Leading by Example - E-Learning

Transcription

Warren Reeve Duchac
ACCOUNTING
23e
Carl S. Warren
Professor Emeritus of Accounting
University of Georgia, Athens
James M. Reeve
Professor Emeritus of Accounting
University of Tennessee, Knoxville
Jonathan E. Duchac
Professor of Accounting
Wake Forest University
Accounting, 23e
Warren Reeve Duchac
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Student Edition
ISBN 13: 978-0-324-66296-2
ISBN 10: 0-324-66296-3
Instructor Edition
ISBN 13: 978-0-324-66377-8
ISBN 10: 0-324-66377-3
Softbound Chapters 14–26
ISBN 13: 978-0-324-66390-7
ISBN 10: 0-324-66390-0
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1 2 3 4 5 6 7 11 10 09 08
The Author Team
Carl S. Warren
Dr. Carl S. Warren is Professor Emeritus of Accounting at the University of Georgia,
Athens. Dr. Warren has taught classes at the University of Georgia, University of Iowa,
Michigan State University, and University of Chicago. Professor Warren focused his
teaching efforts on principles of accounting and auditing. He received his Ph.D. from
Michigan State University and his B.B.A. and M.A. from the University of Iowa. During
his career, Dr. Warren published numerous articles in professional journals, including
The Accounting Review, Journal of Accounting Research, Journal of Accountancy, The CPA
Journal, and Auditing: A Journal of Practice & Theory. Dr. Warren has served on numerous
committees of the American Accounting Association, the American Institute of Certified
Public Accountants, and the Institute of Internal Auditors. He has also consulted with
numerous companies and public accounting firms. Warren’s outside interests include
playing handball, golfing, skiing, backpacking, and fly-fishing.
James M. Reeve
Dr. James M. Reeve is Professor Emeritus of Accounting and Information Management at
the University of Tennessee. Professor Reeve taught on the accounting faculty for 25
years, after graduating with his Ph.D. from Oklahoma State University. His teaching
effort focused on undergraduate accounting principles and graduate education in the
Master of Accountancy and Senior Executive MBA programs. Beyond this, Professor
Reeve is also very active in the Supply Chain Certification program, which is a major
executive education and research effort of the College. His research interests are varied
and include work in managerial accounting, supply chain management, lean manufacturing, and information management. He has published over 40 articles in academic and
professional journals, including the Journal of Cost Management, Journal of Management
Accounting Research, Accounting Review, Management Accounting Quarterly, Supply Chain
Management Review, and Accounting Horizons. He has consulted or provided training
around the world for a wide variety of organizations, including Boeing, Procter and
Gamble, Norfolk Southern, Hershey Foods, Coca-Cola, and Sony. When not writing
books, Professor Reeve plays golf and is involved in faith-based activities.
Jonathan Duchac
Dr. Jonathan Duchac is the Merrill Lynch and Co. Professor of Accounting and Director of
the Program in Enterprise Risk Management at Wake Forest University. He earned his
Ph.D. in accounting from the University of Georgia and currently teaches introductory and
advanced courses in financial accounting. Dr. Duchac has received a number of awards
during his career, including the Wake Forest University Outstanding Graduate Professor
Award, the T.B. Rose award for Instructional Innovation, and the University of Georgia
Outstanding Teaching Assistant Award. In addition to his teaching responsibilities, Dr.
Duchac has served as Accounting Advisor to Merrill Lynch Equity Research, where he
worked with research analysts in reviewing and evaluating the financial reporting practices of public companies. He has testified before the U.S. House of Representatives, the
Financial Accounting Standards Board, and the Securities and Exchange Commission; and
has worked with a number of major public companies on financial reporting and accounting policy issues. In addition to his professional interests, Dr. Duchac is the Treasurer of
The Special Children’s School of Winston-Salem; a private, nonprofit developmental day
school serving children with special needs. Dr. Duchac is an avid long-distance runner,
mountain biker, and snow skier. His recent events include the Grandfather Mountain
Marathon, the Black Mountain Marathon, the Shut-In Ridge Trail run, and NO MAAM
(Nocturnal Overnight Mountain Bike Assault on Mount Mitchell).
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Leading by Example
For nearly 80 years, Accounting has been used effectively to teach generations of businessmen and women. The text has been used by millions of business students. For
many, this book provides the only exposure to accounting principles that they will ever
receive. As the most successful business textbook of all time, it continues to introduce
students to accounting through a variety of time-tested ways.
The previous edition, 22e, started a new journey into learning more about the
changing needs of accounting students through a variety of new and innovative
research and development methods. Our Blue Sky Workshops brought accounting faculty from all over the country into our book development process in a very direct and
creative way. Many of the features and themes present in this text are a result of the collaboration and countless conversations we’ve had with accounting instructors over the
last several years. 23e continues to build on this philosophy and strives to be reflective
of the suggestions and feedback we receive from instructors and students on an ongoing basis. We’re very happy with the results, and think you’ll be pleased with the
improvements we’ve made to the text.
The original author of Accounting, James McKinsey, could not have imagined the
success and influence this text has enjoyed or that his original vision would continue to
lead the market into the twenty-first century. As the current authors, we appreciate the
responsibility of protecting and enhancing this vision, while continuing to refine it to
meet the changing needs of students and instructors. Always in touch with a tradition
of excellence but never satisfied with yesterday’s success, this edition enthusiastically
embraces a changing environment and continues to proudly lead the way. We sincerely
thank our many colleagues who have helped to make it happen.
“The teaching of accounting is no longer designed to train professional accountants
only. With the growing complexity of business and the constantly increasing difficulty
of the problems of management, it has become essential that everyone who aspires to a
position of responsibility should have a knowledge of the fundamental principles of
accounting.”
— James O. McKinsey, Author, first edition, 1929
iv
Leading by Example
Textbooks continue to play an invaluable role in the teaching and learning
environment. Continuing our focus from previous editions, we reached
out to accounting teachers in an effort to improve the textbook presentation. New for this edition, we have extended our discussions to reach out
to students directly in order to learn what they value in a textbook. Here’s
a preview of some of the improvements we’ve made to this edition based
on student input:
Guiding Principles System
NEW!
Students can easily locate the information they need to master course concepts with the
new “Guiding Principles System (GPS).” At the beginning of every chapter, this innovative system plots a course through the chapter content by displaying the chapter
objectives, major topics, and related Example Exercises. The GPS reference to the chapter “At a Glance” summary completes this proven system.
After studying this chapter, you should be able to:
1
2
Describe the
characteristics of
an account and a
chart of accounts.
Describe and
illustrate
journalizing
transactions
using the doubleentry accounting
system.
3
Using Accounts
to Record
Transactions
Double-Entry
Accounting
System
Chart of
Accounts
Balance Sheet
Accounts
Income
Statement
Accounts
Describe and
illustrate the
journalizing and
posting of
transactions to
accounts.
Posting Journal
Entries to
Accounts
2-3
EE (page 63)
2-4
EE (page
66)
2-5
EE (page 66)
Owner
Withdrawals
4
Prepare an
unadjusted trial
balance and
explain how it
can be used to
discover errors.
Trial Balance
Errors Affecting
the Trial Balance
EE 2-6
(page 70)
Errors Not
Affecting the Trial
Balance
2-7
EE (page
71)
Normal Balances
2-1
EE (page
54)
Journalizing
2-2
EE (page
58)
At a Glance
NEW!
Menu
Turn to pg 72
Written for Today’s Students
Designed for today’s students, the 23rd edition has been extensively revised using an
innovative, high-impact writing style that emphasizes topics in a concise and clearly
written manner. Direct sentences, concise paragraphs, numbered lists, and step-by-step
calculations provide students with an easy-to-follow structure for learning accounting.
This is achieved without sacrificing content or rigor.
v
Leading by Example
NEW!
Mornin’ Joe Financial Statements
Beginning after “Accounting for Merchandising Businesses” and continuing through
Chapter 15, “Investments and Fair Value Accounting,” each chapter contains an excerpt
from the full financial statements for Mornin’ Joe, a coffee company. The addition of this
new example shows students the big picture of accounting by providing a consistent reference point for users who want to see an entire set of financial statements and the way
each chapter topic fits within them. The financial statements were crafted by the authors
to be consistent with the presentation in each chapter.
NEW!
Revised Coverage of Investments
A new chapter on investments and fair value accounting has been written to consolidate coverage of both dept and equity investments. The chapter also contains a conceptual discussion of fair value accounting and its increasing role in defining today’s
modern accounting methods.
NEW!
Modern User-Friendly Design
Based on students’ testimonials of what they find most useful, this streamlined presentation includes a wealth of helpful resources without the clutter. To update the look of the
material, some exhibits use computerized spreadsheets to better reflect the changing environment of business. Visual learners will appreciate the generous number of exhibits and
illustrations used to convey concepts and procedures.
Exhibit 4
Statement
of Owner’s
Equity for
Merchandising
Business
NetSolutions
Statement of Owner’s Equity
For the Year Ended December 31, 2011
$153,800
Chris Clark, capital, January 1, 2011
Net income for the year
Less withdrawals
Increase in owner’s equity
Chris Clark, capital, December 31, 2011
$75,400
18,000
57,400
$211,200
Journal
Date
Description
Page 25
Post.
Ref.
Debit
Credit
2011
Jan.
vi
3
Cash
Sales
To record cash sales.
1,800
1,800
Leading by Example
Chapter Updates and Enhancements
The following includes some of the specific content changes that can be
found in Accounting, 23e.
Chapter 1: Introduction to Accounting and Business
• Starbucks replaces DaimlerChrysler in opening lead-in example.
• Discussion of “types of business organizations” has been moved to later in the chapter.
Proprietorships, partnerships, corporations, and limited liability companies (LLC) are now discussed with the business entity concept.
• “General-purpose financial statements” has been added as a new key term.
• New Exhibit 3 provides guidelines for ethical conduct.
• Discussion on career opportunities for accountants has been updated.
• Improved formatting of transaction discussion for NetSolutions for greater clarity.
• International Accounting Standards Board (IASB) and International Financial Reporting Standards are
now mentioned in the discussion of generally accepted accounting principles.
• New Financial Analysis and Interpretation (FAI) box has been added that introduces the ratio for
liabilities to owner’s equity.
Chapter 2: Analyzing Transactions
• New chapter opener features Apple.
• New section on the double-entry accounting system (Objective 2) provides improved coverage of
the rules of debit and credit for balance sheet, income statement, and owner drawing account. This
discussion includes normal balances of accounts. In addition, Exhibit 3 was revised so that it better
summarizes the rules of debits and credits for students to refer to when working end-of-chapter
homework.
• Discussion of recording transactions in accounts has been streamlined by including the discussion
of the rules of debits and credits earlier in the chapter. Also, a new more simplified format for the
journal and accounts is used.
• Each illustrated transaction now includes the following sections: “Transaction, Analysis, and Journal
Entry.” In addition, new line art design improves the presentation of journal entries and accounts.
• Discussion of discovery and correction of errors has been revised and is now integrated into the discussion of the unadjusted trial balance.
• New FAI feature has been added that discusses horizontal analysis of financial statements.
Chapter 3: The Adjusting Process
• Discussion of the adjusting process has been revised to list the reasons for updating some accounts
in the ledger under accrual accounting.
• A new Exhibit 6 on Summary of Adjustments has been developed to include the reason for each
adjustment, the adjusting entry, example adjusting entries from NetSolutions, and the financial
statement impact if adjusting is omitted.
• New FAI feature has been added that discusses vertical analysis of financial statements.
Chapter 4: Completing the Accounting Cycle
• New spreadsheet format provides row and column labels that are more consistent with Microsoft
Excel to reflect what students will see in practice.
• Integrated all accounts necessary to complete the spreadsheet directly into the spreadsheet rather
than adding them at the bottom of the spreadsheet. As reviewer feedback notes, this is consistent
with using Microsoft Excel where new rows (accounts) can be directly inserted into the spreadsheet
at their appropriate place.
• New acetate for preparing the work sheet (spreadsheet) has been added that separates the individual adjustments from the adjusted trial balance totals.
• Added stepwise approach to preparing the work sheet (spreadsheet).
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Leading by Example
• Added “closing the books” as a key term. Added (permanent) descriptor to real accounts key term.
• New FAI feature covers working capital and the current ratio.
Chapter 5: Accounting Systems
• Added stepwise approach to journalizing and posting transactions to special journal and subsidiary
ledgers.
• Updated QuickBooks illustration to QuickBooks 2008 and tied better (using steps) into the chapter
illustrations of a manual accounting system.
• New FAI feature covers horizontal and vertical analyses as they relate to how accounting systems
can provide analysis of business segments.
Chapter 6: Accounting for Merchandising Businesses
• New chapter opener features Dollar Tree, Inc.
• For added clarity, “transportation” terminology has been changed to “freight.” For example, instead
of transportation costs, we use freight costs or simply freight.
• For added clarity, this edition provides a fuller definition of debit (credit) memorandums. For efficiency, they are usually referenced as just debit memo or credit memo.
• In Appendix 2 (The Periodic Inventory System), “Transportation In” was switched to “Freight In”
for consistency with the chapter presentation.
Chapter 7: Inventories
• Begin financial reporting illustrations using Mornin’ Joe to reinforce the importance of financial
statements to a business and as a framework to learn accounting.
• Significantly revised section on “Effect of Inventory Errors on the Financial Statements.” Added new
Exhibits 9, 10, and 11. The section begins with a list of reasons that inventory errors can occur. Further
illustrations get into the effects on the income statement and balance sheet. Exhibit 9 depicts the
inventory error and whether the effect is understated or overstated in terms of COMS, gross profit,
and net income. Exhibit 10 shows the effects of inventory errors on two years of income statements.
Exhibit 11 shows the ending error and whether it is overstated or understated as it relates to merchandise inventory, current assets, total assets, and owner’s equity (capital).
• Moved the “Estimating Inventory Cost” section from the chapter to an appendix at the end of the
chapter. This section describes and illustrates “retail” and the “gross profit” methods of estimating
inventory. The end-of-chapter materials still include exercises and one problem (A and B) for this
appendix.
Chapter 8: Sarbanes-Oxley, Internal Control,
and Cash
• New illustration and journal entry for “Cash Short and Over” provides a visual presentation to reinforce this concept.
• For added clarity, “Depositor” terminology has change to “Company” in the bank reconciliations.
• Added check numbers to Exhibit 5, illustration of a bank statement. This is done based on user feedback and reflects that most banks do not return checks but simply list the cleared checks (by check
number) on the bank statement.
• Added stepwise illustration of how to prepare the bank statement (see Exhibit 7).
• Used Mornin’ Joe as the financial statement reporting illustration to reinforce the importance of
financial statements to a business and as a framework to learn accounting.
Chapter 9: Receivables
• New chapter opener features Oakley, Inc.
• Illustrations for allowance methods revised to use the same data to facilitate comparisons of the
percent of sales and aging of receivables methods.
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Leading by Example
• New Exhibit 2 comparing percent of sales and aging of receivables methods.
• New illustration of promissory note (Exhibit 4) provides a visual reference to reinforce this concept.
Chapter 10: Fixed Assets and Intangible Assets
• New Exhibit 7, Comparing Depreciation Methods, compares depreciation methods using chapter
illustration.
• Exchanging of similar fixed assets moved to end of chapter appendix (Appendix 2). Related end-ofchapter materials are still included.
Chapter 11: Current Liabilities and Payroll
• Updated federal withholding table and revised chapter illustrations.
• Revised “Contingent Liabilities” section including Exhibit 10.
• Used Mornin’ Joe as the financial statement reporting illustration to reinforce the importance of financial statements to a business and as a framework to learn accounting.
Chapter 12: Accounting for Partnerships and Limited
Liability Companies
• New chapter opener features AgentBlaze, LLC.
• Revised Exhibit 1 to be consistent with chapter discussion using parallel terminology.
• New illustration of a partner not paying capital deficiency in liquidation visually reinforces this concept.
Chapter 13: Corporations: Organization, Stock
Transactions, and Dividends
• New chapter opener features Hasbro, Inc.
• Added discussion of cumulative preferred stock with dividends in arrears.
Chapter 14: Long-Term Liabilities: Bonds and Notes
This chapter was based on Chapter 15 in 22e. Objectives for this chapter are:
•
•
•
•
•
Objective 1: Compute the potential impact of long-term borrowing on earnings per share.
Objective 2: Describe the characteristics and terminology of bonds payable.
Objective 3: Journalize entries for bonds payable.
Objective 4: Describe and illustrate the accounting for installment notes.
Objective 5: Describe and illustrate the reporting of long-term liabilities including bonds and notes
payable.
• A new objective has been added that includes discussion of installment notes.
• Discussion of pricing of bonds using present values moved to Appendix 1 at the end of the chapter.
Related end-of-chapter is still included.
• “Effective Interest Rate Method of Amortization” is now Appendix 2 at the end of the chapter.
Related end-of-chapter is still included.
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Leading by Example
NOTE: Chapter 14 from the prior edition no longer exists. The material from Chapter 14 of 22e has been redistributed as follows:
22e Chapter
Topic
23e Chapter
Chapter
Chapter
Chapter
Chapter
Chapter
Chapter
Chapter
Chapter
Chapter
Deferred Taxes
Reporting Unusual Items on the Income Statement
Earnings Per Common Share
Comprehensive Income
Accounting for Investments in Stocks
Characteristics of Bonds Payable
Payment and Redemption of Bonds Payable
Investments in Bonds
Appendix: Effective Interest Rate Method of Amortization
Appendix D (back of text)
Chapter 17 (FSA Appendix)
Chapters 14, 17
Chapter 15 (Appendix 2)
Chapter 15
Chapter 14
Chapter 14
Chapter 15
Chapter 14
14
14
14
14
14
15
15
15
15
Chapter 15: Investments and Fair Value
Accounting
NEW!
A new chapter on “Investments and Fair Value Accounting” has been written for this
edition, consolidating all investments-related topics into one chapter based on market
feedback. The objectives for this chapter are:
•
•
•
•
•
•
•
•
Objective 1: Describe why companies invest in debt and equity securities.
Objective 2: Describe and illustrate the accounting for debt investments.
Objective 3: Describe and illustrate the accounting for equity investments.
Objective 4: Describe and illustrate valuing and reporting investments in the financial statements.
Objective 5: Describe fair value accounting and its implications for the future.
Chapter opener features News Corporation.
Appendix 1 covers accounting for held-to-maturity investments.
Appendix 2 covers the topic of comprehensive income.
Chapter 16: Statement of Cash Flows
• Revised beginning section discussing the statement of cash flows (SCF) and illustrating the format
for the SCF under the direct and indirect methods.
• Revised beginning discussion of direct method to emphasize conversion of accrual income statement to cash flows from operations (on an item-by-item basis). New graphic for conversion of interest expense to cash payments for interest provides visual reinforcement for this topic.
• Used stepwise format for preparing the statement of cash flows under indirect and direct methods.
• Used stepwise format for preparing the work sheet for the indirect method in the end-of-chapter
appendix.
Chapter 17: Financial Statement Analysis
• New chapter opener features Nike, Inc.
• Real world financial statement analysis problem features data from the Nike, Inc. 2007 10K, which
can be found in Appendix E in the back of the text.
• Each ratio is highlighted in a boxed screen for easier review.
• Appendix on “Unusual Items on the Income Statement” was added.
Chapter 18: Managerial Accounting Concepts
and Principles
• Added a new section at the beginning of the chapter on the uses of managerial accounting, which
references subsequent chapters where the uses are described and illustrated.
• Added an illustration of comparing merchandising and manufacturing income statements.
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Leading by Example
• Added format for the cost of goods manufactured statement.
• Added stepwise preparation of the cost of goods manufactured.
Chapter 19: Job Order Costing
• Added format for the entries used to dispose of overapplied or underapplied factory overhead.
• Changed order of entries so that entries for sales and cost of goods sold are shown separately from
the finished goods entry for completed units.
Chapter 20: Process Cost Systems
• Revised Exhibit 2 and accompanying narrative so that Exhibit 2 ties into Exhibit 8, which illustrates
entries for Frozen Delights.
• Revised illustration of cost of production report so that units are classified into groups consisting of
beginning work in process units (Group 1), started and completed units (Group 2), and ending work
in process units (Group 3). This aids students in computing unit costs and assigning costs to groups
using first-in, first-out inventory cost flow. Accompanying exhibits and art also classify units by
these groups.
• Revised and expanded the section on using the cost of production report for decision making to
include an example from Frozen Delights.
Chapter 21: Cost Behavior and Cost-Volume-Profit
Analysis
•
•
•
•
•
•
•
•
•
Supplemented the mixed cost discussion by adding an equation for determining fixed costs.
Added contribution margin equation to cost-volume-profit discussion.
Added unit contribution margin equation to cost-volume-profit discussion.
Added “change in income from operations” equation based on unit contribution margin to costvolume-profit discussion.
Incorporated a discussion of computing break-even in sales dollars using contribution margin ratio.
Added a stepwise approach to discussion of preparing cost-volume-profit and profit-volume charts.
Added equation for computing the percent change in income from operations using “operating
leverage.”
Expanded discussion of margin of safety so that margin of safety may be expressed in sales dollars,
units, or percent of current sales.
Revised appendix on variable costing to include format for variable costing income statement.
Chapter 22: Budgeting
•
•
•
•
Made minor changes to chapter objectives.
Added stepwise approach to preparing a flexible budget.
Modified the definition of the master budget.
Added new classifications of budget components of the master budget as operating, investing, and
financing budget components.
• Added format for determining “total units to be produced.”
• Added format for determining “direct materials to be purchased.”
Chapter 23: Performance Evaluation Using Variances
from Standard Costs
• Added a 2nd level heading for Objective 1, “Criticisms of Standard Costs.”
• Added several new headings for Objective 2, “Budget Performance Report” and “Manufacturing
Cost Variances.”
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Leading by Example
• Revised discussion of “Manufacturing Cost Variances” to better tie into subsequent discussion of
standard cost variances.
• Utilized a new equation format for computing standard cost variances. Using these equations, a positive amount indicates an unfavorable variance while a negative amount indicates a favorable variance. Later in the chapter, positive variance amounts are recorded as debits and negative variance
amounts are recorded as credits.
• Revised the factory overhead variance discussion to include equations for computing total, variable,
and fixed factory overhead rates. These rates are then used to explain and illustrate the computation
of the controllable factory overhead variance and the volume factory overhead variance.
• Revised the factory overhead variance discussion to use equations for computing the controllable
and volume variances.
• Revised the discussion of how the total factory overhead cost variance is related to overapplied or
underapplied overhead balance. Further explanation is provided to show how the overapplied or
underapplied overhead balance can be separated into the controllable and volume variances.
• Added new key terms for budgeted variable factory overhead, favorable cost variance, unfavorable
cost variance, and standards.
Chapter 24: Performance Evaluation for Decentralized
Operations
• Modified the chapter objectives slightly.
• Added equations for computing service department charge rates.
• Presented equations for allocating service department charges to decentralized operations
(divisions).
• Added example format for determining residual income.
• Added equations for computing increases and decreases in divisional income using different
negotiated transfer prices.
Chapter 25: Differential Analysis and Product Pricing
• Added section on managerial decision making. Objective 1 now includes a new flowchart depicting
the steps that define the decision-making process.
• Added equations (e.g., markup percentages, desired profit) to “Setting Normal Product Selling
Prices” Section.
• Adopted a stepwise approach to setting normal prices for each cost-plus (total, product, variable)
concept.
• Added Exhibit 11 to summarize cost-plus approaches to setting normal prices.
• Added equation to determine “contribution margin per bottleneck constraint.”
• Presented equations for assessing product pricing and cost decisions related to bottlenecks.
• Added equation for determining “activity rate” in Activity-Based Costing appendix.
Chapter 26: Capital Investment Analysis
• Replaced XM Satellite Radio with Carnival Corporation as the opener vignette.
• Revised the learning objectives so that the nonpresent value (average rate of return and cash payback) methods have a separate learning objective from the present value (net present value and
internal rate of return) methods.
• Added an equation for determining the “average investment” for use in the average rate of return
method.
• Added an equation for determining the “cash payback period.”
• Added a graphic for determining the present value of $1 along with additional explanations of present values.
• Added format for using the net present value method that is consistent with that shown in the
solutions manual.
