Week 2 Homework Problems
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LEARNING OBJECTIVE 1
Identify the forms of business organization and the uses of accounting information.
Suppose you graduate with a business degree and decide you want to start your own business. But what kind of business? You enjoy working with people, especially teaching them new skills. You also spend most of your free time outdoors, kayaking, backpacking, skiing, rock climbing, and mountain biking. You think you might be successful in opening an outdoor guide service where you grew up, in the Sierra Nevada mountains.
FORMS OF BUSINESS ORGANIZATION Your next decision is to determine the organizational form of your business. You have three choices—sole proprietorship, partnership, or corporation.
SOLE PROPRIETORSHIP
You might choose the sole proprietorship form for your outdoor guide service. A business owned by one person is a sole proprietorship. It is simple to set up and gives you control over the business. Small owner-operated businesses such as barber shops, law of�ices, and auto repair shops are often sole proprietorships, as are farms and small retail stores.
PARTNERSHIP
Another possibility is for you to join forces with other individuals to form a partnership. A business owned by two or more persons associated as partners is a partnership. Partnerships often are formed because one individual does not have enough economic resources to initiate or expand the business. Sometimes partners bring unique skills or resources to the partnership. You and your partners should formalize your duties and contributions in a written partnership agreement. Retail and service-type businesses, including professional practices (lawyers, doctors, architects, and certi�ied public accountants), often organize as partnerships.
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Alternative Terminology notes present synonymous terms that you may come across in practice.
CORPORATION
As a third alternative, you might organize as a corporation. A business organized as a separate legal entity owned by stockholders is a corporation. Investors in a corporation receive shares of stock to indicate their ownership claim. Buying stock in a corporation is often more attractive than investing in a partnership because shares of stock are easy to sell (transfer ownership). Selling a proprietorship or partnership interest is much more involved. Also, individuals can become stockholders by investing relatively small amounts of money. Therefore, it is easier for corporations to raise funds. Successful corporations often have thousands of stockholders, and their stock is traded on organized stock exchanges like the New York Stock Exchange. Many businesses start as sole proprietorships or partnerships and eventually incorporate.
Other factors to consider in deciding which organizational form to choose are taxes and legal liability. If you choose a sole proprietorship or partnership, you generally receive more favorable tax treatment than a corporation. However, proprietors and partners are personally liable for all debts and legal obligations of the business; corporate stockholders are not. In other words, corporate stockholders generally pay higher taxes but have no personal legal liability. We will discuss these issues in more depth in a later chapter.
Finally, while sole proprietorships, partnerships, and corporations represent the main types of business organizations, hybrid forms are now allowed in all states. These hybrid business forms combine the tax advantages of partnerships with the limited liability of corporations. Probably the most common among
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these hybrids types are limited liability companies (LLCs) and subchapter S corporations. These forms are discussed extensively in business law classes.
The combined number of proprietorships and partnerships in the United States is more than �ive times the number of corporations. However, the revenue produced by corporations is eight times greater. Most of the largest businesses in the United States—for example, Coca-Cola, ExxonMobil, General Motors, Citigroup, and Microsoft—are corporations. Because the majority of U.S. business is done by corporations, the emphasis in this textbook is on the corporate form of organization.
ALTERNATIVE TERMINOLOGY
Stockholders are sometimes called shareholders.
USERS AND USES OF FINANCIAL INFORMATION The purpose of �inancial information is to provide inputs for decision-making. Accounting is the information system that identi�ies, records, and communicates the economic events of an organization to interested users. Users of accounting information can be divided broadly into two groups: internal users and external users.
Internal Users
Internal users of accounting information are managers who plan, organize, and run a business. These include marketing managers, production supervisors, �inance directors, and company of�icers. In running a business, managers must answer many important questions, as shown in Illustration 1-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo1#c01-�ig-0001) .
ILLUSTRATION 1-1 Questions that internal users ask
Accounting Across the Organization boxes show applications of accounting information in various business functions.
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To answer these and other questions, you need detailed information on a timely basis. For internal users, accounting provides internal reports, such as �inancial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year. In addition, companies present summarized �inancial information in the form of �inancial statements.
ACCOUNTING ACROSS THE ORGANIZATION
Clif Bar & Company
Owning a Piece of the Bar
The original Clif Bar® energy bar was created in 1990 after six months of experimentation by Gary Erickson and his mother in her kitchen. Today, the company has almost 300 employees and is considered one of the leading Landor's Breakaway Brands®. One of Clif Bar & Company's proudest moments was the creation of an employee stock ownership plan (ESOP) in 2010. This plan gives its employees 20% ownership of the company. The ESOP also resulted in Clif Bar enacting an open-book management program, including the commitment to educate all employee-owners about its �inances. Armed with basic accounting knowledge, employees are more aware of the �inancial impact of their actions, which leads to better decisions.
What are the bene�its to the company and to the employees of making the �inancial statements available to all employees? (Go to WileyPLUS for this answer and additional questions.)
External Users
There are several types of external users of accounting information. Investors (owners) use accounting information to make decisions to buy, hold, or sell stock. Creditors such as suppliers and bankers use accounting information to evaluate the risks of selling on credit or lending money. Some questions that investors and creditors may ask about a company are shown in Illustration 1-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo1#c01-�ig-0002) .
ILLUSTRATION 1-2 Questions that external users ask
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The information needs and questions of other external users vary considerably. Taxing authorities, such as the Internal Revenue Service, want to know whether the company complies with the tax laws. Customers are interested in whether a company like General Motors will continue to honor product warranties and otherwise support its product lines. Labor unions, such as the Major League Baseball Players Association, want to know whether the owners have the ability to pay increased wages and bene�its. Regulatory agencies, such as the Securities and Exchange Commission or the Federal Trade Commission, want to know whether the company is operating within prescribed rules. For example, Enron, Dynegy, Duke Energy, and other big energy-trading companies reported record pro�its at the same time as California was paying extremely high prices for energy and suffering from blackouts. This disparity caused regulators to investigate the energy traders to make sure that the pro�its were earned by legitimate and fair practices.
ACCOUNTING ACROSS THE ORGANIZATION
Spinning the Career Wheel
How will the study of accounting help you? A working knowledge of accounting is desirable for virtually every �ield of business. Some examples of how accounting is used in business careers include the following.
General management: Managers of Ford Motors, Massachusetts General Hospital, California State University– Fullerton, a McDonald's franchise, and a Trek bike shop all need to understand accounting data in order to make wise business decisions.
Marketing: Marketing specialists at Procter & Gamble must be sensitive to costs and bene�its, which accounting helps them quantify and understand. Making a sale is meaningless unless it is a pro�itable sale.
Finance: Do you want to be a banker for Citicorp, an investment analyst for Goldman Sachs, or a stock broker for Merrill Lynch? These �ields rely heavily on accounting knowledge to analyze �inancial statements. In fact, it is dif�icult to get a good job in a �inance function without two or three courses in accounting.
Real estate: Are you interested in being a real estate broker for Prudential Real Estate? Because a third party—the bank —is almost always involved in �inancing a real estate transaction, brokers must understand the numbers involved: Can the buyer afford to make the payments to the bank? Does the cash �low from an industrial property justify the purchase price? What are the tax bene�its of the purchase?
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How might accounting help you? (Go to WileyPLUS for this answer and additional questions.)
ETHICS IN FINANCIAL REPORTING People won't gamble in a casino if they think it is “rigged.” Similarly, people won't “play” the stock market if they think stock prices are rigged. At one time, the �inancial press was full of articles about �inancial scandals at Enron, WorldCom, HealthSouth, and AIG. As more scandals came to light, a mistrust of �inancial reporting in general seemed to be developing. One article in the Wall Street Journal noted that “repeated disclosures about questionable accounting practices have bruised investors' faith in the reliability of earnings reports, which in turn has sent stock prices tumbling.” Imagine trying to carry on a business or invest money if you could not depend on the �inancial statements to be honestly prepared. Information would have no credibility. There is no doubt that a sound, well-functioning economy depends on accurate and dependable �inancial reporting.
United States regulators and lawmakers were very concerned that the economy would suffer if investors lost con�idence in corporate accounting because of unethical �inancial reporting. Congress passed the Sarbanes-Oxley Act (SOX) to reduce unethical corporate behavior and decrease the likelihood of future corporate scandals. As a result of SOX, top management must now certify the accuracy of �inancial information. In addition, penalties for fraudulent �inancial activity are much more severe. Also, SOX increased both the independence of the outside auditors who review the accuracy of corporate �inancial statements and the oversight role of boards of directors.
ETHICS NOTE
Circus-founder P.T. Barnum is alleged to have said, “Trust everyone, but cut the deck.” What Sarbanes-Oxley does is to provide measures that (like cutting the deck of playing cards) help ensure that fraud will not occur.
Ethics Notes help sensitize you to some of the ethical issues in accounting.
Effective �inancial reporting depends on sound ethical behavior. To sensitize you to ethical situations and to give you practice at solving ethical dilemmas, we address ethics in a number of ways in this textbook. (1) A number of the Feature Stories and other parts of the text discuss the central importance of ethical behavior to �inancial reporting. (2) Ethics Insight boxes and marginal Ethics Notes highlight ethics situations and issues in actual business settings. (3) Many of the People, Planet, and Pro�it Insight boxes focus on ethical issues that companies face in measuring and reporting social and environmental issues. (4) At the end of each chapter, an Ethics Case simulates a business situation and asks you to put yourself in the position of a decision-maker in that case.
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When analyzing these various ethics cases and your own ethical experiences, you should apply the three steps outlined in Illustration 1-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo1#c01-�ig-0003) .
ILLUSTRATION 1-3 Steps in analyzing ethics cases
ETHICS INSIGHT
Dewey & LeBoeuf LLP
I Felt the Pressure—Would You?
“I felt the pressure.” That's what some of the employees of the now- defunct law �irm of Dewey & LeBoeuf LLP indicated when they helped to overstate revenue and use accounting tricks to hide losses and cover up cash shortages. These employees worked for the former �inance director and former chief �inancial of�icer (CFO) of the �irm. Here are some of their comments:
“I was instructed by the CFO to create invoices, knowing they would not be sent to clients. When I created these invoices, I knew that it was inappropriate.”
“I intentionally gave the auditors incorrect information in the course of the audit.”
What happened here is that a small group of lower-level employees over a period of years carried out the instructions of their bosses. Their bosses, however, seemed to have no concern as evidenced by various e-mails with one another in which they referred to their �inancial manipulations as accounting tricks, cooking the books, and fake income.
Source: Ashby Jones, “Guilty Pleas of Dewey Staff Detail the Alleged Fraud,” Wall Street Journal (March 28, 2014).
Why did these employees lie, and what do you believe should be their penalty for these lies? (Go to WileyPLUS for this answer and additional questions.)
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Insight boxes provide examples of business situations from various perspectives—ethics, investor, international, and corporate social responsibility. Guideline answers to the critical thinking questions are available in WileyPLUS and at www.wiley.com/college/weygandt (http://www.wiley.com/college/weygandt) . Additional questions are offered in WileyPLUS.
DO IT! 1
Business Organization Forms
DO IT! exercises prompt you to stop and review the key points you have just studied. The Action Plan offers you tips about how to approach the problem.
In choosing the organizational form for your outdoor guide service, you should consider the pros and cons of each. Identify each of the following organizational characteristics with the organizational form or forms with which it is associated.
1. Easier to raise funds.
2. Simple to establish.
3. No personal legal liability.
4. Tax advantages.
5. Easier to transfer ownership.
Action Plan ✓ Know which organizational form best matches the business
type, size, and preferences of the owner(s).
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SOLUTION
1. Easier to raise funds: Corporation.
2. Simple to establish: Sole proprietorship and partnership.
3. No personal legal liability: Corporation.
4. Tax advantages: Sole proprietorship and partnership.
5. Easier to transfer ownership: Corporation.
Related exercise material: BE1-1 and DO IT! 1-1.
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4
Accrual Accounting Concepts
CHAPTER PREVIEW
As indicated in the Feature Story, making adjustments is necessary to avoid misstatement of revenues and expenses such as those at Groupon. In this chapter, we introduce you to the accrual accounting concepts that make such adjustments possible.
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Keeping Track of Groupons
Who doesn't like buying things at a discount? That's why it's not surprising that three years after it started as a company, Groupon, Inc. was estimated to be worth $16 billion. This translates into an average increase in value of almost $15 million per day.
Now consider that Groupon had previously been estimated to be worth even more than that. What happened? Well, accounting regulators and investors began to question the way that Groupon had accounted for some of its transactions. Groupon sells coupons (“Groupons”), so how hard can it be to account for that? It turns out that accounting for coupons is not as easy as you might think.
First, consider what happens when Groupon makes a sale. Suppose it sells a Groupon for $30 for Highrise Hamburgers. When it receives the $30 from the customer, it must turn over half of that amount ($15) to Highrise Hamburgers. So should Groupon record revenue for the full $30 or just $15? Until recently, Groupon recorded the full $30. But, in response to an SEC ruling on the issue, Groupon now records revenue of $15 instead. This caused Groupon to restate its previous �inancial statements. This restatement reduced annual revenue by $312.9 million.
A second issue is a matter of timing. When should Groupon record this $15 revenue? Should it record the revenue when it sells the Groupon, or must it wait until the customer uses the Groupon at Highrise Hamburgers? The accounting becomes even more complicated when you consider the company's loyalty programs. Groupon offers free or discounted Groupons to its subscribers for doing things such as referring new customers or participating in promotions. These Groupons are to be used for future purchases, yet the company must record the expense at the time the customer receives the Groupon.
Finally, Groupon, like all other companies, relies on many estimates in its �inancial reporting. For example, Groupon reports that “estimates are utilized for, but not limited to, stock-based compensation, income taxes, valuation of acquired goodwill and intangible assets, customer refunds, contingent liabilities and the depreciable lives of �ixed assets.” It notes that “actual results could differ materially from those estimates.” So, next time you use a coupon, think about what that means for the company's accountants!
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LEARNING OBJECTIVE 1
Explain the accrual basis of accounting and the reasons for adjusting entries.
Businesses need feedback about how well they are performing during a period of time. For example, management usually wants monthly reports on �inancial results, most large corporations are required to present quarterly and annual �inancial statements to stockholders, and the Internal Revenue Service requires all businesses to �ile annual tax returns. Accounting divides the economic life of a business into arti�icial time periods. As indicated in Chapter 2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch02#ch02) , this is the periodicity assumption. Accounting time periods are generally a month, a quarter, or a year. Companies often report using the calendar year (i.e., January 1 to December 31) but sometimes choose a different 12- month period (e.g., August 1 to July 31).
Many business transactions affect more than one of these arbitrary time periods. For example, a new building purchased by Citigroup or a new airplane purchased by Delta Air Lines will be used for many years. It would not make sense to expense the full cost of the building or the airplane at the time of purchase because each will be used for many subsequent periods. Instead, companies allocate the cost to the periods of use.
Determining the amount of revenues and expenses to report in a given accounting period can be dif�icult. Proper reporting requires an understanding of the nature of the company's business. Two principles are used as guidelines: the revenue recognition principle and the expense recognition principle.
▼ HELPFUL HINT
An accounting time period that is one year long is called a �iscal year.
THE REVENUE RECOGNITION PRINCIPLE When a company agrees to perform a service or sell a product to a customer, it has a performance obligation. The revenue recognition principle requires that companies recognize revenue in the accounting period in which the performance obligation is satis�ied. To illustrate, assume Conrad Dry Cleaners cleans clothing on June 30, but customers do not claim and pay for their clothes until the �irst week of July. Under the revenue recognition principle, Conrad records revenue in June when it satis�ies its performance obligation, which is when it performs the service, not in July when it receives the cash. At June 30, Conrad would report a receivable on its balance sheet and revenue in its income statement for the service performed. The journal entries for June and July would be as follows.
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THE EXPENSE RECOGNITION PRINCIPLE In recognizing expenses, a simple rule is followed: “Let the expenses follow the revenues.” Thus, expense recognition is tied to revenue recognition. Applied to the preceding example, this means that the salary expense Conrad incurred in performing the cleaning service on June 30 should be reported in the same period in which it recognizes the service revenue. The critical issue in expense recognition is determining when the expense makes its contribution to revenue. This may or may not be the same period in which the expense is paid. If Conrad does not pay the salary incurred on June 30 until July, it would report salaries and wages payable on its June 30 balance sheet.
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The practice of expense recognition is referred to as the expense recognition principle (often referred to as the matching principle). It dictates that efforts (expenses) be matched with results (revenues). Illustration 4-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo1#c04-�ig-0001) shows these relationships.
ILLUSTRATION 4-1 GAAP relationships in revenue and expense recognition
INVESTOR INSIGHT
Apple Inc.
