Friedlan4e SM Ch03

John Friedlan, Financial Accounting: A Critical Approach, 4
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Solutions Manual Copyright 2013 McGraw-Hill Ryerson Ltd.
CHAPTER 3
The Accounting Cycle

QUESTIONS

Q3-1.
Much more judgement is required for accrual accounting than for cash accounting because there
is greater uncertainty at the time events are recorded in the accounting system. There is no
uncertainty around the point in time when the cash is paid or collected. Accrual accounting
records economic events, not cash flows. When an economic event occurs can be ambiguous. Its
less certain when revenue has been earned than when cash is received. It can also be unclear
what expenses were incurred to earn revenue (matching) whereas the amount of cash expended is
rarely ambiguous.

Q3-2.
Closing entries are made to reset balances in the temporary (income statement) accounts to zero
so that the entity can record the transactions and accumulate information pertaining only to the
following period. The effect of the closing entry is to transfer balances in the temporary accounts
to retained earnings (in a corporation) or owners equity (proprietorship). Closing entries are
made after the end of the reporting period, when financial statements are prepared.

Q3-3.
If the temporary accounts were not closed on December 31, 2017, retained earnings would be
understated by $100,000 on the 2017balance sheet and income would be overstated by $100,000
in 2018. The individual accounts on the income statements would be misstated by the amount in
those accounts at the end of the previous period.

Q3-4.
Adjusting entries are necessary in accrual accounting because recognition of revenues and
expenses does not always correspond with cash flows. Some economic changes may occur that
should be reflected under accrual accounting but that are not triggered by exchanges with
external parties. As a result adjusting entries are needed to reflect these changes. Adjusting
entries are not required in a cash accounting system because recording is triggered only by the
exchange of cash, and so revenues and expenses always correspond with cash flows.

Q3-5.
Transactional journal entries are triggered by exchanges between an entity and an external party.
Adjusting entries are necessary to reflect economic changes that are not triggered by an exchange
with an external party but that should be captured by the accounting system.

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Q3-6.
The four types are:
Deferred expense/prepaid
expense:
Needed to ensure that expenses that are paid before the
benefits are received are recognized as expenses when the
benefits are received.
Deferred revenue: Needed to ensure that revenues that are collected before
they are earned are recognized when they are earned.
Accrued Expense/Accrued
liability:
Needed to ensure that expenses that are incurred before
they are paid are recognized in the period when they are
incurred.
Accrued Revenue/Accrued
asset:
Needed to ensure that revenues that are earned before they
are collected are recognized in the period when they are
earned.

Q3-7.
The following table indicates the impacts if the particular entry was not made:
Deferred
expense/prepaid
expense:
Deferred
revenue
Accrued
Expense/Accrued
liability:
Accrued
Revenue/Accrued
asset:
Assets Overstated No effect No effect Understated
Liabilities No effect Overstated Understated No effect
Owners
equity
Overstated Understated Overstated Understated
Revenue No effect Understated No effect Understated
Expenses Understated No effect Understated No effect
Net income Overstated Understated Overstated Understated

Q3-8.
Adjusting entries have to be made when the financial statements are prepared to ensure that all
appropriate economic events are properly reflected in the financial statements. Even though
many of the economic changes reflected by adjusting entries (depreciation, earning of interest,
etc.) happen throughout the accounting period, there is no need to record these changes until the
financial statements are actually prepared.

Q3-9.
The terms simply refer to whether the balance in an account has increased or decreased. A debit
refers to an increase in an asset or expense or a decrease in a liability, owners equity, or
revenue. A credit refers to a decrease in an asset or expense or an increase in a liability, owners
equity, or revenue.

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Q3-10.
A contra-asset account is used to accumulate subtractions from a related asset account (such as
an account to accumulate the depreciation of property, plant, and equipment). Its used so that
the amount originally recorded for the asset can be readily determined. If subtractions were made
directly to the original asset, it would be time-consuming to determine the amount originally
recorded for the asset and the amount that had been deducted against the asset. (Note that contra-
liability accounts also exist but these were not discussed in the chapter.)

Q3-11.
A dividend is a distribution of earnings to the shareholders of a corporation. Earnings are
accumulated in a corporations retained earnings account so when earnings are distributed, the
retained earnings account is decreased. Since a dividend decreases the amount a shareholder has
invested in the corporation (by distributing assets of the corporation to shareholders), a debit
must be made to retained earnings (owners equity) to reduce the amount by which the owners
investment has decreased (which is the amount of the dividend). A dividend is not an expense
and is not reported on the income statement.

Q3-12.
On the balance sheet of the customer, there will be an increase in liabilities (accounts payable) of
$1,000. There will also be an increase in assets of $1,000 (inventory, supplies, property, plant,
and equipment, etc.) (This assumes the merchandise has not been used as of the balance sheet
date). On the balance sheet of the selling company there will be an increase in assets (accounts
receivable) of $1,000. The salewould increase revenue on the sellers income statement by
$1,000. When the closing entryis prepared the sale would flow through to the balance sheet and
retained earnings would increase by $1,000. Inventory would decrease by the cost of the
inventory sold and cost of goods sold would increase by that amount.

Q3-13.
Permanent accounts are balance sheet accounts.The balances in these accounts carry forward
from period to period.Temporary accounts are income statement accounts and are closed at the
end of each accounting period to bring their balance to zero.This is done so that the amounts
reported on the income statement reflect only the economic events that occurred in the current
fiscal period. The balance in the temporary accounts is closed to retained earnings,which is a
permanent account.

Q3-14.
Recording of transactions can require judgement as it may not be apparent when and where an
economic event should be recorded (for example, revenue recognition). Adjusting journal entries
also require judgement as many of the adjustments are based on the judgement of management.
Management has some flexibility in determining how much to adjust the various accounts by.
Posting of entries, preparation of the trial balance, and the posting of closing entries require the
least amount of judgement as the amounts related to these items are indicated in the original
journal entries.

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Q3-15.
Dividends are not treated as an expense because they are not a cost of doing business. When
dividends are paid, the profit of the company is being distributed to shareholders. Retained
earnings (owners equity) decrease to reflect the assets being distributed to the owners.

Q3-16.
At the end of a fiscal period revenue and expenses are closed to retained earnings (an equity
account). Revenue increases retained earnings, while expenses decrease retained earnings. This
is because revenue represents an inflow of wealth to the entity.Expenses represent an outflow of
wealth as they represent costs the entity must incur to operate.

Q3-17.
The bank credits your account since from the perspective of the bank, the amount that you have
on deposit is a liability and an increase in a liability is a credit. The bank views your deposit as a
liability since it owes you the money you have on deposit.

Q3-18.
An executory contract is an exchange of promises where one party promises to supply goods or
services and the other party promises to pay for them, but neither side has yet fulfilled its side of
the bargain. Under IFRS (and ASPE) these arrangements are not usually recorded in the
accounting system.

Q3-19.
The things that must be known are:
1. Which elements of the accounting equation are affected?
2. Which specific asset, liability, owners equity, revenue, and expense accounts are affected?
3. How the accounts are affecteddoes the amount in each account increase or decrease?
4. By how much has each specific asset, liability, owners equity, revenue, and expense account
increased or decreased?

Q3-20.
Dividing accounts into sub-accounts provides detailed information about the different types of
assets, liabilities, owners equity, revenues, and expenses. Without such detail it would not be
possible, for example, to tell the amount the entity is owed by customers, the amount it paid for
its buildings, and the amount it owes to suppliers. Also, it couldnt determine the different types
of expenses it incurred and the amounts. Without the detail provided by sub-accounts it would be
very difficult to obtain much useful information from the financial statements.

Q3-21.
The number of accounts is determined by the information needs of management and financial
reporting requirements. There are no rules inIFRS or ASPE that specify the exact accounts an
entity should keep, although they do specify that certain information must be provided, which
requires that information be accumulated separately. Constraints such as tax law will require an
entity to have certain information and this will lead an entity to organize its accounting system to
accumulate that information.

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Q3-22.
Under accrual accounting its not always clear when an economic event takes place. As a result
judgement must be exercised by the managers to determine when, how, and how much should be
recorded in the financial statements. Revenue recognition and matching of expenses are not
always straightforward, requiring that judgement be exercised based on the facts of the specific
situation. Under accrual accounting its not always clear when (and sometimes how much)
revenue should be recognized and what and how much expenses should be matched to the
revenue. The implication of choices in recognizing revenues and expenses is that alternative
choices could result in different amounts of revenues and/or expenses, and, as a result, income
could vary depending on the accounting choices that are made. As well the amount of assets,
liabilities, and owners equity could be affected by the accounting choices managers make.
While different ways of measuring economic activity in the financial statements has no effect on
the actual economic activity of the entity, different ways of measuring economic activity can
have economic consequences for stakeholders (amount of taxes the entity pays, the amount of
bonus managers receive, etc.) and the perceptions of users of financial statements regarding the
profitability and financial health of the company could be changed.

Q3-23.
The fact that all economic events are not captured by an accounting system means that the
information provided by the system is not comprehensive or complete. As a result, users of the
financial statements may have false beliefs about the future profitability and financial health of
the company and may draw incorrect conclusions. Of course, if a stakeholder is aware of the
information, regardless of whether its captured by the accounting system, the stakeholder may
be able to adjust the accounting information to reflect that knowledge. For example, if a major
customer declares bankruptcy, the companys bank may be aware of the event and its
implications for the company. A small investor may not be aware of either the event or its
implications and purchase shares at a higher price than if the information was known.

Q3-24.
Many examples could be provided. Some examples are the signing of a large contract with a
customer that does not come into effect until a later period, an improving economy, or a
favourable mention in the media, changes in tax laws, new senior executives, and increases in the
market value of assets.

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Q3-25.
The steps of the accounting cycle are:
An economic event happens, which must be recorded as a transaction.
Prepare the journal entry, which is recording the transaction in the general journal.
Post the journal entry to the general ledger, which is recording the amounts in the journal
entry in the appropriate specific accounts in the general ledger.
Prepare and post the adjusting journal entries, which results in the necessary adjustments to
the related accounts.
Prepare the trial balance, which is a listing of any debit and credit balances in all the accounts
in the general ledger.
Prepare the financial statements from the information in the trial balance.
Prepare and post-closing entries to reduce the balances in temporary accounts to zero.
Prepare the post-closing trial balance, which is a listing of the debit and credit balances in the
permanent accounts in the general ledger (balances in the temporary accounts are zero).

Q3-26.
A T-account is a device used to represent a general ledger account for teaching purposes. A T-
account is set up to record the transactions and economic events that affect each asset, liability,
equity, revenue, or expense account.

Q3-27.
Posting a journal entry to the general ledger is the process of transferring each line of a journal
entry to the corresponding account in the general ledger. Posting updates the balance in the
account to reflect the effect of the transaction or economic event recorded in the journal entry.

Q3-28.
A trial balance is a listing of all the accounts in the general ledger with their balances. The
purpose is to ensure that the debits equal the credits and to provide a summary of the balances in
each account. Some errors would result in the trial balance having debit and credit totals that are
unequal. Other errors, such as posting the same entry twice or not posting it at all, or entries
made to an incorrect account, would not be evident simply by examining the trial balance.

Q3-29.
Cross-referencing transactions from the journal to the general ledger facilitates the tracing of
transactions through the accounting system at a later time.

Q3-30.
Information in the general ledger is organized by account. Each account represents a specific
type of asset, liability, equity, revenue, or expense. The general journal is a chronological listing
of entries made to the accounting system. By examining the general ledger one could see all the
entries that affected each account. For example, by looking at the cash account one could see all
the entries to cash. To find the entries to cash in the general journal, it would be necessary to
track through the ledger those transactions specifically involving cash.

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Q3-31.
Bookkeeping is the process of recording financial transactions and maintaining financial records.
Bookkeeping is only part of the entire accounting process. Accounting involves much more,
including the design and management of information systems, decisions involving how to
account for and report an entitys economic activity and interpretation/analysis of financial
information.

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EXERCISES

E3-1.
a. adjusting entry
b. transactional entry
c. adjusting entry
d. adjusting entry
e. no entry
f. transactional entry
g. adjusting entry
h. transactional entry
i. transactional entry
j. transactional entry
k. adjusting entry

E3-2.
There are many possible answers that is acceptable (one example provided)
a) Asset increases, asset decreases A customer pays an amount owing (pays an
account receivable).
b) Asset increases, liability increases Borrow money from bank
c) Asset increases, shareholders equity increases A shareholder purchases shares in
the corporation for cash.
d) Asset increases, revenue increases A customer purchases merchandise for cash or
on credit.
e) Liability decreases, asset decreases Cash used to pay off amounts owed to suppliers
f) Asset decreases, expense increase - Pay employees for work they have done for the
business
g) Liability decrease, revenue increase Performed work for customer where customer
paid for the work in advance
h) Asset decreases, shareholders equity decreases Pay cash dividends
i) Liability increase, expense increase Accrue an expense at the end of a period (e.g.
for utilities or warranty costs)
j) Asset decreases, revenue decreases A dissatisfied customer returns merchandise for
a refund

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E3-3.
a.
Balance before closing entry on
Retained earnings Revenue Expenses
December 31, 2017
$13,750,000 $5,125,000 ($3,225,000)
Closing entry
5,125,000 (5,125,000)
Closing entry
(3,225,000) 3,225,000
Balance after closing entry on
December 31, 2017
15,650,000

-

-

b.
Dr. Revenue 5,125,000
Cr. Expenses 3,225,000
Cr. Retained earnings 1,900,000

c. The primary purposes of closing entries are to reset the balances in the temporary (income
statement) accounts to zero and to transfer the amounts in those accounts to retained
earnings.

d. Net income for 2018would be overstated by $1,900,000 because all revenues and expenses
from 2017would be included in 2018revenues and expenses.

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E3-4.
a.
Retained
Earnings
Sales Cost of
sales
Selling
andmarketing
General
andadministrative
Research and
development
Depreciation. Interest Other Income
taxes
Balance
on August
31, 2016,
before
closing
entry
0 225,720 (76,200) (22,740) ($15,450) ($9,675) ($9,420) ($4,500) ($3,315) ($30,390)
225,720 (225,720)
Closing (76,200) 76,200
Closing (22,740) 22,740
Closing ($15,450) $15,450
Closing ($9,675) $9,675
Closing ($9,420) $9,420
Closing ($4,500) $4,500
Closing ($3,315) $3,315
Closing ($30,390) $30,390
Balance
on August
31, 2016,
after
closing
entry
54,030 $0 $0 $0 $0 $0 $0 $0 $0 $0
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b.
DR Sales 225,720
CR Cost of Sales 76,200
Selling and marketing 22,740
General and administrative 15,450
Research and development 9,675
Depreciation. 9,420
Interest 4,500
Other 3,315
Income taxes 30,390
Retained Earnings 54,030

c. The primary purposes of closing entries are to reset the balances in the temporary accounts to
zero and to transfer the amounts in those accounts to the retained earnings account.

d. Net income for 2017would be overstated by $54,030 because all revenues and expenses from
2016would be included in the 2017 revenues and expenses.

E3-5.
a. Increase assets, increase liabilities
b. Decrease assets, decrease retained earnings (increase in expenses)
c. No impact (cash increases, accounts receivable decreases)
d. Decrease assets, decrease liabilities
e. Decrease assets, decrease retained earnings (increase in expenses)
f. No impact (cash decreases, prepaid insurance increases)
g. Increase assets, increase liabilities
h. Increase liabilities, decrease retained earnings (increase in expenses)
i. Increase assets, increase retained earnings (increase inrevenue)

E3-6.
a. debit
b. credit
c. credit
d. credit
e. debit
f. credit
g. credit
h. debit
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E3-7.
a. credit
b. debit
c. credit
d. debit
e. debit
f. debit
g. credit
h. debit

E3-8.
a. Deferred expense/prepaid expense since cash is paid for the supplies before they are
expensed (supplies are expensed as they are used).
b. Accrued expense/accrued liability assuming Beulah received some advertising services in
December, that portion would be accrued and expensed regardless of the fact it wont be paid
until next year.
c. Deferred expense/prepaid expense since cash is paid before the expense is recognized.
d. Deferred revenue since cash is received before the revenue is recognized (not recognized
until gift card is actually used to purchase goods/services.
e. Accrued expense/accrued liabilitysince the bonus expense is recognized in the period in
which its earned, not when the bonus is actually paid out in cash to management.
f. Accrued revenue/accrued asset since the revenues must be recognized (royalties have been
earned prior to the year-end) before the cash is received.
g. Accrued expense/accrued liability since the expense must be recognized before the cash is
paid (loan has been outstanding during the period so that interest must be accrued as it will
eventually have to be paid).

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E3-9.

Assets = Liabilities + Owners Equity
Cash Accounts
Receivable
Inventory Automobile Loan
Payable
Dividends
Payable
Common
shares
Retained
Earnings
Sales Cost of
sales
a. ($25,000) $25,000
b. ($15,000) $25,000 $10,000
c. $100,000 $100,000
d. ($1,000,000) ($1,000,000)
e. $1,000,000 ($1,000,000)
f. ($1,000,000) ($1,000,000)
g. $300
($200)
$300
($200)
h. $300
($200)
$300
($200)
i. $1,000 ($1,000)
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E3-10.

a. Dr. Automobile (assets +) 25,000
Cr. Cash (assets -) 25,000

b. Dr. Automobile (assets +) 25,000
Cr. Cash (assets -) 15,000
Cr. Loan payable 10,000
(liabilities +)

c. Dr. Cash (assets +) 100,000
Cr. Common shares 100,000
(owners equity +)

d. Dr. Retained earnings 1,000,000
(owners equity -)
Cr. Cash (assets -) 1,000,000

e. Dr. Retained earnings 1,000,000
(owners equity -)
Cr. Dividends payable 1,000,000
(liabilities +)

f. Dr. Dividends payable 1,000,000
(liabilities -)
Cr. Cash (assets -) 1,000,000

g. Dr. Cash (assets +) 300
Cr. Sales 300
(revenue +, owners equity +)

Dr. Cost of sales 200
(expenses +, owners equity -)
Cr. Inventory (assets -) 200

h. Dr. Accounts receivable (assets +) 300
Cr. Sales 300

Dr. Cost of sales 200
(expenses +, owners equity -)
Cr. Inventory (assets -) 200

i. Dr. Cash (assets +) 1,000
Cr. Accounts receivable (assets -) 1,000

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Cash Accounts receivable
a

25,000 h 300
b 15,000
i.
1,000

c 100,000
d 1,000,000
f 1,000,000
g 300

i

1,000

Automobile Inventory
a

25,000 g 200
b 25,000 h 200

Loan Payable Dividends Payable Common Stock
b

10,000 e

1,000,000 c

100,000
f 1,000,000

Retained Earnings Sales Cost of sales
d 1,000,000 g 300 g 200
e 1,000,000 h 300 h 200

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E3-11.

Assets

(=) Liabilities (+) Partners Equity
Trans Cash
Accounts
receivable
Building Real estate Bank Loan
Accounts
payable
Wages
payable
Unearned
revenue

Partners
Equity
Revenue
Wage
expense
Other
expenses
a 5,000 5,000
b 425,000 (425,000)
c (2,500) (2,500)
d 50,000 50,000
e 18,000 18,000
f 25,000 (25,000)
g*
h 7,000 7,000
i 3,700 (3,700)
j (1,500) (1,500)

g*: There is no impact on the financial statements at this time.
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E3-12.