• Added an equation for determining the present value index.
xii
Leading by Example
Accounting, 23e, is unparalleled in pedagogical innovation. Our constant
dialogue with accounting faculty continues to affect how we refine and
improve the text to meet the needs of today’s students. Our goal is to provide
a logical framework and pedagogical system that caters to how students of
today study and learn.
Clear Objectives and Key Learning Outcomes
To help guide students, the authors provide clear chapter objectives and important
learning outcomes. All aspects of the chapter materials relate back to
these key points and outcomes, which keeps students focused on the
Describe the
most important topics and concepts in order to succeed in the course.
nature of a
1
business, the role of
accounting, and
ethics in business.
EX 6-1
Determining gross
profit
obj. 1
During the current year, merchandise is sold for $795,000. The cost of the merchandise
sold is $477,000.
a. What is the amount of the gross profit?
b. Compute the gross profit percentage (gross profit divided by sales).
c.
Will the income statement necessarily report a net income? Explain.
Example Exercises
Example Exercises were developed to reinforce concepts and procedures in a bold, new
way. Like a teacher in the classroom, students follow the authors’ example to see how
to complete accounting applications as they are presented in the text. This feature also
provides a list of Practice Exercises that parallel the Example Exercises so students get
the practice they need. In addition, the Practice Exercises also include references to the
chapter Example Exercises so that students can easily cross-reference when completing
homework.
See the example of the
application being
presented.
Follow along as
the authors
work through
the Example
Exercise.
Example Exercise 2-2
Follow My Example 2-2
June 3
Try these
corresponding
end-of-chapter
exercises for
practice!
2
Journal Entry for Asset Purchase
Prepare a journal entry for the purchase of a truck on June 3 for $42,500, paying $8,500 cash and the
remainder on account.
Truck . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
42,500
8,500
34,000
For Practice: PE 2-2A, PE 2-2B
xiii
Leading by Example
“At a Glance” Chapter Summary
The “At a Glance” summary grid ties everything together and helps students stay on
track. First, the Key Points recap the chapter content for each chapter objective. Second,
the related Key Learning Outcomes list all of the expected student performance capabilities that come from completing each objective. In case students need further practice
on a specific outcome, the last two columns reference related Example Exercises and
their corresponding Practice Exercises. In addition, the “At a Glance” grid guides struggling students from the assignable Practice Exercises to the resources in the chapter that
will help them complete their homework. Through this intuitive grid, all of the chapter
pedagogy links together in one cleanly integrated summary.
1
Describe the nature of the adjusting process.
Key Points
The accrual basis of accounting requires that
revenues are reported in the period in which
they are earned and expenses matched with
the revenues they generate. The updating of accounts at the end of the accounting period is
called the adjusting process. Each adjusting entry affects an income statement and balance
sheet account. The four types of accounts requiring adjusting entries are prepaid expenses,
unearned revenues, accrued revenues, and accrued expenses.
Provides a conceptual
review of each
objective.
Example
Exercises
Practice
Exercises
• List accounts that do and do
NOT require adjusting entries
at the end of the accounting
period.
3-1
3-1A, 3-1B
• Give an example of a prepaid
expense, unearned revenue,
accrued revenue, and accrued
expense.
3-2
3-2A, 3-2B
Key Learning Outcomes
• Explain why accrual accounting
requires adjusting entries.
Creates a checklist of
skills to help review for
a test.
Real-World Chapter
Openers
xiv
H
A
P
T
E
R
Analyzing Transactions
© AP Photo/Paul Sakuma
Building on the strengths of past editions,
these openers continue to relate the
accounting and business concepts in the
chapter to students’ lives. These openers
employ examples of real companies and
provide invaluable insight into real practice.
Several of the openers created especially for
this edition focus on interesting companies
such as Apple; Dollar Tree; Hasbro; and
News Corporation (Fox), the parent company of the hit television shows American Idol
and The Simpsons.
C
Directs the student
to this helpful
feature!
A P P L E,
E
veryday it seems like we get an incredible amount of
incoming e-mail messages; you get them from your
friends, relatives, subscribed e-mail lists, and even spammers! But how do you organize all of these messages? You
might create folders to sort messages by sender, topic, or
project. Perhaps you use keyword search utilities. You
might even use filters/rules to automatically delete spam
or send messages from your best friend to a special folder.
In any case, you are organizing information so that it is simple to retrieve and allows you to understand, respond, or
refer to the messages.
In the same way that you organize your e-mail, companies develop an organized method for processing, recording,
and summarizing financial transactions. For example, Apple,
Inc., has a huge volume of financial transactions, resulting
from sales of its innovative computers, digital media (like
iPod music and video players), and iPhone mobile phones.
When Apple sells an iPhone online or at The Apple Store, a
customer has the option of paying with credit card, a debit
I N C.™
or check card, an Apple gift card, a financing arrangement,
or cash (using a cashier’s check, a money order, or a wire
transfer). In order to analyze only the information related to
Apple’s cash transactions, the company must record or summarize all these similar sales using a single category or “cash”
account. This is comparable to how you summarize cash in
the check register of your checkbook. Similarly, Apple will
record credit card payments for iPhones and sales from financing arrangements in different accounts (records).
While Chapter 1 uses the accounting equation (Assets =
Liabilities + Owner’s Equity) to analyze and record financial
transactions, this chapter presents more practical and efficient
recording methods that most
companies use. In addition, this
chapter discusses possible accounting errors that may occur,
along with methods to detect
and correct them.
2
Leading by Example
Financial Analysis and Interpretation
The “Financial Analysis and Interpretation” section at the end of each accounting
chapter introduces relevant key ratios used throughout the textbook. Students connect
with the business environment as they learn how stakeholders interpret financial
reports. This section covers basic analysis tools that students will use again in
Chapter 17, “Financial Statement Analysis.” Furthermore, students get to test their proficiency with these tools through special activities and exercises at the end of each chapter. To ensure a consistent presentation, a unique icon is used for both the section and
related end-of-chapter materials.
Comparing each item in a current statement with a
total amount within that same statement is useful in analyzing relationships within a financial statement. Vertical
analysis is the term used to describe such comparisons.
In vertical analysis of a balance sheet, each asset
item is stated as a percent of the total assets. Each liability and owner’s equity item is stated as a percent of
the total liabilities and owner’s equity. In vertical analysis
of an income statement, each item is stated as a percent
of revenues or fees earned.
Vertical analysis may be prepared for several periods to
analyze changes in relationships over time. Vertical analysis
of two years of income statements for J. Holmes, Attorneyat-Law, is shown below.
J. Holmes, Attorney-at-Law
Income Statements
For the Years Ended December 31, 2010 and 2009
2010
Amount
Fees earned
$187,500
__________
Operating expenses:
Wages expense
$ 60,000
Rent expense
15,000
Utilities expense
12,500
Supplies expense
2,700
Miscellaneous
expense
2,300
__________
Total operating
expenses
$ 92,500
__________
Net income
$ 95,000
__________
__________
The preceding vertical analysis indicates both favorable and unfavorable trends affecting the income statement of J. Holmes, Attorney-at-Law. The increase in wages
expense of 2% (32% 30%) is an unfavorable trend, as
is the increase in utilities expense of 0.7% (6.7% 6.0%).
A favorable trend is the decrease in supplies expense of
0.6% (2.0%
1.4%). Rent expense and miscellaneous
expense as a percent of fees earned were constant. The
net result of these trends was that net income decreased
as a percent of fees earned from 52.8% to 50.7%.
The analysis of the various percentages shown for J.
Holmes, Attorney-at-Law, can be enhanced by comparisons with industry averages. Such averages are published
by trade associations and financial information services.
Any major differences between industry averages should
be investigated.
2009
Percent Amount Percent
100.0%
______
$150,000
__________ 100.0%
______
32.0% $ 45,000
8.0%
12,000
6.7%
9,000
1.4%
3,000
30.0%*
8.0%
6.0%
2.0%
1.2%
______
1,800 ______
1.2%
__________
49.3%
______
$ 70,800 ______
47.2%
__________
50.7%
______
______
$ 79,200 ______
52.8%
__________
__________
______
*$45,000 ÷ $150,000
Business Connection and Comprehensive
Real-World Notes
Students get a close-up look at how accounting operates in the marketplace through a
variety of items in the margins and in the “Business Connection” boxed features. In addition, a variety of end-ofchapter exercises and
problems employ reallargest business, such as Ford Motor Company, compaTHE ACCOUNTING EQUATION
nies use the accounting equation. Some examples taken
world data to give stuThe accounting equation serves as the basic foundation for from recent financial reports of well-known companies are
the accounting systems of all companies. From the small- shown below.
dents a feel for the materiest business, such as the local convenience store, to the
al that accountants see
Company
Assets*
Liabilities
Owner’s Equity
daily. No matter where
The Coca-Cola Company
$ 29,963
$13,043
$16,920
Circuit City Stores, Inc.
4,007
2,216
1,791
they are found, elements
Dell Inc.
25,635
21,196
4,439
eBay Inc.
13,494
2,589
10,905
that use material from real
Google
18,473
1,433
17,040
McDonald’s
29,024
13,566
15,458
companies are indicated
Microsoft Corporation
63,171
32,074
31,097
Southwest Airlines Co.
13,460
7,011
6,449
with a unique icon for a
Wal-Mart
151,193
89,620
61,573
consistent presentation.
*Amounts are shown in millions of dollars.
xv
Leading by Example
Integrity, Objectivity, and Ethics in Business
In each chapter, these cases help students develop their ethical compass. Often coupled
with related end-of-chapter activities, these cases can be discussed in class or students
can consider the cases as they read the chapter. Both the section and related end-ofchapter materials are indicated with a unique icon for a consistent presentation.
ACCOUNTING REFORM
The financial accounting and reporting failures of Enron,
WorldCom, Tyco, Xerox, and others shocked the investing public. The disclosure that some of the nation’s largest and best-known corporations had overstated profits
and misled investors raised the question: Where were the
CPAs?
In response, Congress passed the Investor Protection,
Auditor Reform, and Transparency Act of 2002, called the
Sarbanes-Oxley Act. The Act establishes a Public Company
Accounting Oversight Board to regulate the portion of the
accounting profession that has public companies as clients.
In addition, the Act prohibits auditors (CPAs) from providing certain types of nonaudit services, such as investment
banking or legal services, to their clients, prohibits employment of auditors by clients for one year after they
last audited the client, and increases penalties for the
reporting of misleading financial statements.
Continuing Case Study
Students follow a fictitious company, NetSolutions, throughout Chapters 1–6, which
demonstrates a variety of transactions. The continuity of using the same company facilitates student learning especially for Chapters 1–4, which cover the accounting cycle. Also,
using the same company allows students to follow the transition of the company from a
service business in Chapters 1–4 to a merchandising business in Chapters 5 and 6.
Summaries
Within each chapter, these synopses draw special attention to important points and
help clarify difficult concepts.
Self-Examination Questions
Five multiple-choice questions, with answers at the end of the chapter, help students
review and retain chapter concepts.
Illustrative Problem and Solution
A solved problem models one or more of the chapter’s assignment problems so that students can apply the modeled procedures to end-of-chapter materials.
Market Leading End-of-Chapter Material
Students need to practice accounting so that they can understand and use it. To give
students the greatest possible advantage in the real world, Accounting, 23e, goes beyond
presenting theory and procedure with comprehensive, time-tested, end-of-chapter
material.
xvi
Online Solutions
South-Western, a division of Cengage Learning, offers a vast array of
online solutions to suit your course needs. Choose the product that best
meets your classroom needs and course goals. Please check with your
Cengage representative for more details or for ordering information.
Aplia
Founded in 2000 by economist and Stanford professor Paul Romer, Aplia is an educational technology company dedicated to improving learning by increasing student
effort and engagement. Currently, our products support college-level courses and have
been used by more than 650,000 students at over 750 institutions.
For students, Aplia offers a way to stay on top of coursework with regularly scheduled homework assignments. Interactive tools and content further increase engagement
and understanding.
For professors, Aplia offers high-quality, auto-graded assignments, which ensure
that students put forth effort on a regular basis throughout the term. These assignments
have been developed for a range of textbooks and are easily customized for individual
teaching schedules.
Every day, we develop our
products by responding to the
needs and concerns of the students
and professors who use Aplia in
their classrooms. As you explore
the features and benefits Aplia has
to offer, we hope to hear from you
as well.
Welcome to Aplia.
CengageNOW Express
CengageNOW Express™ for Warren/Reeve/Duchac Accounting, 23e, is an
online homework solution that delivers better student outcomes—NOW! CengageNOW
Express focuses on the textbook homework that is central to success in accounting with
streamlined course start-up, straightforward assignment creation, automatic grading
and tracking student progress, and instant feedback for students.
• Streamlined Course Start-Up: All Brief Exercises, Exercises, Problems, and
Comprehensive Problems are available immediately for students to practice.
• Straightforward Assignment Creation: Select required exercises and problems, and
CengageNOW Express automatically applies faculty approved, Accounting
Homework Options.
• Automatic grading and tracking student progress: CengageNOW Express grades and
captures students’ scores to easily monitor their progress. Export the grade book to
Excel for easy data management.
• Instant feedback for students: Students stay on track with instructor-written hints
and immediate feedback with every assignment. Links to the e-book, animated exercise demonstrations, and Excel spreadsheets from specific assignments are ideal for
student review.
xvii
Online Solutions
CengageNOW
CengageNOW for Warren/Reeve/Duchac Accounting, 23e, is a powerful
and fully integrated online teaching and learning system that provides you with flexibility and control. This complete digital solution offers a comprehensive set of digital
tools to power your course. CengageNOW offers the following:
• Homework, including algorithmic variations
• Integrated E-book
• Personalized Study Plans, which include a variety of multimedia assets (from
exercise demonstrations to video to iPod content) for students as they master the
chapter materials
• Assessment options which include the full test bank, including algorithmic
variations
• Reporting capability based on AACSB, AICPA, and IMA competencies and
standards
• Course Management tools, including grade book
• WebCT and Blackboard Integration
WebTutor™!
Available packaged with Warren/Reeve/Duchac Accounting, 23e, or for
individual student purchase Jumpstart your course with customizable, rich, textspecific content within your Course Management System.
• Jumpstart—Simply load a WebTutor cartridge into your Course Management System.
• Customizable—Easily blend, add, edit, reorganize, or delete content.
• Content—Rich, text-specific content, media assets, quizzing, test bank, weblinks, discussion topics, interactive games and exercises, and more.
Visit academic.cengage.com for more information.
xviii
For the Instructor
When it comes to supporting instructors, South-Western is unsurpassed.
Accounting, 23e, continues the tradition with powerful print and digital
ancillaries aimed at facilitating greater course successes.
Instructor’s Manual This manual contains a number of resources designed to aid
instructors as they prepare lectures, assign homework, and teach in the classroom. For each
chapter, the instructor is given a brief synopsis and a list of objectives. Then each objective
is explored, including information on Key Terms, Ideas for Class Discussion, Lecture Aids,
Demonstration Problems, Group Learning Activities, Exercises and Problems for
Reinforcement, and Internet Activities. Also, Suggested Approaches are included that incorporate many of the teaching initiatives being stressed in higher education today, including
active learning, collaborative learning, critical thinking, and writing across the curriculum.
Solutions Manual The Solutions Manual contains answers to all exercises, problems,
and activities that appear in the text. As always, the solutions are author-written and
verified multiple times for numerical accuracy and consistency with the core text.
Solutions transparencies are also available.
Test Bank For each chapter, the Test Bank includes True/False questions, MultipleChoice questions, and Problems, each marked with a difficulty level, chapter objective
association, and a tie-in to standard course outcomes. Along with the normal update
and upgrade of the 2,800 test bank questions, variations of the new Example Exercises
have been added to this bank for further quizzing and better integration with the textbook. In addition, the bank provides a grid for each chapter that compiles the correlation of each question to the individual chapter’s objectives, as well as a ranking of difficulty based on a clearly described categorization. Through this helpful grid, making a
test that is comprehensive and well-balanced is a snap!
ExamView® Pro Testing Software This intuitive software allows you to easily customize exams, practice tests, and tutorials and deliver them over a network, on the
Internet, or in printed form. In addition, ExamView comes with searching capabilities
that make sorting the wealth of questions from the printed test bank easy. The software
and files are found on the IRCD.
PowerPoint® Each presentation, which is included on the IRCD and on the product
support site, enhances lectures and simplifies class preparation. Each chapter contains
objectives followed by a thorough outline of the chapter that easily provide an entire
lecture model. Also, exhibits from the chapter, such as the new Example Exercises, have
been recreated as colorful PowerPoint slides to create a powerful, customizable tool.
Instructor Excel® Templates These templates provide the solutions for the problems and exercises that have Enhanced Excel® templates for students. Through these
files, instructors can see the solutions in the same format as the students. All problems
with accompanying templates are marked in the book with an icon and are listed in the
information grid in the solutions manual. These templates are available for download
on academic.cengage.com/accounting/warren or on the IRCD.
Instructor’s Resource CD-ROM This convenient resource includes the PowerPoint®
Presentations, Instructor’s Manual, Solutions Manual, Test Bank, ExamView®, An
Instructor’s Guide to Online Resources, and Excel Application Solutions. Lively demonstrations of support technology are also included. All the basic material an instructor
would need is available in one place on this IRCD.
xix
For the Student
Students come to accounting with a variety of learning needs. Accounting,
23e, offers a broad range of supplements in both printed form and easy-touse technology. We continue to refine our entire supplement package
around the comments instructors have provided about their courses and
teaching needs.
Study Guide This author-written guide provides students Quiz and Test Hints,
Matching questions, Fill-in-the-Blank questions (Parts A & B), Multiple-Choice questions, True/False questions, Exercises, and Problems for each chapter. Designed to
assist students in comprehending the concepts and principles in the text, solutions for
all of these items are available in the guide for quick reference.
Working Papers for Exercises and Problems The traditional working papers
include problem-specific forms for preparing solutions for Exercises, A & B Problems,
the Continuing Problem, and the Comprehensive Problems from the textbook. These
forms, with preprinted headings, provide a structure for the problems, which helps
students get started and saves them time. Additional blank forms are included.
Blank Working Papers These Working Papers are available for completing exercises and problems either from the text or prepared by the instructor. They have no
preprinted headings. A guide at the front of the Working Papers tells students which
form they will need for each problem.
Enhanced Excel® Templates These templates are provided for selected long or
complicated end-of-chapter exercises and problems and provide assistance to the
student as they set up and work the problem. Certain cells are coded to display a red
asterisk when an incorrect answer is entered, which helps students stay on track.
Selected problems that can be solved using these templates are designated by an icon.
Klooster & Allen General Ledger Software Prepared by Dale Klooster and
Warren Allen, this best-selling, educational, general ledger package introduces students
to the world of computerized accounting through a more intuitive, user-friendly system
than the commercial software they’ll use in the future. In addition, students have access
to general ledger files with information based on problems from the textbook and practice sets. The program is enhanced with a problem checker that enables students to
determine if their entries are correct and emulates commercial general ledger packages
more closely than other educational packages. Problems that can be used with
Klooster/Allen are highlighted by an icon. A free Network Version is available to
schools whose students purchase Klooster/Allen GL.
Product Support Web Site academic.cengage.com/accounting/warren. This site
provides students with a wealth of introductory accounting resources, including
quizzing and supplement downloads and access to the Enhanced Excel® Templates.
xx
Acknowledgments
Many of the enhancements made to Accounting, 23e, are a direct result of countless conversations
we’ve had with principles of accounting students over the past several years. We want to take this
opportunity to thank them for their perspectives and feedback on textbook use; we think that 23e
represents our finest edition yet!
