Review of Accounting Environment and the Basic Accounting Cycle

Lesson 1 Problem 1-1 Respond briefly to the following questions: Lesson 1 Review of Accounting Environment and the Basic Accounting Cycle A. Why is accounting sometimes referred to as the "language of business?" B. Financial accounting information is provided through generalpurpose financial statements. i. What are the three general-purpose financial statements required under generally accepted accounting principles? ii. What are the "notes to the financial statements?" iii. Who uses financial statement information and why? C. What is managerial accounting information and who uses it? 1 2 Problem 1-1 - Answer Problem 1-1 - Answer A. Why is accounting sometimes referred to as the "language of business?" Answer: Language exists to provided a means of communication. Accounting is referred to as the "language of business" because its sole purpose is to communicate business information. B. Financial accounting information is provided through generalpurpose financial statements. i. What are the three general-purpose financial statements required under generally accepted accounting principles? Answer: Balance Sheet (sometimes referred to as a Statement of Financial Position) Income Statement (sometimes referred to as a Statement of Earnings, Statement of Operations, Statement of Profits and Losses, or P&L Statement) Statement of Cash Flows Although not required, most companies also provide a Statement of Retained Earnings or a more complete Statement of Owners' Equity, which provides information as to the causes of changes in retained earnings and other elements of owners' equity over a period of time. 3 4 Problem 1-1 - Answer Problem 1-1 - Answer B. Financial accounting information is provided through generalpurpose financial statements. ii. What are the "notes to the financial statements?" Answer: The notes to a company's financial statements provide supplemental information that; (1) explains certain key accounting policies used in the preparation of the financial statements, (2) provides additional detailed information in support of financial statement amounts and (3) discloses other important information not reflected in the financial statements. Most notes to the financial statements are provided in compliance with requirements under generally accepted accounting principles. B. Financial accounting information is provided through generalpurpose financial statements. iii. Who uses financial statement information and why? Answer: The primary users of financial statement information are current or potential investors and creditors, analysts providing investment advice and government regulatory bodies such as the Securities and Exchange Commission ("SEC") and Federal Trade Commission ("FTC"). In addition, employee unions, suppliers, prospective employees and the media are among other frequent users of financial statement information. Although management personnel require much more detailed information in administering a company's day-to-day operations, the summarized results provided through a company's financial statements can be helpful to managers in evaluating progress in reaching a company's overall goals. Managers are especially interested in financial statement results if bonuses and raises are predicated on overall performance measures. 5 6 1-1 Problem 1-1 - Answer Problem 1-2 C. What is managerial accounting information and who uses it? Answer: Managerial accounting information refers to all of the various other kinds of information, above and beyond the information found in a company's general-purpose financial statements, which may be used by managers and other company employees in their efforts to successfully operate a company. This information is generally restricted to use by company employees and is not subject to public dissemination. Managerial accounting often involves budgeting and the forecasting of future operations as well as the use of historical data. Respond briefly to the following questions: A. What is the SEC and what is its role? B. What is GAAP and why is it important to financial statement users? C. Who is legally authorized to determine GAAP? D. What is the FASB and what is its role? E. How do the SEC and the FASB relate to one another? F. What is the IASB and what is its role? G. Why are international accounting standards not allowed for companies whose securities trade in the United States and what would be the benefit if they were allowed? 