Chapter 1 – Accounting in Action Questions – 1-22, Pages 32-33
1. “Accounting “Accounting is ingrained in our society and it is vital to our economic system.” Do you agree? Explain. I agree with the statement that “Accounting is ingrained in our society and it is vital to our economic system” because as we all know that accounting accounting is vital to maintain the competitiveness of our economic system and to uplift the business society. Accounting gives us the financial position position of an organization in respect of its its production, sales, profit etc. It indicates areas that need improvement improvement and areas that are doing well. well. Accounting gives an idea of the allocation allocation of funds of an organization. The utilization utilization of funds is a key element in any economy. It will give an indication of any mal practices and frauds if any have occurred during the allocation of funds. Accounting is very important to to calculate some important metrics metrics such as the growth growth rate of the economy. Based on these metrics the crdibility of every company is measured and these metrics are also crucial from a historical perspective as data over a period of time can be compared.
2. Identify and describe the steps in the accounting process. Accounting is the process of identifying, identifying, recording, and communicating communicating the economic events of an organization to interested users of the information. The first step of the accounting process is therefore to identify economic events that are relevant to a particular business. Once O nce a company identifies economic events, it records those events in order to provide a history of its financial activities. Recording consists of keeping a systematic, chronological diary of these measured events events, measured in dollars and cents. In the final step the information is communicated through the preparation and distribution of accounting reports, the most common of which are called financial statements.
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(a) Who are internal users of accounting data? (b) How does accounting provide provide relevant data to these users? (a) Internal users of accounting data are managers who plan, organize, and run the business. These include include marketing managers, production supervisors, finance directors, and company officers. (b) Managerial accounting provides internal reports to these users to help them make decisions about their companies. Examples of internal reports are financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year.
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4. What uses of financial accounting information are made by (a) investors and (b) creditors? Investors (owners) and creditors (such as suppliers and bankers) are external users. Investors use financial accounting information to make decisions to buy, hold, or sell ownership shares of a company. Creditors use accounting information to evaluate the risks of granting credit or lending money. a) Investors, also known as owners use accounting information to make decisions to buy, hold, or sell ownership shares of a company. b) Creditors also known as suppliers and bankers use the accounting information to analyze the risks of granting credit or lending money.
5. “Bookkeeping and accounting are the same.” Do you agree? Explain. Bookkeeping and accounting are not the same. Bookkeeping usually involves only the recording of economic events in other words it is the process of recording financial transactions and keeping financial records. It is a small and it is just one part of accounting process. Accounting, on the other hand involves the entire process of identifying, recording, and communicating economic events.
6. Eve Myles Travel Agency purchased land for $90,000 cash on December 10, 2012. At December 31, 2012, the land’s value has increased to $93,000. What amount should be reported for land on Eve Myles’s balance sheet at December 31, 2012? Explain.
As per the cost principle, assets should be recorded at their cost. cost. Cost has an important advantage over other valuations, it is reliable and cost can be objectively measured and can be verified. Under the Cost principle although the fair value of land has increased from $ 90,000 to $ 93,0000 from Dec 10, 2012 to to December 31, 2012 but Eve Myles’s Myles’s balance sheet should report the land at $90,000 on its December 31, 2012 balance sheet.
7. What is the monetary unit assumption?
The monetary unit assumption requires that only transactions data that can be expressed or measured in terms of money should should be included included in the accounting records. records. This assumption enables accounting to quantify (measure) economic events. The monetary unit assumption is vital to applying the cost principle. Monetary unit assumption prevents the inclusion of some relevant information in the accounting records. eg, the health of the owner, the quality of service, and the morale of employees are not included because companies cannot quantify this information in terms of money.
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8. What is the economic entity assumption?