Bucks County Community
College
Instructors: Lori Grady,
Judy Toland
Bernadette Allen
Matarazzo
Vikas Patel
Erica Olsen
Eric Goldner
Shelly Rushbrook
Eamon Coleman
Tracy Bunsick
Baltimore City Community
College
Instructors: Jeff Hillard,
John Wiley
Sulaimon Adeyemi
Udeya Diour
Dwain White
Debra Witherspoon
Jacqueline Tuggle
Mabono Soumahoo
Des Moines Area
Community College
Instructors: Shea Mears,
Patty Holmes
Zach Schmidt
Angie Lee
Tim Hoffman
Richard Palmer
Sharon Beattie
Joseph J. Johnson
Armina Kahrimanovic
Ryan Wisnousky
Lindsay Tripp
Tiffany Shuey
Jenny Leonard
Susann Shaffner
Cori Shanahan
Nicholas Wallace
Kyle Melohn
Wendy Doolittle
LaRue Brannan
Nicholas Christopher
Yaeger
Jason Aitchison
Kean University
Instructor: Gary Schader
Margherita Marjotta
Hugo Prado
Marta Domanska
Nicole Foy
Andrea Colbert
Khatija Bibi
Houston Community
College
Instructor: Linda
Flowers
Yildirim Kocoglu
Ana Zelaya
Seungkyu Kim
Mohammad Arsallan
Bakali
Vanessa K. Rangel
Cher Lay
Sherika Gibson
Ulsi Ramos
Muhammad Shaikha
Hong Yang
Pamela Ruiz
Yvonne Ngo
Lansing Community
College
Instructor: Patricia
Walczak
Ana Topor
John Barrett
Brandon Smithwick
Bradley L. Moore
Cassandra DeVos
Elizabeth C. Escalera
Clara Powers
Lance Spencer
Jennifer Jones
Aristoteles Paiva Lopes
Oakland Community
College
Instructor: Deborah
Niemer
Paul Boker
Tracie M. Leitner
Thetnia Lynette Cobb
Vera Kolaj
Olivia Burke
Thomas J. Zuchowski
Ryan Shead
Austen Michaels
Michaele Jones
Bradlee J. VanAlstine
Tim Doherty
Vanya Jelezarova
Nilda Dervishaj
Maja Lulgjuraj
Pierce Radtke
Butler Community
College
Instructors: Jennifer
Brewer, Janice Akao
Sarah Kirkwood
Kimberly Brothers
Christine Brown
Chelsey Perkins
Thomas Mackay
Tucker Stewart
Austin Birkholtz
Santa Monica College
Instructors: Greg Brookins,
Terri Bernstein, and Pat
Halliday
Julieta Loreto
Noah Johnson
Matthew Nyby
Anitha Guna Wijaya
Jovani Rodriguez
Michelle Sharma
Marisol Granele
Prashila Sharma
Karlie Bryant
Wing San Kwong
Anthony Mitchell
Metropolitan Community
College
Instructor: Idalene
Williams
Suquett Saunders
Danette Cook
Ewokem Akohachere
Ivina Washington
Queen Esther Tucker
Jamie Rusch
Daisuke Motomura
Comlanri S. Zannou
Melissa Brunious
Marc Anderson
Keith Costello
Robyn Adler
Kelly Fitzgerald
Volunteer State
Community College
Instructor: Brent
Trentham
Kris Anderson
Jasmine Cox
Wendy Nabors
Patrick Farmer
Justin Gill
Kathryn Gambrell
Dana Mihalko
Kavitha Sudheendra
April Jeffries
Ray Mefford
Ashlee Kilpatrick
Cedar Valley
Instructor: S.T. Desai
Tiffany King
Kareem Aziz
Ebony Wingard
Cheryl Boyd
Dwevelyn Jennings
Kal Takieddin
Lazari Vanly
Adrian McKinney
Tanya Hubbard
Angela Fulbright
Tenisha Blair
Jamie Riley
Roshunda Webb
Porsha Espie
Keisha Murrell
Dawn Smith
Sinclair Community College
Instructor: Donna
Chadwick
Emanuel Gena
Victoria Wiseman
Daniel Hulet
Naaman Beck
Eric Pedro
Kathy Ernest
Jessica Weiss
Jessica Baker
Champer Murtery
Steve Huffman
Regis Allison
Hiba Ligawad
Cara Scott
Tammy Baughman
Kevin Ricketts
Nora Hatlab
Mary Kasper
Nicole Sutherland,
Grossmont College
Katie Longo, Southern
Adventist University
Joel Hughes, Southern
Lisa Hubbard, Mid-State
Technical College
Amanda Baker,
Davenport University
Phillipe Bouzy, Southern
Barbara Bryant, DeKalb
Technical College
Charisse Dolina,
Maharishi School of
Management
Amanda Worrell,
Southern Adventist
University
Angela Snider, Cardinal
Stritch University
Star Maddox, DeKalb
Technical College
Charles Balliet, Lehigh
Carbon CC
Ashley Heath, Buena
Vista University
Brianna Miller, Southern
John Varga,
Orange Coast College
Roger Montero, East
Los Angeles College
Terry Thorpe,
Irvine Valley
Jim Sugden,
WebEx Focus Group
Participants
April Wakefield,
Northcentral Technical
College
xxi
The following instructors
are members of our Blue
Sky editorial board,
whose helpful comments
and feedback continue to
have a profound impact
on the presentation and
core themes of this text:
Ana M. Cruz
Miami Dade College
Gloria Worthy
Southwest Tennessee
Community College
Walter DeAguero
Saddleback College
Lee Smart
Southwest Tennessee
Community College
Rick Andrews
Sinclair Community College
Donna Chadwick
Sinclair Community
College
Warren Smock
Ivy Tech Community College
Terry Dancer
Arkansas State University
David L. Davis
Tallahassee Community
College
Robert Dunlevy
Montgomery County
Community College
Richard Ellison
Middlesex County College
W. Michael Fagan
Raritan Valley Community
College
Carol Flowers
Shirly A. Kleiner
Johnson County
Community College
Carol Welsh
Rowan University
Patrick Borja
Citrus College
Michael M. Landers
Middlesex College
Chris Widmer
Tidewater Community
College
Robert Adkins
Clark State Community
College
Phillip Lee
Nashville State
Community College
Lynnette Mayne Yerbury
Salt Lake Community
College
Melvin Williams
College of the Mainland
Denise Leggett
Middle Tennessee State
University
The following instructors have participated in
the review process,
focus groups, and marketing events for this
new edition:
Patrick Rogan
Consumes River
College
Lynne Luper
Ocean County College
Maria C. Mari
Miami Dade College
Thomas S. Marsh
Northern Virginia
Community College—
Annandale
Cynthia McCall
Des Moines Area
Community College
Gary Schader
Kean University
Linda S. Flowers
Houston Community
College
Priscilla Wisner
Montana State University
Mike Foland
Southwest Illinois College
Andrea Murowski
Brookdale Community
College
Audrey Hunter
Broward Community College
Anthony Fortini
Camden Community College
Rachel Pernia
Essex County College
Renee Rigoni
Monroe Community College
Terry Thorpe
Irvine Community College
Patricia Walczak
Lansing Community College
Judith Zander
Grossmont College
Gilda M. Agacer
Monmouth University
Irene C. Bembenista
Laurel L. Berry
Bryant & Stratton College
Bill Black
Raritan Valley Community
College
Gregory Brookins
Barbara M. Gershowitz
Nashville State
Community College
Angelina Gincel
Middlesex County College
Lori Grady
College
Joseph R. Guardino
Kingsborough Community
College
Amy F. Haas
College
Betty Habershon
Prince George’s
Community College
Patrick A. Haggerty
Lansing Community
College
Rebecca Carr
Arkansas State University
Becky Hancock
El Paso Community
College
James L. Cieslak
Cuyahoga Community
College
Paul Harris
Camden County College
Sue Cook
Tulsa Community College
xxii
Patricia H. Holmes
Des Moines Area
Community College
Brenda Fowler
Alamance Community
College
James Cieslaks
Cuyahoga Community
College
Shelia Ammons
Austin Community College
Felicia Baldwin
Daley College
Peggy Smith
Baker College—Auburn
Hills
Debra Kiss
Christopher Mayer
Bergen Community
College
Dawn Peters
Southwest Illinois College
Gary J. Pieroni
Diablo Valley College
Audrey Hunter
Broward Community College
Debra Prendergast
Northwestern Business
College
Cathy Montesarchio
Broward Community
College
Lou Rosamillia
Hudson Valley Community
College
Laurel L. Berry
Bryant and Stratton
College
Eric Rothernburg
College
Judy Toland
College
Gerald Savage
Essex Community College
Janice Stoudemire
Midlands Technical
College
Linda H. Tarrago
Hillsborough Community
College
Lawrence Roman
Cuyahoga Community
College
Darlene B. Lindsey
Hinds Community College
Michelle Grant
Bossier Parish Community
College
Richard Sarkisian
Camden Community College
Sandee Cohen
Columbia College—Chicago
Lori Grady
College
Rafik Elias
California State University
—Los Angeles
Norris Dorsey
California State University
—Northridge
Judy Toland
Buck Community College
Angela Siedel
Cambria-Rowe Business
College
Bob Urell
Irvine Valley College
Suryakant Desai
Cedar Valley College
Marilyn Ciolino
Delgado Community
College
Patti Holmes
Des Moines Area
Community College
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East Los Angeles College
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Edmonds Community
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El Paso Community
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El Paso Community
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Farmingdale State College
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Florida Southern College
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Foothill College
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Forest Park Community
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Fresno City College
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Glendale Community
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Green River Community
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University of Cincinnati
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University of
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Victor Valley College
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Waubonsee Community
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Leaping Lizards Lawn Care
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Practice Set
Edward Krohn,
Miami Dade, College
Star Computer Sales and
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Ana Cruz & Blanca Ortega,
Miami Dade College
Artistic Décor Practice Set
Craig Pence
Highland Community
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Spreadsheets
xxiii
BRIEF CONTENTS
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
CHAPTER
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
A
APPENDIX B
APPENDIX C
APPENDIX
D
APPENDIX E
APPENDIX
xxiv
Introduction to Accounting and Business . . . . . . . . . . . . . . . . . . . .
Analyzing Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
The Adjusting Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Completing the Accounting Cycle . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for Merchandising Businesses . . . . . . . . . . . . . . . . . .
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Sarbanes-Oxley, Internal Control, and Cash . . . . . . . . . . . . . . . . . .
Receivables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Fixed Assets and Intangible Assets . . . . . . . . . . . . . . . . . . . . . . . .
Current Liabilities and Payroll . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for Partnerships and Limited Liability Companies . . . . .
Corporations: Organization, Stock Transactions, and Dividends . . .
Long-Term Liabilities: Bonds and Notes . . . . . . . . . . . . . . . . . . . .
Investments and Fair Value Accounting. . . . . . . . . . . . . . . . . . . . . .
Financial Statements for Mornin’ Joe . . . . . . . . . . . . . . . . . . . . . .
Statement of Cash Flows . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Financial Statement Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Managerial Accounting Concepts and Principles . . . . . . . . . . . . .
Job Order Costing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Process Cost Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cost Behavior and Cost-Volume-Profit Analysis . . . . . . . . . . . . .
Budgeting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Performance Evaluation Using Variances from Standard Costs . .
Performance Evaluation for Decentralized Operations . . . . . . . . .
Differential Analysis and Product Pricing . . . . . . . . . . . . . . . . . .
Capital Investment Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1
49
99
143
201
251
311
352
397
440
484
532
574
617
657
707
710
762
817
854
896
947
996
1042
1086
1131
1179
Interest Tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Reversing Entries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
End-of-Period Spreadsheet (Work Sheet)
for a Merchandising Business . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounting for Deferred Income Taxes . . . . . . . . . . . . . . . . . . . .
Nike, Inc., Annual Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Subject Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Company Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
A-2
B-1
C-1
D-1
E-1
G-1
I-1
I-18
Contents
CHAPTER
1
Introduction to Accounting and
Business ................................................1
Nature of Business and Accounting 2
Types of Businesses 2
The Role of Accounting in Business 3
Role of Ethics in Accounting and Business 4
Opportunities for Accountants 6
Generally Accepted Accounting Principles 7
Business Entity Concept 8
The Cost Concept 8
The Accounting Equation 9
Business Transactions and the Accounting Equation 10
Business Connection: The Accounting Equation 10
Financial Statements 15
Income Statement 16
Statement of Owner’s Equity 17
Balance Sheet 17
Statement of Cash Flows 19
Interrelationships Among Financial Statements 21
Financial Analysis and Interpretation 21
CHAPTER
2
Analyzing Transactions.....................49
Using Accounts to Record Transactions 50
Chart of Accounts 52
Business Connection: The Hijacking Receivable 52
Double-Entry Accounting System 53
Balance Sheet Accounts 53
Income Statement Accounts 54
Owner Withdrawals 54
Normal Balances 54
Journalizing 55
Posting Journal Entries to Accounts 59
Trial Balance 68
Errors Affecting the Trial Balance 68
Errors Not Affecting the Trial Balance 70
CHAPTER
3
The Adjusting Process ......................99
Nature of the Adjusting Process 100
The Adjusting Process 101
Types of Accounts Requiring Adjustment 102
Recording Adjusting Entries 104
Prepaid Expenses 105
Unearned Revenues 107
Accrued Revenues 108
Accrued Expenses 109
Depreciation Expense 111
Summary of Adjustment Process 113
Business Connection: Microsoft Corporation 116
Adjusted Trial Balance 118
CHAPTER
4
Completing the Accounting
Cycle...................................................143
Flow of Accounting Information 144
Financial Statements 146
Income Statement 146
Balance Sheet 149
Business Connection: International Differences 150
Closing Entries 150
Journalizing and Posting Closing Entries 152
Post-Closing Trial Balance 155
Accounting Cycle 156
Illustration of the Accounting Cycle 157
Step 1. Analyzing and Recording Transactions in the
Journal 158
Step 2. Posting Transactions to the Ledger 159
Step 3. Preparing an Unadjusted Trial Balance 160
Step 4. Assembling and Analyzing Adjustment Data 160
Step 5. Preparing an Optional End-of-Period Spreadsheet
(Work Sheet) 161
Step 6. Journalizing and Posting Adjusting Entries 161
Step 7. Preparing an Adjusted Trial Balance 163
Step 8. Preparing the Financial Statements 163
Step 9. Journalizing and Posting Closing Entries 165
Step 10. Preparing a Post-Closing Trial Balance 165
Fiscal Year 168
Financial Analysis and Interpretation 168A
Appendix: End-of-Period Spreadsheet (Work Sheet) 168A
Step 1. Enter the Title 168C
Step 2. Enter the Unadjusted Trial Balance 168C
Step 3. Enter the Adjustments 168C
Step 4. Enter the Adjusted Trial Balance 168D
Step 5. Extend the Accounts to the Income Statement and
Balance Sheet Columns 168D
Step 6. Total the Income Statement and Balance Sheet
Columns, Compute the Net Income or Net Loss, and
Complete the Spreadsheet 168D
Preparing the Financial Statements from the Spreadsheet 169
xxv
Comprehensive Problem 1 196
Practice Set: Leaping Lizards Lawn Care
This set is a service business operated as a proprietorship. It
includes a narrative of transactions and instructions for an
optional solution with no debits and credits. This set can be
solved manually or with the Klooster/Allen software.
CHAPTER
5
Accounting Systems........................201
Basic Accounting Systems 202
Manual Accounting System 203
Subsidiary Ledgers 203
Special Journals 204
Revenue Journal 205
Cash Receipts Journal 208
Accounts Receivable Control Account and Subsidiary
Ledger 210
Purchases Journal 211
Cash Payments Journal 214
Accounts Payable Control Account and Subsidiary Ledger 216
Adapting Manual Accounting Systems 217
Additional Subsidiary Ledgers 217
Modified Special Journals 217
Computerized Accounting Systems 218
Business Connection: Accounting Systems and Profit
Measurement 219
E-Commerce 222
CHAPTER
6
Accounting for Merchandising
Businesses........................................251
Nature of Merchandising Businesses 252
Financial Statements for a Merchandising Business 253
Multiple-Step Income Statement 254
Single-Step Income Statement 258
Balance Sheet 258
Business Connection: H&R Block Versus The Home
Depot 260
Merchandising Transactions 260
Chart of Accounts for a Merchandising Business 260
Sales Transactions 260
Purchase Transactions 266
Freight, Sales Taxes, and Trade Discounts 269
Dual Nature of Merchandise Transactions 272
The Adjusting and Closing Process 273
Adjusting Entry for Inventory Shrinkage 273
Closing Entries 274
Appendix: Accounting Systems for Merchandisers 276
Manual Accounting System 276
Computerized Accounting Systems 278
xxvi
Appendix: The Periodic Inventory System 279
Cost of Merchandise Sold Using the Periodic Inventory
System 279
Chart of Accounts Under the Periodic Inventory System 280
Recording Merchandise Transactions Under the Periodic
Inventory System 281
Adjusting Process Under the Periodic Inventory System 281
Financial Statements Under the Periodic Inventory System 282
Closing Entries Under the Periodic Inventory System 282
Practice Set: Fitness City Merchandise
This set is a merchandising business operated as a
proprietorship. It includes business documents, and it can be
CHAPTER
7
Inventories ........................................311
Control of Inventory 312
Safeguarding Inventory 312
Reporting Inventory 313
Inventory Cost Flow Assumptions 313
Inventory Costing Methods Under a Perpetual Inventory
System 316
First-In, First-Out Method 316
Last-In, First-Out Method 318
Average Cost Method 319
Computerized Perpetual Inventory Systems 319
Inventory Costing Methods Under a Periodic Inventory
System 320
First-In, First-Out Method 320
Last-In, First-Out Method 321
Average Cost Method 322
Comparing Inventory Costing Methods 323
Reporting Merchandise Inventory in the Financial
Statements 324
Valuation at Lower of Cost or Market 325
Valuation at Net Realizable Value 326
Merchandise Inventory on the Balance Sheet 326
Effect of Inventory Errors on the Financial Statements 327
Business Connection: Rapid Inventory at Costco 330
Appendix: Estimating Inventory Cost 331
Retail Method of Inventory Costing 331
Gross Profit Method of Inventory Costing 332
CHAPTER
8
Sarbanes-Oxley, Internal Control,
and Cash............................................352
Sarbanes-Oxley Act of 2002 353
Internal Control 355
Objectives of Internal Control 355
Elements of Internal Control 355
Control Environment 356
Risk Assessment 357
Control Procedures 357
Monitoring 359
Information and Communication 360
Limitations of Internal Control 360
Cash Controls Over Receipts and Payments 360
Control of Cash Receipts 361
Control of Cash Payments 363
Bank Accounts 364
Bank Statement 364
Using the Bank Statement as a Control Over Cash 366
Bank Reconciliation 367
Special-Purpose Cash Funds 371
Financial Statement Reporting of Cash 372
Business Connection: Microsoft Corporation 374
CHAPTER
9
Accounts Receivable 398
Notes Receivable 398
Other Receivables 399
Uncollectible Receivables 399
Direct Write-Off Method for Uncollectible Accounts 400
Allowance Method for Uncollectible Accounts 401
Write-Offs to the Allowance Account 402
Estimating Uncollectibles 403
Comparing Direct Write-Off and Allowance Methods 408
Notes Receivable 410
Characteristics of Notes Receivable 410
Accounting for Notes Receivable 411
Reporting Receivables on the Balance Sheet 413
Business Connection: Delta Air Lines 415
Appendix: Discounting Notes Receivable 415
10
Discarding Fixed Assets 454
Selling Fixed Assets 455
Natural Resources 456
Intangible Assets 457
Patents 457
Copyrights and Trademarks 458
Goodwill 459
Financial Reporting for Fixed Assets and Intangible Assets 460
Business Connection: Hub-and-Spoke or Point-to-Point? 461
Appendix: Sum-of-the-Years-Digits Depreciation 462
Appendix: Exchanging Similar Fixed Assets 463
Gain on Exchange 464
Loss on Exchange 464
Practice Set: Danielle’s Dog Care
Receivables.......................................397
Classification of Receivables 398
CHAPTER
Disposal of Fixed Assets 454
Fixed Assets and Intangible
Assets.................................................440
Nature of Fixed Assets 441
Classifying Costs 442
The Cost of Fixed Assets 443
Capital and Revenue Expenditures 444
Leasing Fixed Assets 445
Accounting for Depreciation 446
Factors in Computing Depreciation Expense 447
Straight-Line Method 448
Units-of-Production Method 449
Double-Declining-Balance Method 450
Comparing Depreciation Methods 451
Depreciation for Federal Income Tax 452
Revising Depreciation Estimates 452
This set includes payroll transactions for a merchandising
business operated as a proprietorship. It includes business
documents, and it can be solved manually or with the
Klooster/Allen software.
CHAPTER
11
Current Liabilities and
Payroll ................................................484
Current Liabilities 485
Accounts Payable 485
Current Portion of Long-Term Debt 486
Short-Term Notes Payable 486
Payroll and Payroll Taxes 489
Liability for Employee Earnings 489
Deductions from Employee Earnings 489
Computing Employee Net Pay 492
Liability for Employer’s Payroll Taxes 492
Business Connection: The Most You Will Ever Pay 493
Accounting Systems for Payroll and Payroll Taxes 493
Payroll Register 494
Employee’s Earnings Record 497
Payroll Checks 497
Payroll System Diagram 498
Internal Controls for Payroll Systems 499
Employees’ Fringe Benefits 501
Vacation Pay 501
Pensions 502
Postretirement Benefits Other than Pensions 503
Current Liabilities on the Balance Sheet 504
Contingent Liabilities 504
Probable and Estimable 504
Probable and Not Estimable 505
Reasonably Possible 505
Remote 505
xxvii
CHAPTER
12
Accounting for Partnerships and
Limited Liability Companies............532
Proprietorships, Partnerships, and Limited Liability
Companies 533
Proprietorships 533
Partnerships 534
Limited Liability Companies 535
Comparing Proprietorships, Partnerships, and Limited Liability
Companies 536
Business Connection: Organizational Forms in the
Accounting and Consulting Industry 536
Forming and Dividing Income of a Partnership 536
Forming a Partnership 537
Dividing Income 538
Partner Admission and Withdrawal 540
Admitting a Partner 540
Withdrawal of a Partner 545
Death of a Partner 545
Liquidating Partnerships 546
Gain on Realization 547
Loss on Realization 548
Loss on Realization—Capital Deficiency 550
Errors in Liquidation 553
Statement of Partnership Equity 553
Practice Set: Artistic Décor
This set is a service and merchandising business operated as
a corporation. It includes narrative for six months of transactions, which are to be recorded in a general journal. The set
can be solved manually or with the Klooster/Allen software.
Practice Set: Star Computer Sales and Services
This set is a departmentalized merchandising business operated as a corporation. It includes a narrative of transactions,
which are to be recorded in special journals. The set can be
CHAPTER
14
Long-Term Liabilities: Bonds and
Notes ..................................................617
Financing Corporations 618
Nature of Bonds Payable 621
Bond Characteristics and Terminology 621
Proceeds from Issuing Bonds 621
Accounting for Bonds Payable 622
Bonds Issued at Face Amount 622
Bonds Issued at a Discount 623
Amortizing a Bond Discount 624
Bonds Issued at a Premium 625
Amortizing a Bond Premium 626
Business Connection: Ch-Ch-Ch-Changes in Bond Trends 627
Bond Redemption 627
Installment Notes 629
CHAPTER
13
Corporations: Organization, Stock
Transactions, and Dividends .........574
Nature of a Corporation 575
Characteristics of a Corporation 575
Forming a Corporation 576
Stockholders’ Equity 578
Paid-In Capital from Issuing Stock 579
Characteristics of Stock 579
Classes of Stock 579
Issuing Stock 581
Premium on Stock 582
No-Par Stock 582
Business Connection: Cisco Systems, Inc. 583
Accounting for Dividends 584
Cash Dividends 584
Stock Dividends 586
Treasury Stock Transactions 587
Reporting Stockholders’ Equity 589
Stockholders’ Equity in the Balance Sheet 589
Reporting Retained Earnings 591
Statement of Stockholders’ Equity 592
Reporting Stockholders’ Equity for Mornin’ Joe 593
Stock Splits 594
xxviii
Issuing an Installment Note 629
Annual Payments 629
Reporting Long-Term Liabilities 631
Appendix: Present Value Concepts and Pricing Bonds
Payable 632
Present Value Concepts 633
Pricing Bonds 635
Appendix: Effective Interest Rate Method of Amortization 637
Amortization of Discount by the Interest Method 637
Amortization of Premium by the Interest Method 638
CHAPTER
15
Investments and Fair Value
Accounting........................................657
Why Companies Invest 658
Investing Cash in Current Operations 658
Investing Cash in Temporary Investments 659
Investing Cash in Long-Term Investments 659
Accounting for Debt Investments 660
Purchase of Bonds 660
Interest Revenue 660
Sale of Bonds 661
Accounting for Equity Investments 662
Less Than 20% Ownership 662
Between 20%–50% Ownership 664
More Than 50% Ownership 666
Valuing and Reporting Investments 667
Trading Securities 667
Held-to-Maturity Securities 670
Available-for-Sale Securities 671
Summary 674
Business Connection: Warren Buffett: The Sage of Omaha 676
Fair Value Accounting 676
Trend to Fair Value Accounting 676
Effect of Fair Value Accounting on the Financial Statements 677
Future of Fair Value Accounting 678
Appendix: Accounting for Held-to-Maturity Investments 678
Purchase of Bonds 678
Amortization of Premium or Discount 679
Receipt of Maturity Value of Bond 680
Appendix: Comprehensive Income 681
Financial Statements for Mornin’ Joe 707
CHAPTER
16
Statement of Cash Flows................710
Reporting Cash Flows 711
Cash Flows from Operating Activities 712
Cash Flows from Investing Activities 714
Cash Flows from Financing Activities 714
Noncash Investing and Financing Activities 714
Business Connection: Too Much Cash! 714
No Cash Flow per Share 715
Statement of Cash Flows—The Indirect Method 715
Retained Earnings 717
Adjustments to Net Income 717
Dividends 722
Common Stock 722
Bonds Payable 723
Building 723
Land 724
Preparing the Statement of Cash Flows 724
Statement of Cash Flows—The Direct Method 725
Cash Received from Customers 726
Cash Payments for Merchandise 727
Cash Payments for Operating Expenses 728
Gain on Sale of Land 728
Interest Expense 728
Cash Payments for Income Taxes 729
Reporting Cash Flows from Operating Activities—Direct
Method 729
Appendix: Spreadsheet (Work Sheet) for Statement
of Cash Flows—The Indirect Method 731
Analyzing Accounts 731
Retained Earnings 731
Other Accounts 733
Preparing the Statement of Cash Flows 733
CHAPTER
17
Financial Statement Analysis ........762
Basic Analytical Methods 763
Horizontal Analysis 764
Vertical Analysis 766
Common-Sized Statements 767
Other Analytical Measures 769
Solvency Analysis 769
Current Position Analysis 770
Accounts Receivable Analysis 772
Inventory Analysis 773
Ratio of Fixed Assets to Long-Term Liabilities 775
Ratio of Liabilities to Stockholders’ Equity 775
Number of Times Interest Charges Earned 776
Profitability Analysis 777
Ratio of Net Sales to Assets 777
Rate Earned on Total Assets 778
Rate Earned on Stockholders’ Equity 779
Rate Earned on Common Stockholders’ Equity 780
Earnings Per Share on Common Stock 781
Price-Earnings Ratio 782
Dividends Per Share 783
Dividend Yield 783
Summary of Analytical Measures 783
Corporate Annual Reports 785
Management Discussion and Analysis 785
Report on Internal Control 785
Report on Fairness of the Financial Statements 786
Business Connection: Investing Strategies 786
Appendix: Unusual Items on the Income Statement 787
Unusual Items Affecting the Current Period’s Income
Statement 787
Unusual Items Affecting the Prior Period’s Income
Statement 789
Nike, Inc., Problem 813
CHAPTER
18
Managerial Accounting
Concepts and Principles.................817
Managerial Accounting 818
Differences Between Managerial and Financial
Accounting 819
The Management Accountant in the Organization 820
Managerial Accounting in the Management
Process 821
Manufacturing Operations: Costs and Terminology 823
Direct and Indirect Costs 824
Manufacturing Costs 825
Financial Statements for a Manufacturing Business 829
Balance Sheet for a Manufacturing Business 829
Income Statement for a Manufacturing Company 830
Uses of Managerial Accounting 832
Business Connection: Navigating the Information
Highway 835
xxix
CHAPTER
19
Job Order Costing ............................854
Cost Accounting System Overview 855
Job Order Cost Systems for Manufacturing Businesses 856
Materials 857
Factory Labor 859
Factory Overhead Cost 861
Work in Process 866
Finished Goods 867
Sales and Cost of Goods Sold 868
Period Costs 868
Summary of Cost Flows for Legend Guitars 868
Job Order Costing for Decision Making 870
Job Order Cost Systems for Professional Service
Businesses 870
Business Connection: Making Money in the Movie
Business 872
Practice Set: Bath Designs, Inc.