7 8 Problem 1-2 - Answer Problem 1-2 - Answer A. What is the SEC and what is its role? Answer: The SEC (Securities and Exchange Commission) is a federal regulatory agency charged with the responsibility of regulating the stock and bond ("securities") markets of the United States to insure their fairness and integrity for purposes of protecting the investing public. The SEC's authority extends only to larger businesses that seek capital from large numbers of investors in the United States ("publicly-held businesses"). Many companies in the U.S. today are publicly-held and subject to the SEC's regulations. The SEC seeks to guarantee that investors and creditors have adequate and accurate information to make informed decisions and that rules of fairness in the marketplace are enforced. It does not guarantee that quality decisions are made or guarantee the ultimate success of any business investment. SEC regulations and oversight extend not only to publicly-held companies but to stock exchanges, broker-dealers, investment advisers and others involved in the public capital markets. B. What is GAAP and why is it important to financial statement users? Answer: Generally accepted accounting principles ("GAAP") are the methods of accounting and the financial statement disclosures required of SEC-regulated companies. The purpose of GAAP is to improve the comparability and usefulness of financial statement information. Although not required, companies not subject to SEC regulation will also typically prepare financial statements in accordance with GAAP to add credibility for current or potential investors and creditors. C. Who is legally authorized to determine GAAP? Answer: The SEC has the legal authority to determine GAAP for companies required to file financial statements with the SEC; however, the SEC currently allows the FASB to function in this capacity. 9 10 Problem 1-2 - Answer Problem 1-2 - Answer D. What is the FASB and what is its role? Answer: The Financial Accounting Standards Board (FASB) is a private non-profit organization currently responsible for the establishment of GAAP in the United States. The SEC recognizes the pronouncements of the FASB as authoritative. Funding for the organization's operations come from donations from the accounting profession, industry and the financial community along with revenues from the sale of its publications. F. What is the IASB and what is its role? Answer: The International Accounting Standards Board (IASB) is a private organization headquartered in London and committed to developing a single set of high quality global accounting standards. In addition, the Board cooperates with national accounting standard setters in an attempt to achieve convergence in accounting standards around the world. E. How do the SEC and the FASB relate to one another? Answer: Because the SEC has the ultimate power to determine GAAP, the FASB exists and functions at the SEC's pleasure. As a result, when the SEC talks the FASB listens. The SEC has considerable influence over the pronouncements issued by the FASB. G. Why are international accounting standards not allowed for companies whose securities trade in the United States and what would be the benefit if they were allowed? Answer: At this time, the SEC requires the use of FASB accounting standards (GAAP) because it currently deems FASB standards superior in providing fuller and fairer disclosure of financial information. As the IASB continues to develop and improve their standards it is possible that the SEC could modify its position. A clear benefit in the application of international standards among countries is the breakdown of a significant investment and trade barrier. Capital markets will never be truly global until common accounting standards are applied to companies world wide. 11 12 1-2 Problem 1-3 Problem 1-3 - Answer Respond briefly to the following questions: A. Who is responsible for financial statement accuracy and compliance with GAAP? B. What are internal controls and provide examples of common controls over a company's cash. C. How does a person become a CPA and what do CPAs do besides audits of financial statements? D. What is the AICPA and what is its role? E. Why aren't auditors completely independent in the performance of an audit? F. What risks does a CPA face if they knowingly misrepresent the accuracy of a company's financial statements and its compliance with GAAP or are negligent in their performance of an audit. A. Who is responsible for financial statement accuracy and compliance with GAAP? Answer: A company's management is primarily responsible for financial statement accuracy and compliance with GAAP. In fact, management failure to provide accurate financial information may constitute a crime under the Foreign Corrupt Practices Act. This act requires management of public companies to safeguard company assets and maintain accurate financial records through the implementation of internal controls. Public companies subject to SEC regulation must also have an annual financial statement audit performed by an independent CPA firm. Such an audit, however, does not relieve management of their primary reporting responsibilities. 