Economic entity assumption is an assumption under the Generally Accepted Accounting Principles. This principle requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. 9. What are the three basic forms of business organizations for profit-oriented enterprises? The three basic forms of business organization are the proprietorship, the partnership, and the corporation.
is generally a proprietorship. proprietorship. Proprietorship - A business owned by one person is The owner is often the manager/operator of the business. Usually only a relatively small amount of money (capital) is necessary to start in business as a proprietorship. The owner (proprietor) takes all the profits or losses of the business and is personally liable for all debts of the business. Partnership - is like a sole proprietorship in most ways, but it has two or more owners. The partners share the profits and losses of the business according to a prearranged agreement. Both the sole proprietorship and the partnership are convenient ways of separating the owners’ commercial activities from their personal activities. chartered by the state and legally separate separate from its owners (the Corporation - is a business unit chartered stockholders). The stockholders, whose ownership is represented by shares of stock, do not directly control the corporation’s operations. Instead, they elect a board of directors to run the corporation for their benefit. In exchange for their limited involvement in the corporation’s operations, stockholders enjoy limited liability; that is, they are not personally liable for the debts of the corporate entity. Stockholders may transfer all or part of their ownership shares to other investors at any time.
10. Maria Contreras is the owner of a successful printing shop. Recently, her business has been increasing, and Maria has been thinking about changing the organization of her business from a proprietorship to a corporation. Discuss some of the advantages Maria would enjoy if she were to incorporate her business.
If Maria decides to incorporate her business then she will have below advantages; In corporation, the stockholders enjoy limited liability means they are not personally liable for the debts of the corporate entity. In corporation, stockholders may transfer all or par t of their ownership shares to other investors at any time (i.e., sell their shares). The ease with which ownership can change attracts the investors to invest in a corporation. Since the ownership can be transferred without dissolving the corporation, the life of a corporation is unlimited and not subject to the whims or health of a proprietor or a partner. 11. What is the basic accounting equation?
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The basic accounting equation is Assets = Liabilities + Owner’s Equity. Assets must equal the sum of liabilities and owner’s equity. 12. (a) Define the terms assets, liabilities, and owner’s equity. Assets are resources owned by a business. The business uses its assets in carrying out activities such as production and sales. Common characteristics of all assets is the capacity to provide future services or benefits. benefits. It can be classified as monetary monetary and non monetary assets; for example, cash and money that customers owe to the company (called accounts receivable ) are monetary items. Other assets such as inventories (goods held for sale), land, buildings, and equipment are non-monetary, physical items. Liabilities are claims against assets, in other words liabilities are a business’s present obligations to pay cash, transfer assets, or provide services to other entities in the future. Among these obligations are amounts owed to suppliers for goods or services bought on credit (called accounts payable ), borrowed money (e.g., money owed on bank loans), salaries and wages owed to employees, taxes owed to the government, and services to be performed. Owner’s equity represents the claims by the owner of a business to the assets of the business. Theoretically, owner’s equity is what would be left if all liabilities were paid, and it is sometimes said to equal net assets. In Accounting equation, we can define owner’s equity as listed below;
Owner’s Equity = Assets - Liabilities (b) What items affect owner’s equity? Owner’s equity is affected by owner’s investments, drawings, revenues, and expenses. Investments by owner and revenues from business operations increases owner’s equity. Withdraw cash or other assets for personal use and expenses decreases the owner’s equity. 13. Which of the following items are liabilities of Karl Jewelry Stores? (a) Cash - Asset (b) Accounts payable (c) Owner’s drawings - Owner’s equity (d) Accounts receivable - Asset (e) Supplies - Asset (f) Equipment - Asset (g) Salaries and wages payable (h) Service revenue - Revenue, Cash assets (i) Rent expense - Expense
For Karl Jewelry Stores, liabilities liabilities are (b) Accounts payable and (g) Salaries and wages wages payable.
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14. Can a business enter into a transaction in which only the left side of the basic accounting equation is affected? If so, give an example.
Yes, I believe that a business can enter into a transaction in which only the left side of the accounting equation is affected. An example would be a transaction where an increase in one asset is offset by a decrease in another asset. Eg - An increase in the Equipment account which is offset by a decrease in the Cash account
15. Are the following events recorded in the accounting records? Explain your answer in each case.
Business transactions are the economic events of the company and they are recorded because they affect the basic equation. (a) The owner of the company dies – No, death of the owner of owner of the company is not
a business transaction as it does not affect the basic accounting equation. (b) Supplies are purchased on account - Yes, purchase of supplies on account is
a business transaction is a business transaction, as it affects the basic accounting equation, it debits the assets-supplies and credits the accounts payable. (c) An employee employee is fired - No, an an employee being fired is not a business transaction as it does not affect the basic accounting equation. (d) The owner of the business withdraws cash from the business for personal
use – Yes, withdrawal of cash from the business is a business transaction as it affects the basic accounting equation, equation, it decreases Owner’s Equity.