Reporting Revenue Accurately
Until recently, electronics manufacturer Apple was required to spread the revenues from iPhone sales over the two-year period following the sale of the phone. Accounting standards required this because Apple was obligated to provide software updates after the phone was sold. Since Apple had service obligations after the initial date of sale, it was forced to spread the revenue over a two-year period. As a result, the rapid growth of iPhone sales was not fully re�lected in the revenue amounts reported in Apple's income statement. A new accounting standard now enables Apple to report much more of its iPhone revenue at the point of sale. It was estimated that under the new rule revenues would have been about 17% higher and earnings per share almost 50% higher.
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In the past, why was it argued that Apple should spread the recognition of iPhone revenue over a two-year period, rather than recording it upfront? (Go to WileyPLUS for this answer and additional questions.)
DECISION TOOLS
The revenue recognition principle and the expense recognition principle help to ensure that companies report the correct amount of revenues and expenses in a given period.
ACCRUAL VERSUS CASH BASIS OF ACCOUNTING Accrual-basis accounting means that transactions that change a company's �inancial statements are recorded in the periods in which the events occur, even if cash was not exchanged. For example, using the accrual basis means that companies recognize revenues when they perform the services (the revenue recognition principle), even if cash was not received. Likewise, under the accrual basis, companies recognize expenses when incurred (the expense recognition principle), even if cash was not paid.
An alternative to the accrual basis is the cash basis. Under cash-basis accounting, companies record revenue at the time they receive cash. They record an expense at the time they pay out cash. The cash basis seems appealing due to its simplicity, but it often produces misleading �inancial statements. For example, it fails to record revenue for a company that has performed services but has not yet received payment. As a result, the cash basis may not re�lect revenue in the period that a performance obligation is satis�ied. Cash-basis accounting is not in accordance with generally accepted accounting principles (GAAP).
Illustration 4-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo1#c04-�ig-0002) compares accrual-based numbers and cash-based numbers. Suppose that Fresh Colors paints a large building in 2016. In 2016, it incurs and pays total expenses (salaries and paint costs) of $50,000. It bills the customer $80,000 but does not receive payment until 2017. On an accrual basis, Fresh Colors reports $80,000 of revenue during 2016 because that is when it performed the service. The company matches expenses of $50,000 to the $80,000 of revenue. Thus, 2016 net income is $30,000 ($80,000−$50,000). The $30,000 of net income reported for 2016 indicates the pro�itability of Fresh Colors' efforts during that period.
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ILLUSTRATION 4-2 Accrual-versus cash-basis accounting
If Fresh Colors instead used cash-basis accounting, it would report $50,000 of expenses in 2016 and $80,000 of revenues during 2017. As shown in Illustration 4-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo1#c04-�ig-0002) , it would report a loss of $50,000 in 2016 and net income of $80,000 in 2017. Clearly, the cash-basis measures are misleading because the �inancial performance of the company would be misstated for both 2016 and 2017.
INTERNATIONAL NOTE Although different accounting standards are often used by companies in other countries, the accrual basis of accounting is central to all of these standards.
THE NEED FOR ADJUSTING ENTRIES In order for revenues to be recorded in the period in which the performance obligations are satis�ied and for expenses to be recognized in the period in which they are incurred, companies make adjusting entries. Adjusting entries ensure that the revenue recognition and expense recognition principles are followed.
Adjusting entries are necessary because the trial balance—the �irst pulling together of the transaction data—may not contain up-to-date and complete data. This is true for several reasons:
1. Some events are not recorded daily because it is not ef�icient to do so. Examples are the use of supplies and the earning of wages by employees.
2. Some costs are not recorded during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transactions. Examples are charges related to the use of buildings and equipment, rent, and insurance.
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3. Some items may be unrecorded. An example is a utility service bill that will not be received until the next accounting period.
Adjusting entries are required every time a company prepares �inancial statements. The company analyzes each account in the trial balance to determine whether it is complete and up-to-date for �inancial statement purposes. Every adjusting entry will include one income statement account and one balance sheet account.
TYPES OF ADJUSTING ENTRIES Adjusting entries are classi�ied as either deferrals or accruals. As Illustration 4-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo1#c04-�ig-0003) shows, each of these classes has two subcategories.
ILLUSTRATION 4-3 Categories of adjusting entries
Subsequent sections give examples of each type of adjustment. Each example is based on the October 31 trial balance of Sierra Corporation from Chapter 3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch03#ch03) . It is reproduced in Illustration 4-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo1#c04-�ig-0004) . Note that Retained Earnings has been added to this trial balance with a zero balance. We will explain its use later.
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ILLUSTRATION 4-4 Trial balance
We assume that Sierra uses an accounting period of one month. Thus, monthly adjusting entries are made. The entries are dated October 31.
DO IT! 1
Timing Concepts
Below is a list of concepts in the left column, with descriptions of the concepts in the right column. There are more descriptions provided than concepts. Match the description of the concept to the concept.
1. ________ Accrual-basis accounting.
2. ________ Calendar year.
3. ________ Periodicity assumption.
4. ________ Expense recognition principle.
(a) Monthly and quarterly time periods.
(b) Efforts (expenses) should be matched with results (revenues).
(c) Accountants divide the economic life of a business into arti�icial time periods.
(d) Companies record revenues when they receive cash and record expenses when they pay out cash.
(e) An accounting time period that starts on January 1 and ends on December 31.
(f) Companies record transactions in the period in which the events occur.
Action Plan ✓ Review the terms identi�ied on pages 152–153.
✓ Study carefully the revenue recognition principle, the expense recognition principle, and the periodicity assumption.
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SOLUTION
1. f 2. e 3. c 4. b
Related exercise material: BE4-1, BE4-2, DO IT! 4-1, E4-1, E4-2, E4-3, and E4-5.
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LEARNING OBJECTIVE 2
Prepare adjusting entries for deferrals.
To defer means to postpone or delay. Deferrals are costs or revenues that are recognized at a date later than the point when cash was originally exchanged. Companies make adjusting entries for deferred expenses to record the portion that was incurred during the period. Companies also make adjusting entries for deferred revenues to record services performed during the period. The two types of deferrals are prepaid expenses and unearned revenues.
PREPAID EXPENSES Companies record payments of expenses that will bene�it more than one accounting period as assets. These prepaid expenses or prepayments are expenses paid in cash before they are used or consumed. When expenses are prepaid, an asset account is increased (debited) to show the service or bene�it that the company will receive in the future. Examples of common prepayments are insurance, supplies, advertising, and rent. In addition, companies make prepayments when they purchase buildings and equipment.
Prepaid expenses are costs that expire either with the passage of time (e.g., rent and insurance) or through use (e.g., supplies). The expiration of these costs does not require daily entries, which would be impractical and unnecessary. Accordingly, companies postpone the recognition of such cost expirations until they prepare �inancial statements. At each statement date, they make adjusting entries to record the expenses applicable to the current accounting period and to show the remaining amounts in the asset accounts.
Prior to adjustment, assets are overstated and expenses are understated. Therefore, as shown in Illustration 4-5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0005) , an adjusting entry for prepaid expenses results in an increase (a debit) to an expense account and a decrease (a credit) to an asset account.
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ILLUSTRATION 4-5 Adjusting entries for prepaid expenses
Let's look in more detail at some speci�ic types of prepaid expenses, beginning with supplies.
Supplies
The purchase of supplies, such as paper and envelopes, results in an increase (a debit) to an asset account. During the accounting period, the company uses supplies. Rather than record supplies expense as the supplies are used, companies recognize supplies expense at the end of the accounting period. At the end of the accounting period, the company counts the remaining supplies. The difference between the unadjusted balance in the Supplies (asset) account and the actual cost of supplies on hand represents the supplies used (an expense) for that period.
Recall from Chapter 3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch03#ch03) that Sierra Corporation purchased supplies costing $2,500 on October 5. Sierra recorded the purchase by increasing (debiting) the asset Supplies. This account shows a balance of $2,500 in the October 31 trial balance. A physical count of the inventory at the close of business on October 31 reveals that $1,000 of supplies are still on hand. Thus, the cost of supplies used is $1,500 ($2,500−$1,000). This use of supplies decreases an asset, Supplies. It also decreases stockholders' equity by increasing an expense account, Supplies Expense. This is shown in Illustration 4-6 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0006) .
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ILLUSTRATION 4-6 Adjustment for supplies
After adjustment, the asset account Supplies shows a balance of $1,000, which is equal to the cost of supplies on hand at the statement date. In addition, Supplies Expense shows a balance of $1,500, which equals the cost of supplies used in October. If Sierra does not make the adjusting entry, October expenses will be understated and net income overstated by $1,500. Moreover, both assets and stockholders' equity will be overstated by $1,500 on the October 31 balance sheet.
▼ HELPFUL HINT
Due to their nature, adjusting entries have no effect on cash �lows. As a result, we do not show the cash �low effects as we did in Chapter 3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch03#ch03) .
Insurance
Companies purchase insurance to protect themselves from losses due to �ire, theft, and unforeseen events. Insurance must be paid in advance, often for multiple months. The cost of insurance (premiums) paid in advance is recorded as an increase (debit) in the asset account Prepaid Insurance. At the �inancial statement date, companies increase (debit) Insurance Expense and decrease (credit) Prepaid Insurance for the cost of insurance that has expired during the period.
On October 4, Sierra Corporation paid $600 for a one-year �ire insurance policy. Coverage began on October 1. Sierra recorded the payment by increasing (debiting) Prepaid Insurance. This account shows a balance of $600 in the October 31 trial balance. Insurance of $50 ($600÷12) expires each month. The expiration of prepaid insurance decreases an asset, Prepaid Insurance. It also decreases stockholders' equity by increasing an expense account, Insurance Expense.
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As shown in Illustration 4-7 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0007) , the asset Prepaid Insurance shows a balance of $550, which represents the unexpired cost for the remaining 11 months of coverage. At the same time, the balance in Insurance Expense equals the insurance cost that expired in October. If Sierra does not make this adjustment, October expenses are understated by $50 and net income is overstated by $50. Moreover, both assets and stockholders' equity will be overstated by $50 on the October 31 balance sheet.
ILLUSTRATION 4-7 Adjustment for insurance
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Depreciation
A company typically owns a variety of assets that have long lives, such as buildings, equipment, and motor vehicles. The period of service is referred to as the useful life of the asset. Because a building is expected to be of service for many years, it is recorded as an asset, rather than an expense, on the date it is acquired. As explained in Chapter 2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch02#ch02) , companies record such assets at cost, as required by the historical cost principle. To follow the expense recognition principle, companies allocate a portion of this cost as an expense during each period of the asset's useful life. Depreciation is the process of allocating the cost of an asset to expense over its useful life.
NEED FOR ADJUSTMENT
The acquisition of long-lived assets is essentially a long-term prepayment for the use of an asset. An adjusting entry for depreciation is needed to recognize the cost that has been used (an expense) during the period and to report the unused cost (an asset) at the end of the period. One very important point to understand: Depreciation is an allocation concept, not a valuation concept. That is, depreciation allocates an asset's cost to the periods in which it is used. Depreciation does not attempt to report the actual change in the value of the asset.
For Sierra Corporation, assume that depreciation on the equipment is $480 a year, or $40 per month. As shown in Illustration 4-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04- �ig-0008) , rather than decrease (credit) the asset account directly, Sierra instead credits Accumulated
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Depreciation—Equipment. Accumulated Depreciation is called a contra asset account. Such an account is offset against an asset account on the balance sheet. Thus, the Accumulated Depreciation—Equipment account offsets the asset Equipment. This account keeps track of the total amount of depreciation expense taken over the life of the asset. To keep the accounting equation in balance, Sierra decreases stockholders' equity by increasing an expense account, Depreciation Expense.
ILLUSTRATION 4-8 Adjustment for depreciation
The balance in the Accumulated Depreciation—Equipment account will increase $40 each month, and the balance in Equipment remains $5,000.
STATEMENT PRESENTATION
As noted above, Accumulated Depreciation—Equipment is a contra asset account. It is offset against Equipment on the balance sheet. The normal balance of a contra asset account is a credit. A theoretical alternative to using a contra asset account would be to decrease (credit) the asset account by the amount of depreciation each period. But using the contra account is preferable for a simple reason: It discloses both the original cost of the equipment and the total cost that has expired to date. Thus, in the balance sheet, Sierra deducts Accumulated Depreciation—Equipment from the related asset account, as shown in Illustration 4-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0009) (page 160).
ILLUSTRATION 4-9 Balance sheet presentation of accumulated depreciation
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Book value is the difference between the cost of any depreciable asset and its related accumulated depreciation. In Illustration 4-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0009) , the book value of the equipment at the balance sheet date is $4,960. The book value and the fair value of the asset are generally two different values. As noted earlier, the purpose of depreciation is not valuation but a means of cost allocation.
Depreciation expense identi�ies the portion of an asset's cost that expired during the period (in this case, in October). Without this adjusting entry, total assets, total stockholders' equity, and net income are overstated by $40 and depreciation expense is understated by $40.
Illustration 4-10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0010) summarizes the accounting for prepaid expenses.
ILLUSTRATION 4-10 Accounting for prepaid expenses
▼ HELPFUL HINT
All contra accounts have increases, decreases, and normal balances opposite to the account to which they relate.
ALTERNATIVE TERMINOLOGY
Book value is also referred to as carrying value.
UNEARNED REVENUES Companies record cash received before services are performed by increasing (crediting) a liability account called unearned revenues. In other words, the company has a performance obligation to transfer a service to one of its customers. Items like rent, magazine subscriptions, and customer deposits for future service may result in unearned revenues. Airlines such as United, American, and Delta, for instance, treat receipts from the sale of tickets as unearned revenue until the �light service is provided.
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Unearned revenues are the opposite of prepaid expenses. Indeed, unearned revenue on the books of one company is likely to be a prepaid expense on the books of the company that has made the advance payment. For example, if identical accounting periods are assumed, a landlord will have unearned rent revenue when a tenant has prepaid rent.
When a company receives payment for services to be performed in a future accounting period, it increases (credits) an unearned revenue account. Unearned revenue is a liability account used to recognize the obligation that exists. The company subsequently recognizes revenues when it performs the service. During the accounting period, it is not practical to make daily entries as the company performs services. Instead, the company delays recognition of revenue until the adjustment process. The company then makes an adjusting entry to record the revenue for services performed during the period and to show the liability that remains at the end of the accounting period. Prior to adjustment, liabilities are typically overstated and revenues are understated. Therefore, as shown in Illustration 4-11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0011) , the adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.
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ILLUSTRATION 4-11 Adjusting entries for unearned revenues
Sierra Corporation received $1,200 on October 2 from R. Knox for guide services for multi-day trips expected to be completed by December 31. Sierra credited the payment to Unearned Service Revenue. This liability account shows a balance of $1,200 in the October 31 trial balance. From an evaluation of the service Sierra performed for Knox during October, the company determines that it should recognize $400 of revenue in October. The liability (Unearned Service Revenue) is therefore decreased and stockholders' equity (Service Revenue) is increased.
As shown in Illustration 4-12 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0012) , the liability Unearned Service Revenue now shows a balance of $800. That amount represents the remaining guide services Sierra is obligated to perform in the future. Service Revenue shows total revenue for October of $10,400. Without this adjustment, revenues and net income are understated by $400 in the income statement. Moreover, liabilities are overstated and stockholders' equity is understated by $400 on the October 31 balance sheet.
ILLUSTRATION 4-12 Service revenue accounts after adjustment
Illustration 4-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo2#c04-�ig-0013) summarizes the accounting for unearned revenues.
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ILLUSTRATION 4-13 Accounting for unearned revenues
ACCOUNTING ACROSS THE ORGANIZATION
Best Buy
Turning Gift Cards into Revenue
Those of you who are marketing majors (and even most of you who are not) know that gift cards are among the hottest marketing tools in merchandising today. Customers purchase gift cards and give them to someone for later use. In a recent year, gift-card sales were expected to exceed $124 billion.
Although these programs are popular with marketing executives, they create accounting questions. Should revenue be recorded at the time the gift card is sold, or when it is exercised? How should expired gift cards be accounted for? In a recent balance sheet, Best Buy reported unearned revenue related to gift cards of $406 million.
Source: “2014 Gift Card Sales to Top $124 Billion, But Growth Slowing,” PRNewswire (December 10, 2014).
Suppose that Robert Jones purchases a $100 gift card at Best Buy on December 24, 2016, and gives it to his wife, Mary Jones, on December 25, 2016. On January 3, 2017, Mary uses the card to purchase $100 worth of CDs. When do you think Best Buy should recognize revenue and why? (Go to WileyPLUS for this answer and additional questions.)