13 14 Problem 1-3 - Answer Problem 1-3 - Answer B. What are internal controls and provide examples of common controls over a company's cash. Answer: Internal controls are policies and procedures designed to safeguard a company's assets, produce accurate accounting records, and promote the effective and efficient operation of the company's business. Some common controls designed to safeguard and improve the management of cash are: (1) segregation of duties in the handling of cash transactions, (2) the use of pre-numbered checks for all cash expenditures, (3) dual-signatures required for all checks written over a certain dollar amount, (4) the monthly preparation of a bank reconciliation, and (5) the use of cash flow budgets to project future cash needs. C. How does a person become a CPA and what do CPAs do besides audits of financial statements? Answer: CPA certification is administered by each state. CPAs licensed to practice in a state may be able to practice in other states if reciprocal licensing agreements exist. All states require CPA candidates to be college graduates with credit earned in designated accounting courses. Candidates must also pass a uniform CPA exam administered by the American Institute of Certified Public Accountants (AICPA). In addition, certain supervised work experience with a licensed CPA firm is also required. Subsequent to initial certification, a CPA must complete continuing professional education (CPE) requirements to maintain the right to practice. 15 16 Problem 1-3 - Answer Problem 1-3 - Answer D. What is the AICPA and what is its role? Answer: The AICPA is a private professional organization made up of CPAs across the nation. In addition to the administration of the CPA exam, the AICPA also determines generally accepted auditing standards (GAAS), which govern the practices and procedures to be used by CPA firms in the conduct of a certified audit of financial statements. Common audit procedures include interviewing of employees, observation of assets, verification of transactions and analytical analysis. The AICPA is also involved in establishing practice standards for CPAs providing tax, consulting, personal financial planning and other services. E. Why aren't auditors completely independent in the performance of an audit? Answer: CPA firms conducting financial statement audits are paid by the companies they audit creating an inherent conflict of interest. In most cases, a company's management team is motivated to prepare financial statements that present the most favorable financial impression possible. If management/auditor disagreements arise on financial statement presentation, management may threaten to change auditors. As a result, CPA firms may be tempted to compromise the integrity of their audit work in order to preserve the engagement and resulting fee income. Auditors also create financial conflicts when they engage in consulting projects for the companies they audit. As a result, auditors are now prohibited from performing certain kinds of consulting services for their audit clients. 17 18 1-3 Problem 1-3 - Answer F. What risks does a CPA face if they knowingly misrepresent the accuracy of a company's financial statements and its compliance with GAAP or are negligent in their performance of an audit. Answer: CPAs who certify misleading financial statements expose themselves to potential investor and creditor lawsuits that may result in the payment of significant financial damages. In addition, the loss of license and professional censure are probable consequences for CPAs who fail the public trust. 13 1-4 Problem 1-4 In the "Introduction to Accounting: The Language of Business" a financial practice set was provided for a fictional company referred to as Hot Cars, Inc (HCI), a wholesale distributor of miniature model cars. This review problem continues the HCI story for an additional year through 20X3. HCI's income statement, statement of retained earnings and balance sheet for the years 20X1 and 'X2 (a blank column is left for the 'X3 amounts to be determined in this problem), along with a simplified general ledger reflecting balances in all of the company's accounts as of 1/1/X3 are provided herein for use in completing this problem. More formal ledger formats, special journals and subsidiary ledgers used in the previous Financial Practice Set will not be used in this review. Problem Requirements: 1. On a blank sheet of paper record the following summarized 'X3 transactions for HCI in basic general journal form as shown below: Account Name Account Name XXX XXX A. Inventory purchased on account totaled $201,922. B. Customer sales on account and the cost of inventory sold