CH-2 Review of the Accounting Process – Intermediate Accounting : Book Guide

Chapter 2 Review of the Accounting Process 1 Question 2-1 External events involve an exchange transaction between the company and a separate economic entity. For every external transaction, the company is receiving something in exchange for something else. Internal events do not involve an exchange transaction but do affect the financial position of the company. Examples of external events are the purchase of inventory, a sale to a customer, and the borrowing of cash from a bank. Examples of internal events include the recording of depreciation expense, the expiration of prepaid rent, and the accrual of salary expense. Question 2-2 According to the accounting equation, there is equality between the total economic resources of an entity, its assets, and the claims to those resources, liabilities and equity. This implies that, since resources must always equal claims, the net effect of any transaction cannot affect one side of the accounting equation differently than the other side. Question 2-3 The purpose of a journal is to capture, in chronological order, the dual effect of a transaction. A general ledger is a collection of storage areas called accounts. These accounts keep track of the increases and decreases in each element of financial position. Question 2-4 Permanent accounts represent the financial position of a company, assets, liabilities and owners' equity, at a particular point in time. Temporary accounts represent the changes in shareholders’ equity, the retained earnings component of equity for a corporation, caused by revenue, expense, gain and loss transactions. It would be cumbersome to record revenue/expense, gain/loss transactions directly into the permanent retained earnings account. Recording these transactions in temporary accounts facilitates the preparation of the financial statements. Question 2-5 Assets are increased by debits and decreased by credits. Liabilities and equity accounts are increased by credits and decreased by debits. Question 2-6 Revenues and gains are increased by credits and decreased by debits. Expenses and losses are increased by debits (thus causing owners’ equity to decrease) and decreased by credits (thus causing owners’ equity to increase). Chapter 2 Review of the Accounting Process QUESTIONS FOR REVIEW OF KEY TOPICS 2 Answers to Questions (continued) Question 2-7 The first step in the processing cycle is to identify external transactions affecting the accounting equation. Source documents, such as sales invoices, bills from suppliers and cash register tapes, help to identify the transactions and then provide the information necessary to process the transaction. Question 2-8 Transaction analysis is the process of reviewing the source documents to determine the dual effect on the accounting equation and the specific elements involved. Question 2-9 After transactions are recorded in a journal, the debits and credits must be transferred to the appropriate general ledger accounts. This transfer is called posting. Question 2-10 Transaction 1 records the purchase of $20,000 of inventory on account. Transaction 2 records a credit sale of $30,000 and the corresponding cost of goods sold of $18,000. Question 2-11 An unadjusted trial balance is a list of the general ledger accounts and their balances at a time before any end-of-period adjusting entries have been recorded. An adjusted trial balance is prepared after adjusting entries have been recorded and posted to the accounts. Question 2-12 Adjusting entries record the effect on financial position of internal events, those that do not involve an exchange transaction with another entity. They must be recorded at the end of any period when financial statements are prepared to properly reflect financial position and results of operations according to the accrual accounting model. Question 2-13 Closing entries transfer the balances in the temporary owners’ equity accounts to a permanent owners’ equity account, retained earnings for a corporation. This is done only at the end of a fiscal year in order to reduce the temporary accounts to zero before beginning the next reporting year. Question 2-14 Prepaid expenses represent assets recorded when a cash disbursement creates benefits beyond the current reporting period. Examples are supplies on hand at the end of a period, prepaid rent, and the cost of plant and equipment. Question 2-15 The adjusting entry required when unearned revenues are earned is a debit to the unearned revenue liability and a credit to revenue. 3 Answers to Questions (continued) Question 2-16 Accrued liabilities are recorded when an expense has been incurred that will not be paid until a subsequent reporting period. The adjusting entry required to record an accrued liability is a debit to an expense and a credit to a liability. Question 2-17 Income statement - The purpose of the income statement is to summarize the operating activities of the company during a particular period of time. It is a change statement that is reporting the changes in owners’ equity that occurred during the period as a result of operating transactions (revenues, expenses, gains and losses). Balance sheet - The purpose of the balance sheet is to present the financial position of the company at a particular point in time. It is an organized array of assets, liabilities, and permanent owners’ equity accounts. Statement of cash flows - The purpose of the statement of cash flows is to disclose the events that caused cash to change during the period. Statement of shareholders’ equity - The purpose of the statement of shareholders’ equity is to disclose the sources of the changes in the various permanent shareholders’ equity accounts that occurred during the period. Question 2-18 A worksheet provides a means of organizing the accounting information needed to prepare adjusting and closing entries and the financial statements. This error would result in an overstatement of revenue and thus net income and retained earnings, and an understatement of liabilities. Question 2-19 Reversing entries are recorded at the beginning of a reporting period. They remove the effects of some of the adjusting entries made at the end of the previous reporting period. This simplifies the journal entries made during the new period by allowing cash payments or cash receipts to be entered directly into the expense or revenue account without regard to the accrual made at the end of the previous period. Question 2-20 The purpose of special journals is to record, in chronological order, the dual effect of repetitive types of transactions, such as cash receipts, cash disbursements, credit sales and credit purchases. Special journals simplify the recording process in the following ways: (1) journalizing the effects of a particular transaction is made more efficient through the use of specifically designed formats, (2) individual transactions are not posted to the general ledger accounts, but are accumulated in the special journals and a summary posting is made on a periodic basis, and (3) the responsibility for recording journal entries for the repetitive types of transactions is placed on individuals who have specialized training in handling them. 4 Answers to Questions (concluded) Question 2-21 The general ledger is a collection of control accounts representing assets, liabilities, permanent and temporary shareholders’ equity accounts. The subsidiary ledger contains a group of subsidiary accounts associated with a particular general ledger control account. For example, there will be a subsidiary ledger for accounts receivable that will keep track of the increases and decreases in the account receivable balance for each of the company’s customers purchasing goods or services on credit. At any point in time, the balance in the accounts receivable control account should equal the sum of the balances in the accounts receivable subsidiary ledger accounts. 5 Brief Exercise 2-1 Assets = Liabilities + Paid-in Capital + Retained Earnings 1. + 165,000 (inventory) + 165,000 (accounts payable) 2. - 40,000 (cash) - 40,000 (expense) 3. + 200,000 (accounts receivable) + 200,000 (revenue) - 120,000 (inventory) - 120,000 (expense) 4. + 180,000 (cash) - 180,000 (accounts receivable) 5. - 145,000 (cash) - 145,000 (accounts payable) Brief Exercise 2-2 1. Inventory .................................................................. 165,000 Accounts payable ................................................. 165,000 2. Salaries expense ....................................................... 40,000 Cash .................................................................... 40,000 3. Accounts receivable ................................................. 200,000 Sales revenue ....................................................... 200,000 Cost of goods sold ................................................... 120,000 Inventory .............................................................. 120,000 4. Cash ........................................................................ 180,000 Accounts receivable ............................................ 180,000 5. Accounts payable .................................................... 145,000 Cash ..................................................................... 145,000 BRIEF EXERCISES 6 Brief Exercise 2-3 BALANCE SHEET ACCOUNTS Cash Accounts receivable ___________________________ ___________________________ 6/1 Bal. 65,000 6/1 Bal. 43,000 4. 180,000 40,000 2. 3. 200,000 180,000 4. 145,000 5. _______________ ______________ 6/30 Bal. 60,000 6/30 Bal. 63,000 Inventory Accounts payable ___________________________ ___________________________ 6/1 Bal. 0 6/1 Bal. 22,000 1. 165,000 120,000 3. 5. 145,000 165,000 1. _______________ ______________ 6/30 Bal. 45,000 6/30 Bal. 42,000 INCOME STATEMENT ACCOUNTS Sales revenue Cost of goods sold ___________________________ ___________________________ 0 6/1 Bal. 6/1 Bal. 0 200,000 3. 3. 120,000 _______________ ______________ 200,000 6/30 Bal. 6/30 Bal. 120,000 Salaries expense ___________________________ 6/1 Bal. 0 2. 40,000 _______________ 6/30 Bal. 40,000 7 Brief Exercise 2-4 1. Prepaid insurance ..................................................... 12,000 Cash .................................................................... 12,000 2. Note receivable ....................................................... 10,000 Cash .................................................................... 10,000 3. Equipment ............................................................... 60,000 Cash .................................................................... 60,000 Brief Exercise 2-5 1. Insurance expense ($12,000 x 3/12) ............................. 3,000 Prepaid insurance ................................................ 3,000 2. Interest receivable ($10,000 x 6% x 6/12) ..................... 300 Interest revenue.................................................... 300 3. Depreciation expense ............................................... 12,000 Accumulated depreciation - equipment ............... 12,000 Brief Exercise 2-6 Net income would be higher by $14,700 ($3,000 - 300 + 12,000). 8 Brief Exercise 2-7 1. Service revenue ....................................................... 