16. Indicate how the following business transactions affect the basic accounting equation. (a) Paid cash cash for janitor janitorial ial services services Decrease assets and decrease owner’s equity (b) Purchased Purchased equipmen equipmentt for cash Equal increase and decrease in total assets but composition of assets changes; cash decreases and asset equipment increases. (c) Invested Invested cash in the business business Equal increase in cash assets and owner's equity (d) Paid account accounts s payable payable in full Decrease assets and decrease liabilities
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17. Listed below are some items found in the financial statements of Dave Ramsey Co. Indicate in which financial financial statement(s) the following following items would appear. appear. (a) Service revenue (b)Equipment (c) Accounts receivable (d)Owner’s capital (e) Advertising expense. (e)Salaries and wages payable
– Income Statement -- Balance Sheet – Balance Sheet – Balance sheet and owner’s equity statement – Income Statement – Balance sheet
18. In February 2012, Betty King invested an additional $10,000 in her business, King’s Pharmacy, which is organized as a proprietorship. King’s accountant, Leroy James, recorded this receipt as an increase in cash and revenues. Is this treatment appropriate? Why or why not?
I believe, this treatment is not proper. $10,000 investment by Betty King in her business King’s Pharmacy is an increase in Cash (Assets) and also increase in Owner’s Equity but it does not represent revenue. This transaction is simply an additional investment in vestment made by the owner in the business and Investment by owner do not represent the Revenue and they are excluded in determining net income. 19. “A company’s net income appears directly on the income statement and the owner’s equity statement, and it is included indirectly in the company’s balance sheet.” Do you agree? Explain.
I agree with statement that “A company’s net income appears directly on the income statement, it is the result of subtracting expenses from revenues. In addition, net income appears in the statement of owner’s equity. Net Income is indirectly included in a balance sheet because balance sheet reports the assets, liabilities, and owner’s equity at a specific date and since Owner’s Equity includes the Net Income so in this way Net Income is indirectly reported in Balance sheet. 20. Torchwood Enterprises had a capital balance of $168,000 at the beginning of the period. At the end of the accounting period, the capital balance was $198,000. (a) Assuming no additional additional investment or withdrawals during the period, what is the net income for the period? Ending capital balance Beginning capital balance Net income
$198,000 168,000 $30,000
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(b) Assuming an additional investment of $13,000 but no withdrawals during the period, what is the net income for the period? Ending capital balance Beginning capital balance
$198,000 168,000 30,000 13,000 $30,000
Less Investment Net income
21. Summarized operations for J. R. Ewing Co. for the month of July are as follows. Revenues earned: for cash $20,000; on account $70,000. Expenses incurred: for cash $26,000; on account $40,000. Indicate for J. R. Ewing Co. (a) the total total reven revenues ues,, (b) the total total expen expenses ses,, and (c) net income income for for the month of July. July. Revenue Service Revenue
Expenses Expenses on cash Expenses on credit Total Expenses
$90,000 (26,000) (40,000) _________ (66,000) $24,000
Net Income
a) The total total revenu revenues es = $90,00 $90,000 0 ( 20,000 + 70,000) 70,000) (Sum of cash revenue and on account revenue) b) The total total expens expenses es = $66,00 $66,000 0 (26,000) + (40,000) = $66,000 (sum of Expense on cash and expesne on credit) c) Net income income for the month month of July July = $24,00 $24,000 0 Total Revenue Total Expenses Net Income
$90,000 66,000 $24,000
22. The basic accounting equation is: Assets = Liabilities + Owner’s Equity. Replacing the words in that equation with dollar amounts, what is Coca-Cola’s accounting equation at December 31, 2009? ( Hint: Owner’s equity is equivalent to shareowners’ equity.)
Coca-Cola’s accounting equation at December 31, 2009 is as listed below;
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Assets = Liabilities + Owner’s Equity Equity 48,671 = 23,325 + 25,346
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Chapter 2 – The Recording Process Questions – 1-21, Pages 78-79 1. Describe the parts of a T account. T account consists of three parts: (1) a title, (2) a left or debit side, and (3) a right or credit side. Because the format of an account resembles the letter T, we refer to it as a T account.
2. “The terms debit and credit mean increase and decrease, respectively.” Do you agree? Explain.