totaled $318,432 and $206,145, respectively. C. Cash purchases of office supplies totaled $4,677. D. Cash payments of utility bills amounted to $7,607 of which $400 had been previously recorded as an expense of the prior year. E. Cash of $50,000 was paid down and a $250,000 mortgage note payable executed in the purchase of land and a building on 10/1/X3. The 30-year fully amortizing mortgage note bears 8% annual interest with monthly payments of $1,834. Monthly cash payments on the note totaled $5,502 for the year of which $507 was applied to principal and the rest to interest. The amount of principal due over the next 12 months amounts to $2,130. F. Paid off a $10,000 note payable (bank loan) plus interest of $1,500 of which $99 had been previously recorded as an expense in 20X2. G. Paid off $4,000 of principal on a note payable (equipment loan) plus interest of $1,440, of which $79 had been previously recorded as an expense in 20X2. The remaining $8,000 of principal on this note is due in two equal $4,000 installments over the next two years. H. Cash payments of employee salaries totaled $53,409. (Ignore payroll withholdings and employer payroll taxes for this problem.) 14 1-5 Continued... I. Insurance premiums prepaid during the year totaled $4,313. J. Cash collections of accounts receivable amounted to $310,406. K. Paid the $6,408 of 20X2 income taxes payable at 1/1X3. L. Cash payments on accounts payable totaled $163,407. M. Cash dividends paid to stockholders amounted to $12,000. N. Payments of miscellaneous expenses totaled $617. O. Payments of postage expenses totaled $373. P. Cash purchases of warehouse equipment totaled $13,456. Q. Warehouse equipment having an original cost of $10,000 and associated accumulated depreciation of $2,000 was sold for $10,000 cash. 2. Post the 20X3 summarized journal entries to the HCI general ledger. 3. Prepare the 12/31/X3 year-end adjusting entries given the following information: a. Unpaid and unrecorded December, 20X3 salaries payable in January, 20X4 totaled $7,280. b. Unpaid and unrecorded December 20X3 utility costs payable in January, 20X4 totaled $937. c. Unearned rent revenue totaling $280 as of 12/31/X2 was earned in 20X3. d. Unpaid and unrecorded 20X3 interest costs payable in the following year totaled $53. e. Prepaid insurance applicable to 20X4 operations totals $2,368 at 12/31/X3 f. Depreciation on warehouse equipment and the newly purchased building amount to $6,985 for the year. g. All 12/31/X2 prepaid rent expired in 20X3. h. Unpaid and unrecorded 20X3 income taxes payable in the following year totaled $4,747. i. A physical count of office supplies on hand at 12/31/X3 totaled $1,962. 4. Post the 12/31/X3 adjusting entries to the HCI general ledger and determine the 12/31/X3 balance for each account. 5. Prepare a 12/31/X3 adjusted trial balance. 6. Extend the enclosed HCI income statements, statements of retained earnings and balance sheets for the additional year ended 12/31/X3 so the statements reflect comparative amounts for the last three years. 7. Prepare the required closing entries at 12/31/X3 and post the entries to the general ledger. 15 1-6 Problem 1-4 Hot Cars, Inc. Income Statement for the years ended December 31, 20X1, 20X2 and 20X3 20X1 Sales Revenues Cost of Goods Sold Gross Margin Operating Expenses: Salaries Expense Office Supplies Expense Rent Expense Utilities Expense Depreciation Expense Insurance Expense Miscellaneous Expense Postage Expense Operating Expenses Operating Income Other Revenue and (Expense) Rental Revenue Interest Revenue Interest Expense Income Before Income Taxes Income Tax Expense Net Income Earnings Per Share $ 185,043 111,026 74,017 49,500 3,893 4,150 6,345 1,436 1,055 900 298 67,577 6,440 0 135 ( 0) 6,575 1,644 4,931 2.05 20X2 $ 261,950 164,026 97,924 53,600 3,958 4,800 6,850 1,640 1,105 312 321 72,586 25,338 420 52 (178) 25,632 6,408 $ 19,224 $ 4.52 20X3 $ $ Hot Cars, Inc. Statement of Retained Earnings for the years ended December 31, 20X1, 20X2 and 20X3 20X1 Balance at beginning of year Net Income for the year Less: Dividends Balance at end of year $ 7,821 4,931 (1,250) $ 11,502 20X2 $ 11,502 19,224 (675) $ 30,051 20X3 16 1-7 Problem 1-4 Hot Cars, Inc. Balance Sheet December 31, 20X1, 20X2 and 20X3 Assets Current Assets: Cash Accounts Receivable Inventory Office Supplies Prepaid Insurance Prepaid Rent Notes Receivable Building Warehouse Equipment Less: Accumulated Depreciation Total Assets 12/31/X1 12/31/X2 12/31/X3 $ 12,665 11,750 11,432 470 350 4,400 750 41,817 0 18,466 (3,766) $ 56,517 $ 21,808 34,315 25,000 750 400 4,400 0 86,673 0 42,800 (5,406) $ 124,067 12/31/X2 12/31/X3 12/31/X1 Liabilities & Equity Current Liabilities: Accounts Payable $ 13,511 Salaries Payable 4,125 Income Tax Payable 1,644 Dividend Payable 1,250 