Chapter 04 Solutions

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. 5. (a) Income statement: (Revenues + Gains) - (Expenses + Losses) = Net Income McGraw-Hill/Irwin Financial Accounting, 5/e

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(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). 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). McGraw-Hill/Irwin 4-2

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(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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Authors' Recommended Solution Time (Time in minutes)

Mini-exercises No. Time 1 5 2 5 3 3 4 5 5 5 6 5 7 5 8 5 9 5 10 5 11 5 12 3

Exercises No. Time 1 10 2 10 3 10 4 15 5 10 6 20 7 20 8 20 9 15 10 20 11 10 12 20 13 15 14 15 15 20 16 20 17 20 18 20 19 10 20 15

Problems No. Time 1 15 2 20 3 25 4 20 5 20 6 25 7 30 8 30 9 60

Alternate Problems No. Time 1 15 2 20 3 20 4 20 5 20 6 25 7 30 8 30

Cases and Projects No. Time 1 25 2 25 3 25 4 25 5 25 6 40 7 45 8 35 9 50 10 25 11 *

* 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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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 2. Unearned rent revenue (−L).......................... 200 Rent revenue (+R, +SE)......................... To record one month of rent revenue earned ($800 ÷ 4 months).

(b )

200

1. Deferred expense 2. Insurance expense (+E, −SE)........................ 900 Prepaid insurance (−A)........................... 900 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

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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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M4–6. (a )

1. Accrued expense 2. Utilities expense (+E, −SE)............................ 320 Accrued utilities payable (+L)................. To record utilities expense incurred but not yet paid.

(b )

320

1. Accrued expense 2. Wages expense (+E, −SE)............................. 4,500 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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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

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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

Earnings per share*

$20.33

* 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

Total Stockholders’ Equity $ 1,400 2,000 6,100 6,100 0 0 $ 7,100 $ 9,500 * From the trial balance.

Contributed Capital $ 400 2,000

Retained Earnings $ 1,000*

$ 2,400 Work backwards

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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) ...............................

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42,000 120 300 6,100 21,600 2,000 220 600 9,000 2,900

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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. McGraw-Hill/Irwin 4-12

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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.

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75,000 75,000

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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 Revenues Expenses NE +6,000 +3,000 NE NE +1,300 NE +75,000

Net Income –6,000 +3,000 –1,300 –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.

850 850

3,700 3,700

3,000 3,000

1,640 1,640

5,000 5,000

1,050 1,050

750 750

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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)

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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

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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

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

E4–11. Selected Balance Sheet Amounts at December 31, 2007 McGraw-Hill/Irwin Financial Accounting, 5/e

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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. Balance Sheet Income Statement Stockholders’ Net Assets Liabilities Equity Revenues Expenses Income +20,000/ NE NE NE NE NE –20,000

Date Note 1: April 1, 2008 December 31, 2008a March 31, 2009b Note 2: August 1, 2008

NE

+ 1,500

+ 1,500

NE

+ 1,500

NE

+ 500

+500

NE

+ 500

NE

NE

NE

NE

+ 20,000 + 20,000

December 31, 2008c January 31, 2009

+ 1,500 +22,000/ –21,500

d

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. E4–13. Req. 1

(a) (b) (c)

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(d) (e) (f)

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 (c) Beg. Bal.+ $43 + (f) Beg. Bal. + $45 +

cash paid = ? = ? =

End. bal. $80 $323 paid

dividends declared 176

cash paid = ? = ? =

End. bal. $48 $171 paid

accrued interest expense ? ?

cash paid = 297 = =

End. bal. $51 $303 accrued

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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

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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

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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)

Stockholders’ Equity $50,000

71,000

17,000 (1,600) 45,400

(9,000) (17,000) 1,600 25,600

$71,000

4,680 $50,080

(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.

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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

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$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.

Unearned rent revenue (−L).......................................... 4,800 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.

Wage expense (+E, −SE).............................................. 14,300 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.

Insurance expense (+E, −SE)........................................ 1,000 Prepaid insurance (−A)....................................... 1,000 $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.

Depreciation expense (+E, −SE)................................... 1,500 Accumulated depreciation, service truck (+XA, −A) 1,500 To record depreciation expense to recognize the use of the truck during the year. Amount is given.

g.

Unearned service revenue (−L)..................................... 400 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.

Insurance expense (+E, −SE)........................................ 200 Prepaid insurance (−A)....................................... 200 $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.

Supplies expense (+E, −SE).......................................... 700 Supplies (−A)........................................................ 700 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.

Repairs and maintenance expense (+E, −SE).............. 800 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.