This set is a manufacturing business operated as a
corporation that uses a job order cost system. The set can
be solved manually or with the Klooster/Allen software.
CHAPTER
20
Process Cost Systems ....................896
Comparing Job Order and Process Cost Systems 898
Cost Flows for a Process Manufacturer 900
Cost of Production Report 903
Step 1: Determine the Units to Be Assigned Costs 903
Step 2: Compute Equivalent Units of Production 905
Step 3: Determine the Cost per Equivalent Unit 908
Step 4: Allocate Costs to Units Transferred Out and Partially
Completed Units 910
Preparing the Cost of Production Report 912
Journal Entries for a Process Cost System 913
Using the Cost of Production Report for Decision Making 916
Frozen Delight 916
Holland Beverage Company 917
Yield 917
Just-in-Time Processing 918
Business Connection: Radical Improvement: Just in Time for
Pulaski’s Customers 920
Appendix: Average Cost Method 920
Determining Costs Using the Average Cost Method 920
The Cost of Production Report 922
21
Cost Behavior and Cost-VolumeProfit Analysis...................................947
Cost Behavior 948
Variable Costs 949
Fixed Costs 950
Mixed Costs 950
Summary of Cost Behavior Concepts 953
xxx
Contribution Margin 954
Contribution Margin Ratio 954
Unit Contribution Margin 955
Mathematical Approach to Cost-Volume-Profit Analysis 957
Break-Even Point 957
Business Connection: Breaking Even on Howard
Stern 960
Target Profit 960
Graphic Approach to Cost-Volume-Profit Analysis 962
Cost-Volume-Profit (Break-Even) Chart 962
Profit-Volume Chart 964
Use of Computers in Cost-Volume-Profit Analysis 965
Assumptions of Cost-Volume-Profit Analysis 965
Special Cost-Volume-Profit Relationships 966
Sales Mix Considerations 967
Operating Leverage 968
Margin of Safety 970
Appendix: Variable Costing 971
CHAPTER
22
Budgeting ..........................................996
Nature and Objectives of Budgeting 997
Process Cost Systems 897
CHAPTER
Cost-Volume-Profit Relationships 953
Objectives of Budgeting 998
Human Behavior and Budgeting 998
Budgeting Systems 1000
Static Budget 1001
Flexible Budget 1001
Business Connection: Build Versus Harvest 1002
Computerized Budgeting Systems 1003
Master Budget 1004
Income Statement Budgets 1005
Sales Budget 1005
Production Budget 1006
Direct Materials Purchases Budget 1007
Direct Labor Cost Budget 1008
Factory Overhead Cost Budget 1009
Cost of Goods Sold Budget 1010
Selling and Administrative Expenses Budget 1012
Budgeted Income Statement 1012
Balance Sheet Budgets 1012
Cash Budget 1013
Capital Expenditures Budget 1016
Budgeted Balance Sheet 1017
CHAPTER
23
Performance Evaluation
Using Variances from Standard
Costs.................................................1042
Standards 1043
Setting Standards 1044
Types of Standards 1044
Reviewing and Revising Standards 1045
Criticisms of Standard Costs 1045
Business Connection: Making the Grade in the Real
World—The 360-Degree Review 1045
Budgetary Performance Evaluation 1046
Budget Performance Report 1047
Manufacturing Cost Variances 1048
Direct Materials and Direct Labor Variances 1049
Direct Materials Variances 1049
Direct Labor Variances 1051
Factory Overhead Variances 1054
The Factory Overhead Flexible Budget 1054
Variable Factory Overhead Controllable Variance 1055
Fixed Factory Overhead Volume Variance 1056
Reporting Factory Overhead Variances 1058
Factory Overhead Account 1058
Recording and Reporting Variances from Standards 1060
Nonfinancial Performance Measures 1063
CHAPTER
24
Performance Evaluation for
Decentralized Operations.............1086
Centralized and Decentralized Operations 1087
Advantages of Decentralization 1088
Disadvantages of Decentralization 1088
Responsibility Accounting 1088
Responsibility Accounting for Cost Centers 1089
Responsibility Accounting for Profit Centers 1091
Service Department Charges 1091
Profit Center Reporting 1094
Responsibility Accounting for Investment Centers 1095
Rate of Return on Investment 1096
Business Connection: Return on Investment 1099
Residual Income 1099
The Balanced Scorecard 1101
Variable Cost Concept 1147
Choosing a Cost-Plus Approach Cost Concept 1149
Activity-Based Costing 1150
Target Costing 1150
Production Bottlenecks, Pricing, and Profits 1151
Production Bottlenecks and Profits 1151
Production Bottlenecks and Pricing 1152
Business Connection: What Is a Product? 1153
Appendix: Activity-Based Costing 1154
CHAPTER
26
Nature of Capital Investment Analysis 1180
Methods Not Using Present Values 1181
Average Rate of Return Method 1181
Cash Payback Method 1182
Methods Using Present Values 1184
Present Value Concepts 1184
Net Present Value Method 1187
Internal Rate of Return Method 1189
Business Connection: Panera Bread Store Rate of Return 1191
Factors that Complicate Capital Investment Analysis 1192
Income Tax 1192
Unequal Proposal Lives 1192
Lease versus Capital Investment 1194
Uncertainty 1194
Changes in Price Levels 1194
Qualitative Considerations 1195
Capital Rationing 1195
A
APPENDIX B
APPENDIX C
APPENDIX
Transfer Pricing 1102
Market Price Approach 1103
Negotiated Price Approach 1104
Cost Price Approach 1106
CHAPTER
25
Differential Analysis and
Product Pricing...............................1131
Differential Analysis 1132
Lease or Sell 1134
Discontinue a Segment or Product 1135
Make or Buy 1137
Replace Equipment 1139
Process or Sell 1140
Accept Business at a Special Price 1141
Capital Investment Analysis.........1179
APPENDIX
D
Interest Tables .................................A-2
Reversing Entries.............................B-1
End-of-Period Spreadsheet
(Work Sheet) for a Merchandising
Business ............................................C-1
Accounting for Deferred Income
Taxes..................................................D-1
Temporary Differences D-1
Reporting Deferred Taxes D-3
Permanent Differences D-3
APPENDIX
E
Nike, Inc., Annual Report................E-1
Glossary G-1
Subject Index I-1
Company Index I-18
Setting Normal Product Selling Prices 1143
Total Cost Concept 1143
Product Cost Concept 1146
xxxi
C
H
A
P
T
E
R
1
© AP Photo/Paul Sakuma
Introduction to Accounting and Business
G O O G L E™
W
hen two teams pair up for a game of football, there
is often a lot of noise. The band plays, the fans cheer,
and fireworks light up the scoreboard. Obviously, the fans
are committed and care about the outcome of the game.
Just like fans at a football game, the owners of a business
want their business to “win” against their competitors in
the marketplace. While having our football team win can
be a source of pride, winning in the marketplace goes beyond pride and has many tangible benefits. Companies that
are winners are better able to serve customers, to provide
good jobs for employees, and to make more money for the
owners.
One such successful company is Google, one of the most
visible companies on the Internet. Many of us cannot visit the
Web without first stopping at Google to power your search.
As one writer said, “Google is the closest thing the Web has
to an ultimate answer machine.” And yet, Google is a free
tool—no one asks for your credit card when you use any of
Google’s search tools. So, do you think Google has been a
successful company? Does it make money? How would you
know? Accounting helps to answer these questions. Google’s
accounting information tells us that Google is a very successful company that makes a lot of money, but not from you
and me. Google makes its money
from advertisers.
In this textbook, we will
introduce you to accounting,
the language of business. In this
chapter, we begin by discussing what a business is, how it
operates, and the role that
accounting plays.
2
Chapter 1
After studying this chapter, you should be able to:
1
2
3
4
Describe the nature of
a business, the role of
accounting, and ethics
in business.
Summarize the
development of
accounting principles
and relate them to
practice.
Nature of Business and
Accounting
Generally Accepted
Accounting Principles
The Accounting
Equation
Types of Businesses
Business Entity Concept
1-2
EE (page
9)
The Role of Accounting
in Business
The Cost Concept
Role of Ethics in
Accounting and
Business
State the accounting
equation and define
each element of the
equation.
5
Describe and illustrate
how business
transactions can be
recorded in terms of
the resulting change in
the elements of the
accounting equation.
Business Transactions
and the Accounting
Equation
1-3
EE (page 15)
Describe the financial
statements of a
proprietorship and
explain how they
interrelate.
Financial Statements
Income Statement
1-4
EE (page
16)
Statement of Owner’s
Equity
1-1
EE (page
9)
1-5
EE (page
17)
Balance Sheet
Opportunities for
Accountants
1-6
EE (page
19)
Statement of Cash Flows
1-7
EE (page
20)
Interrelationships Among
At a Glance
1
Describe the
nature of a
business, the role of
accounting, and
ethics in business.
Menu
Turn to pg 22
Nature of Business and Accounting
A business1 is an organization in which basic resources (inputs), such as materials and
labor, are assembled and processed to provide goods or services (outputs) to customers.
Businesses come in all sizes, from a local coffee house to Starbucks, which sells over
$9 billion of coffee and related products each year.
The objective of most businesses is to earn a profit. Profit is the difference between the
amounts received from customers for goods or services and the amounts paid for the inputs used to provide the goods or services. In this text, we focus on businesses operating
to earn a profit. However many of the same concepts and principles also apply to not-forprofit organizations such as hospitals, churches, and government agencies.
Types of Businesses
Three types of businesses operated for profit include service, merchandising, and
manufacturing businesses.
1 A complete glossary of terms appears at the end of the text.
Chapter 1
3
Each type of business and some examples are described below.
Service businesses provide services rather than products to customers.
Roughly eight out of every
ten workers in the United
States are service providers.
Delta Air Lines (transportation services)
The Walt Disney Company (entertainment services)
Merchandising businesses sell products they purchase from other businesses to
customers.
Wal-Mart (general merchandise)
Amazon.com (Internet books, music, videos)
Manufacturing businesses change basic inputs into products that are sold to
customers.
General Motors Corporation (cars, trucks, vans)
Dell Inc. (personal computers)
The Role of Accounting in Business
What is the role of accounting in business? The simplest answer is that accounting provides information for managers to use in operating the business. In addition, accounting
provides information to other users in assessing the economic performance and condition
of the business.
Thus, accounting can be defined as an information system that
provides reports to users about the economic activities and conAccounting is an information sysdition of a business. You may think of accounting as the “language
tem that provides reports to users
of business.” This is because accounting is the means by which
about the economic activities and
businesses’ financial information is communicated to users.
condition of a business.
The process by which accounting provides information to
users is as follows:
1. Identify users.
2. Assess users’ information needs.
3. Design the accounting information system to meet users’ needs.
4. Record economic data about business activities and events.
5. Prepare accounting reports for users.
As illustrated in Exhibit 1, users of accounting information can be divided into two
groups: internal users and external users.
Exhibit 1
Users of
Accounting
Information
Providing Accounting Information to Users
Identify
users
Internal users:
Managers,
employees
Users
External users:
Customers,
creditors,
investors,
government
Assess
users’
information
needs
Prepare accounting
reports for
users
Record economic
data about
business activities
and events
Design the accounting
information system
to meet users’
needs
4
Chapter 1
Internal users of accounting information include managers and employees. These
users are directly involved in managing and operating the business. The area of accounting that provides internal users with information is called managerial accounting or management accounting. The objective of managerial accounting is to provide
relevant and timely information for managers’ and employees’ decision-making needs.
Often times, such information is sensitive and is not distributed outside the business.
Examples of sensitive information might include information about customers, prices,
and plans to expand the business. Managerial accountants employed by a business are
employed in private accounting.
External users of accounting information include customers, creditors, and the government. These users are not directly involved in managing and operating the business. The area of accounting that provides external users with information is called
financial accounting. The objective of financial accounting is to provide relevant and
timely information for the decision-making needs of users outside of the business. For
example, financial reports on the operations and condition of the business are useful
for banks and other creditors in deciding whether to lend money to the business.
General-purpose financial statements are one type of financial accounting report that
is distributed to external users. The term general-purpose refers to the wide range of
decision-making needs that these reports are designed to serve. Later in this chapter,
we describe and illustrate general-purpose financial statements.
Role of Ethics in Accounting and Business
The objective of accounting is to provide relevant, timely information for user decision
making. Accountants must behave in an ethical manner so that the information they
provide will be trustworthy and, thus, useful for decision making. Managers and employees must also behave in an ethical manner in managing and operating a business.
Otherwise, no one will be willing to invest in or loan money to the business.
Ethics are moral principles that guide the conduct of individuals. Unfortunately,
business managers and accountants sometimes behave in an unethical manner. A number of managers of the companies listed in Exhibit 2 engaged in accounting or business
fraud. These ethical violations led to fines, firings, and lawsuits. In some cases, managers were criminally prosecuted, convicted, and sent to prison.
What went wrong for the managers and companies listed in Exhibit 2? The answer
normally involved one or both of the following two factors:
Failure of Individual Character. An ethical manager and accountant is honest and
fair. However, managers and accountants often face pressures from supervisors to
meet company and investor expectations. In many of the cases in Exhibit 2, managers and accountants justified small ethical violations to avoid such pressures.
However, these small violations became big violations as the company’s financial
problems became worse.
Culture of Greed and Ethical Indifference. By their behavior and attitude, senior
managers set the company culture. In most of the companies listed in Exhibit 2, the
senior managers created a culture of greed and indifference to the truth.
DOING THE RIGHT THING
Time Magazine named three women as “Persons of
the Year 2002.” Each of these not-so-ordinary women
had the courage, determination, and integrity to do the
right thing. Each risked their personal careers to expose
shortcomings in their organizations. Sherron Watkins,
an Enron vice president, wrote a letter to Enron’s chairman, Kenneth Lay, warning him of improper accounting
that eventually led to Enron’s collapse. Cynthia Cooper,
an internal accountant, informed WorldCom’s Board of
Directors of phony accounting that allowed WorldCom
to cover up over $3 billion in losses and forced
WorldCom into bankruptcy. Coleen Rowley, an FBI staff
attorney, wrote a memo to FBI Director Robert Mueller,
exposing how the Bureau brushed off her pleas to investigate Zacarias Moussaoui, who was indicted as a
co-conspirator in the September 11 terrorist attacks.
Chapter 1
Exhibit 2
Accounting and Business Fraud in the 2000s
Nature of Accounting
or Business Fraud
Company
Result
Adelphia Communications
Rigas family treated the company assets
as their own.
Bankruptcy. Rigas family members found
guilty of fraud and lost their investment in
the company.
American International Group,
Inc. (AIG)
Used sham accounting transactions to
inflate performance.
CEO resigned. Executives criminally
convicted. AIG paid $126 million in fines.
America Online, Inc. and
PurchasePro
Artificially inflated their financial results.
Civil charges filed against senior executives
of both companies. $500 million fine.
Computer Associates
International, Inc.
Fraudulently inflated its financial results.
CEO and senior executives indicted. Five
executives pled guilty. $225 million fine.
Enron
Fraudulently inflated its financial results.
Bankrupcty. Senior executives criminally
convicted. Over $60 billion in stock market
losses.
Fannie Mae
Improperly shifted financial performance
between periods.
CEO and CFO fired. Company made a
$9 billion correction to previously reported
earnings.
HealthSouth
Overstated performance by $4 billion in
false entries.
Senior executives criminally convicted.
Qwest Communications
International, Inc.
Improperly recognized $3 billion in false
receipts.
CEO and six other executives criminally
convicted of “massive financial fraud.”
$250 million SEC fine.
Tyco International, Ltd.
Failed to disclose secret loans to executives
that were subsequently forgiven.
CEO forced to resign and subjected
to frozen asset order and criminally
convicted.
WorldCom
Misstated financial results by nearly
$9 billion.
Bankruptcy. Criminal conviction of CEO
and CFO. Over $100 billion in stock market
losses. Directors forced to pay $18 million.
Xerox Corporation
Recognized $3 billion in revenue prior to
when it should have been.
$10 million fine to SEC. Six executives
forced to pay $22 million.
Exhibit 3
Guideline for
Ethical Conduct
1. Identify an ethical decision by using your personal ethical standards of honesty and fairness.
2. Identify the consequences of the decision and its effect on others.
3. Consider your obligations and responsibilities to those that will be affected
by your decision.
4 . Make a decision that is ethical and fair to those affected by it.
5
6
Chapter 1
As a result of the accounting and business frauds shown in Exhibit 2, Congress
passed new laws to monitor the behavior of accounting and business. For example, the
Sarbanes-Oxley Act of 2002 (SOX) was enacted. SOX established a new oversight body
for the accounting profession called the Public Company Accounting Oversight Board
(PCAOB). In addition, SOX established standards for independence, corporate responsibility, and disclosure.
How does one behave ethically when faced with financial or other types of pressure?
A guideline for behaving ethically is shown in Exhibit 3. 2
Opportunities for Accountants
Numerous career opportunities are available for students majoring in accounting.
Currently, the demand for accountants exceeds the number of new graduates entering the job market. This is partly due to the increased regulation of business
caused by the accounting and business frauds shown in Exhibit 2. Also, more and
more businesses have come to recognize the importance and value of accounting
information.
As we indicated earlier, accountants employed by a business are said to be employed
in private accounting. Private accountants have a variety of possible career options within
a company. Some of these career options are shown in Exhibit 4 along with their starting salaries. Accountants who provide audit services, called auditors, verify the accuracy
of financial records, accounts, and systems. As shown in Exhibit 4, several private
accounting careers have certification options.
Exhibit 4
Accounting Career Paths and Salaries
Accounting
Career Track
Private Accounting
Public Accounting
Annual Starting
Salaries1
Description
Career Options
Accountants employed by
companies, government,
and not-for-profit entities.
Bookkeeper
$34,875
Payroll clerk
$33,500
General accountant
Budget analyst
Cost accountant
$40,750
$42,875
$42,125
Internal auditor
$46,375
Information
technology auditor
$54,625
Certified Information
Systems Auditor (CISA)
Local firms
$43,625
Certified Public
Accountant (CPA)
National firms
$52,500
Certified Public
Accountant (CPA)
Accountants employed
individually or within a
public accounting firm
in tax or audit services.
Certification
Certified Payroll
Professional (CPP)
Certified Management
Accountant (CMA)
Certified Internal
Auditor (CIA)
Source: Robert Half 2008 Salary Guide (Finance and Accounting), Robert Half International, Inc.
1
Median salaries of a reported range. Private accounting salaries are reported for large companies. Salaries may vary by region.
2 Many companies have ethical standards of conduct for managers and employees. In addition, the Institute of Management
Accountants and the American Institute of Certified Public Accountants have professional codes of conduct.
Chapter 1
7
Accountants and their staff who provide services on a fee basis are said to be
employed in public accounting. In public accounting, an accountant may practice as
an individual or as a member of a public accounting firm. Public accountants who have
met a state’s education, experience, and examination requirements may become
Certified Public Accountants (CPAs). CPAs generally perform general accounting, audit, or tax services. As can be seen in Exhibit 4, CPAs have slightly better starting salaries
than private accountants. Career statistics indicate, however, that these salary differences tend to disappear over time.
Because all functions within a business use accounting information, experience in
private or public accounting provides a solid foundation for a career. Many positions
in industry and in government agencies are held by individuals with accounting
backgrounds.
ACCOUNTING REFORM
The financial accounting and reporting failures of Enron,
WorldCom, Tyco, Xerox, and others shocked the investing public. The disclosure that some of the nation’s largest and best-known corporations had overstated profits
and misled investors raised the question: Where were the
CPAs?
In response, Congress passed the Investor Protection,
Auditor Reform, and Transparency Act of 2002, called the
2
Summarize
the
development of
accounting principles
and relate them to
practice.
Sarbanes-Oxley Act. The Act establishes a Public Company
Accounting Oversight Board to regulate the portion of the
accounting profession that has public companies as clients.
In addition, the Act prohibits auditors (CPAs) from providing certain types of nonaudit services, such as investment
banking or legal services, to their clients, prohibits employment of auditors by clients for one year after they
last audited the client, and increases penalties for the
reporting of misleading financial statements.
Generally Accepted Accounting
Principles
If a company’s management could record and report financial data as it saw fit, comparisons among companies would be difficult, if not impossible. Thus, financial accountants
follow generally accepted accounting principles (GAAP) in preparing reports. These
reports allow investors and other users to compare one company to another.
Accounting principles and concepts develop from research, accepted accounting
practices, and pronouncements of regulators. Within the United States, the Financial
Accounting Standards Board (FASB) has the primary responsibility for developing accounting principles. The FASB publishes Statements of Financial Accounting Standards
as well as Interpretations of these Standards. In addition, the Securities and Exchange
Commission (SEC), an agency of the U.S. government, has authority over the accounting and financial disclosures for companies whose shares of ownership (stock) are
traded and sold to the public. The SEC normally accepts the accounting principles set
forth by the FASB. However, the SEC may issue Staff Accounting Bulletins on accounting matters that may not have been addressed by the FASB.
Many countries outside the United States use generally accepted accounting principles adopted by the International Accounting Standards Board (IASB). The IASB issues International Financial Reporting Standards (IFRSs). Significant differences currently
exist between FASB and IASB accounting principles. However, the FASB and IASB are
working together to reduce and eliminate these differences into a single set of accounting
principles. Such a set of worldwide accounting principles would help facilitate investment and business in an increasingly global economy.
In this chapter and text, we emphasize accounting principles and concepts. It is by
this emphasis on the “why” as well as the “how” that you will gain an understanding
of accounting.
8
Chapter 1
Business Entity Concept
The business entity concept limits the economic data in an accounting system to
data related directly to the activities of the business. In other words, the business is
viewed as an entity separate from its owners, creditors, or other
businesses. For example, the accountant for a business with
Under the business entity concept,
one owner would record the activities of the business only and
the activities of a business are
would not record the personal activities, property, or debts of
recorded separately from the
the owner.
activities of its owners, creditors,
A business entity may take the form of a proprietorship, partor other businesses.
nership, corporation, or limited liability company (LLC). Each of
these forms and their major characteristics are listed below.
Form of Business Entity
Characteristics
Proprietorship is owned by
one individual.
•
•
•
•
Partnership is owned by
two or more individuals.
• 10% of business organizations in the United States
(combined with limited liability companies).
• Combines the skills and resources of more than one
person.
Corporation is organized
under state or federal
statutes as a separate legal
taxable entity.
•
•
•
•
•
Limited liability company (LLC)
combines the attributes of a
partnership and a corporation.
• 10% of business organizations in the United States
(combined with partnerships).
• Often used as an alternative to a partnership.
• Has tax and legal liability advantages for owners.
70% of business entities in the United States.
Easy and cheap to organize.
Resources are limited to those of the owner.
Used by small businesses.
Generates 90% of business revenues.
20% of the business organizations in the United States.
Ownership is divided into shares called stock.
Can obtain large amounts of resources by issuing stock.
Used by large businesses.
The three types of businesses we discussed earlier—service, merchandising, and
manufacturing—may be organized as proprietorships, partnerships, corporations, or
limited liability companies. Because of the large amount of resources required to operate a manufacturing business, most manufacturing businesses such as Ford Motor
Company are corporations. Most large retailers such as Wal-Mart and Home Depot are
also corporations.
The Cost Concept
Under the cost concept, amounts are initially recorded in the accounting records at
their cost or purchase price. To illustrate, assume that Aaron Publishers purchased the
following building on February 20, 2008:
Price listed by seller on January 1, 2008
Aaron Publishers’ initial offer to buy on January 31, 2008
Purchase price on February 20, 2008
Estimated selling price on December 31, 2010
Assessed value for property taxes, December 31, 2010
$160,000
140,000
150,000
220,000
190,000
Under the cost concept, Aaron Publishers records the purchase of the building on
February 20, 2008, at the purchase price of $150,000. The other amounts listed above
have no effect on the accounting records.