DO IT! 2
Adjusting Entries for Deferrals
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The ledger of Hammond, Inc. on March 31, 2017, includes these selected accounts before adjusting entries are prepared.
Debit Credit Prepaid Insurance $ 3,600 Supplies 2,800 Equipment 25,000 Accumulated Depreciation—Equipment $5,000 Unearned Service Revenue 9,200
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $100 per month.
2. Supplies on hand total $800.
3. The equipment depreciates $200 a month.
4. During March, services were performed for $4,000 of the unearned service revenue reported.
Prepare the adjusting entries for the month of March.
Action Plan ✓ Make adjusting entries at the end of the period for revenues
recognized and expenses incurred in the period.
✓ Don't forget to make adjusting entries for deferrals. Failure to adjust for deferrals leads to overstatement of the asset or liability and understatement of the related expense or revenue.
Related exercise material: BE4-4, BE4-5, BE4-6, BE4-7, and DO IT! 4-2.
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LEARNING OBJECTIVE 3
Prepare adjusting entries for accruals.
The second category of adjusting entries is accruals. Prior to an accrual adjustment, the revenue account (and the related asset account) or the expense account (and the related liability account) are understated. Thus, the adjusting entry for accruals will increase both a balance sheet and an income statement account.
ACCRUED REVENUES Revenues for services performed but not yet recorded at the statement date are accrued revenues. Accrued revenues may accumulate (accrue) with the passing of time, as in the case of interest revenue. These are unrecorded because the earning of interest does not involve daily transactions. Companies do not record interest revenue on a daily basis because it is often impractical to do so. Accrued revenues also may result from services that have been performed but not yet billed nor collected, as in the case of commissions and fees. These may be unrecorded because only a portion of the total service has been performed and the clients won't be billed until the service has been completed.
An adjusting entry records the receivable that exists at the balance sheet date and the revenue for the services performed during the period. Prior to adjustment, both assets and revenues are understated. As shown in Illustration 4-14 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0014) , an adjusting entry for accrued revenues results in an increase (a debit) to an asset account and an increase (a credit) to a revenue account.
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ILLUSTRATION 4-14 Adjusting entries for accrued revenues
In October, Sierra Corporation performed guide services worth $200 that were not billed to clients on or before October 31. Because these services were not billed, they were not recorded. The accrual of unrecorded service revenue increases an asset account, Accounts Receivable. It also increases stockholders' equity by increasing a revenue account, Service Revenue, as shown in Illustration 4-15 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0015) (page 164).
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ILLUSTRATION 4-15 Adjustment for accrued revenue
Equation analyses summarize the effects of transactions on the three elements of the accounting equation, as well as the effect on cash �lows.
The asset Accounts Receivable shows that clients owe Sierra $200 at the balance sheet date. The balance of $10,600 in Service Revenue represents the total revenue for services Sierra performed during the month ($10,000+$400+$200). Without the adjusting entry, assets and stockholders' equity on the balance sheet and revenues and net income on the income statement are understated.
On November 10, Sierra receives cash of $200 for the services performed in October and makes the following entry.
The company records the collection of the receivables by a debit (increase) to Cash and a credit (decrease) to Accounts Receivable.
Illustration 4-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0016) summarizes the accounting for accrued revenues.
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ILLUSTRATION 4-16 Accounting for accrued revenues
▼ HELPFUL HINT
For accruals, there may have been no prior entry, and the accounts requiring adjustment may both have zero balances prior to adjustment.
ACCRUED EXPENSES Expenses incurred but not yet paid or recorded at the statement date are called accrued expenses. Interest, taxes, utilities, and salaries are common examples of accrued expenses.
Companies make adjustments for accrued expenses to record the obligations that exist at the balance sheet date and to recognize the expenses that apply to the current accounting period. Prior to adjustment, both liabilities and expenses are understated. Therefore, as shown in Illustration 4-17 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0017) , an adjusting entry for accrued expenses results in an increase (a debit) to an expense account and an increase (a credit) to a liability account.
ILLUSTRATION 4-17 Adjusting entries for accrued expenses
Let's look in more detail at some speci�ic types of accrued expenses, beginning with accrued interest.
ETHICS NOTE
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A report released by Fannie Mae's board of directors stated that improper adjusting entries at the mortgage-�inance company resulted in delayed recognition of expenses caused by interest-rate changes. The motivation for this improper accounting apparently was the desire to meet earnings targets.
Accrued Interest
Sierra Corporation signed a three-month note payable in the amount of $5,000 on October 1. The note requires Sierra to pay interest at an annual rate of 12%.
The amount of the interest recorded is determined by three factors: (1) the face value of the note; (2) the interest rate, which is always expressed as an annual rate; and (3) the length of time the note is outstanding. For Sierra, the total interest due on the $5,000 note at its maturity date three months in the future is $150 ($5,000×12%×312), or $50 for one month. Illustration 4-18 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0018) shows the formula for computing interest and its application to Sierra for the month of October.
ILLUSTRATION 4-18 Formula for computing interest
As Illustration 4-19 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig- 0019) shows, the accrual of interest at October 31 increases a liability account, Interest Payable. It also decreases stockholders' equity by increasing an expense account, Interest Expense.
ILLUSTRATION 4-19 Adjustment for accrued interest
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Interest Expense shows the interest charges for the month of October. Interest Payable shows the amount of interest the company owes at the statement date. Sierra will not pay the interest until the note comes due at the end of three months. Companies use the Interest Payable account, instead of crediting Notes Payable, to disclose the two different types of obligations—interest and principal—in the accounts and statements. Without this adjusting entry, liabilities and interest expense are understated, and net income and stockholders' equity are overstated.
▼ HELPFUL HINT
In computing interest, we express the time period as a fraction of a year.
Accrued Salaries
Companies pay for some types of expenses, such as employee salaries and wages, after the services have been performed. Sierra paid salaries on October 26 for its employees' �irst two weeks of work; the next payment of salaries will not occur until November 9. As Illustration 4-20 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0020) shows, three working days remain in October (October 29–31).
ILLUSTRATION 4-20 Calendar showing Sierra Corporation's pay periods
At October 31, the salaries for these three days represent an accrued expense and a related liability to Sierra. The employees receive total salaries of $2,000 for a �ive-day work week, or $400 per day. Thus, accrued salaries at October 31 are $1,200 ($400×3). This accrual increases a liability, Salaries and Wages Payable. It also decreases stockholders' equity by increasing an expense account, Salaries and Wages Expense, as shown in Illustration 4-21 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0021) .
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ILLUSTRATION 4-21 Adjustment for accrued salaries
After this adjustment, the balance in Salaries and Wages Expense of $5,200 (13 days×$400) is the actual salary expense for October. (The employees worked 13 days in October after beginning work on October 15.) The balance in Salaries and Wages Payable of $1,200 is the amount of the liability for salaries Sierra owes as of October 31. Without the $1,200 adjustment for salaries, Sierra's expenses are understated $1,200 and its liabilities are understated $1,200.
Sierra pays salaries every two weeks. Consequently, the next payday is November 9, when the company will again pay total salaries of $4,000. The payment consists of $1,200 of salaries and wages payable at October 31 plus $2,800 of salaries and wages expense for November (7 working days as shown in the November calendar×$400). Therefore, Sierra makes the following entry on November 9.
This entry eliminates the liability for Salaries and Wages Payable that Sierra recorded in the October 31 adjusting entry, and it records the proper amount of Salaries and Wages Expense for the period between November 1 and November 9.
Illustration 4-22 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0022) summarizes the accounting for accrued expenses.
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ILLUSTRATION 4-22 Accounting for accrued expenses
PEOPLE, PLANET, AND PROFIT INSIGHT Got Junk?
Do you have an old computer or two in your garage? How about an old TV that needs replacing? Many people do. Approximately 163,000 computers and televisions become obsolete each day. Yet, in a recent year, only 11% of computers were recycled. It is estimated that 75% of all computers ever sold are sitting in storage somewhere, waiting to be disposed of. Each of these old TVs and computers is loaded with lead, cadmium, mercury, and other toxic chemicals. If you have one of these electronic gadgets, you have a responsibility, and a probable cost, for disposing of it. Companies have the same problem, but their discarded materials may include lead paint, asbestos, and other toxic chemicals.
What accounting issue might this cause for companies? (Go to WileyPLUS for this answer and additional questions.)
SUMMARY OF BASIC RELATIONSHIPS Illustration 4-23 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0023) (page 168) summarizes the four basic types of adjusting entries. Take some time to study and analyze the adjusting entries. Be sure to note that each adjusting entry affects one balance sheet account and one income statement account.
ILLUSTRATION 4-23 Summary of adjusting entries
Illustrations 4-24 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig- 0024) and 4-25 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0025)
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show the journalizing and posting of adjusting entries for Sierra Corporation on October 31. When reviewing the general ledger in Illustration 4-25 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0025) , note that for learning purposes we have highlighted the adjustments in red.
ILLUSTRATION 4-24 General journal showing adjusting entries
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ILLUSTRATION 4-25 General ledger after adjustments
DO IT! 3
Adjusting Entries for Accruals
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Micro Computer Services Inc. began operations on August 1, 2017. At the end of August 2017, management attempted to prepare monthly �inancial statements. The following information relates to August.
1. At August 31, the company owed its employees $800 in salaries that will be paid on September 1.
2. On August 1, the company borrowed $30,000 from a local bank on a 15-year mortgage. The annual interest rate is 10%.
3. Revenue for services performed but unrecorded for August totaled $1,100.
Prepare the adjusting entries needed at August 31, 2017.
Action Plan ✓ Make adjusting entries at the end of the period to recognize
revenue for services performed and for expenses incurred.
✓ Don't forget to make adjusting entries for accruals. Adjusting entries for accruals will increase both a balance sheet and an income statement account.
SOLUTION
Related exercise material: BE4-8, DO IT! 4-3, E4-8, E4-9, E4-10, E4-11, E4-12, E4-13, E4-14, E4-15, E4-16, E4-17, and E4-18.
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LEARNING OBJECTIVE 4
Prepare an adjusted trial balance and closing entries.
After a company has journalized and posted all adjusting entries, it prepares another trial balance from the ledger accounts. This trial balance is called an adjusted trial balance. It shows the balances of all accounts, including those adjusted, at the end of the accounting period. The purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments. Because the accounts contain all data needed for �inancial statements, the adjusted trial balance is the primary basis for the preparation of �inancial statements.
PREPARING THE ADJUSTED TRIAL BALANCE Illustration 4-26 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0026) presents the adjusted trial balance for Sierra Corporation prepared from the ledger accounts in Illustration 4-25 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0025) . The amounts affected by the adjusting entries are highlighted in red.
ILLUSTRATION 4-26 Adjusted trial balance
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PREPARING FINANCIAL STATEMENTS Companies can prepare �inancial statements directly from an adjusted trial balance. Illustrations 4-27 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0027) (page 172) and 4-28 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0028) (page 173) present the relationships between the data in the adjusted trial balance of Sierra Corporation and the corresponding �inancial statements. As Illustration 4-27 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0027) shows, companies prepare the income statement from the revenue and expense accounts. Similarly, they derive the retained earnings statement from the Retained Earnings account, Dividends account, and the net income (or net loss) shown in the income statement. As Illustration 4-28 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0028) shows, companies then prepare the balance sheet from the asset, liability, and stockholders' equity accounts. They obtain the amount reported for retained earnings on the balance sheet from the ending balance in the retained earnings statement.
ILLUSTRATION 4-27 Preparation of the income statement and retained earnings statement from the adjusted trial balance
QUALITY OF EARNINGS Companies and employees are continually under pressure to “make the numbers”—that is, to have earnings that are in line with expectations. Therefore, it is not surprising that many companies practice earnings management. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. The quality of earnings is greatly affected when a company manages earnings up or down to meet some targeted earnings number. A company that has a high quality of earnings provides full and transparent information that will not confuse or mislead �inancial statement users. A company with questionable quality of earnings may mislead investors and creditors, who believe
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they are relying on relevant information that provides a faithful representation of the company. As a result, investors and creditors lose con�idence in �inancial reporting, and it becomes dif�icult for our capital markets to work ef�iciently.
Companies manage earnings in a variety of ways. One way is through the use of one-time items to prop up earnings numbers. For example, ConAgra Foods recorded a non-recurring gain from the sale of Pilgrim's Pride stock for $186 million to help meet an earnings projection for the quarter.
ILLUSTRATION 4-28 Preparation of the balance sheet from the adjusted trial balance
Another way is to in�late revenue numbers in the short-run to the detriment of the long-run. For example, Bristol-Myers Squibb provided sales incentives to its wholesalers to encourage them to buy products at the end of the quarter (often referred to as channel-stuf�ing). This practice allowed Bristol- Myers to meet its sales projections. The problem was that the wholesalers could not sell that amount of merchandise and ended up returning it to Bristol-Myers. The result was that Bristol-Myers had to restate its income numbers.
Companies also manage earnings through improper adjusting entries. Regulators investigated Xerox for accusations that it was booking too much revenue upfront on multi-year contract sales. Financial executives at Of�ice Max resigned amid accusations that the company was recognizing rebates from its vendors too early and therefore overstating revenue. Finally, WorldCom's abuse of adjusting entries to meet its net income targets is unsurpassed. It used adjusting entries to increase net income by reclassifying liabilities as revenue and reclassifying expenses as assets. Investigations of the company's books after it went bankrupt revealed adjusting entries of more than a billion dollars that had no supporting documentation.
DO IT! 4a
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Trial Balance
Skolnick Co. was organized on April 1, 2017. The company prepares quarterly �inancial statements. The adjusted trial balance amounts at June 30 are shown below.
Debit Credit
Cash $ 6,700 Accumulated Depreciation—Equipment $ 850 Accounts Receivable 600 Notes Payable 5,000 Prepaid Rent 900 Accounts Payable 1,510 Supplies 1,000 Salaries and Wages Payable 400 Equipment 15,000 Interest Payable 50 Dividends 600 Unearned Rent Revenue 500 Salaries and Wages Expense 9,400 Common Stock 14,000 Rent Expense 1,500 Retained Earning 0 Depreciation Expense 850 Service Revenue 14,200 Supplies Expense 200 Rent Revenue 800 Utilities Expense 510 Interest Expense 50
$37,310 $37,310
(a) Determine the net income for the quarter April 1 to June 30.
(b) Determine the total assets and total liabilities at June 30, 2017, for Skolnick Co.
(c) Determine the balance in Retained Earnings at June 30, 2017.
Action Plan ✓ In an adjusted trial balance, all asset, liability, revenue, and
expense accounts are properly stated.
✓ To determine the ending balance in Retained Earnings, add net income and subtract dividends.
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SOLUTION
Related exercise material: BE4-9, BE4-10, BE4-11, BE4-12, DO IT! 4-4a, E4-21, and E4- 22.
CLOSING THE BOOKS In previous chapters, you learned that revenue and expense accounts and the Dividends account are subdivisions of retained earnings, which is reported in the stockholders' equity section of the balance sheet. Because revenues, expenses, and dividends relate only to a given accounting period, they are considered temporary accounts. In contrast, all balance sheet accounts are considered permanent accounts because their balances are carried forward into future accounting periods. Illustration 4-29 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0029) identi�ies the accounts in each category.
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ILLUSTRATION 4-29 Temporary versus permanent accounts
ALTERNATIVE TERMINOLOGY
Temporary accounts are sometimes called nominal accounts, and permanent accounts are sometimes called real accounts.
Preparing Closing Entries
At the end of the accounting period, companies transfer the temporary account balances to the permanent stockholders' equity account—Retained Earnings—through the preparation of closing entries. Closing entries transfer net income (or net loss) and dividends to Retained Earnings, so the balance in Retained Earnings agrees with the retained earnings statement. For example, in the adjusted trial balance in Illustration 4-26 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0026) (page 171), Retained Earnings has a balance of zero. Prior to the closing entries, the balance in Retained Earnings is its beginning-of-the-period balance. (For Sierra Corporation, this is zero because it is the company's �irst month of operations.)
In addition to updating Retained Earnings to its correct ending balance, closing entries produce a zero balance in each temporary account. As a result, these accounts are ready to accumulate data about revenues, expenses, and dividends that occur in the next accounting period. Permanent accounts are not closed.
When companies prepare closing entries, they could close each income statement account directly to Retained Earnings. However, to do so would result in excessive detail in the Retained Earnings account. Instead, companies close the revenue and expense accounts to another temporary account, Income Summary. The balance in Income Summary is the net income or loss for the accounting period. Income Summary is then closed, which transfers the net income or net loss from this account to Retained Earnings. Illustration 4-30 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0030) (page 176) depicts the closing process. While it still takes the average large company seven days to close, some companies such as Cisco employ technology that allows them to do a so-called “virtual close” almost instantaneously any time during the year. Besides dramatically reducing the cost of closing, the virtual close provides companies with accurate data for decision-making whenever they desire it.