Unearned Rent Revenue 0 Utilities Payable 485 Interest Payable 0 Current Portion of Long-Term Debt 0 21,015 Equipment Note Payable 0 Mortgage Note Payable 0 Total Liabilities 21,015 Equity Capital Stock (2,400 and 4,250 shares, respectively) Retained Earnings Total Equity Total Liabilities & Equity $ 22,250 0 6,408 0 280 400 178 14,000 43,516 8,000 0 51,516 24,000 11,502 35,502 $ 56,517 42,500 30,051 72,551 $ 124,067 17 1-8 Cash 1/1/X3 21,808 1/1/X3 Office Supplies 750 Prepaid Insurance 1/1/X3 400 Prepaid Rent 1/1/X3 4,400 Notes Receivable 1/1/X3 0 Accounts Receivable 1/1/X3 34,315 Land & Building 1/1/X3 0 Inventory 1/1/X3 25,000 Warehouse Equipment 1/1/X3 42,800 18 1-9 Accumulated Depreciation 5,406 1/1/X3 Utilities Payable 400 1/1/X3 Accounts Payable 22,250 1/1/X3 Interest Payable 178 1/1/X3 Salaries Payable 0 1/1/X3 Bank Note Payable 10,000 1/1/X3 Income Tax Payable 6,408 1/1/X3 Equipment Note Payable 12,000 1/1/X3 Dividend Payable 0 1/1/X3 Mortgage Note Payable 0 1/1/X3 Unearned Rent Revenue 280 1/1/X3 19 1-10 Capital Stock 42,500 1/1/X3 Interest Revenue 0 1/1/X3 Retained Earnings 30,051 1/1/X3 1/1/X3 Cost of Goods Sold 0 Dividends 1/1/X3 0 1/1/X3 Salaries Expense 0 Sales Revenues 0 1/1/X3 Office Supplies Expense 1/1/X3 0 Rental Revenue 0 1/1/X3 1/1/X3 Rent Expense 0 20 1-11 Utilities Expense 1/1/X3 0 1/1/X3 Interest Expense 0 Depreciation Expense 1/1/X3 0 Gain on Sale 0 1/1/X3 Miscellaneous Expense 1/1/X3 0 1/1/X3 Income Tax Expense 0 Insurance Expense 1/1/X3 0 Postage Expense 1/1/X3 0 21 1-12 Problem 1-4 - Answer Problem 1-4 - Answer 1. A. Inventory Accounts Payable B. Accounts Receivable Sales Revenues Cost of Goods Sold Inventory C. Office Supplies Cash D. Utilities Payable Utilities Expense Cash DR 201,922 318,432 206,145 4,677 400 7,207 CR 201,922 318,432 206,145 4,677 1. (continued) E. Land and Building Cash Mortgage Note Payable Interest Expense Mortgage Note Payable Cash F. Bank Note Payable Cash Interest Expense Interest Payable Cash DR 300,000 CR 50,000 250,000 4,995 507 10,000 1,401 99 5,502 10,000 7,607 1,500 22 23 Problem 1-4 - Answer Problem 1-4 - Answer 1. (continued) G. Equipment Note Payable Cash Interest Expense Interest Payable Cash H. Salaries Expense Cash I. Prepaid Insurance Cash J. Cash Accounts Receivable K. Income Tax Payable Cash DR 4,000 1,361 79 CR 4,000 1. (continued) L. Accounts Payable Cash M. Dividends Cash N. Miscellaneous Expense Cash O. Postage Expense Cash P. Warehouse Equipment Cash Q. Cash Accumulated Depreciation Warehouse Equipment Gain on Sale DR 163,407 12,000 CR 163,407 12,000 1,440 53,409 53,409 4,313 310,406 310,406 6,408 6,408 4,313 617 373 13,456 617 373 13,456 10,000 2,000 10,000 2,000 24 25 2. Cash 1/1/X3 J. Q. 21,808 310,406 10,000 4,677 7,607 50,000 5,502 10,000 1,500 4,000 1,440 53,409 4,313 6,408 163,407 12,000 617 373 13,456 Problem 1-4 - Answer 2. (continued) Prepaid Insurance 1/1/X3 310,406 J. I. 400 4,313 34,315 318,432 Problem 1-4 - Answer Accounts Receivable 1/1/X3 C. D. E. E. F. F. G. G. H. I. K. L. M. N. O. P. 1/1/X3 C. 1/1/X3 A. B. Land & Building 1/1/X3 E. 0 300,000 Inventory 25,000 201,922 206,145 B. 1/1/X3 Prepaid Rent 4,400 1/1/X3 P. Warehouse Equipment 42,800 13,456 10,000 Q. Office Supplies 750 4,677 1/1/X3 Notes Receivable 0 Accumulated Depreciation 5,406 Q. 2,000 1/1/X3 26 27 1-13 2. (continued) Accounts Payable 22,250 L. 163,407 201,922 Problem 1-4 - Answer 2. (continued) Dividend Payable Interest Payable 1/1/X3 F. G. 99 79 178 0 Problem 1-4 - Answer Mortgage Note Payable 1/1/X3 E. 507 0 250,000 1/1/X3 E. 1/1/X3 A. Unearned Rent Revenue Salaries Payable 0 1/1/X3 F. 280 1/1/X3 Bank Note Payable 10,000 10,000 1/1/X3 Capital Stock 42,500 1/1/X3 Utilities Payable Income Tax Payable 6,408 K. 6,408 G. 4,000 1/1/X3 400 1/1/X3 Retained Earnings Equipment Note Payable 12,000 1/1/X3 30,051 1/1/X3 28 29 2. (continued) Dividends 1/1/X3 M. 0 12,000 Problem 1-4 - Answer 2. (continued) Rental Revenue 0 1/1/X3 1/1/X3 H. Problem 1-4 - Answer Salaries Expense 0 53,409 1/1/X3 Rent Expense 0 Interest Revenue Sales Revenues 0 318,432 1/1/X3 B. 0 1/1/X3 Utilities Expense Office Supplies Expense 1/1/X3 0 1/1/X3 D. 0 7,207 Cost of Goods Sold 1/1/X3 B. 0 206,145 30 31 2. (continued) 1/1/X3 0 Problem 1-4 - Answer 2. (continued) Postage Expense Gain on Sale 0 2,000 0 373 Problem 1-4 - Answer Depreciation Expense 1/1/X3 O. Income Tax Expense 1/1/X3 Q. 1/1/X3 0 Miscellaneous Expense 1/1/X3 N. 0 617 1/1/X3 E. F. G. Interest Expense 0 4,995 1,401 1,361 Insurance Expense 1/1/X3 0 32 33 1-14 Problem 1-4 - Answer Problem 1-4 - Answer 3. a. Salaries Expense Salaries Payable b. Utilities Expense Utilities Payable c. Unearned Rent Revenue Rental Revenue d. Interest Expense Interest Payable e. Insurance Expense Prepaid Insurance DR 7,280 937 CR 7,280 937 3. (continued) f. Depreciation