4,000 Unearned service revenue ................................... 4,000 2. Advertising expense ($2,000 x 1/2) ............................ 1,000 Prepaid advertising ............................................. 1,000 3. Salaries expense ....................................................... 16,000 Salaries payable ................................................... 16,000 4. Interest expense ($60,000 x 8% x 4/12) ........................ 1,600 Interest payable .................................................... 1,600 Brief Exercise 2-8 Assets would be higher by $1,000, the amount of prepaid advertising that expired during the month. Liabilities would be lower by $21,600 ($4,000 + 16,000 + 1,600). Shareholders’ equity (and net income for the period) would be higher by $22,600. 9 Brief Exercise 2-9 BOWLER CORPORATION Income Statement For the Year Ended December 31, 2006 Sales revenue .............................................. $325,000 Cost of goods sold .................................... 168,000 Gross profit ................................................. 157,000 Operating expenses: Salaries ..................................................... $45,000 Rent .......................................................... 20,000 Depreciation ............................................. 30,000 Miscellaneous ........................................... 12,000 Total operating expenses ............. 107,000 Net income .................................................. $ 50,000 10 Brief Exercise 2-10 BOWLER CORPORATION Balance Sheet At December 31, 2006 Assets Current assets: Cash .......................................................... $ 5,000 Accounts receivable ................................. 10,000 Inventory .................................................. 16,000 Total current assets .............................. 31,000 Property and equipment: Machinery and Equipment ....................... 100,000 Less: Accumulated depreciation .............. (40,000) 60,000 Total assets ....................................... $91,000 Liabilities and Shareholders' Equity Current liabilities: Accounts payable ..................................... $ 20,000 Salaries payable ........................................ 12,000 Total current liabilities ........................ 32,000 Shareholders’ equity: Common stock .......................................... $50,000 Retained earnings ..................................... 9,000 Total shareholders’ equity ................... 59,000 Total liabilities and shareholders’ equity $91,000 11 Brief Exercise 2-11 Sales revenue .................................................................. 850,000 Income summary......................................................... 850,000 Income summary ............................................................. 815,000 Cost of goods sold ...................................................... 580,000 Salaries expense .......................................................... 180,000 Rent expense ............................................................... 40,000 Interest expense .......................................................... 15,000 Income summary ($850,000 - 815,000) .............................. 35,000 Retained earnings ....................................................... 35,000 Brief Exercise 2-12 Revenues $428,000* Expenses: Salaries (240,000) Utilities (33,000)** Advertising (12,000) Net Income $143,000 *$420,000 cash received plus $8,000 increase ($60,000 – 52,000) in amount due from customers: Cash ....................................................................... 420,000 Accounts receivable (increase in account) .............. 8,000 Sales revenue (to balance) ................................... 428,000 ** $35,000 cash paid less $2,000 decrease in amount owed to utility company: Utilities expense (to balance) ................................. 33,000 Utilities expense payable (decrease in account) ...... 2,000 Cash .................................................................... 35,000 12 Exercise 2-1 Assets = Liabilities + Paid-in Capital + Retained Earnings 1. + 300,000 (cash) + 300,000 (common stock) 2. - 10,000 (cash) + 40,000 (equipment) + 30,000 (note payable) 3. + 90,000 (inventory) + 90,000 (accounts payable) 4. + 120,000 (accounts receivable) + 120,000 (revenue) - 70,000 (inventory) - 70,000 (expense) 5. - 5,000 (cash) - 5,000 (expense) 6. - 6,000 (cash) + 6,000 (prepaid insurance) 7. - 70,000 (cash) - 70,000 (accounts payable) 8. + 55,000 (cash) - 55,000 (accounts receivable) 9. - 1,000 (accumulated depreciation) - 1,000 (expense) EXERCISES 13 Exercise 2-2 1. Cash ......................................................................... 300,000 Common stock ..................................................... 300,000 2. Equipment ................................................................ 40,000 Note payable ........................................................ 30,000 Cash .................................................................... 10,000 3. Inventory .................................................................. 90,000 Accounts payable ................................................. 90,000 4. Accounts receivable ................................................. 120,000 Sales revenue ....................................................... 120,000 Cost of goods sold ................................................... 70,000 Inventory .............................................................. 70,000 5. Rent expense ............................................................ 5,000 Cash ..................................................................... 5,000 6. Prepaid insurance ..................................................... 6,000 Cash ..................................................................... 6,000 7. Accounts payable ..................................................... 70,000 Cash ..................................................................... 70,000 8. Cash ......................................................................... 55,000 Accounts receivable ............................................. 55,000 9. Depreciation expense ............................................... 1,000 Accumulated depreciation ................................... 1,000 14 Exercise 2-3 BALANCE SHEET ACCOUNTS Cash Accounts receivable ___________________________ ___________________________ 3/1 Bal. 0 3/1 Bal. 0 1. 300,000 10,000 2. 4. 120,000 55,000 8. 8. 55,000 5,000 5. 6,000 6. 70,000 7. _______________ ______________ 3/31 Bal. 264,000 3/31 Bal. 65,000 Inventory Prepaid Insurance ___________________________ ___________________________ 3/1 Bal. 0 3/1 Bal. 0 3. 90,000 70,000 4. 6. 6,000 _______________ ______________ 3/31 Bal. 20,000 3/31 Bal. 6,000 Equipment Accumulated depreciation ___________________________ ___________________________ 3/1 Bal. 0 0 3/1 Bal. 2. 40,000 1,000 9. _______________ ______________ 3/31 Bal. 40,000 1,000 3/31 Bal. Accounts payable Note payable ___________________________ ___________________________ 0 3/1 Bal. 0 3/1 Bal. 7. 70,000 90,000 3. 30,000 2. _______________ ______________ 20,000 3/31 Bal. 30,000 3/31 Bal. Common stock ___________________________ 0 3/1 Bal. 300,000 1. _______________ 300,000 3/31 Bal. 15 Exercise 2-3 (concluded) INCOME STATEMENT ACCOUNTS Sales revenue Cost of goods sold ___________________________ ___________________________ 0 3/1 Bal. 3/1 Bal. 0 120,000 4. 4. 70,000 _______________ ______________ 120,000 3/31 Bal. 3/31 Bal. 70,000 Rent expense Depreciation expense ___________________________ ___________________________ 3/1 Bal. 0 3/1 Bal. 0 5. 5,000 9. 1,000 _______________ ______________ 3/31 Bal. 5,000 3/31 Bal. 1,000 Account Title Debits Credits Cash 264,000 Accounts receivable 65,000 Inventory 20,000 Prepaid insurance 6,000 Equipment 40,000 Accumulated depreciation 1,000 Accounts payable 20,000 Note payable 30,000 Common stock 300,000 Sales revenue 120,000 Cost of goods sold 70,000 Rent expense 5,000 Depreciation expense 1,000 ______ Totals 471,000 471,000 16 Exercise 2-4 1. Cash ..................................................................... 500,000 Common stock .................................................. 500,000 2. Furniture and fixtures .......................................... 100,000 Note payable ..................................................... 60,000 Cash .................................................................. 40,000 3. Inventory .............................................................. 200,000 Accounts payable .............................................. 200,000 4. Accounts receivable ............................................. 280,000 Sales revenue..................................................... 280,000 Cost of goods sold ............................................... 140,000 Inventory ........................................................... 140,000 5. Rent expense ........................................................ 6,000 Cash ................................................................... 6,000 6. Prepaid insurance ................................................. 3,000 Cash ................................................................... 3,000 7. Accounts payable ................................................. 120,000 Cash ................................................................... 120,000 8. Cash ..................................................................... 55,000 Accounts receivable .......................................... 55,000 9. Retained earnings ................................................ 5,000 Cash ................................................................... 5,000 10. Depreciation expense ........................................... 2,000 Accumulated depreciation ................................ 2,000 11. Insurance expense ($3,000 ÷ 12 months) ................. 250 Prepaid insurance .............................................. 250 17 Exercise 2-5 List A List B k 1. Source documents a. Records the dual effect of a transaction in debit/credit form. e 2. Transaction analysis b. Internal events recorded at the end of a reporting period. a 3. Journal c. Primary means of disseminating information to external decision makers. j 4. Posting d. To zero out the owners’ equity temporary accounts. f 5. Unadjusted trial balance e. Determine the dual effect on the accounting equation. b 6. Adjusting entries f. List of accounts and their balances before recording adjusting entries. h 7. Adjusted trial balance g. List of accounts and their balances after recording closing entries. c 8. Financial statements h. List of accounts and their balances after recording adjusting entries. d 9. Closing entries i. A means of organizing information; not part of the formal accounting system. g 10. Post-closing trial balance j. Transferring balances from the journal to the ledger. i 11. Worksheet k. Used to identify and process external transactions. Exercise 2-6 Increase (I) or Decrease (D) Account 1. I Inventory 2. I Depreciation expense 3. D Accounts payable 4. I Prepaid rent 5. D Sales revenue 6. D Common stock 7. D Wages payable 8. I Cost of goods sold 9. I Utility expense 10. I Equipment 11. I Accounts receivable 12. D Allowance for uncollectible accounts 13. I Bad debt expense 18 14. I Interest expense 15. D Interest revenue 16. D Gain on sale of equipment 19 Exercise 2-7 Account(s) Account(s) Debited Credited Example: Purchased inventory for cash 3 5 1. Paid a cash dividend. 