Property tax expense (+E, −SE).................................... 1,600 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

Depreciation expense (+E, −SE)................................... 1,100 Accumulated depreciation, van (+XA, −A) 1,100 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

Income tax expense (+E, −SE)...................................... 9,990 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 55,10 0 $ (8,700)

41,700 $ 4,300

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.

Wages Payable o 12 Bal. 12 Contributed Capital Bal. 65 d 3 Bal. 68 Depreciation Expense m 6 CE Bal. 0 Supplies Expense l 16 CE Bal. 0

McGraw-Hill/Irwin 4-38

Equipment 60 60

6

16

Interest Payable n 1 Bal. 1

k

Bal.

Retained Earnings 17 Bal. CE 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 Bal. 0

85

© 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

Req. 4

16,000

6,000

1,000

12,000

8,000

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.

Insurance expense (+E, −SE)........................................ 1,600 Prepaid insurance (−A)....................................... 1,600 $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.

Wage expense (+E, −SE).............................................. 900 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.

Unearned maintenance revenue (−L)............................ 225 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.

Unearned service revenue (−L)..................................... 700 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.

Supplies expense (+E, −SE).......................................... 1,150 Supplies (−A)........................................................ 1,150 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.

Repairs and maintenance expense (+E, −SE).............. 600 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.

Insurance expense (+E, −SE)........................................ 200 Prepaid insurance (−A)....................................... 200 $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.

Rent expense (+E, −SE)................................................ 700 Prepaid rent (−A).................................................... 700 $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.

Depreciation expense (+E, −SE)................................... 1,600 Accumulated depreciation, display counters (+XA, −A) Depreciation is given.

1,600

AP4–3. (continued) McGraw-Hill/Irwin Financial Accounting, 5/e

© The McGraw-Hill Companies, Inc., 2007 4-47

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

Income tax expense (+E, −SE)...................................... 7,719 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

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

AP4–5. Req. 1 McGraw-Hill/Irwin 4-48

© The McGraw-Hill Companies, Inc., 2007 Solutions Manual

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 f 3 Bal. 8

1

Bal.

Bal.

8

4

18

Bal.

Accounts Payable h 11 Bal. 7 e 7 i 10 Bal. 13

9

Supplies 2 l 10

Accumulated Depreciation m 2

Equipment 18

b Bal.

Other Assets Bal. 9

Bal. i

2

Notes Payable a 20 Bal.

20

Income Taxes Payable p 4 Bal. 4

Wages Payable o 3 Bal. 3

Interest Payable n 1 Bal. 1

Unearned Revenue

Retained Earnings

Interest Expense n 1 CE 1 Bal. 0

j

3

Bal.

3

Contributed Capital Bal. 15 c 5 Bal. 20

Service Revenue d 65 CE 65 Bal. 0

Income Tax Expense p 4 CE 4 Bal. 0

Depreciation Expense m 2 CE Bal.

0

McGraw-Hill/Irwin 4-54

o

Wages Expense 3

2

CE Bal.

0

3

k

10

Bal. CE Bal.

4 11 5

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

Total assets

$27,000 5,000 4,000 8,000 44,000 18,000 (2,000) 9,000

$69,000

Liabilities: Current Liabilities: Accounts payable Notes payable Wages payable Interest payable Income taxes payable Unearned revenue Total current liabilities Stockholders' Equity: Contributed capital Retained earnings Total stockholders' equity Total liabilities and stockholders' equity

$13,000 20,000 3,000 1,000 4,000 3,000 44,000 20,000 5,000 25,000 $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

(18,000) (3,000) (21,000)

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

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. Req. 6

65,000 11,000 2,000 1,000 3,000 44,000 4,000

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

847,150

= Net Income = $80,200 = 0.077 Sales

2004:

Net Profit Margin

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

Pacific Sunwear of California

2002: Net Profit = Net Income Margin Sales

$88,108 = 0.064 1,382,923

$49,666 = 0.059 $847,150

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

5.

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.

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© 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 longterm 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 4-66

© 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.

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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: Depreciation expense (+E, −SE) 1,400 Accumulated depreciation (+XA, −A) 1,400 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

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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.

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103 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 Cash Basis Per Crystal’s Statement

Items Revenues: Spa fees Expenses: Office rent

$1,115,000

**

See * below.

$1,012,000

130,000

Utilities Telephone Salaries Supplies Miscellaneous Depreciation Total expenses Net income *

Explanation of Changes

Corrected Basis

Exclude rent for Jan. 2009 ($130,000 ÷ 13) (g) 43,600 No change 12,200 See ** below. 522,000 Add December 2008 salary ($18,000 ÷ 12) (e) 31,900 See *** below. 12,400 No change 0 Given for 2008 (c) 752,100 $ 362,900

120,000 43,600 11,800 523,500 29,825 12,400 20,500 761,625 $ 250,375

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

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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

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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.

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