The fact that the building has an estimated selling price on December 31, 2010,
indicates that the building has increased in value. However, to use the $220,000 in the
accounting records would be to record an illusory or unrealized profit. If Aaron
Publishers sells the building on January 9, 2011, for $220,000, a profit of $70,000 is then
realized and recorded. The new owner would record $220,000 as its cost of the building.
Chapter 1
9
The cost concept also involves the objectivity and unit of measure concepts. The
objectivity concept requires that the amounts recorded in the accounting records be
based on objective evidence. In exchanges between a buyer and a seller, both try to get
the best price. Only the final agreed-upon amount is objective enough to be recorded
in the accounting records. If amounts in the accounting records were constantly being
revised upward or downward based on offers, appraisals, and opinions, accounting reports could become unstable and unreliable.
The unit of measure concept requires that economic data be recorded in dollars.
Money is a common unit of measurement for reporting financial data and reports.
2
Cost Concept
On August 25, Gallatin Repair Service extended an offer of $125,000 for land that had been priced for
sale at $150,000. On September 3, Gallatin Repair Service accepted the seller’s counteroffer of $137,000.
On October 20, the land was assessed at a value of $98,000 for property tax purposes. On December 4,
Gallatin Repair Service was offered $160,000 for the land by a national retail chain. At what value should
the land be recorded in Gallatin Repair Service’s records?
$137,000. Under the cost concept, the land should be recorded at the cost to Gallatin Repair Service.
3
State the
accounting
equation and define
each element of the
equation.
The Accounting Equation
The resources owned by a business are its assets. Examples of assets include cash, land,
buildings, and equipment. The rights or claims to the assets are divided into two types:
(1) the rights of creditors and (2) the rights of owners. The rights of creditors are the
debts of the business and are called liabilities. The rights of the owners are called
owner’s equity. The following equation shows the relationship among assets, liabilities,
and owner’s equity:
Assets Liabilities Owner’s Equity
3
Accounting Equation
John Joos is the owner and operator of You’re A
Star, a motivational consulting business. At the
end of its accounting period, December 31, 2009,
You’re A Star has assets of $800,000 and liabilities
of $350,000. Using the accounting equation,
determine the following amounts:
a. Owner’s equity, as of December 31, 2009.
b. Owner’s equity, as of December 31, 2010,
assuming that assets increased by $130,000
and liabilities decreased by $25,000
during 2010.
a.
$800,000 $350,000 Owner’s Equity
Owner’s Equity $450,000
b. First, determine the change in Owner’s Equity
during 2010 as follows:
Next, add the change in Owner’s Equity on
December 31, 2009 to arrive at Owner’s Equity
on December 31, 2010, as shown below.
Owner’s Equity on December 31, 2010 $605,000 $450,000 $155,000
$130,000 $25,000 Owner’s Equity
Owner’s Equity $155,000
10
Chapter 1
This equation is called the accounting equation. Liabilities usually are shown before
owner’s equity in the accounting equation because creditors have first rights to the assets.
Given any two amounts, the accounting equation may be solved for the third unknown
amount. To illustrate, if the assets owned by a business amount to $100,000 and the liabilities amount to $30,000, the owner’s equity is equal to $70,000, as shown below.
$100,000 $30,000 $70,000
4
Describe and
illustrate
how business
transactions can be
recorded in terms of
the resulting change
in the elements of
the accounting
equation.
Business Transactions and the
Accounting Equation
Paying a monthly telephone bill of $168 affects a business’s financial condition because
it now has less cash on hand. Such an economic event or condition that directly changes
an entity’s financial condition or its results of operations is a business transaction. For
example, purchasing land for $50,000 is a business transaction. In contrast, a change in
a business’s credit rating does not directly affect cash or any other asset, liability, or
owner’s equity amount.
All business transactions can be stated in terms of changes in the elements of the
accounting equation. We illustrate how business transactions affect the accounting
equation by using some typical transactions. As a basis for illustration, we use a business organized by Chris Clark.
Assume that on November 1, 2009, Chris Clark begins a business that will be known
as NetSolutions. The first phase of Chris’s business plan is to operate NetSolutions as
a service business assisting individuals and small businesses in
developing Web pages and installing computer software. Chris
expects this initial phase of the business to last one to two years.
All business transactions can be
During this period, Chris plans on gathering information on the
stated in terms of changes in
software and hardware needs of customers. During the second
the elements of the accounting
phase of the business plan, Chris plans to expand NetSolutions into
equation.
a personalized retailer of software and hardware for individuals
and small businesses.
THE ACCOUNTING EQUATION
The accounting equation serves as the basic foundation for
the accounting systems of all companies. From the smallest business, such as the local convenience store, to the
largest business, such as Ford Motor Company, companies use the accounting equation. Some examples taken
from recent financial reports of well-known companies are
shown below.
Company
Assets* Liabilities Owner’s Equity
The Coca-Cola Company
Circuit City Stores, Inc.
Dell Inc.
eBay Inc.
Google
McDonald’s
Microsoft Corporation
Southwest Airlines Co.
Wal-Mart
$ 29,963
4,007
25,635
13,494
18,473
29,024
63,171
13,460
151,193
*Amounts are shown in millions of dollars.
$13,043
2,216
21,196
2,589
1,433
13,566
32,074
7,011
89,620
$16,920
1,791
4,439
10,905
17,040
15,458
31,097
6,449
61,573
Chapter 1
11
Each transaction during NetSolutions’ first month of operations is described in the following paragraphs. The effect of each transaction on the accounting equation is then shown.
Transaction A
Nov. 1, 2009 Chris Clark deposits $25,000 in a bank account in the name of
NetSolutions.
This transaction increases the asset cash (on the left side of the equation) by $25,000.
To balance the equation, the owner’s equity (on the right side of the equation) increases
by the same amount. The equity of the owner is identified using the owner’s name and
“Capital,” such as “Chris Clark, Capital.”
The effect of this transaction on NetSolutions’ accounting equation is shown below.
a.
Assets
Owner’s Equity
Cash
25,000
Chris Clark, Capital
25,000
Since Chris Clark is the sole owner, NetSolutions is a proprietorship. Also, the
accounting equation shown above is only for the business, NetSolutions. Under the
business entity concept, Chris Clark’s personal assets, such as a home or personal bank
account, and personal liabilities are excluded from the equation.
Transaction B
Nov. 5, 2009 NetSolutions paid $20,000 for the purchase of land as a future
building site.
The land is located in a business park with access to transportation facilities. Chris Clark
plans to rent office space and equipment during the first phase of the business plan.
During the second phase, Chris plans to build an office and a warehouse on the land.
The purchase of the land changes the makeup of the assets, but it does not change
the total assets. The items in the equation prior to this transaction and the effect of the
transaction are shown below. The new amounts are called balances.
Assets
Cash Land
Bal.
25,000
b.
20,000 20,000
Bal.
5,000
20,000
Owner’s Equity
Chris Clark, Capital
25,000
25,000
Transaction C
Nov. 10, 2009 NetSolutions purchased supplies for $1,350 and agreed to pay the
supplier in the near future.
You have probably used a credit card to buy clothing or other merchandise. In
this type of transaction, you received clothing for a promise to pay your credit card
bill in the future. That is, you received an asset and incurred a liability to pay a future
bill. NetSolutions entered into a similar transaction by purchasing supplies for $1,350
and agreeing to pay the supplier in the near future. This type of transaction is called a
purchase on account and is often described as follows: Purchased supplies on account,
$1,350.
12
Chapter 1
The liability created by a purchase on account is called an account payable. Items
such as supplies that will be used in the business in the future are called prepaid
expenses, which are assets. Thus, the effect of this transaction is to increase assets
(Supplies) and liabilities (Accounts Payable) by $1,350, as follows:
Other examples of common
prepaid expenses include
insurance and rent.
Businesses often report
these assets together as
a single item, prepaid
expenses.
Bal.
c.
Bal.
Assets
Cash Supplies Land
5,000
20,000
1,350
5,000
1,350
20,000
Liabilities Owner’s Equity
Accounts Chris Clark,
Payable
Capital
25,000
1,350
1,350
25,000
Transaction D
Nov. 18, 2009 NetSolutions received cash of $7,500 for providing services to
customers.
You may have earned money by painting houses or mowing lawns. If so, you received
money for rendering services to a customer. Likewise, a business earns money by selling goods or services to its customers. This amount is called revenue.
During its first month of operations, NetSolutions received cash of $7,500 for providing services to customers. The receipt of cash increases NetSolutions’ assets and also
increases Chris Clark’s equity in the business. The revenues of $7,500 are recorded in
a Fees Earned column to the right of Chris Clark, Capital. The effect of this transaction
is to increase Cash and Fees Earned by $7,500, as shown below.
Bal.
d.
Bal.
Assets
Cash Supplies Land
5,000
1,350
20,000
7,500
12,500
1,350
20,000
Accounts
Chris Clark,
Fees
Payable Capital
Earned
1,350
25,000
7,500
1,350
25,000
7,500
Different terms are used for the various types of revenues. As illustrated above,
revenue from providing services is recorded as fees earned. Revenue from the sale of
merchandise is recorded as sales. Other examples of revenue include rent, which is
recorded as rent revenue, and interest, which is recorded as interest revenue.
Instead of receiving cash at the time services are provided or goods are sold, a business may accept payment at a later date. Such revenues are described as fees earned on
account or sales on account. For example, if NetSolutions had provided services on account
instead of for cash, transaction (d) would have been described as follows: Fees earned on
account, $7,500.
In such cases, the firm has an account receivable, which is a claim against the
customer. An account receivable is an asset, and the revenue is earned and recorded
as if cash had been received. When customers pay their accounts, Cash increases and
Accounts Receivable decreases.
Transaction E
Nov. 30, 2009 NetSolutions paid the following expenses during the month:
wages, $2,125; rent, $800; utilities, $450; and miscellaneous, $275.
During the month, NetSolutions spent cash or used up other assets in earning revenue.
Assets used in this process of earning revenue are called expenses. Expenses include
supplies used and payments for employee wages, utilities, and other services.
Chapter 1
13
NetSolutions paid the following expenses during the month: wages, $2,125; rent,
$800; utilities, $450; and miscellaneous, $275. Miscellaneous expenses include small
amounts paid for such items as postage, coffee, and newspapers. The effect of expenses
is the opposite of revenues in that expenses reduce assets and owner’s equity. Like fees
earned, the expenses are recorded in columns to the right of Chris Clark, Capital.
However, since expenses reduce owner’s equity, the expenses are entered as negative
amounts. The effect of this transaction is shown below.
Liabilities Assets
Cash Supplies Land Bal. 12,500 1,350
20,000
e. 3,650
Bal. 8,850 1,350
20,000
Owner’s Equity
Accounts
Chris Clark,
Fees
Wages
Rent
Utilities
Misc.
Payable Capital Earned Exp. Exp. Exp. Exp.
1,350
25,000
7,500
2,125
800
450
275
1,350
25,000
7,500 2,125
800
450
275
Businesses usually record each revenue and expense transaction as it occurs.
However, to simplify, we have summarized NetSolutions’ revenues and expenses for
the month in transactions (d) and (e).
Transaction F
Nov. 30, 2009
NetSolutions paid creditors on account, $950.
When you pay your monthly credit card bill, you decrease the cash in your checking
account and decrease the amount you owe to the credit card company. Likewise, when
NetSolutions pays $950 to creditors during the month, it reduces assets and liabilities,
as shown below.
Assets
Cash Supplies Land
Bal. 8,850
1,350
20,000
f. 950
Bal. 7,900
1,350
20,000
Liabilities Accounts
Chris Clark,
Payable Capital 1,350
25,000
950
400
25,000
Owner’s Equity
Fees
Wages
Rent
Utilities
Misc.
Earned Exp. Exp. Exp. Exp.
7,500 2,125
800
450
275
7,500
2,125
800
450
275
Paying an amount on account is different from paying an expense. The paying of
an expense reduces owner’s equity, as illustrated in transaction (e). Paying an amount
on account reduces the amount owed on a liability.
Transaction G
Nov. 30, 2009 Chris Clark determined that the cost of supplies on hand at the
end of the month was $550.
The cost of the supplies on hand (not yet used) at the end of the month is $550. Thus,
$800 ($1,350 $550) of supplies must have been used during the month. This decrease
in supplies is recorded as an expense, as shown at the top of the next page.
14
Chapter 1
Assets
Bal.
g.
Bal.
Cash Supplies Land
7,900
1,350
20,000
800
7,900
550
20,000
Liabilities
Owner’s Equity
Accounts Chris Clark, Fees Wages Rent Supplies Utilities Misc.
Payable Capital Earned Exp. Exp. Exp. Exp. Exp.
400
25,000
7,500 2,125 800
450 275
800
400
25,000
7,500 2,125 800
800
450 275
Transaction H
Nov. 30, 2009
Chris Clark withdrew $2,000 from NetSolutions for personal use.
At the end of the month, Chris Clark withdrew $2,000 in cash from the business for personal use. This transaction is the opposite of an investment in the business by the owner.
Withdrawals by the owner should not be confused with expenses. Withdrawals do not
represent assets or services used in the process of earning revenues. Instead, withdrawals
are a distribution of capital to the owner. Owner withdrawals are identified by the
owner’s name and Drawing. For example, Chris Clark’s withdrawal is identified as Chris
Clark, Drawing. Like expenses, withdrawals are recorded in a column to the right of
Chris Clark, Capital. The effect of the $2,000 withdrawal is shown as follows:
Assets
Cash Supp. Land
Bal. 7,900
550
20,000
h. 2,000
Bal. 5,900
550
20,000
Accounts Chris Clark, Chris Clark,
Payable Capital Drawing 400
25,000
2,000
400
25,000
2,000
Fees
Wages Rent Supplies Utilities Misc.
Earned Exp. Exp. Exp. Exp. Exp.
7,500
2,125 800
800
450 275
7,500
2,125 800
800
450
275
Summary The transactions of NetSolutions are summarized below. Each transaction is
identified by letter, and the balance of each item is shown after every transaction.
Assets
Cash Supp. Land
a. 25,000
b. 20,000
20,000
Bal.
5,000
20,000
c.
1,350
Bal.
5,000 1,350
20,000
d.
7,500
Bal. 12,500 1,350
20,000
e.
3,650
Bal.
8,850 1,350
20,000
f.
950
Bal.
7,900 1,350
20,000
g.
800
Bal.
7,900
550
20,000
h.
2,000
Bal.
5,900
550
20,000
Accounts Chris Clark, Chris Clark,
Fees
Wages Rent Supplies Utilities Misc.
Payable Capital Drawing Earned Exp. Exp. Exp. Exp. Exp.
25,000
25,000
1,350
1,350
25,000
1,350
25,000
7,500
7,500
1,350
950
400
25,000
7,500
2,125 800
2,125 800
25,000
7,500
2,125 800
400
400
25,000
25,000
2,000
2,000
7,500
2,125 800
800
800
7,500
2,125 800
800
450
450
275
275
450
275
450
275
450
275
Chapter 1
15
You should note the following in the preceding summary:
1.
2.
3.
The effect of every transaction is an increase or a decrease in one or more of the accounting equation elements.
The two sides of the accounting equation are always equal.
The owner’s equity is increased by amounts invested by the owner and is decreased by
withdrawals by the owner. In addition, the owner’s equity is increased by revenues and
is decreased by expenses.
The effects of these four types of transactions on owner’s equity are illustrated in
Exhibit 5.
Exhibit 5
Effects of
Transactions on
Owner’s Equity
Ow ne r's Eq ui ty
Increased by
Decreased by
• Owner’s investments
• Revenues
• Owner’s withdrawals
• Expenses
4
Transactions
Salvo Delivery Service is owned and operated by Joel Salvo. The following selected transactions were
completed by Salvo Delivery Service during February:
1.
2.
3.
4.
5.
Received cash from owner as additional investment, $35,000.
Paid creditors on account, $1,800.
Billed customers for delivery services on account, $11,250.
Received cash from customers on account, $6,740.
Paid cash to owner for personal use, $1,000.
Indicate the effect of each transaction on the accounting equation elements (Assets, Liabilities, Owner’s
Equity, Drawing, Revenue, and Expense) by listing the numbers identifying the transactions, (1) through (5).
Also, indicate the specific item within the accounting equation element that is affected. To illustrate, the answer to (1) is shown below.
(1) Asset (Cash) increases by $35,000; Owner’s Equity (Joel Salvo, Capital) increases by $35,000.
(2) Asset (Cash) decreases by $1,800; Liability (Accounts Payable) decreases by $1,800.
(3) Asset (Accounts Receivable) increases by $11,250; Revenue (Delivery Service Fees) increases by $11,250.
(4) Asset (Cash) increases by $6,740; Asset (Accounts Receivable) decreases by $6,740.
(5) Asset (Cash) decreases by $1,000; Drawing (Joel Salvo, Drawing) increases by $1,000.
5
Describe the
financial
statements of a
proprietorship and
explain how they
interrelate.
After transactions have been recorded and summarized, reports are prepared for users.
The accounting reports providing this information are called financial statements.
The primary financial statements of a proprietorship are the income statement, the statement of owner’s equity, the balance sheet, and the statement of cash flows. The order
that the financial statements are prepared and the nature of each statement is described
as follows.
16
Chapter 1
Order
Prepared
Financial Statement
Description of Statement
1.
Income statement
2.
Statement of owner’s
equity
3.
Balance sheet
4.
Statement of cash flows
A summary of the revenue and expenses
for a specific period of time, such as a
month or a year.
A summary of the changes in the owner’s
equity that have occurred during a specific
period of time, such as a month or a year.
A list of the assets, liabilities, and owner’s
equity as of a specific date, usually at the
close of the last day of a month or a year.
A summary of the cash receipts and cash
payments for a specific period of time, such
as a month or a year.
The four financial statements and their interrelationships are illustrated in Exhibit 6,
on page 18. The data for the statements are taken from the summary of transactions of
NetSolutions on page 14.
All financial statements are identified by the name of the business, the title of the
statement, and the date or period of time. The data presented in the income statement,
the statement of owner’s equity, and the statement of cash flows are for a period of
time. The data presented in the balance sheet are for a specific date.
Income Statement
When you buy something at
a store, you may match the
cash register total with the
amount you paid the cashier
and with the amount of
change, if any, you received.
The income statement reports the revenues and expenses for a period of time, based on the
matching concept. This concept is applied by matching the expenses with the revenue generated during a period by those expenses. The excess of the revenue over the expenses is
called net income or net profit. If the expenses exceed the revenue, the excess is a net loss.
The revenue and expenses for NetSolutions were shown in the equation as separate
increases and decreases in each item. Net income for a period increases the owner’s equity
(capital) for the period. A net loss decreases the owner’s equity (capital) for the period.
5
Income Statement
The assets and liabilities of Chickadee Travel Service at April 30, 2010, the end of the current year,
and its revenue and expenses for the year are listed below. The capital of the owner, Adam Cellini,
was $80,000 at May 1, 2009, the beginning of the current year.
Accounts payable
Accounts receivable
Cash
Fees earned
Land
$ 12,200
31,350
53,050
263,200
80,000
Miscellaneous expense
Office expense
Supplies
Wages expense
$ 12,950
63,000
3,350
131,700
Prepare an income statement for the current year ended April 30, 2010.
Chickadee Travel Service
Income Statement
For the Year Ended April 30, 2010
Fees earned . . . . . . . . . .
Expenses:
Wages expense . . . . . .
Office expense . . . . . .
Total expenses . . . . .
Net income . . . . . . . . . . .
..............
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$263,200
$131,700
63,000
12,950
207,650
$ 55,550
Chapter 1
17
The revenue, expenses, and the net income of $3,050 for NetSolutions are reported
in the income statement in Exhibit 6, on page 18. The order in which the expenses are
listed in the income statement varies among businesses. Most businesses list expenses
in order of size, beginning with the larger items. Miscellaneous expense is usually shown
as the last item, regardless of the amount.
The statement of owner’s equity reports the changes in the owner’s equity for a period
of time. It is prepared after the income statement because the net income or net loss
for the period must be reported in this statement. Similarly, it is prepared before
the balance sheet, since the amount of owner’s equity at the end of the period must
be reported on the balance sheet. Because of this, the statement of owner’s equity
is often viewed as the connecting link between the income statement and balance
sheet.
Three types of transactions affected owner’s equity for NetSolutions during
November: (1) the original investment of $25,000, (2) the revenue and expenses that
resulted in net income of $3,050 for the month, and (3) a withdrawal of $2,000 by the
owner. This information is summarized in the statement of owner’s equity in Exhibit 6.
5
Using the data for Chickadee Travel Service shown in Example Exercise 1-4, prepare a statement
of owner’s equity for the current year ended April 30, 2010. Adam Cellini invested an additional
$50,000 in the business during the year and withdrew cash of $30,000 for personal use.
Adam Cellini, capital, May 1, 2009 . . . . . . . . . . . . . . .
Additional investment by owner during year . . . . . . .
Net income for the year . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity . . . . . . . . . . . . . . . . . . . . .
Adam Cellini, capital, April 30, 2010 . . . . . . . . . . . . . .
$ 80,000
$ 50,000
55,550
$105,550
30,000
75,550
$155,550
Balance Sheet
Bank loan officers use a business’s financial statements in
deciding whether to grant a
loan to the business. Once
the loan is granted, the borrower may be required to
maintain a certain level of
assets in excess of liabilities.
The business’s financial
statements are used to monitor this level.
The balance sheet in Exhibit 6 reports the amounts of NetSolutions’ assets, liabilities,
and owner’s equity as of November 30, 2009. The asset and liability amounts are taken
from the last line of the summary of transactions on page 14. Chris Clark, Capital as of
November 30, 2009, is taken from the statement of owner’s equity. The form of balance
sheet shown in Exhibit 6 is called the account form. This is because it resembles the
basic format of the accounting equation, with assets on the left side and the liabilities
and owner’s equity sections on the right side.3
The assets section of the balance sheet presents assets in the order that they will
be converted into cash or used in operations. Cash is presented first, followed by receivables, supplies, prepaid insurance, and other assets. The assets of a more permanent nature are shown next, such as land, buildings, and equipment.
3 We illustrate an alternative form of balance sheet, called the report form, in Chapter 6. It presents the liabilities and
owner’s equity sections below the assets section.
18
Chapter 1
Exhibit 6
Financial
Statements for
NetSolutions
NetSolutions
Income Statement
For the Month Ended November 30, 2009
Fees earned . . . . . . . . .
Expenses:
Wages expense . . . . .
Rent expense . . . . . . .
Supplies expense . . . .
Utilities expense . . . . .
Total expense . . . . .
Net income . . . . . . . . . .
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$7,500
$2,125
800
800
450
275
4,450
$3,050
NetSolutions
Chris Clark, capital, November 1, 2009. . . . . . . . . . . . . . . . . .
Investment on November 1, 2009 . . . . . . . . . . . . . . . . . . . . .
Net income for November . . . . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity . . . . . . . . . . . . . . . . . . . . . . . . . .
Chris Clark, capital, November 30, 2009 . . . . . . . . . . . . . . . . .
$
0
$25,000
3,050
$ 28,050
2,000
26,050
$26,050
NetSolutions
Balance Sheet
November 30, 2009
Cash . . . . .
Supplies . .
Land . . . . .
Total assets
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Assets
......
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$ 5,900
550
20,000
$26,450
Liabilities
Accounts payable . . . . . . . . . . . . . .
Owner’s Equity
Chris Clark, capital . . . . . . . . . . . . .
Total liabilities and owner’s equity . .
$
400
26,050
$26,450
NetSolutions
Cash flows from operating activities:
Cash received from customers . . . . . . . . . . . . . . .
Deduct cash payments for expenses and payments
to creditors . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net cash flow from operating activities. . . . . . . . . .
Cash flows from investing activities:
Cash payments for purchase of land. . . . . . . . . . . .
Cash flows from financing activities:
Cash received as owner’s investment . . . . . . . . . . .
Deduct cash withdrawal by owner . . . . . . . . . . . . .
Net cash flow from financing activities . . . . . . . . . .
Net cash flow and November 30, 2009, cash balance .
......
$ 7,500
......