Expense Accumulated Depreciation g. Rent Expense Prepaid Rent h. Income Tax Expense Income Tax Payable i. Office Supplies Expense Office Supplies DR 6,985 4,400 CR 6,985 4,400 280 53 280 53 4,747 3,465 4,747 3,465 2,345 2,345 34 35 4. Cash 1/1/X3 J. Q. 21,808 310,406 10,000 4,677 7,607 50,000 5,502 10,000 1,500 4,000 1,440 53,409 4,313 6,408 163,407 12,000 617 373 13,456 12/31/X3 3,505 Problem 1-4 - Answer 4. (continued) Prepaid Insurance 1/1/X3 310,406 J. I. 12/31/X3 400 4,313 2,368 2,345 34,315 318,432 42,341 Problem 1-4 - Answer Accounts Receivable 1/1/X3 C. D. E. E. F. F. G. G. H. I. K. L. M. N. O. P. 1/1/X3 C. 12/31/X3 12/31/X3 20,777 12/31/X3 1/1/X3 A. 12/31/X3 B. Land & Building 1/1/X3 e. E. 0 300,000 12/31/X3 300,000 Inventory 25,000 201,922 206,145 B. 1/1/X3 Prepaid Rent 4,400 4,400 0 g. 1/1/X3 P. Warehouse Equipment 42,800 13,456 46,256 10,000 Q. 12/31/X3 Office Supplies 750 4,677 1,962 3,465 i. 12/31/X3 1/1/X3 Notes Receivable 0 Accumulated Depreciation 5,406 Q. 2,000 6,985 10,391 1/1/X3 f. 12/31/X3 0 36 37 4. (continued) Accounts Payable 22,250 L. 163,407 201,922 60,765 Problem 1-4 - Answer 4. (continued) Dividend Payable Interest Payable 1/1/X3 F. 0 12/31/X3 G. 99 79 53 178 0 Problem 1-4 - Answer Mortgage Note Payable 1/1/X3 d. E. 507 249,493 12/31/X3 0 250,000 1/1/X3 E. 1/1/X3 A. 12/31/X3 Unearned Rent Revenue Salaries Payable 0 7,280 1/1/X3 a. 0 7,280 12/31/X3 12/31/X3 F. 10,000 c. 280 280 1/1/X3 53 12/31/X3 Bank Note Payable 10,000 1/1/X3 Capital Stock 42,500 42,500 1/1/X3 12/31/X3 Utilities Payable Income Tax Payable 6,408 K. 6,408 4,747 1/1/X3 h. 937 4,747 12/31/X3 12/31/X3 G. 4,000 d. 400 400 937 1/1/X3 b. 0 12/31/X3 Retained Earnings Equipment Note Payable 12,000 1/1/X3 30,051 1/1/X3 8,000 12/31/X3 38 39 1-15 4. (continued) Dividends 1/1/X3 M. 12/31/X3 0 12,000 12,000 Problem 1-4 - Answer 4. (continued) Rental Revenue 0 280 1/1/X3 c. 1/1/X3 H. a. 12/31/X3 Problem 1-4 - Answer Salaries Expense 0 53,409 7,280 60,689 1/1/X3 g. 12/31/X3 Rent Expense 0 4,400 4,400 280 12/31/X3 Interest Revenue Sales Revenues 0 318,432 1/1/X3 B. 0 1/1/X3 0 12/31/X3 i. 12/31/X3 Utilities Expense Office Supplies Expense 1/1/X3 0 3,465 3,465 1/1/X3 D. b. 12/31/X3 0 7,207 937 8,144 318,432 12/31/X3 Cost of Goods Sold 1/1/X3 B. 0 206,145 12/31/X3 206,145 40 41 4. (continued) 1/1/X3 f. 12/31/X3 0 6,985 6,985 Problem 1-4 - Answer 4. (continued) Postage Expense Gain on Sale 0 2,000 0 373 373 Problem 1-4 - Answer Depreciation Expense 1/1/X3 O. 12/31/X3 Income Tax Expense 1/1/X3 Q. 1/1/X3 h. 12/31/X3 0 4,747 4,747 2,000 12/31/X3 Miscellaneous Expense 1/1/X3 N. 12/31/X3 0 617 617 1/1/X3 E. F. G. d. 12/31/X3 Interest Expense 0 4,995 1,401 1,361 53 7,810 Insurance Expense 1/1/X3 e. 12/31/X3 0 2,345 2,345 42 43 Problem 1-4 - Answer 5.Adjusted Trial Balance Accounts: Cash Accounts Receivable Inventory Office Supplies Prepaid Insurance Prepaid Rent Notes Receivable Warehouse Equipment Land and Building Accumulated Depreciation Accounts Payable Salaries Payable Income Tax Payable Dividend Payable Unearned Rent Revenue Utilities Payable Interest Payable Bank Note Payable Equipment Note Payable Mortgage Note Payable Capital Stock Retained Earnings (1/1/X3) Dividends DR 3,505 42,341 20,777 1,962 2,368 0 0 46,256 300,000 10,391 60,765 7,280 4,747 0 0 937 53 0 8,000 249,493 42,500 30,051 12,000 6. DR CR Accounts (cont): Sales Revenues Rental Revenue Interest Revenue Cost of Goods Sold Salaries Expense Office Supplies Expense Rent Expense Utilities Expense Depreciation Expense Misc. Expense Insurance Expense Postage Expense Interest Expense Gain on Sale Income Tax Expense Totals CR 318,432 280 0 Problem 1-4 - Answer Hot Cars, Inc. Income Statement for the years ended December 31, 20X1, 20X2 and 20X3 20X1 Sales Revenues Cost of Goods Sold Gross Margin Operating Expenses: Salaries Expense Office Supplies Expense Rent Expense Utilities Expense Depreciation Expense Insurance Expense Miscellaneous Expense Postage Expense Operating Expenses Operating Income Other Revenue and (Expense) Gain on Sale Rental Revenue Interest Revenue Interest Expense Income Before Income Taxes Income Tax Expense Net Income Earnings Per Share $ 185,043 111,026 74,017 49,500 3,893 4,150 6,345 1,436 1,055 900 298 67,577 6,440 0 0 135 ( 0) 6,575 1,644 4,931 2.05 20X2 $ 261,950 164,026 97,924 53,600 3,958 4,800 6,850 1,640 1,105 312 321 72,586 25,338 0 420 52 (178) 25,632 6,408 $ 19,224 $ 4.52 20X3 $ 318,432 206,145 112,287 60,689 3,465 4,400 8,144 6,985 2,345 617 373 87,018 25,269 2,000 280 0 (7,810) 19,739 4,747 $ 14,992 $ 3.53 206,145 60,689 3,465 4,400 8,144 6,985 617 2,345 373 7,810 2,000 4,747 734,929 734,929 $ $ 44 45 1-16 6. (continued) Problem 1-4 - Answer Hot Cars, Inc. Statement of Retained Earnings for the years ended December 31, 20X1, 20X2 and 20X3 20X1 Problem 1-4 - Answer Hot Cars, Inc. Balance Sheet December 31, 20X1, 20X2 and 20X3 Assets Current Assets: Cash Accounts Receivable Inventory Office Supplies Prepaid Insurance Prepaid Rent Notes Receivable Building Warehouse Equipment Less: Accumulated Depreciation Total Assets 12/31/X1 12/31/X2 12/31/X3 12/31/X1 Liabilities & Equity Current Liabilities: Accounts Payable $ 13,511 Salaries Payable 4,125 Income Tax Payable 1,644 Dividend Payable 1,250 Unearned Rent Revenue 0 Utilities Payable 485 Interest Payable 0 Current Portion of Long-Term Debt 0 21,015 Equipment Note Payable 0 Mortgage Note Payable 0 Total Liabilities 21,015 Equity Capital Stock (2,400 and 4,250 shares, respectively) Retained Earnings Total Equity Total Liabilities & Equity 12/31/X2 12/31/X3 20X2 $ 11,502 19,224 (675) $ 30,051 20X3 $ 30,051 14,992 (12,000) $ 33,043 Balance at beginning of year Net Income for the year Less: Dividends Balance at end of year $ 7,821 4,931 (1,250) $ 11,502 $ 12,665 11,750 11,432 470 350 4,400 750 41,817 0 18,466 (3,766) $ 56,517 $ 21,808 34,315 25,000 750 400 4,400 0 86,673 0 42,800 (5,406) $ 124,067 $ 3,505 42,341 20,777 1,962 2,368 0 0 70,953 300,000 46,256 (10,391) $ 406,818 $ 22,250 $ 60,765 7,280 0 4,747 6,408 0 0 0 280 937 400 53 178 6,130 14,000 79,912 43,516 4,000 8,000 247,363 0 331,275 51,516 24,000 11,502 35,502 $ 56,517 42,500 30,051 72,551 $ 124,067 42,500 33,043 75,543 $ 406,818 46 47 Problem 1-4 - Answer 7. Closing Entires: Sales Revenues Rental Revenue Gain on Sale Cost of Goods Sold Salaries Expense Office Supplies Expense Rent Expense Utilities Expense Depreciation Expense Misc. Expense Insurance Expense Postage Expense Interest Expense Income Tax Expense Retained Earnings Retained Earnings Dividends DR 318,432 280 2,000 CR 7. (continued) Cash 1/1/X3 J. Q. 21,808 310,406 10,000 4,677 7,607 50,000 5,502 10,000 1,500 4,000 1,440 53,409 4,313 6,408 163,407 12,000 617 373 13,456 12/31/X3 3,505 Problem 1-4 - Answer Accounts Receivable 1/1/X3 C. D. E. E. F. F. G. G. H. I. K. L. M. N. O. P. 1/1/X3 C. 12/31/X3 12/31/X3 20,777 1/1/X3 A. 12/31/X3 42,341 B. 34,315 318,432 310,406 J. 206,145 60,689 3,465 4,400 8,144 6,985 617 2,345 373 7,810 4,747 14,992 12,000 Inventory 25,000 201,922 206,145 B. Office Supplies 750 4,677 1,962 3,465 i. 12,000 48 49 7. (continued) Prepaid Insurance 1/1/X3 I. 12/31/X3 400 4,313 2,368 2,345 Problem 1-4 - Answer 7. (continued) Land & Building Accounts Payable 22,250 L. 163,407 201,922 60,765 0 300,000 Problem 1-4 - Answer Dividend Payable 1/1/X3 A. 0 12/31/X3 12/31/X3 0 1/1/X3 1/1/X3 e. E. 12/31/X3 300,000 Unearned Rent Revenue Prepaid Rent 1/1/X3 4,400 4,400 12/31/X3 0 g. 1/1/X3 P. 12/31/X3 Warehouse Equipment 42,800 13,456 46,256 10,000 Q. Salaries Payable 0 7,280 1/1/X3 a. c. 280 280 1/1/X3 0 7,280 12/31/X3 12/31/X3 Utilities Payable Notes Receivable 1/1/X3 12/31/X3 0 Q. 0 10,391 12/31/X3 4,747 12/31/X3 2,000 Accumulated Depreciation 5,406 6,985 1/1/X3 f. K. Income Tax Payable 6,408 6,408 4,747 1/1/X3 h. d. 400 400 937 937 1/1/X3 b. 12/31/X3 50 51 1-17 7. (continued) Interest Payable 178 F. G. 99 79 53 53 Problem 1-4 - Answer 7. (continued) Dividends 1/1/X3 M. 12/31/X3 0 12,000 12,000 12,000 1/1/X4 0 E. 0 250,000 1/1/X3 Problem 1-4 - Answer Mortgage Note Payable 1/1/X3 d. 12/31/X3 E. 507 Rental Revenue 0 280 close close 280 0 1/1/X4 1/1/X3 c. 280 12/31/X3 249,493 12/31/X3 Bank Note Payable 10,000 F. 10,000 1/1/X3 Capital Stock 42,500 42,500 1/1/X3 12/31/X3 close 1/1/X3 close 12/31/X3 Interest Revenue 0 1/1/X3 0 318,432 1/1/X3 B. close 0 0 1/1/X4 0 12/31/X3 Sales Revenues 0 12/31/X3 318,432 12/31/X3 Retained Earnings Equipment Note Payable 12,000 G. 4,000 8,000 12/31/X3 1/1/X3 Dividends 12,000 33,043 30,051 14,992 318,432 0 1/1/X4 1/1/X3 B. Cost of Goods Sold 0 206,145 206,145 1/1/X4 0 close 12/31/X3 206,145 52 53 7. (continued) Salaries Expense 1/1/X3 H. a. 12/31/X3 1/1/X4 0 53,409 7,280 60,689 60,689 0 Problem 1-4 - Answer 7. (continued) Rent Expense 0 4,400 4,400 4,400 close 1/1/X4 0 0 1/1/X3 f. 12/31/X3 0 6,985 6,985 6,985 Problem 1-4 - Answer Depreciation Expense 1/1/X3 O. 12/31/X3 close 1/1/X4 Postage Expense 0 373 373 373 0 close 1/1/X3 g. 12/31/X3 close 1/1/X4 Utilities Expense Office Supplies Expense 1/1/X3 i. 12/31/X3 1/1/X4 0 3,465 3,465 3,465 0 close 1/1/X4 0 1/1/X3 e. 1/1/X3 D. b. 12/31/X3 0 7,207 937 8,144 8,144 close 1/1/X3 N. Miscellaneous Expense 0 617 617 617 1/1/X4 0 close 1/1/X3 E. F. G. d. 12/31/X3 1/1/X4 Interest Expense 0 4,995 1,401 1,361 53 7,810 7,810 0 close 12/31/X3 Insurance Expense 0 2,345 2,345 2,345 1/1/X4 0 close 12/31/X3 54 55 7. (continued) Gain on Sale 0 2,000 close 2,000 0 Problem 1-4 - Answer Income Tax Expense 1/1/X3 Q. 1/1/X3 h. 12/31/X3 1/1/X4 0 4,747 4,747 4,747 1/1/X4 0 close Accounting for Adjustments of Prepaid Expenses and Unearned Revenues Example: Assume on 10/1/X1, Berry, Inc. prepays a $1,200 insurance premium providing fire insurance coverage through 9/30/X2. Previously discussed accounting: 10/1/X1 Original Entry: 2,000 12/31/X3 Prepaid Insurance Expense Cash 12/31/X1 Adjusting Entry: 1,200 1,200 Insurance Expense Prepaid Insurance Expense $300 Insurance Expense 300 300 $900 Prepaid Insurance 56 57 1-18 Now, assume that the original entry made on October 1st to record the $1,200 prepayment was made to insurance expense rather than to the asset, prepaid insurance. 10/1/X1 Original Entry: Example: Assume Jones Real Estate Company receives $24,000 rent in advance from a tenant on a one year lease beginning at the time of the rent receipt, 8/1/X1. 8/1/X1 Original Entry: Insurance Expense Cash 1,200 1,200 Cash Unearned Rent Revenue 24,000 24,000 In this case what adjusting entry could be made on 12/31, three months later, to properly adjust the books and accurately reflect the company's expenses for the year and prepaid insurance at the end of the year? 12/31/X1 Adjusting Entry: 12/31/X1 Adjusting Entry: Unearned Rent Revenue Rent Revenue $10,000 Rent Revenues 10,000 10,000 $14,000 Unearned Revenues Prepaid Insurance Expense Insurance Expense $300 Insurance Expense 900 900 $900 Prepaid Insurance 58 59 Problem 1-5 Problem 1-5 A. Cobb Industries prepays 3-month warehouse rental costs on 12/1/X1 amounting to $15,000. 1. Prepare the original and 12/31/X1 adjusting entries assuming the payment is originally recorded as an asset. 2. Prepare the original and 12/31/X1 adjusting entries assuming the payment is originally recorded as an expense. 3. Assuming the original entry was made to an expense what would be the effect on Cobb's financial position if no adjusting entry was made? What principle of accounting mandates an adjusting entry in this case? Which approach to the original entry and resulting adjustment is preferred? B. On 12/15/X1 Cobb collects $10,000 in advance on a customer order for goods to be shipped as soon as possible. Assume that 30% of the ordered goods are actually shipped by Cobb on 12/31/X1 with the remainder to be shipped the first week of January. 1. Prepare the original and 12/31/X1 adjusting entries assuming the cash receipt is originally recorded as unearned revenue. 2. Prepare the original and 12/31/X1 adjusting entries assuming the payment is originally recorded as revenue. 3. What principle of accounting mandates an adjusting entry in this case? 60 61 Problem 1-5 - Answer Problem 1-5 - Answer A. Cobb Industries prepays 3-month warehouse rental costs on 12/1/X1 amounting to $15,000. 1. Prepare the original and 12/31/X1 adjusting entries assuming the payment is originally recorded as an asset. 12/1/X1 Original Entry: 2. Prepare the original and 12/31/X1 adjusting entries assuming the payment is originally recorded as an expense. 12/1/X1 Original Entry: Rent Expense Cash Prepaid Rent Expense Cash 12/31/X1 Adjusting Entry: 15,000 15,000 15,000 12/31/X1 Adjusting Entry: 15,000 Prepaid Rent Expense Rent Expense 10,000 10,000 Rent Expense Prepaid Rent Expense 5,000 5,000 62 63 1-19 Problem 1-5 - Answer Problem 1-5 - Answer 3. Assuming the original entry was made to an expense, what would be the effect on Cobb's financial position if no adjusting entry was made? Expenses Net Income Retained Earnings Owners' Equity Assets Overstated Understated Understated Understated Understated B. On 12/15/X1 Cobb collects $10,000 in advance on a customer order for goods to be shipped as soon as possible. Assume that 30% of the ordered goods are actually shipped by Cobb on 12/31/X1 with the remainder to be shipped the first week of January. 1. Prepare the original and 12/31/X1 adjusting entries assuming the cash receipt is originally recorded as unearned revenue. 12/15/X1 Original Entry: What principle of accounting mandates an adjusting entry in this case? Answer: The matching principle of accrual basis accounting mandates the year-end adjusting entry to properly record expenses in both 'X1 and 'X2. Cash Unearned Sales Revenue 10,000 10,000 12/31/X1 Adjusting Entry: Which approach to the original entry and resulting adjustment is preferred? Answer: Both approaches produce the same financial statement results at year-end…..no preference. Unearned Sales Revenue Sales Revenue Cost of Goods Sold Inventory 3,000 ? 3,000 ? 64 65 Problem 1-5 - Answer 2. Prepare the original and 12/31/X1 adjusting entries assuming the payment is originally recorded as revenue. 12/15/X1 Original Entry: Cash Sales Revenue 10,000 10,000 12/31/X1 Adjusting Entry: Sales Revenue Unearned Sales Revenue Cost of Goods Sold Inventory 7,000 ? 7,000 ? 3. What principle of accounting mandates an adjusting entry in this case? Answer: The revenue recognition principle mandates the adjusting entry in this case. 66 1-20