Trans DR CR
a Accounts receivable 5,000
Revenue 5,000
b Building 425,000
Real estate 425,000
c Accounts payable 2,500
Cash 2,500
d Cash 50,000
Partners equity 50,000
e Cash 18,000
Bank loan 18,000
f Wage expense 25,000
Wages payable 25,000
g No entry
h Cash 7,000
Unearned revenue 7,000
i Cash 3,700
Accounts receivable 3,700
j Other expenses 1,500
Cash 1,500

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Cash Accounts receivable Building
c 2,500 a 5,000 b 425,000
d 50,000 i 3,700
e 18,000
h 7,000
i 3,700
j 1,500 Real estate
b 425,000

Bank loan Accounts payable Unearned revenue
e 18,000 c 2,500 h 7,000

Wages payable Partners equity Revenue
f 25,000 d 50,000 a 5,000

Wage expense Other expenses
f 25,000 j 1,500

E3-13.
a. Equipment was purchasedfor cash.
b. Goods/services were provided to a customer on credit.
c. Common shares of a corporation were issued for cash.
d. Land was purchased in exchange for a note.
e. Salary earned by employees but not paid was accrued at the end of the period.
f. A company provided goods/services to customers that had been paid for in a previous period.
g. The company paid a supplier the amount owed.
h. Insurance that was originally paid in advance is expensed when the insurance period is over.
i. Interest has been earned but will not be paid until the next accounting periodis accrued at the
end of the period.

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E3-14.
a. Equipment was purchased in part for cash and the remainder in exchanged for a note payable.
b. A bank loan is received in cash from the bank.
c. Land was sold for cash and an amount that is to be receivedmore than one year from the date
of the sale.
d. The company made a rental payment for a specified period before that period actually begins
(prepayment of rent to be used in the future).
e. Dividends have been declared and will be paid in the future.
f. Shares of a corporation were issued in exchange for a patent.
g. Cash of $35,000 was received for $10,000 in goods/services to be provided in the future and
$25,000 of goods/services already provided.
h. As a result of selling products with a warranty, the estimated cost of providing warranty
service is accrued when the products are sold to match the cost with the revenue earned.

E3-15.
Trans DR CR
1 Accounts receivable 10,000
Revenue 10,000
To record a sale on credit.
2 Cash 8,000
To record collection of cash from a customer.
3 Inventory 15,000
Accounts payable 15,000
To record the purchase of inventory on credit.
4 Accounts payable 11,000
Cash 11,000
To record payment to a supplier
5 Cash 25,000
Common shares 25,000
To record the sale of the companys shares for cash.
6 Equipment 52,000
Cash 21,000
To record purchase of equipment partially for cash and partially on credit.
7 Cash 75,000
Bank loan 75,000
To record a bank loan.
8 Cost of goods sold 4,000
Inventory 4,000
To record the expensing of inventory.

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E3-16.

Trans DR CR
1 Salaries expense 31,000
Cash 31,000
To record salary expense paid in cash.
2 Depreciation expense 15,000
Accumulated depreciation 15,000
To record depreciation expense.
3 Cash 11,000
To record unearned revenue
4 Unearned revenue 6,000
Revenue 6,000
To recognize previously unearned revenue.
5 Retained earnings 50,000
Cash 50,000
To record declaration and payment of a dividend.
6 Utilities expense 8,000
Accrued liabilities 8,000
To accrue a utility expense.
7 Bank loan 18,000
Interest expense 2,000
Cash 20,000
To record repayment of a bank loan and interest

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E3-17.
a-c.

Assets (=) Liabilities (+) Shareholder Equity
Accounts Supplies Prepaid Renovation Equipment Accumulated Accounts Wages Common Retained Revenues Expenses
Date Trans Cash Receivable rent depreciation payable payable shares earnings Supplies Rent Wages Utilities Depreciation
Beg
Sept 1 1 125,000 125,000
Sept 3 2 (3,000) 3,000
Sept 3-20 3 (20,000) 20,000
Sept 21 4 (75,000) 125,000 50,000
Sept 25 5 5,000 5,000
Sept&Oct 6 52,500 52,500 105,000
Sept&Oct 7 (10,000) 1,200

(11,200)
Sept&Oct 8 (2,000)

(2,000)
Sept&Oct 9 (2,700) (2,700)
Sept&Oct 10 30,000 (30,000)
Sept&Oct 11 (3,900) (3,900)
adj (1,500)

(1,500)
adj (4,167)

(4,167)
adj (1,111)

(1,111)
Balance 94,800 22,500 1,100 1,500 20,000 125,000 (5,278) 52,300 1,200 125,000 0 105,000 (3,900) (1,500) (11,200) (2,000) (5,278)

Closing
Entries

81,122 (105,000) 3,900 1,500 11,200

2,000 5,278

Ending
Balance 94,800 22,500 1,100 1,500 20,000 125,000 (5,278) 52,300 1,200 125,000 81,122 0 0 0 0 0 0

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d.
Fitness for All Ltd.
Balance Sheet
As of October 31, 2017

Assets
Current Assets
Cash $ 94,800
Supplies 1,100
Prepaid rent 1,500
119,900

Renovations 20,000
Equipment 125,000
Accumulated depreciation (5,278)
Total $259,622

Liabilities and Shareholders Equity
Current Liabilities
Accounts payable $ 52,300
Wages payable 1,200
53,500

206,122
Total Liabilities and Shareholders Equity $259,622

Fitness for All Ltd.
Income Statement and Statement of Retained Earnings
For the two months ended October 31, 2017

Sales $ 105,000*
Expenses
Rent expense $ 1,500
Wages expense 11,200
Utilities expense 2,000
Supplies expense 3,900
Depreciation expense 5,278**
Total expenses 23,878
Net income 81,122
Retained earnings on September 1, 2017 0
Retained earnings on October 31, 2017 $ 81,122

*The full amount of memberships was recognized in the Octoberincome statement. It would
have been reasonable to recognize two months of revenue ($17,500), which would have resulted
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in a dramatically different income statement (probably a more realistic one). In this case net
income and ending retained earnings would have been $-6,378.
**The renovations are depreciated over three years, the period of the lease ($20,000/36months *
2 months = $1,111) and the equipment is depreciated over five years ($125,000/60 months * 2
months).

E3-18.

a. Under cash accounting, $120,000($600 * 200) would be recorded as revenue for the year
ended December 31, 2017. The reason for this is that each memberhas to pay the entire $600 in
cash up front.
b. Under accrual accounting, only $40,000 ($200 * 200) would be recorded as revenue for the
year ended December 31, 2017, The reason for this is that members pay $600 for the use of the
gym for a period of three years or $200 for each year $600/3 years). Accrual accounting seeks to
record revenue on the basis as its earned, it does not matter when cash is received.
c. Under cash accounting, ending retained earnings would include $120,000 of revenue instead
of the $40,000 recognized under accrual accounting. Disregarding expenses (as we do not know
what they are), retained earnings would be $80,000 higher under cash accounting. Under accrual
accounting, there would be an unearned revenue liability of $80,000 on December 31, 2017,
representing the cash collected from members but not recognized as revenue. This liability would
not exist under cash accounting. Cash would increase by $120,000 under both methods.
d. Cash and accrual accounting each provide different measures of the revenues of the company.
Accrual accounting isa more relevant measure of revenue from an economic perspective because
it reflects the amount Saanich has earned providing service to members.Revenue under cash
accounting represents the amount of cash collected in the period. This depiction does not capture
the economic activity of Saanich as well as accrual accounting but it does reflect an important
aspect of operations; cash inflows. Care has to be taking in concluding a particular method is
always more relevant than another. Its likely that accrual accounting will be more relevant for
most stakeholders and uses of financial information, but probably not all.

E3-19.

a. Dr. Depreciation Expense $25,000
Cr. Accumulated Depreciation $25,000
b. Dr. Interest Receivable $5,000
Cr. Interest Revenue $5,000
c. Dr. Consulting Expense $10,000
Cr. Accounts Payable $10,000
d. Dr. Unearned Revenue $6,000
Cr. Revenue $6,000

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E3-20.
Date Type DR CR
a 12-Sep Trans Loan Receivable 25,000
Cash 25,000

31-Dec Adj Interest Receivable 490
Interest Revenue 490
$750*(111/170 days)

1-Mar Trans Cash 25,750
Interest Revenue 260
Loan Receivable 25,000
Interest Receivable 490
Interest revenue = $750 - $490 = $260

b 31-Dec Adj Wages Expense 4,500
Wages Payable 4,500

15-Jan Trans Wages Expense 4,500
Wages Payable 4,500
Cash 9,000

c 10-Jul Trans Cash 10,000

31-Dec Adj Unearned revenue 5,000
Revenue 5,000
10,000/10 months*5 months

d 2-Nov Trans Inventory 32,000
Cash 32,000

31-Dec Adj Inventory loss 5,000
Inventory 5,000

e 30-Jun Trans Building 10,000,000
Cash 10,000,000

31-Dec Adj Depreciation Expense 200,000
Accumulated Depreciation 200,000
(10,000,000/25)*(6/12)

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E3-21.
Date Type DR CR
a 31-Jul Adj Accounts Receivable 60,000
Royalty revenue 60,000

Dec 31 Trans Cash 60,000
Accounts Receivable 60,000

b 15-Feb Trans Advance payment for inventory 100,000
Cash 100,000

31-Jul Adj Inventory 60,000

Advance payment for
inventory 60,000

c 31-Jul Adj Utilities expense

5,000
Utilities payable

5,000

8-Sept Trans Utilities payable 5,000
Cash 5,000

d During yr Trans Cash

50,000
Unearned Revenue

50,000

31-Jul Adj Unearned Revenue 30,000
Revenue 30,000

e 1-Mar Trans Cash 100,000
Bank Loan 100,000

31-Jul Adj Interest expense 2,917
Interest Payable

2,917
$7,000 * (5/12) = $2,917

28-Feb Interest Payable 2,917
Interest Expense 4,083
Cash 7,000
Interest expense = $7,000 - $2,917

f 1-Dec Trans Prepaid Insurance 12,000
Cash 12,000

31-Jul Adj Insurance Expense

8,000
Prepaid Insurance

8,000

$12,000*(8/12) = $8,000

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E3-22.
a. Dr. Depreciation Expense 70,000
(expense +, owners equity -)
Cr. Accumulated Depreciation 70,000
(Contra-asset +)
The entity recorded a $70,000 depreciation expense to reflect consumption of depreciable
assets.

b. Dr. Unearned Revenue 5,000
(liability -)
Cr. Revenue 5,000
The entity performed services for customers that had paid deposits in advance.

c. Dr. Interest receivable (asset +) 4,000
Cr. Interest revenue 4,000
The entity earned interest of $4,000on an investment or bank deposit in the current period
but the interest will not be paid until after the year end.

d. Dr. Interestexpense 5,000
Cr. Interest payable (liability +) 5,000
Interest on a loan accrued but does not have to be paid until after the year-end.

e. Dr. Insuranceexpense 6,000
Cr. Prepaid insurance (asset -) 6,000
The entity used up some of its insurance that it had paid for in advance. When an entity
purchased insurance in advance, it records it as an asset and expenses it when it uses it
up.

f. Dr. Supplies expense 14,000
Cr. Supplies Inventory (asset -) 14,000
A supplies inventory count revealed that $14,000 of supplies previously purchased had
been used up and therefore have to be expensed.

g. Dr. Utilities expense 9,000
Cr. Utilitiespayable (liability +) 9,000
Utilities consumed have been estimated (accrued) as the entity has used utilities but will
not be billed until after the year-end.

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E3-23.

Charnys Ltd.
Income Statement
For the year ended December 31, 2016

Sales 650,000
Interest revenue 3,000
Total revenue 653,000

Expenses
Cost of goods sold 225,000
Wage expense 125,000
Advertising expense 35,000
Depreciation expense 25,000
Selling and administrative expense 32,000
Rent expense 18,000
Miscellaneous expense 9,500
Income tax expense 59,000
Total expenses 541,000

Net income 112,000

E3-24.

a. Net income would be overstated because expenses would be understated (no depreciation
expense). The adjusting entry would record adepreciation expense and an increase in a
contra-asset.
b. Net income would be understated because earned revenue isnt recorded. The adjusting
entry would record an increase in revenue and an increase in an asset.
c. Net income would be understated because earned revenue isnt recorded. The adjusting
entry would record an increase in revenue and a decrease in the unearned revenue liability.
d. Net income would be overstatedbecause expenses would be understated (no insurance
expense). The adjusting entry would record an increase in insurance expense and a decrease
in the asset prepaid insurance.
e. Net income would be overstatedbecause expenses would be understated (no interest
expense). The adjusting entry would record an increase in interest expense and an increase in
interest payable.
f. Net income would be overstatedbecause expenses would be understated (understated wage
expense). The adjusting entry would record an increase in wage expense and an increase in
wages payable.

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E3-25.
a. Expenses will be understated, owners equity will be overstated, and assets will be
overstated. The adjusting entry would record an expense and increase a contra-asset
account (accumulated depreciation) which would increase expenses and decrease assets.
b. Revenue will be understated, owners equity will be understated, and assets would be
understated. The adjusting entry would record revenue, which increases owners equity
as well as a receivable, which increases assets.
c. Revenue and owners equity will be understated, liabilities will be overstated.
Recognizing revenue would decrease the unearned revenue liability and increase revenue
and owners equity.
d. Assets and owners equity will be overstated, expenses will be understated. An adjusting
entry would reduce prepaid insurance and recognize the reduction as an expense which
decreases owners equity.
e. Liabilities and expenses will be understated; owners equity will be overstated. An
adjusting entry would recognize the portion of interest that is owed which will create a
liability and recognize an expense.
f. Liabilities and expenses will be understated; owners equity will be overstated. An
adjusting entry would recognize the wages that are owed to employees and the related
wage expense.

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E3-26.

Reversal of
transactions:

Cash
Accounts
receivable
Equipment
Unearned
revenue
Accounts
payable
Bank
loan
Sales
Wage
expense
Other
expenses
Beginning ?
a 15-Mar (20,000) 100,000 80,000
b 20-Mar (10,000) (10,000)
c During 25,000 150,000 175,000
d During 110,000 (110,000)
(90,000) (90,000)
e During (32,000) 32,000
f During 4,500 4,500
g During (8,000) 8,000
Ending 31-Mar 125,000

Ending
balance
= Beginning
balance
+ Changes to cash
during March
125,000 ? (20,500)
145,500
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E3-27.
Trans Date Cash
Accounts
receivable Sales
Opening bal 1-Nov 350,000
Collections During 410,000 (410,000)
Additions During 440,000 440,000
Ending bal 30-Nov 410,000 380,000 440,000

Ending balance = Beginning balance + Increases Decreases
380,000 350,000 ? 410,000
Credit sales = 440,000

Amount of credit sales during November were $440,000.

E3-28.

Trans Date Cash Supplies Accounts payable
Opening bal 1-Jun 150,000
Purchases During 760,000 760,000
Payments During 730,000 (730,000)
Ending bal 30-Jun 180,000

Ending balance = Beginning balance Payments + Purchases
180,000 150,000 ? 760,000
Amount paid to suppliers = 730,000

Amount of payments during June was $730,000.

.

E3-29.
Ending accounts receivable = Beginning accounts receivable
+ Transactions that increase accounts receivable
Transactions that decrease accounts receivable

Ending accounts receivable = $20,000 + $150,000 $152,000
= $18,000

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E3-30.
a. Dr. Inventory(asset +) 15,000
Cr. Cost of sales (expenses +, owners equity -) 15,000

b. Dr. Revenue (revenue -, shareholders equity -) 200,000
Cr. Common shares (shareholders equity +) 200,000

c. Dr. Equipment (asset +) 10,000
Cr. Computer expense (expenses -, owners equity +) 10,000

d. Dr. Revenue(revenue -, shareholders equity -) 3,000
Cr. Accounts receivable (asset -) 3,000

E3-31.
Note: the following responses address only the impact on the current period financial statements.
If the error was not corrected:
a. Expenses would be overstated meaning net income and shareholders equity would be
understated. Also, assets would be understated.
b. Revenue would be overstated so net income would be overstated. Common shares would be
understated but no overall effect to shareholders equity (because retained earnings would be
overstated).
c. Assets would be understated because these computers were expensed immediately. Expenses
would be overstated meaning net income and shareholders equity would be understated.
d. Revenue would be overstated meaning net income and shareholders equity would be
overstated. Assets would also be overstated as the balance paid would still be in accounts
receivable.

E3-32.
a. Dr. Revenue (OE-, R-) 175,000
Cr. Bank Loan (L +) 175,000

b. Dr. Prepaid Rent (A+) 15,000
Cr. Rent Expense (OE+, E-) 15,000

c. Dr. Retained Earnings (OE-) 50,000
Cr. Dividend Expense (E -, OE+) 50,000

d. Dr. Long-term debt (L -) 100,000
Cr. Interest Expense (OE+, E-) 100,000

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E3-33.
Note: the following responses address only the impact on the current period financial statements.
If the error was not corrected:
a. Revenue would be overstated sonet income and shareholders equity would be overstated.
Liabilities would be understated.
b. Expenses would be overstated sonet income and shareholders equity would be understated.
Assets would be understated as the rent should have been recorded as a prepaid asset.
c. Expenses would be overstated so net income would be understated. Overall shareholders
equity would be unaffected as the dividend expense and to the failure to debit retained
earnings offset.
d. Expenses would be overstated so net income and shareholders equity would be understated.
Liabilities would be overstated because long-term debt hasnt been debited.

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E3-34.

Kuskonook Inc.
Balance Sheet
As of December 31, 2017

Assets Liabilities and Shareholders Equity
Current Assets: Current Liabilities
Cash $25,000 Bank loan payable $150,000
Accounts receivable 125,000 Accounts payable and accrued liabilities 200,000
Inventory 224,000 Salaries and commissions payable 29,000
Loan receivable 48,000 Income taxes payable 15,000
Prepaid assets 18,000 Interest payable 12,000
440,000 Unearned Revenue 100,000
Dividends Payable 18,000
Note payable - current portion 300,000
824,000
Long-term loan receivable 110,000
Property, plant and equipment 5,825,000 Note payable 2,100,000
Intangible Assets 1,000,000 Common shares 1,250,000
Retained earnings 2,376,000
3,626,000
Total Assets $6,550,000 Total Liabilities and Shareholders Equity $6,550,000

Kuskonook Inc.
Income Statement

Revenue $6,650,000
Cost of goods sold 2,445,000
Gross margin 4,205,000

Expenses
Selling, general and administrative expense $725,000
Salaries and commissions expense 950,000
Other expense 182,000
Total expenses 2,637,000
Net income 1,568,000

Retained earnings at the beginning of the year 808,000

Retained earnings at the end of the year $2,376,000

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E3-35.
Closing Entry December 31, 2017:
DR CR
Revenue 6,650,000
Cost of sales 2,445,000
Selling, general, and administrative expense 725,000
Other expenses 182,000
Kuskonook Inc.
Post-closing Trial Balance
December 31, 2017
Account Debit Credit
Cash 25,000
Intangible Assets 1,000,000
Inventory 224,000
Loan receivable 48,000
Long-term loan receivable 110,000
Prepaid assets 18,000
Property, plant and equipment 5,825,000
Accounts payable and accrued liabilities 200,000
Bank loan payable 150,000
Common shares 1,250,000
Dividends Payable 18,000
Income taxes payable 15,000
Interest payable 12,000
Note payable - current portion 300,000
Note payable 2,100,000
Salaries and commissions payable 29,000
Unearned Revenue 100,000
Revenue 0
Cost of sales 0
Depreciation expense 0
Income tax expense 0
Interest expense 0
Other expenses 0
Selling, general, and administrative
expense 0
Salaries and commissions expense 0
7,375,000 7,375,000

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E3-36.
a.
Cash Inventory
Prepaid
rent
Prepaid
advertising
Furniture and
fixtures
Accounts
payable
Loan
payable
Owners'
equity
Sept
Opening 10,000 10,000
7,000 7,000
15-Oct (2,000) 2,000
(3,000) 3,000
29-Oct (10,000) 22,000 12,000
(500) 500
Total 1,500 22,000 2,000 500 3,000 12,000 7,000 10,000

b.
Denis' Great Gifts
Balance Sheet
As of October 31 2017
Assets Liabilities
Cash $1,500 Accounts payable $12,000
Inventory 22,000 Loan payable 7,000
Prepaid rent 2,000
Prepaid advertising 500 Owners' equity 10,000
Furniture and fixtures 3,000
Total assets $29,000 Total liabilities and owners' equity $29,000

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E3-37.