10 5 2. Paid rent for the next three months. 8 5 3. Sold goods to customers on account. 4,16 9,3 4. Purchased inventory on account. 3 1 5. Purchased supplies for cash. 6 5 6. Paid employees wages for September. 15 5 7. Issued common stock in exchange for cash. 5 12 8. Collected cash from customers for goods sold in 3. 5 4 9. Borrowed cash from a bank and signed a note. 5 11 10. At the end of October, recorded the amount of supplies that had been used during the month. 7 6 11. Received cash for advance payment from customer. 5 13 12. Accrued employee wages for October. 17 15 Exercise 2-8 1. Prepaid insurance ($12,000 x 30/36) .............................. 10,000 Insurance expense .................................................. 10,000 2. Depreciation expense ................................................. 15,000 Accumulated depreciation .................................... 15,000 3. Bad debt expense ($6,500 - 2,000) ................................ 4,500 Allowance for uncollectible accounts ................... 4,500 4. Salaries expense ......................................................... 18,000 Salaries payable ..................................................... 18,000 5. Interest expense ($200,000 x 12% x 2/12) ....................... 4,000 Interest payable ...................................................... 4,000 6. Unearned rent revenue ............................................... 1,500 Rent revenue (1/2 x $3,000) ...................................... 1,500 20 Exercise 2-9 1. Interest receivable ($90,000 x 8% x 3/12) ....................... 1,800 Interest revenue...................................................... 1,800 2. Rent expense ($6,000 x 2/3) .......................................... 4,000 Prepaid rent ............................................................ 4,000 3. Rent revenue ($12,000 x 7/12) ....................................... 7,000 Unearned rent revenue .......................................... 7,000 4. Depreciation expense ................................................. 4,500 Accumulated depreciation ..................................... 4,500 5. Salaries expense ........................................................ 8,000 Salaries payable ..................................................... 8,000 6. Supplies expense ($2,000 + 6,500 - 3,250) ..................... 5,250 Supplies ................................................................. 5,250 Exercise 2-10 Requirement 1 BLUEBOY CHEESE CORPORATION Income Statement For the Year Ended December 31, 2006 Sales revenue .............................................. $800,000 Cost of goods sold .................................... 480,000 Gross profit ................................................. 320,000 Operating expenses: Salaries ...................................................... $120,000 Rent ........................................................... 30,000 Depreciation ............................................. 60,000 Bad debt .................................................... 5,000 Total operating expenses ............. 215,000 Operating income ........................................ 105,000 Other expense: Interest ...................................................... 4,000 Net income .................................................. $101,000 21 Exercise 2-10 (continued) BLUEBOY CHEESE CORPORATION Balance Sheet At December 31, 2006 Assets Current assets: Cash .......................................................... $ 21,000 Accounts receivable ................................. $300,000 Less: Allowance for uncollectible accounts (20,000) 280,000 Inventory ................................................... 50,000 Prepaid rent .............................................. 10,000 Total current assets .............................. 361,000 Property and equipment: Equipment ................................................ 600,000 Less: Accumulated depreciation .............. (250,000) 350,000 Total assets ....................................... $711,000 Liabilities and Shareholders' Equity Current liabilities: Accounts payable ..................................... $ 40,000 Salaries payable ........................................ 8,000 Interest payable ........................................ Note payable ............................................. 2,000 60,000 Total current liabilities ........................ 110,000 Shareholders’ equity: Common stock .......................................... $400,000 Retained earnings ..................................... 201,000* Total shareholders’ equity ................... 601,000 Total liabilities and shareholders’ equity $711,000 *Beginning balance of $100,000 plus net income of $101,000. 22 Exercise 2-10 (concluded) Requirement 2 December 31, 2006 Sales revenue .................................................................. 800,000 Income summary......................................................... 800,000 Income summary ............................................................. 699,000 Cost of goods sold ...................................................... 480,000 Salaries expense .......................................................... 120,000 Rent expense ............................................................... 30,000 Depreciation expense .................................................. 60,000 Interest expense .......................................................... 4,000 Bad debt expense ........................................................ 5,000 Income summary ($800,000 - 699,000) .............................. 101,000 Retained earnings ........................................................ 101,000 23 Exercise 2-11 December 31, 2006 Sales revenue .................................................................. 750,000 Interest revenue ............................................................... 3,000 Income summary......................................................... 753,000 Income summary ............................................................. 576,000 Cost of goods sold ...................................................... 420,000 Salaries expense .......................................................... 100,000 Rent expense ............................................................... 15,000 Depreciation expense .................................................. 30,000 Interest expense .......................................................... 5,000 Insurance expense ....................................................... 6,000 Income summary ($753,000 - 576,000) .............................. 177,000 Retained earnings ....................................................... 177,000 Exercise 2-12 Requirement 1 Supplies 11/30 Balance 1,500 Expense 2,000 Purchased ? 12/31 Balance 3,000 Cost of supplies purchased = $3,000 + 2,000 - 1,500 = $3,500 24 Exercise 2-12 (continued) Requirement 2 Prepaid insurance 11/30 Balance 6,000 Expense ? 12/31 Balance 4,500 Insurance expense for December = $6,000 - 4,500 = $1,500 December 31, 2006 Insurance expense ........................................................... 1,500 Prepaid insurance ........................................................ 1,500 Requirement 3 Wages payable 10,000 11/30 Balance Wages paid 10,000 ? Accrued wages 15,000 12/31 Balance Accrued wages for December = $15,000 December 31, 2006 Wages expense ................................................................ 15,000 Wages payable ............................................................ 15,000 25 Exercise 2-12 (concluded) Requirement 4 Unearned rent revenue 2,000 11/30 Balance Earned for Dec. 1,000 1,000 12/31 Balance Rent revenue recognized each month = $3,000 x 1/3 = $1,000 December 31, 2006 Unearned rent revenue .................................................... 1,000 Rent revenue ............................................................... 1,000 26 Exercise 2-13 Requirement 1 2006 Debit Credit Feb. 1 Cash .................................................... 12,000 Note payable ................................... 12,000 April 1 Prepaid insurance ............................... 3,600 Cash ................................................. 3,600 July 17 Supplies .............................................. 2,800 Accounts payable ............................ 2,800 Nov. 1 Note receivable ................................... 6,000 Cash ................................................. 6,000 Requirement 2 2006 Debit Credit Dec. 31 Interest expense ($12,000 x 10% x 11/12) 1,100 Interest payable ............................... 1,100 Dec. 31 Insurance expense ($3,600 x 9/24) ........ 1,350 Prepaid insurance ........................... 1,350 Dec. 31 Supplies expense ($2,800 - 1,250) .......... 1,550 Supplies ......................................... 1,550 Dec. 31 Interest receivable .............................. 80 Interest revenue ($6,000 x 8% x 2/12) 80 27 Exercise 2-14 Unadjusted net income $30,000 Adjustments: a. Only $2,000 in insurance should be expensed + 4,000 b. Sales revenue overstated - 1,000 c. Supplies expense overstated + 750 d. Interest expense understated ($20,000 x 12% x 3/12) - 600 Adjusted net income $33,150 28 Exercise 2-15 Stanley and Jones Lawn Service Company Income Statement For the Year Ended December 31, 2006 Sales revenue (1) .......................................... $315,000 Operating expenses: Salaries ..................................................... $180,000 Supplies (2) ................................................ 24,500 Rent .......................................................... 12,000 Insurance (3) ............................................. 4,000 Miscellaneous (4) ...................................... 21,000 Depreciation ............................................. 10,000 Total operating expenses ............. 251,500 Operating income ........................................ 63,500 Other expense: Interest (5) .................................................. 1,500 Net income .................................................. $62,000 (1) $320,000 cash collected less $5,000 decrease in accounts receivable. Cash ....................................................................... 320,000 Accounts receivable (decrease in account) ......... 5,000 Sales revenue (to balance) ................................... 315,000 (2) $25,000 cash paid for the purchase of supplies less $500 increase in supplies. Supplies expense (to balance) ................................ 24,500 Supplies (increase in account) ................................. 500 Cash .................................................................... 25,000 29 Exercise 2-15 (concluded) (3) $6,000 cash paid for insurance less $2,000 ending balance in prepaid insurance. Insurance expense (to balance) ............................... 4,000 Prepaid insurance (increase in account) .................. 2,000 Cash .................................................................... 6,000 (4) $20,000 cash paid for miscellaneous expenses plus increase in accrued liabilities. Miscellaneous expense (to balance) ....................... 