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ILLUSTRATION 4-30 The closing process
Illustration 4-31 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0031) shows the closing entries for Sierra Corporation. Illustration 4-32 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0032) (page 177) diagrams the posting process for Sierra's closing entries.
ILLUSTRATION 4-31 Closing entries journalized
▼ HELPFUL HINT
Income Summary is a very descriptive title: Companies close total revenues to Income Summary and total expenses to Income Summary. The balance in Income Summary in this case is net income of $2,860.
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Preparing a Post-Closing Trial Balance
After a company journalizes and posts all closing entries, it prepares another trial balance, called a post- closing trial balance, from the ledger. A post-closing trial balance is a list of all permanent accounts and their balances after closing entries are journalized and posted. The purpose of this trial balance is to prove the equality of the total debit balances and total credit balances of the permanent account balances that the company carries forward into the next accounting period. Since all temporary accounts will have zero balances, the post-closing trial balance will contain only permanent— balance sheet—accounts.
ILLUSTRATION 4-32 Posting of closing entries
SUMMARY OF THE ACCOUNTING CYCLE Illustration 4-33 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig-0033) (page 178) shows the required steps in the accounting cycle. You can see that the cycle begins with the analysis of business transactions and ends with the preparation of a post-closing trial balance. Companies perform the steps in the cycle in sequence and repeat them in each accounting period.
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ILLUSTRATION 4-33 Required steps in the accounting cycle
Steps 1–3 may occur daily during the accounting period, as explained in Chapter 3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch03#ch03) . Companies perform Steps 4–7 on a periodic basis, such as monthly, quarterly, or annually. Steps 8 and 9, closing entries and a post- closing trial balance, usually take place only at the end of a company's annual accounting period.
▼ HELPFUL HINT
Some companies reverse certain adjusting entries at the beginning of a new accounting period. The company makes a reversing entry at the beginning of the next accounting period. This entry is the exact opposite of the adjusting entry made in the previous period.
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KEEPING AN EYE ON CASH In this chapter, you learned that adjusting entries are used to adjust numbers that would otherwise be stated on a cash basis. Sierra Corporation's income statement (Illustration 4-27 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo4#c04-�ig- 0027) , page 172) shows net income of $2,860. The statement of cash �lows reports a form of cash-basis income referred to as “Net cash provided by operating activities.” For example, Illustration 1-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01lo3#c01-�ig-0008) (page 14), which shows a statement of cash �lows, reports net cash provided by operating activities of $5,700 for Sierra. Net income and net cash provided by operating activities often differ. The difference for Sierra is $2,840 ($5,700−$2,860). The following summary shows the causes of this difference of $2,840.
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Computation of Net Cash Provided by Operating Activities
Computation of Net Income
(1)
Cash received in advance from customer
$ 1,200 $ 0
(2)
Cash received from customers for services performed
10,000 10,000
(3)
Services performed for cash received previously in (1)
0 400
(4)
Services performed on account
0 200
(5)
Payment of rent (900) (900)
(6)
Purchase of insurance (600) 0
(7)
Payment of employee salaries
(4,000) (4,000)
(8)
Use of supplies 0 (1,500)
(9)
Use of insurance 0 (50)
(10)
Depreciation 0 (40)
(11)
Interest cost incurred, but not paid
0 (50)
(12)
Salaries incurred, but not paid
0 (1,200)
$ 5,700 $ 2,860
For each item included in the computation of net cash provided by operating activities, con�irm that cash was either received or paid. For each item in the income statement, con�irm that revenue should be recorded because a performance obligation has been satis�ied (even when cash was not received) or that an expense was incurred (even when cash was not paid).
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DO IT! 4b
CLOSING ENTRIES
Hancock Company has the following balances in selected accounts of its adjusted trial balance.
Accounts Payable $27,000 Dividends $15,000 Service Revenue 98,000 Retained Earnings 42,000 Rent Expense 22,000 Accounts Receivable 38,000 Salaries and Wages Expense 51,000 Supplies Expense 7,000
Prepare the closing entries at December 31.
Action Plan ✓ Close revenue and expense accounts to Income Summary.
✓ Close Income Summary to Retained Earnings.
✓ Close Dividends to Retained Earnings.
SOLUTION
Related exercise material: BE4-13, BE4-14, DO IT! 4-4b, E4-19, E4-20, and E4-23.
USING DECISION TOOLS—GROUPON, INC.
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Groupon, Inc. operates online marketplaces that provide goods and services at discounted prices worldwide. Headquartered in Chicago, Illinois, it has over 11,843 employees. Suppose that the information shown in the trial balance below was taken from Groupon's 2017 �inancial records.
INSTRUCTIONS
From the trial balance, prepare an income statement, retained earnings statement, and classi�ied balance sheet. Be sure to prepare them in that order since each statement depends on information determined in the preceding statement. (Hint: Note that because Groupon has experienced losses, it reports an Accumulated De�icit rather than Retained Earnings. Remember that the amount of the Accumulated De�icit reported in the trial balance represents the balance at the beginning of the year.)
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SOLUTION
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LEARNING OBJECTIVE *5
APPENDIX 4A: Describe the purpose and the basic form of a worksheet.
In Chapter 4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04#ch04) , we used T- accounts and trial balances to arrive at the amounts used to prepare �inancial statements. Accountants frequently use a device known as a worksheet to determine these amounts. A worksheet is a multiple- column form that may be used in the adjustment process and in preparing �inancial statements. Accountants can prepare worksheets manually, but today most use computer spreadsheets.
As its name suggests, the worksheet is a working tool for the accountant. A worksheet is not a permanent accounting record; it is neither a journal nor a part of the general ledger. The worksheet is merely a supplemental device used to make it easier to prepare adjusting entries and the �inancial statements. Small companies with relatively few accounts and adjustments may not need a worksheet. In large companies with numerous accounts and many adjustments, a worksheet is almost indispensable.
Illustration 4A-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo5#c04-�ig-0034) shows the basic form and procedures for preparing a worksheet. Note the headings. The worksheet starts with two columns for the Trial Balance. The next two columns record all Adjustments. Next is the Adjusted Trial Balance. The last two sets of columns correspond to the Income Statement and the Balance Sheet. All items listed in the Adjusted Trial Balance columns are included in either the Income Statement or the Balance Sheet columns.
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ILLUSTRATION 4A-1 Form and procedure for a worksheet
REVIEW AND PRACTICE
LEARNING OBJECTIVES REVIEW 1. Explain the accrual basis of accounting and the reasons for adjusting
entries. The revenue recognition principle dictates that companies recognize revenue when a performance obligation has been satis�ied. The expense recognition principle dictates that companies recognize expenses in the period when the company makes efforts to generate those revenues.
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Under the cash basis, companies record events only in the periods in which the company receives or pays cash. Accrual-based accounting means that companies record, in the periods in which the events occur, events that change a company's �inancial statements even if cash has not been exchanged.
Companies make adjusting entries at the end of an accounting period. These entries ensure that companies record revenues in the period in which the performance obligation is satis�ied and that companies recognize expenses in the period in which they are incurred. The major types of adjusting entries are prepaid expenses, unearned revenues, accrued revenues, and accrued expenses.
2. Prepare adjusting entries for deferrals. Deferrals are either prepaid expenses or unearned revenues. Companies make adjusting entries for deferrals at the statement date to record the portion of the deferred item that represents the expense incurred or the revenue for services performed in the current accounting period.
3. Prepare adjusting entries for accruals. Accruals are either accrued revenues or accrued expenses. Adjusting entries for accruals record revenues for services performed and expenses incurred in the current accounting period that have not been recognized through daily entries.
4. Prepare an adjusted trial balance and closing entries. An adjusted trial balance is a trial balance that shows the balances of all accounts, including those that have been adjusted, at the end of an accounting period. The purpose of an adjusted trial balance is to show the effects of all �inancial events that have occurred during the accounting period.
One purpose of closing entries is to transfer net income or net loss for the period to Retained Earnings. A second purpose is to “zero-out” all temporary accounts (revenue accounts, expense accounts, and Dividends) so that they start each new period with a zero balance. To accomplish this, companies “close” all temporary accounts at the end of an accounting period. They make separate entries to close revenues and expenses to Income Summary, Income Summary to Retained Earnings, and Dividends to Retained Earnings. Only temporary accounts are closed.
The required steps in the accounting cycle are (a) analyze business transactions, (b) journalize the transactions, (c) post to ledger accounts, (d) prepare a trial balance, (e) journalize and post adjusting entries, (f) prepare an adjusted trial balance, (g) prepare �inancial statements, (h) journalize and post closing entries, and (i) prepare a post-closing trial balance.
5. Describe the purpose and the basic form of a worksheet. The worksheet is a device to make it easier to prepare adjusting entries and the �inancial statements. Companies often prepare a worksheet using a computer spreadsheet. The sets of columns of the worksheet are, from left to right, the unadjusted trial balance, adjustments, adjusted trial balance, income statement, and balance sheet.
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DECISION TOOLS REVIEW
GLOSSARY REVIEW Accrual-basis accounting Accounting basis in which companies record, in the periods in
which the events occur, transactions that change a company's �inancial statements, even if cash was not exchanged.
Accrued expenses Expenses incurred but not yet paid in cash or recorded.
Accrued revenues Revenues for services performed but not yet received in cash or recorded.
Adjusted trial balance A list of accounts and their balances after all adjustments have been made.
Adjusting entries Entries made at the end of an accounting period to ensure that the revenue recognition and expense recognition principles are followed.
Book value The difference between the cost of a depreciable asset and its related accumulated depreciation.
Cash-basis accounting Accounting basis in which a company records revenue only when it receives cash and an expense only when it pays cash.
Closing entries Entries at the end of an accounting period to transfer the balances of temporary accounts to a permanent stockholders' equity account, Retained Earnings.
Contra asset account An account that is offset against an asset account on the balance sheet.
Depreciation The process of allocating the cost of an asset to expense over its useful life.
Earnings management The planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income.
Expense recognition principle The principle that matches expenses with revenues in the period when the company makes efforts to generate those revenues.
Fiscal year An accounting period that is one year long.
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Income Summary A temporary account used in closing revenue and expense accounts.
Periodicity assumption An assumption that the economic life of a business can be divided into arti�icial time periods.
Permanent accounts Balance sheet accounts whose balances are carried forward to the next accounting period.
Post-closing trial balance A list of permanent accounts and their balances after a company has journalized and posted closing entries.
Prepaid expenses (prepayments) Expenses paid in cash before they are used or consumed.
Quality of earnings Indicates the level of full and transparent information that a company provides to users of its �inancial statements.
Revenue recognition principle The principle that companies recognize revenue in the accounting period in which the performance obligation is satis�ied.
Reversing entry An entry made at the beginning of the next accounting period; the exact opposite of the adjusting entry made in the previous period.
Temporary accounts Revenue, expense, and dividend accounts whose balances a company transfers to Retained Earnings at the end of an accounting period.
Unearned revenues Cash received and a liability recorded before services are performed.
Useful life The length of service of a productive asset.
*Worksheet A multiple-column form that companies may use in the adjustment process and in preparing �inancial statements.
PRACTICE MULTIPLE-CHOICE QUESTIONS (LO 1)
1. What is the periodicity assumption?
(a) Companies should recognize revenue in the accounting period in which services are performed.
(b) Companies should match expenses with revenues.
(c) The economic life of a business can be divided into arti�icial time periods.
(d) The �iscal year should correspond with the calendar year.
(LO 1)
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2. Which principle dictates that efforts (expenses) be recorded with accomplishments (revenues)?
(a) Expense recognition principle.
(b) Historical cost principle.
(c) Periodicity principle.
(d) Revenue recognition principle.
(LO 1)
3. Which one of these statements about the accrual basis of accounting is false?
(a) Companies record events that change their �inancial statements in the period in which events occur, even if cash was not exchanged.
(b) Companies recognize revenue in the period in which the performance obligation is satis�ied.
(c) This basis is in accordance with generally accepted accounting principles.
(d) Companies record revenue only when they receive cash and record expense only when they pay out cash.
(LO 1)
4. Adjusting entries are made to ensure that:
(a) expenses are recognized in the period in which they are incurred.
(b) revenues are recorded in the period in which the performance obligation is satis�ied.
(c) balance sheet and income statement accounts have correct balances at the end of an accounting period.
(d) All of the above.
(LO 2, 3)
5. Each of the following is a major type (or category) of adjusting entry except:
(a) prepaid expenses.
(b) accrued revenues.
(c) accrued expenses.
(d) unearned expenses.
(LO 2)
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6. The trial balance shows Supplies $1,350 and Supplies Expense $0. If $600 of supplies are on hand at the end of the period, the adjusting entry is:
(LO 2)
7. Adjustments for unearned revenues:
(a) decrease liabilities and increase revenues.
(b) increase liabilities and increase revenues.
(c) increase assets and increase revenues.
(d) decrease revenues and decrease assets.
(LO 2)
8. Adjustments for prepaid expenses:
(a) decrease assets and increase revenues.
(b) decrease expenses and increase assets.
(c) decrease assets and increase expenses.
(d) decrease revenues and increase assets.
(LO 2)
9. Queenan Company computes depreciation on delivery equipment at $1,000 for the month of June. The adjusting entry to record this depreciation is as follows:
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(LO 3)
10. Adjustments for accrued revenues:
(a) increase assets and increase liabilities.
(b) increase assets and increase revenues.
(c) decrease assets and decrease revenues.
(d) decrease liabilities and increase revenues.
(LO 3)
11. Colleen Mooney earned a salary of $400 for the last week of September. She will be paid on October 1. The adjusting entry for Colleen's employer at September 30 is:
(LO 4)
12. Which statement is incorrect concerning the adjusted trial balance?
(a) An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made.
(b) The adjusted trial balance provides the primary basis for the preparation of �inancial statements.
(c) The adjusted trial balance does not list temporary accounts.
(d) The company prepares the adjusted trial balance after it has journalized and posted the adjusting entries.
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(LO 4)
13. Which account will have a zero balance after a company has journalized and posted closing entries?
(a) Service Revenue.
(b) Supplies.
(c) Prepaid Insurance.
(d) Accumulated Depreciation.
(LO 4)
14. Which types of accounts will appear in the post-closing trial balance?
(a) Permanent accounts.
(b) Temporary accounts.
(c) Expense accounts.
(d) None of the above.
(LO 4)
15. All of the following are required steps in the accounting cycle except:
(a) journalizing and posting closing entries.
(b) preparing an adjusted trial balance.
(c) preparing a post-closing trial balance.
(d) prepare �inancial statements from the unadjusted trial balance.
SOLUTIONS
1. (c) The periodicity assumption states that the economic life of a business can be divided into arti�icial time periods. The other choices are incorrect because (a) this statement describes the revenue recognition principle, (b) this statement describes the expense recognition principle, and (d) the periodicity assumption states that the life of a business can be divided into arti�icial time periods, not that the �iscal year and calendar year must coincide.
2. (a) The expense recognition principle dictates that efforts (expenses) be recorded with accomplishments (revenues). The other choices are incorrect because (b) the historical cost principle
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states that when assets are purchased, they should be recorded at cost; (c) the periodicity assumption states that the life of a business can be divided into arti�icial time periods; and (d) the revenue recognition principle states that revenue should be recorded in the period in which the performance obligation is satis�ied.
3. (d) If companies record revenue only when they receive cash and record expense only when they pay out cash, they are using the cash basis of accounting. The other choices are true statements about accrual-basis accounting.
4. (d) Adjusting entries are made to ensure that expenses are recognized in the period in which they are incurred, that revenues are recorded in the period in which the performance obligation is satis�ied, and that balance sheet and income statement accounts have correct balances at the end of an accounting period. Although choices (a), (b), and (c) are correct, choice (d) is the better answer.
5. (d) Unearned expenses are not a major type of adjusting entry. Choices (a) prepaid expenses, (b) accrued revenues, and (c) accrued expenses are all a major type of adjusting entry.
6. (c) The adjusting entry is to debit Supplies Expense for $750 ($1,350−$600) and credit Supplies for $750. The other choices are therefore incorrect.
7. (a) Adjustments for unearned revenues decrease liabilities and increase revenues. The other choices are therefore incorrect.
8. (c) Adjustments for prepaid expenses decrease assets and increase expenses. The other choices are therefore incorrect.
9. (c) The adjusting entry is to debit Depreciation Expense and credit Accumulation Depreciation—Equipment. The other choices are incorrect because (a) the contra asset account title includes the asset being depreciated, not the company name; (b) the credit should be to the contra asset account, not the asset; and (d) the debit should be to Depreciation Expense, not Equipment Expense.