Cash
Accounts
receivable
Inventory
Prepaid
rent
Prepaid
advertising
Furniture
and
fixtures
Accounts
payable
Wages
payable
Loan
payable
Owners'
equity
Revenue
Cost of
sales
Wage
Expense
Advertising
expense
Rent
expense
Utilities
expense
Depreciation
expense
Sept Opening 10,000 10,000
7,000 7,000
15-Oct (2,000) 2,000
(3,000) 3,000
29-Oct (10,000) 22,000 12,000
(500) 500
Total 1,500 22,000 2,000 500 3,000 12,000 7,000 10,000
Nov-Dec 50,800 1,200 52,000
Nov-Dec (12,000) (12,000)
Nov-Dec (8,250) 10,000 1,750
Nov-Dec (31,400) (31,400)
Nov-Dec (3,000) 400 (3,400)
Nov-Dec
Nov-Dec (1,500) (500) (2,000)
Nov-Dec 500 (500)
Nov-Dec (2,000) (2,000)
Nov-Dec (1,000)* (1,000)
27,550 1,200 600 0 0 2,000 2,250 400 7,000 10,000 52,000 (31,400) (3,400) (2,000) (2,000) (500) (1,000)
Closing 11,700 (52,000) 31,400 3,400 2,000 2,000 500 1,000
27,550 1,200 600 0 0 2,000 2,250 400 7,000 21,700 0 0 0 0 0 0 0

*Depreciation expense assumes straight-line depreciation over three years. Other reasonable assumptions are possible.
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a.
Denis' Great Gifts
Income Sheet
As of December 31
(Prepared using the cash basis)
Revenue ($52,000 - $1,200)
$50,800
Cost of sales ($22,000 +$10,000 - $1,750)
30,250
Gross margin
20,550
Expenses:

Wage expense
$ 3,000
Advertising ($500 + $1,500)
2,000
Rent expense
2,000
Total Expenses
7,000
Net income
$13,550

Denis' Great Gifts
Income Sheet
As of December 31
(Prepared using the accrual basis)
Revenue
$52,000
Cost of sales ($22,000 +$10,000 - $600)
31,400
Gross margin
20,600
Expenses:

Wage expense
$3,400
Advertising ($500 + $1,500)
2,000
Utilities expense
500
Rent expense
2,000
Depreciation expense*
1,000
Total Expenses
8,900
Net income
$ 11,700
*Different assumptions are possible for depreciation. The solution assumes
a three-year life for the depreciable assets. Its a good and important habit
for students to develop to recognize the need to fill in missing information.

b. The two income statements are different because two different bases of accounting methods
were used to determine net income. Cash accounting only recognizes cash transactions. Revenue
is recognized only when cash is received thus the accounts receivable of $1,200 is not included
as Revenue. The cost of sales does not include the accounts payable because its not paid and
goods paid for are expensed, not goods sold.

Accrual accounting tries to recognize the economic events of an entity over a set period.
Revenue is recognized,as its earned when performance occurs, not when cash is collected. Cost
of sales is determined by how much the cost of inventory was sold during November and
December, not the amount paid for inventory during the period. This takes into account not just
all the inventory purchased in this time but also the amount of inventory left over at the end.
With accrual accounting all expenses incurred during the two months are recognized regardless
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of whether they have been paid or not. Regardless of the accounting method used the real
economic performance of the entity was the same. What differs is the accounting representation
of that activity.

c.
Denis' Great Gifts
Balance Sheet
As of December 31 2017
Assets Liabilities
Accounts receivable 1,200 Wages payable 400
Inventory 600 Loan payable 7,000
Prepaid rent 0
Prepaid advertising 0 Owners' equity 21,700
Total assets $31,350 Total liabilities and owners' equity $31,350

Denis is $11,700 better off than he was two months ago (on an accrual basis). Its difficult to say
for sure how he did but almost $6,000 a month in income seems pretty good. From the balance
sheet you can see Denis has more than enough cash to pay off his liabilities and has significant
amount remaining in his account. It would be helpful to evaluate this business if a similar
business could be found to compare results with. ItsDenis first year in business so these
statements can be used to compare future years and help analyze those years. He could compare
the gross margin percentage of his business with other retail stores to get an idea of how hes
doing. Otherwise, the costs seem reasonable for the size of business (his profit margin percentage
is 22.5%). Additional non-financial information would be helpful such as interviewing Denis and
obtaining information such as how many hours he worked and how stressful was the ordeal. Its
very difficult to assess performance with only a single income statement. In regards to Denis
inventory, its likely of little value unless Denis plans to operate a Christmas business next year.
As the Christmas season is over there is likely little demand for these products and as a result the
$600 remaining in inventory may need to be written down to reflect its market value. Similarly,
it might be appropriate to write down the furniture and fixtures to what they could be sold for
unless Denis is planning to use them again.

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PROBLEMS

P3-1.
a. Given Transaction Entry
January 2, 2017
Dr. Insurance Expense (E+, OE -) $15,000
Cr. Cash (A-) $15,000
Adjusting Entry
June 30, 2017
Dr. Prepaid Insurance (A+) $11,250
Cr. Insurance Expense (E-, OE+) $11,250
$15,000/24 months * 18 months remaining

b. Given Transaction Entry
April 1, 2017
Dr. Cash (A+) 25,000
Cr. Revenue (R+, OE +) 25,000

Adjusting Entry
June 30, 2017
Dr. Revenue (R-, OE-) 15,000
Cr. Unearned revenue (L+) 15,000
[$25,000/5 months *3 months remaining = $15,000] Revenue should not have been initially
recognized.

c. Given Transaction Entry
March 1, 2017
Dr. Investment certificate (A+) 100,000
Cr. Cash (A-) 100,000
Dr. Interest receivable (A+) 6,000
Cr. Interest revenue (R+, OE+) 6,000

Adjusting
Dr. Interest revenue (R-, OE-) 4,000
Cr. Interest receivable (A-) 4,000
[$6,000/12 months * 8 months remaining] Revenue should not have been initially recognized.

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P3-2.
a. Given Transaction Entry
April 1, 2016
Dr. Prepaid rent (A+) 25,000
Cr. Cash (A-) 25,000

Adjusting Entry
December 31, 2016
Dr. Rent expense (E+, OE -) 9,375
Cr. Prepaid rent (A-) 9,375
[$25,000/24 months * 9 months]
The initial entry was correct. No correction required in the adjusting entry.

b. Given Transaction Entry
November 1, 2016
Dr. Cash (A+) 10,000
Cr. Revenue (R+, OE+) 10,000

December 31, 2016
Dr. Revenue (R-, OE-) 10,000
Cr. Unearned revenue ) (L+) 10,000
No revenue should have been recognized as goods will not be delivered until 2017.

c. Given Transaction Entry
July 2, 2016
Dr. Equipment expense (E+, OE -) 50,000
Cr. Cash (A-) 50,000

December 31, 2016
Dr. Equipment (A+) 50,000
Cr. Equipment expense (E-, OE +) 50,000
Original transactional entry should have debited equipment (asset) rather than an
expense
Another entry required (Adjusting) to record depreciation:

December 31, 2016
Dr. Depreciation expense (E+, OE -) 5,000
Cr. Accumulated depreciation 5,000
(contra asset +)
[$50,000/5 years * 6/12]
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P3-3.
a.
Aug 20 Dr. Prepaid rent (asset +) 1,000
Cr. Cash (asset -) 1,000
Transactional entry

Sept 30 Dr. Rent expense 1,000
(expense +, partners equity -)
Cr. Prepaid rent (asset -) 1,000
Adjusting entry

On the September 1 balance sheet there would be an asset called prepaid rent for $1,000.
On the September 30 income statement a rent expense of $1,000 would appear.

b.
Cr. Rent Payable (liability +) 1,000
Adjusting entry

Nothing would appear on the September 1 financial statements, but a liability would appear on
the September 30 balance sheet and an expense would appear on the income statement.

c.
Aug 20 Dr. Prepaid rent (asset +) 1,000
Transactional entry

Sept 15 Dr. Prepaid rent (asset +) 1,000
Transactional entry

Adjusting entry

There would be an asset called prepaid rent of $1,000 on the September 1 and September 30
balance sheets and a $1,000 rent expense would appear on the September 30 income statement.

d.
Sept 15 Dr. Prepaid rent (asset +) 1,000
Transactional entry

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Adjusting entry

A $1,000 rent expense would appear on the September 30 income statement. Students could also
elect to charge the payment directly to expense when its incurred on September 15 since it
covers the rent for the current month.

P3-4.
a.
Aug 20 Dr. Cash (asset +) 1,000
Cr. Unearned Revenue (liability +) 1,000
Transactional entry

Sept 30 Dr. Unearned Revenue (liability -) 1,000
Cr. Rental revenue 1,000
(revenue +, shareholders equity +)
Adjusting entry

On the September 1 balance sheet, there would be a liability called unearned revenue for $1,000.
On the September 30 income statement revenue for $1,000 would appear.

b.
Sept 30 Dr. Rent receivable (asset +) 1,000
Adjusting entry

Nothing would appear on the September 1 financial statements, but an asset, rent receivable,
would appear on the September 30 balance sheet and revenue would appear on the income
statement.

c.
Aug 20 Dr. Cash (asset +) 1,000
Cr. Unearned revenue (liability +) 1,000
Transactional entry

Sept 15 Dr. Cash (asset +) 1,000
Transactional entry

Sept 30 Dr. Unearned revenue (liability -) 1,000
Adjusting entry

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There would be an unearned revenue liability of $1,000 on the September 1 and September 30
balance sheets and $1,000 of revenue would appear on the September 30 income statement.

d.
Sept 15 Dr. Cash (asset +) 1,000
Transactional entry

Sept 30 Dr. Unearned revenue (liability -) 1,000
Adjusting entry

Revenue would appear on the September 30 income statement. Students could also elect to post
the cash receipt directly to rental revenue when its received on September 15 since it covers the
rent for the current month.

P3-5.
a. Cayley should recognize the sale of gift cards as unearned revenue. The balance in this
account should be (at January 31, 2017):

Unredeemed amount on February 1, 2016 $110,000
Plus: Gift card purchases during year 370,000
Less: Gift card redemptions during year (325,000)
Balance, January 31, 2017: $155,000

b. The $155,000 should be recorded as a liability (unearned revenue) on the balance sheet.
Cayley Gifts has an obligation to sacrifice resources (inventory) in the future when
customers redeem their gift cards. Cayley can only recognize revenue when gift cards are
redeemed because that is when goods are provided to customers. Until they are
redeemed, they are a liability because Cayley received the cash for the gift cards but has
not delivered any goods; They owe customers goods in the future (present obligation
involving a future sacrifice).

c. If there was a solid basis for saying that about 5 percent of gift cards go unredeemed, then
Cayley should reduce its liability by 5 percent. Financial statements should report the
expected amount of the liability, which is estimated to be 95 percent of the amount of gift
cards outstanding. If Cayley does not adjust its unearned revenue balance related to gift
cards that never will be redeemed, its liabilities would be overstated.When a customer
does not redeem a gift card, Cayley effectively gets money for doing nothing as no goods
are provided to customers. Unredeemed gift cards are good for Cayley since the money
received is a windfallno sacrifice of inventory is required. However, a large proportion
of gift cards not being redeemed may indicate a problem with the attractiveness of the
gift cards (maybe people cant find anything to buy).

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P3-6
Cash
Accounts
receivable
Unearned
revenue
Revenue
Beginning 75,000 10,000
Credit sales 393,000 (7,000) 400,000
Collection of receivables 355,000 (355,000)
Collection of advances 12,000 12,000
Ending 367,000 113,000 15,000

This is a tricky question. The yellow boxes in the spreadsheet show the information that was
given. The key is recognizing that to get the unearned revenue account to balance there has to be
a reduction (debit) of $7,000. When unearned revenue is debited, revenue would be credited. As
a result the amount of credit sales is $393,000 because $7,000 of the revenue is from unearned
revenue.

P3-7.
Situation Assets Liabilities Owners
Equity
Revenues Expenses
a. Overstated NE Overstated NE Understated
b. NE Understated Overstated Overstated NE
c. NE Understated Overstated NE Understated
d. NE Understated Overstated NE Understated
e. NE NE NE NE NE

Explanations:
a. Assets are overstated because accumulated depreciation was not increased. Expenses are
understated and therefore owners equity is overstated because no expense was recorded.
b. Liabilities are understated because the obligation to provide admission to games in the future
is not recorded. Revenue and owners equity are overstated because revenue that was not
earned is included in income.
c. Liabilities are understated because the amount owed to the water supplier is not recorded.
Expenses are understated because the cost of water is not recorded. Owners equity is
overstated because expenses are understated.
d. Liabilities are understated because the interest owed at the balance sheet date is not recorded.
Expenses are understated since the cost of borrowing the money for the period is not
recorded and, therefore, income is overstated. As a result, owners equity is overstated.
e. Cash will be understated since the cash account was credited for less than the amount paid
and capital assets will be overstated by an equal amount. As a result the accounting equation
is in balance but individual assets are not correct.

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P3-8
Situation Assets Liabilities Owners
Equity
Revenues Expenses
a. Overstated NE Overstated NE Understated
b. NE Understated Overstated Overstated NE
c. NE Understated Overstated NE Understated
d. Understated NE Understated Understated NE
e. Understated NE Understated NE Overstated

Explanations:
a. Due to the failure to record an adjusting entry, the balance in prepaid insurance was not
reduced to reflect the use of the asset and so assets are overstated. Expenses are understated
because the adjusting entry was required to record the insurance expense. As a result of the
understatement of expenses, owners equity is overstated.
b. Because the liability for the services to be provided in 2018 was not recorded, the liabilities
are understated. Since the revenue is inappropriately included in 2017, revenues are
overstated in 2017 as is owners equity.
c. Liabilities are understated because the amount owed for electricity is not reported. Expenses
are understated because the cost of electricity is not recorded and therefore owners equity is
overstated.
d. Assets are understated because the interest that has been earned is not reported. Interest
revenue is understated since the interest earned by lending the money for the period is not
recorded and therefore owners equity is understated.
e. Cash will be understated since the cash account was credited by an amount greater than the
amount paid. The net effect is that total assets will be understated by the amount of the error
and expenses will overstated by the same amount. As a result, owners equity will be
understated.

P3-9.

` Current ratio

Current assets/
Current
liabilities
Debt-to-equity
ratio

Total debt/
Total equity
Profit margin

Net income/
Sales
Return on
Equity

Net income/
Shareholders
equity
a. Decrease No effect No effect No effect
CA -
b. Increase Increase No effect No effect
CA+ L+
c. Increase Decrease Increase* Increase
CA+ OE+ NI+, Sales+ NI+, OE+
d. Decrease Increase Decrease Decrease
L+ L+, OE- NI- NI-, OE-
e. Increase Decrease No effect Decrease
CA+ OE+ OE+
*Ignores the impact of any costs associated with the sale.

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P3-10.

` Current ratio

Current assets/
Current
liabilities
Debt-to-equity
ratio

Total debt/
Total equity
Profit margin

Net income/
Sales
Return on
Equity

Net income/
Shareholders
equity
a. No effect No effect No effect No effect

b. Decrease Increase Decrease Decrease
CA- OE- NI- NI-, OE-
c. Increase Decrease No effect No effect
CA-, CL- L-
d. Decrease Increase No effect Increase
CA- OE- OE-

P3-11.

` Current ratio

Current assets/
Current
liabilities
Debt-to-equity
ratio

Total debt/
Total equity
Profit margin

Net income/
Sales
Return on
Equity

Net income/
Shareholders
equity (opening)
a. No effect Increase Decrease Decrease
OE- NI- NI-
b. Increase Decrease Increase Increase
CL- L-,OE+ NI+,Sales+ NI+
c. Increase Decrease Increase Increase
CA+ OE+ NI+ NI+
d. Decrease Increase Decrease Decrease
CL+ L+, OE- NI- NI-
e. Decrease Increase Decrease Decrease
CA- OE- NI- NI-

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P3-12

` Current ratio

Current assets/
Current
liabilities
Debt-to-equity
ratio

Total debt/
Total equity
Profit margin

Net income/
Sales
Return on
Equity

Net income/
Shareholders
equity (opening)
a. No effect Understated Overstated Overstated
b. Understated Overstated Understated Understated
c. Understated Overstated Understated Understated
d. Overstated Understated Overstated Overstated
e. Overstated Understated Overstated Overstated

P3-13.
a. During July there was $5,900 of supplies available for use ($2,000 + $3,900). At the end
of the month there was $900 on hand so the amount of supplies used and the expense on
the income statement for July would be $5,000 ($5,900 $900). This will reduce retained
earnings on the balance sheet by $5,000 and supplies, an asset on the balance sheet, will
be reduced by the same amount to $900 at the end of July.
b. No revenue should be reported in July because no work has been performed. On the
balance sheet, the cash received will be in the asset section. Also, $2,000 would appear as
unearned revenue (a liability) as Woking Ltd. has a present obligation to provide services
in the future.
c. For the month of July, $2,000 ($14,000/7 months) should be reported as a rent expense
for the use of the equipment. Also, prepaid assets on the balance sheet would be reduced
by $2,000. The balance in prepaid assets on the balance sheet at the end of July would be
$6,000. Retained earnings would decrease by $2,000.
d. For the month of July, $2,000 should be reported as an expense as this relates to services
used by Woking during the month. The other $500 would appear as an expense in the
month of June. The $500 would have been reported on the balance sheet on July 1 as an
account payable. When paid accounts payable would have decreased by $500. Retained
earnings would fall by $2,000 as a result of this transaction. Cash would have decreased
by $2,500.
e. The payment in June would have been recorded as unearned revenue (a liability) on the
balance sheet. For the month of July, $3,000 should be reported as revenue ($5,000*60
percent) as this amount relates to the work that was actually done in July. In the month of
July, the unearned revenue balance in the liability section of the balance sheet would be
reduced by $3,000. Also, retained earnings (equity) would increase by $3,000 as a result
of the work performed.
f. For July, $3,000 would be reported as wages expense as this is the amount that was
earned by Wokings employees. At the beginning of July there would have been wages
payable (liability) of $1,100, which would be removed when paid in July. The $600 owed
to employees at the end of July would appear as wages payable on the balance sheet at
the end of July. Retained earnings (equity) would decrease by $3,000. The cash paid to
employees during the month would decrease the cash balance by $3,500.

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P3-14.

Paul's Dogs
a.
Assets (=) (+) Shareholder Equity

Accounts
receivable Inventory
Prepaid
licence
Capital
assets
Accum.
deprn.