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4,600
$ 2,900
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(20,000)
$ 25,000
2,000
23,000
$ 5,900
Chapter 1
19
In the liabilities section of the balance sheet in Exhibit 6, accounts payable is the only
liability. When there are two or more liabilities, each should be listed and the total amount
of liabilities presented as follows:
Liabilities
Accounts payable
Wages payable
Total liabilities
$12,900
2,570
$15,470
5
Balance Sheet
Using the data for Chickadee Travel Service shown in
Example Exercises 1-4 and 1-5, prepare the balance sheet as of April 30, 2010.
Balance Sheet
April 30, 2010
Cash . . . . . . . . . . . .
Accounts receivable
Supplies . . . . . . . . .
Land . . . . . . . . . . . .
Total assets . . . . . . .
Assets
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$ 53,050
31,350
3,350
80,000
$167,750
Liabilities
Accounts payable . . . . . . . . . . . . . .
$ 12,200
Owner’s Equity
Adam Cellini, capital . . . . . . . . . . . .
Total liabilities and owner’s equity . .
155,550
$167,750
The statement of cash flows consists of three sections, as shown in Exhibit 6: (1) operating activities, (2) investing activities, and (3) financing activities. Each of these sections is
briefly described below.
Cash Flows from Operating Activities This section reports a summary of cash
receipts and cash payments from operations. The net cash flow from operating activities normally differs from the amount of net income for the period. In Exhibit 6,
NetSolutions reported net cash flows from operating activities of $2,900 and net income
of $3,050. This difference occurs because revenues and expenses may not be recorded
at the same time that cash is received from customers or paid to creditors.
Cash Flows from Investing Activities This section reports the cash transactions
for the acquisition and sale of relatively permanent assets. Exhibit 6 reports that
NetSolutions paid $20,000 for the purchase of land during November.
Cash Flows from Financing Activities This section reports the cash transactions
related to cash investments by the owner, borrowings, and withdrawals by the owner.
Exhibit 6 shows that Chris Clark invested $25,000 in the business and withdrew $2,000
during November.
Preparing the statement of cash flows requires that each of the November cash transactions for NetSolutions be classified as operating, investing, or financing activities.
Using the summary of transactions shown on page 14, the November cash transactions
for NetSolutions are classified as follows:
Transaction
a.
b.
d.
e.
f.
h.
Amount
Cash Flow Activity
$25,000
20,000
7,500
3,650
950
2,000
Financing (Investment by Chris Clark)
Investing (Purchase of land)
Operating (Fees earned)
Operating (Payment of expenses)
Operating (Payment of account payable)
Financing (Withdrawal by Chris Clark)
20
Chapter 1
Transactions (c) and (g) are not listed above since they did not involve a cash receipt or payment. In addition, the payment of accounts payable in transaction (f) is classified as an operating activity since the account payable arose from the purchase of
supplies, which are used in operations. Using the preceding classifications of November
cash transactions, the statement of cash flows is prepared as shown in Exhibit 6.4
The ending cash balance shown on the statement of cash flows is also reported on
the balance sheet as of the end of the period. To illustrate, the ending cash of $5,900 reported on the November statement of cash flows in Exhibit 6 is also reported as the
amount of cash on hand in the November 30, 2009, balance sheet.
Since November is NetSolutions’ first period of operations, the net cash flow for
November and the November 30, 2009, cash balance are the same amount, $5,900, as
shown in Exhibit 6. In later periods, NetSolutions will report in its statement of cash
flows a beginning cash balance, an increase or a decrease in cash for the period, and
an ending cash balance. For example, assume that for December NetSolutions has a decrease in cash of $3,835. The last three lines of NetSolutions’ statement of cash flows
for December would be as follows:
Decrease in cash
Cash as of December 1, 2009
Cash as of December 31, 2009
$3,835
5,900
$2,065
5
A summary of cash flows for Chickadee Travel Service for the year ended April 30, 2010, is shown below.
Cash receipts:
Cash received from customers . . . . . . . . . . . . . . . . . . . . . . . . .
Cash received from additional investment of owner . . . . . . . . .
$251,000
50,000
Cash payments:
Cash paid for expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash paid for land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cash paid to owner for personal use . . . . . . . . . . . . . . . . . . . .
210,000
80,000
30,000
The cash balance as of May 1, 2009, was $72,050. Prepare a statement of cash flows for Chickadee Travel
Service for the year ended April 30, 2010.
Cash received from customers . . . . . . . . .
Deduct cash payments for expenses . . . .
Net cash flows from operating activities. .
Cash payments for purchase of land . . . .
Cash received from owner as investment .
Deduct cash withdrawals by owner . . . . .
Net cash flows from financing activities . .
Net decrease in cash during year . . . . . . . . . .
Cash as of May 1, 2009 . . . . . . . . . . . . . . . . . .
Cash as of April 30, 2010 . . . . . . . . . . . . . . . . .
..............
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..............
$251,000
210,000
$ 41,000
..............
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(80,000)
$ 50,000
30,000
20,000
$ (19,000)
72,050
$ 53,050
4 This method of preparing the statement of cash flows is called the “direct method.” This method and the indirect
method are discussed further in Chapter 16.
Chapter 1
21
Interrelationships Among Financial Statements
Financial statements are prepared in the order of the income statement, statement of
owner’s equity, balance sheet, and statement of cash flows. This order is important because the financial statements are interrelated. These interrelationships for NetSolutions
are shown in Exhibit 6 and are described below.5
Interrelationship
NetSolutions Example (Exhibit 6)
Income Statement and
Equity
Net income or net loss
reported on the income
statement is also reported
on the statement of
owner’s equity as either
an addition (net income)
to or deduction (net loss)
from the beginning owner’s
equity and any additional
investments by the owner
during the period.
NetSolutions’ net income of
$3,050 for November is added to
Chris Clark’s investment of
$25,000 in the statement of
owner’s equity.
Equity and Balance
Sheet
Owner’s capital at the end
of the period reported on
the statement of owner’s
equity is also reported on
the balance sheet as
owner’s capital.
Chris Clark, Capital of $26,050 as
of November 30, 2009, on the
statement of owner’s equity also
appears on the November 30,
2009, balance sheet as Chris
Clark, Capital.
Balance Sheet and
Statement of Cash
Flows
The cash reported on the
balance sheet is also
reported as the end-ofperiod cash on the
statement of cash flows.
Cash of $5,900 reported on the
balance sheet as of November 30,
2009, is also reported on the
November statement of cash
flows as the end-of-period cash.
The preceding interrelationships are important in analyzing financial statements
and the impact of transactions on a business. In addition, these interrelationships serve
as a check on whether the financial statements are prepared correctly. For example, if
the ending cash on the statement of cash flows doesn’t agree with the balance sheet
cash, then an error has occurred.
Financial statements are useful to bankers, creditors, owners, and other users in analyzing and interpreting the financial performance and condition of a business. Throughout
this text, we discuss various tools that are often used to analyze and interpret the financial performance and condition
of a business. The first such tool we introduce is useful in
analyzing the ability of a business to pay its creditors.
The relationship between liabilities and owner’s equity, expressed as a ratio, is computed as follows:
Total Liabilities
Ratio of Liabilities
to Owner’s Equity = Total Owner ,s Equity (or
,
Total Stockholders Equity)
$400
Ratio of Liabilities
=
= 0.015
,
to Owner s Equity
$26,050
Corporations refer to total owner’s equity as total
stockholders’ equity. Thus, you should substitute total
stockholders’ equity for total owner’s equity when computing this ratio for a corporation.
The rights of creditors to a business’s assets take
precedence over the rights of the owners or stockholders.
Thus, the lower the ratio of liabilities to owner’s equity,
the better able the business is to withstand poor business
conditions and pay its obligations to creditors.
To illustrate, NetSolutions’ ratio of liabilities to owner’s
equity at the end of November is 0.015, as calculated at
the top of the next column.
5 Depending on the method of preparing the cash flows from operating activities section of the statement of cash
flows, net income (or net loss) may also appear on the statement of cash flows. This interrelationship or method of
preparing the statement of cash flows, called the “indirect method,” is described and illustrated in Chapter 16.
At a Glance
1
1
Describe the nature of a business, the role of accounting, and ethics in business.
Key Points
A business provides goods or services (outputs) to customers with the objective of earning a
profit. Three types of businesses include service,
merchandising, and manufacturing businesses.
Accounting, called the “language of business,” is an information system that provides
reports to users about the economic activities
and condition of a business.
Ethics are moral principles that guide the
conduct of individuals. Good ethical conduct depends on individual character and firm culture.
Accountants are engaged in private accounting or public accounting.
2
Example
Exercises
Practice
Exercises
• Distinguish among service,
merchandising, and manufacturing businesses.
• Describe the role of accounting
in business and explain why accounting is called the “language
of business.”
• Define ethics and list the two
factors affecting ethical conduct.
• Describe what private and public accounting means.
Summarize the development of accounting principles and relate them to practice.
Key Points
Generally accepted accounting principles
(GAAP) are used in preparing financial statements so that users can compare one company
to another. Accounting principles and concepts
develop from research, practice, and pronouncements of authoritative bodies such as the
Financial Accounting Standards Board (FASB),
Securities and Exchange Commission (SEC), and
the International Accounting Standards Board
(IASB).
The business entity concept views the business as an entity separate from its owners,
creditors, or other businesses. Businesses may
be organized as proprietorships, partnerships,
corporations, and limited liability companies. The
cost concept requires that properties and services bought by a business be recorded in terms
of actual cost. The objectivity concept requires
that the accounting records and reports be
based on objective evidence. The unit of measure concept requires that economic data be
recorded in dollars.
3
Example
Exercises
Practice
Exercises
1-1
1-1A, 1-1B
Example
Exercises
Practice
Exercises
1-2
1-2A, 1-2B
• Explain what is meant by generally
accepted accounting principles.
• Describe how generally accepted accounting principles
are developed.
• Describe and give an example
of what is meant by the business entity concept.
• Describe the characteristics of
a proprietorship, partnership,
corporation, and limited liability
company.
of what is meant by the cost
concept.
of what is meant by the objectivity concept.
of what is meant by the unit of
measure concept.
State the accounting equation and define each element of the equation.
Key Points
The resources owned by a business and the
rights or claims to these resources may be
stated in the form of an equation, as follows:
• State the accounting equation.
• Given two elements of the
accounting equation, solve for
the third element.
22
• Define assets, liabilities, and
owner’s equity.
4
5
Describe and illustrate how business transactions can be recorded in terms of the resulting change in the
elements of the accounting equation.
Key Points
All business transactions can be stated in
terms of the change in one or more of the
three elements of the accounting equation.
• Define a business transaction.
• Using the accounting equation
as a framework, record
transactions.
Example
Exercises
Practice
Exercises
1-3
1-3A, 1-3B
Describe the financial statements of a proprietorship and explain how they interrelate.
Key Points
Example
Exercises
Practice
Exercises
• Prepare an income statement.
1-4
1-4A, 1-4B
• Prepare a statement of owner’s
equity.
1-5
1-5A, 1-5B
• Prepare a balance sheet.
1-6
1-6A, 1-6B
• Prepare a statement of cash
flows.
1-7
1-7A, 1-7B
The primary financial statements of a
proprietorship are the income statement, the
statement of owner’s equity, the balance sheet,
and the statement of cash flows. The income
statement reports a period’s net income or net
loss, which is also reported on the statement of
owner’s equity. The ending owner’s capital reported on the statement of owner’s equity is
also reported on the balance sheet. The ending
cash balance is reported on the balance sheet
and the statement of cash flows.
• List and describe the financial
statements of a proprietorship.
• Explain how the financial
statements of a proprietorship
are interrelated.
Key Terms
account form (17)
account payable (12)
account receivable (12)
accounting (3)
accounting equation (10)
assets (9)
balance sheet (16)
business (2)
business entity concept
(8)
business transaction (10)
Certified Public Accountant
(CPA) (7)
corporation (8)
cost concept (8)
ethics (4)
expenses (12)
fees earned (12)
financial accounting (4)
Financial Accounting Standards
Board (FASB) (7)
financial statements (15)
general-purpose financial
statements (4)
generally accepted accounting
principles (GAAP) (7)
income statement (16)
interest revenue (12)
International Accounting
Standards Board (IASB) (7)
liabilities (9)
limited liability company (LLC)
(8)
management (or managerial)
accounting (4)
manufacturing business (3)
matching concept (16)
merchandising business (3)
net income (or net profit) (16)
net loss (16)
objectivity concept (9)
owner’s equity (9)
partnership (8)
prepaid expenses (12)
private accounting (4)
profit (2)
23
24
Chapter 1
proprietorship (8)
public accounting (7)
rent revenue (12)
revenue (12)
sales (12)
Securities and Exchange
Commission (SEC) (7)
service business (3)
statement of cash flows (16)
statement of owner’s
equity (16)
unit of measure concept (9)
Illustrative Problem
Cecil Jameson, Attorney-at-Law, is a proprietorship owned and operated by Cecil
Jameson. On July 1, 2009, Cecil Jameson, Attorney-at-Law, has the following assets and
liabilities: cash, $1,000; accounts receivable, $3,200; supplies, $850; land, $10,000; accounts payable, $1,530. Office space and office equipment are currently being rented,
pending the construction of an office complex on land purchased last year. Business
transactions during July are summarized as follows:
a.
b.
c.
d.
e.
f.
g.
h.
Received cash from clients for services, $3,928.
Received cash from Cecil Jameson as an additional investment, $3,700.
Paid office rent for the month, $1,200.
Charged clients for legal services on account, $2,025.
Purchased supplies on account, $245.
Received cash from clients on account, $3,000.
Received invoice for paralegal services from Legal Aid Inc. for July (to be paid on
August 10), $1,635.
i. Paid the following: wages expense, $850; answering service expense, $250; utilities
expense, $325; and miscellaneous expense, $75.
j. Determined that the cost of supplies on hand was $980; therefore, the cost of supplies used during the month was $115.
k. Jameson withdrew $1,000 in cash from the business for personal use.
Instructions
1. Determine the amount of owner’s equity (Cecil Jameson’s capital) as of July 1, 2009.
2. State the assets, liabilities, and owner’s equity as of July 1 in equation form similar to that shown in this chapter. In tabular form below the equation, indicate the
increases and decreases resulting from each transaction and the new balances after
each transaction.
3. Prepare an income statement for July, a statement of owner’s equity for July, and
a balance sheet as of July 31, 2009.
4. (Optional). Prepare a statement of cash flows for July.
Solution
1.
Assets Liabilities Owner’s Equity (Cecil Jameson, capital)
($1,000 $3,200 $850 $10,000) $1,530 Owner’s Equity (Cecil Jameson, capital)
$15,050 $1,530 Owner’s Equity (Cecil Jameson, capital)
$13,520 Owner’s Equity (Cecil Jameson, capital)
Chapter 1
25
2.
Liabilities Assets
Bal.
a.
Bal.
b.
Bal.
c.
Bal.
d.
Bal.
e.
Bal.
f.
Bal.
g.
Bal.
h.
Bal.
i.
Bal.
j.
Bal.
k.
Bal.
Owner’s Equity
Cecil
Cecil
Answering
Accts.
Accts. Jameson, Jameson,
Fees
Paralegal
Wages
Rent Utilities
Service
Cash Rec. Supp. Land Pay. Capital Drawing Earned Exp. Exp. Exp. Exp. Exp.
1,000
3,200
850 10,000
1,530
13,520
3,928
3,928
4,928
3,200
850 10,000
1,530
13,520
3,928
1,055
1,055
3,873
3,200
850 10,000
475
13,520
3,928
3,700
3,700
7,573
3,200
850 10,000
475
17,220
3,928
1,200
1,200
6,373
3,200
850 10,000
475
17,220
3,928
1,200
2,025
2,025
6,373 5,225
850 10,000
475
17,220
5,953
1,200
245
245
6,373 5,225
1,095 10,000
720
17,220
5,953
1,200
3,000 3,000
9,373 2,225
1,095 10,000
720
17,220
5,953
1,200
1,635
1,635
9,373 2,225
1,095 10,000
2,355
17,220
5,953
1,635
1,200
1,500
850
325
250
7,873 2,225
1,095 10,000
2,355
17,220
5,953
1,635
850 1,200 325
250
115
7,873 2,225
980 10,000
2,355
17,220
5,953
1,635
850 1,200 325
250
1,000
1,000
6,873 2,225
980 10,000
2,355
17,220
1,000
5,953
1,635
850 1,200 325
250
Supp.
Misc.
Exp. Exp.
75
75
115
115
75
115
75
3.
Cecil Jameson, Attorney-at-Law
Income Statement
For the Month Ended July 31, 2009
Fees earned . . . . . . . . . . . . .
Expenses:
Paralegal expense . . . . . . . .
Rent expense . . . . . . . . . . .
Wages expense . . . . . . . . .
Utilities expense . . . . . . . . .
Answering service expense .
Supplies expense . . . . . . . .
Miscellaneous expense . . . .
Total expenses . . . . . . . .
Net income . . . . . . . . . . . . . .
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$5,953
$1,635
1,200
850
325
250
115
75
4,450
$1,503
Cecil Jameson, capital, July 1, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Additional investment by owner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income for the month. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Cecil Jameson, capital, July 31, 2009 . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$13,520
$3,700
1,503
$5,203
1,000
4,203
$17,723
(continued)
26
Chapter 1
Balance Sheet
July 31, 2009
Cash . . . . . . . . . . .
Accounts receivable
Supplies . . . . . . . .
Land . . . . . . . . . . .
Total assets . . . . . .
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Assets
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Liabilities
Accounts payable . . . . . . . . . . . . . . .
Owner’s Equity
Cecil Jameson, capital . . . . . . . . . . .
Total liabilities and
owner’s equity . . . . . . . . . . . . . . .
$ 6,873
2,225
980
10,000
$20,078
$ 2,355
17,723
$20,078
4. Optional.
Cash received from customers. . . . . . . . . . . .
Deduct cash payments for operating expenses
Net cash flows from operating activities . . . . .
Cash flows from investing activities . . . . . . . . . .
Cash received from owner as investment . . . .
Deduct cash withdrawals by owner . . . . . . . .
Net cash flows from financing activities . . . . .
Net increase in cash during year . . . . . . . . . . . .
Cash as of July 1, 2009. . . . . . . . . . . . . . . . . . .
Cash as of July 31, 2009. . . . . . . . . . . . . . . . . .
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$6,928*
3,755**
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$3,700
1,000
$3,173
—
2,700
$5,873
1,000
$6,873
*$6,928 $3,928 $3,000
**$3,755 $1,055 $1,200 $1,500
Self-Examination Questions
1. A profit-making business operating as a separate
legal entity and in which ownership is divided
into shares of stock is known as a:
A. proprietorship.
C. partnership.
B. service business.
D. corporation.
2. The resources owned by a business are called:
A. assets.
C. the accounting equation.
B. liabilities.
D. owner’s equity.
3. A listing of a business entity’s assets, liabilities,
and owner’s equity as of a specific date is a(n):
A. balance sheet.
B. income statement.
C. statement of owner’s equity.
D. statement of cash flows.
(Answers at End of Chapter)
4. If total assets increased $20,000 during a period
and total liabilities increased $12,000 during the
same period, the amount and direction (increase
or decrease) of the change in owner’s equity for
that period is a(n):
A. $32,000 increase.
C. $8,000 increase.
B. $32,000 decrease.
D. $8,000 decrease.
5. If revenue was $45,000, expenses were $37,500,
and the owner’s withdrawals were $10,000, the
amount of net income or net loss would be:
A. $45,000 net income. C. $37,500 net loss.
B. $7,500 net income.
D. $2,500 net loss.
Eye Openers
1. What is the objective of most businesses?
2. What is the difference between a manufacturing business and a service business?
Is a restaurant a manufacturing business, a service business, or both?
Chapter 1
27
3. Name some users of accounting information.
4. What is the role of accounting in business?
5. Why are most large companies like Microsoft, PepsiCo, Caterpillar, and AutoZone
organized as corporations?
6. Barry Bergan is the owner of Elephant Delivery Service. Recently, Barry paid interest of $3,000 on a personal loan of $40,000 that he used to begin the business.
Should Elephant Delivery Service record the interest payment? Explain.
7. On April 2, Gremlin Repair Service extended an offer of $100,000 for land that had
been priced for sale at $125,000. On May 10, Gremlin Repair Service accepted the
seller’s counteroffer of $115,000. Describe how Gremlin Repair Service should
record the land.
8. a. Land with an assessed value of $300,000 for property tax purposes is acquired
by a business for $475,000. Ten years later, the plot of land has an assessed
value of $500,000 and the business receives an offer of $900,000 for it. Should
the monetary amount assigned to the land in the business records now be
increased?
b. Assuming that the land acquired in (a) was sold for $900,000, how would the
various elements of the accounting equation be affected?
9. Describe the difference between an account receivable and an account payable.
10. A business had revenues of $600,000 and operating expenses of $715,000. Did the
business (a) incur a net loss or (b) realize net income?
11. A business had revenues of $687,500 and operating expenses of $492,400. Did the
business (a) incur a net loss or (b) realize net income?
12. What particular item of financial or operating data appears on both the income
statement and the statement of owner’s equity? What item appears on both the
balance sheet and the statement of owner’s equity? What item appears on both the
balance sheet and the statement of cash flows?
Practice Exercises
PE 1-1A
Cost concept
obj. 2
EE 1-1
p. 9
PE 1-1B
Cost concept
obj. 2
EE 1-1
p. 9
PE 1-2A
Accounting equation
obj. 3
EE 1-2
p. 9
On February 7, Snap Repair Service extended an offer of $75,000 for land that had been
priced for sale at $85,000. On February 21, Snap Repair Service accepted the seller’s
counteroffer of $81,000. On April 30, the land was assessed at a value of $125,000 for
property tax purposes. On August 30, Snap Repair Service was offered $130,000 for the
land by a national retail chain. At what value should the land be recorded in Snap
Repair Service’s records?
On November 23, Terrier Repair Service extended an offer of $40,000 for land that had
been priced for sale at $48,500. On December 2, Terrier Repair Service accepted the
seller’s counteroffer of $44,000. On December 27, the land was assessed at a value of
$50,000 for property tax purposes. On April 1, Terrier Repair Service was offered $75,000
for the land by a national retail chain. At what value should the land be recorded in
Terrier Repair Service’s records?
Paul Eberly is the owner and operator of You’re Great, a motivational consulting business.
At the end of its accounting period, December 31, 2009, You’re Great has assets of $475,000
and liabilities of $115,000. Using the accounting equation, determine the following amounts:
b. Owner’s equity, as of December 31, 2010, assuming that assets increased by $90,000
and liabilities increased by $28,000 during 2010.
28
Chapter 1
PE 1-2B
Accounting equation
obj. 3
EE 1-2
p. 9
PE 1-3A
Transactions
obj. 4
EE 1-3
p. 15
PE 1-3B
Transactions
obj. 4
EE 1-3
p. 15
PE 1-4A
Income statement
obj. 5
EE 1-4
p. 16
Lynn Doyle is the owner and operator of Star LLC, a motivational consulting business.
At the end of its accounting period, December 31, 2009, Star has assets of $750,000 and
liabilities of $293,000. Using the accounting equation, determine the following amounts:
b. Owner’s equity, as of December 31, 2010, assuming that assets increased by $75,000
and liabilities decreased by $30,000 during 2010.
Zany Delivery Service is owned and operated by Joey Bryant. The following selected
transactions were completed by Zany Delivery Service during February:
1. Received cash from owner as additional investment, $15,000.
2. Paid advertising expense, $900.
3. Purchased supplies on account, $600.
4. Billed customers for delivery services on account, $9,000.
5. Received cash from customers on account, $5,500.
Indicate the effect of each transaction on the accounting equation elements (Assets,
Liabilities, Owner’s Equity, Drawing, Revenue, and Expense) by listing the numbers
identifying the transactions, (1) through (5). Also, indicate the specific item within the
accounting equation element that is affected. To illustrate, the answer to (1) is shown
below.
(1) Asset (Cash) increases by $15,000; Owner’s Equity (Joey Bryant, Capital) increases
by $15,000.