10. (b) When the adjustment is made for accrued revenues, an asset account (usually Accounts Receivable) is increased and a revenue account is increased. The other choices are therefore incorrect.
11. (b) The adjusting entry should be to debit Salaries and Wages Expense $400 and credit Salaries and Wages Payable for $400. Choice (a) is incorrect because if an adjusting entry is not made, the amount of money owed (liability) that is shown on the balance sheet will be understated and the amount of salaries and wages expense will also be understated. Choices (c) and (d) are incorrect because adjusting entries never affect cash.
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12. (c) The adjusted trial balance does list temporary accounts. The other choices are true statements about the adjusted trial balance.
13. (a) Service Revenue will have a zero balance after a company has journalized and posted closing entries. The other choices are incorrect because (b) Supplies is an asset, or permanent account, and will not be closed at the end of the year; (c) Prepaid Insurance is an asset, or permanent account, and will not be closed at the end of the year; and (d) Accumulated Depreciation is a contra asset account. Contra asset accounts are permanent accounts and are not closed at the end of the year.
14. (a) Permanent accounts are the only type of accounts that appear in the post-closing trial balance because they are not closed at the end of the accounting period. Choices (b) and (c) are temporary accounts. Choice (d) is wrong because there is a correct answer.
15. (d) Financial statements are prepared from the adjusted trial balance, not the unadjusted trial balance. The other choices are incorrect because (a) journalizing and posting closing entries, (b) preparing an adjusted trial balance, and (c) preparing a post- closing trial balance are all required steps in the accounting cycle.
PRACTICE EXERCISES
Prepare correct income statement.
(LO 2, 3)
1. The income statement of Bragg Co. for the month of July shows net income of $1,400 based on Service Revenue $5,500, Salaries and Wages Expense $2,300, Supplies Expense $1,200, and Utilities Expense $600. In reviewing the statement, you discover the following.
1. Insurance expired during July of $450 was omitted.
2. Supplies expense includes $300 of supplies that are still on hand at July 31.
3. Depreciation on equipment of $180 was omitted.
4. Accrued but unpaid salaries and wages at July 31 of $400 were not included.
5. Services performed but unrecorded totaled $600.
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INSTRUCTIONS
Prepare a correct income statement for July 2017.
SOLUTION
1.
Journalize and post closing entries, and prepare a postclosing trial balance.
(LO 4)
2. Arapaho Company ended its �iscal year on July 31, 2017. The company's adjusted trial balance as of the end of its �iscal year is as shown below.
INSTRUCTIONS
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(a) Prepare the closing entries.
(b) Post to Retained Earnings and Income Summary T-accounts.
(c) Prepare a post-closing trial balance at July 31, 2017.
SOLUTION
PRACTICE PROBLEM
Prepare adjusting entries from selected data.
(LO 2, 3)
Terry Thomas and a group of investors incorporated the Green Thumb Lawn Care Corporation on April 1. At April 30, the trial balance shows the following balances for
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selected accounts.
Prepaid Insurance $ 3,600 Equipment 28,000 Notes Payable 20,000 Unearned Service Revenue 4,200 Service Revenue 1,800
Analysis reveals the following additional data pertaining to these accounts.
1. Prepaid insurance is the cost of a 2-year insurance policy, effective April 1.
2. Depreciation on the equipment is $500 per month.
3. The note payable is dated April 1. It is a 6-month, 6% note.
4. Seven customers paid for the company's 6-month lawn service package of $600 beginning in April. These customers received the �irst month of services in April.
5. Lawn services performed for other customers but not billed at April 30 totaled $1,500.
INSTRUCTIONS
Prepare the adjusting entries for the month of April. Show computations.
SOLUTION
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WileyPLUS Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.
NOTE: All asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.
QUESTIONS 1. (a) How does the periodicity assumption affect an accountant's analysis of accounting
transactions?
(b) Explain the term �iscal year.
2. Identify and state two generally accepted accounting principles that relate to adjusting the accounts.
3. Max Wilson, a lawyer, accepts a legal engagement in March, performs the work in April, and is paid in May. If Wilson's law �irm prepares monthly �inancial statements, when should it recognize revenue from this engagement? Why?
4. In completing the engagement in Question 3, Wilson pays no costs in March, $2,500 in April, and $2,200 in May (incurred in April). How much expense should the �irm deduct from revenues in the month when it recognizes the revenue? Why?
5. “The historical cost principle of accounting requires adjusting entries.” Do you agree? Explain.
6. Why may the �inancial information in an unadjusted trial balance not be up-to-date and complete?
7. Distinguish between the two categories of adjusting entries, and identify the types of adjustments applicable to each category.
8. What types of accounts does a company debit and credit in a prepaid expense adjusting entry?
9. “Depreciation is a process of valuation that results in the reporting of the fair value of the asset.” Do you agree? Explain.
10. Explain the differences between depreciation expense and accumulated depreciation.
11. Steele Company purchased equipment for $15,000. By the current balance sheet date, the company had depreciated $7,000. Indicate the balance sheet presentation of the data.
12. What types of accounts are debited and credited in an unearned revenue adjusting entry?
13. Abe Technologies provides maintenance service for computers and of�ice equipment for companies throughout the Northeast. The sales manager is elated because she closed a $300,000, 3-year maintenance contract on December 29, 2016, two days before the company's year-end. “Now we will hit this year's net income target for sure,” she crowed. The customer is required to pay $100,000 on December 29 (the day the deal was closed). Two more payments of $100,000
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each are also required on December 29, 2017 and 2018. Discuss the effect that this event will have on the company's �inancial statements.
14. BeneMart, a large national retail chain, is nearing its �iscal year-end. It appears that the company is not going to hit its revenue and net income targets. The company's marketing manager, Ed Mellon, suggests running a promotion selling $50 gift cards for $45. He believes that this would be very popular and would enable the company to meet its targets for revenue and net income. What do you think of this idea?
15. Whistler Corp. performed services for a customer but has not received payment, nor has it recorded any entry related to the work. Which of the following types of accounts are involved in the adjusting entry: (a) asset, (b) liability, (c) revenue, or (d) expense? For the accounts selected, indicate whether they would be debited or credited in the entry.
16. A company fails to recognize an expense incurred but not paid. Indicate which of the following types of accounts is debited and which is credited in the adjusting entry: (a) asset, (b) liability, (c) revenue, or (d) expense.
17. A company makes an accrued revenue adjusting entry for $780 and an accrued expense adjusting entry for $510. How much was net income understated or overstated prior to these entries? Explain.
18. On January 9, a company pays $6,200 for salaries, of which $1,100 was reported as Salaries and Wages Payable on December 31. Give the entry to record the payment.
19. For each of the following items before adjustment, indicate the type of adjusting entry—prepaid expense, unearned revenue, accrued revenue, and accrued expense—that is needed to correct the misstatement. If an item could result in more than one type of adjusting entry, indicate each of the types. (a) Assets are understated.
(b) Liabilities are overstated.
(c) Liabilities are understated.
(d) Expenses are understated.
(e) Assets are overstated.
(f) Revenue is understated.
20. 20. One-half of the adjusting entry is given below. Indicate the account title for the other half of the entry. (a) Salaries and Wages Expense is debited.
(b) Depreciation Expense is debited.
(c) Interest Payable is credited.
(d) Supplies is credited.
(e) Accounts Receivable is debited.
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(f) Unearned Service Revenue is debited.
21. “An adjusting entry may affect more than one balance sheet or income statement account.” Do you agree? Why or why not?
22. Which balance sheet account provides evidence that Apple records sales on an accrual basis rather than a cash basis? Explain.
23. Why is it possible to prepare �inancial statements directly from an adjusted trial balance?
24. (a) What information do accrual-basis �inancial statements provide that cash-basis statements do
not?
(b) What information do cash-basis �inancial statements provide that accrual-basis statements do not?
25. What is the relationship, if any, between the amount shown in the adjusted trial balance column for an account and that account's ledger balance?
26. Identify the account(s) debited and credited in each of the four closing entries, assuming the company has net income for the year.
27. Some companies employ technologies that allow them to do a so-called “virtual close.” This enables them to close their books nearly instantaneously any time during the year. What advantages does a “virtual close” provide?
28. Describe the nature of the Income Summary account, and identify the types of summary data that may be posted to this account.
29. What items are disclosed on a post-closing trial balance. What is its purpose?
30. Which of these accounts would not appear in the post-closing trial balance? Interest Payable, Equipment, Depreciation Expense, Dividends, Unearned Service Revenue, Accumulated Depreciation—Equipment, and Service Revenue.
31. Indicate, in the sequence in which they are made, the three required steps in the accounting cycle that involve journalizing.
32. Identify, in the sequence in which they are prepared, the three trial balances that are required in the accounting cycle.
33. Explain the terms earnings management and quality of earnings.
34. Give examples of how companies manage earnings. What is the purpose of a worksheet?
What is the basic form of a worksheet?
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BRIEF EXERCISES
Identify impact of transactions on cash and net income.
(LO 1), C
BE4-1 Transactions that affect earnings do not necessarily affect cash. Identify the effect, if any, that each of the following transactions would have upon cash and net income. The �irst transaction has been completed as an example.
(a) Purchased $100 of supplies for cash.
(b) Recorded an adjusting entry to record use of $20 of the above supplies.
(c) Made sales of $1,300, all on account.
(d) Received $800 from customers in payment of their accounts.
(e) Purchased equipment for cash, $2,500.
(f) Recorded depreciation of building for period used, $600.
Indicate why adjusting entries are needed.
(LO 1), C
BE4-2 The ledger of Melmann Company includes the following accounts. Explain why each account may require adjustment.
(a) Prepaid Insurance.
(b) Depreciation Expense.
(c) Unearned Service Revenue.
(d) Interest Payable.
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Identify the major types of adjusting entries.
(LO 1), AN
BE4-3 Cortina Company accumulates the following adjustment data at December 31. Indicate (1) the type of adjustment (prepaid expense, accrued revenue, and so on) and (2) the status of the accounts before adjustment (for example, “assets understated and revenues understated”).
(a) Supplies of $400 are on hand. Supplies account shows $1,600 balance.
(b) Services performed but unbilled total $700.
(c) Interest of $300 has accumulated on a note payable.
(d) Rent collected in advance totaling $1,100 has been earned.
Prepare adjusting entry for supplies.
(LO 2), AP
BE4-4 Lahey Advertising Company's trial balance at December 31 shows Supplies $8,800 and Supplies Expense $0. On December 31, there are $1,100 of supplies on hand. Prepare the adjusting entry at December 31 and, using T-accounts, enter the balances in the accounts, post the adjusting entry, and indicate the adjusted balance in each account.
Prepare adjusting entry for depreciation.
(LO 2), AP
BE4-5 At the end of its �irst year, the trial balance of Rayburn Company shows Equipment $22,000 and zero balances in Accumulated Depreciation—Equipment and Depreciation Expense. Depreciation for the year is estimated to be $2,750. Prepare the annual adjusting entry for depreciation at December 31, post the adjustments to T-accounts, and indicate the balance sheet presentation of the equipment at December 31.
Prepare adjusting entry for prepaid expense.
(LO 2), AP
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BE4-6 On July 1, 2017, Ling Co. pays $12,400 to Marsh Insurance Co. for a 2-year insurance contract. Both companies have �iscal years ending December 31. For Ling Co., journalize and post the entry on July 1 and the annual adjusting entry on December 31.
Prepare adjusting entry for unearned revenue.
(LO 2), AP
BE4-7 Using the data in BE4-6, journalize and post the entry on July 1 and the adjusting entry on December 31 for Marsh Insurance Co. Marsh uses the accounts Unearned Service Revenue and Service Revenue.
Prepare adjusting entries for accruals.
(LO 3), AP
BE4-8 The bookkeeper for Tran Company asks you to prepare the following accrual adjusting entries at December 31. Use these account titles: Service Revenue, Accounts Receivable, Interest Expense, Interest Payable, Salaries and Wages Expense, and Salaries and Wages Payable.
(a) Interest on notes payable of $300 is accrued.
(b) Services performed but unbilled totals $1,700.
(c) Salaries of $780 earned by employees have not been recorded.
Analyze accounts in an adjusted trial balance.
(LO 4), AN
BE4-9 The trial balance of Woods Company includes the following balance sheet accounts. Identify the accounts that might require adjustment. For each account that requires adjustment, indicate (1) the type of adjusting entry (prepaid expense, unearned revenue, accrued revenue, and accrued expense) and (2) the related account in the adjusting entry.
(a) Accounts Receivable.
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(b) Prepaid Insurance.
(c) Equipment.
(d) Accumulated Depreciation—Equipment.
(e) Notes Payable.
(f) Interest Payable.
(g) Unearned Service Revenue.
Prepare an income statement from an adjusted trial balance.
(LO 4), AP
BE4-10 The adjusted trial balance of Levin Corporation at December 31, 2017, includes the following accounts: Retained Earnings $17,200, Dividends $6,000, Service Revenue $32,000, Salaries and Wages Expense $14,000, Insurance Expense $1,800, Rent Expense $3,900, Supplies Expense $1,500, and Depreciation Expense $1,000. Prepare an income statement for the year.
Prepare a retained earnings statement from an adjusted trial balance.
(LO 4), AP
BE4-11 Partial adjusted trial balance data for Levin Corporation are presented in BE4-10. The balance in Retained Earnings is the balance as of January 1. Prepare a retained earnings statement for the year assuming net income is $10,400.
Identify �inancial statement for selected accounts.
(LO 4), K
BE4-12 The following selected accounts appear in the adjusted trial balance for Deane Company. Indicate the �inancial statement on which each account would be reported.
(a) Accumulated Depreciation.
(b) Depreciation Expense.
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(c) Retained Earnings (beginning).
(d) Dividends.
(e) Service Revenue.
(f) Supplies.
(g) Accounts Payable.
Identify post-closing trial balance accounts.
(LO 4), K
BE4-13 Using the data in BE4-12, identify the accounts that would be included in a post-closing trial balance.
Prepare and post closing entries.
(LO 4), AP
BE4-14 The income statement for the Bonita Pines Golf Club Inc. for the month ended July 31 shows Service Revenue $16,000, Salaries and Wages Expense $8,400, Maintenance and Repairs Expense $2,500, and Income Tax Expense $1,000. The statement of retained earnings shows an opening balance for Retained Earnings of $20,000 and Dividends $1,300.
(a) Prepare closing journal entries.
(b) What is the ending balance in Retained Earnings?
List required steps in the accounting cycle sequence.
(LO 4), K
BE4-15 The required steps in the accounting cycle are listed in random order below. List the steps in proper sequence.
(a) Prepare a post-closing trial balance.
(b) Prepare an adjusted trial balance.
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(c) Analyze business transactions.
(d) Prepare a trial balance.
(e) Journalize the transactions.
(f) Journalize and post closing entries.
(g) Prepare �inancial statements.
(h) Journalize and post adjusting entries.
(i) Post to ledger accounts.
DO IT! EXERCISES
Identify timing concepts.
(LO 1), C
DO IT! 4-1 A list of concepts is provided below in the left column, with descriptions of the concepts in the right column. There are more descriptions provided than concepts. Match the description to the concept.
1. _______ Cash-basis accounting.
2. _______ Fiscal year.
3. _______ Revenue recognition principle.
4. _______ Expense recognition principle.
(a) Monthly and quarterly time periods.
(b) Accountants divide the economic life of a business into arti�icial time periods.
(c) Efforts (expenses) should be matched with accomplishments (revenues).
(d) Companies record revenues when they receive cash and record expenses when they pay out cash.
(e) An accounting time period that is one year in length.
(f) An accounting time period that starts on January 1 and ends on December 31.
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(g) Companies record transactions in the period in which the events occur.
(h) Recognize revenue in the accounting period in which a performance obligation is satis�ied.
Prepare adjusting entries for deferrals.
(LO 2), AP
DO IT! 4-2 The ledger of Umatilla, Inc. on March 31, 2017, includes the following selected accounts before adjusting entries.
Debit Credit Supplies 2,500 Prepaid Insurance 2,400 Equipment 30,000 Unearned Service Revenue 10,000
An analysis of the accounts shows the following.
1. Insurance expires at the rate of $300 per month.
2. Supplies on hand total $900.
3. The equipment depreciates $200 per month.
4. During March, services were performed for two-�ifths of the unearned service revenue.
Prepare the adjusting entries for the month of March.
Prepare adjusting entries for accruals.
(LO 3), AP
DO IT! 4-3 Jean Karns is the new owner of Jean's Computer Services. At the end of July 2017, her �irst month of ownership, Jean is trying to prepare monthly �inancial statements. She has the following information for the month.
1. At July 31, Jean owed employees $1,100 in salaries that the company will pay in August.
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2. On July 1, Jean borrowed $20,000 from a local bank on a 10-year note. The annual interest rate is 9%.