Wages
payable Loan

Owners
Equity Sales
Expenses
Date Trans Cash Cost of Sales Maintenance Wages Other Depreciation Licence
Beg
1-Apr a 2,000 a a 2,000
8-Apr b (1,000) 1,500 b 500 b
beg c (300) c c (300)
beg d (250) 250 d d
during e 15,750 e e 15,750
August f 1,115 f f 1,115
during g (8,525) 8,525 g g
end h (7,775) h h (7,775)
during i (375) i 75 i (450)
during j (1,000) j j (1,000)
15-
Aug k (1,500) k k (1,500)
5-Sep l (500) l (500) l
Adj-m (375)

adj

adj (375)
Adj-n (125)

adj

adj (125)
Balance 4,300 1,115 750 125 1,500 (375) 75 0 500 16,865 (7,775) (300) (450) (1,000) (375) (125)
Closing Entry-o

6,840

(16,865) 7,775 300 450 1,000 375

125
End Bal 7,340 0 0 0 0 0 0 0

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b. Explanations for entries (some of these explanations may be more detailed than would be
expected from a student at this point in the book):
a. To record the contribution of cash to the business by the owner. Cash increases
because cash has been received and owners capital increases because the owner has
made an investment.
b. To record the purchase of the cart for cash and a promise to pay later. The cart is an
asset because it will provide future benefit to the business over the next three or four
years. According to IFRS/ASPE, capital assets increase by the cost of the cart. Paul
paid $1,000 to his friend so cash decreases by $1,000 and he promised to pay the
remainder, $500 later. The promise to pay is an obligation or liability. Notice that the
asset account increases by the full cost of the cart, not just the amount paid in cash.
c. To record amount paid to repair the cart. The cost of repairing the cart reduces cash
by $300 because Paul paid for the repairs in cash. There are actually two ways the
cost of repairs could have been treated. The spreadsheet treats the cost as an expense.
This makes sense because repairs are considered a cost of doing business and are
expensed as incurred. The $300 could also be classified as an asset. If the cost was
necessary to get the asset in shape to use (perhaps without the repairs it was not
usable) then the cost could be treated as an asset and included in capital assets. In that
case the cost of the repairs would have to be depreciated.
d. To record purchase of the license for $250. The license is an asset because it provides
the benefit of allowing Paul to operate his business for two years. As a result the asset
account license increases and cash decreases. The cost of the license has to be
amortized over the two years.
e. To record sales during the summer. Cash increases by the amount sold as does the
account sales.
f. To record sales at the tournament. This is also a sales transaction, but its on credit.
Paul recorded the sales when the hot dogs were provided, but cash will be coming
later when the organizers pay the bill. Therefore, an asset accounts receivable is
recorded to reflect the amount of money owing.
g. To record the purchase of supplies for cash. The supplies are assets until they are
sold, so when the purchase is made the inventory account increases. The supplies
were paid for in cash so the cash account decreases.
h. To record the cost of supplies used. During the summer Paul used up $7,775 of his
supplies. That means that at the end of the summer he had inventory of $750
remaining. Therefore the entry reduces the inventory account by $7,775 to reflect the
supplies used and an expense called cost of sales is recorded to reflect the amount
of inventory used to generate the sales recorded. There is another aspect of this
question that some students might have considered. Is the remaining inventory really
worth anything at the end of the summer?
i. To record the cost of wages. Paul agreed to pay his brother to operate the cart. Since
the wages relate to work done during the current summer, they are accounted for as
expenses. The full amount is expensed in the period and the amount owing ($75) is
recorded as a liability.
j. To record other expense incurred. Expenses are costs of doing business and are
recorded in the period they help earn revenue. Paul paid $1,000 for things to help run
the business (we dont know exactly what). As a result, cash decreases and an
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expense is recorded, which is a decrease in owners equity because some of the
owners assets (his cash) are being paid to the suppliers.
k. To record cash withdrawn from the business. When an owner removes assets from the
entity, owners equity decreases. The owner is taking his/her wealth that is reflected
in ownership of the entity and transferring that wealth to him/herself. Thus the
ownership interest decreases (the owner owns less) and assets, in this case cash,
decrease.
l. To record payment of the amount owing to the friend. Paul paid his friend $500 so
cash decreases. The loan liability also decreases because Paul has fulfilled his
obligation to the friend.
m. To record deprecation of the cart. The cart will contribute to Pauls business for three
or four years. The first year of use has passed so part of the cost of the cart is
expensed or depreciated to reflect its usage. The cost of assets that contribute to
earning revenue over a number of periods is expensed over the period that it will be
contributing. Notice there is some judgement here. The solution based the calculation
on an estimated four-year life ($375 = $1,500/4). It would have also been reasonable
to use three years. Estimating the life of an asset is an educated guess. Some
accountants would say that using the three-year period is more appropriate because
its conservative. More will be said about this later in the book.
n. To record amortization of the license. The license has a two-year life, meaning Paul
can use it for two summers. One summer has passed so half of the license has been
used up. Its possible the amortization of the license may be subtracted out of the
prepaid license column as opposed to the accumulated amortization column; either
way is acceptable.
o. The closing entry resets the temporary income statement accounts to zero and records
the balance in retained earnings.

c.
Pauls Dogs
Balance Sheet
As of September 10

Assets Liabilities and Equity
Cash $4,300 Wages payable $75
Accounts receivables 1,115
Inventory 750
License (net of amortization) 125
Cart 1,500
Accumulated depreciation (375)

Owner's capital 7,340
Total assets $7,415 Total liabilities and equity $7,415

Pauls Dogs
Income Statement
For the period ended September 10

Sales $16,865
Expenses
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Cost of sales 7,775
License expense 125
Wage expense 450
Maintenance expense 300
Income $6,840

Pauls Dogs
Statement of Owners Equity

Owners equity at beginning $0
Investment by owner 2,000
Net income 6,840
Less drawings (1,500)
Owners equity at end $7,340

d. (This is a sample answer rather than the right one. Good answers should have addressed
some of these issues, but the discussion could have approached them from different
perspectives)

The financial statements provide a useful summary of how Pauls Dogs did during the
summer. It provides Paul with information that will allow him to assess whether he should do
it again next summer. If he wants to do something else, he will have information that he
could show to the next owner of the cart. The income statement offers some detail on the
costs Paul incurred operating his business and could be the starting point for looking at how
he could do even better next summer.

The balance sheet tells Paul the resources he has on hand at the end of the summer. The
information might be somewhat misleading because one has to wonder whether all the $750
of non-perishable inventory would keep for the entire winter. Napkins and plastic cutlery
would but condiments might have to be replaced. The balance sheet also reminds Paul that he
is owed $1,115, but given that this is from a single group, he probably would remember
anyway. The closing balance of cash lets Paul know how much extra cash he has in addition
to his initial investment. The wages payable reminds him that he owes his brother $75, but
his brother would probably remind him if he forgot.

The format of these statements is quite simple, probably suitable for the situation.

e. (This is a sample answer rather than the right one. Good answers should have addressed
perspectives)

The statements suggest that Paul had a fairly successful summer. $6,840 for a summer job is
pretty good although from the statements we cant tell how much Paul worked to earn the
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edition Page 3-52
money (on an hourly basis he may have earned a relatively small amount). Its interesting to
see that even though Pauls income is $6,840, on a cash basis he is only $3,800 better off (he
invested $2,000 and now has $4,300 plus the withdrawal of $1,500). The cash position will
improve once he collects the $1,115 that is owed to him. The difference between income and
the increase in cash is the investment that had to be made in the cart, license, and inventory.
These amounts did not affect income during the year but did cost cash.

There seems to be a large amount of inventory on hand at the end of the year. Will it be
usable next year? If some has to be disposed of (like condiments), the cost of the amounts
thrown away should be expensed this year since they really are a cost of doing business this
year.

The statements dont tell Paul anything about the market value of the cart. He needs to know
what he could sell the cart for if he wants complete information about whether he should
continue in business or sell the cart and get cash for it. The book value of the cart simply tells
how much the cart cost less the amount depreciated (really not a very useful number). The
statements also do not tell whether the license could be sold.

In examining the performance of Pauls business, its difficult to fully assess it because there
is no basis of comparison. In predicting how Paul would do next year one might wonder
whether it will be necessary to spend $300 on repairs. It would be useful to find out how
other vendors do.

Its possible to do some ratio analysis such as profit margin and return on equity. The current
ratio and debt to equity would not be relevant because the debt is too small. (Profit margin =
.41) (Return on equity = 1.86). However, we dont have benchmarks to compare these ratios
with.

Questions remain on how good Pauls locations were, how much food was wasted, whether Paul
priced his products well, etc. This information is not available in the financial statements.

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edition Page 3-53
P3-15.
a.
Dr. Cash 2,000
Cr. Owners equity 2,000

b.
Dr. Capital assets (cart) 1,500
Cr. Cash 1,000
Loan 500

c.
Dr. Repairs Expense 300
Cr. Cash 300

d.
Dr. Prepaid License 250
Cr. Cash 250

e.
Dr. Cash 15,750
Cr. Sales 15,750

f.
Dr. Accounts Receivable 1,115
Cr. Sales 1,115

g.
Dr. Inventory 8,525
Cr. Cash 8,525

h.
Dr. Cost of sales 7,775
Cr. Inventory 7,775

i.
Dr. Wage expense 450
Cr. Cash 375
Wages payable 75
j.
Dr. Other expenses 1,000
Cr. Cash 1,000
k.
Dr. Owners Capital 1,500
Cr. Cash 1,500
l.
Dr. Loan 500
Cr. Cash 500
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m.
Dr. Depreciation expense 375
Cr. Accumulated depreciation 375

n.
Dr. License expense 125
Cr. Prepaid license 125
Part B & C
Cash Accounts
receivables
Inventory
a. 2,000 b. 1,000 f. 1,115 g. 8,525 h. 7,775
e. 15,750 c. 300
d. 250
g. 8,525
i. 375
j. 1,000
k. 1,500
l. 500 1,115 750
4,300

License Cart Accumulated
depreciation

d. 250 b. 1,500 m. 375
n. 125

125 1,500 375

Loan
l. 500 b. 500

0

Wages payable Owners Capital Sales
i. 75 k. 1,500 a. 2,000 e. 15,750
f. 1,115
16,865

75 500

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Cost of Sales Repairs Expense Wage Expense
h. 7,775 c. 300 i. 450

7,775 300 450

Other Expense Depreciationexpens
e (cart)
License expense
j. 1,000 m. 375 n. 125

1,000 375 125

Part D
Pauls Dogs
Trial Balance
September 10

Debits Credits
Cash $ 4,300
Inventory 750
License 125
Cart 1,500
Accumulated depreciation $375
Wages payable 75
Owners equity 500
Sales 16,865
Cost of sales 7,775
Repairs expense 300
Wage expense 450
License expense 125
Other expense 1,000
$ 17,815 $ 17,815

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Part E.
Pauls Dogs
Balance Sheet
As of September 10

Assets Liabilities and Equity
Cash $4,300 Wages payable $75
Inventory 750
Cart 1,500
Accumulated depreciation (375)

Owner's capital 7,340
Total assets $7,415 Total liabilities and equity $7,415

Pauls Dogs
Income Statement

Sales $16,865
Expenses
Cost of sales 7,775
License expense 125
Wage expense 450
Maintenance expense 300
Income $6,840

Pauls Dogs
Statement of Owners Equity

Owners equity at beginning $0
Investment by owner 2,000
Net income 6,840
Less drawings (1,500)
Owners equity at end $7,340

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Part F
(o.) Closing entry
Dr. Sales 16,865
Cr. Cost of sales 7,775
Wage expense 450
Other expense 1,000
Repairs expense 300
License expense 125
Owners capital 6,840

Owners Capital Sales Other Expense
k. 1,500 a. 2,000 e. 15,750 j. 1,000
f. 1,115
500 16,865 1,000
o. 6,840 o. 16,865 o. 1,000
7,340 0 0

Cost of Sales Repairs Expense Wage Expense Depreciation
Expense (cart)
h. 7,775 c. 300 i. 450 m. 375

7,775 300 450 375
o. 7,775 o. 300 o. 450 o. 375
0 0 0 0

License
Expense
n. 125

125
o. 125
0

Part G
Pauls Dogs
Post-closing Trial Balance
As of September 10

Debits Credits
Cash $ 4,300
Inventory 750
Cart 1,500
Accumulated depreciation $375
Wages payable 75
Owners capital 7,340
$ 7,790 $ 7,790
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edition Page 3-58
h (This is a sample answer rather than the right one. Good answers should have addressed
perspectives)

The financial statements provide a useful summary of how Pauls Dogs did during the
summer. It provides Paul with information that will allow him to assess whether he should do
it again next summer. If he wants to do something else, he will have information that he
could show to the next owner of the cart. The income statement offers some detail on the
costs Paul incurred operating his business and could be the starting point for looking at how
he could do even better next summer.

The balance sheet tells Paul the resources he has on hand at the end of the summer. The
information might be somewhat misleading because one has to wonder whether all the $750
of non-perishable inventory would keep for the entire winter. Napkins and plastic cutlery
would but condiments might have to be replaced. The balance sheet also reminds Paul that he
is owed $1,115, but given that this is from a single group, he probably would remember
anyway. The closing balance of cash lets Paul know how much extra cash he has in addition
to his initial investment. The wages payable reminds him that he owes his brother $75, but
his brother would probably remind him if he forgot.

The format of these statements is quite simple, probably suitable for the situation.

i. (This is a sample answer rather than the right one. Good answers should have addressed
perspectives)

The statements suggest that Paul had a fairly successful summer. $6,840 for a summer job is
pretty good although from the statements we cant tell how much Paul worked to earn the
money (on an hourly basis he may have earned a relatively small amount). Its interesting to
see that even though Pauls income is $6,840, on a cash basis he is only $3,800 better off (he
invested $2,000 and now has $4,300 plus the withdrawal of $1,500). The cash position will
improve once he collects the $1,115 that is owed to him. The difference between income and
the increase in cash is the investment that had to be made in the cart, license, and inventory.
These amounts did not affect income during the year but did cost cash.

There seems to be a large amount of inventory on hand at the end of the year. Will it be
usable next year? If some has to be disposed of (like condiments), the cost of the amounts
thrown away should be expensed this year since they really are a cost of doing business this
year.

The statements dont tell Paul anything about the market value of the cart. He needs to know
what he could sell the cart for if he wants complete information about whether he should
continue in business or sell the cart and get cash for it. The book value of the cart simply tells
how much the cart cost less the amount depreciated (really not a very useful number). The
statements also do not tell whether the license could be sold.

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edition Page 3-59
In examining the performance of Pauls business, its difficult to fully assess it because there
is no basis of comparison. In predicting how Paul would do next year one might wonder
whether it will be necessary to spend $300 on repairs. It would be useful to find out how
other vendors do.

Its possible to do some ratio analysis such as profit margin and return on equity. The current
ratio and debt to equity would not be relevant because the debt is too small. (Profit margin =
.41) (Return on equity = 1.86). However, we dont have benchmarks to compare these ratios
with.

Questions remain on how good Pauls locations were, how much food was wasted, whether Paul
priced his products well, etc. This information is not available in the financial statements.

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P3-16.


Cash
Accounts
receivable

Prepaid
Assets

Accum.
depreciation.

Accounts
Payable
Curr.
portion
of note
Wages
Payable
Interest
Payable
Long-term
Common
shares
Retained
earnings
Cost of Expenses
Date Trans Inventory PPE Note Sales
Cost of
sales Rent Wages Other Depreciation Interest Utilities
Beg
7/04/17 i. 20,000 i. i. 20,000
8/01/17 ii. (3,000) 3,000 ii. ii.
8/04/17 iii. (12,000) 22,000 iii. 10,000 iii.
8/10/17 iv. 20,000 iv. 10,000 10,000 iv.
During
August v. (7,000) 7,000 v. v.
9/01/17 vi. (1,600) 1,600 vi. vi.
11/01/17 vii. (3,000) 3,000 vii. vii.
12/18/17 viii. 300 viii. viii. 300
During ix. (18,000) 18,000 ix. ix.
During ix. (17,200) ix. ix. (17,200)
During x. 42,000 x. x. 42,000
During xi. (11,200) xi. xi. (11,200)
During xii. (1,200) xii. xii. (1,200)
During xiii. (9,500) xiii. xiii. (9,500)
During xiv. (5,000) xiv. xiv. (5,000)
adj. xv. xv. 846 xv. (846)
adj. xvi. (1,933) xvi. xvi. (1,933)
adj. xvii xvii 710 xvii (710)
adj. xviii (400) xviii xviii (400)
adj. xix. (4,000) xix. xix. (4,000)
adj. xx. xx. 500 xx. (500)
End Balance 10,500 300 800 3,200 29,000 (1,933) 10,846 10,000 500 710 10,000 20,000 (5,000) 42,300 (17,200) (4,846) (11,700) (9,900) (1,933) (710) (1,200)
xxi.
Closing
Entry (5,189) (42,300) 17,200 4,846 11,700 9,900 1,933 710 1,200

End Balance 10,500 300 800 3,200 29,000 (1,933) 0 10,846 10,000 500 710 10,000 (10,189) 0 0 0 0 0 0 0 0

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2. Explanations for entries (some of these explanations may be more detailed than would be
expected from a student at this point in the book):
i. To record the contribution of $20,000 to the corporation by the owner. Cash increases
because cash has been received and common shares increases because the owner has
made an investment.
ii. To record the payment of rent in advance.Cash decreases as it has been used up in
prepaying the rent. Prepaid rent (an asset) increases. Prepaid rent is an asset because it
represents a future benefit (the right to use the rented space in the future which will
help generate revenues for Cookie.
iii. To record the purchase of capital assets. The oven, refrigerator, display cases, etc. are
capital assets (PPE) and this account increases. These items are capital assets as they
will contribute to the revenue generating process for more than one accounting
period. Cash decreases by $12,000 as this amount was used to pay partially for the
items. Accounts payable (a liability) increases as Cookie has the obligation to pay the
final $10,000 owing on February 15, 2018.
iv. To record the acquisition of a loan. Cash increases by $20,000, the amount of the
loan. Liabilities increase by the same amount. One part of the liability is current as
$10,000 is due within one year (current portion of note payable). The other portion
the note is long-term as its not due within one year (Long-term note payable).
v. To record repairs and renovations to the shop. Since the work is necessary to ready
the shop for business the $7,000 is capitalized and will be depreciated over its useful
life. (For purposes of the question these costs will be depreciated over five years (the
lives of the other capital assets) but the period would more likely be different, perhaps
the period of the lease.)
vi. To record the purchase of insurance. Cash decreases as it has been used up in paying
for the insurance. Prepaid insurance an asset, increases. Prepaid insurance is an asset
because the insurance policy represents a future benefit, insurance coverage. None of
the insurance has been used up at this point so it remains an asset until used up.
vii. To record the payment of $3,000 of rent in advance. Cash decreases as it has been
used up in prepaying for the rent. Prepaid rent (an asset) increases. Prepaid rent is an
asset because it represents a future benefit (the right to use the rented space in the
future which will help generate revenues for Cookie.
viii. To record $300 in revenue for Cookie. Accounts receivable (an asset) increases as
Cookie has the right to receive money from the university in January 2018. Revenue
increases as Cookie has performed and earned catering services.
ix. To record the cost of supplies purchased and used in the period. During the summer,
Cookie used up $17,200 of its supplies. That means that at the end of the year they
had inventory of $800 remaining. Usually, the inventory is recorded as its purchased.
This entry just records the $800 of inventory remaining and simply expenses the
$17,200 of inventory used up.
x. To record sales during the year. Cash increases as all sales were for cash. Revenue
increases as this represents goods sold and services performed by Cookie during the
period.
xi. To record the payment of employee wages. Cash decreases by $11,200 as cash was
used up in paying for the wages. Wages expense increases by the same amount as the
employees earned these wages during the year. Wages is an expense as it represents
an economic sacrifice to earn revenue.
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xii. To record the payment of utilities. Cash decreases as it was paid. Utilities expense
increases as utilities represent an economic sacrifice in order to earn revenue in the
period.
xiii. To record other expense incurred. Expenses are costs of doing business and are
recorded in the period they help earn revenue. Cookie paid $9,500 for things to help
run the business (we dont know exactly what). As a result, cash decreases and an
expense is recorded, which is a decrease in owners equity because some of the
owners assets (his cash) are being paid to the suppliers.
xiv. To record a cash dividend paid to the owner. When an owner removes assets from the
entity, shareholders equity decreases. The owner is taking his wealth that is in the
entity and transferring that wealth to himself. Thus the ownership interest decreases
(the owner owns less) and assets, in this case cash, decrease.
xv. To adjust for the portion of rent payable as a result of Cookies sales. Accounts
payable (a liability) increases as Cookie has the obligation to pay 2 % of sales
(2%*$42,300 = $846). Rent expense increases as this represents an economic
sacrifice in order to earn revenue.
xvi. To record depreciation of the equipment and renovations. The equipment and
renovations will contribute to Cookie for an estimated five years from its purchase
date. The cost of assets that contribute to earning revenue over a number of periods is
expensed over the period that it will be contributing. Its assumed that the asset began
to be used on September 1
st
. Depreciation for September-December is calculated as:
[($29,000/5)*4/12] = $1,933.
xvii. To accrue the interest payable on the loan. Interest payable (a liability) increases as
Cookie has the obligation to pay the interest accrued on January 31. Interest expense
increases as the interest accrued represents an economic sacrifice of earning revenue.
Its necessary to accrue the interest as even though it will not be paid until the next
fiscal year because the interest from the inception of the loan until December 31
relates to the 2017 fiscal year .Calculation: $20,000 * 9% *144 days/365 days = $710.
xviii. To adjust the balance of prepaid insurance. Prepaid Insurance (an asset) decreases as
some of the insurance that was prepaid has been used up. The portion of insurance
used up becomes an expense (other expense) as the cost of insurance represents an
economic sacrifice to earn revenue.
xix. To adjust the balance of prepaid rent. Prepaid rent (an asset) decreases as some of the
rent that was prepaid has been used up ($4,000) from September December. The
portion of rent used up becomes an expense (rent expense) as the use of rent
represents an economic sacrifice of earning revenue.
xx. To accrue wages earned but not paid during the current period. A corresponding
liability is recognized as Cookie has the obligation to pay these wages to the
employees
xxi. The closing entry resets the temporary income statement accounts to zero and records
the balance as a reduction to retained earnings since the business recorded a loss
(shareholders equity decreases).