Yukon Delivery Service is owned and operated by Betty Pasha. The following selected
transactions were completed by Yukon Delivery Service during June:
2. Paid creditors on account, $1,500.
5. Paid cash to owner for personal use, $2,000.
Indicate the effect of each transaction on the accounting equation elements (Assets,
Liabilities, Owner’s Equity, Drawing, Revenue, and Expense) by listing the numbers
identifying the transactions, (1) through (5). Also, indicate the specific item within the
accounting equation element that is affected. To illustrate, the answer to (1) is shown
below.
(1) Asset (Cash) increases by $10,000; Owner’s Equity (Betty Pasha, Capital) increases
by $10,000.
The assets and liabilities of Impeccable Travel Service at November 30, 2010, the end of the
current year, and its revenue and expenses for the year are listed below. The capital of the
owner, Charly Maves, was $380,000 at December 1, 2009, the beginning of the current year.
Accounts payable
Accounts receivable
Cash
Fees earned
Land
$ 42,000
75,500
45,400
754,000
290,000
Office expense
Supplies
Wages expense
$ 12,700
313,300
5,100
450,000
Prepare an income statement for the current year ended November 30, 2010.
PE 1-4B
Income statement
obj. 5
EE 1-4
p. 16
The assets and liabilities of Express Travel Service at June 30, 2010, the end of the
current year, and its revenue and expenses for the year are listed at the top of the following page. The capital of the owner, Janis Paisley, was $125,000 at July 1, 2009, the
beginning of the current year.
Chapter 1
Accounts payable
Accounts receivable
Cash
Fees earned
Land
$ 12,000
32,000
78,000
475,000
150,000
Office expense
Supplies
Wages expense
29
$ 8,000
111,000
6,000
239,000
Prepare an income statement for the current year ended June 30, 2010.
PE 1-5A
equity
obj. 5
EE 1-5
p. 17
PE 1-5B
equity
obj. 5
EE 1-5
Using the data for Impeccable Travel Service shown in Practice Exercise 1-4A, prepare
a statement of owner’s equity for the current year ended November 30, 2010. Charly
Maves invested an additional $36,000 in the business during the year and withdrew
cash of $20,000 for personal use.
Using the data for Express Travel Service shown in Practice Exercise 1-4B, prepare a
statement of owner’s equity for the current year ended June 30, 2010. Janis Paisley invested an additional $30,000 in the business during the year and withdrew cash of
$18,000 for personal use.
p. 17
PE 1-6A
Balance sheet
Using the data for Impeccable Travel Service shown in Practice Exercises 1-4A and
1-5A, prepare the balance sheet as of November 30, 2010.
obj. 5
EE 1-6
p. 19
PE 1-6B
Balance sheet
Using the data for Express Travel Service shown in Practice Exercises 1-4B and 1-5B,
prepare the balance sheet as of June 30, 2010.
obj. 5
EE 1-6
p. 19
PE 1-7A
Statement of cash
flows
obj. 5
EE 1-7
p. 20
A summary of cash flows for Impeccable Travel Service for the year ended November
30, 2010, is shown below.
Cash receipts:
Cash received from additional investment of owner
Cash payments:
Cash paid for operating expenses . . . . . . . . . . . . .
Cash paid for land . . . . . . . . . . . . . . . . . . . . . . . .
Cash paid to owner for personal use . . . . . . . . . . .
......
......
$700,000
36,000
......
......
......
730,000
54,000
20,000
The cash balance as of December 1, 2009, was $113,400.
Prepare a statement of cash flows for Impeccable Travel Service for the year ended
November 30, 2010.
PE 1-7B
Statement of cash
flows
obj. 5
EE 1-7
p. 20
A summary of cash flows for Express Travel Service for the year ended June 30, 2010,
is shown below.
Cash receipts:
Cash payments:
......
......
$460,000
30,000
......
......
......
355,000
104,000
18,000
The cash balance as of July 1, 2009, was $65,000.
Prepare a statement of cash flows for Express Travel Service for the year ended
June 30, 2010.
30
Chapter 1
Exercises
EX
1 1-1
Types of
businesses
obj. 1
EX
1 1-2
Professional ethics
obj. 1
EX
2 1-3
Business entity
concept
obj. 2
Indicate whether each of the following companies is primarily a service, merchandise,
or manufacturing business. If you are unfamiliar with the company, use the Internet to
locate the company’s home page or use the finance Web site of Yahoo.
1.
2.
3.
4.
5.
6.
7.
8.
H&R Block
eBay Inc.
Wal-Mart Stores, Inc.
Ford Motor Company
Citigroup
Boeing
SunTrust
Alcoa Inc.
9.
10.
11.
12.
13.
14.
15.
Procter & Gamble
FedEx
Gap Inc.
Hilton Hospitality, Inc.
CVS
Caterpillar
The Dow Chemical Company
A fertilizer manufacturing company wants to relocate to Collier County. A 13-year-old
report from a fired researcher at the company says the company’s product is releasing
toxic by-products. The company has suppressed that report. A second report commissioned by the company shows there is no problem with the fertilizer.
Should the company’s chief executive officer reveal the context of the unfavorable report in discussions with Collier County representatives? Discuss.
Chalet Sports sells hunting and fishing equipment and provides guided hunting and
fishing trips. Chalet Sports is owned and operated by Cliff Owen, a well-known sports
enthusiast and hunter. Cliff’s wife, Judy, owns and operates Joliet Boutique, a women’s
clothing store. Cliff and Judy have established a trust fund to finance their children’s
college education. The trust fund is maintained by City Bank in the name of the children, John and Morgan.
For each of the following transactions, identify which of the entities listed should
record the transaction in its records.
Entities
C
B
J
X
Chalet Sports
City Bank Trust Fund
Joliet Boutique
None of the above
1. Cliff paid a local doctor for his annual physical, which was required by the workmen’s compensation insurance policy carried by Chalet Sports.
2. Cliff received a cash advance from customers for a guided hunting trip.
3. Judy paid her dues to the YWCA.
4. Cliff paid a breeder’s fee for an English springer spaniel to be used as a hunting
guide dog.
5. Judy deposited a $5,000 personal check in the trust fund at City Bank.
6. Cliff paid for an advertisement in a hunters’ magazine.
7. Judy authorized the trust fund to purchase mutual fund shares.
8. Judy donated several dresses from inventory for a local charity auction for the benefit of a women’s abuse shelter.
9. Cliff paid for dinner and a movie to celebrate their fifteenth wedding anniversary.
10. Judy purchased two dozen spring dresses from a Seattle designer for a special
spring sale.
Chapter 1
EX
3 1-4
Accounting equation
31
The total assets and total liabilities of Coca-Cola and PepsiCo are shown below.
obj. 3
Coca-Cola (in millions)
PepsiCo (in millions)
$ 29,963
13,043
$29,930
14,483
Assets
Liabilities
Determine the owners’ equity of each company.
✔ Coca-Cola,
$16,920
EX
3 1-5
Accounting equation
The total assets and total liabilities of eBay and Google are shown below.
obj. 3
eBay (in millions)
Google (in millions)
$13,494
2,589
$18,473
1,433
Assets
Liabilities
Determine the owners’ equity of each company.
✔ eBay, $10,905
3
EX 1-6
Accounting equation
Determine the missing amount for each of the following:
Assets
obj. 3
✔ a. 1,030,000
3
EX 1-7
Accounting equation
objs. 3, 4
✔ b. $568,000
EX
3 1-8
Asset, liability,
owner’s equity items
obj. 3
EX
4 1-9
Effect of transactions
on accounting
equation
obj. 4
a.
b.
c.
$125,000 60,000 $250,000 7,500 $780,000
39,500
Donna Ahern is the owner and operator of Omega, a motivational consulting business.
At the end of its accounting period, December 31, 2009, Omega has assets of $760,000
and liabilities of $240,000. Using the accounting equation and considering each case independently, determine the following amounts:
a. Donna Ahern, capital, as of December 31, 2009.
b. Donna Ahern, capital, as of December 31, 2010, assuming that assets increased by
$120,000 and liabilities increased by $72,000 during 2010.
c. Donna Ahern, capital, as of December 31, 2010, assuming that assets decreased by
$60,000 and liabilities increased by $21,600 during 2010.
d. Donna Ahern, capital, as of December 31, 2010, assuming that assets increased by
$100,000 and liabilities decreased by $38,400 during 2010.
e. Net income (or net loss) during 2010, assuming that as of December 31, 2010, assets
were $960,000, liabilities were $156,000, and there were no additional investments
or withdrawals.
Indicate whether each of the following is identified with (1) an asset, (2) a liability, or
(3) owner’s equity:
a. accounts payable
b. cash
c. fees earned
d. land
e. supplies
f. wages expense
Describe how the following business transactions affect the three elements of the accounting equation.
a. Invested cash in business.
(continued)
b. Received cash for services performed.
32
Chapter 1
c. Paid for utilities used in the business.
d. Purchased supplies for cash.
e. Purchased supplies on account.
EX
4 1-10
on accounting
equation
obj. 4
✔ a. (1) increase
$140,000
EX
4 1-11
on owner’s equity
obj. 4
EX
4 1-12
Transactions
obj. 4
a. A vacant lot acquired for $150,000 is sold for $290,000 in cash. What is the effect of
the sale on the total amount of the seller’s (1) assets, (2) liabilities, and (3) owner’s
equity?
b. Assume that the seller owes $80,000 on a loan for the land. After receiving the
$290,000 cash in (a), the seller pays the $80,000 owed. What is the effect of the
payment on the total amount of the seller’s (1) assets, (2) liabilities, and (3) owner’s
equity?
Indicate whether each of the following types of transactions will either (a) increase
owner’s equity or (b) decrease owner’s equity:
1. expenses
2. revenues
3. owner’s investments
4. owner’s withdrawals
The following selected transactions were completed by Lindbergh Delivery Service
during October:
2. Paid rent for October, $4,200.
3. Paid advertising expense, $4,000.
4. Received cash for providing delivery services, $39,750.
5. Purchased supplies for cash, $2,500.
7. Paid creditors on account, $9,280.
9. Determined that the cost of supplies on hand was $900; therefore, $1,600 of supplies
had been used during the month.
10. Paid cash to owner for personal use, $3,000.
Indicate the effect of each transaction on the accounting equation by listing the numbers identifying the transactions, (1) through (10), in a column, and inserting at the right
of each number the appropriate letter from the following list:
a. Increase in an asset, decrease in another asset.
b. Increase in an asset, increase in a liability.
c. Increase in an asset, increase in owner’s equity.
d. Decrease in an asset, decrease in a liability.
e. Decrease in an asset, decrease in owner’s equity.
EX
4 1-13
Nature of transactions
obj. 4
✔ d. $6,000
Murray Kiser operates his own catering service. Summary financial data for February
are presented in equation form as follows. Each line designated by a number indicates
the effect of a transaction on the equation. Each increase and decrease in owner’s equity, except transaction (5), affects net income.
Chapter 1
Liabilities Assets
Cash Supplies Land
Bal. 30,000
1. 35,000
2.
15,000
3. 26,000
4.
5.
2,000
6.
7,200
7.
Bal. 14,800
4,000
Net income and
owner’s withdrawals
obj. 5
5 1-15
EX
Net income and
owner’s equity for
four businesses
75,000
33
Owner’s Equity
Accounts
Murray Kiser, Murray Kiser,
Fees
Payable Capital
Drawing Earned Expenses
8,000
101,000
35,000
15,000
1,500
3,000
2,500
a.
b.
c.
d.
e.
EX
5 1-14
26,000
1,500
2,000
7,200
90,000
2,300
101,000
2,000
35,000
3,000
29,000
Describe each transaction.
What is the amount of net decrease in cash during the month?
What is the amount of net increase in owner’s equity during the month?
What is the amount of the net income for the month?
How much of the net income for the month was retained in the business?
The income statement of a proprietorship for the month of December indicates a net
income of $75,000. During the same period, the owner withdrew $100,000 in cash from
the business for personal use.
Would it be correct to say that the business incurred a net loss of $25,000 during
the month? Discuss.
Four different proprietorships, Jupiter, Mercury, Saturn, and Venus, show the same balance sheet data at the beginning and end of a year. These data, exclusive of the amount
of owner’s equity, are summarized as follows:
obj. 5
Beginning of the year
End of the year
✔ Saturn: Net
income, $108,000
Total Assets
Total Liabilities
$ 810,000
1,296,000
$324,000
540,000
On the basis of the above data and the following additional information for the year,
determine the net income (or loss) of each company for the year. (Hint: First determine
the amount of increase or decrease in owner’s equity during the year.)
EX
5 1-16
Balance sheet items
obj. 5
Jupiter:
The owner had made no additional investments in the business and had
made no withdrawals from the business.
Mercury:
The owner had made no additional investments in the business but had
withdrawn $72,000.
Saturn:
The owner had made an additional investment of $162,000 but had made
no withdrawals.
Venus:
The owner had made an additional investment of $162,000 and had
withdrawn $72,000.
From the following list of selected items taken from the records of Hoosier Appliance
Service as of a specific date, identify those that would appear on the balance sheet:
1. Accounts Payable
6. Supplies
2. Cash
7. Supplies Expense
3. Fees Earned
8. Utilities Expense
4. Land
9. Wages Expense
5. Sarah Neil, Capital
10. Wages Payable
34
Chapter 1
EX
5 1-17
Income statement
items
Based on the data presented in Exercise 1-16, identify those items that would appear
on the income statement.
obj. 5
EX
5 1-18
Statement of
owner’s equity
obj. 5
Financial information related to Teflon Company, a proprietorship, for the month ended
April 30, 2010, is as follows:
Net income for April
Hedi Fry’s withdrawals during April
Hedi Fry, capital, April 1, 2010
$ 93,780
10,000
715,320
Prepare a statement of owner’s equity for the month ended April 30, 2010.
✔ Hedi Fry, capital,
April 30, 2010:
$799,100
EX
5 1-19
Income statement
obj. 5
✔ Net income:
$116,600
5
EX 1-20
Missing amounts
from balance sheet
and income statement
data
obj. 5
✔ (a) $46,890
Relax Services was organized on May 1, 2010. A summary of the revenue and expense
transactions for May follows:
Fees earned
Wages expense
Rent expense
Supplies expense
$363,200
187,000
36,000
11,500
12,100
Prepare an income statement for the month ended May 31.
One item is omitted in each of the following summaries of balance sheet and income
statement data for the following four different proprietorships:
Beginning of the year:
Assets
Liabilities
End of the year:
Assets
Liabilities
During the year:
Additional investment in the business
Withdrawals from the business
Revenue
Expenses
Earth
Mars
Neptune
Pluto
$216,000
129,600
$250,000
130,000
$100,000
76,000
(d)
$120,000
268,200
117,000
350,000
110,000
90,000
80,000
248,000
136,000
(a)
14,400
71,190
38,880
50,000
16,000
(b)
64,000
10,000
(c)
115,000
122,500
40,000
60,000
112,000
128,000
Determine the missing amounts, identifying them by letter. (Hint: First determine the
amount of increase or decrease in owner’s equity during the year.)
EX
5 1-21
Balance sheets, net
income
Financial information related to the proprietorship of Plexiglass Interiors for October
and November 2010 is as follows:
obj. 5
✔ b. $136,275
Accounts payable
Accounts receivable
Claudia Symonds, capital
Cash
Supplies
October 31, 2010
November 30, 2010
$ 46,200
102,000
?
180,000
9,000
$ 49,800
117,375
?
306,000
7,500
a. Prepare balance sheets for Plexiglass Interiors as of October 31 and as of November
30, 2010.
b. Determine the amount of net income for November, assuming that the owner made
no additional investments or withdrawals during the month.
c. Determine the amount of net income for November, assuming that the owner made
no additional investments but withdrew $37,500 during the month.
Chapter 1
35
EX
5 1-22
Financial statements
Each of the following items is shown in the financial statements of ExxonMobil
Corporation. Identify the financial statement (balance sheet or income statement) in
obj. 5
which each item would appear.
a.
b.
c.
d.
e.
f.
g.
h.
EX
5 1-23
Statement of
cash flows
obj. 5
EX
5 1-24
Statement of
cash flows
obj. 5
i. Marketable securities
j. Notes and loans payable
k. Notes receivable
l. Operating expenses
m. Prepaid taxes
n. Sales
o. Selling expenses
Accounts payable
Cash equivalents
Crude oil inventory
Equipment
Exploration expenses
Income taxes payable
Investments
Long-term debt
Indicate whether each of the following activities would be reported on the statement
of cash flows as (a) an operating activity, (b) an investing activity, or (c) a financing
activity:
1. Cash received as owner’s investment
2. Cash paid for land
3. Cash received from fees earned
4. Cash paid for expenses
A summary of cash flows for Pickerel Consulting Group for the year ended March 31,
2010, is shown below.
Cash receipts:
Cash payments:
......
......
$239,100
50,000
......
......
......
162,900
75,000
10,000
The cash balance as of April 1, 2009, was $30,800.
Prepare a statement of cash flows for Pickerel Consulting Group for the year ended
March 31, 2010.
EX
5 1-25
obj. 5
Driftwood Realty, organized July 1, 2010, is owned and operated by Steffy Owen. How
many errors can you find in the following statements for Driftwood Realty, prepared
after its second month of operations?
Driftwood Realty
Income Statement
August 31, 2010
✔ Correct amount
of total assets is
$176,400
Sales commissions. . . . . .
Expenses:
Office salaries expense .
Rent expense. . . . . . . .
Automobile expense . . .
Miscellaneous expense .
Supplies expense . . . . .
Total expenses . . . . .
Net income . . . . . . . . . . .
.............................
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$467,100
$291,600
99,000
22,500
7,200
2,700
423,000
$134,100
36
Chapter 1
Steffy Owen
August 31, 2009
Steffy Owen, capital, August 1, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 93,600
Less withdrawals during August . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
18,000
$ 75,600
Additional investment during August . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
22,500
$ 98,100
Net income for the month. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 134,100
Steffy Owen, capital, August 31, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $232,200
Balance Sheet
For the Month Ended August 31, 2010
EX 1-26
Ratio of liabilities to
stockholders’ equity
Assets
Cash. . . . . . . . . . . . . . . . . . . . .
Accounts payable. . . . . . . . . . . .
$29,700
34,200
Total assets. . . . . . . . . . . . . . . .
$63,900
Liabilities
Accounts receivable. . . . . . . . . . .
Supplies . . . . . . . . . . . . . . . . . . .
Owner’s Equity
Steffy Owen, capital . . . . . . . . . .
Total liabilities and owner’s equity .
...
...
$128,700
18,000
...
...
232,200
$378,900
The Home Depot, Inc., is the world’s largest home improvement retailer and one of
the largest retailers in the United States based on net sales volume. The Home Depot
operates over 2,000 Home Depot® stores that sell a wide assortment of building materials and home improvement and lawn and garden products. The Home Depot also
operates over 30 EXPO Design Center stores that offer interior design products, such
as kitchen and bathroom cabinetry, tiles, flooring, and lighting fixtures, and installation
services.
The Home Depot reported the following balance sheet data (in millions):
Total assets
Total stockholders’ equity
Jan. 28,
2007
Jan. 29,
2006
$52,263
25,030
$44,405
26,909
a. Determine the total liabilities as of January 28, 2007, and January 29, 2006.
b. Determine the ratio of liabilities to stockholders’ equity for 2007 and 2006. Round
to two decimal places.
c. What conclusions regarding the margin of protection to the creditors can you draw
from (b)?
EX 1-27
Ratio of liabilities to
stockholders’ equity
Lowe’s, a major competitor of The Home Depot in the home improvement business,
operates over 1,300 stores. For the years ending February 2, 2007, and February 3, 2006,
Lowe’s reported the following balance sheet data (in millions):
Total assets
Total liabilities
2007
2006
$27,767
12,042
$24,639
10,343
a. Determine the total stockholders’ equity as of February 2 , 2007, and February 3, 2006.
b. Determine the ratio of liabilities to stockholders’ equity for 2007 and 2006. Round
to two decimal places.
c. What conclusions regarding the margin of protection to the creditors can you draw
from (b)?
d. Using the balance sheet data for The Home Depot in Exercise 1-26, how does the ratio
of liabilities to stockholders’ equity of Lowe’s compare to that of The Home Depot?
Chapter 1
37
Problems Series A
PR 1-1A
4
Transactions
obj. 4
✔ Cash bal. at end
of July: $50,450
Jean Howard established an insurance agency on July 1 of the current year and completed the following transactions during July:
a. Opened a business bank account with a deposit of $50,000 from personal funds.
b. Purchased supplies on account, $1,600.
c. Paid creditors on account, $500.
d. Received cash from fees earned on insurance commissions, $9,250.
e. Paid rent on office and equipment for the month, $2,500.
f. Paid automobile expenses for month, $900, and miscellaneous expenses, $300.
g. Paid office salaries, $1,900.
h. Determined that the cost of supplies on hand was $550; therefore, the cost of supplies used was $1,050.
i. Billed insurance companies for sales commissions earned, $11,150.
j. Withdrew cash for personal use, $2,700.
Instructions
1. Indicate the effect of each transaction and the balances after each transaction, using
the following tabular headings:
Assets
Jean
Jean
Accounts
Accounts Howard,
Howard,
Fees
Rent
Salaries
Supplies
Auto
Misc.
Cash Receivable Supplies Payable Capital Drawing Earned Expense Expense Expense Expense Expense
2.
PR
5 1-2A
obj. 5
✔ 1. Net income:
$208,860
Briefly explain why the owner’s investment and revenues increased owner’s
equity, while withdrawals and expenses decreased owner’s equity.
The amounts of the assets and liabilities of Heavenly Travel Service at April 30, 2010,
the end of the current year, and its revenue and expenses for the year are listed below.
The capital of Jennifer Burch, owner, was $45,540 at May 1, 2009, the beginning of the
current year, and the owner withdrew $25,000 during the current year.
Accounts payable
Accounts receivable
Cash
Fees earned
Rent expense
$ 14,600
78,000
159,200
600,000
5,000
80,900
Supplies
Supplies expense
Taxes expense
Utilities expense
Wages expense
$
6,800
13,200
10,250
49,150
232,640
Instructions
1. Prepare an income statement for the current year ended April 30, 2010.
2. Prepare a statement of owner’s equity for the current year ended April 30, 2010.
3. Prepare a balance sheet as of April 30, 2010.
PR
5 1-3A
obj. 5
✔ 1. Net income:
$22,975
Doug Van Buren established Ohm Computer Services on July 1, 2010. The effect of each
transaction and the balances after each transaction for July are shown at the top of the
following page.
Instructions
1. Prepare an income statement for the month ended July 31, 2010.
2. Prepare a statement of owner’s equity for the month ended July 31, 2010.
3. Prepare a balance sheet as of July 31, 2010.
4. (Optional). Prepare a statement of cash flows for the month ending July 31, 2010.
38
Chapter 1
Liabilities Assets
Owner’s Equity
Doug
Doug
Van
Van
Accounts
Accounts
Buren
Buren
Fees
Salaries
Rent
Auto
Supplies
Misc.
a.
b.
Bal.
c.
Bal.
d.
Bal.
e.
Bal.
f.
Bal.
g.
Bal.
h.
Bal.
i.
Bal.
j.
Bal.
30,000
30,000
29,500
59,500
8,000
51,500
1,250
50,250
50,250
5,750
44,500
12,000
32,500
30,000
2,600
2,600
2,600
2,600
2,600
2,600
30,000
29,500
29,500
2,600
30,000
29,500
30,000
8,000
8,000
3,875
3,875
8,000
3,875
30,000
2,600
2,600
1,250
1,350
20,750
20,750
2,600
1,350
30,000
29,500
20,750
50,250
20,750
2,600
1,350
30,000
50,250
20,750
2,600
1,525
1,075
1,350
30,000
50,250
32,500
7,500
25,000
20,750
20,750
PR 1-4A
Transactions;
financial statements
objs. 4, 5
✔ 2. Net income:
$14,450
1,075
1,350
1,350
30,000
30,000
7,500
7,500
8,000
8,000
8,000
12,000
12,000
1,875
1,875
50,250
12,000
8,000
3,875
1,525
1,525
50,250
12,000
8,000
3,875
1,525
1,875
1,875
1,875
On April 1, 2010, Ryan Barnes established Coyote Realty. Ryan completed the following transactions during the month of April:
b. Paid rent on office and equipment for the month, $3,200.
c. Paid automobile expenses (including rental charge) for month, $1,200, and miscellaneous expenses, $800.
d. Purchased supplies (pens, file folders, and copy paper) on account, $900.
e. Earned sales commissions, receiving cash, $24,000.
f. Paid creditor on account, $400.
g. Paid office salaries, $3,600.
h. Withdrew cash for personal use, $3,000.
i. Determined that the cost of supplies on hand was $150; therefore, the cost of supplies
used was $750.