3. Service revenue unrecorded in July totaled $1,600.
Prepare the adjusting entries needed at July 31, 2017.
Prepare �inancial statements from adjusted trial balance.
(LO 4), C
DO IT! 4-4a Indicate in which �inancial statement each of the following adjusted trial balance accounts would be presented.
Service Revenue Accounts Receivable Notes Payable Accumulated Depreciation Common Stock Utilities Expense
Prepare closing entries.
(LO 4), AP
DO IT! 4-4b Paloma Company shows the following balances in selected accounts of its adjusted trial balance.
Supplies $32,000 Service Revenue $108,000 Supplies Expense 6,000 Salaries and Wages Expense 40,000 Accounts Receivable 12,000 Utilities Expense 8,000 Dividends 22,000 Rent Expense 18,000 Retained Earnings 70,000
Prepare the remaining closing entries at December 31.
EXERCISES
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Identify point of revenue recognition.
(LO 1), C
E4-1 The following independent situations require professional judgment for determining when to recognize revenue from the transactions.
(a) Southwest Airlines sells you an advance-purchase airline ticket in September for your �light home in December.
(b) Ultimate Electronics sells you a home theater on a “no money down and full payment in three months” promotional deal.
(c) The Toronto Blue Jays sell season tickets online to games in the Skydome. Fans can purchase the tickets at any time, although the season doesn't of�icially begin until April. The major league baseball season runs from April through October.
(d) RBC Financial Group loans money on August 1. The loan and the interest are repayable in full in November.
(e) In August, you order a sweater from Sears using its online catalog. The sweater arrives in September, which you charged to your Sears credit card. You receive and pay the Sears bill in October.
Instructions
Identify when revenue should be recognized in each of the above situations.
Identify accounting assumptions, principles, and constraint.
(LO 1), K
E4-2 These accounting concepts were discussed in this and previous chapters.
1. Economic entity assumption.
2. Expense recognition principle.
3. Monetary unit assumption.
4. Periodicity assumption.
5. Historical cost principle.
6. Materiality.
7. Full disclosure principle.
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8. Going concern assumption.
9. Revenue recognition principle.
10. Cost constraint.
Instructions
Identify by number the accounting concept that describes each situation below. Do not use a number more than once.
______ (a) Is the rationale for why plant assets are not reported at liquidation value. (Do not use the historical cost principle.)
______ (b) Indicates that personal and business recordkeeping should be separately maintained.
______ (c) Ensures that all relevant �inancial information is reported.
______ (d) Assumes that the dollar is the “measuring stick” used to report on �inancial performance.
______ (e) Requires that accounting standards be followed for all items of signi�icant size.
______ (f) Separates �inancial information into time periods for reporting purposes.
______ (g) Requires recognition of expenses in the same period as related revenues.
______ (h) Indicates that fair value changes subsequent to purchase are not recorded in the accounts.
Identify the violated assumption, principle, or constraint.
(LO 1), C
E4-3 Here are some accounting reporting situations.
(a) East Lake Company recognizes revenue at the end of the production cycle but before sale. The price of the product, as well as the amount that can be sold, is not certain.
(b) Hilo Company is in its �ifth year of operation and has yet to issue �inancial statements. (Do not use the full disclosure principle.)
(c) Gomez, Inc. is carrying inventory at its original cost of $100,000. Inventory has a fair value of $110,000.
(d) Bly Hospital Supply Corporation reports only current assets and current liabilities on its balance sheet. Equipment and bonds payable are reported as current assets and current liabilities, respectively. Liquidation of the company is unlikely.
(e) Chieu Company has inventory on hand that cost $400,000. Chieu reports inventory on its balance sheet at its current fair value of $425,000.
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(f) Toxy Syles, president of Classic Music Company, bought a computer for her personal use. She paid for the computer by using company funds and debited the “Computers” account.
Instructions
For each situation, list the assumption, principle, or constraint that has been violated, if any. (Some were presented in earlier chapters.) List only one answer for each situation.
Convert earnings from cash to accrual basis.
(LO 1, 2, 3), AP
E4-4 Your examination of the records of a company that follows the cash basis of accounting tells you that the company's reported cash-basis earnings in 2017 are $33,640. If this �irm had followed accrual-basis accounting practices, it would have reported the following year-end balances.
2017 2016 Accounts receivable $3,400 $2,800 Supplies on hand 1,300 1,460 Unpaid wages owed 2,000 2,400 Other unpaid expenses 1,400 1,100
Instructions
Determine the company's net earnings on an accrual basis for 2017. Show all your calculations in an orderly fashion.
Determine cash-basis and accrual-basis earnings.
(LO 1), AP
E4-5 In its �irst year of operations, Gomes Company recognized $28,000 in service revenue, $6,000 of which was on account and still outstanding at year-end. The remaining $22,000 was received in cash from customers.
The company incurred operating expenses of $15,800. Of these expenses, $12,000 were paid in cash; $3,800 was still owed on account at year-end. In addition, Gomes prepaid $2,400 for insurance coverage that would not be used until the second year of operations.
Instructions
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(a) Calculate the �irst year's net earnings under the cash basis of accounting, and calculate the �irst year's net earnings under the accrual basis of accounting.
(b) Which basis of accounting (cash or accrual) provides more useful information for decision-makers?
Convert earnings from cash to accrual basis; prepare accrual-based �inancial statements.
(LO 1, 2, 3), AP
E4-6 Franken Company, a ski tuning and repair shop, opened on November 1, 2016. The company carefully kept track of all its cash receipts and cash payments. The following information is available at the end of the ski season, April 30, 2017.
Cash Receipts Cash Payments Issuance of common shares $20,000 Payment to purchase repair shop equipment $ 9,200 Payments to landlord 1,225 Newspaper advertising payment 375 Utility bill payments 970 Part-time helper's wage payments 2,600 Income tax payment 10,000 Cash receipts from ski and snowboard repair services 32,150
Subtotals 52,150 24,370 Cash balance 27,780
Totals $52,150 $52,150
The repair shop equipment was purchased on November 1 and has an estimated useful life of 4 years. Lease payments to the landlord are made at the beginning of each month. The amount of the payments to the landlord shown above includes a one-time security deposit of $175. The part-time helper is owed $420 at April 30, 2017, for unpaid wages. At April 30, 2017, customers owe Franken Company $540 for services they have received but have not yet paid for.
Instructions (a) Prepare an accrual-basis income statement for the 6 months ended April 30, 2017.
(b) Prepare the April 30, 2017, classi�ied balance sheet.
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Identify differences between cash and accrual accounting.
(LO 1, 2, 3), C
E4-7 BizCon, a consulting �irm, has just completed its �irst year of operations. The company's sales growth was explosive. To encourage clients to hire its services, BizCon offered 180-day �inancing—meaning its largest customers do not pay for nearly 6 months. Because BizCon is a new company, its equipment suppliers insist on being paid cash on delivery. Also, it had to pay up front for 2 years of insurance. At the end of the year, BizCon owed employees for one full month of salaries, but due to a cash shortfall, it promised to pay them the �irst week of next year.
Instructions (a) Explain how cash and accrual accounting would differ for each of the events listed above and describe
the proper accrual accounting.
(b) Assume that at the end of the year, BizCon reported a favorable net income, yet the company's management is concerned because the company is very short of cash. Explain how BizCon could have positive net income and yet run out of cash.
Identify types of adjustments and accounts before adjustment.
(LO 1, 2, 3), AN
E4-8 Wang Company accumulates the following adjustment data at December 31.
(a) Services performed but unbilled total $600.
(b) Store supplies of $160 are on hand. The supplies account shows a $1,900 balance.
(c) Utility expenses of $275 are unpaid.
(d) Services performed of $490 collected in advance.
(e) Salaries of $620 are unpaid.
(f) Prepaid insurance totaling $400 has expired.
Instructions
For each item, indicate (1) the type of adjustment (prepaid expense, unearned revenue, accrued revenue, or accrued expense) and (2) the status of the accounts before adjustment (overstated or understated).
Prepare adjusting entries from selected account data.
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(LO 2, 3), AP
E4-9 The ledger of Howard Rental Agency on March 31 of the current year includes the selected accounts below before adjusting entries have been prepared.
Debit Credit
Supplies $ 3,000 Prepaid Insurance 3,600 Equipment 25,000 Accumulated Depreciation—Equipment $ 8,400 Notes Payable 20,000 Unearned Rent Revenue 12,400 Rent Revenue 60,000 Interest Expense 0 Salaries and Wages Expense 14,000
An analysis of the accounts shows the following.
1. The equipment depreciates $280 per month.
2. Half of the unearned rent revenue was earned during the quarter.
3. Interest of $400 is accrued on the notes payable.
4. Supplies on hand total $850.
5. Insurance expires at the rate of $400 per month.
Instructions
Prepare the adjusting entries at March 31, assuming that adjusting entries are made quarterly. Additional accounts are Depreciation Expense, Insurance Expense, Interest Payable, and Supplies Expense.
Prepare adjusting entries.
(LO 2, 3), AP
E4-10 Al Medina, D.D.S., opened an incorporated dental practice on January 1, 2017. During the �irst month of operations, the following transactions occurred.
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1. Performed services for patients who had dental plan insurance. At January 31, $760 of such services was completed but not yet billed to the insurance companies.
2. Utility expenses incurred but not paid prior to January 31 totaled $450.
3. Purchased dental equipment on January 1 for $80,000, paying $20,000 in cash and signing a $60,000, 3-year note payable (interest is paid each December 31). The equipment depreciates $400 per month. Interest is $500 per month.
4. Purchased a 1-year malpractice insurance policy on January 1 for $24,000.
5. Purchased $1,750 of dental supplies (recorded as increase to Supplies). On January 31, determined that $550 of supplies were on hand.
Instructions
Prepare the adjusting entries on January 31. Account titles are Accumulated Depreciation—Equipment, Depreciation Expense, Service Revenue, Accounts Receivable, Insurance Expense, Interest Expense, Interest Payable, Prepaid Insurance, Supplies, Supplies Expense, Utilities Expense, and Accounts Payable.
Prepare adjusting entries.
(LO 2, 3), AP
E4-11 The unadjusted trial balance for Sierra Corp. is shown in Illustration 4-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo1#c04-�ig-0004) (page 155). Instead of the adjusting entries shown in the text at October 31, assume the following adjustment data.
1. Supplies on hand at October 31 total $500.
2. Expired insurance for the month is $100.
3. Depreciation for the month is $75.
4. As of October 31, services worth $800 related to the previously recorded unearned revenue had been performed.
5. Services performed but unbilled (and no receivable has been recorded) at October 31 are $280.
6. Interest expense accrued at October 31 is $70.
7. Accrued salaries at October 31 are $1,400.
Instructions
Prepare the adjusting entries for the items above.
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Prepare adjusting entries from selected account data.
(LO 2, 3), AP
E4-12 The ledger of Armour Lake Lumber Supply on July 31, 2017, includes the selected accounts below before adjusting entries have been prepared.
Debit Credit
Investment in Note Receivable $ 20,000 Supplies 24,000 Prepaid Rent 3,600 Buildings 250,000 Accumulated Depreciation—Buildings $140,000 Unearned Service Revenue 11,500
An analysis of the company's accounts shows the following.
1. The investment in the notes receivable earns interest at a rate of 6% per year.
2. Supplies on hand at the end of the month totaled $18,600.
3. The balance in Prepaid Rent represents 4 months of rent costs.
4. Employees were owed $3,100 related to unpaid salaries and wages.
5. Depreciation on buildings is $6,000 per year.
6. During the month, the company satis�ied obligations worth $4,700 related to the Unearned Services Revenue.
7. Unpaid maintenance and repairs costs were $2,300.
Instructions
Prepare the adjusting entries at July 31 assuming that adjusting entries are made monthly. Use additional accounts as needed.
Prepare a correct income statement.
(LO 1, 2, 3), AN
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E4-13 The income statement of Norski Co. for the month of July shows net income of $2,000 based on Service Revenue $5,500, Salaries and Wages Expense $2,100, Supplies Expense $900, and Utilities Expense $500. In reviewing the statement, you discover the following:
1. Insurance expired during July of $350 was omitted.
2. Supplies expense includes $200 of supplies that are still on hand at July 31.
3. Depreciation on equipment of $150 was omitted.
4. Accrued but unpaid wages at July 31 of $360 were not included.
5. Services performed but unrecorded totaled $700.
Instructions
Prepare a correct income statement for July 2017.
Journalize basic transactions and adjusting entries.
(LO 2, 3), AN
E4-14 Selected accounts of Villa Company are shown here.
Instructions
After analyzing the accounts, journalize (a) the July transactions and (b) the adjusting entries that were made on July 31. (Hint: July transactions were for cash.)
Analyze adjusted data.
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(LO 1, 2, 3), AN
E4-15 This is a partial adjusted trial balance of Ramon Company.
Instructions
Answer these questions, assuming the year begins January 1.
(a) If the amount in Supplies Expense is the January 31 adjusting entry and $300 of supplies was purchased in January, what was the balance in Supplies on January 1?
(b) If the amount in Insurance Expense is the January 31 adjusting entry and the original insurance premium was for 1 year, what was the total premium and when was the policy purchased?
(c) If $2,500 of salaries was paid in January, what was the balance in Salaries and Wages Payable at December 31, 2016?
(d) If $1,800 was received in January for services performed in January, what was the balance in Unearned Service Revenue at December 31, 2016?
Determine effect of adjusting entries.
(LO 2, 3), AN
E4-16 On December 31, 2017, Waters Company prepared an income statement and balance sheet, but failed to take into account three adjusting entries. The balance sheet showed total assets $150,000, total liabilities $70,000, and stockholders' equity $80,000. The incorrect income statement showed net income of $70,000.
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The data for the three adjusting entries were:
1. Salaries and wages amounting to $10,000 for the last 2 days in December were not paid and not recorded. The next payroll will be in January.
2. Rent payments of $8,000 was received for two months in advance on December 1. The entire amount was credited to Unearned Rent Revenue when paid.
3. Depreciation expense for 2017 is $9,000.
Instructions
Complete the following table to correct the �inancial statement amounts shown (indicate deductions with parentheses).
Prepare and post transaction and adjusting entries for prepayments.
(LO 2, 3), AP
E4-17 Action Quest Games Inc. adjusts its accounts annually. The following information is available for the year ended December 31, 2017.
1. Purchased a 1-year insurance policy on June 1 for $1,800 cash.
2. Paid $6,500 on August 31 for 5 months' rent in advance.
3. On September 4, received $3,600 cash in advance from a corporation to sponsor a game each month for a total of 9 months for the most improved students at a local school.
4. Signed a contract for cleaning services starting December 1 for $1,000 per month. Paid for the �irst 2 months on November 30. (Hint: Use the account Prepaid Cleaning to record prepayments.)
5. On December 5, received $1,500 in advance from a gaming club. Determined that on December 31, $475 of these games had not yet been played.
Instructions (a) For each of the above transactions, prepare the journal entry to record the initial transaction.
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(b) For each of the above transactions, prepare the adjusting journal entry that is required on December 31. (Hint: Use the account Service Revenue for item 3 and Repairs and Maintenance Expense for item 4.)
(c) Post the journal entries in parts (a) and (b) to T-accounts and determine the �inal balance in each account balance. (Note: Posting to the Cash account is not required.)
Prepare adjusting and subsequent entries for accruals.
(LO 2, 3), AP
E4-18 Greenock Limited has the following information available for accruals for the year ended December 31, 2017. The company adjusts its accounts annually.
1. The December utility bill for $425 was unrecorded on December 31. Greenock paid the bill on January 11.
2. Greenock is open 7 days a week and employees are paid a total of $3,500 every Monday for a 7- day (Monday–Sunday) workweek. December 31 is a Thursday, so employees will have worked 4 days (Monday, December 28–Thursday, December 31) that they have not been paid for by year- end. Employees will be paid next on January 4.
3. Greenock signed a $45,000, 5% bank loan on November 1, 2016, due in 2 years. Interest is payable on the �irst day of each following month.
4. Greenock receives a fee from Pizza Shop next door for all pizzas sold to customers using Greenock's facility. The amount owed for December is $300, which Pizza Shop will pay on January 4. (Hint: Use the Service Revenue account.)
5. Greenock rented some of its unused warehouse space to a client for $6,000 a month, payable the �irst day of the following month. It received the rent for the month of December on January 2.
Instructions (a) For each situation, prepare the adjusting entry required at December 31. (Round all calculations to the
nearest dollar.)
(b) For each situation, prepare the journal entry to record the subsequent cash transaction in 2018.
Prepare closing entries.
(LO 4), AP
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E4-19 A partial adjusted trial balance for Ramon Company is given in E4-15.