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c)
Cookie Dough Inc.
Balance Sheet

Accounts receivable 300 Current portion of note payable 10,000
Inventory 800 Interest payable 710
Prepaid assets 3,200 Wages payable 500
Total Current Liabilities 22,050
Total current assets 14,800
Non-current assets: Long-term note payable 10,000
Property, plant, and equipment 29,000 Total Liabilities 32,056
Shareholders Equity
Retained earnings (10,189)

Total Assets $41,867 Total Liabilities and Shareholders Equity $41,867

Cookie Dough Inc.
Income Statement
For the year Ended December 31, 2017

Sales $42,300
Cost of Sales 17,200
Gross margin 25,100
Expenses:
Rent $4,846
Wages 11,700
Other 9,900
Depreciation 1,933
Interest 710
Utilities 1,200
Total Expenses 30,289
Net Income ($5,189)

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d. Cookies Cash Information:

Beginning Cash Balance (after initial investment) $20,000
Ending Cash Balance $10,500
Overall Decrease in Cash Balance $9,500

As we can see, after Ernests initial investment of $20,000, his cash balance has declined by
$9,500. It would be good to analyze where the cash went by examining cash from operations,
cash from investing activities and cash from financing activities (after the initial investment):

Cash used by operations (sales, purchase of insurance/goods/utilities, etc.) ($5,500)
Cash from financing (Loan minus payment of dividends) $15,000
Cash for investing (Purchase of equipment, renovations) ($19,000)
Overall Decrease in Cash Flow $9,500

Its evident that the decrease in cash is due to the negative cash from operations and investing
activities. Expenditures on PPE were necessary to get the business going and will not have to
be incurred for the next few years. The loan covered most of these costs. However, Cookie
failed to generate positive cash from day to day operations which is definitely not a good
sign. Cookie still has a cash buffer in the event cash from operations do not become positive.
However, the balance owed on the equipment is due in February so the company could be in
trouble. Also, a $10,000 loan payment is due in August so Ernest should probably start
looking for financing. Ernest has to hope that sales improve so that he can begin generating
cash to meet Cookies requirements. Paying the dividend might not have been the best idea.

Notice that Cookies cash from operations (-$5,500) is lower than its net income for the
period (-$5,189). The reason why these two figures are different is because the income
statement captures events that do not always involve cash. For example, the $500 of wages
owed to employees would be classified as wages expense because even though the wages
have not been paid, the employees have worked the hours and have earned the right to be
paid. This $500 does not affect cash flow as the amount has not been paid at the time of the
preparation of the financial statements. Also, the $300 Ernest expects to be paid for the
holiday party he catered for one of the faculties would be recognized as revenue on the
income statement. The reason is that even though Ernest has not been paid, he has performed
the work or, in other words, he has effectively earned the revenue. This $300 would not
affect cash flow until the amount is actually paid. There is also $800 of inventory on hand
that has been paid for.

e. (This is a sample answer rather than the right one. Good answers should have addressed
perspectives)

The income statement suggests that Cookiedid not have a successful four months. The
income statement showed the company posting a loss of $5,189 on his business before he
even paid himself anything. Its common for businesses in their first year of operations to
post a loss. Still, Ernest would likely be discouraged by these results. He could have worked
elsewhere and earned a steady paycheque. Its clear that if Ernest is to continue to operate
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this business, some changes needed or he would no longer be able to meet his personal needs
nor have the ability to pay off his debts.

One would definitely want to warn Ernest about his cash situation. At the end of the season,
he had $10,500 in cash on hand. However, in the coming year, Cookie has many debts
coming due. On February 15, payment is expected for the remaining $10,000 owing on all
the equipment Cookie purchased to start his business. Also, Cookie must pay the lender
$10,000 on August 1
st
of the coming year. He also has interest to pay, some wages to pay off,
etc. In total, Ernest had current liabilities amounting to $22,050 with only $14,800 in current
assets to meet those obligations. I would definitely highlight to Ernest the necessity of
keeping control over his cash flow situation. Its imperative for him to generate more cash
from operations to be able to pay off his current liabilities and keep his business financially
healthy, or invest additional cash.

In examining the performance of Ernests business, its difficult to fully assess it because
there is no basis of comparison. I would want to investigate how similar stores performed and
especially note what made other stores successful. Ernest may have to review his pricing, the
amount of hours his store is open and many other factors.

P3-17.

a.
i.
Dr. Cash 20,000
Cr. Common shares 20,000

ii.
Dr. Prepaid assets (rent) 3,000
Cr. Cash 3,000

iii.
Dr Property, plant, and equipment 22,000
Cr. Cash 12,000

iv.
Dr. Cash 20,000
Cr. Note payable-current 10,000
Note payable-non-current 10,000

v.
Dr. Property, plant, and equipment (renovations) 7,000
Cr. Cash 7,000

vi.
Dr. Prepaid assets (insurance) 1,600
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Cr. Cash 1,600

vii.
Dr. Prepaid assets (rent) 3,000
Cr. Cash 3,000

viii.
Dr. Accounts receivable 300
Cr. Revenue 300

ix.
Dr. Inventory 18,000
Cr. Cash 18,000

Dr. Cost of sales 17,200
Cr. Inventory 17,200

x.
Dr. Cash 42,000
Cr. Sales 42,000

xi.
Dr. Wage expense 11,200
Cr. Cash 11,200
xii.
Dr. Utilities expense 1,200
Cr. Cash 1,200

xiii.
Dr. Other expenses 9,500
Cr. Cash 9,500

xiv.
Dr. Retained earnings 5,000
Cr. Cash 5,000

Adjusting entries:
xv.
Dr. Rent expense 846
Cr. Accounts payable 846

xvi.
Dr. Depreciation expense 1,933

xvii.
Dr. Interest expense 710
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Cr. Interest payable 710

xviii.
Dr. Other expenses (insurance) 400
Cr. Prepaid assets 400

xix.
Dr. Rent expense 4,000
Cr. Prepaid assets 4,000

xx.
Dr. Wage expense 500
Cr. Wages payable 500

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Part b&c
Cash Accounts receivable Inventory
i. 20,000 ii. 3,000 viii. 300 ix. 18,000
iv. 20,000 iii.12,000 ix. 17,200
x. 42,000 v. 7,000
vi. 1,600
vii. 3,000
ix. 18,000
xi. 11,200
xii. 1,200
xiii. 9,500
xiv 5,000 300 800
10,500

Prepaid assets
(rent/insurance)
Property, plant, and
equipment
Accumulated
depreciation

ii. 3,000 xviii. 400 iii.22,000 xvi.1,933
vi. 1,600 xix. 4,000 v. 7,000
vii. 3,000

3,200 29,000 1,933

Accounts payable Interest payable
iii.10,000 xvii. 710
xv. 846
10,846 710

Wages payable Note payable-
current
Note payable-
noncurrent

xx. 500 iv.10,000 iv. 10,000

500 10,000
10,000

Common shares Retained earnings Sales
i. 20,000 xiv.5,000 viii.
300

x.
42,000

20,000 5,000 42,300

Cost of sales Wage expense
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ix. 17,200 xi. 11,200
xx. 500
17,200 11,700

Other expense
(including insurance)
Depreciation
expense
Utilities expense
xiii. 9,500 xvi.1,933 xii. 1,200
xviii. 400
9,900 1,933 1,200

Rent expense Interest expense
xiv. 846 xvi. 710 xvii. 710
xix 4,000
4,846 710

Part d
Cookie Dough Inc.
Trial Balance
December 31,2017

Debits Credits
Cash $ 10,500
Accounts receivable 300
Inventory 800
Prepaid assets 3,200
Property, plant, and equipment 29,000
Accumulated depreciation $1,933
Wages payable 500
Interest payable 710
Note payable-current portion 10,000
Note payable-long-term portion 10,000
Retained earnings 5,000
Sales 42,300
Cost of sales 17,200
Rent expense 4,846
Utilities expense 1,200
Interest expense 710
Wage expense 11,700
Other expense 9,900
$ 96,289 $ 96,289

Part e.
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Cookie Dough Inc.
Balance Sheet

Accounts receivable 300 Current portion of note payable 10,000
Inventory 800 Interest payable 710
Prepaid assets 3,200 Wages payable 500
Total Current Liabilities 22,056
Total current assets 14,800
Non-current assets: Long-term debt 10,000
Property, plant, and equipment 29,000 Total Liabilities 32,056
Shareholders Equity
Retained earnings (10,189)

Total Assets $41,867 Total Liabilities and Shareholders Equity $41,867

Cookie Dough Inc.
Income Statement
For the year Ended December 31, 2017

Sales $42,300
Cost of Sales 17,200
Gross margin 25,100
Expenses:
Rent $4,846
Wages 11,700
Other 9,900
Depreciation 1,933
Interest 710
Utilities 1,200
Total Expenses 30,289
Net Income ($5,189)

Closing Journal Entry:
Dr. Sales 42,300
Dr. Owners capital 5,189
Cr. Cost of Sales 17,200
Cr. Rent expense 4,846
Cr. Wages expense 11,700
Cr. Other expense 9,900
Cr. Depreciation expense 1,933
Cr. Interest expense 710
Cr. Utilities expense 1,200

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Common shares Retained earnings Sales Other expense
i. 20,000 xiv. 5,000 viii. 300 xiii. 9,500
x. 42,000 xviii. 400
5,000 42,300 9,900
xxi. 5,189 xxi. 42,300 xxi. 9,900
20,000 10,189 0 0

Cost of sales Interest expense Wage expense Depreciation expense
ix. 17,200 xvii. 710 xi. 11,200 xvi. 1,933
xx. 500
17,200 710 11,700 1,933
xxi. 17,200 xxi. 710 xxi. 11,700 xxi. 1,933
0 0 0 0

Rent expense Utilities expense
xiv. 846 xii. 1,200
xviii4,000
4,846 1,200
xxi. 4,846 xxi. 1,200
0 0

Part f.

Cookie Dough Inc.
Trial Balance (post-closing)
December 27,2017

Debits Credits
Cash $ 10,500
Accounts receivable 300
Inventory 800
Prepaid Assets 3,200
Property, plant, and equipment 29,000
Accumulated depreciation $1,933
Wages payable 500
Interest Payable 710
Note payable-current 10,000
Notes payable-noncurrent 10,000
$ 53,989 $ 53,989

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g. Cookies Cash Information:

Beginning Cash Balance (after initial investment) $20,000
Ending Cash Balance $10,500
Overall Decrease in Cash Balance $9,500

As we can see, after Ernests initial investment of $20,000, his cash balance has declined by
$11,500. It would be good to analyze where the cash went by examining cash from
operations, cash from investing activities and cash from financing activities (after the initial
investment):

Cash used by operations (sales, purchase of insurance/goods/utilities, etc.) ($5,500)
Cash from financing (Loan minus payment of dividends) $15,000
Cash for investing (Purchase of equipment, renovations) ($19,000)
Overall Decrease in Cash Flow $9,500

Its evident that the decrease in cash is due to the negative cash from operations and investing
activities. Expenditures on PPE were necessary to get the business going and will not have to
be incurred for the next few years. The loan covered most of these costs. However, Cookie
failed to generate positive cash from day to day operations which is definitely not a good
sign. Cookie still has a cash buffer in the event cash from operations do not become positive.
However, the balance owed on the equipment is due in February so the company could be in
trouble. Also, a $10,000 loan payment is due in August so Ernest should probably start
looking for financing. Ernest has to hope that sales improve so that he can begin generating
cash to meet Cookies requirements. Paying the dividend might not have been the best idea.

Notice that Cookies cash from operations (-$5,500) is lower than its net income for the
period (-$5,189). The reason why these two figures are different is because the income
statement captures events that do not always involve cash. For example, the $500 of wages
owed to employees would be classified as wages expense because even though the wages
have not been paid, the employees have worked the hours and have earned the right to be
paid. This $500 does not affect cash flow as the amount has not been paid at the time of the
preparation of the financial statements. Also, the $300 Ernest expects to be paid for the
holiday party he catered for one of the faculties would be recognized as revenue on the
income statement. The reason is that even though Ernest has not been paid, he has performed
the work or, in other words, he has effectively earned the revenue. This $300 would not
affect cash flow until the amount is actually paid. There is also $800 of inventory on hand
that has been paid for.

h. (This is a sample answer rather than the right one. Good answers should have addressed
perspectives)

The income statement suggests that Cookie did not have a successful four months. The
income statement showed the company posting a loss of $5,189 on his business before he
even paid himself anything. Its common for businesses in their first year of operations to
post a loss. Still, Ernest would likely be discouraged by these results. He could have worked
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edition Page 3-73
elsewhere and earned a steady paycheque. Its clear that if Ernest is to continue to operate
this business, some changes needed or he would no longer be able to meet his personal needs
nor have the ability to pay off his debts.

One would definitely want to warn Ernest about his cash situation. At the end of the season,
he had $10,500 in cash on hand. However, in the coming year, Cookie has many debts
coming due. On February 15, payment is expected for the remaining $10,000 owing on all
the equipment Cookie purchased to start his business. Also, Cookie must pay the lender
$10,000 on August 1
st
of the coming year. He also has interest to pay, some wages to pay off,
etc. In total, Ernest had current liabilities amounting to $22,050 with only $14,800 in current
assets to meet those obligations. I would definitely highlight to Ernest the necessity of
keeping control over his cash flow situation. Its imperative for him to generate more cash
from operations to be able to pay off his current liabilities and keep his business financially
healthy, or invest additional cash.

In examining the performance of Ernests business, its difficult to fully assess it because
there is no basis of comparison. I would want to investigate how similar stores performed and
especially note what made other stores successful. Ernest may have to review his pricing, the
amount of hours his store is open and many other factors.
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P3-18.
a.

Property,
plant, Expenses
Date Trans Cash Accountsreceivable Inventory
and
equipment Accumulateddepreciation Bankloan Accountspayable Wagespayable Taxespayable Interestpayable
Unearned
revenue
Current
portionLTD
Long-
termdebt Commonshares Retainedearnings Revenue
Cost of
sales Wages Interest Maintenance Other Taxes Depreciation
Open 1,987,500 62,500 210,000 18,750,000 (4,875,000) 225,000 181,250 21,250 115,000 31,250 1,218,750 937,500 7,326,250 4,706,250 1,372,500
During i (1,625,000) 4,750,000 i 1,875,000 i 1,250,000
During ii 5,701,250 625,000 ii (1,218,750) ii 7,545,000
During iia 614,000 (614,000) iia iia
May iii 1,310,000 iii 1,310,000 iii
v (1,062,000) (21,250) (1,040,750)
v-adj v 35,250 v (35,250)
During vi (937,500) vi (937,500) vi
June via via 1,125,000 (1,125,000) via
During vii (563,000) vii (31,250) vii (531,750)
During viii 756,000 viii 756,000 viii
viii (750,000) (750,000)
During ix ix 1,969,000 ix (1,969,000)
ix (1,938,000) (1,938,000)
June x (765,000) x x (765,000)
During xi (375,000) xi xi (375,000)
During xii (115,000) xii (115,000) xii
During xiia (64,000) xiia xiia (64,000)
June xiiadj xiiadj 42,000 xiiadj (42,000)
June xiiiadj (1,563,000)

xiiiadj

xiiiadj (1,563,000)
During xiv xiv xiv 26,000 (26,000)
Bal 2,183,250 73,500 201,000 23,500,000 (6,438,000) 225,000 218,250 35,250 42,000 0 1,310,000 1,125,000 8,076,250 5,956,250 1,372,500 7,571,000 (765,000) (1,076,000) (531,750) (1,969,000) (401,000) (106,000) (1,563,000)

Closing 1,159,250 (7,571,000) 765,000 1,076,000 531,750 1,969,000 401,000 106,000 1,563,000
End Bal 5,956,250 2,531,750 0 0 0 0 0 0 0 0

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b.
i.Purchasing an arena increases property, plant, and equipment. Issuing stock to help finance the
purchase increases the balance in common shares and taking out a loan to pay for the remainder
of the purchase increases the amount of long-term debt.
ii. The renting of ice as well as pro-shop and restaurant sales represents the earning of revenue
for SIR. The amount paid on credit increases SIRs accounts receivable.When cash is collected,
cash will increase and accounts receivable will decrease. Its assumed that unearned revenue
outstanding at the beginning of the year is recognized in full during 2017.
iii. The deposit represents a liability (unearned revenue) as the company has been paid for a
service that its obligated to provide in the future. Revenue will be recognized when the ice time
is used beginning in September.
iv. A line of credit does not impact the financial statements until money is borrowed. Simply
having credit available does not represent a liability.
v. The $1,076,000 represents the total wage expense for the year as this number reflects the
amount employees earned this fiscal year.The $1,062,000 payment includes the $21,250 owed to
employees at the end of fiscal 2016. An adjusting entry of $35,250 is required to accrue the
amount earned by employees during 2017 but unpaid at the end of the year..
vi. Paying $937,500 decreases the current portion of long-term debt.The $1,125,000 which must
be paid in the next year must be reclassified as a current liability.
vii. The $563,000 payment reduces cash and the interest payable liability. The difference
between the amount paid and the opening balance in the interest payable account ($31,250)
represents the interest expense related to this fiscal year ($531,750).
viii. The purchase of goods increases inventory by $756,000.Since these items were purchased
on credit, accounts payable increases ($756,000).Subsequent cash payments reduce the liability
(and cash balance) by $750,000.
ix. SIR incurred $1,969,000 in maintenance expenses during the year.By the end of the year
$1,938,000 had been paid and $31,000 was outstanding.
x. Products sold decrease inventory and increase cost of sales.
xi. Additional expenses will increase the other expense balance and decrease the cash balance.
xii. The repayment of taxes owing from fiscal 2016reduces the taxes payable liability and the
cash balance.Paying $64,000 in instalments increases the tax expense for 2017 and decreases the
cash balance. The additional $42,000 owed also represents a tax expense this year but since itis
unpaid, the amount owing is recorded as a liability.
xiii. Depreciation matches a portion of the cost of property, plant, and equipment against the
revenues that they help generate.
xiv. This is a barter transaction. SIR has provided ice time worth $26,000.This is recorded as a
revenue as its reflective of the amount that SIR would have earned had cash been
exchanged.The services SIR received represent an expense as SIR had to give up an economic
resource (ice time) in order to receive the services.
Closing: The closing entry resets the temporary income statement accounts to zero and records
the balance in retained earnings.
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c.
Superstar Ice Rinks Inc.
Balance Sheet
As of June 30, 2017

Cash $2,183,250 Bank loan $225,000
Accounts receivable 73,500 Accounts payable 218,250
Inventory 201,000 Wages payable 35,250
Taxes payable 42,000
Total current assets 2,457,750 Unearned revenue 1,310,000
Current portion of long-term debt 1,125,000
Property, plant, and equipment 23,500,000 Total Current Liabilities 2,955,500
Accumulated depreciation (6,438,000) Long-term debt 8,076,250
Total Liabilities 11,031,750
Shareholders Equity

Income Statement
For the year Ended June 30, 2017

Sales $7,571,000
Expenses:
Wage expense $1,076,000
Maintenance
expense 1,969,000
Tax expense 106,000
Depreciation expense 1,563,000
Total Expenses 5,646,750
Net Income $1,159,250

d.
(This is a sample answer rather than the right one. Good answers should have addressed some of
these issues, but the discussion could have approached them from different perspectives)

REPORT TO SHAREHOLDERS OF SUPERSTAR ICE RINKS
Dear shareholders:

The statements suggest that SIR had a fairly successful year earning a profit of $1,159,250.
This represents a profit margin of 15.3 percent which appears to be a goodsign.However, this
information is difficult to interpret as we have not been provided with income statements
from prior years or industry data.To determine whether or not SIR was truly successful this
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year, one would want to compare the current earnings and profit margin to earnings and
profit margins from prior years and from industry.