Instructions
Assets
Cash
Ryan
Ryan
Office
Accounts
Barnes,
Barnes,
Sales
Salaries
Rent
Auto
Supplies
Misc.
Supplies Payable Capital Drawing Commissions Expense Expense Expense Expense Expense
2. Prepare an income statement for April, a statement of owner’s equity for April, and
a balance sheet as of April 30.
PR 1-5A
Transactions;
objs. 4, 5
✔ 3. Net income:
$13,950
Colfax Dry Cleaners is owned and operated by Maria Acosta. A building and equipment are currently being rented, pending expansion to new facilities. The actual work
of dry cleaning is done by another company at wholesale rates. The assets and the
liabilities of the business on November 1, 2010, are as follows: Cash, $34,200; Accounts
Receivable, $40,000; Supplies, $5,000; Land, $50,000; Accounts Payable, $16,400. Business
transactions during November are summarized as follows:
a. Maria Acosta invested additional cash in the business with a deposit of $35,000 in
the business bank account.
Chapter 1
39
b.
c.
d.
e.
f.
g.
h.
i.
Purchased land for use as a parking lot, paying cash of $30,000.
Paid rent for the month, $4,500.
Charged customers for dry cleaning revenue on account, $18,250.
Purchased supplies on account, $2,800.
Received cash from cash customers for dry cleaning revenue, $31,750.
Received cash from customers on account, $27,800.
Received monthly invoice for dry cleaning expense for November (to be paid on
December 10), $14,800.
j. Paid the following: wages expense, $8,200; truck expense, $1,875; utilities expense,
$1,575; miscellaneous expense, $850.
k. Determined that the cost of supplies on hand was $3,550; therefore, the cost of supplies used during the month was $4,250.
l. Withdrew $10,000 for personal use.
Instructions
1. Determine the amount of Maria Acosta’s capital as of November 1.
2. State the assets, liabilities, and owner’s equity as of November 1 in equation form
similar to that shown in this chapter. In tabular form below the equation, indicate
increases and decreases resulting from each transaction and the new balances after
each transaction.
3. Prepare an income statement for November, a statement of owner’s equity for
November, and a balance sheet as of November 30.
4. (Optional) Prepare a statement of cash flows for November.
PR 1-6A
Missing amounts
from financial
statements
The financial statements at the end of Four Corners Realty’s first month of operations
are shown below and on the next page.
Four Corners Realty
Income Statement
obj. 5
✔ i. $515,610
Fees earned . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Expenses:
Wages expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Rent expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Supplies expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utilities expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Miscellaneous expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$239,700
$
(a)
24,480
20,400
13,770
8,415
121,890
(b)
Four Corners Realty
Jeremy Parks, capital, July 1, 2010. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Investment on July 1, 2010. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income for July . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Jeremy Parks, capital, July 31, 2010. . . . . . . . . . . . . . . . . . . . . . . . . . .
$
$
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Four Corners Realty
Balance Sheet
July 31, 2010
Cash . . . . .
Supplies . . .
Land . . . . .
Total assets
.
.
.
.
.
.
.
.
.
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.
.
.
.
.
.
.
.
Assets
......
......
......
......
.
.
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.
.
.
.
.
$150,450
10,200
(j)
(k)
Liabilities
Accounts payable. . . . . . . . . . . . . . .
Owner’s Equity
Jeremy Parks, capital . . . . . . . . . . . .
Total liabilities and owner’s equity . . .
$12,240
(l)
(m)
40
Chapter 1
Four Corners Realty
Deduct cash payments for expenses and payments
Net cash flow from operating activities . . . . . . . . .
Cash payments for acquisition of land . . . . . . . . . .
Cash received as owner’s investment . . . . . . . . . .
Deduct cash withdrawal by owner. . . . . . . . . . . . .
Net cash flow from financing activities . . . . . . . . .
Net cash flow and July 31, 2010, cash balance . . . . .
.............
to creditors . . . .
.............
$
(n)
119,850
$
.............
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(o)
(367,200)
459,000
61,200
(p)
(q)
Instructions
By analyzing the interrelationships among the four financial statements, determine the
proper amounts for (a) through (q).
Problems Series B
PR 1-1B
Transactions
obj. 4
✔ Cash bal. at end
of November:
$28,100
On November 1 of the current year, Rhea Quade established a business to manage
rental property. She completed the following transactions during November:
b. Purchased supplies (pens, file folders, and copy paper) on account, $1,750.
c. Received cash from fees earned for managing rental property, $3,600.
d. Paid rent on office and equipment for the month, $1,300.
e. Paid creditors on account, $500.
f. Billed customers for fees earned for managing rental property, $4,800.
g. Paid automobile expenses (including rental charges) for month, $500, and miscellaneous expenses, $200.
h. Paid office salaries, $1,000.
i. Determined that the cost of supplies on hand was $800; therefore, the cost of supplies used was $950.
j. Withdrew cash for personal use, $2,000.
Instructions
Assets
Liabilities Rhea
Rhea
Accounts
Accounts
Quade,
Quade,
Cash Receivable Supplies Payable Capital Drawing
2.
PR 1-2B
obj. 5
Owner’s Equity
Fees
Rent
Salaries
Supplies
Auto
Misc.
Earned Expense Expense Expense Expense Expense
Briefly explain why the owner’s investment and revenues increased owner’s
equity, while withdrawals and expenses decreased owner’s equity.
Following are the amounts of the assets and liabilities of St. Kitts Travel Agency at
December 31, 2010, the end of the current year, and its revenue and expenses for the
year. The capital of Robin Egan, owner, was $45,000 on January 1, 2010, the beginning
of the current year. During the current year, Robin withdrew $7,500.
Chapter 1
Accounts payable
Accounts receivable
Cash
Fees earned
✔ 1. Net income:
$68,750
$ 6,250
21,150
90,000
125,000
750
Rent expense
Supplies
Supplies expense
Utilities expense
Wages expense
41
$12,500
1,350
1,400
9,100
32,500
Instructions
1. Prepare an income statement for the current year ended December 31, 2010.
2. Prepare a statement of owner’s equity for the current year ended December 31, 2010.
3. Prepare a balance sheet as of December 31, 2010.
PR 1-3B
obj. 5
✔ 1. Net income:
$8,800
Ashley Rhymer established Fair Play Financial Services on January 1, 2010. Fair Play
Financial Services offers financial planning advice to its clients. The effect of each transaction and the balances after each transaction for January are shown below.
Instructions
1. Prepare an income statement for the month ended January 31, 2010.
2. Prepare a statement of owner’s equity for the month ended January 31, 2010.
3. Prepare a balance sheet as of January 31, 2010.
4. (Optional). Prepare a statement of cash flows for the month ending January 31, 2010.
Liabilities Assets
Owner’s Equity
Ashley
Ashley
Accounts
Accounts Rhymer,
Rhymer,
Fees
Salaries
Rent
Auto
Supplies
Misc.
a.
b.
Bal.
c.
Bal.
d.
Bal.
e.
Bal.
f.
Bal.
g.
Bal.
h.
Bal.
i.
Bal.
j.
Bal.
15,000
2,180
2,180
15,000
600
14,400
28,000
42,400
7,500
34,900
5,700
29,200
16,000
13,200
2,180
2,180
1,580
15,000
28,000
28,000
2,180
1,580
15,000
28,000
7,500
7,500
2,180
1,580
15,000
28,000
7,500
4,500
4,500
2,180
1,500
680
1,580
15,000
28,000
7,500
4,500
1,580
15,000
680
1,580
15,000
13,200
13,200
5,000
8,200
11,500
11,500
11,500
PR 1-4B
Transactions;
objs. 4, 5
✔ 2. Net income:
$9,200
15,000
2,180
2,180
600
1,580
680
1,580
15,000
15,000
15,000
5,000
5,000
16,000
16,000
1,200
1,200
1,200
28,000
11,500
39,500
16,000
7,500
4,500
1,500
1,500
16,000
7,500
4,500
1,500
1,200
39,500
16,000
7,500
4,500
1,500
1,200
1,200
On August 1, 2010, Tanja Zier established Royal Realty. Tanja completed the following
transactions during the month of August:
b. Purchased supplies (pens, file folders, paper, etc.) on account, $2,650.
c. Paid creditor on account, $1,600.
d. Earned sales commissions, receiving cash, $28,750.
e. Paid rent on office and equipment for the month, $4,200.
f. Withdrew cash for personal use, $5,000.
g. Paid automobile expenses (including rental charge) for month, $2,500, and miscellaneous expenses, $1,200.
(continued)
42
Chapter 1
h. Paid office salaries, $10,000.
i. Determined that the cost of supplies on hand was $1,000; therefore, the cost of supplies used was $1,650.
Instructions
Assets
Cash
Office
Accounts Tanja Zier, Tanja Zier,
Sales
Salaries
Rent
Auto
Supplies
Misc.
Supplies Payable Capital Drawing Commissions Expense Expense Expense Expense Expense
2. Prepare an income statement for August, a statement of owner’s equity for August,
and a balance sheet as of August 31.
PR 1-5B
Transactions;
objs. 4, 5
✔ 3. Net income:
$22,050
Swan Dry Cleaners is owned and operated by Peyton Keyes. A building and equipment
are currently being rented, pending expansion to new facilities. The actual work of dry
cleaning is done by another company at wholesale rates. The assets and the liabilities
of the business on July 1, 2010, are as follows: Cash, $17,000; Accounts Receivable, $31,000;
Supplies, $3,200; Land, $36,000; Accounts Payable, $10,400. Business transactions during
July are summarized as follows:
a. Peyton Keyes invested additional cash in the business with a deposit of $25,000 in
the business bank account.
b. Paid $24,000 for the purchase of land as a future building site.
c. Received cash from cash customers for dry cleaning revenue, $19,500.
d. Paid rent for the month, $3,000.
e. Purchased supplies on account, $1,550.
f. Paid creditors on account, $5,100.
g. Charged customers for dry cleaning revenue on account, $24,750.
h. Received monthly invoice for dry cleaning expense for July (to be paid on August 10),
$8,200.
i. Paid the following: wages expense, $5,100; truck expense, $1,200; utilities expense,
$800; miscellaneous expense, $950.
j. Received cash from customers on account, $26,750.
k. Determined that the cost of supplies on hand was $1,800; therefore, the cost of
supplies used during the month was $2,950.
l. Withdrew $18,000 cash for personal use.
Instructions
1. Determine the amount of Peyton Keyes’ capital as of July 1 of the current year.
2. State the assets, liabilities, and owner’s equity as of July 1 in equation form similar to
that shown in this chapter. In tabular form below the equation, indicate increases and
decreases resulting from each transaction and the new balances after each transaction.
3. Prepare an income statement for July, a statement of owner’s equity for July, and a
balance sheet as of July 31.
4. (Optional). Prepare a statement of cash flows for July.
PR 1-6B
Missing amounts
from financial
statements
obj. 5
The financial statements at the end of Palo Duro Realty’s first month of operations are
shown at the top of the next page.
Chapter 1
43
Palo Duro Realty
Income Statement
✔ k. $180,000
Fees earned . . . . . . . . . .
Expenses:
Wages expense . . . . .
Rent expense . . . . . . .
Supplies expense . . . .
Utilities expense . . . . .
Total expenses . . . .
Net income . . . . . . . . . .
...................................
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$
(a)
$51,000
19,200
(b)
10,800
6,600
105,600
$ 74,400
Palo Duro Realty
Laura Biddle, capital, November 1, 2010 . . . . . . . . . . . . . . . . . . . . . . . . .
Investment on November 1, 2010 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Net income for November . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Less withdrawals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Increase in owner’s equity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Laura Biddle, capital, November 30, 2010 . . . . . . . . . . . . . . . . . . . . . . . .
$
(c)
$240,000
(d)
(e)
36,000
(f)
(g)
Palo Duro Realty
Balance Sheet
November 30, 2010
Cash . . . . .
Supplies . . .
Land. . . . . .
Total assets.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
Assets
......
......
......
......
$ 26,700
21,300
240,000
(h)
Liabilities
Accounts payable . . . . . . . . . . . . . . .
Owner’s Equity
Laura Biddle, capital . . . . . . . . . . . . .
Total liabilities and owner’s equity . . .
$ 9,600
(i)
(j)
Palo Duro Realty
Cash received from customers . . . . . . . . . . . . . . . . . . . . . . . .
Deduct cash payments for expenses and payments to creditors
Net cash flow from operating activities . . . . . . . . . . . . . . . . . .
Cash payments for acquisition of land . . . . . . . . . . . . . . . . . . .
Cash received as owner’s investment . . . . . . . . . . . . . . . . . . .
Deduct cash withdrawal by owner . . . . . . . . . . . . . . . . . . . . .
Net cash flow from financing activities . . . . . . . . . . . . . . . . . .
Net cash flow and November 30, 2010, cash balance . . . . . . . . .
......
......
......
$
(k)
117,300
$
......
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
(l)
(m)
(n)
(o)
(p)
(q)
Instructions
By analyzing the interrelationships among the four financial statements, determine the
proper amounts for (a) through (q).
Continuing Problem
✔ 2.Net income:
$1,480
Lee Chang enjoys listening to all types of music and owns countless CDs. Over the years,
Lee has gained a local reputation for knowledge of music from classical to rap and the
ability to put together sets of recordings that appeal to all ages.
During the last several months, Lee served as a guest disc jockey on a local
radio station. In addition, Lee has entertained at several friends’ parties as the host
deejay.
44
Chapter 1
On June 1, 2010, Lee established a proprietorship known as Music Depot. Using an
extensive collection of music CDs, Lee will serve as a disc jockey on a fee basis for
weddings, college parties, and other events. During June, Lee entered into the following transactions:
June 1. Deposited $8,000 in a checking account in the name of Music Depot.
2. Received $2,400 from a local radio station for serving as the guest disc jockey
for June.
2. Agreed to share office space with a local real estate agency, Upstairs Realty.
Music Depot will pay one-fourth of the rent. In addition, Music Depot agreed
to pay a portion of the salary of the receptionist and to pay one-fourth of the
utilities. Paid $750 for the rent of the office.
4. Purchased supplies (blank CDs, poster board, extension cords, etc.) from City
Office Supply Co. for $350. Agreed to pay $100 within 10 days and the remainder by July 5, 2010.
6. Paid $600 to a local radio station to advertise the services of Music Depot
twice daily for two weeks.
8. Paid $500 to a local electronics store for renting digital recording equipment.
12. Paid $250 (music expense) to Cool Music for the use of its current music
demos to make various music sets.
13. Paid City Office Supply Co. $100 on account.
16. Received $400 from a dentist for providing two music sets for the dentist to
play for her patients.
22. Served as disc jockey for a wedding party. The father of the bride agreed to
pay $1,350 the 1st of July.
25. Received $500 from a friend for serving as the disc jockey for a cancer charity
ball hosted by the local hospital.
29. Paid $240 (music expense) to Galaxy Music for the use of its library of music
demos.
30. Received $1,000 for serving as disc jockey for a local club’s monthly dance.
30. Paid Upstairs Realty $400 for Music Depot’s share of the receptionist’s salary
for June.
30. Paid Upstairs Realty $300 for Music Depot’s share of the utilities for June.
30. Determined that the cost of supplies on hand is $170. Therefore, the cost of supplies used during the month was $180.
30. Paid for miscellaneous expenses, $150.
30. Paid $800 royalties (music expense) to National Music Clearing for use of
various artists’ music during the month.
30. Withdrew $200 of cash from Music Depot for personal use.
Instructions
Assets
Lee
Lee
Office
Equipment
Accounts
Accounts Chang,
Chang,
Fees
Music
Rent
Rent
Advertising
Wages
Utilities
Supplies
Misc.
Cash Receivable Supplies Payable Capital Drawing Earned Expense Expense Expense Expense Expense Expense Expense Expense
2. Prepare an income statement for Music Depot for the month ended June 30, 2010.
3. Prepare a statement of owner’s equity for Music Depot for the month ended June 30,
2010.
4. Prepare a balance sheet for Music Depot as of June 30, 2010.
Chapter 1
45
Special Activities
SA 1-1
Ethics and
professional conduct
in business
Group Project
SA 1-2
Net income
Blake Gillis, president of Wayside Enterprises, applied for a $175,000 loan from American
National Bank. The bank requested financial statements from Wayside Enterprises as
a basis for granting the loan. Blake has told his accountant to provide the bank with a
balance sheet. Blake has decided to omit the other financial statements because there
was a net loss during the past year.
In groups of three or four, discuss the following questions:
1. Is Blake behaving in a professional manner by omitting some of the financial
statements?
2. a. What types of information about their businesses would owners be willing to
provide bankers? What types of information would owners not be willing to
provide?
b. What types of information about a business would bankers want before extending
a loan?
c. What common interests are shared by bankers and business owners?
On August 1, 2009, Dr. Dana Hendley established Med, a medical practice organized
as a proprietorship. The following conversation occurred the following February between Dr. Hendley and a former medical school classmate, Dr. Elyse Monti, at an
American Medical Association convention in New York City.
Dr. Monti: Dana, good to see you again. Why didn’t you call when you were in Denver? We could have
had dinner together.
Dr. Hendley: Actually, I never made it to Denver this year. My husband and kids went up to our Vail
condo twice, but I got stuck in Fort Lauderdale. I opened a new consulting practice this August and
haven’t had any time for myself since.
Dr. Monti: I heard about it . . . Med . . . something . . . right?
Dr. Hendley: Yes, Med. My husband chose the name.
Dr. Monti: I’ve thought about doing something like that. Are you making any money? I mean, is it worth
your time?
Dr. Hendley: You wouldn’t believe it. I started by opening a bank account with $30,000, and my January
bank statement has a balance of $75,000. Not bad for six months—all pure profit.
Dr. Monti: Maybe I’ll try it in Denver! Let’s have breakfast together tomorrow and you can fill me in on
the details.
Comment on Dr. Hendley’s statement that the difference between the opening
bank balance ($30,000) and the January statement balance ($75,000) is pure profit.
SA 1-3
Transactions and
Amber Keck, a junior in college, has been seeking ways to earn extra spending money.
As an active sports enthusiast, Amber plays tennis regularly at the North Fulton Tennis
Club, where her family has a membership. The president of the club recently approached Amber with the proposal that she manage the club’s tennis courts. Amber’s
primary duty would be to supervise the operation of the club’s four indoor and six
outdoor courts, including court reservations.
In return for her services, the club would pay Amber $200 per week, plus Amber
could keep whatever she earned from lessons and the fees from the use of the ball machine. The club and Amber agreed to a one-month trial, after which both would consider an arrangement for the remaining two years of Amber’s college career. On this
basis, Amber organized Deuce. During June 2009, Amber managed the tennis courts
and entered into the following transactions:
a. Opened a business account by depositing $1,250.
b. Paid $250 for tennis supplies (practice tennis balls, etc.).
46
Chapter 1
c. Paid $150 for the rental of video equipment to be used in offering lessons during
June.
d. Arranged for the rental of two ball machines during June for $200. Paid $100 in
advance, with the remaining $100 due July 1.
e. Received $1,500 for lessons given during June.
f. Received $400 in fees from the use of the ball machines during June.
g. Paid $600 for salaries of part-time employees who answered the telephone and took
reservations while Amber was giving lessons.
h. Paid $120 for miscellaneous expenses.
i. Received $800 from the club for managing the tennis courts during June.
j. Determined that the cost of supplies on hand at the end of the month totaled $150;
therefore, the cost of supplies used was $100.
k. Withdrew $270 for personal use on June 30.
As a friend and accounting student, you have been asked by Amber to aid her in
assessing the venture.
Assets
Amber
Amber
Accounts
Keck,
Keck,
Service
Salary
Rent
Supplies
Misc.
Cash Supplies Payable Capital Drawing Revenue Expense Expense Expense Expense
2.
3.
4.
5.
SA 1-4
Certification
requirements for
accountants
Internet Project
Prepare an income statement for June.
Prepare a statement of owner’s equity for June.
Prepare a balance sheet as of June 30.
a. Assume that Amber Keck could earn $8 per hour working 30 hours a week as
a waitress. Evaluate which of the two alternatives, working as a waitress or
operating Deuce, would provide Amber with the most income per month.
b.
Discuss any other factors that you believe Amber should consider before discussing a long-term arrangement with the North Fulton Tennis Club.
By satisfying certain specific requirements, accountants may become certified as public accountants (CPAs), management accountants (CMAs), or internal auditors (CIAs).
Find the certification requirements for one of these accounting groups by accessing the
appropriate Internet site listed below.
Site
Description
http://www.ais-cpa.com
This site lists the address and/or Internet link for each state’s board of
accountancy. Find your state’s requirements.
This site lists the requirements for becoming a CMA.
This site lists the requirements for becoming a CIA.
http://www.imanet.org
http://www.theiia.org
SA 1-5
Amazon.com, an Internet retailer, was incorporated and began operation in the mid-
Cash flows
90s. On the statement of cash flows, would you expect Amazon.com’s net cash flows
from operating, investing, and financing activities to be positive or negative for its first
three years of operations? Use the following format for your answers, and briefly explain your logic.
First Year
Net cash flows from operating activities
Net cash flows from investing activities
Net cash flows from financing activities
negative
Second Year
Third Year
Chapter 1
SA 1-6
Financial analysis of
Enron Corporation
47
The now defunct Enron Corporation, once headquartered in Houston, Texas, provided
products and services for natural gas, electricity, and communications to wholesale and
retail customers. Enron’s operations were conducted through a variety of subsidiaries
and affiliates that involved transporting gas through pipelines, transmitting electricity,
and managing energy commodities. The following data were taken from Enron’s
financial statements:
In millions
Internet Project
Total revenues
Total costs and expenses
Operating income
Net income
$100,789
98,836
1,953
979
Total assets
Total liabilities
Total owners’ equity
65,503
54,033
11,470
Net
Net
Net
Net
4,779
(4,264)
571
1,086
cash flows
cash flows
cash flows
increase in
from operating activities
from investing activities
from financing activities
cash
The market price of Enron’s stock was approximately $83 per share when the prior
financial statement data were taken. However, eventually Enron’s stock was selling for
$0.22 per share.
Review the preceding financial statement data and search the Internet for articles
on Enron Corporation. Briefly explain why Enron’s stock dropped so dramatically.
Answers to Self-Examination Questions
1. D A corporation, organized in accordance with
state or federal statutes, is a separate legal entity
in which ownership is divided into shares of
stock (answer D). A proprietorship (answer A) is
an unincorporated business owned by one individual. A service business (answer B) provides
services to its customers. It can be organized as
a proprietorship, partnership, corporation, or
limited liability company. A partnership (answer
C) is an unincorporated business owned by two
or more individuals.
2. A The resources owned by a business are called
assets (answer A). The debts of the business are
called liabilities (answer B), and the equity of the
owners is called owner’s equity (answer D). The relationship between assets, liabilities, and owner’s
equity is expressed as the accounting equation
(answer C).
3. A The balance sheet is a listing of the assets,
liabilities, and owner’s equity of a business at a
specific date (answer A). The income statement
(answer B) is a summary of the revenue and
expenses of a business for a specific period of
time. The statement of owner’s equity (answer C)
summarizes the changes in owner’s equity for a
proprietorship or partnership during a specific
period of time. The statement of cash flows
(answer D) summarizes the cash receipts and
cash payments for a specific period of time.
4. C The accounting equation is:
Therefore, if assets increased by $20,000 and liabilities increased by $12,000, owner’s equity must
have increased by $8,000 (answer C), as indicated
in the following computation:
Assets
$20,000
$12,000 Owner’s Equity
$20,000 $12,000 Owner’s Equity
$8,000
Owner’s Equity
5. B Net income is the excess of revenue over
expenses, or $7,500 (answer B). If expenses exceed
revenue, the difference is a net loss. Withdrawals
by the owner are the opposite of the owner’s
investing in the business and do not affect the
amount of net income or net loss.

Leading by Example - E-Learning

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