21,000 Accrued liabilities (increase in account) ............. 1,000 Cash .................................................................... 20,000 (5) $100,000 x 6% x 3/12 = $1,500 Interest expense ..................................................... 1,500 Interest payable .................................................... 1,500 30 Exercise 2-16 Requirement 1 Account Title Unadjusted Trial Balance Adjusting Entries Adjusted Trial Balance Income Statement Balance Sheet Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash 20,000 20,000 20,000 Accounts receivable 35,000 35,000 35,000 Allowance for uncollectible accounts 2,000 (2) 3,000 5,000 5,000 Prepaid rent 5,000 5,000 5,000 Inventory 50,000 50,000 50,000 Equipment 100,000 100,000 100,000 Accumulated depreciation- equipment 30,000 (1) 10,000 40,000 40,000 Accounts payable 23,000 23,000 23,000 Wages payable 0 (3) 4,000 4,000 4,000 Common stock 100,000 100,000 100,000 Retained earnings 29,000 29,000 29,000 Sales revenue 323,000 323,000 323,000 Cost of goods sold 180,000 180,000 180,000 Wage expense 71,000 (3) 4,000 75,000 75,000 Rent expense 30,000 30,000 30,000 Depreciation expense 0 (1) 10,000 10,000 10,000 Utility expense 12,000 12,000 12,000 Bad debt expense 4,000 (2) 3,000 7,000 7,000 Net Income 9,000 9,000 Totals 507,000 507,000 17,000 17,000 524,000 524,000 323,000 323,000 210,000 210,000 31 Exercise 2-16 (continued) Requirement 2 WOLKSTEIN DRUG COMPANY Income Statement For the Year Ended December 31, 2006 Sales revenue ............................................... $323,000 Cost of goods sold ..................................... 180,000 Gross profit .................................................. 143,000 Operating expenses: Wage .......................................................... $75,000 Rent ........................................................... 30,000 Depreciation ............................................... 10,000 Utility ......................................................... 12,000 Bad debt .................................................... 7,000 Total operating expenses ............ 134,000 Net income ................................................... $ 9,000 32 Exercise 2-16 (concluded) WOLKSTEIN DRUG COMPANY Balance Sheet At December 31, 2006 Assets Current assets: Cash ............................................................. $ 20,000 Accounts receivable .................................... $ 35,000 Less: Allowance for uncollectible accounts (5,000) 30,000 Inventory ..................................................... 50,000 Prepaid rent ................................................. 5,000 Total current assets .................................. 105,000 Property and equipment: Equipment ................................................... 100,000 Less: Accumulated depreciation (40,000) 60,000 Total assets .......................................... $165,000 Liabilities and Shareholders' Equity Current liabilities: Accounts payable ........................................ $ 23,000 Wages payable ............................................ 4,000 Total current liabilities ............................ 27,000 Shareholders’ equity: Common stock ............................................ $100,000 Retained earnings ........................................ 38,000* Total shareholders’ equity ....................... 138,000 Total liabilities and shareholders’ equity $165,000 *Beginning balance of $29,000 plus net income of $9,000. 33 Exercise 2-17 Requirement 1 June 30 - adjusting entry Wages expense ($10,000 x 3/5) ......................................... 6,000 Wages payable ............................................................ 6,000 July 1 - reversing entry Wages payable ................................................................ 6,000 Wages expense ........................................................... 6,000 July 2 - payment of salaries Wages expense ............................................................... 10,000 Cash ............................................................................ 10,000 Requirement 2 June 30 - adjusting entry Wages expense ............................................................... 6,000 Wages payable ............................................................ 6,000 July 2 - payment of salaries Wages expense ............................................................... 4,000 Wages payable ................................................................ 6,000 Cash ............................................................................ 10,000 34 Exercise 2-18 Requirement 1 The accountant would reverse adjusting entry 1, the accrual of interest receivable, and entry 5, the accrual of salaries payable. Requirement 2 1. Interest receivable ($90,000 x 8% x 3/12) ....................... 1,800 Interest revenue ..................................................... 1,800 5. Salaries expense ....................................................... 8,000 Salaries payable ..................................................... 8,000 Requirement 3 1. Interest revenue ........................................................ 1,800 Interest receivable .................................................. 1,800 5. Salaries payable ........................................................ 8,000 Salaries expense .................................................... 8,000 35 Exercise 2-19 Transaction Journal 1. Purchased merchandise on account. PJ 2. Collected an account receivable. CR 3. Borrowed $20,000 and signed a note. CR 4. Recorded depreciation expense. GJ 5. Purchased equipment for cash. CD 6. Sold merchandise for cash. (the sale only, not the cost of the merchandise) CR 7. Sold merchandise on credit. (the sale only, not the cost of the merchandise) SJ 8. Recorded accrued wages payable. GJ 9. Paid employee wages. CD 10. Sold equipment for cash. CR 11. Sold equipment on credit. GJ 12. Paid a cash dividend to shareholders. CD 13. Issued common stock in exchange for cash. CR 14. Paid accounts payable. CD 36 Problem 2-1 Requirement 1 2006 Debit Credit Jan. 1 Cash ...................................................... 100,000 Common stock ................................. 100,000 Jan. 2 Inventory .............................................. 35,000 Accounts payable ............................. 35,000 Jan. 4 Prepaid insurance ................................. 2,400 Cash .................................................. 2,400 Jan. 10 Accounts receivable ............................. 12,000 Sales revenue .................................... 12,000 Jan. 10 Cost of goods sold ................................ 7,000 Inventory .......................................... 7,000 Jan. 15 Cash ...................................................... 30,000 Note payable .................................... 30,000 Jan. 20 Wages expense ..................................... 6,000 Cash .................................................. 6,000 Jan. 22 Cash ...................................................... 10,000 Sales revenue .................................... 10,000 Jan. 22 Cost of goods sold ................................ 6,000 Inventory .......................................... 6,000 Jan. 24 Accounts payable ................................. 15,000 Cash .................................................. 15,000 Jan. 26 Cash ...................................................... 6,000 Accounts receivable ......................... 6,000 Jan. 28 Utilities expense ................................... 1,000 Cash .................................................. 1,000 Jan. 30 Prepaid rent .......................................... 2,000 Rent expense ........................................ 2,000 Cash ................................................... 4,000 PROBLEMS 37 Problem 2-1 (continued) Requirement 2 BALANCE SHEET ACCOUNTS Cash Accounts receivable ____________________________ ____________________________ 1/1 Bal. 0 1/1 Bal. 0 1/1 100,000 2,400 1/4 1/10 12,000 6,000 1/26 1/15 30,000 6,000 1/20 1/22 10,000 15,000 1/24 1/26 6,000 1,000 1/28 4,000 1/30 _______________ ______________ 1/31 Bal. 117,600 1/31 Bal. 6,000 Inventory Prepaid insurance ____________________________ ____________________________ 1/1 Bal. 0 1/1 Bal. 0 1/2 35,000 7,000 1/10 1/4 2,400 6,000 1/22 _______________ ______________ 1/31 Bal. 22,000 1/31 Bal. 2,400 Prepaid rent Accounts payable ____________________________ ____________________________ 1/1 Bal. 0 0 1/1 Bal. 1/30 2,000 1/24 15,000 35,000 1/2 _______________ ______________ 1/31 Bal. 2,000 20,000 1/31 Bal. Note payable Common stock ____________________________ ____________________________ 0 1/1 Bal. 0 1/1 Bal. 30,000 1/15 100,000 1/1 _______________ ______________ 30,000 1/31 Bal. 100,000 1/31 Bal. 38 Problem 2-1 (continued) INCOME STATEMENT ACCOUNTS Sales revenue Cost of goods sold ____________________________ ____________________________ 0 1/1 Bal. 1/1 Bal. 0 12,000 1/10 1/10 7,000 10,000 1/22 1/22 6,000 _______________ ______________ 22,000 1/31 Bal. 1/31 Bal. 13,000 Rent expense Wages expense ____________________________ ____________________________ 1/1 Bal. 0 1/1 Bal. 0 1/30 2,000 1/20 6,000 _______________ ______________ 1/31 Bal. 2,000 1/31 Bal. 6,000 Utilities expense ____________________________ 1/1 Bal. 0 1/28 1,000 _______________ 1/31 Bal. 1,000 39 Problem 2-1 (concluded) Requirement 3 Account Title Debits Credits Cash 117,600 Accounts receivable 6,000 Inventory 22,000 Prepaid rent 2,000 Prepaid insurance 2,400 Accounts payable 20,000 Note payable 30,000 Common stock 100,000 Sales revenue 22,000 Cost of goods sold 13,000 Wages expense 6,000 Rent expense 2,000 Utilities expense 1,000 ______ Totals 172,000 172,000 40 Problem 2-2 Requirements 1 and 2 2006 Debit Credit Jan. 1 Cash ..................................................... 3,500 Sales revenue ................................... 3,500 Jan. 1 Cost of goods sold ............................... 2,000 Inventory .......................................... 2,000 Jan. 2 Equipment ............................................ 5,500 Accounts payable ............................. 5,500 Jan. 4 Advertising expense ............................. 150 Accounts payable ............................. 150 Jan. 8 Accounts receivable ............................. 5,000 Sales revenue ................................... 5,000 Jan. 8 Cost of goods sold ............................... 2,800 Inventory .......................................... 2,800 Jan. 10 Inventory .............................................. 9,500 Accounts payable ............................. 9,500 Jan. 13 Equipment ............................................ 800 Cash ................................................. 800 Jan. 16 Accounts payable ................................. 5,500 Cash ................................................. 5,500 Jan. 18 Cash ..................................................... 4,000 Accounts receivable ......................... 4,000 Jan. 20 Rent expense ........................................ 800 Cash .................................................. 800 Jan. 30 Wage expense ...................................... 3,000 Cash ................................................. 3,000 Jan. 31 Retained earnings ................................. 