SIRs cash balance has increased from $1,987,500 to $2,183,250, slightly higher than last
year. However, having this much cash on hand might not be beneficial.SIR could use this
money to pay down their debts and reduce interest charges or invest in expanding the
company.Its also possible that SIR feels they will need to have this cash readily available for
future activities and its not necessarily a bad thing.After all, its better to have too much cash
than not enough.

Additionally, SIRs current ratio has remained the same as last year at 0.83.This means that it
has $1 in current liabilities for every $0.83 in current assets. The stability of the current ratio
is positive and suggests the company is able to operate effectively even though current
liabilities exceed current assets. To have a better idea of the situation it will be necessary to
know the terms of the bank loan. If in fact there is no requirement to pay the loan in the short
term, the liquidity position is stronger.

SIRs debt-to-equity ratio has improved since last year, decreasing from 1.65 to 1.30. This is
due to equity increasing (net income plus new shares) faster than liabilities..

Other expenses were quite high, $401,000 and more information regarding these expenses
would be useful.

P3-19.
Journal entries: a, c, f
DR CR
i Property, plant, and equipment 4,750,000
Long-term debt 1,875,000
CommonShares 1,250,000
Cash 1,625,000

ii Cash 5,701,250
Unearned revenue 1,218,750
Sales 7,545,000

iia Cash 614,000

iii Cash 1,310,000
Unearnedrevenue 1,310,000

v Wage expense 1,040,750
Cash 1,062,000
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v adj Wage expense 35,250

vi Long-term debt-current portion 937,500
Cash 937,500

via Long-term debt 1,125,000

Long-term debt-
current 1,125,000

vii Interest expense 531,750
Cash 563,000

viii Inventory 756,000

viii Accounts payable 750,000
Cash 750,000

ix Maintenance expense 1,969,000
Accounts payable 1,969,000

ix Accounts payable 1,938,000
Cash 1,938,000

x Cost of sales 765,000
Inventory 765,000

xi Other expenses 375,000
Cash 375,000

xii Taxes payable 115,000
Cash 115,000

xiia Tax expense 64,000
Cash 64,000

xiiadj Tax expense 42,000

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xiiiadj Depreciation expense 1,563,000
Accumulated depreciation 1,563,000

xiv Other expenses 26,000
Sales 26,000

Closing entry
Revenue 7,571,000
Wage expense 1,076,000
Maintenance expense 1,969,000
Tax expense 106,000

T-accounts: b, c, f
equipment
Accumulated
depreciation
open 1,987,500 open 62,500 open 210,000 open 18,750,000 open 4,875,000
i 1,625,000 ii 625,000 vii 756,000 i 4,750,000 xiiiadj 1,563,000
ii 5,701,250 iia 614,000 x 765,000 end bal 23,500,000 endbal 6,438,000
iia 614,000 end bal 73,500 end bal 201,000
iii 1,310,000
v 1,062,000 Bank loan Accounts payable Wages payable
vi 937,500 open 225,000 open 181,250 open 21,250
vii 563,000 end bal 225,000 viii 756,000 v 21,250
viii 750,000 viii 750,000 v 35,250
ix 1,938,000 ix 1,969,000 end bal 35,250
xi 375,000 ix 1,938,000
xii 115,000 end bal 218,250
xiia 64,000 Taxes payable Interest payable Unearned revenue
end bal 2,183,250 open 115,000 open 31,250 open 1,218,750
xii 115,000 vii 31,250 ii 1,218,750
xiiadj 42,000 end bal 0 iii 1,310,000
end bal 42,000 end bal 1,310,000

Current portion LTD LTD Commonshares Retained earnings
open 937,500 open 7,326,250 open 4,706,000 open 1,372,500
vi 937,500 i 1,875,000 i 1,250,000 pre-close 1,372,500
via 1,125,000 via 1,125,000 end bal 5,956,250 cls 1,159,250
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end bal 1,125,000 end bal 8,076,250 end bal 2,531,750

Revenue Cost of sales Wage expense Interest expense
ii 7,545,000 x 765,000 v 1,040,750 vii 531,750
xiv 26,000
pre-
close 765,000 vadj 35,250 pre-close 531,750
pre-
close 7,571,000 cls 765,000
pre-
close 1,076,000 cls 531,750
cls 7,571,000 end bal 0 cls 1,076,000 end bal 0
end bal 0 end bal 0

Maintenance expense Other expense Tax expense Depreciation expense
ix 1,969,000 xi 375,000 xiia 64,000 xiiadj 1,563,000
pre-
close 1,969,000 xiv 26,000 xiiadj 42,000 pre-close 1,563,000
cls 1,969,000
pre-
close 401,000
pre-
close 106,000 cls 1,563,000
end bal 0 cls 401,000 cls 106,000 end bal 0
end bal 0 end bal 0

d.
Pre-Close Trial Balance
As of June 30, 2017
DR CR
Cash 2,183,250
Inventory 201,000
Property, plant, and equipment 23,500,000
Bank loan 225,000
Interest payable 0
Current portion LTD 1,125,000
LTD 8,076,250
Revenue 7,571,000
Wage expense 1,076,000
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Tax expense 106,000
32,369,500 32,369,500

e.

Balance Sheet
As of June 30, 2017

Cash $2,183,250 Bank loan $225,000
Accounts receivable 73,500 Accounts payable 218,250
Inventory 201,000 Wages payable 35,250
Total current assets 2,457,750 Unearned revenue 1,310,000
Current portion of long-term debt 1,125,000
Property, plant, and equipment 23,500,000 Total Current Liabilities 2,955,500
Accumulated depreciation (6,438,000) Long-term debt 8,076,250
Total Liabilities 11,031,750
Shareholders Equity

Income Statement
For the year Ended June 30, 2017

Revenue $7,571,000
Expenses:
Wage expense $1,076,000
Tax expense 106,000
Net Income $1,159,250

g.
Post-Close Trial Balance
As of June 30
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Debits Credits
Cash 2,183,250
Inventory 201,000
equipment 23,500,000

Bank loan 225,000




Interest payable 0


Current portion LTD 1,125,000

LTD 8,076,250

25,957,750 25,957,750

h.
(This is a sample answer rather than the right one. Good answers should have addressed some of
these issues, but the discussion could have approached them from different perspectives)

The statements suggest that SIR had a fairly successful year earning a profit of $1,159,250.
This represents a profit margin of 15.3% which appears to be a good sign. However, this
information is difficult to interpret as we have not been provided with income statements
from prior years or industry data. To determine whether or not SIR was truly successful this
year, one would want to compare the current earnings and profit margin to earnings and
profit margins from prior years and from industry.

SIRs cash balance has increased from $1,987,500 to $2,183,250 which shows that SIR is
able to collect its receivables and is not experiencing difficulties with their cash flow. This is
a very significant increase in cash flow which is a positive sign. However, having this much
cash on hand might not be beneficial. SIR could use this money to pay down their debts and
reduce interest charges or invest in expanding the company. Its also possible that SIR feels
they will need to have this cash readily available for future activities and its not necessarily a
bad thing. After all, its better to have too much cash than not enough.

Additionally, SIRs current ratio is the same as last year at 0.83. This means that for every $1
in current liabilities it has $0.83 in current assets. The stability of the current ratio is positive
and suggests the company is able to operate even though current liabilities exceed current
assets. To have a better idea of the situation it will be necessary to know the terms of the
bank loan. If in fact there is no requirement to pay the loan in the short term, the liquidity
position is stronger

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The company still has a large portion of unearned revenue sitting in its liability account from
a prior year. Information on this would be useful to determine if this should have been
recognized in the current year or if this work is still going to be performed in the future. If the
contract has fallen through, SIR would likely need to refund their customers the amount paid
for in advance.

Other expenses were quite high, $401,000 and more information regarding these expenses
would be useful.

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P3-20.

Majestic Trucking Inc. - December 31, 2017

Accounts
receivable
Prepaid
assets
Capital
assets
Accumulated
depreciation

Accounts
payable Accruedliability
Interest
payable
Wages
payable Taxespayable Unearnedrevenue
Long-
termnote
Expenses
Date Trans Cash
Common
shares
Retained
earnings Revenues Fuel Maintenance Wages Other Interest Depreciation Insurance Tax

Beg 77,340 81,500 18,000 465,000 (201,700) 42,220 11,900 10,000 15,000 27,000 140,000 80,000 114,020
during i 1,065,225 i i 1,065,225
during ii ii 275,000 ii (275,000)
31-Dec-17 iiadj iiadj 10,000 iiadj (10,000)
during iii (117,000) iii 8,000 iii (125,000)
during iv (475,000) iv (10,000) iv (465,000)
31-Dec-17 ivadj ivadj 27,500 ivadj (27,500)
during v 1,075,000 (1,075,000) v v
during vi (250,000) vi (250,000) vi
during vii (15,000) vii (15,000) vii
during viia (11,000) viia viia (11,000)
31-Dec-17 viiadj viiadj 12,000 viiadj (12,000)
during viii viii (27,000) viii 27,000
during ix ix ix (11,000) 11,000
during x (98,000) 98,000 x x
31-Dec-17 xiadj (48,000) xiadj xiadj (48,000)
during xii (21,000) 21,000 xii xii
31-Dec-17 xiiadj (15,000) xiiadj xiiadj (15,000)
2-Jan-17 xiii (11,900) xiii (11,900) xiii
2-Jan-17 xiiia (20,000) xiiia (20,000) xiiia
31-Dec-17 xiiiadj xiiiadj 10,200 xiiiadj (10,200)
during xiv (75,000) xiv xiv (75,000)
during xv (55,000) xv xv (55,000)
End Balance 3,440 71,725 24,000 563,000 (249,700) 75,220 10,000 10,200 27,500 12,000 0 120,000 80,000 48,020 1,092,225 (285,000) (125,000) (481,500) (75,000) (10,200) (48,000) (15,000) (23,000)
Closing 29,525 (1,092,225) 285,000 125,000 481,500 75,000 10,200 48,000 15,000 23,000
Ending balances 3,440 71,725 24,000 563,000 (249,700) 75,220 10,000 10,200 27,500 12,000 0 120,000 80,000 77,545 0 0 0 0 0 0 0 0 0
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b. Explanations for entries (Note that transactional and adjusting entries are separated on the
spreadsheet. The numbering matches the items listed in the question and on the spreadsheet.):

i. To record revenue during the year. Accounts receivable increase and revenue increases
in the amount of the years credit sales. (In practice each revenue transaction or each
days revenue would be entered separately into the spreadsheet. In these textbook
examples, they are entered as a single economic event.)
ii. To record the purchase and use of fuel during the year. Assuming that there was no fuel
in inventory at the beginning or end of the year, the expense for the year is the total of
the fuel purchased plus an additional $10,000 of fuel that must be accrued because it
was received but not yet billed or paid for. The accrued liabilities increase reflects the
amount that is owed by the company for the fuel. (Its unlikely that Majestic would keep
track of fuel in its trucks so its likely expensed as purchased.)
iii. To record maintenance expense for the year. The costs that were incurred for
maintenance are an expense of the period, and the portion that is not yet paid is a
liability. Maintenance keeps the vehicles operating as intended and does not usually
improve them, so its usually treated as an expense.
iv. To record wage expense for fiscal 2017, payments to employees in fiscal 2017, and
accrual of wages payable at the end of fiscal 2017. The company paid $475,000 to
employees during the year for wages, of which $465,000 pertained to fiscal 2017 and
$10,000 was owing at the end of fiscal 2016. Additionally, the employees earned
$27,500 that was not paid at year-end, which is an increase in wages payable. This
amount is expensed even though it has not been paid as of the end of the year.
v. To record the collection of cash from customers. The collection of $1,075,000 is an
increase in cash and a decrease in the amount owed to the company by customers
(accounts receivable).
vi. To record payments made to suppliers. The amount paid to suppliers is a decrease in
cash and a decrease in the amount owed to Majestics suppliers (accounts payable).
vii. To record payment of taxes owing at the end of fiscal 2016 and to record the tax
expense for 2017. This entry has three components. The first is payment of taxes owing
at the end of fiscal 2016. The amounts paid for previous years taxes reduce taxes
payable and are not an expense of the current period. The expense pertaining to this
amount was recorded in fiscal 2016. The second component is payment of instalments
pertaining to fiscal 2017. This is a transactional entry because cash is paid to
government. The third component is an accrual of the amount of tax that is owing at the
end of fiscal 2017. This is an adjusting entry. Note that the amounts relating to the
current period are expensed in fiscal 2017 regardless of whether they are paid or not.
The company paid $26,000 to governments for income taxes, of which $15,000 is a
reduction of taxes payable, and $11,000 relates to taxes payable for the current period.
The last $12,000 is an increase in taxes payable to accrue taxes that are an expense of
2017 but will not be paid until 2018.
viii. To record fulfillment of the liability to provide service to customers who paid in
advance.
ix. To record the cost of work performed by company employees for personal use of the
shareholders. Work performed by company employees on personal work at owners
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cottages can be considered a dividend to the shareholders and retained earnings is
reduced by the cost of the work done. Since this work has been originally
inappropriately recorded as a wages expense, that amount must be subtracted from the
wages expense account. It would also be reasonable to treat the work done by
employees as a receivable from the shareholders. The solution uses the dividend
treatment. Some students may consider the work done by the employees as being over
and above the amounts earned by them as described in item iv.
x. To record the purchase of a new truck. The purchase of the truck increases the balance
in capital assets and decreases cash.
xi. To record depreciation expense for fiscal 2017. The depreciation expense of $48,000
increases the balance in accumulated depreciation.
xii. To record the purchase of insurance in fiscal 2017 (transactional) and to record the use
of insurance purchased in a previous period (adjusting). The payment of $21,000
increases the asset prepaid insurance and the receipt of insurance benefits of $15,000
decreases prepaid insurance.
xiii. To record repayment of $20,000 owing on the long-term notes payable, payment of
$11,900 in interest accrued in fiscal 2016, and to accrue the interest expense for fiscal
2017. The $11,900 payment represents the expense of the previous period that was paid
on January 2, 2017. The expense for the current year must be accrued, and is 8.5 % of
$120,000 ($140,000 - $20,000) or $10,200. The $20,000 reduces the long-term notes
payable. The payment of the interest relating to 2016 reduces the liability interest
payable. The accrual of the interest expense for 2017 increases the liability by $10,200.
xiv. To record other cash expenses incurred during fiscal 2017. The payment of $75,000 for
other expenses decreases cash and increases other expenses.
xv. To record payment of dividends to shareholders. The payment of $55,000 to
shareholders reduces both retained earnings and cash.
xvi. The Closing entry resets the temporary income statement accounts to zero and records
the balance in the retained earnings.

Majestic Trucking Inc.
Balance Sheet
As at December 31, 2017

Assets Liabilities and shareholders equity
Accounts receivable 71,725 Taxes payable 12,000
Prepaid insurance 24,000 Wages payable 27,500
99,165 Interest payable 10,200
Capital assets 563,000 Accrued liabilities 10,000
Accumulated depreciation (249,700) 134,920

Long-term notes payable 120,000

Total Assets $412,465 Total liabilities and shareholders equity $412,465

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Income Statement

Revenue $1,092,225
Expenses
Wage expense $481,500
Fuel expense 285,000
Maintenance expense 125,000
Insurance expense 15,000
Interest expense 10,200 1,039,700
Income before taxes 52,525
Tax expense 23,000
Net Income $29,525

Statement of Retained Earnings

Retained earnings, December 31, 2016 $114,020
Net income 29,525
Dividends (66,000)

d. (The first part of this question is very wide open and there are many comments that could be
made. Issues that could be raised include profitability of Majestic, its liquidity, the limitations
of the statements, cash flow, comments on specific items on the balance sheet and income
statements, and additional information required. Below is an example of a response that
could be provided.)

As a lender, I am concerned about being paid the principal and interest owed to me and, in
the event that Majestic is unable to pay the loan, that there is security available to protect my
investment. From the information provided, Majestic does not appear to be an attractive
candidate for a loan. To begin with, the company is not that profitable. It made just less than
$30,000 on over $1 million in revenue. Second, the cash position of the company is very
weak, with only $3,440 on hand at the end of 2017. The amount of cash on hand has
decreased dramatically since the beginning of the year. In addition, the companys current
ratio is well below 1 (0.73), suggesting that the company may have trouble meeting its
existing current obligations. The current ratio at the end of 2017 is significantly lower than
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the ratio at the end of 2016 (1.67). This suggests a deteriorating financial position. That said,
Majestic was able to reduce its long-term debt and purchase new equipment for cash during
the year. Also, Majestic does seem to be generating positive cash from operations, however,
additional information would be required to assess its cash flow. A major concern is the
circumstances in the industry. The trucking business is highly competitive and its not clear
at this point how efficient Majestic is (additional information will be necessary to evaluate
this). In addition, expanding in a competitive industry can be risky since its not clear that
Majestic will be able to utilize the new vehicles to adequate capacity. In sum, lending money
to Majestic may be too much of a risk at this point. While the amount of the loan is relatively
small, the company survival may be in doubt. Perhaps if the shareholders would be willing to
provide personal guarantees to protect my investment, I would be more willing to support a
loan.

Some questions (of course there are others one could ask):
1. Are all accounts receivable collectable? Is there an allowance for uncollectables?
2. When must the long-term notes be repaid?
3. What are other expenses? This item is large and not well described. Does it contain
recurring costs only or are there unusual items?
4. Do you have a statement showing Majestics cash flow?
5. Do you have statements from earlier years that I could use for comparative purposes?
6. Are there any transactions with individuals or companies owned or controlled by
Majestics owners or senior managers?
7. How much will each new vehicle cost?
8. How much revenue can a new vehicle generate?
9. What interest rate do you expect to pay on the loan?
10. To what extent do you expect the new vehicles to be used once they have been acquired?
11. Do you have guaranteed new business for the new vehicles?
12. What is the condition of existing vehicles? How much will it cost to upgrade the fleet?
13. How much are the managers being paid? What is the basis of their compensation?

P3-21.
a. and c.

i.
Dr. Accounts receivable 1,065,225
Cr. Revenue 1,065,225

ii.
Dr. Fuel expense 275,000
Cr. Accounts payable 275,000

Dr. Fuel expense 10,000
Cr. Accrued liabilities 10,000

iii.
Dr. Maintenance expense 125,000
Cr. Cash 117,000
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Accounts Payable 8,000

iv.
Wage payable 10,000
Cr. Cash 475,000

Cr. Wages payable 27,500
v.
Dr. Cash 1,075,000
Cr. Accounts receivable 1,075,000

vi.
Dr. Accounts payable 250,000
Cr. Cash 250,000

vii.
Dr. Taxes payable 15,000
Cr. Cash 15,000

Dr. Tax expense 11,000
Cr. Cash 11,000

Dr. Tax expense 12,000
Cr. Taxes payable 12,000

viii.
Dr. Deposits 27,000
Cr. Sales 27,000

ix.
Cr. Wage expense 11,000

x.
Dr. Capital assets 98,000
Cr. Cash 98,000

xi.
Dr. Depreciationexpense 48,000

xii.
Dr. Prepaid insurance 21,000
Cr. Cash 21,000

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Dr. Insurance expense 15,000
Cr. Prepaid insurance 15,000

xiii.
Dr. Interest payable 11,900
Cr. Cash 11,900

Dr. Interest expense 10,200
Cr. Interest payable 10,200

Dr. Long-term notes payable 20,000
Cr. Cash 20,000

xiv.
Dr. Other expense 75,000
Cr. Cash 75,000

xv.
Cr. Cash 55,000

b., c., f.