Instructions
Prepare the closing entries at January 31, 2017.
Prepare closing entries.
(LO 4), AP
E4-20 Selected year-end account balances from the adjusted trial balance as of December 31, 2017, for Tippy Corporation is provided below.
Instructions (a) Prepare closing entries
(b) Determine the post-closing balance in Retained Earnings.
Prepare adjusting entries from analysis of trial balance.
(LO 2, 3, 4), AN
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E4-21 The trial balances shown below are before and after adjustment for Ryan Company at the end of its �iscal year.
Instructions
Prepare the adjusting entries that were made.
Prepare �inancial statements from adjusted trial balance.
(LO 4), AP
E4-22 The adjusted trial balance for Ryan Company is given in E4-21.
Instructions
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Prepare the income and retained earnings statements for the year and the classi�ied balance sheet at August 31.
Prepare closing entries.
(LO 4), AP
E4-23 The adjusted trial balance for Ryan Company is given in E4-21.
Instructions
Prepare the closing entries for the temporary accounts at August 31.
EXERCISES: SET B AND CHALLENGE EXERCISES Visit the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Exercises: Set B and Challenge Exercises.
PROBLEMS: SET A
Record transactions on accrual basis; convert revenue to cash receipts.
(LO 1, 2, 3), AP
P4-1A The following selected data are taken from the comparative �inancial statements of Yankee Curling Club. The club prepares its �inancial statements using the accrual basis of accounting.
September 30 2017 2016 Accounts receivable for member dues $ 15,000 $ 19,000 Unearned sales revenue 20,000 23,000 Service revenue (from member dues) 151,000 135,000
Dues are billed to members based upon their use of the club's facilities. Unearned sales revenues arise from the sale of tickets to events, such as the Skins Game.
Instructions
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(Hint: You will �ind it helpful to use T-accounts to analyze the following data. You must analyze these data sequentially, as missing information must �irst be deduced before moving on. Post your journal entries as you progress, rather than waiting until the end.)
(a) Prepare journal entries for each of the following events that took place during 2017.
1. Dues receivable from members from 2016 were all collected during 2017.
2. During 2017, goods were provided for all of the unearned sales revenue at the end of 2016.
3. Additional tickets were sold for $44,000 cash during 2017; a portion of these were used by the purchasers during the year. The entire balance remaining in Unearned Sales Revenue relates to the upcoming Skins Game in 2017.
4. Dues for the 2016–2017 �iscal year were billed to members.
5. Dues receivable for 2017 (i.e., those billed in item 4 above) were partially collected.
(b) Determine the amount of cash received by Yankee from the above transactions during the year ended September 30, 2017.
(b) Cash received $199,000
Prepare adjusting entries, post to ledger accounts, and prepare adjusted trial balance.
(LO 2, 3, 4), AP
P4-2A Len Kumar started his own consulting �irm, Kumar Consulting, on June 1, 2017. The trial balance at June 30 is as follows.
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In addition to those accounts listed on the trial balance, the chart of accounts for Kumar also contains the following accounts: Accumulated Depreciation—Equipment, Salaries and Wages Payable, Depreciation Expense, Insurance Expense, Utilities Expense, and Supplies Expense.
Other data:
1. Supplies on hand at June 30 total $720.
2. A utility bill for $180 has not been recorded and will not be paid until next month.
3. The insurance policy is for a year.
4. Services were performed for $4,100 of unearned service revenue by the end of the month.
5. Salaries of $1,250 are accrued at June 30.
6. The equipment has a 5-year life with no salvage value and is being depreciated at $250 per month for 60 months.
7. Invoices representing $3,900 of services performed during the month have not been recorded as of June 30.
Instructions (a) Prepare the adjusting entries for the month of June.
(b) Post the adjusting entries to the ledger accounts. Enter the totals from the trial balance as beginning account balances. (Use T-accounts.)
(c) Prepare an adjusted trial balance at June 30, 2017.
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(b) Service rev. $16,300 (c) Tot. trial balance $45,310
Prepare adjusting entries, adjusted trial balance, and �inancial statements.
(LO 2, 3, 4), AP
P4-3A The Moto Hotel opened for business on May 1, 2017. Here is its trial balance before adjustment on May 31.
Other data:
1. Insurance expires at the rate of $450 per month.
2. A count of supplies shows $1,050 of unused supplies on May 31.
3. Annual depreciation is $3,600 on the building and $3,000 on equipment.
4. The mortgage interest rate is 6%. (The mortgage was taken out on May 1.)
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5. Unearned rent of $2,500 has been earned.
6. Salaries of $900 are accrued and unpaid at May 31.
Instructions (a) Journalize the adjusting entries on May 31.
(b) Prepare a ledger using T-accounts. Enter the trial balance amounts and post the adjusting entries.
(c) Prepare an adjusted trial balance on May 31.
(d) Prepare an income statement and a retained earnings statement for the month of May and a classi�ied balance sheet at May 31.
(e) Identify which accounts should be closed on May 31.
(c) Rent revenue $11,500 Tot. adj. trial balance $114,630 (d) Net income $3,570
Prepare adjusting entries and �inancial statements; identify accounts to be closed.
(LO 2, 3, 4), AP
P4-4A Salt Creek Golf Inc. was organized on July 1, 2017. Quarterly �inancial statements are prepared. The trial balance and adjusted trial balance on September 30 are shown on page 203.
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Instructions (a) Journalize the adjusting entries that were made.
(b) Prepare an income statement and a retained earnings statement for the 3 months ending September 30 and a classi�ied balance sheet at September 30.
(c) Identify which accounts should be closed on September 30.
(d) If the note bears interest at 12%, how many months has it been outstanding?
(b) Net income $2,510 Tot. assets $23,430
Prepare adjusting entries.
(LO 2, 3), AP
P4-5A A review of the ledger of Lewis Company at December 31, 2017, produces these data pertaining to the preparation of annual adjusting entries.
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2. Rent revenue $84,000
1. Prepaid Insurance $15,200. The company has separate insurance policies on its buildings and its motor vehicles. Policy B4564 on the building was purchased on July 1, 2016, for $9,600. The policy has a term of 3 years. Policy A2958 on the vehicles was purchased on January 1, 2017, for $7,200. This policy has a term of 18 months.
2. Unearned Rent Revenue $429,000. The company began subleasing of�ice space in its new building on November 1. At December 31, the company had the following rental contracts that are paid in full for the entire term of the lease.
Date Term (in months) Monthly Rent Number of Leases
Nov. 1 9 $5,000 5
Dec. 1 6 $8,500 4
3. Notes Payable $40,000. This balance consists of a note for 6 months at an annual interest rate of 7%, dated October 1.
4. Salaries and Wages Payable $0. There are eight salaried employees. Salaries are paid every Friday for the current week. Five employees receive a salary of $600 each per week, and three employees earn $700 each per week. Assume December 31 is a Wednesday. Employees do not work weekends. All employees worked the last 3 days of December.
Instructions
Prepare the adjusting entries at December 31, 2017.
Prepare adjusting entries and a corrected income statement.
(LO 2, 3), AN
P4-6A Roadside Travel Court was organized on July 1, 2016, by Betty Johnson. Betty is a good manager but a poor accountant. From the trial balance prepared by a part-time bookkeeper, Betty prepared the following income statement for her fourth quarter, which ended June 30, 2017.
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Betty suspected that something was wrong with the statement because net income had never exceeded $30,000 in any one quarter. Knowing that you are an experienced accountant, she asks you to review the income statement and other data.
You �irst look at the trial balance. In addition to the account balances reported above in the income statement, the trial balance contains the following additional selected balances at June 30, 2017.
Supplies $ 8,200 Prepaid Insurance 14,400 Notes Payable 14,000
You then make inquiries and discover the following.
1. Roadside rental revenues include advanced rental payments received for summer occupancy, in the amount of $57,000.
2. There were $1,800 of supplies on hand at June 30.
3. Prepaid insurance resulted from the payment of a 1-year policy on April 1, 2017.
4. The mail in July 2017 brought the following bills: advertising for the week of June 24, $110; repairs made June 18, $4,450; and utilities for the month of June, $215.
5. Wage expense is $300 per day. At June 30, 4 days' wages have been incurred but not paid.
6. The note payable is a 6% note dated May 1, 2017, and due on July 31, 2017.
7. Income tax of $13,400 for the quarter is due in July but has not yet been recorded.
Instructions (a) Prepare any adjusting journal entries required at June 30, 2017.
(b) Prepare a correct income statement for the quarter ended June 30, 2017.
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(c) Explain to Betty the generally accepted accounting principles that she did not recognize in preparing her income statement and their effect on her results.
(b) Net income $33,285
Journalize transactions and follow through accounting cycle to preparation of �inancial statements.
(LO 2, 3, 4), AP
P4-7A On November 1, 2017, the following were the account balances of Soho Equipment Repair.
During November, the following summary transactions were completed.
Nov. 8 Paid $1,220 for salaries due employees, of which $600 is for November and $620 is for October salaries payable.
10 Received $1,800 cash from customers in payment of account. 12 Received $3,700 cash for services performed in November. 15 Purchased store equipment on account $3,600. 17 Purchased supplies on account $1,300. 20 Paid creditors $2,500 of accounts payable due. 22 Paid November rent $480. 25 Paid salaries $1,000. 27 Performed services on account worth $900 and billed customers. 29 Received $750 from customers for services to be performed in the future.
Adjustment data:
1. Supplies on hand are valued at $1,100.
2. Accrued salaries payable are $480.
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3. Depreciation for the month is $250.
4. Services were performed to satisfy $500 of unearned service revenue.
Instructions (a) Enter the November 1 balances in the ledger accounts. (Use T-accounts.)
(b) Journalize the November transactions.
(c) Post to the ledger accounts. Use Service Revenue, Depreciation Expense, Supplies Expense, Salaries and Wages Expense, and Rent Expense.
(d) Prepare a trial balance at November 30.
(e) Journalize and post adjusting entries.
(f) Prepare an adjusted trial balance.
(g) Prepare an income statement and a retained earnings statement for November and a classi�ied balance sheet at November 30.
(f) Cash $3,840 Tot. adj. trial balance $24,680 (g) Net income $970
PROBLEMS: SET B AND SET C Visit the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Problems: Set B and Set C.
CONTINUING PROBLEM Cookie Creations
(Note: This is a continuation of the Cookie Creations problem from Chapters 1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01#ch01) through 3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch03#ch03) .)
CC4 It is the end of November and Natalie has been in touch with her grandmother. Her grandmother asked Natalie how well things went in her �irst month of business. Natalie, too,
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would like to know if her business has been pro�itable or not during November. Natalie realizes that in order to determine Cookie Creations' income, she must �irst make adjustments.
Go to the book's companion website, www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , to see the completion of this problem.
COMPREHENSIVE ACCOUNTING CYCLE | REVIEW
Complete all steps in accounting cycle.
(LO 2, 3, 4), AP
ACR4-1 Mike Greenberg opened Kleene Window Washing Inc. on July 1, 2017. During July, the following transactions were completed.
July 1 Issued 12,000 shares of common stock for $12,000 cash. 1 Purchased used truck for $8,000, paying $2,000 cash and the balance on account. 3 Purchased cleaning supplies for $900 on account. 5 Paid $1,800 cash on a 1-year insurance policy effective July 1. 12 Billed customers $3,700 for cleaning services performed. 18 Paid $1,000 cash on amount owed on truck and $500 on amount owed on cleaning
supplies. 20 Paid $2,000 cash for employee salaries. 21 Collected $1,600 cash from customers billed on July 12. 25 Billed customers $2,500 for cleaning services performed. 31 Paid $290 for maintenance of the truck during month. 31 Declared and paid $600 cash dividend.
The chart of accounts for Kleene Window Washing contains the following accounts: Cash, Accounts Receivable, Supplies, Prepaid Insurance, Equipment, Accumulated Depreciation— Equipment, Accounts Payable, Salaries and Wages Payable, Common Stock, Retained Earnings, Dividends, Income Summary, Service Revenue, Maintenance and Repairs Expense, Supplies Expense, Depreciation Expense, Insurance Expense, and Salaries and Wages Expense.
Instructions (a) Journalize the July transactions.
(b) Post to the ledger accounts. (Use T-accounts.)
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(c) Prepare a trial balance at July 31.
(d) Journalize the following adjustments.
(1) Services performed but unbilled and uncollected at July 31 were $1,700.
(2) Depreciation on equipment for the month was $180.
(3) One-twelfth of the insurance expired.
(4) A count shows $320 of cleaning supplies on hand at July 31.
(5) Accrued but unpaid employee salaries were $400.
(e) Post adjusting entries to the T-accounts.
(f) Prepare an adjusted trial balance.
(g) Prepare the income statement and a retained earnings statement for July and a classi�ied balance sheet at July 31.
(h) Journalize and post closing entries and complete the closing process.
(i) Prepare a post-closing trial balance at July 31.
(f) Cash $5,410 (g) Tot. assets $21,500
Complete all steps in accounting cycle.
(LO 2, 3, 4), AP
ACR4-2 Lars Linken opened Lars Cleaners on March 1, 2017. During March, the following transactions were completed.
Mar. 1 Issued 10,000 shares of common stock for $15,000 cash. 1 Borrowed $6,000 cash by signing a 6-month, 6%, $6,000 note payable. Interest will
be paid the �irst day of each subsequent month. 1 Purchased used truck for $8,000 cash. 2 Paid $1,500 cash to cover rent from March 1 through May 31. 3 Paid $2,400 cash on a 6-month insurance policy effective March 1.
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6 Purchased cleaning supplies for $2,000 on account. 14 Billed customers $3,700 for cleaning services performed. 18 Paid $500 on amount owed on cleaning supplies. 20 Paid $1,750 cash for employee salaries. 21 Collected $1,600 cash from customers billed on March 14. 28 Billed customers $4,200 for cleaning services performed. 31 Paid $350 for gas and oil used in truck during month (use Maintenance and Repairs
Expense). 31 Declared and paid a $900 cash dividend.
The chart of accounts for Lars Cleaners contains the following accounts: Cash, Accounts Receivable, Supplies, Prepaid Insurance, Prepaid Rent, Equipment, Accumulated Depreciation— Equipment, Accounts Payable, Salaries and Wages Payable, Notes Payable, Interest Payable, Common Stock, Retained Earnings, Dividends, Income Summary, Service Revenue, Maintenance and Repairs Expense, Supplies Expense, Depreciation Expense, Insurance Expense, Salaries and Wages Expense, Rent Expense, and Interest Expense.
Instructions (a) Journalize the March transactions.
(b) Post to the ledger accounts. (Use T-accounts.)
(c) Prepare a trial balance at March 31.
(d) Journalize the following adjustments.
1. Services performed but unbilled and uncollected at March 31 was $200.
2. Depreciation on equipment for the month was $250.
3. One-sixth of the insurance expired.
4. An inventory count shows $280 of cleaning supplies on hand at March 31.
5. Accrued but unpaid employee salaries were $1,080.
6. One month of the prepaid rent has expired.
7. One month of interest expense related to the note payable has accrued and will be paid April 1. (Hint: Use the formula from Illustration 4-18 to compute interest.)
(e) Post adjusting entries to the T-accounts.
(f) Prepare an adjusted trial balance.
(g) Prepare the income statement and a retained earnings statement for March and a classi�ied balance sheet at March 31.
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(h) Journalize and post closing entries and complete the closing process.
(i) Prepare a post-closing trial balance at March 31.
(f) Tot. adj. trial balance $31,960 (g) Tot. assets $24,730
Journalize transactions and follow through accounting cycle to preparation of �inancial statements.
(LO 2, 3, 4), AP
ACR4-3 On August 1, 2017, the following were the account balances of B&B Repair Services.
During August, the following summary transactions were completed.
Aug. 1 Paid $400 cash for advertising in local newspapers. Advertising �lyers will be included with newspapers delivered during August and September.
3 Paid August rent $380. 5 Received $1,200 cash from customers in payment of account. 10 Paid $3,120 for salaries due employees, of which $1,700 is for August and $1,420 is
for July salaries payable. 12 Received $2,800 cash for services performed in August. 15 Purchased store equipment on account $2,000. 20 Paid creditors $2,000 of accounts payable due. 22 Purchased supplies on account $800. 25 Paid $2,900 cash for employees' salaries. 27 Billed customers $3,760 for services performed. 29 Received $780 from customers for services to be performed in the future.
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Adjustment data:
1. A count shows supplies on hand of $960.
2. Accrued but unpaid employees' salaries are $1,540.
3. Depreciation on equipment for the month is $320.
4. Services were performed to satisfy $800 of unearned service revenue.
5. One month's worth of advertising services has been received.
6. One month of interest revenue related to the $4,000 note receivable has accrued. The 4- month note has a 6% annual interest rate. (Hint: Use the formula from Illustration 4- 18 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig- 0018) to compute interest.)