1,000 Cash ................................................. 1,000 41 Problem 2-2 (continued) Requirement 3 BALANCE SHEET ACCOUNTS Cash Accounts receivable ____________________________ ____________________________ 1/1 Bal. 5,000 1/1 Bal. 2,000 1/1 3,500 800 1/13 1/8 5,000 4,000 1/18 1/18 4,000 5,500 1/16 800 1/20 3,000 1/30 1,000 1/31 _______________ ______________ 1/31 Bal. 1,400 1/31 Bal. 3,000 Inventory Equipment ____________________________ ____________________________ 1/1 Bal. 5,000 1/1 Bal. 11,000 1/10 9,500 2,000 1/1 1/2 5,500 2,800 1/8 1/13 800 _______________ ______________ 1/31 Bal. 9,700 1/31 Bal. 17,300 Accumulated depreciation Accounts payable ____________________________ ____________________________ 3,500 1/1 Bal. 3,000 1/1 Bal. 1/16 5,500 5,500 1/2 150 1/4 9,500 1/10 _______________ ______________ 3,500 1/31 Bal. 12,650 1/31 Bal. Common stock Retained earnings ____________________________ ____________________________ 10,000 1/1 Bal. 6,500 1/1 Bal. 1/31 1,000 _______________ ______________ 10,000 1/31 Bal. 5,500 1/31 Bal. 42 Problem 2-2 (continued) INCOME STATEMENT ACCOUNTS Sales revenue Cost of goods sold ____________________________ ____________________________ 0 1/1 Bal. 1/1 Bal. 0 3,500 1/1 1/1 2,000 5,000 1/8 1/8 2,800 _______________ ______________ 8,500 1/31 Bal. 1/31 Bal. 4,800 Rent expense Wage expense ____________________________ ____________________________ 1/1 Bal. 0 1/1 Bal. 0 1/20 800 1/30 3,000 _______________ ______________ 1/31 Bal. 800 1/31 Bal. 3,000 Advertising expense ____________________________ 1/1 Bal. 0 1/4 150 _______________ 1/31 Bal. 150 43 Problem 2-2 (concluded) Requirement 4 Account Title Debits Credits Cash 1,400 Accounts receivable 3,000 Inventory 9,700 Equipment 17,300 Accumulated depreciation 3,500 Accounts payable 12,650 Common stock 10,000 Retained earnings 5,500 Sales revenue 8,500 Cost of goods sold 4,800 Wage expense 3,000 Rent expense 800 Advertising expense 150 ______ Totals 40,150 40,150 44 Problem 2-3 1. Depreciation expense ................................................ 10,000 Accumulated depreciation ..................................... 10,000 2. Bad debt expense ($5,500 - 3,000) ............................... 2,500 Allowance for uncollectible accounts ................... 2,500 3. Wage expense ............................................................ 1,500 Wages payable ....................................................... 1,500 4. Interest expense ($50,000 x 12% x 3/12) ....................... 1,500 Interest payable ...................................................... 1,500 5. Interest receivable ($20,000 x 8% x 10/12) .................... 1,333 Interest revenue ..................................................... 1,333 6. Prepaid insurance ($6,000 x 15/24) .............................. 3,750 Insurance expense .................................................. 3,750 7. Supplies expense ($1,500 - 800) .................................. 700 Supplies ................................................................. 700 8. Sales revenue ............................................................. 2,000 Unearned revenue .................................................. 2,000 9. Rent expense .............................................................. 1,000 Prepaid rent ........................................................... 1,000 45 Problem 2-4 Requirements 1 and 2 BALANCE SHEET ACCOUNTS Cash Accounts receivable ____________________________ ____________________________ Bal. 30,000 Bal. 40,000 _______________ ______________ 12/31 Bal. 30,000 12/31 Bal. 40,000 Prepaid rent Allowance for uncollectible accounts ____________________________ ____________________________ Bal. 2,000 3,000 Bal. 1,000 9. 2,500 2. _______________ ______________ 12/31 Bal. 1,000 5,500 12/31 Bal. Prepaid insurance Supplies ____________________________ ____________________________ Bal. 0 Bal. 1,500 6. 3,750 700 7. _______________ ______________ 12/31 Bal. 3,750 12/31 Bal. 800 Inventory Note receivable ____________________________ ____________________________ Bal. 60,000 Bal. 20,000 _______________ ______________ 12/31 Bal. 60,000 12/31 Bal. 20,000 Equipment Interest receivable ____________________________ ____________________________ Bal. 80,000 Bal. 0 5. 1,333 _______________ ______________ 12/31 Bal. 80,000 12/31 Bal. 1,333 46 Problem 2-4 (continued) Accumulated depreciation Accounts payable ____________________________ ____________________________ 30,000 Bal. 28,000 Bal. 10,000 1. _______________ ______________ 40,000 12/31 Bal. 28,000 12/31 Bal. Wages payable Note payable ____________________________ ____________________________ 0 Bal. 50,000 Bal. 1,500 3. _______________ ______________ 1,500 12/31 Bal. 50,000 12/31 Bal. Interest payable Unearned revenue ____________________________ ____________________________ 0 Bal. 0 Bal. 1,500 4. 2,000 8. _______________ ______________ 1,500 12/31 Bal. 2,000 12/31 Bal. Common stock Retained earnings ____________________________ ____________________________ 60,000 Bal. 24,500 Bal. _______________ ______________ 60,000 12/31 Bal. 24,500 12/31 Bal. 47 Problem 2-4 (continued) INCOME STATEMENT ACCOUNTS Sales revenue Interest revenue ____________________________ ____________________________ 148,000 Bal. 0 Bal. 8. 2,000 1,333 5. _______________ ______________ 146,000 12/31 Bal. 1,333 12/31 Bal. Cost of goods sold Wage expense ____________________________ ____________________________ Bal. 70,000 Bal. 18,900 3. 1,500 _______________ ______________ 12/31 Bal. 70,000 12/31 Bal. 20,400 Rent expense Depreciation expense ____________________________ ____________________________ Bal. 11,000 Bal. 0 9. 1,000 1. 10,000 _______________ ______________ 12/31 Bal. 12,000 12/31 Bal. 10,000 Interest expense Supplies expense ____________________________ ____________________________ Bal. 0 Bal. 1,100 4. 1,500 7. 700 _______________ ______________ 12/31 Bal. 1,500 12/31 Bal. 1,800 Insurance expense Bad debt expense ____________________________ ____________________________ Bal. 6,000 Bal. 3,000 3,750 6. 2. 2,500 _______________ ______________ 12/31 Bal. 2,250 12/31 Bal. 5,500 48 Problem 2-4 (continued) Requirement 3 Account Title Debits Credits Cash 30,000 Accounts receivable 40,000 Allowance for uncollectible accounts 5,500 Prepaid rent 1,000 Prepaid insurance 3,750 Supplies 800 Inventory 60,000 Note receivable 20,000 Interest receivable 1,333 Equipment 80,000 Accumulated depreciation-equipment 40,000 Accounts payable 28,000 Wages payable 1,500 Note payable 50,000 Interest payable 1,500 Unearned revenue 2,000 Common stock 60,000 Retained earnings 24,500 Sales revenue 146,000 Interest revenue 1,333 Cost of goods sold 70,000 Wage expense 20,400 Rent expense 12,000 Depreciation expense 10,000 Interest expense 1,500 Supplies expense 1,800 Insurance expense 2,250 Bad debt expense 5,500 ______ Totals 360,333 360,333 49 Problem 2-4 (continued) Requirement 4 PASTINA COMPANY Income Statement For the Year Ended December 31, 2006 Sales revenue ............................................. $146,000 Cost of goods sold .................................. 70,000 Gross profit ................................................ 76,000 Operating expenses: Wages ...................................................... $20,400 Rent ........................................................ 12,000 Depreciation ............................................ 10,000 Supplies .................................................. 1,800 Insurance ................................................ 2,250 Bad debt ................................................. 5,500 Total operating expenses ................ 51,950 Operating income 24,050 Other income (expense): Interest revenue ..................................... 1,333 Interest expense ..................................... (1,500) (167) Net income ................................................. $ 23,883 50 Problem 2-4 (continued) PASTINA COMPANY Statement of Shareholders' Equity For the Year Ended December 31, 2006 Total Common Retained Shareholders’ Stock Earnings Equity Balance at January 1, 2006 $60,000 $28,500 $ 88,500 Issue of common stock - 0 - - 0 - Net income for 2006 23,883 23,883 Less: Dividends ______ (4,000) (4,000) Balance at December 31, 2006 $60,000 $48,383 $108,383 51 Problem 2-4 (continued) PASTINA COMPANY Balance Sheet At December 31, 2006 Assets Current assets: Cash ............................................................ $ 30,000 Accounts receivable ................................... $40,000 Less: Allowance for uncollectible accounts (5,500) 34,500 Supplies ...................................................... 800 Inventory .................................................... 60,000 Note receivable ........................................... 20,000 Interest receivable ...................................... 1,333 Prepaid rent ................................................ 1,000 Prepaid insurance ....................................... 3,750 Total current assets ................................. 151,383 Equipment ..................................................... 80,000 Less: Accumulated depreciation ................ (40,000) 40,000 Total assets ........................................... $191,383 Liabilities and Shareholders' Equity Current liabilities Accounts payable ........................................ $ 28,000 Wages payable ............................................ 1,500 Note payable ............................................... Interest payable ........................................... 50,000 1,500 Unearned revenue ....................................... 2,000 Total current liabilities ............................ 83,000 Shareholders’ equity: Common stock ............................................ $60,000 Retained earnings ........................................ 48,383 Total shareholders’ equity ....................... 108,383 Total liabilities and shareholders’ equity $191,383 52 Problem 2-4 (continued) Requirement 5 December 31, 2006 Sales revenue .................................................................. 146,000 Interest revenue ............................................................... 1,333 Income summary ........................................................ 147,333 Income summary ............................................................ 123,450 Cost of goods sold ...................................................... 70,000 Wage expense ............................................................. 20,400 Rent expense ............................................................... 12,000 Depreciation expense .................................................. 10,000 Interest expense .......................................................... 1,500 Supplies expense ....................................................... 1,800 Insurance expense ....................................................... 2,250 Bad debt expense ........................................................ 5,500 Income summary ($147,333 - 123,450) .............................. 23,883 Retained earnings ....................................................... 23,883 53 Problem 2-4 (continued) Sales revenue Interest revenue ____________________________ ____________________________ 148,000 Bal. 0 Bal. 8. 