loan has been denied.
Our review showed that various adjustments were required to the original set of
financial statements provided to us. The original (unadjusted) financial statements
overstated net income for 2007 by $27,050 (i.e., $38,000 - $10,950).
This
overstatement was caused by incorrectly including $7,000 of revenue collected in
advance that had not been earned in 2007. Further, all of the expenses were
understated and income tax expense had been incorrectly excluded.
Total assets were overstated by $14,200 (i.e., $82,000 - $67,800). Supplies was
overstated by $4,200, prepaid insurance was overstated by $2,000, and the net book
value of the equipment was overstated by $8,000 because annual depreciation was not
properly recognized.
A review of key financial ratios indicates that the adjustments caused earnings per
share and net profit margin to decline. Net profit margin declined from 44.7% to 14.0%.
The adjusted ratios, however, would be compared to those of other start-up companies
in the same industry.
We require that there be sufficient collateral pledged against the loan before we can
consider it. The current market value of the equipment may be able to provide
additional collateral against which the loan could be secured. Your personal
investments may also be considered viable collateral if you are willing to sign an
agreement pledging these assets as collateral for the loan. This is a common
requirement for small start-up businesses.
If you would like us to reconsider your application, please provide us the current market
values of any assets you would pledge as collateral.
Regards,
(your name)
Loan Application Department,
Your Bank
McGraw-Hill/Irwin
4-78
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP4–10.
Req. 1 Cash from Operations:
$18,000
Req. 2 Subscriptions Revenue for fiscal year ended March 31, 2008
($18,000 x 7/36): $3,500
Req. 3 March 31, 2008 Unearned Subscriptions Revenue
($18,000 x 29/36) = $14,500 or $18,000 - $3,500 = $14,500.
Req. 4
Adjusting entry (cash receipt credited to Unearned Subscriptions Revenue):
Unearned Subscriptions
Revenue (L)
9/1
18,000
AJE
3,500
End. 14,500
Subscriptions Revenue (R)
AJE
3,500
End.
3,500
Unearned subscriptions revenue (L) ........................
3,500
Subscriptions revenue (+R, +SE) ....................
3,500
To record the earning of revenue for seven months ($500 per month).
Req. 5
a. $4,000 revenue target based on cash sales:
This target is not clearly defined. Does management mean any cash
subscriptions received during the period? Your region generated $18,000 in
cash subscriptions. By this assumption, your region far exceeded the company’s
target. You may be entitled to a generous bonus due to your strong
performance.
On the other hand, management may mean any sales revenue earned that has
also been received in cash during the period. Under this assumption, sales
revenue earned and received in cash is $3,500 (the accrual accounting basis
amount). If this is the company’s intention of its target, then your region did not
meet the goal, only generating 87.5% of the target. You may need to provide an
analysis to management regarding this below par performance.
This example demonstrates the need for clear communication of expectations by
management.
b. $4,000 revenue target based on accrual accounting:
This situation is the same as the second assumption under a. Your region earned $500
less than expected by the company.
McGraw-Hill/Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
4-79
FINANCIAL REPORTING AND ANLYSIS PROJECT
CP4–11.
The solutions to this project will depend on the company and/or accounting period
selected for analysis.
McGraw-Hill/Irwin
4-80
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual