CHAPTER 3

Measuring Revenues and Expenses

THINKING BEYOND THE QUESTION How do we know how much profit our business has earned? Revenues earned over several fiscal periods usually are allocated to each of the periods involved. Some reasonable basis of allocation is required. Usually, an attempt is made to allocate the revenues in proportion to the amount of activity that occurred each period. Activity may be measured by estimating how much of the total service has been provided each period or by how much of the total cost associated with providing the service has been incurred each period. In some cases, revenues are earned each period, and an equal portion of the revenues is allocated to each fiscal period. For example, revenue associated with leasing a facility to a customer usually is allocated proportionately to each period of the lease under the assumption that the value of services provided is the same each period. QUESTIONS Q3-1 The flow of cash often predates or follows the economic event to which it is related. If financial reports are supposed to measure the economic activities that occurred during a period, the amount of cash that flowed will often not yield useful measurements. For example, a tenant may pay his rent for six months in advance. To recognize six months worth of rent revenue in the period the cash was received will overstate the significance of the economic events occurring then. Similarly, if goods are sold in the current accounting period but the cash will not be received until a subsequent period, cash basis accounting will understate the economic significance of sales activities during the current period. Q3-2 Agree. While the accrual measurement of revenue and expense is traced to the accounting period in which the economic event occurred, the cash from that same event might flow in an earlier period, in the same period, or in a later period. Over time, however, the total amount of cash flow is equal to the accrual measure. In fact, the accrual measure is based on the amount of cash that is ultimately expected to flow from the event.

51

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Q3-3 Profitability is reported on the income statement using an accrual measure. It is the difference between revenues earned and expenses consumed. Profit is the amount of cash that is ultimately expected to result after all transactions are complete. In the meantime, however, there could be a severe shortage of cash. For example, sales could be made and recorded on the accrual basis even though the related cash is not scheduled for collection until well into the future. Similarly, certain expenses such as insurance, rent, or advertising could be paid for well in advance of their being used. As a result of these events, net income would be high but cash flow would be very low, or perhaps negative. When a company cannot pay its bills on time it can be forced into bankruptcy and dissolution. Q3-4 Accounts Receivable links Revenue and Cash by recording the amount owed the company until the customer pays for the merchandise or services provided. Q3-5 Unearned Revenue is a liability that is reported on a companys balance sheet. The unearned revenue account records the obligation resulting from receiving cash before revenue has been earned. Q3-6 Accrued revenue occurs when revenue is recognized prior to the receipt of cash. Deferred revenue is revenue recognized after cash has been received Q3-7 At the moment the rent is paid, the company has acquired an asset. It has purchased the exclusive right to use the landlords property for one month. Therefore, it is reasonable to show the payment as acquisition of an asset (Prepaid Rent). At the end of June when the rent has been used up, an adjustment will be necessary to transfer the $900 of Prepaid Rent to Rent Expense. Q3-8 No expense has been incurred in this transaction. The company is no better off or worse off after the transaction. Prior to the transaction the company had $35,000 of one form of asset (cash), whereas after the transaction it has $35,000 of a different form of asset (inventory). Q3-9 Subsidiary accounts are used to record the detail associated with an individual item of importance to a company. For example, a separate subsidiary account (Accounts ReceivableSally Jobers) is maintained for each customer who purchases goods on credit from the company. A collection of subsidiary accounts is called a subsidiary ledger. A control account summarizes the overall total balance of a group of subsidiary accounts. For example, the overall balance of all subsidiary Accounts Receivable accounts is maintained in an Accounts Receivable control

Measuring Revenues and Expenses

53

account. Only the control accounts are reported in the financial statements. Q3-10 Control accounts summarize the detailed information contained in subsidiary accounts. When decision makers outside the firm make decisions concerning the organization, these summaries are sufficient and appropriate. For example, for external decision making purposes, it is quite sufficient for a decision maker to know only the total cost of a companys merchandise on hand. External decision makers dont need (or care) to know what portion of Home Depots merchandise on hand is composed of tools, paint, lumber, or shrubbery. The control account balances are sufficient. To internal decision makers, though, detailed subsidiary information is critical. For those decision makers it is critical to monitor the mix of merchandise on hand and available for sale. Q3-11 Other common examples of period costs are interest, property taxes, rent on office facilities, and management salaries. All of these costs generally occur with the passage of time. In many cases, the company does not ever receive a bill for these items and, even if it did, the billing period often doesnt coincide with the accounting period. For example, annual property taxes are often billed in July even though the assessment period runs on a calendar year. For another example, the monthly rent payments may be due on the 14th of the month, but the end of the accounting period is usually the end of a month. Similarly, interest on a loan runs from the origination date of the loan, which may not coincide with the end of the companys fiscal period. Q3-12 This statement is not true. The numbers reported on a balance sheet are related to the cost of the asset, not its current value. When an asset such as a building or land is acquired, it is entered into the accounting records at its cost (which is probably a good measure of its current value at that date). Subsequently, however, no attempt is made to update those numbers for changes in current value. In the case of land, the original cost is retained in the account until sold. In the case of depreciable assets such as a building, a portion of the assets cost is allocated to depreciation expense each period that the asset is used. The difference between the assets cost and the balance in the accumulated depreciation account does not represent current value. Instead, this amount is simply the original cost minus the portion of cost that has been allocated to depreciation expense. Q3-13 The purpose of preparing a trial balance is to make sure the accounting equation is in balance. If the general ledger does not balance, the accounting equation (and financial statements) will not balance.

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Q3-14 The closing entries zero out the revenue and expense account balances at the end of a fiscal period. Consequently, the next fiscal period begins with zero balances and accumulates revenues and expenses for the new fiscal period. Closing is necessary to ensure revenues and expenses are reported in the appropriate fiscal period. Q3-15 No. Payments to owners are considered a return of capital, not an expense. The cash and retained earnings accounts are reduced when a cash payment is made to an owner. Q3-16 Proper accounting procedures make unethical behavior difficult. The procedures are designed to protect a companys accounting records and assets. Q3-17 Good accounting controls protect owners, creditors, and other stakeholders from receiving inaccurate or improperly prepared financial information. Q3-18 Non-zero balancesasset, liability, and equity accounts Zero balancesrevenue and expense accounts

EXERCISES E3-1 Definitions of all terms are listed in the glossary. E3-2 Sale of wheat (all cash) Operating costs ($532,500 in cash) Loan payment Net income Net cash flow Net Income $ 650,000 (585,000) $ 65,000 Net Cash Flow $650,000 (532,500) (40,000) $ 77,500

Depreciation is not a cash flow item. It is an allocation of cost for resources consumed during a period. The cash flow associated with the plant assets was incurred when the assets were purchased. The repayment of part of the loan is not an operating activity. Therefore, it is not considered in computing net income. It is a cash outflow for financing activities.

Measuring Revenues and Expenses

55

E3-3

Received for miles traveled ($4.50 2,400 miles) Expenses: Gas Food Lodging Helpers Total expenses Net income

$10,800 500 116 204 100 $ 920 $ 9,880

Cash received = zero Cash outflow = $920 Accrual accounting recognizes income when earned and expenses when incurred. Thus, Jeni earned $9,880 in June associated with the job, even though her June cash flow is ($920) for the job. E3-4
Cash Flow for September Cash from prior sales Cash from September sales Total cash received in September $165,000 $75,000 $240,000 $147,500 $222,500 Cash Flow in Future Sales Revenue for September

E3-5 Journal
Date 1. 2. 3. 4. Accounts Interest Expense Interest Payable Rent Revenue Unearned Rent Insurance Expense Prepaid Insurance Depreciation Expense Accumulated Depreciation Debits 3,600* 3,600 4,000** 4,000 3,150*** 3,150 48,000 48,000 48,000 3,150 48,000 +4,000 3,150 +3,600 4,000 Credits

Effect on Accounting Equation

A = L+ OE CC + RE 3,600

* ($40,000 9%) ** (12,000 3 months) *** ($8,400 24 months = $350; $350 9 months = $3,150) E3-6 Journal Date Oct. 1 Accounts Merchandise Debits 3,600 Credits Effect on Accounting Equation A +3,600 = L+ OE CC + RE

56 Accounts Payable Cash Sales Revenue Cost of Goods Sold Merchandise Oct. 6 Accounts Receivable Sales Revenue Cost of Goods Sold Merchandise Oct. 7 Ordering merchandise does not result in a transaction that should be recorded in the accounting system. Oct. 9 Spoilage Expense Merchandise Oct. 10 Accounts Payable Cash Oct. 16 Cash Accounts Receivable Oct. 3 3,600 900 900 270 270 1,800 1,800 590 590 590 270 +1,800 +900 +3,600

Chapter 3

+900 270

+1,800 590

400 400 1,800 1,800 1,200 1,200 1,800 +1,200 1,200 400 1,800

400

E3-7
Cash received from customers during 2007 Sales revenue for 2007 Accounts receivable at beginning of 2007 Accounts receivable at end of 2007 Company A $300,000 $352,500 $31,000 $83,500 Company B $625,000 $580,000 $130,000 $85,000 Company C $242,000 $260,000 $35,000 $53,000

Company A Revenue was $52,500 more than cash collected. Therefore, accounts receivable must have increased by $52,500 during the year. B Revenue was $45,000 less than cash collected. Therefore, accounts receivable must have decreased by $45,000 during the year. C Accounts receivable increased by $18,000 during the year. Therefore, sales revenue must have been $18,000 more than cash received for the year. Alternative presentations include: Company A Cash received in 2007 Cash for prior year sales Cash for 2007 sales $300,000 31,000 $269,000 Revenue for 2007 Cash for 2007 sales Accounts receivable at end of 2007 $352,500 269,000 $ 83,500

Measuring Revenues and Expenses

57

Company B Revenue for 2007 Cash to be collected in 2008 Cash for 2007 sales Company C Revenue for 2007 Cash to be collected in 2008 Cash for 2007 sales

$580,000 85,000 $495,000

Cash received in 2007 Cash for 2007 sales Accounts receivable at beginning of 2007 Accounts receivable at beginning of 2007 Cash for 2007 sales Cash received in 2007

$625,000 495,000 $130,000 $ 35,000 207,000 $242,000

$260,000 53,000 $207,000

E3-8 a.
Journal Date 1. 2. 3. 4. 5. Accounts Wages Expense Wages Payable Office Supplies Inventory Office Supplies Expense Rent Receivable Rent Revenue Depreciation Expense Accumulated Deprec. Interest Expense Interest Payable * Accumulated Debits 7,600 7,600 500 500 2,500 2,500 11,000 11,000 5,700 5,700 +5,700 11,000* 5,700 +2,500 +2,500 11,000 +500 +500 +7,600 Credits Effect on Accounting Equation A = L+ OE CC + RE 7,600

Depreciation is a contra account. It is increased each period when depreciation expense is recognized. It is shown here as a deduction, because its overall effect on the accounting system is to decrease total assets. b. Net income = $72,400 $7,600 + $500 + $2,500 $11,000 $5,700 = $51,100

E3-9 a.
Past Revenues Expenses Cash received Cash paid $1,500 $5,000 September $2,500 Future $1,000 Total $5,000 $5,000

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b.
Past Revenues Expenses Cash received Cash paid September $15,000 $9,000 Future Total $15,000 $15,000

$6,000

c.
Past Revenues Expenses Cash received Cash paid September $7,500 $5,000 $2,500 Future Total $7,500 $7,500

d.
Past Revenues Expenses Cash received Cash paid September Future Total

$50,000 $2,500 $47,500

$50,000 $50,000

e.
Past Revenues Expenses Cash received Cash paid September $500 $25,000 Future $24,500 Total $25,000 $25,000

E3-10
Cash Flow for June $5,800 $44,200 $50,000 Cash Flow in July $4,200 Wages Expense for June $48,400

Cash paid for prior wages Cash paid for June wages Total cash paid in June for wages

E3-11
January $0 $1,250 February $0 $1,250 March $3,750 $1,250 Total for Quarter $3,750 $3,750

Cash paid for interest Interest expense

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59

E3-12
2007 $600,000 $200,000 2008 $0 $200,000 2009 $0 $200,000 Total for 3 Years $600,000 $600,000

Cash paid for equipment Depreciation expense

A cash payment is recorded when cash is paid for the equipment. An expense is recorded on an accrual basis each fiscal period as resources are consumed in the operation of the company. An assumption is made that the equipment benefits the company each year it is used. Therefore, depreciation allocates the cost of the equipment to the periods benefited and matches it with revenues earned in those periods. E3-13
April $850 $850 May $1,025 $1,025 June $1,150 $1,150 Total for 3 Months $3,025 $3,025

Cash paid for utilities Utilities expense

Cash and accrual basis measures are different when cash is received or paid in one fiscal period but resources are created or consumed in a different period. They are the same when cash is received or paid in the same period resources are created or consumed, as in this exercise. E3-14
Journal
Date a. b. c. d. Accounts Interest Expense Interest Payable Unearned Rent Rent Revenue Insurance Expense Prepaid Insurance Depreciation Expense Accumulated Deprec. Debits 1,200 1,200 1,000 1,000 2,000 2,000 35,000 35,000 35,000* 2,000 35,000 +1,200 1,000 +1,000 2,000 Credits

Effect on Accounting Equation

OE A = L+ CC + RE 1,200

*Accumulated Depreciation is a contra account. It is increased each period when depreciation expense is recognized. It is shown here as a deduction, though, because its overall effect on the accounting system is to decrease total assets.

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E3-15

a. b. c.

MerchandiseCanvas Material Accounts PayableRamirez, Inc. Merchandise Inventory Accounts Payable Assets: Merchandise Inventory Liabilities: Accounts Payable Assets

+$20,000 +$20,000 +$20,000 +$20,000 $155,000 $ 37,000 Liabilities Equity $2,820 $4,805 (400) 375 (375) $3,195 $4,030 (375) $ 425 Net Income $1,200 (400)

E3-16

Year-end amounts before correction $7,625 Adjusting entry (a): Decrease Prepaid Insurance (400) Increase Insurance Expense Adjusting entry (b): Increase Wages Payable Increase Wages Expense Year-end corrected amounts $7,225 E3-17

a. The purpose of closing the books is to empty out all of the revenue and expense accounts. Each of these account balances must be set back to zero before the following years data can start being collected by the accounting system.
b. Journal Effect on Accounting Equation
Accounts Debits 2,200 2,200 1,850 900 400 150 50 100 150 100 Credits A = L+ OE CC + RE 2,200 +2,200 1,850 +900 +400 +150 +50 +100 +150 +100

Date

Dec. 31 Sales Revenue Retained Earnings Retained Earnings Cost of Goods Sold Wages Expense Utilities Expense Depreciation Expense Insurance Expense Supplies Expense Interest Expense

c.

$4,525

Original balance of Owners Equity Add: Net income Ending balance of Owners Equity

$4,175 350 $4,525

E3-18 a.
Journal
Date Accounts Debits Credits

Effect on Accounting Equation

A = L+ OE CC + RE

Measuring Revenues and Expenses Dec. 31 Sales Revenue Retained Earnings Retained Earnings Rent Expense Wages Expense Internet Service Expense 3,315 3,315 750 400 315 35

61 3,315 +3,315 750 +400 +315 +35

b.
Account Cash Debit 20,600 Accounts Receivable Equipment Wages Payable Payable to Internet Service Note Payable Contributed Capital Retained Earnings Total Credit 2,250 11,000 250 35 17,000 13,000 3,565 33,850

33,850

E3-19 a.
Journal
Date Accounts Debits 290,000 290,000 273,000 128,000 5,000 72,000 40,000 8,000 20,000 Credits

Effect on Accounting Equation

A = L+ OE CC + RE 290,000 +290,000 273,000 +128,000 +5,000 +72,000 +40,000 +8,000 +20,000

Dec. 31 Sales Revenue Retained Earnings Retained Earnings Cost of Goods Sold Insurance Expense Wages Expense Utilities Expense Interest Expense Depreciation Expense

(continued)

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b. Account Cash Debit 10,500 Accounts Receivable Inventory Prepaid Insurance Equipment Accumulated Depreciation Accounts Payable Notes Payable Contributed Capital Retained Earnings Total Credit 25,000 47,000 5,000 300,000 80,000 31,000 130,000 84,500 62,000 387,500

387,500

E3-20

a.

The purpose of closing the books is to empty out all of the revenue and expenses accounts and reset their balances to zero. Each of these account balances must be set back to zero before the following years data can start being collected by the accounting system.
Journal Effect on Accounting Equation
Debits 7,600 7,600 6,385 2,840 1,015 550 660 495 525 300 Credits A = L+ OE CC + RE 7,600 +7,600 6,385 +2,840 +1,015 +550 +660 +495 +525 +300

b.
Date Accounts

Dec. 31 Sales Revenue Retained Earnings Retained Earnings Cost of Goods Sold Wages Expense Utilities Expense Depreciation Expense Insurance Expense Supplies Expense Interest Expense

c.

$12,740 Original balance of Owners Equity Add: Net income ($7,600 $6,385) Ending balance of Owners Equity

$11,525 1,215 $12,740

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63

PROBLEMS P3-1 DATE: TO: FROM: RE: MEMORANDUM (todays date) Robin Garrison (students name) Klinger Realty operating results

Managers (and other parties) are interested in measuring the results of transformation processes that occur during a fiscal period. As with many things, there is more than one way to measure these results. The two reports are the result of different measurement systems. Under the cash basis system of measurement, cash receipts are measured and recorded at the point at which cash is received from customers. For example, during the third quarter of 2007, $300,000 was received in cash for sales commissions. The related services might have been performed in the third quarter or in some previous quarter (or might be performed later). We cant tell that from a cash basis measurement. Cash payments are measured and recorded when cash is paid out to suppliers of goods or services to be sold to customers. The difference between cash receipts and cash payments is net cash flow. Under the accrual basis system of measurement, revenues are measured and recorded when they have been earned, that is, at the point at which goods have been sold to a customer or services have been performed for a customer. Revenue is measured and recorded even though the cash has not yet been collected. For example, we know from the accrual basis statement that sales services priced at $400,000 were performed during the third quarter of 2007. What we dont know from that statement, however, is how much of the revenue was collected in cash. Similarly, expenses are measured and recorded at the point at which goods or services have been used up in generating revenue. Accrual basis accounting is generally the preferred measurement because the earning or consumption of resources is an early signal of the cash flows that will occur when all cash flows associated with current-period operations have been received or paid. Therefore, they provide a more complete measure of operating results than do current period cash flows. At the same time, cash basis reports are not incorrect or wrong. They simply are a different measurement. They can be misleading, however, in certain circumstances. For example, suppose $200,000 of services were performed for customers during a period, but all work was on credit to be collected during the subsequent period. None of the $200,000 would show up on the current cash basis report, though all the work was completed. Thus, performance for the current period might appear poor. Next

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(continued) period, when collections are made, the performance would look good though the services had been provided in the prior period. Generally, interested parties find both cash flow and accrual basis accounting information helpful in assessing the performance of an organization. A company must have both net income and positive cash flow to operate successfully in the long run.

P3-2 Hardys reasoning about the revenues is correct. Revenues should be recorded on the accrual basis during the period the sales occur. A complete reporting of the transaction would include Accounts Receivable on a balance sheet noting that $50,000 of the amount was still owed by customers. Hardys reasoning about the cost of goods sold is incorrect. Expenses should be recorded on the accrual basis during the period they are incurred. The cost of merchandise should be matched against revenues as an expense for the amount sold during a fiscal period. The fact that cash had not been paid for the merchandise has no effect on the amount of expense. A complete reporting of the transaction would include Accounts Payable on a balance sheet of $45,000. Hardy is presenting misleading information to the bank by mixing cash and accrual results. An income statement should be prepared on the accrual basis. Hardy is concealing some accrual basis expenses to make his operating results appear better than they really are. The correct reporting of the effect of these transactions on net income would be as follows: Added to revenues Added to expenses ($60,000 2) Added to net income $ 75,000 30,000 $ 45,000

P3-3 The key to each event is a clear definition of revenue. Revenue is an increase in assets as a result of goods sold or services rendered. Applying this definition to each event yields the following results: 1. No revenue. Cash increased, but not as a result of selling goods or providing services. 2. $11,000 of revenue. Accounts Receivable (an asset) increased as a result of services rendered during the month. 3. No revenue. The company did not earn the $25,000. Instead, it was loaned to the company. No goods were sold, and no services were rendered. 4. No revenue. This transaction involves $6,000 of expenses for November. 5. No revenue. Under accrual basis accounting, the revenue was recognized in the month services were performed.

Measuring Revenues and Expenses

65

6. $4,500 of revenue. Even though the cash was collected previously, revenue should be recognized when the services are rendered in November. P3-4
Journal
Date Accounts Debits 4,500 4,500 4,500 4,500 3,000 3,000 3,000 Sales Revenue 0 4,500 4,500 Credits

Effect on Accounting Equation

A +4,500 +4,500 4,500 +4,500 3,000 = L+ OE CC + RE

March 15 Cash Unearned Revenue April 30 Unearned Revenue Sales Revenue Cost of Goods Sold Merchandise Inventory Date Mar. 15 Apr. 30 Net result Cash 4,500 0 4,500

Unearned Revenue 4,500 4,500 0

P3-5
Journal
Date Jan. 1 Accounts Debits 3,600 3,600 3,600 3,600 3,600 Insurance Expense 0 3,600 3,600 Credits

Effect on Accounting Equation

A +3,600 3,600 3,600 = L+ OE CC + RE

Prepaid Insurance Cash Dec. 31 Insurance Expense Prepaid Insurance Date Jan. 1 Dec. 31 Net result Cash 3,600 0 3,600

Prepaid Insurance 3,600 3,600 0

P3-6 The key to each event is a clear definition of expense. An expense is the consumption of resources in producing or providing goods or services during a period. Applying this definition to the events yields the following: 1. An expense of $950. Even though not yet paid for, resources were consumed during the current month. 2. No expense. Even though paid for, none of the new items were used during the current month. 3. An expense of $3,800. The labor services of the executive director were consumed during the current month. 4. No expense. None of the resources have been consumed yet. 5. No expense. This was an expense of the prior month during which electric service was consumed.

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6. Expense of $7,550. The advertising services were consumed during the month of May. P3-7 a. Because accounts receivable increased during the month, the cash collections were less than the amount of sales. Further, this difference is equal to the increase in accounts receivable. Therefore, cash collections from customers are as follows: Sales revenue (accrual basis) Less: Increase in accounts receivable Cash collected from customers $95,000 10,000 $85,000

b. Because accounts payable decreased during the month, the company paid for all of this months expenses plus some of the prior months obligations. This means that cash paid out to suppliers was greater than this months accrual basis expenses. Expenses (accrual basis) Add: Decrease in accounts payable Cash paid out for expenses $ 71,000 7,000 $ 78,000

c. Net cash flow is the difference between cash collections and cash paid out. Cash collections Cash paid out Net cash flow P3-8 Carlyle Company Income Statement For the First Year Revenues ($235,000 + $80,000) Expenses: Cost of goods sold ($55,000 + $12,000) Wages ($77,500 + $18,000) Advertising (same as cash basis) Taxes ($30,000 + $20,000) Net income $315,000 $ 67,000 95,500 13,000 50,000 $85,000 78,000 $ 7,000

225,500 $ 89,500

Measuring Revenues and Expenses P3-9

67

A. Tinkers financial report relied improperly on cash basis numbers. Profits should be measured on the accrual basis. Sales should be included during the period of the sale even if cash has not been collected. Cost of goods sold should reflect merchandise sold during the period rather than merchandise purchased. Equipment should be depreciated over its useful life rather than being expensed when purchased. Tinkers statement confuses cash flow from operations with cash used for investing activities. Therefore, it is not even an accurate report of cash flow from operations. B. The other partners would be foolish to sell out based on Tinkers income statement. A properly prepared accrual basis income statement shows the business to be highly profitable. A proper income statement and distribution of profits would show the following: Tinker, Evers, and Chance Income Statement For Fiscal 2007 $7,600,000 $3,300,000 200,000 650,000 4,150,000 $3,450,000 $1,150,000 1,150,000 1,150,000 $3,450,000

Revenues Expenses: Cost of goods sold Depreciation Other Total expenses Net income Distribution of net income: Increase in owners capital: Tinker Evers Chance Total distribution of net income

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P3-10

A.

The Water Fun Store Net Cash Flow from Operating Activities For August Cash receipts: Collected from customers ($5,350 + $3,700) Cash payments: Merchandise ($3,000 + $9,200) $12,200 Advertising 450 Rent (for August and September) 1,950 Wages 1,050 Total payments Net cash flow from operating activities $ 9,050

15,650 $ (6,600)

B.

The Water Fun Store Accrual Basis Income Statement For August Sales ($7,350 + $6,350) Expenses: Cost of goods sold ($3,600 + $2,400) $6,000 Rent (one month only) 975 Wages ($1,050 + $1,200) 2,250 Total expenses Net income

$13,700

9,225 $ 4,475 (continued)

Measuring Revenues and Expenses

69

C.

Accrual basis income yields a more realistic and complete picture of a periods activity. This is because cash flows do not always occur at the same time as goods are sold or resources are consumed. Accrual-based financial statements report revenues when earned and expenses when incurred. This gives a more realistic view of a companys achievement during a given accounting period. Based on the income statement and changes in the balance sheet, the following transactions must have occurred: 1. Revenue from services rendered totaled $840,000. It was billed and collected in cash. 2. The bonds payable were paid off in full. (Because no interest expense is recorded, the bonds must have been paid off on the first day of October.) 3. Supplies costing $39,200 ($65,700 $26,500) were consumed. 4. Depreciation expense totaling $8,900 was recorded on the equipment and the building. 5. The companys employees earned $410,000 of wages that were paid in cash. Explanation of the changes in cash: Beginning cash balance Sale of services for cash Payoff of bonds payable Payment of wages Ending cash balance $ 43,725 840,000 (470,000) (410,000) $ 3,725

P3-11

A.

B.

P3-12

A.

Revenues Expenses: Supplies Rent Interest Depreciation Electricity Water Net income

Caldwell Furniture Repair Income Statement For March $7,600 2,400 1,200 150 250 332 78 $3,190

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Chapter 3

B.

Explanation of the cash account: Beginning balance Owner investment Borrowing from relative Borrowing from bank Cash sales ($7,600 75%) Purchase of tools/equipment Purchase of supplies Payment of 3 months rent Payment of interest Ending balance $ 0 2,000 16,000 3,000 5,700 (15,000) (5,200) (3,600) (150) $ 2,750

C.

At the end of March there is an incomplete transformation cycle. A transformation cycle begins when resources are acquired via a financing transaction, continues when those resources are invested into other resources (i.e., trucks, buildings, inventory), and ends when those resources are either used up or converted into cash. In this problem, the cycle is incomplete because not all resources have been converted back into cash. At the end of March, there are a variety of resources that have not been converted into cash, such as accounts receivable, supplies, prepaid rent, tools, and equipment. The existence of assets other than cash is evidence that the transformation cycle is incomplete.

P3-13 A.
Event 1. 2. 3. Revenue, Expense, or Cash Flow? Expense Cash Flow Revenue Cash Flow Expense Cash Flow Expense Cash Flow Revenue Cash Flow Month of February 0 0 0 0 $15,000 0 $10,000 $45,000 $9,000 Month of March $1,200 0 0 0 $300 ($15,000 0.02) $1,300 $6,000 0 0 $18,000 Month of April $1,200 $3,600 $7,500 0 $280 ($14,000 0.02) $1,280 $4,000 0 0 $13,500 Month of May $1,200 0 $7,500 $22,500 $260 ($13,000 0.02) $1,260 $3,600 $12,000 0 $4,500 Month of June 0 0 $7,500 0 $240 ($12,000 0.02) $1,240 $8,400 0 0 0

4. 5.

B. In this problem, the patterns of accrual-based measures (revenues and expenses) are very different from the patterns of cash-based measures (cash inflows and cash outflows). This is the situation for most companies. (continued)

Measuring Revenues and Expenses

71

C. Because the patterns between them are so different, managers need both types of information to manage their firms effectively. Accrualbasis measures are necessary to report on the success (or lack thereof) of the companys earning activities during a specific period. Cash flow measures are necessary to be sure that the company can meet its obligations and pay its bills on time. P3-14 A. Desert Harbor Inn Income Statement For the Year Ended December 31, 2007 Revenue from room rentals Revenue from parking and other services Total revenue Expenses: Staff wages Utilities Supplies used Depreciation Interest Cost of goods sold by gift shop Miscellaneous Total expenses Net income $49,000 10,400 4,300 5,000 4,700 11,000 3,300 87,700 $112,300 $165,000 35,000 $200,000

Desert Harbor Inn Statement of Cash Flows For the Year Ended December 31, 2007 Cash flow from operating activities: Collected from customers Paid to employees ($49,000 $890) Paid for utilities Paid for supplies Paid for interest Paid to suppliers of gift shop Paid for miscellaneous expenses Cash flow for investing activities: Cash flow for financing activities: Repayment on loan Withdrawal by owners Net increase in cash Add: Cash balance on January 1 Ending cash balance $187,000 (48,110) (10,400) (800) (4,700) (11,000) (3,300) 108,690 $(35,000) (45,000)

$ 0 (80,000) $ 28,690 4,900 $ 33,590

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Desert Harbor Inn Balance Sheet December 31, 2007 Assets Cash $ 33,590 Accounts receivable 13,000 Supplies on hand 5,300* Furniture and equipment 25,000 Buildings 95,000 Accumulated depreciation (15,000) Land 12,000 Total assets $168,890 *$8,800 $4,300 + $800 = $5,300 **$19,200 + $112,300 $45,000 = $86,500 B. From a financial perspective, this appears to be an attractive business. It generated net income of $112,300 on a beginning-of-the-year Owners Equity balance of $79,200 ($60,000 + $19,200). This is an impressive 142% return on investment ($112,300 $79,200). While the owners withdrew only $45,000 in cash from the company for living expenses, they could have withdrawn more without hurting the company. If this years results are typical of this company, it would be an attractive company to own from a financial perspective. P3-15 A. Zorditch.com Income Statement End of the First Year Sales revenue ($173,400 + $18,200)* Expenses: Depreciation expense Office supplies Rent Wages Advertising and promotion Miscellaneous Total expenses Net income $191,600 $ 5,700 1,560 12,000 36,200 12,140 11,300 78,900 $112,700 Liabilities and Owners Equity Wages payable Notes payable $ 890 21,500

Investment by owners 60,000 Retained earnings 86,500** $168,890

*Because this is the companys first year, all accounts receivable arose from sales made during the period. (continued)

Measuring Revenues and Expenses

73

B.

Item

Justification of change

1. Money I contributed to firm This is not an expense. It represents Owners Equity and should be reported on the balance sheet. 2. Purchase of furnishings andPurchase of assets does not create an equipment expense. Only 1/5 of the assets lives have been used up. Therefore, depreciation expense of $5,700 should be recorded ($28,500 5 years). 3. Rent on office space The original amount includes $1,000 that does not apply to the accounting period just ended. 4. Loan from the bank A loan is a liability, not an expense. 5. Advertising and promotion Only half of the amount is for expenses during the period just ended. C. 1. Dont close the business, especially if the future looks bright. Companies often have a tough time during the startup phase. Yours appears to have done just fine. 2. Get some competent accounting help. You nearly abandoned a very profitable business because you were using bad accounting information. P3-16 A.
Journal
Date Accounts Debits 6,250 6,250 5,000 5,000 12,500 12,500 7,500 7,500 12,500 +7,500 +7,500 5,000 12,500 +6,250 5,000 Credits

Effect on Accounting Equation

A = L+ OE CC + RE 6,250

Dec. 31 Interest Expense Interest Payable ($7,500 6 months 5 months = $6,250) Dec. 31 Insurance Expense Prepaid Insurance ($10,000 6/12 = $5,000) Dec. 31 Depreciation Expense Accumulated Depreciation ($50,000 4 = $12,500) Dec. 31 Rent Receivable Rent Revenue ($15,000 3/6 = $7,500)

B. The imbalance on the balance sheet is exactly equal to the amount of year 2007s net income ($37,500). If closing entries were omitted, 2007s net income would not have been transferred to owners equity causing the imbalance. Failure to record adjusting entries would not

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cause the balance sheet to be out of balance. It would balance, but with incorrect amounts. C. The adjusting entries would affect the balance sheet and income statement information as follows: Assets ($625,000 $5,000 $12,500 + $7,500) $615,000 Liabilities ($250,000 + $6,250) $256,250 Owners equity ($337,500 + 37,500* $16,250**) $358,750 Revenues ($150,000 + $7,500) $157,500 Expenses ($112,500 + $6,250 + $5,000 + $12,500) $136,250 * from transfer of original net income to owners equity ** from adjusting entry effects on net income P3-17 A. and B.
Account Balance Before Adjustment Cash Accounts receivable Supplies Prepaid insurance Equipment Accumulated depreciation equipment Buildings Accumulated depreciation buildings Land Total assets Unearned revenues Accounts payable Interest payable Wages payable Notes payable Common stock Retained earnings Total liabilities & stockholders equity Rent revenues Wages expense Supplies expense Insurance expense Interest expense Depreciation expense Net income 52,500 35,250 19,200 4,050 468,000 (129,000) 649,500 (85,500) 58,500 1,072,500 36,000 27,900 6,000 0 420,000 300,000 224,100 1,014,000 100,500 (36,000) 0 0 (6,000) 0 58,500 (3) (5) (1) 12,000 3,000 4,350 Adjustments Account Balance After Adjustment 52,500 35,250 10,050 2,700 468,000 (133,500) 649,500 (87,300) 58,500 1,055,700 24,000 27,900 9,000 4,350 420,000 300,000 224,100 1,009,350 112,500 (40,350) (9,150) (1,350) (9,000) (6,300) 46,350

(4) (2) (6) (6)

9,150 1,350 4,500 1,800

(3) (1) (4) (2) (5) (6)

12,000 4,350 9,150 1,350 3,000 6,300

(continued)

Measuring Revenues and Expenses

75

C. The net income earned during the year has not yet been transferred to retained earnings. This is true for both the unadjusted account balance column (column 1) and for the adjusted account balance column (column 3). D. The closing entries need to be identified. Closing entries have the effect of transferring all revenue and expense account balances (i.e., net income) to Retained Earnings. When this is done, the total of all asset accounts will equal the total of liability and equity accounts. Total assets before closing entries Total liabilities and equity before closing entries Add: Net income Difference E. Net income before adjustments Actual net income Misstatement in dollars $1,055,700 $1,009,350 46,350 1,055,700 $ 0

$58,500 46,350 $12,150

Misstatement in percent ($12,150 $46,350) = 26.2% P3-18 a. A. Prepaid Insurance B. Retained Earnings C. Accumulated Depreciation D. Wages Expense E. Commissions Revenue F. Interest Payable G. Supplies H. Insurance Expense I. Unearned Rent J. Prepaid Advertising K. Notes Payable L. Cost of Goods Sold M. Machinery N. Owners Capital O. Accounts Receivable P. Bonds Payable Q. Supplies Expense R. Depreciation Expense Account Type Asset Owners equity Asset (negative) Expense Revenue Liability Asset Expense Liability Asset Liability Expense Asset Owners equity Asset Liability Expense Expense

b. The following accounts are closed at the end of the year: D, E, H, L, Q, and R.

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P3-19 Mary should be suspicious. The procedures being used permit the sales rep to receive commissions the rep has not earned. Some of the sales reported for the customer are fictitious. Rather than reducing sales revenue when the sales are canceled, an expense is recorded. This procedure overstates revenues and overstates expenses. Because the rep is paid a commission on sales, the rep is defrauding the company by claiming more sales than were made. Apparently, the supervisor is colluding with the rep and perhaps sharing in the ill-gotten gain. A problem with the accounting system is that the supervisor is permitted to override the appropriate recording of transactions. A standard format should exist for recording transactions that would inform Mary of the proper way of handling these transactions. In addition, special authorization should be needed for unusual transactions that would require someone outside of the sales department to note these events. Perhaps Mary needs additional training so she is better able to determine when inappropriate transactions are recorded. The system should provide reports of customer activity that are reviewed by managers who are not directly engaged in selling activities. These reports should identify unusual activities that may indicate improper behavior. Mary should report these events to the vice president of finance. An anonymous letter could solve the problem if Mary is concerned about her own job. P3-20 MEMO TO: Flora Wiser FROM: (Students Name) SUBJECT: Processing accounting information I have been asked to provide a summary of accounting information processes to help you obtain a better understanding of accounting systems and how they convert data to useful information. In this memo, I will summarize the basic purpose of accounting systems and the processes used to accomplish this purpose. I will be pleased to meet with you to answer questions or to discuss other related matters. The purpose of accounting systems is to convert data about economic events into information that is useful to decision makers. Therefore, in all accounting systems, analysis of events is necessary to determine transactions that should be recorded in the system. Converting accounting data into useful information requires systematic processing. The conversion can be thought of as involving five interrelated steps: (1) examining business activities, (2) recording transactions, (3) updating account balances, (4) making fiscal period-end adjustments, and (5) preparing financial reports. (continued)

Measuring Revenues and Expenses

77

Business activities occur in the day-to-day operations of a company. Data about a companys business activities are recorded in a companys information system. Some of these data are in the form of financial measures. These financial measures are recorded in the companys accounting system by identifying specific accounts that are affected by the activities. Once financial data are recorded in individual accounts, the account balances are updated periodically. Two primary levels of detail are maintained in an accounting systems accounts: subsidiary and control. Subsidiary accounts record financial data about individual items of importance to a company, such as transactions for individual customers, suppliers, or products. Thus, when goods are sold to a customer on credit, the system records customer and product identification data. A separate subsidiary account is maintained for each customer so a company is able to bill that customer for sales and keep track of payments from the customer. Control accounts are summary accounts that maintain totals for all subsidiary accounts of a particular type. For example, the balance of the Accounts Receivable control account is the sum of the balances of all Accounts Receivable subsidiary accounts for each of the companys customers. A company maintains subsidiary accounts for management purposes. It reports control account balances in financial statements to external users and in reports for higher level management decisions. Accordingly, account balances must be updated on a regular basis and subsidiary balances must be summarized in control accounts. Control account balances are maintained in a companys general ledger. A general ledger is an accounting record of individual (control) accounts and the balances of each account. In addition to updating account balances as transactions occur, an accounting system must adjust these accounts periodically for activities that are not part of normal business processes. Many of these adjustments relate to period costs (costs associated with a particular period rather than product-related costs). For example, depreciation expense is recorded at the end of a fiscal period to adjust the Accumulated Depreciation and Depreciation Expense for the use of plant assets during that fiscal period. In addition, net income is transferred to Retained Earnings at the end of each fiscal period to bring the balance sheet into balance. Revenue and expense accounts are formally closed to Retained Earnings at the end of each fiscal year. Once all account balances have been updated at the end of a fiscal period, these balances are used to prepare financial statements. Financial statements are summaries of account balances prepared in specific formats to make them more useful to decision makers. General-purpose fi-

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nancial statements (those reported to external parties) usually do not list all account balances. Instead, they combine certain types of accounts. Accordingly, an accounting system records financial measures of economic events and converts these data into useful information by recording the effects of the events in separate accounts, summarizing and updating the account balances, and reporting the balances in financial statements. Financial statements are summaries of business events. P3-21 See Excel spreadsheet on pages 8283. P3-22 1 b 2 a 3 c 4 a 5 a 6 a 7 b 8 d 9 b 10 d

CASES C3-1 This sales plan has manipulation, distortion, and fraud written all over it. In general, very little is favorable. The underlying motivation for each aspect of this plan appears to be temporary personal enrichment of Flash and his (her?) regional sales directors. This is not a sales improvement plan that can be repeated in following years. The company is in a powerful position concerning its distributors in that the distributorships are very profitable and very desirable. Flash has exploited that position by pressuring the distributors to buy inventory they did not need, had no room for, could not pay for, and at higher than normal prices. For only a temporary gain (by Flash and cohorts), the company is risking the goodwill and favorable relationships with its distribution channel. Unhappy distributors could cause a lot of financial pain in future years. If these forced sales are not reported explicitly as such, creditors and investors will be misled as to the true amount of this years sales and profits. Also, some distributors have been told they may return these special purchases that remain unsold. At minimum, this is likely to cause unhappiness if returns cannot be made. This technique cannot be used again next year because distributors will already be overburdened with excess inventory and cash payments stemming from Flashs plan. In fact, sales can be expected to drop precipitously next year as distributors work off the extra inventory they were forced to buy earlier. This will be a shock to the creditors and investors who were misled into thinking that the company had increased sales by 12% in the face of an impending recession. (continued)

Measuring Revenues and Expenses

79

Flashs plan has negative cash flow implications for the company. While the firm will record the higher sales revenue (and profit), the resulting cash inflows will not occur in 30 days as is customary, but over the next 12 months. The company will need extra cash to finance these receivables. This is exacerbated by the companys need to pay for storing these goods at third-party warehouses. Lastly, Flashs suggestion to hold the books open for a few days after the end of the year to obtain maximum benefit of the new sales program is outright fraud. It is an intentional procedure designed to mislead users of the financial statements into believing that the financial results were better than they actually were. This is fraud. C3-2 Students will first have to decide what information they wish to provide before analyzing the data in the problem. Based on the chapter discussion, students might reasonably prepare some or all of the following: a. b. c. d. e. Summary of all cash flows Summary of cash flows segmented into operating activities, investing activities, and financing activities Report of net cash flow from operating activities Income statement Balance sheet

Each of these items is shown below. Because the results of these analyses are so different, a useful discussion might ensue regarding why certain of these items are more helpful than others. For example, net cash flow from operations was $7,950 while net income was ($1,610). Students might be asked to defend their choice of reports they prepared. For example, why did they prepare a net cash flow report and not an income statement or vice versa? Interesting questions might include the following: 1. 2. 3. Why are the measurements for net cash flow ($20,950), net cash flow from operations ($7,950), and net income (loss of $1,610) so different? Did Softech.com have a good first quarter? What are the financial prospects for the second quarter?

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a.

Summary of Cash Flows: Purchase of new office furniture Payment of wages and salaries Collections of accounts receivable Collection of cash from current sales ($18,000 60%) Payment of dividends Purchase of inventory ($10,500 10%) Obtain loan from a bank Sell new shares of stock Payment of rent ($900 6 months) Sale of land Net cash flow for the first quarter Beginning cash balance (January 1) Ending cash balance (March 31) $ (500) (3,200) 6,800 10,800 (1,500) (1,050) 4,000 2,000 (5,400) 9,000 $20,950 4,240 $25,190

b.

Summary of Cash Flows Segmented by Financing, Investing, and Operating Activities Financing activities: Loan from bank Sell new shares of stock Pay dividends Net cash flow from financing activities Investing activities: Buy new office furniture Sale of land Net cash flow from investing activities Operating activities: Pay wages and salaries Collection of accounts receivable Collections from current sales Purchase of inventory ($10,500 10%) Payment of rent ($900 6 months) Net cash flow from operating activities Net cash flow for the first quarter Beginning cash balance (January 1) Ending cash balance (March 31) $ 4,000 2,000 (1,500) $ 4,500 $ (500) 9,000 8,500 $ (3,200) 6,800 10,800 (1,050) (5,400) 7,950 $20,950 4,240 $25,190

(continued)

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81

c.

Net Cash Flow from Operating Activities Cash receipts: From accounts receivable From current sales Total cash receipts Cash payments: Purchase of inventory ($10,500 10%) Wages and salaries Rent ($900 6 months) Total cash payments Net cash from operations $ 6,800 10,800 $17,600 $ 1,050 3,200 5,400 9,650 $ 7,950

d.

Income Statement Revenues: Sales Expenses: Cost of goods sold Wages and salaries ($3,200 80%) Rent ($900 3 months) Advertising Depreciation Total expenses Net income $18,000 $13,000 2,560 2,700 1,000 350 19,610 $ (1,610)

e. Assets Cash Accounts receivable Inventory5 Prepaid rent1 Office furniture Buildings & equipment Accumulated depreciation Total assets
1 2

Balance Sheet Liabilities and Stockholders Equity $25,190 Accounts payable2 $ 9,450 7,200 Advertising payable 1,000 12,700 Loan payable 4,000 2,700 Capital stock3 500 (owners investment) 35,000 16,780 Retained earnings4 10,490 (5,130) Total liabilities and $59,940 stockholders equity $ 59,940

$900 3 months $10,500 90% 3 $33,000 + $2,000 4 $13,600 $1,610 loss $1,500 dividends 5 15,200 $13,000 cost of goods sold + $10,500

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P3-21
Retained Supplies $ 2,343.28 27,318.93 18,243.27 1,750.92 2,129.48 527.12 1,122.77 721.62 500.00 500.00 1,964.72 226,816.69 55,650.00 13,074.62 527.12 122,330.11 100,000.00 2,070.64 64,389.11 $235,892.35 $ 55,650.00 $12,353.00 $ $123,452.88 $100,000.00 Inventory Equipment Accumulated Depreciation Wages Payable Notes Payable Investment by Owners

Cash

Accounts Receivable

$ 4,238.72 38,246.50

$62,318.47

18,243.27 1,750.92

3,620.83

Measuring Revenues and Expenses

Date Earnings 9/30/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007 10/31/2007

1,122.77 823.02 1,534.86

15,389.55

The Book Wermz Income Statement For October 2007 $ 527.12 122,330.11 100,000.00 64,389.11 $287,246.34 $38,246.50 500.00 $38,746.50 $27,318.93 2,129.48 4,147.95 1,534.86 Depreciation 721.62 Interest 823.02 Total $36,675.86 Net $ 2,070.64 Revenues Sales Services Total Revenues Expenses Cost of Good Sold Supplies Wages Rent

Assets Cash Accounts Receivable Supplies Inventory Equipment Accumulated Depreciation Total

The Book Wermz Balance Sheet October 31, 2007 Liabilities & Equity $ 15,389.55 Wages Payable 500.00 Notes Payable 1,964.72 Investment by Owners 226,816.69 Retained Earnings 55,650.00 (13,074.62) $287,246.34 Total

Expenses

83
Income

84

P321 continued
Cost of Goods Sold 27,318.93 2,129.48 3,620.83 527.12 823.02 1,534.86 721.62 27,318.93 27,318.93 0.00 0.00 0.00 2,129.48 2,129.48 4,147.95 4,147.95 1,534.86 1,534.86 0.00 721.62 721.62 0.00 823.02 $ $ $ $ $ Supplies Expense Wages Expense Rent Expense Depreciation Expense Interest

Sales Expense $

Service Revenues

$ $ 38,246.50

500.00 500.00 500.00 0.00

38,246.50 38,246.50 823.02 0.00 0.00

Chapter 3

Measuring Revenues and Expenses

85

COMPREHENSIVE REVIEW 1 a. Favorite Cookie Company Income Statement For the Month Ended February 28, 2007 Sales revenue Cost of goods sold Wages expense Rent expense Depreciation expense Supplies expense Utilities expense Interest expense Net income b.
Journal
Date Jan. 31 Accounts Sales Revenue Retained Earnings Retained Earnings Cost of Goods Sold Wages Expense Rent Expense Depreciation Expense Supplies Expense Utilities Expense Interest Expense Debits 17,160 17,160 14,380 11,440 1,000 600 520 400 220 200 Credits

$ 17,160 (11,440) (1,000) (600) (520) (400) (220) (200) $ 2,780

Effect on Accounting Equation

A = L+ OE CC + RE 17,160 +17,160 14,380 +11,440 +1,000 +600 +520 +400 +220 +200

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Ledger Retained Earnings

Date Jan. 31 Feb. 28 Date Feb. 28 Debit 14,380 Debit Credit 11,440 Debit Credit 600 Debit Credit 400 Debit Credit 200 Credit 17,160 Balance 3,000 20,160 5,780 Balance 11,440 0 Balance 600 0 Balance 400 0 Balance 200 0

Sales Revenue
Date Feb. 28 Debit 17,160 Credit Balance 17,160 0

Cost of Goods Sold

Wages Expense
Date Feb. 28 Debit Credit 1,000 Debit Credit 520 Debit Credit 220 Balance 1,000 0 Balance 520 0 Balance 220 0

Rent Expense
Date Feb. 28

Depreciation Expense
Date Feb. 28

Supplies Expense
Date Feb. 28

Utilities Expense
Date Feb. 28

Interest Expense
Date Feb. 28

(continued)

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87

c.

Favorite Cookie Company Post-Closing Trial Balance February 28, 2007

Account Assets: Cash Accounts Receivable Merchandise Inventories Supplies Prepaid Rent Equipment Accumulated Depreciation Liabilities: Accounts Payables Unearned Revenue Interest Payable Notes Payable Owners Equity: Contribution by Owners Retained Earnings Sales Revenue Cost of Goods Sold Wages Expense Rent Expense Depreciation Expense Supplies Expense Utilities Expense Interest Expense Totals Debit 7,740 4,100 7,520 60 1,200 31,000 1,040 1,400 3,000 400 30,000 10,000 5,780 0 0 0 0 0 0 0 0 51,620 Credit

51,620

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Chapter 3

d.

Favorite Cookie Company Balance Sheet At February 28, 2007 Assets Cash Accounts receivable Merchandise inventories Supplies Prepaid rent Equipment Accumulated depreciation Total assets Liabilities and Owners Equity Accounts payable Unearned revenue Interest payable Notes payable Total liabilities Contribution by owners Retained earnings Total liabilities and owners equity $ 7,740 4,100 7,520 60 1,200 31,000 (1,040) $50,580 $ 1,400 3,000 400 30,000 $34,800 10,000 5,780 $50,580 (continued)

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COMPREHENSIVE REVIEW 2 a. Additional Transactions and Adjustments

Debit 8,400 4,300 4,300 7,600 7,600 3,200 3,200 2,100 2,100 1,800 1,800 600 3,700 4,300 900 900 700 700 800 800 1,000 1,000 570 570 + + + + + + Credit 8,400 A + = L+ CC + RE +

A.

B. C. D. E. F.

G. H. I. J. K.

Accounts Receivable Sales Revenue Cost of Goods Sold Merchandise Inventory Cash Accounts Receivable Supplies Accounts Payable Accounts Payable Cash Prepaid Rent Cash Wages Payable Wages Expense Cash Interest Payable Cash Supplies Expense Supplies Wages Expense Wages Payable Interest Expense Interest Payable Depreciation Expense Accumulated Depreciation

b. Closing Entries
Accounts Sales Revenue Cost of Goods Sold Wages Expense Rent Expense Supplies Expense Depreciation Expense Interest Expense Retained Earnings Debit 206,400 Credit 109,300 46,500 16,000 6,600 4,270 7,300 16,430 A = L+ CC+ RE + + + + + + +

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c.

Trial Balance
Account Pre-Closing Debit Credit 3,500 8,800 52,700 6,100 3,600 183,000 37,070 7,200 2,400 1,000 76,400 80,000 37,200 206,400 109,300 46,500 16,000 6,600 4,270 7,300 447,670 Post-Closing Debit Credit 3,500 8,800 52,700 6,100 3,600 183,000 37,070 7,200 2,400 1,000 76,400 80,000 53,630

Assets: Cash Accounts Receivable Merchandise Inventory Supplies Prepaid Rent Property and Equipment Accumulated Depreciation Liabilities: Accounts Payable Wages Payable Interest Payable Notes Payable, Long-Term Owners Equity: Contributed Capital Retained Earnings Sales Revenue Cost of Goods Sold Wages Expense Rent Expense Supplies Expense Depreciation Expense Interest Expense Totals

447,670

257,700

257,700

d.

Income Statement and Balance Sheet Orlando Co. Income Statement For the Year Ended October 31, 2007 Sales Revenue Cost of Goods Sold Gross Profit Operating Expenses: Wages Expense Rent Expense Supplies Expense Depreciation Expense Income from Operations Interest Expense Net Income $ 206,400 (109,300) 97,100 (46,500) (16,000) (6,600) (4,270) 23,730 (7,300) $ 16,430 (continued)

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Orlando Co. Balance Sheet October 31, 2007 Assets Cash Accounts Receivable Merchandise Inventory Supplies Prepaid Rent Current Assets Property and Equipment Accumulated Depreciation Total Assets Liabilities & Owners Equity Accounts Payable Wages Payable Interest Payable Current Liabilities Notes Payable, Long-Term Total Liabilities Contributed Capital Retained Earnings Total Owners Equity Total Liabilities & Equity $ 3,500 8,800 52,700 6,100 3,600 74,700 183,000 (37,070) $ 220,630 $ 7,200 2,400 1,000 10,600 76,400 87,000 80,000 53,630 133,630 $ 220,630