2,000 1,333 5. Closing 146,000 Closing 1,333 _______________ ______________ 0 12/31 Bal. 0 12/31 Bal. Cost of goods sold Wage expense ____________________________ ____________________________ Bal. 70,000 Bal. 18,900 3. 1,500 70,000 Closing 20,400 Closing _______________ ______________ 12/31 Bal. 0 12/31 Bal. 0 Rent expense Depreciation expense ____________________________ ____________________________ Bal. 11,000 Bal. 0 9. 1,000 1. 10,000 12,000 Closing 10,000 Closing _______________ ______________ 12/31 Bal. 0 12/31 Bal. 0 Interest expense Supplies expense ____________________________ ____________________________ Bal. 0 Bal. 1,100 4. 1,500 7. 700 1,500 Closing 1,800 Closing _______________ ______________ 12/31 Bal. 0 12/31 Bal. 0 54 Problem 2-4 (continued) Insurance expense Bad debt expense ____________________________ ____________________________ Bal. 6,000 Bal. 3,000 3,750 6. 2. 2,500 2,250 Closing 5,500 Closing _______________ ______________ 12/31 Bal. 0 12/31 Bal. 0 Income summary Retained earnings ____________________________ ____________________________ Bal. 0 24,500 Bal. 147,333 Closing Closing 123,450 Closing 23,883 23,883 Closing _______________ ______________ 12/31 Bal. 0 48,383 12/31 Bal. 55 Problem 2-4 (concluded) Requirement 6 Account Title Debits Credits Cash 30,000 Accounts receivable 40,000 Allowance for uncollectible accounts 5,500 Prepaid rent 1,000 Prepaid insurance 3,750 Supplies 800 Inventory 60,000 Note receivable 20,000 Interest receivable 1,333 Equipment 80,000 Accumulated depreciation-equipment 40,000 Accounts payable 28,000 Wages payable 1,500 Note payable 50,000 Interest payable 1,500 Unearned revenue 2,000 Common stock 60,000 Retained earnings _______ 48,383 Totals 236,883 236,883 56 Problem 2-5 Bad debt expense ............................................................ 1,500 Allowance for uncollectible accounts ........................ 1,500 Rent expense ................................................................... 800 Prepaid rent ................................................................ 800 Supplies expense ............................................................ 700 Supplies ...................................................................... 700 Interest receivable .......................................................... 1,500 Interest revenue........................................................... 1,500 Depreciation expense ...................................................... 5,000 Accumulated depreciation .......................................... 5,000 Wage expense ................................................................. 6,200 Wages payable ............................................................ 6,200 Interest expense ............................................................. 2,500 Interest payable ........................................................... 2,500 Rent revenue .................................................................. 2,000 Unearned rent revenue ................................................ 2,000 Problem 2-6 Requirement 2 a. Cash ........................................................................... 70,000 Accounts receivable ................................................. 30,000 Service revenue ..................................................... 100,000 b. Cash ........................................................................... 27,300 Accounts receivable .............................................. 27,300 c. Cash ........................................................................... 10,000 Common stock ....................................................... 10,000 d. Salaries expense ....................................................... 41,000 Salaries payable ........................................................ 9,000 Cash ....................................................................... 50,000 e. Miscellaneous expenses ............................................ 24,000 Cash ....................................................................... 24,000 f. Equipment.................................................................. 15,000 Cash ....................................................................... 15,000 g. Retained earnings ..................................................... 2,500 Cash ....................................................................... 2,500 57 Problem 2-6 (continued) Requirements 1 and 3 BALANCE SHEET ACCOUNTS Cash Accounts receivable ____________________________ ____________________________ 1/1 Bal. 30,000 1/1 Bal. 15,000 a. 70,000 50,000 d. a. 30,000 27,300 b. b. 27,300 24,000 e. c. 10,000 15,000 f. 2,500 g. _______________ ______________ 12/31 Bal. 45,800 12/31 Bal. 17,700 Equipment Allow. for uncollectible accounts ____________________________ ____________________________ 1/1 Bal. 20,000 500 1/1 Bal. f. 15,000 _______________ ______________ 12/31 Bal. 35,000 500 12/31 Bal. Accumulated depreciation Salaries payable ____________________________ ____________________________ 6,000 1/1 Bal. 9,000 1/1 Bal. d. 9,000 _______________ ______________ 6,000 12/31 Bal. 0 12/31 Bal. Common stock Retained earnings ____________________________ ____________________________ 40,000 1/1 Bal. 9,500 1/1 Bal. 10,000 c. g. 2,500 _______________ ______________ 50,000 12/31 Bal. 7,000 12/31 Bal. 58 Problem 2-6 (continued) INCOME STATEMENT ACCOUNTS Service revenue Miscellaneous expenses ____________________________ ____________________________ 0 1/1 Bal. 1/1 Bal. 0 100,000 a. e. 24,000 _______________ ______________ 100,000 12/31 Bal. 12/31 Bal. 24,000 Salaries expense ____________________________ 1/1 Bal. 0 d. 41,000 _______________ 12/31 Bal. 41,000 Requirement 4 Account Title Debits Credits Cash 45,800 Accounts receivable 17,700 Allowance for uncollectible accounts 500 Equipment 35,000 Accumulated depreciation 6,000 Salaries payable - 0 - Common stock 50,000 Retained earnings 7,000 Service revenue 100,000 Salaries expense 41,000 Miscellaneous expenses 24,000 ______ Totals 163,500 163,500 59 Problem 2-6 (continued) Requirement 5 Salaries expense .............................................................. 1,000 Salaries payable .......................................................... 1,000 Depreciation expense ...................................................... 2,000 Accumulated depreciation .......................................... 2,000 Bad debt expense ............................................................ 1,000 Allowance for uncollectible accounts ($1,500 - 500).... 1,000 60 Problem 2-6 (continued) BALANCE SHEET ACCOUNTS Cash Accounts receivable ____________________________ ____________________________ 1/1 Bal. 30,000 1/1 Bal. 15,000 a. 70,000 50,000 d. a. 30,000 27,300 b. b. 27,300 24,000 e. c. 10,000 15,000 f. 2,500 g. _______________ ______________ 12/31 Bal. 45,800 12/31 Bal. 17,700 Equipment Allow. for uncollectible accounts ____________________________ ____________________________ 1/1 Bal. 20,000 500 1/1 Bal. f. 15,000 1,000 Adjusting _______________ ______________ 12/31 Bal. 35,000 1,500 12/31 Bal. Accumulated depreciation Salaries payable ____________________________ ____________________________ 6,000 1/1 Bal. 9,000 1/1 Bal. 2,000 Adjusting d. 9,000 1,000 Adjusting _______________ ______________ 8,000 12/31 Bal. 1,000 12/31 Bal. Common stock Retained earnings ____________________________ ____________________________ 40,000 1/1 Bal. 9,500 1/1 Bal. 10,000 c. g. 2,500 _______________ ______________ 50,000 12/31 Bal. 7,000 12/31 Bal. 61 Problem 2-6 (continued) INCOME STATEMENT ACCOUNTS Service revenue Miscellaneous expenses ____________________________ ____________________________ 0 1/1 Bal. 1/1 Bal. 0 100,000 a. e. 24,000 _______________ ______________ 100,000 12/31 Bal. 12/31 Bal. 24,000 Depreciation expense Bad debt expense ____________________________ ____________________________ 1/1 Bal. 0 1/1 Bal. 0 Adjusting 2,000 Adjusting 1,000 _______________ ______________ 12/31 Bal. 2,000 12/31 Bal. 1,000 Salaries expense ____________________________ 1/1 Bal. 0 d. 41,000 Adjusting 1,000 _______________ 12/31 Bal. 42,000 62 Problem 2-6 (continued) Requirement 6 Account Title Debits Credits Cash 45,800 Accounts receivable 17,700 Allowance for uncollectible accounts 1,500 Equipment 35,000 Accumulated depreciation 8,000 Salaries payable 1,000 Common stock 50,000 Retained earnings 7,000 Service revenue 100,000 Salaries expense 42,000 Miscellaneous expenses 24,000 Depreciation expense 2,000 Bad debt expense 1,000 ______ Totals 167,500 167,500 Requirement 7 KARLIN COMPANY Income Statement For the Year Ended December 31, 2006 Service revenue ............................................ $100,000 Operating expenses: Salaries .................................................... $42,000 Miscellaneous ......................................... 24,000 Depreciation ........................................... 2,000 Bad debt .................................................. 1,000 Total operating expenses ........... 69,000 Net income ................................................... $ 31,000 63 Problem 2-6 (continued) KARLIN COMPANY Balance Sheet At December 31, 2006 Assets Current assets: Cash ............................................................ $45,800 Accounts receivable ................................... $17,700 Less: Allowance for uncollectible accounts (1,500) 16,200 Total current assets ................................ 62,000 Property and equipment: Equipment .................................................. 35,000 Less: Accumulated depreciation ................ (8,000) 27,000 Total assets ............................................ $89,000 Liabilities and Shareholders' Equity Current liabilities: Salaries payable ......................................... $ 1,000 Total current liabilities ........................... 1,000 Shareholders’ equity: Common stock ........................................... $50,000 Retained earnings ....................................... 38,000* Total shareholders’ equity ..................... 88,000 Total liabilities and shareholders’ equity $89,000 *Beginning balance of $7,000 plus net income of $31,000. 64 Problem 2-6 (continued) Requirement 8 December 31, 2006 Service revenue ............................................................... 100,000 Income summary ........................................................ 100,000 Income summary ............................................................ 69,000 Salaries expense .......................................................... 42,000 Miscellaneous expenses .............................................. 24,000 Depreciation expense .................................................. 2,000 Bad debt expense ........................................................ 1,000 Income summary ............................................................ 31,000 Retained earnings ....................................................... 