(Note: O denotes the opening balance in an account.)

Cash Accounts receivable Prepaid insurance
O 77,340 O 81,500 O 18,000
iii. 117,000 i. 1,065,225 xii. 21,000 xii. 15,000
iv. 475,000 v. 1,075,000
v. 1,075,000
vi. 250,000
vii. 15,000
vii. 11,000
x. 98,000 71,725 24,000
xii. 21,000
xiii.11,900
xiii.20,000
xiv. 75,000
xv. 55,000
3,440

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Capital assets Accumulated Depreciation Accounts payable
O 465,000 O 201,700 O 42,220
x. 98,000 xi. 48,000 vi. 250,000 ii. 275,000
iii. 8,000
563,000 249,700 75,220

Taxes payable Wages payable Deposits
O 15,000 O 10,000 O 27,000
vii. 15,000 iv. 10,000 viii. 27,000
vii. 12,000 iv. 27,500
12,000 27,500 0

Interest payable Accrued liabilities Long-term notes payable
O 11,900 ii. 10,000 O 140,000
xiii. 11,900 xiii. 10,200 xiii. 20,000

10,200 10,000 120,000

Common shares Retained earnings Revenue
O 80,000 O 114,020 i. 1,065,225
xv. 55,000 viii. 27,000
80,000 ix. 11,000 1,092,225
cl. 29,525 cl. 1,092,225
77,545 0

Wage expense Fuel expense Maintenance expense
iv. 465,000 ix. 11,000 ii. 275,000 iii. 125,000
iv. 27,500 ii. 10,000
481,500 285,000 125,000
cl. 481,500 cl. 285,000 cl. 125,000
0 0 0

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Other expense Depreciationexpense Insurance expense
xiv. 75,000 xi. 48,000 xii. 15,000

75,000 48,000 15,000
cl. 75,000 cl. 48,000 cl. 15,000
0 0 0

Interest expense Tax expense
xiii. 10,200 vii. 11,000
vii. 12,000
10,200 23,000
cl. 10,200 cl. 23,000
0 0

d. (trial balance)
Trial Balance
December 31, 2017

Debits Credits
Cash $3,440
Prepaid insurance 24,000
Capital assets 563,000
Accumulated amortization $249,700
Deposits 0
Revenue 1,092,225
Wage expense 481,500
Amortization expense 48,000
Tax expense 23,000
$1,724,865 $1,724,865

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e. (financial statements)
Balance Sheet
As at December 31, 2017

Assets Liabilities and shareholders equity
Accounts receivable 71,725 Taxes payable 12,000
Prepaid insurance 24,000 Wages payable 27,500
99,165 Interest payable 10,200
Capital assets 563,000 Accrued liabilities 10,000
Accumulated depreciation (249,700) 134,920


Total Assets $412,465 Total liabilities and shareholders equity $412,465

Income Statement

Revenue $1,092,225
Expenses
Wage expense $481,500
Interest expense 10,200 1,039,700
Income before taxes 52,525
Tax expense 23,000
Net Income $29,525


Net income 29,525
Dividends (66,000)

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f. (Closing entry)
Dr. Revenue 1,092,225
Amortization expense 48,000
Tax expense 23,000

g. (Post-closing trial balance)

Post-Closing Trial Balance
December 31, 2017

Debits Credits
Cash $3,440
Prepaid insurance 24,000
Capital assets 563,000
Accumulated amortization $249,700
Deposits 0
$662,165 $662,165

h. (The first part of this question is very wide open and there are many comments that could be
made. Issues that could be raised include profitability of Majestic, its liquidity, the limitations
of the statements, cash flow, comments on specific items on the balance sheet and income
could be provided.)

As a lender, I am concerned about being paid the principal and interest owed to me and, in
the event that Majestic is unable to pay the loan, that there is security available to protect my
investment. From the information provided, Majestic does not appear to be an attractive
candidate for a loan. To begin with, the company is not that profitable. It made just less than
$30,000 on over $1 million in revenue. Second, the cash position of the company is very
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weak, with only $3,440 on hand at the end of 2017. The amount of cash on hand has
decreased dramatically since the beginning of the year. In addition, the companys current
ratio is well below 1 (0.73), suggesting that the company may have trouble meeting its
existing current obligations. The current ratio at the end of 2017 is significantly lower than
the ratio at the end of 2016 (1.67). This suggests a deteriorating financial position. That said,
Majestic was able to reduce its long-term debt and purchase new equipment for cash during
the year. Also, Majestic does seem to be generating positive cash from operations, however,
additional information would be required to assess its cash flow. A major concern is the
circumstances in the industry. The trucking business is highly competitive and its not clear
at this point how efficient Majestic is (additional information will be necessary to evaluate
this). In addition, expanding in a competitive industry can be risky since its not clear that
Majestic will be able to utilize the new vehicles to adequate capacity. In sum, lending money
to Majestic may be too much of a risk at this point. While the amount of the loan is relatively
small, the company survival may be in doubt. Perhaps if the shareholders would be willing to
provide personal guarantees to protect my investment, I would be more willing to support a
loan.

Some questions (of course there are others one could ask):
2. When must the long-term notes be repaid?
4. Do you have a statement showing Majestics cash flow?
5. Do you have statements from earlier years that I could use for comparative purposes?
6. Are there any transactions with individuals or companies owned or controlled by
Majestics owners or senior managers?
7. How much will each new vehicle cost?
8. How much revenue can a new vehicle generate?
9. What interest rate do you expect to pay on the loan?
10. To what extent do you expect the new vehicles to be used once they have been acquired?
11. Do you have guaranteed new business for the new vehicles?
12. What is the condition of existing vehicles? How much will it cost to upgrade the fleet?
13. How much are the managers being paid? What is the basis of their compensation?

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P3-22.
a.
Appliance Town Ltd (ATL) - August 31, 2017

Accountsreceivable Inventory Prepaids Capitalassets Accumulateddepreciation

Accounts
payable
Accrued
rent
Interest
payable
Wages
payable
Taxes
payable
Unearned
revenue
Long-termnotes
payable
Expenses
Date Trans Cash
Common
shares
Retained
earnings RevenuesSales
Cost of
sales Rent
Salaries and
commissions Other Depreciation Interest Tax
Beg 60,000 246,000 893,000 28,000 380,000 (80,000) Beg 530,000 17,000 40,000 200,000 Beg 220,000 520,000
i 1,700,000 i 1,700,000 i
ii 1,550,000 1,150,000 ii ii 2,700,000
iii (1,490,000) iii iii (1,490,000)
iv (400,000) iv iv (400,000)
31-Aug- iv-adj
iv-
adj 15,000 iv-adj (15,000)
v 750,000 (750,000) v v
vi (1,200,000) vi (1,200,000) vi6
vii (40,000) vii (40,000) vii
viia (30,000) viia viia (30,000)
31-Aug-17 vii-adj
vii-
adj 24,000 vii-adj (24,000)
viii 20,000 viii 20,000 viii
31-Aug-17 ix-adj (28,000)
ix-
adj ix-adj (28,000)
1-Jan-17 ix (42,000) 42,000 ix ix
31-Aug-17 ix-adj (42,000)
ix-
adj ix-adj (42,000)
1-Jul-17 ixb (48,000) 48,000 ixb ixb
31-Aug-17 ix-adj (16,000)
ix-
adj ix-adj (16,000)
31-Aug-17 ix-adj
ix-
adj 9,000 ix-adj (9,000)
x (9,000) x x (9,000)
xi (50,000) 50,000 xi xi
xii (44,000) xii xii (44,000)
1-Sep-16 xiii (17,000) xiii (17,000) xiii
1-Sep-16 xiiia (40,000) xiiia (40,000) xiiia
31-Aug-17
xiii-
adj
xiii-
adj 13,600 xiii-adj (13,600)
xiv (450,000) xiv xiv (450,000)
Bal 63,000 646,000 1,094,000 32,000 430,000 (124,000) 1,030,000 9,000 13,600 15,000 24,000 20,000 160,000 220,000 511,000 2,700,000 (1,490,000) (95,000) (415,000) (450,000) (44,000) (13,600) (54,000)

Closing 138,400 (2,700,000) 1,490,000
95
,000 415,000 450,000 44,000 13,600 54,000
EndBal 220,000 649,400 0 0 0 0 0 0 0 0
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b. Explanations for entries (Note that transactional and adjusting entries are separated on the
spreadsheet. The numbering matches the items listed in the question and on the spreadsheet.):
i. To record the purchase of inventory on credit. The appliances are ATLs
inventory and the amount owed is accounts payable.
ii. To record sales of appliances to customers. Sales are recorded when goods are
delivered to the customer so sales are recorded regardless of whether cash is
collected. Amounts owed by customers are classified as accounts receivable.
iii. To record the cost of inventory sold during the year. (As will be discussed in
Chapter 8, whether this is an adjusting or a transactional entry depends on how
ATL accounts for its inventory.)
iv. To record wages earned by employees during the year. The amount actually paid
to employees is a transactional entry and the amount owed at the end of the fiscal
year has to be accrued and so is an adjusting entry. The amount earned by
employees during the year is wages expense for the period regardless of whether
the employees have been paid or not.
v. To record amounts collected from customers. The amount collected from
customers on account reduces accounts receivable and increases cash.
vi. To record amounts paid to suppliers. The amounts paid to suppliers reduce
accounts payable and decrease cash.
vii. To record payment of taxes owing at the end of fiscal 2016 and to record the tax
expense for 2017. This entry has three components. The first is payment of taxes
owing at the end of fiscal 2016. The amounts paid for previous years taxes
reduce taxes payable and is not an expense of the current period. The expense
pertaining to this amount was recorded in fiscal 2016. The second component is
payment of instalments pertaining to fiscal 2017. This is a transactional entry
because cash is paid to government. The third component is an accrual of the
amount of tax that is owing at the end of fiscal 2017. This is an adjusting entry.
Note that the amounts relating to the current period are expensed in fiscal 2017
regardless of whether they are paid or not.
viii. To record cash deposits from customers. The amounts received on deposit
are a liability. The liability represents the obligation to deliver appliances in the
future.
ix. To record rent payments and rent expense, and to accrue amounts owing at the
end of fiscal 2017. The amount in beginning prepaid on August 31, 2016 was paid
on July 1, 2016 and represents four months rent at $7,000 per month. During
fiscal 2017 ATL made payments of $42,000 and $48,000 to the property owner
for rent. During fiscal 2017 ATL incurred rent expense of $86,000 (10 months *
$7,000 + 2 months * $8,000). Prepaids must be reduced by this amount. The
ending balance in prepaids should be $32,000 (4 months * $8,000). An additional
$9,000 is accrued for the portion of sales that must be paid to the property owner
at year-end (2% * $2,700,000 * 2 months/12 months). This assumes sales are
made evenly throughout the year. Only two months is accrued because the new
lease went into effect on July 1, 2017.
x. To record the cost of appliance the shareholder took for his own use as a dividend.
The cost of the appliances that are taken for Wilfreds home are effectively a
withdrawal from the company and are considered dividends, which reduce
retained earnings. Alternative treatments include recording the appliances Wilfred
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took for his personal use as a receivable (Wilfred will repay HAEL for the cost of
the appliances) or as salary. All three treatments are valid. The solution presented
assumes a dividend.
xi. To record the purchase of capital assets for cash. The furniture and fixtures are
considered capital assets because they will contribute to operations for several
periods.
xii. To record the depreciation expense. The depreciation expense results in an
increase in the accumulated depreciation account.
xiii. To record repayment of $40,000 owing on the long-term notes payable,
payment of $17,000 in interest accrued in fiscal 2016, and to accrue the interest
expense for fiscal 2017. The $17,000 payment represents the expense of the
previous period that was paid on September 1, 2016. The expense for the current
year must be accrued, and is 8.5% of $160,000 ($200,000 - $40,000). The
$40,000 reduces the long-term notes payable.
xiv. To record other cash expenses incurred during fiscal 2017.
Closing: The closing entry resets the temporary income statement accounts to zero and
records the balance in the retained earnings.

c.
Appliance Town Ltd (ATL)
Balance Sheet
As of August 31, 2017

Cash $63,000 Accounts payable $1,030,000
Accounts receivable 646,000 Rent royalty payable 9,000
Inventory 1,094,000 Interest payable 13,600
Prepaid rent 32,000 Wages payable 15,000
Total current assets 1,835,000 Unearned revenue 20,000
Non-current assets: Total Current Liabilities 1,111,600
Capital Assets 430,000 Long-term debt 160,000
Accumulated amortized (124,000) Total Liabilities 1,271,600
Shareholders Equity
Total Assets $2,141,000
Total Liabilities and Shareholders
Equity $2,141,000

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Appliance Town Ltd.
Income Statement
For the year Ended August 31, 2017

Sales $2,700,000
Cost of Sales 1,490,000
Expenses:
Rent $95,000
Salaries and commissions 415,000
Other 450,000
Depreciation 44,000
Interest 13,600
Tax 54,000
Net Income $138,400

Appliance Town Ltd.
R/E at beginning of period $520,000
Net Income 138,400
Less Dividends (9,000)
R/E at end of period $649,400

d. (The first part of this question is very wide open and there are many comments that could be
made. Issues that could be raised include profitability of ATL, its liquidity, the limitations of
the statements, cash flow, comments on specific items on the balance sheet and income
could be provided.)

The desirability of investing in ATL is to earn a reasonable return given the risk of the
investment. I would be concerned about the short-term liquidity of ATLis its situation
strong enough to survive or is any investment I make really an infusion of capital to help it
survive in the short term? ATL earned a profit of $138,400 in fiscal 2017, which represents a
profit margin percentage of 5.1. However, ATLs cash position is not strong. The company
only has $63,000 of cash, although this is comparable with the amount of cash on hand at the
end of last year. The major area of concern is the very large increase in accounts receivable
since the end of last year. Since I have not been given a comparative income statement for
2016 I cannot tell whether the increase is due to a significant growth in sales or more
generous credit terms. If its the latter, or if the economy has significantly weakened, then the
collectability of the receivables must be questioned. Inventory has also increased, which
raises the question of whether that inventory can be sold. Again, there is the question of the
reason for the increase. ATLs current ratio seems reasonable (1.65), but its significantly
lower than last years 2.09. Also, the current ratio assumes the receivables are collectable and
the inventory can be sold. The amount of accounts payable is quite large. That account seems
to mainly pertain to inventory and the amount owing is almost equal to the amount of
inventory. I wonder if ATL is having trouble paying its bills. ATLs debt-to-equity ratio has
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increased from 1.06 to 1.46, despite having reduced the amount of long-term debt by $40,000
or 20 percent. The increase reflects the significant increase in current liabilities, mainly
accounts payable.

Some questions (there are others that could be asked):
1. What will the margins on the new products be compared with the existing product line
(trying to figure out future profitability)?
2. What is in the inventory account? Is all the inventory saleable? Are there any old, out of
date items that will be difficult to sell?
4. When must the long-term debt be repaid?
6. Do you have a statement showing ATLs cash flow?
7. Do you have statements from early years that I could use for comparative purposes?
8. Who are the users of the financial statements you have prepared?
9. What type of investment in capital assets and inventory will be necessary to expand the
product line?
10. What is the condition of existing furniture and fixtures? Do these need to be replaced
soon?
11. What revenue is expected from the new product line?
12. How much do you want to sell an interest in ATL for and what proportion of the
company do you want to sell?

P3-23.

a. and c.

i) Dr. Inventory 1,700,000
Cr. Accounts payable ` 1,700,000

ii)Dr. Cash 1,550,000
Accounts receivable 1,150,000
Cr. Sales 2,700,000

iii) Dr. Cost of sales 1,490,000
Cr. Inventory 1,490,000

iv) Dr. Salaries and commissionsexpense 400,000
Cr. Cash 400,000

iv-adj) Dr. Salaries and commissionsexpense 15,000
Cr. Salaries and commissionspayable 15,000

v) Dr. Cash 750,000
Cr. Accounts receivable 750,000
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vi) Dr. Accounts payable 1,200,000
Cr. Cash 1,200,000

vii) Dr. Taxes payable 40,000
Cr. Cash 40,000

viia) Dr. Taxes expense 30,000
Cr. Cash 30,000

vii-adj.) Dr. Taxes expense 24,000
Cr. Taxes payable 24,000

viii) Dr. Cash 20,000
Cr. Unearned revenue 20,000

ix-adj) Dr. Rent expense 28,000
Cr. Prepaid rent 28,000

ix) Dr. Prepaid rent 42,000
Cr. Cash 42,000


ixb) Dr. Prepaid rent 48,000
Cr. Cash 48,000


Cr. Accrued rent 9,000

x) Dr. Retained earnings 9,000
Cr. Inventory 9,000

xi) Dr. Capital assets 50,000
Cr. Cash 50,000

xii) Dr. Depreciation expense 44,000

xiii) Dr. Interest payable 17,000
Cr. Cash 17,000

xiiia) Dr. Long-term note 40,000
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Cr. Cash 40,000

xiii-adj.) Dr. Interest expense 13,600
Cr. Interest payable 13,600

xiv) Dr. Other expenses 450,000
Cr. Cash 450,000

b and c.
Beg 60,000 Beg 246,000 Beg 893,000
2 1,550,000 4 400,000 2 1,150,000 5 750,000 1 1,700,000 3 1,490,000
5 750,000 6 1,200,000 10 9,000
8 20,000 7 40,000 Bal 646,000 Bal 1,094,000
7a 30,000
9 42,000 Prepaid assets Capital assets
9b 48,000 Beg 28,000 Beg 380,000
11 50,000 9 42,000
9-
adj 28,000 11 50,000
13 17,000 9b 48,000
9-
adj 42,000
13a 40,000
9-
adj 16,000 Bal 430,000
14 450,000 Bal 32,000
Bal 63,000

Accumulated depreciation Accounts payable Accrued rent
Beg 80,000 Beg 530,000 Beg -
12 44,000 6 1,200,000 1 1,700,000
9-
adj 9,000

Bal 124,000 Bal 1,030,000 Bal 9,000

Interest payable Salaries and commissionspayable Taxes payable
Beg 17,000 Beg - Beg 40,000
13 17,000
13-
adj 13,600
4-
adj 15,000 7 40,000
7-
adj 24,000

Bal 13,600 Bal 15,000 Bal 24,000

Unearned Revenue Long-term note Common shares
Beg -

Beg 200,000 Beg 220,000

8 20,000 13a 40,000
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Bal 20,000 Bal 160,000 Bal 220,000

R/E Sales Cost of sales
Beg 520,000 2 2,700,000 3 1,490,000
10 9,000
Bal 2,700,000 Bal 1,490,000
Bal 511,000

Rent expense Salaries and commissionsexpense Other expense
9-
adj 28,000 4 400,000 14 450,000
9-
adj 42,000
4-
adj 15,000
9-
adj 16,000 Bal 415,000 Bal 450,000
9-
adj 9,000
Bal 95,000

Depreciationexpense Interest expense Tax expense
12 44,000
13-
adj 13,600 7a 30,000

7-
adj 24,000

Bal 44,000 Bal 13,600

Bal 54,000

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d.

Appliance Town Ltd.
Trial Balance
August 31, 2017
Debits Credits
Cash 63,000
Inventory 1,094,000
Prepaids 32,000
Accrued rent payable 9,000
Deposits 20,000
Sales 2,700,000
Cost of sales 1,490,000
Rent expense 95,000
Tax expense 54,000

4,826,600 4,826,600

e.