Instructions (a) Enter the August 1 balances in the ledger accounts. (Use T-accounts.)
(b) Journalize the August transactions.
(c) Post to the ledger accounts. B&B's chart of accounts includes Prepaid Advertising, Interest Receivable, Service Revenue, Interest Revenue, Advertising Expense, Depreciation Expense, Supplies Expense, Salaries and Wages Expense, and Rent Expense.
(d) Prepare a trial balance at August 31.
(e) Journalize and post adjusting entries.
(f) Prepare an adjusted trial balance.
(g) Prepare an income statement and a retained earnings statement for August and a classi�ied balance sheet at August 31.
(h) Journalize and post closing entries and complete the closing process.
(i) Prepare a post-closing trial balance at August 31.
(f) Cash $2,020 Tot. adj. trial balance $32,580 (g) Net loss $530
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Record and post transaction, adjusting, and closing journal entries; prepare adjusted trial balance and �inancial statements.
(LO 2, 3, 4), AP
ACR4-4 At June 30, 2017, the end of its most recent �iscal year, Green River Computer Consultants' post-closing trial balance was as follows:
The company underwent a major expansion in July. New staff was hired and more �inancing was obtained. Green River conducted the following transactions during July 2017, and adjusts its accounts monthly.
July 1 Purchased equipment, paying $4,000 cash and signing a 2-year note payable for $20,000. The equipment has a 4-year useful life. The note has a 6% interest rate which is payable on the �irst day of each following month.
2 Issued 20,000 shares of common stock for $50,000 cash. 3 Paid $3,600 cash for a 12-month insurance policy effective July 1. 3 Paid the �irst 2 (July and August 2017) months' rent for an annual lease of of�ice space
for $4,000 per month. 6 Paid $3,800 for supplies. 9 Visited client of�ices and agreed on the terms of a consulting project. Green River will
bill the client, Connor Productions, on the 20th of each month for services performed. 10 Collected $1,200 cash on account from Milani Brothers. This client was billed in June
when Green River performed the service. 13 Performed services for Fitzgerald Enterprises. This client paid $1,120 in advance last
month. All services relating to this payment are now completed. 14 Paid $400 cash for a utility bill. This related to June utilities that were accrued at the
end of June. 16 Met with a new client, Thunder Bay Technologies. Received $12,000 cash in advance
for future services to be performed. 18 Paid semi-monthly salaries for $11,000. 20 Performed services worth $28,000 on account and billed customers.
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20 Received a bill for $2,200 for advertising services received during July. The amount is not due until August 15.
23 Performed the �irst phase of the project for Thunder Bay Technologies. Recognized $10,000 of revenue from the cash advance received July 16.
27 Received $15,000 cash from customers billed on July 20.
Adjustment data:
1. Adjustment of prepaid insurance.
2. Adjustment of prepaid rent.
3. Supplies used, $1,250.
4. Equipment depreciation, $500 per month.
5. Accrual of interest on note payable. (Hint: Use the formula from Illustration 4-18 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch04lo3#c04-�ig-0018) to compute interest.)
6. Salaries for the second half of July, $11,000, to be paid on August 1.
7. Estimated utilities expense for July, $800 (invoice will be received in August).
8. Income tax for July, $1,200, will be paid in August.
The chart of accounts for Green River Computer Consultants contains the following accounts: Cash, Accounts Receivable, Supplies, Prepaid Insurance. Prepaid Rent, Equipment, Accumulated Depreciation—Equipment, Accounts Payable, Notes Payable, Interest Payable, Income Taxes Payable, Salaries and Wages Payable, Unearned Service Revenue, Common Stock, Retained Earnings, Dividends, Income Summary, Service Revenue, Supplies Expense, Depreciation Expense, Insurance Expense, Salaries and Wages Expense, Advertising Expense, Income Tax Expense, Interest Expense, Rent Expense, Supplies Expense, and Utilities Expense.
Instructions (a) Enter the July 1 balances in the ledger accounts. (Use T-accounts.)
(b) Journalize the July transactions.
(c) Post to the ledger accounts.
(d) Prepare a trial balance at July 31.
(e) Journalize and post adjusting entries for the month ending July 31.
(f) Prepare an adjusted trial balance.
(g) Prepare an income statement and a retained earning statement for July and a classi�ied balance sheet at July 31.
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(h) Journalize and post closing entries and complete the closing process.
(i) Prepare a post-closing trial balance at July 31.
(g) Net income $6,770 Tot. assets $99,670
EXPAND YOUR | CRITICAL THINKING
FINANCIAL REPORTING PROBLEM: Apple Inc.
E CT4-1 The �inancial statements of Apple Inc. are presented in Appendix A (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a01#a01) at the end of this textbook.
Instructions (a) Using the consolidated income statement and balance sheet, identify items that may result
in adjusting entries for deferrals.
(b) Using the consolidated income statement, identify two items that may result in adjusting entries for accruals.
(c) What was the amount of depreciation and amortization expense for 2014 and 2013? (You will need to examine the notes to the �inancial statements or the statement of cash �lows.) Where was accumulated depreciation and amortization reported?
(d) What was the cash paid for income taxes during 2014, reported at the bottom of the consolidated statement of cash �lows? What was income tax expense (provision for income taxes) for 2014?
COMPARATIVE ANALYSIS PROBLEM: Columbia Sportswear Company vs. VF Corporation
E CT4-2 The �inancial statements of Columbia Sportswear Company are presented in Appendix B
(http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a02#a02) , following the
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�inancial statements for VF Corporation are presented in Appendix C (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a03#a03) .
Instructions (a) Identify two accounts on Columbia's balance sheet that provide evidence that Columbia uses
accrual accounting. In each case, identify the income statement account that would be affected by the adjustment process.
(b) Identify two accounts on VF's balance sheet that provide evidence that VF uses accrual accounting (different from the two you listed for Columbia). In each case, identify the income statement account that would be affected by the adjustment process.
COMPARATIVE ANALYSIS PROBLEM: Amazon.com, Inc. vs. Wal-Mart Stores, Inc.
E CT4-3 The �inancial statements of Amazon.com, Inc. are presented in Appendix D
(http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a04#a04) . Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a05#a05) .
Instructions (a) Identify two accounts on Amazon's balance sheet that provide evidence that Amazon uses
accrual accounting. In each case, identify the income statement account that would be affected by the adjustment process.
(b) Identify two accounts on Wal-Mart's balance sheet that provide evidence that Wal-Mart uses accrual accounting (different from the two you listed for Amazon). In each case, identify the income statement account that would be affected by the adjustment process.
INTERPRETING FINANCIAL STATEMENTS
E CT4-4 Laser Recording Systems, founded in 1981, produces disks for use in the home market. The following is an excerpt from Laser Recording Systems' �inancial statements (all dollars in thousands).
Instructions
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(a) Can you tell from the discussion whether Laser Recording Systems has prepaid its legal expenses and is now making an adjustment to the asset account Prepaid Legal Expenses, or whether the company is handling the legal expense via an accrued expense adjustment?
(b) Identify each of the adjustments Laser Recording Systems is discussing as one of the four types of possible adjustments discussed in the chapter. How is net income ultimately affected by each of the adjustments?
(c) What journal entry did Laser Recording make to record the accrued interest?
REAL-WORLD FOCUS
E CT4-5 Purpose: To learn about the functions of the Securities and Exchange Commission (SEC).
Address: www.sec.gov/about/whatwedo.shtml, or go to www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel)
Instructions
Use the information in this site to answer the following questions.
(a) What event spurred the creation of the SEC? Why was the SEC created?
(b) What are the �ive divisions of the SEC? Brie�ly describe the purpose of each.
(c) What are the responsibilities of the chief accountant?
DECISION-MAKING ACROSS THE ORGANIZATION
E CT4-6 Abbey Park was organized on April 1, 2016, by Trudy Crawford. Trudy is a good manager but a poor accountant. From the trial balance prepared by a part-time bookkeeper, Trudy prepared the following income statement for the quarter that ended March 31, 2017.
Trudy knew that something was wrong with the statement because net income had never exceeded $20,000 in any one quarter. Knowing that you are an experienced accountant, she
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asks you to review the income statement and other data.
You �irst look at the trial balance. In addition to the account balances reported in the income statement, the ledger contains these selected balances at March 31, 2017.
Supplies $ 4,500 Prepaid Insurance 7,200 Notes Payable 20,000
You then make inquiries and discover the following.
1. Rent revenue includes advanced rentals for summer-month occupancy, $21,000.
2. There were $600 of supplies on hand at March 31.
3. Prepaid insurance resulted from the payment of a 1-year policy on January 1, 2017.
4. The mail on April 1, 2017, brought the following bills: advertising for week of March 24, $110; repairs made March 10, $1,040; and utilities $240.
5. Wage expense totals $290 per day. At March 31, 3 days' wages have been incurred but not paid.
6. The note payable is a 3-month, 7% note dated January 1, 2017.
Instructions
With the class divided into groups, answer the following.
(a) Prepare a correct income statement for the quarter ended March 31, 2017.
(b) Explain to Trudy the generally accepted accounting principles that she did not follow in preparing her income statement and their effect on her results.
COMMUNICATION ACTIVITY
S CT4-7 On numerous occasions, proposals have surfaced to put the federal government on the accrual basis of accounting. This is no small issue because if this basis were used, it would mean that billions in unrecorded liabilities would have to be booked and the federal de�icit would increase substantially.
Instructions (a) What is the difference between accrual-basis accounting and cash-basis accounting?
(b) Comment on why politicians prefer a cash-basis accounting system over an accrual-basis system.
(c) Write a letter to your senators explaining why you think the federal government should adopt the accrual basis of accounting.
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ETHICS CASE
E CT4-8 Wells Company is a pesticide manufacturer. Its sales declined greatly this year due to the passage of legislation outlawing the sale of several of Wells's chemical pesticides. During the coming year, Wells will have environmentally safe and competitive replacement chemicals to replace these discontinued products. Sales in the next year are expected to greatly exceed those of any prior year. Therefore, the decline in this year's sales and pro�its appears to be a one-year aberration.
Even so, the company president believes that a large dip in the current year's pro�its could cause a signi�icant drop in the market price of Wells's stock and make it a takeover target. To avoid this possibility, he urges Tim Allen, controller, to accrue every possible revenue and to defer as many expenses as possible in making this period's year-end adjusting entries. The president says to Tim, “We need the revenues this year, and next year we can easily absorb expenses deferred from this year. We can't let our stock price be hammered down!” Tim didn't get around to recording the adjusting entries until January 17, but he dated the entries December 31 as if they were recorded then. Tim also made every effort to comply with the president's request.
Instructions (a) Who are the stakeholders in this situation?
(b) What are the ethical considerations of the president's request and Tim's dating the adjusting entries December 31?
(c) Can Tim accrue revenues and defer expenses and still be ethical?
ALL ABOUT YOU
AP CT4-9 Companies prepare balance sheets in order to know their �inancial position at a speci�ic point in time. This enables them to make a comparison to their position at previous points in time and gives them a basis for planning for the future. In order to evaluate your �inancial position, you can prepare a personal balance sheet. Assume that you have compiled the following information regarding your �inances. (Hint: Some of the items might not be used in your personal balance sheet.)
Amount owed on student loan balance (long-term) $ 5,000 Balance in checking account 1,200 Certi�icate of deposit (6-month) 3,000 Annual earnings from part-time job 11,300 Automobile 7,000 Balance on automobile loan (current portion) 1,500 Balance on automobile loan (long-term portion) 4,000 Home computer 800 Amount owed to you by younger brother 300 Balance in money market account 1,800
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Annual tuition 6,400 Video and stereo equipment 1,250 Balance owed on credit card (current portion) 150 Balance owed on credit card (long-term portion) 1,650
Instructions
Prepare a personal balance sheet using the format you have learned for a classi�ied balance sheet for a company. For the equity account, use M. Y. Own, Capital.
FASB CODIFICATION ACTIVITY
C CT4-10 If your school has a subscription to the FASB Codi�ication, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following.
Instructions
Access the glossary (“Master Glossary”) to answer the following.
(a) What is the de�inition of revenue?
(b) What is the de�inition of compensation?
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LEARNING OBJECTIVE 6
Compare the procedures for adjusting entries under GAAP and IFRS.
It is often dif�icult for companies to determine in what time period they should report particular revenues and expenses. Both the IASB and FASB are working on a joint project to develop a common conceptual framework that will enable companies to better use the same principles to record transactions consistently over time.
KEY POINTS
Following are the key similarities and differences between GAAP and IFRS as related to accrual accounting.
Similarities
In this chapter, you learned accrual-basis accounting applied under GAAP. Companies applying IFRS also use accrual-basis accounting to ensure that they record transactions that change a company's �inancial statements in the period in which events occur.
Similar to GAAP, cash-basis accounting is not in accordance with IFRS.
IFRS also divides the economic life of companies into arti�icial time periods. Under both GAAP and IFRS, this is referred to as the periodicity assumption.
The general revenue recognition principle required by GAAP that is used in this textbook is similar to that used under IFRS.
Revenue recognition fraud is a major issue in U.S. �inancial reporting. The same situation occurs in other countries, as evidenced by revenue recognition breakdowns at Dutch software company Baan NV, Japanese electronics giant NEC, and Dutch grocer Ahold NV.
Differences
Under IFRS, revaluation (using fair value) of items such as land and buildings is permitted. IFRS allows depreciation based on revaluation of assets, which is not permitted under GAAP.
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The terminology used for revenues and gains, and expenses and losses, differs somewhat between IFRS and GAAP. For example, income under IFRS includes both revenues, which arise during the normal course of operating activities, and gains, which arise from activities outside of the normal sales of goods and services. The term income is not used this way under GAAP. Instead, under GAAP income refers to the net difference between revenues and expenses.
Under IFRS, expenses include both those costs incurred in the normal course of operations as well as losses that are not part of normal operations. This is in contrast to GAAP, which de�ines each separately.
LOOKING TO THE FUTURE
The IASB and FASB are completing a joint project on revenue recognition. The purpose of this project is to develop comprehensive guidance on when to recognize revenue. Presently, the Boards are considering an approach that focuses on changes in assets and liabilities (rather than on earned and realized) as the basis for revenue recognition. It is hoped that this approach will lead to more consistent accounting in this area. For more on this topic, see www.fasb.org/project/revenue_recognition.shtml (http://www.fasb.org/project/revenue_recognition.shtml) .
IFRS Practice IFRS SELF-TEST QUESTIONS
1. IFRS: (a) uses accrual accounting.
(b) uses cash-basis accounting.
(c) allows revenue to be recognized when a customer makes an order.
(d) requires that revenue not be recognized until cash is received.
2. Which of the following statements is false? (a) IFRS employs the periodicity assumption.
(b) IFRS employs accrual accounting.
(c) IFRS requires that revenues and costs must be capable of being measured reliably.
(d) IFRS uses the cash basis of accounting.
3. As a result of the revenue recognition project by the FASB and IASB: (a) revenue recognition places more emphasis on when the performance obligation is satis�ied.
(b) revenue recognition places more emphasis on when revenue is realized.
(c) revenue recognition places more emphasis on when expenses are incurred.
(d) revenue is no longer recorded unless cash has been received.
4. Which of the following is false?
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(a) Under IFRS, the term income describes both revenues and gains.
(b) Under IFRS, the term expenses includes losses.
(c) Under IFRS, companies do not engage in the adjusting process.
(d) Under IFRS, revenue recognition fraud is a major issue.
5. Accrual-basis accounting: (a) is optional under IFRS.
(b) results in companies recording transactions that change a company's �inancial statements in the period in which events occur.
(c) has been eliminated as a result of the IASB/FASB joint project on revenue recognition.
(d) is not consistent with the IASB conceptual framework.
INTERNATIONAL FINANCIAL REPORTING PROBLEM: Louis Vuitton
IFRS4-1 The �inancial statements of Louis Vuitton are presented in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) . Instructions for accessing and using the company's complete annual report, including the notes to its �inancial statements, are also provided in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) .
Instructions
Visit Louis Vuitton's corporate website and answer the following questions from Louis Vuitton's 2014 annual report.
(a) From the notes to the �inancial statements, how does the company determine the amount of revenue to record at the time of a sale?
(b) From the notes to the �inancial statements, how does the company determine the provision for product returns?
(c) Using the consolidated income statement and consolidated statement of �inancial position, identify items that may result in adjusting entries for deferrals.
(d) Using the consolidated income statement, identify two items that may result in adjusting entries for accruals.
Answers to IFRS Self-Test Questions
1. a 2. d 3. a 4. c 5. b