31,000 65 Problem 2-6 (continued) BALANCE SHEET ACCOUNTS Cash Accounts receivable ____________________________ ____________________________ 1/1 Bal. 30,000 1/1 Bal. 15,000 a. 70,000 50,000 d. a. 30,000 27,300 b. b. 27,300 24,000 e. c. 10,000 15,000 f. 2,500 g. _______________ ______________ 12/31 Bal. 45,800 12/31 Bal. 17,700 Equipment Allow. for uncollectible accounts ____________________________ ____________________________ 1/1 Bal. 20,000 500 1/1 Bal. f. 15,000 1,000 Adjusting _______________ ______________ 12/31 Bal. 35,000 1,500 12/31 Bal. Accumulated depreciation Salaries payable ____________________________ ____________________________ 6,000 1/1 Bal. 9,000 1/1 Bal. 2,000 Adjusting d. 9,000 1,000 Adjusting _______________ ______________ 8,000 12/31 Bal. 1,000 12/31 Bal. Common stock Retained earnings ____________________________ ____________________________ 40,000 1/1 Bal. 9,500 1/1 Bal. 10,000 c. g. 2,500 31,000 Closing _______________ ______________ 50,000 12/31 Bal. 38,000 12/31 Bal. 66 Problem 2-6 (continued) INCOME STATEMENT ACCOUNTS Service revenue Miscellaneous expenses ____________________________ ____________________________ 0 1/1 Bal. 1/1 Bal. 0 100,000 a. e. 24,000 Closing 100,000 24,000 Closing _______________ ______________ 0 12/31 Bal. 12/31 Bal. 0 Depreciation expense Bad debt expense ____________________________ ____________________________ 1/1 Bal. 0 1/1 Bal. 0 Adjusting 2,000 Adjusting 1,000 2,000 Closing 1,000 Closing _______________ ______________ 12/31 Bal. 0 12/31 Bal. 0 Salaries expense Income summary ____________________________ ____________________________ 1/1 Bal. 0 100,000 Closing d. 41,000 Closing 69,000 Adjusting 1,000 42,000 Closing Closing 31,000 _______________ ______________ 12/31 Bal. 0 12/31 Bal. 0 67 Problem 2-6 (concluded) Requirement 9 Account Title Debits Credits Cash 45,800 Accounts receivable 17,700 Allowance for uncollectible accounts 1,500 Equipment 35,000 Accumulated depreciation 8,000 Salaries payable 1,000 Common stock 50,000 Retained earnings _____ 38,000 Totals 98,500 98,500 68 Problem 2-7 Requirement 1 a. Interest receivable ..................................................... 600 Interest revenue ($10,000 x 12% x 1/2) ..................... 600 b. Depreciation expense ($30,000 x 1/5) .......................... 6,000 Accumulated depreciation ..................................... 6,000 c. Unearned rent revenue ............................................... 2,000 Rent revenue ($6,000 x 2/6) ..................................... 2,000 d. Prepaid insurance ..................................................... 1,500 Insurance expense ($2,400 x 15/24) ......................... 1,500 e. Interest expense ($20,000 x 12% x 3/12) ....................... 600 Interest payable ...................................................... 600 f. Supplies expense ($1,800 - 700) .................................. 1,100 Supplies ................................................................. 1,100 Requirement 2 Income overstated (understated) Adjustments to revenues: Understatement of interest revenue $ (600) Understatement of rent revenue (2,000) Adjustments to expenses: Overstatement of insurance expense (1,500) Understatement of depreciation expense 6,000 Understatement of interest expense 600 Understatement of supplies expense 1,100 Overstatement of net income $3,600 69 Problem 2-8 1. Depreciation expense ($75,000 ÷ 8 years) .................... 9,375 Accumulated depreciation ..................................... 9,375 2. Wage expense ($4,500 - 3,000) .................................... 1,500 Wages payable ....................................................... 1,500 3. Bad debt expense ...................................................... 550 Allowance for uncollectible accounts ................... 550 [($32,500 x 2%) - $100]............................................. 4. Interest expense ($30,000 x 10% x 4/12) ........................ 1,000 Interest payable ...................................................... 1,000 5. Supplies ..................................................................... 500 Supplies expense ................................................... 500 6. Prepaid rent ................................................................ 1,000 Rent expense .......................................................... 1,000 70 Problem 2-9 Requirement 1 a. Sales revenue Accounts receivable 11/30 Balance 10,000 80,000 Cash collections Sales revenue ? 12/31 Balance 3,000 Sales revenue during December = $3,000 + 80,000 - 10,000 = $73,000 b. Cost of goods sold Accounts payable 12,000 11/30 Balance Cash paid 60,000 ? Purchases 15,000 12/31 Balance Purchases during December = $15,000 + 60,000 - 12,000 = $63,000 Inventory 11/30 Balance 7,000 Purchases 63,000 ? Cost of goods sold 12/31 Balance 6,000 Cost of goods sold during December = $7,000 + 63,000 - 6,000 = $64,000 71 Problem 2-9 (concluded) c. Insurance expense Prepaid insurance 11/30 Balance 5,000 Cash payment 5,000 ? Insurance expense 12/31 Balance 7,500 Insurance expense during December = $5,000 + 5,000 - 7,500 = $2,500 d. Wage expense Wages payable 5,000 11/30 Balance Cash payments 10,000 ? Wage expense 3,000 12/31 Balance Wage expense during December = $3,000 + 10,000 - 5,000 = $8,000 Requirement 2 Accounts receivable ........................................................ 73,000 Sales revenue .............................................................. 73,000 Cost of goods sold .......................................................... 64,000 Inventory ..................................................................... 64,000 72 Problem 2-10 Requirements 1 and 2 a. Depreciation expense ($50,000 ÷ 50 years) ................... 1,000 Accumulated depreciation - buildings .................. 1,000 b. Depreciation expense ($100,000 x 10%) ...................... 10,000 Accumulated depreciation - equipment ................. 10,000 c. Insurance expense ...................................................... 1,500 Prepaid insurance ................................................. 1,500 d. Bad debt expense ...................................................... 850 Allowance for uncollectible accounts ................... 850 [($9,000 x 10%) - $50] e. Salaries expense ........................................................ 1,500 Salaries payable ..................................................... 1,500 f. Rent revenue .............................................................. 1,200 Unearned rent revenue ........................................... 1,200 73 Problem 2-10 (continued) BALANCE SHEET ACCOUNTS Cash Accounts receivable ____________________________ ____________________________ Bal. 8,000 Bal. 9,000 _______________ ______________ 12/31 Bal. 8,000 12/31 Bal. 9,000 Prepaid insurance Allow. for uncollectible accounts ____________________________ ____________________________ Bal. 3,000 50 Bal. 1,500 Adjusting 850 Adjusting _______________ ______________ 12/31 Bal. 1,500 900 12/31 Bal. Land Buildings ____________________________ ____________________________ Bal. 200,000 Bal. 50,000 _______________ ______________ 12/31 Bal. 200,000 12/31 Bal. 50,000 Equipment Accumulated depreciation-bldg. ____________________________ ____________________________ Bal. 100,000 20,000 Bal. 1,000 Adjusting _______________ ______________ 12/31 Bal. 100,000 21,000 12/31 Bal. Accumulated depreciation-equip. Accounts payable ____________________________ ____________________________ 40,000 Bal. 35,000 Bal. 10,000 Adjusting _______________ ______________ 50,000 12/31 Bal. 35,000 12/31 Bal. 74 Problem 2-10 (continued) Salaries payable Unearned rent revenue ____________________________ ____________________________ 0 Bal. 0 Bal. 1,500 Adjusting 1,200 Adjusting _______________ ______________ 1,500 12/31 Bal. 1,200 12/31 Bal. Common stock Retained earnings ____________________________ ____________________________ 200,000 Bal. 56,450 Bal. _______________ ______________ 200,000 12/31 Bal. 56,450 12/31 Bal. INCOME STATEMENT ACCOUNTS Sales revenue Interest revenue ____________________________ ____________________________ 90,000 Bal. 3,000 Bal. _______________ ______________ 90,000 12/31 Bal. 3,000 12/31 Bal. Rent revenue Salaries expense ____________________________ ____________________________ 7,500 Bal. Bal. 37,000 Adjusting 1,200 Adjusting 1,500 _______________ ______________ 6,300 12/31 Bal. 12/31 Bal. 38,500 Bad debt expense Depreciation expense ____________________________ ____________________________ Bal. 0 Bal. 0 Adjusting 850 Adjusting 1,000 Adjusting 10,000 _______________ ______________ 12/31 Bal. 850 12/31 Bal. 11,000 75 Problem 2-10 (continued) Utility expense Insurance expense ____________________________ ____________________________ Bal. 30,000 Bal. 0 Adjusting 1,500 _______________ ______________ 12/31 Bal. 30,000 12/31 Bal. 1,500 Maintenance expense ____________________________ Bal. 15,000 _______________ 12/31 Bal. 15,000 76 Problem 2-10 (continued) Requirement 3 Account Title Debits Credits Cash 8,000 Accounts receivable 9,000 Allowance for uncollectible accounts 900 Prepaid insurance 1,500 Land 200,000 Buildings 50,000 Accumulated depreciation-buildings 21,000 Equipment 100,000 Accumulated depreciation-equipment 50,000 Accounts payable 35,000 Salaries payable 1,500 Unearned rent revenue 1,200 Common stock 200,000 Retained earnings 56,450 Sales revenue 90,000 Interest revenue 3,000 Rent revenue 6,300 Salaries expense 38,500 Bad debt expense 850 Depreciation expense 11,000 Insurance expense 1,500 Utility expense 30,000 Maintenance expense 15,000 ______ Totals 465,350 465,350 77 Problem 2-10 (continued) Requirement 4 December 31, 2006 Sales revenue .................................................................. 90,000 Interest revenue .............................................................. 3,000 Rent revenue .................................................................. 6,300 Income summary ........................................................ 99,300 Income summary ............................................................ 96,850 Salaries expense .......................................................... 38,500 Bad debt expense ........................................................ 850 Depreciation expense .................................................. 11,000 Insurance expense ...................................................... 1,500 Utility expense ........................................................... 30,000 Maintenance expense ................................................. 15,000 Income summary ($99,300 - 96,850) .................................. 2,450 Retained earnings ....................................................... 2,450 78 Problem 2-10 (concluded) Requirement 5 Account Title Debits Credits Cash 8,000 Accounts receivable 9,000 Allowance for uncollectible accounts 900 Prepaid insurance 1,500 Land 200,000 Buildings 50,000 Accumulated depreciation-buildings 21,000 Equipment 100,000 Accumulated depreciation-equipment 50,000 Accounts payable 35,000 Salaries payable 1,500 Unearned rent revenue 1,200 Common stock 200,000 Retained earnings ______ 58,900 Totals 368,500 368,500 79 Problem 2-11 Computations: Sales revenue Sales revenue during 2006 = $320,000 + 22,000 = $342,000 Cost of goods sold Accounts payable 0 1/1 Balance Cash paid 220,000 ? Purchases 30,000 12/31 Balance Purchases during 2006 = $220,000 + 30,000 = $250,000 Inventory 1/1 Balance 0 Purchases 250,000 ? Cost of goods sold 12/31 Balance 50,000 Cost of goods sold during 2006 = $250,000 - 50,000 = $200,000 Rent expense and prepaid rent Prepaid rent = $ 3,000 x 2/3 = $2,000 Rent expense during 2006 = $14,000 - 2,000 = $12,000 Depreciation expense Depreciation during 2006 = $30,000 x 10% = $3,000 Interest expense Interest accrued during 2006 = $40,000 x 12% x 9/12 = $3,600 Salaries expense Cash paid plus accrued salaries = $80,000 + 5,000 = $85,000 80 Problem 2-11 (continued) McGUIRE CORPORATION Income Statement For the Year Ended December 31, 2006 Sales revenue ................................................... $342,000 Cost of goods sold ......................................... 