Appliance Town Ltd (ATL)
Balance Sheet
As of August 31, 2017

Cash $63,000 Accounts payable $1,030,000
Accounts receivable 646,000 Rent royalty payable 9,000
Inventory 1,094,000 Interest payable 13,600
Prepaid rent 32,000 Salaries and commissionspayable 15,000
Total current assets 1,835,000 Unearned revenue 20,000
Non-current assets: Total Current Liabilities 1,156,600
Capital Assets 430,000 Long-term debt 160,000
Accumulated depreciation (124,000) Total Liabilities 1,271,600
Shareholders Equity
Total Assets $2,141,000
Total Liabilities and Shareholders
Equity $2,141,000

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Appliance Town Ltd.
Income Statement

Sales $2,700,000
Cost of Sales 1,490,000
Expenses:
Rent $95,000
Salaries and commissions 415,000
Other 450,000
Depreciation 44,000
Interest 13,600
Tax 54,000
Net Income $138,400

Appliance Town Ltd.
Retained earnings at beginning of period $520,000
Net Income 138,400
Less Dividends (9,000)
Retained earningsat end of period $649,400

f. Dr. Sales 2,700,000
Cr. Cost of Sales 1,490,000
Cr. Rent Expense 95,000
Cr. Other expense 450,000
Cr. Depreciation expense 44,000
Cr. Interest expense 13,600
Cr. Tax expense 54,000
Cr. Retained Earnings 138,400

Retained earnings Sales Cost of sales
Beg 520,000

2 2,700,000

3 1,490,000

10 9,000
Bal 2,700,000 Bal 1,490,000
Bal 511,000 close 2,700,000

close 1,490,000

close 138,400 Bal - Bal -
Bal 649,400
Rent expense Wages expense Other expense
9-adj 28,000

4 400,000

14 450,000
9-adj 42,000 4-adj 15,000
9-adj 16,000 Bal 415,000 Bal 450,000
9-adj 9,000 close 415,000

close 450,000
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Bal 95,000 Bal - Bal -

close 95,000
Bal -

Depreciationexpense Interest expense Tax expense

12 44,000
13-
adj 13,600 7a 30,000

7-
adj 24,000
Bal 44,000 Bal 13,600 Bal 54,000

close 44,000 close 13,600

close 54,000
Bal - Bal - Bal -

g.
Appliance Town Ltd.
Post Closing Trial Balance
August 31, 2017

Debits Credits
Cash 63,000
Inventory 1,094,000
Prepaids 32,000
Accrued rent payable 9,000
Deposits 20,000
2,265,000 2,265,000

h.
(The first part of this question is very wide open and there are many comments that could be
made. Issues that could be raised include profitability of ATL, its liquidity, the limitations of
the statements, cash flow, comments on specific items on the balance sheet and income
could be provided.)

The desirability of investing in ATL is to earn a reasonable return given the risk of the
investment. I would be concerned about the short-term liquidity of ATLis its situation
strong enough to survive or is any investment I make really an infusion of capital to help it
survive in the short term? ATL earned a profit of $138,400 in fiscal 2017, which represents a
profit margin percentage of 5.1. However, ATLs cash position is not strong. The company
only has $63,000 of cash, although this is comparable with the amount of cash on hand at the
end of last year. The major area of concern is the very large increase in accounts receivable
since the end of last year. Since I have not been given a comparative income statement for
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2016 I cannot tell whether the increase is due to a significant growth in sales or more
generous credit terms. If its the latter, or if the economy has significantly weakened, then the
collectability of the receivables must be questioned. Inventory has also increased, which
raises the question of whether that inventory can be sold. Again, there is the question of the
reason for the increase. ATLs current ratio seems reasonable (1.65), but its significantly
lower than last years 2.09. Also, the current ratio assumes the receivables are collectable and
the inventory can be sold. The amount of accounts payable is quite large. That account seems
to mainly pertain to inventory and the amount owing is almost equal to the amount of
inventory. I wonder if ATL is having trouble paying its bills. ATLs debt-to-equity ratio has
increased from 1.06 to 1.46, despite having reduced the amount of long-term debt by $40,000
or 20 percent. The increase reflects the significant increase in current liabilities, mainly
accounts payable.

Some questions (there are others that could be asked):
1. What will the margins on the new products be compared with the existing product line
(trying to figure out future profitability)?
2. What is in the inventory account? Is all the inventory saleable? Are there any old, out of
date items that will be difficult to sell?
4. When must the long-term debt be repaid?
6. Do you have a statement showing ATLs cash flow?
7. Do you have statements from early years that I could use for comparative purposes?
8. Who are the users of the financial statements you have prepared?
9. What type of investment in capital assets and inventory will be necessary to expand the
product line?
10. What is the condition of existing furniture and fixtures? Do these need to be replaced
soon?
11. What revenue is expected from the new product line?
12. How much do you want to sell an interest in ATL for and what proportion of the
company do you want to sell?

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P3-24.

1) Dr. Royalty Revenue receivable $10,000
Cr. Royalty revenue $10,000

2) Dr. Rent expense $2,000
Cr. Prepaid rent $2,000

3) Dr. Depreciation expense $8,000
Cr. Accumulated depreciation $8,000

4) Dr. Unearned revenue $8,000
Cr. Services revenue $8,000

5) Dr. Wages expense $4,000
Cr. Wages payable $4,000

P3-25.

1) Dr. Cost of goods sold $180,000
Cr. Inventory $180,000

2) Dr. Insurance expense $10,000
Cr. Prepaid insurance $10,000

3) Dr. Depreciation expense $25,000
Cr. Accumulated depreciation $25,000

4) Dr. Salaries expense $12,000
Cr. Salaries payable $12,000

5) Dr. Unearned revenue $35,000
Cr. Revenue $35,000

6) Dr. Interest expense $6,000
Cr. Interest payable $6,000

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P3-26.

Situation Assets Liabilities Owners Equity Net Income
a. Overstated NE Overstated Overstated
b. Understated NE Understated Understated
c. Overstated NE Overstated Overstated
d. NE Overstated Understated Understated
e. NE Understated Overstated Overstated

Explanations:
a. The necessary adjusting entry would be a debit to depreciation expense (OE-, E+) and a
credit to accumulated depreciation (A-). Failure to record the depreciation would result in an
understatement of accumulated depreciation and an overstatement of total assets and owners
equity. Since the depreciation expense is understated, net income is overstated.
b. The necessary adjusting entry would be a debit to interest receivable (A+) and a credit to
interest revenue (OE+, R+). Failure to record the entry would understate the asset, understate
owners equity, and understate revenue and net income.
c. The necessary adjusting entry would be a debit to insurance expense (OE-, E+) and a credit
to prepaid assets (A-). Failure to record the entry would result in prepaids being too high thus
overstating assets and not recording the expense will result in overstating owners equity and
net income.
d. The necessary adjusting entry would be a debit to unearned revenue (L-) and a credit to
revenue (OE+, R+). Failure to record the entry would overstate total liabilities and would
understate owners equity and revenue.
e. The necessary adjusting entry would be a debit to wage expense (OE-, E+) and a credit to
accrued liabilities or wages payable (L+). An expense will be missed thus overstating net
income and owners equity and a liability will be overlooked thus understating liabilities.

P3-27.
Situation Assets Liabilities Owners Equity Net Income
a. NE Overstated Understated Understated
b. NE Understated Overstated Overstated
c. Overstated NE Overstated Overstated
d. Understated NE Understated Understated
e. NE Understated Overstated Overstated

Explanations:
a. The necessary adjusting entry would be a debit to unearned revenue (L-) and a credit to
revenue (OE+, R+). Failure to record the entry would result in an overstatement of liabilities.
Since revenue is understated, net income and owners equity are understated.
b. The necessary adjusting entry would be a debit to interest expense (OE-, E+) and a credit to
interest payable (L+). Failure to record the entry would understate liabilities and overstate
owners equity, and net income.
c. The necessary adjusting entry would be debit rent expense (OE-, E+)and credit to prepaid
rent (A-). Failure to record the entry would overstate assets. Expenses would be understated
so, owners equity, and net income would be overstated.
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d. The necessary adjusting entry would be a debit to rent receivable (A+) and a credit to rent
revenue (OE+, R+). Failure to record the entry would understate assets and revenue thus also
understating owners equity and net income.
e. The necessary adjusting entry would be a debit to rent expense (OE-, E+) and a credit to rent
payable (L+). Failure to record the entry would understate liabilities and expenses and
thereby overstate net income and owners equity.

P3-28.
a. Otiss friend told him that his measure of profit was incorrect because part of the resources
that were consumed to earn the revenue of the year was the use of the cart. The cart has a
limited life, which is reduced after its used to sell beverages. This interpretation is correct
under accrual accounting, where the matching concept is applied and expenses are matched
to revenues. However, given that Otis has already spent the $12,000 for the cart (a sunk cost),
a reasonable measure of how well off he is may be the amount of cash he has in hand at the
end of the year.
b. The depreciation expense for 2017 would be one-sixth of the cost or $2,000. Net income
would be $7,000 ($22,000 - $13,000 - $2,000).
c. If the cart were depreciated over three years the depreciation expense for 2017 would be one-
third of the cost or $4,000. In that case net income would be $5,000 ($22,000 - $13,000 -
$4,000). If the cart were depreciated over 10 years, the depreciation expense for 2017 would
be one-tenth of the cost or $1,200. In that case net income would be $7,800 ($22,000 -
$13,000 - $1,200).

d.
Cash basis (what
Otis calculated)
Depreciate cart
over six years
Depreciatecart
over three years
Depreciatecart over
10 years
Net Income $9,000 $7,000 $5,000 $7,800

e. Simply comparing the numbers would say that the higher the net income, the better the
company is doing. But wait a minute! Arent we talking about the identical company in each
case with just a different estimate of the useful life of the cart (or ignoring the cost of the cart
in the case of the cash basis)? The greater the depreciation expense that is recorded for the
cart, the lower the net income and the less profitable the business appears to be. However, the
actual economic performance of the company is not affected by the estimate, only the
measurement of that performance is.
f. The actual cost of using the cart will depend on how many years its is used and the amount
for which the cart can be sold when its no longer needed. This information will only be
known with certainty when the cart is sold. Any calculation of depreciation cost in the
meantime is only an estimate based on an assumption and does not affect the actual cost. The
actual economic performance of The Corner Coffee Cart is not affected by the estimate of the
life of the cart. However, the representation of the economic performance in the financial
statements is affected by the estimate.
g. Its not possible to know in advance. The correct number of years will only be known
when the decision to stop using the cart is actually made (that is, the cart can no longer be
used or its not economic to use it). Its not possible to know the number of years with
certainty. In virtually all situations, the estimated life of an asset is an educated guess by the
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managers. There will be a reasonable range in which it will not be possible to make a strong
argument against the choice. However, the choice will have an effect on net income and
other measures in the financial statements.

P3-29.
a. MTL
Income Statement
April 30, 2017
Revenue ($410,000 - $50,000 - $100,000 10,000) $250,000
Expenses
Cost of books 109,000
Rent ($14,000 2,000) 12,000
Wages ($42,000 +1,100) 43,100
Utilities 5,000
Advertising 11,000
General and administrative 15,000
Depreciation 5,000
Write-down (books) 5,000
Interest ($50,000*.08) 4,000
Net Income $40,900

MTL
Balance Sheet
April 30, 2017

Assets
Cash $99,000
Prepaid Rent 2,000
Inventory (books) ($199,000 109,000 5,000) 85,000
Furniture & fixtures 25,000
Accumulated Depreciation (5,000)
Total Assets $206,000

Liabilities & Owners Equity
Bank Loan $50,000
Unearned Revenue 10,000
Wages Payable 1,100
Interest Payable 4,000

Total Liabilities & Equity $206,000

b.

The first income statement prepared by Arjuns bookkeeper was prepared on the cash basis and the one in
Part a was prepared under accrual accounting. Cash accounting only captures economic events that
involve the exchange of cash. For MTL it shows the cash collected and spent for all purposes during the
year, without consideration for what or when the cash flow was for. The cash income statement
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showshow MTL came to have $99,000 of cash on hand at the end of the year. Certain events like the bank
loan and Arjuns capital contribution were recorded as revenue when these items are balance sheet
items (bank loan is a liability and Arjuns capital contribution is equity) under accrual accounting.

The income statement prepared under accrual accounting captures economic events that do not always
involve the exchange of cash. When we examine the accrual accounting income statement in Part a, there
are many differences. The amount of revenue does not include the cash received from the bank loan and
Arjuns contribution. It only includes sales that took place during the year so the $10,000 received in
advance from the student association isnt recorded as revenue since it has not been earned yet (MTL has
not begun acquiring the books for this transaction as of yet).

There are also differences in the amount of expenses recorded. Rent expense is $2,000 less under accrual
accounting because the two months of rent prepaid for the next fiscal year (May and June) are not
expensedbecause MTL has not used these months yet. These will be expensedin fiscal 2018, when the
spaced is used by MTL. This $2,000 appears as an asset (prepaid rent) on the balance sheet. Also, the cost
of books only includes the books sold up until the year end. The remainder are reported as an asset called
inventory on the balance sheet.The full cost of the furniture and fixtures isnt expensed in the year but
instead is spread over their useful lives. Since its expected they will list five years there is a depreciation
expense of $5,000. The wages employees earned but not paid during the year ($1,100) is expensed during
the year. The unpaid amount is a liability on the balance sheet. Finally, the books that cannot be sold have
to be expensed in the year since they cannot be considered assets, so they represent a cost to the company
in the year.

The income statement prepared under accrual accounting provides a more comprehensive economic view
of the performance of MTL because it looks beyond the flow of cash. The cash based income statement
shows the cash inflows and outflows of the entity.

c.
Using the information concerning MTLs cash flows and accrual accounting information can tell us much
about the performance of the business. MTL currently has $99,000 of cash on hand. However, $150,000
of this cash was generated through financing (bank loan and Arjuns contribution). If we ignore those
inflows of cash, Arjun had a combined negative cash outflow from other activities ($49,000) which is a
bit of a concern. However, he had to purchase a large start-up supply of books as well as furniture and
fixtures. Arjun still has a large supply of books on hand ($85,000). If Arjun can sell all these books in the
next fiscal year, his cash flow situation will improve. However, with the information provided,, its hard
to tell how many of these books can be sold and at what cost. Clearly, this is a business that requires a
large investment in inventory to ensure that the books students want are available, so monitoring cash is
important.

From an accrual accounting perspective, Arjuns net income was $40,900. This means MMLs revenues
exceeded its expenses by $40,900. This is a positive sign for a start-up company. However, its hard to
tell how successful Arjuns business was given the fact we do not have comparative information of
similar business for benchmarking purposes. Arjuns profit margin was 16.4 % ($40,900 / $250,000).
Again, its hard to tell what this figure means given the lack of comparative information from similar
businesses.

Arjun needs to continue to monitor his cash situation given the fact his cash from operations was
negative. We are also unsure when his bank loan needs to be repaid so more information about this
obligation is necessary to assess Arjuns financial situation.

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USING FINANCIAL STATEMENTS

Reitmans

FS3-1.
Most accounts on the balance could be adjusted. Trade and other receivables would have to be
adjusted for uncollectible amounts. Marketable securities and derivative financial assets would
require adjustments to the fair market value. Income taxes recoverable would have to be adjusted
for new estimates of any amount that might be recovered. Inventory might have to be adjusted
for goods sold or for obsolete or unusable items.Inventories would have to be adjusted for
obsolete and stolen items. Prepaid expenses would have to be adjusted to reflect the consumption
of amounts paid for in advance (for example, rent or insurance). Property, plant, and equipment
must be depreciated and perhaps written down for impairment. Intangible assets might have to be
adjusted to their fair market value. On the liabilities side, liabilities have to be accrued to reflect
expenses incurred but not recorded and deferred income taxes would require adjustment.

FS3-2.
a. Reitmans recognizes its revenue when a customer purchases and takes delivery of the
merchandise.
b. For the fiscal year ended January 28, 2012, deferred revenue arises from 1) loyalty points and
awards granted under loyalty programs with attributed amount of $10,979, and 2)
unredeemed gift cards which accounted for $11,299. (Amounts are in thousands of dollars)
c. Deferred revenue is a liability because there has been a transaction with a customer and the
creation of an obligation to provide merchandise in the future when the customer redeems the
loyalty points or gift cards. At the point of redemption Reitmans has settled the obligation by
providing merchandise to the customer.
d. Dr. Cash (asset +) $100
Cr. Deferred revenue (liability +) 100
e. The resulting journal entry would be as follows:

Dr. Cash (asset +) $55
Dr. Deferred revenue (liability -) 100
Cr. Revenue (revenue +) 155

FS3-3.
In thousands of dollars 2010 2011
a. Profit margin ratio
= Net Income/Sales
$88,985/1,059,000
= 8.40%
$47,539/1,019,397
=4.66%
b. Return on equity
= Net Income/Shareholders equity
88,985/512,800
=17.35%
47,539/492,852
=9.65%
c. Current ratio
= Current assets/Current liabilities
389,005/91,309
=4.26
366,983/89,132
=4.12
d. Debt-to-equity ratio
= Total liabilities/Shareholders equity
(91,309+55,248)/512,800
=28.58%
(89,132+51,877)/492,852
=28.61%
e. Gross margin ratio
= Gross margin/Sales
708,329/1,059,000
=66.89%
656,064/1,019,397
=64.36%

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FS3-4.
The closing journal entry for the year ended December 31, 2011is (amounts in thousands):
Dr. Sales $1,019,397
Dr. Finance income 5,562
Cr. Cost of goods sold 363,333
Cr. Selling and distribution expenses 547,367
Cr. Administrative expenses 46,878
Cr. Finance costs 1,509
Cr. Income taxes 18,333
Cr. Retained earnings 47,539

FS3-5. (Amounts in thousands)
Trade and other receivables amount on December 31, 2011 was $3,033. The amount is small
with respect to other accounts because the majority of transactions and revenue generated by the
company is from customers that pay cash at their retail stores, so there would not be a receivable
set up.

FS3-6.(Amounts in thousands)
Reitmans reports $184,221 for property and equipment on December 31, 2011. The major capital
assets would be buildings where the stores are located (although most stores are rented), the
shelves and cash registers required to sell merchandise in stores, and costs to furnish and
decorate the stores. Reitmans needs to invest in such amount to be able to operate their stores and
create a suitable environment for shoppers. Store design, decorations, etc. are important to the
success of a retail business.

FS3-7.
The current ratio is 4.26, suggesting that its current assets are four times that of current liabilities,
and the debt-to-equity ratio is less than 0.5, indicating that Reitmans is primarily financed by
equity. Also, the cash balance at the end of 2011 is more than $196 million relative to
outstanding trade payables of $63 million. Both the ratios and numbers on the financial
statements reflect that the business is in good financial health, so Reitmans would be able to
meet the vendor payables. Therefore as a supplier, I would extend credit to Reitmans.

FS3-8.
Judgments, estimates, and assumptions are necessary for Reitmans when preparing financial
statements since it has to comply with accrual accounting under IFRS, to reflect the impact of
uncertainties and future events that will affect the financial statements. For example, trade and
other receivables require estimates on any uncollectible amounts, the obsolescence of inventories
has to be judged, and property and equipment should also be subject to professional judgments
regarding impairment and useful life.

FS3-9.(Amounts in thousands)
Reitmans reports $63,875 for trade and other payables on December 31, 2011. Reitmans owes
money to suppliers, related parties, property owners, employees, and so on; it also includes
provision for sales returns. Circumstances that would explain why money would be owed to
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edition Page 3-115
these entities include: purchases on credit, timing of payroll; sales credit for returned
merchandise and outstanding amounts owing for leases and rent.

Friedlan4e SM Ch03

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John Friedlan, Financial Accounting: A Critical Approach, 4

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