200,000 Gross profit ...................................................... 142,000 Operating expenses: Salaries ........................................................... 85,000 Rent ................................................................ 12,000 Depreciation ................................................... 3,000 Bad debt ......................................................... 3,000 Miscellaneous ................................................ 10,000 Total operating expenses ................ 113,000 Operating income ............................................. 29,000 Other expense: Interest .......................................................... 3,600 Net income ....................................................... $ 25,400 81 Problem 2-11 (concluded) McGUIRE CORPORATION Balance Sheet At December 31, 2006 Assets Current assets: Cash ............................................................ $ 56,000 (1) Accounts receivable ................................... $22,000 Less: Allowance for uncollectible accounts (3,000) 19,000 Prepaid rent ................................................ 2,000 Inventory .................................................... 50,000 Total current assets .................................. 127,000 Equipment ..................................................... 30,000 Less: Accumulated depreciation ................ (3,000) 27,000 Total assets ............................................ $154,000 Liabilities and Shareholders' Equity Current liabilities: Accounts payable ....................................... $ 30,000 Salaries payable .......................................... 5,000 Note payable ............................................... Interest payable .......................................... 40,000 3,600 Total current liabilities ............................ 78,600 Shareholders’ equity: Common stock ........................................... $50,000 Retained earnings ....................................... 25,400 Total shareholders’ equity ....................... 75,400 Total liabilities and shareholders’ equity $154,000 (1) $410,000 - 354,000 = $56,000 82 Problem 2-12 Account Title Unadjusted Trial Balance Adjusting Entries Adjusted Trial Balance Income Statement Balance Sheet Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Dr. Cr. Cash 23,300 23,300 23,300 Accounts receivable 32,500 32,500 32,500 Allowance for uncollectible accounts 100 (3) 550 650 650 Supplies 0 (5) 500 500 500 Prepaid rent 0 (6) 1,000 1,000 1,000 Inventory 65,000 65,000 65,000 Equipment 75,000 75,000 75,000 Accumulated depreciation- equipment 10,000 (1) 9,375 19,375 19,375 Accounts payable 26,000 26,000 26,000 Wages payable 3,000 (2) 1,500 4,500 4,500 Note payable 30,000 30,000 30,000 Interest payable 0 (4) 1,000 1,000 1,000 Common stock 80,000 80,000 80,000 Retained earnings 16,050 16,050 16,050 Sales revenue 180,000 180,000 180,000 Cost of goods sold 95,000 95,000 95,000 Interest expense 0 (4) 1,000 1,000 1,000 Wage expense 32,350 (2) 1,500 33,850 33,850 Rent expense 14,000 (6) 1,000 13,000 13,000 Supplies expense 2,000 (5) 500 1,500 1,500 Utility expense 6,000 6,000 6,000 Bad debt expense 0 (3) 550 550 550 Depreciation expense 0 (1) 9,375 9,375 9,375 Net Income 19,725 19,725 Totals 345,150 345,150 13,925 13,925 357,575 357,575 180,000 180,000 197,300 197,300 83 Problem 2-12 (continued) EXCALIBUR CORPORATION Income Statement For the Year Ended December 31, 2006 Sales revenue ............................................... $180,000 Cost of goods sold ..................................... 95,000 Gross profit .................................................. 85,000 Operating expenses: Wage ......................................................... 33,850 Rent ............................................................ 13,000 Supplies ..................................................... 1,500 Utility ........................................................ 6,000 Bad debt .................................................... 550 Depreciation ............................................... 9,375 Total operating expenses ............ 64,275 Operating income ......................................... 20,725 Other expense: Interest ...................................................... 1,000 Net income ................................................... $ 19,725 84 Problem 2-12 (continued) EXCALIBUR CORPORATION Statement of Shareholders' Equity For the Year Ended December 31, 2006 Total Common Retained Shareholders’ Stock Earnings Equity Balance at January 1, 2006 $80,000 $22,050 $102,050 Issue of common stock - 0 - - 0 - Net income for 2006 19,725 19,725 Less: Dividends ______ (6,000) (6,000) Balance at December 31, 2006 $80,000 $35,775 $115,775 85 Problem 2-12 (continued) EXCALIBUR CORPORATION Balance Sheet At December 31, 2006 Assets Current assets: Cash ............................................................... $ 23,300 Accounts receivable ...................................... $32,500 Less: Allowance for uncollectible accounts . (650) 31,850 Supplies ......................................................... 500 Prepaid rent .................................................... 1,000 Inventory ....................................................... 65,000 Total current assets ..................................... 121,650 Equipment ........................................................ 75,000 Less: Accumulated depreciation ................... (19,375) 55,625 Total assets ............................................... $177,275 Liabilities and Shareholders' Equity Current liabilities: Accounts payable .......................................... $ 26,000 Wages payable .............................................. 4,500 Note payable .................................................. Interest payable ............................................. 30,000 1,000 Total current liabilities ............................... 61,500 Shareholders’ equity: Common stock .............................................. $80,000 Retained earnings .......................................... 35,775 Total shareholders’ equity .......................... 115,775 Total liabilities and shareholders’ equity $177,275 86 Problem 2-12 (concluded) December 31, 2006 Sales revenue .................................................................. 180,000 Income summary ........................................................ 180,000 Income summary ............................................................ 160,275 Cost of goods sold ...................................................... 95,000 Interest expense .......................................................... 1,000 Wage expense ............................................................. 33,850 Rent expense ............................................................... 13,000 Supplies expense ....................................................... 1,500 Utility expense ............................................................ 6,000 Bad debt expense ........................................................ 550 Depreciation expense .................................................. 9,375 Income summary ($180,000 - 160,275) .............................. 19,725 Retained earnings ....................................................... 19,725 87 Judgment Case 2-1 Requirement 1 Cash basis accounting produces a measure of performance called net operating cash flow. This measure is the difference between cash receipts and cash disbursements during a reporting period from transactions related to providing goods and services to customers. On the other hand, the accrual accounting model measures an entity’s accomplishments (revenues) and resource sacrifices (expenses) during the period, regardless of when cash is received or paid. Requirement 2 In most cases, the accrual accounting model provides a better measure of performance because it attempts to measure the accomplishments and sacrifices that occurred during the year, which may not correspond to cash inflows and outflows. Requirement 3 Adjusting entries, for the most part, are conversions from cash to accrual. Prepayments and accruals occur when cash flow precedes or follows expense or revenue recognition. Judgment Case 2-2 Requirement 1 Cash-basis net income $26,000 Add: 1. Unexpired (prepaid insurance) $12,000 x 8/12 8,000 2. Increase in accounts receivable ($6,500- 5,000) 1,500 5. Increase in inventories ($35,000 – 32,000) 3,000 Deduct: 3. Increase in wages payable ($8,200 – 7,200) (1,000) 4. Increase in utilities payable ($1,200 – 900) (300) 6. Increase in amount owed to suppliers (4,000) Accrual basis net income $33,200 Requirement 2 Assets would be higher by $12,500 ($8,000 + 1,500 + 3,000) and liabilities would also be higher by $5,300 ($1,000 + 300 + 4,000). The difference, $7,200, is the difference between cash and accrual income. Therefore, equity would be higher by $7,200. CASES 88 Communication Case 2-3 Requirement 1 Prepayments occur when the cash flow precedes either expense or revenue recognition. Accruals occur when the cash flow comes after either expense or revenue recognition. Requirement 2 The appropriate adjusting entry for a prepaid expense is a debit to expense and a credit to the prepaid asset. For unearned revenue, the appropriate adjusting entry is a debit to the unearned revenue liability account and a credit to revenue. Failure to record an adjusting entry for a prepaid expense will cause assets and shareholders’ equity to be overstated. Failure to record an adjusting entry for unearned revenue will cause liabilities to be overstated and shareholders’ equity to be understated. Requirement 3 The required adjusting entry for accrued liabilities is a debit to expense and a credit to a liability. For accrued receivables, the appropriate adjusting entry is a debit to a receivable and a credit to revenue. Failure to record an adjusting entry for an accrued liability will cause liabilities to be understated and shareholders’ equity to be overstated. Failure to record an adjusting entry for accrued receivables will cause assets and shareholders’ equity to be understated. 89 Analysis Case 2-4 Requirement 1 ($ in millions) Salaries and employee benefits expense $10,728 Less: Increase in accrued salaries and employee benefits ($1,062 – 724 from Note 5) 338 Cash paid to or in behalf of employees $10,390 Requirement 2 ($ in millions) Fuel expense $1,481 Maintenance and repairs expense 1,523 Add: Increase in spare parts, supplies and fuel in the balance sheet ($249 – 228) 21 Cash paid for maintenance and repairs and spare parts, supplies, and fuel purchased $3,025 Requirement 3 The income statement reports depreciation and amortization of $1,375 million. Solution Manual for Intermediate Accounting David J. Spiceland, James F. Sepe, Lawrence A. Tomassini 9780072994025, 9780072524482