I do not agree with the statement that “The terms debit and credit mean increase and decrease, respectively.” We use the terms debit and credit repeatedly in the recording. Debit simply means that the amount is entered on the left side of the account, while the word Credit means that the amount is entered on the right hand. Depending on the nature of transaction, debit or credit will be increased or in some cases it will be decreased. We can not conclude that Debit implies the increasing value and Credit implies the decreasing value.
3. Jeff Hiller, a fellow student, contends that the double-entry system means each transaction must be recorded twice. Is Jeff correct? Explain.
No Jeff is not correct. Under the double-entry system, the dual (two-sided) effect of each transaction is recorded in appropriate accounts. As per basic accounting equation each transaction must affect two or more accounts to keep the basic accounting equation in balance, means for each transaction, debits must equal credits. The equality of debits and credits provides the basis for the double-entry system of recording transactions. This system provides a logical method for recording transactions. The double-entry system also helps ensure the accuracy of the recorded amounts and helps to detect errors. If every transaction is recorded with equal debits and credits, the sum of all the debits to the accounts must equal the sum of all the credits. 4. Maria Alvarez, a beginning accounting student, believes debit balances are favorable and credit balances are unfavorable. Is Maria correct? Discuss.
No, Maria is not correct in believing that debit balances are favorable and credit balances are unfavorable. Debit and credit are two actions that are opposite in nature. A debit balance only means that debit amounts exceed credit amounts in an account and a credit balance only means that credit amounts are greater than debit amounts in an account. An account that is affected affected by an accounting transaction is either either debited or credited with an amount that is reflected in transaction depending on the nature of account and the rule applicable to it. Below are the two examples to further further explain this analogy; 1 – Purchase of furniture worth $ 5,000 in cash In this case furniture account is debited with $5,000 but Cash account is credited by
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similar amount 2 –Payment of $ 5,000 received from Mr. John by check In this case Mr. John’s account is credited by $5,000 and the bank account is debited With similar amount. 5. State the rules of debit and credit as applied to (a) asset asset acco account unts, s, (b) liability liability accounts, accounts, and (c) the owner’s equity accounts (revenue, expenses, owner’s drawings, and owner’s capital).
Debit
Credit
Asset accounts
Increase
Decrease
liability accounts
Decrease
Increase
Owner’s equity accounts – Revenue
Decrease
Increase
Owner’s equity accounts – Expenses
Increase
Decrease
Owner’s equity accounts – Drawings
Increase
Decrease
Owner’s equity accounts – Capital
Decrease
Increase
6. What is the normal balance for each of the following accounts? (a) Accounts Receivable. (b) Cash. (c) Owner’s Drawings. (d) Accounts Payable. (e) Service Revenue. (f) Salaries and Wages Expense. (g) Owner’s Capital.
a b c d e g g
Account Receivable Cash Owner’s Drawings Accounts Payable Service Revenue Salaries and Wages Expense Owner’s Capital
Normal Balance (Debit/Credit) Debit Balance Debit Balance Debit Balance Credit Balance Credit Balance Debit Balance Credit Balance
7. Indicate whether each of the following accounts is an asset, a liability, or an owner’s equity account and whether it has a normal debit or credit balance: (a) Accounts Receivable, Receivable, (b) Accounts Payable, (c) Equipment, Equipment, (d) Owner’s Drawings, (e) Supplies.
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Type of Account a b c d e
Acco Accoun untt Recei eceiv vable able Accounts Payable Equipment Owner’s Drawings Supplies
Asse Assett Acco Accoun untt Liability Account Asset Account Owner’ Equity Asset Account
Normal Debit/Credit Balance
Debit ebit Bala Balanc nce e Credit Balance Debit Balance Debit Balance Debit Balance
8. For the following transactions, indicate the account debited and the account credited. (a) Supplies are purchased on account.
Account Type Supplies Accounts Payable
Debit (+) xxx
Credit (-) xxx
Debit Supplies and credit Accounts Payable (b) Cash is received on signing a note payable.
Account Type Cash Note Payable
Debit (+) xxx
Credit (-) xxx
Debit Cash and credit Notes Payable (c) Employees are paid salaries in cash.
Account Type Salaries and Wage Expense Cash
Debit (+) xxx
Credit (-) xxx
Debit Salaries Expense and credit Cash
9. Indicate whether the following accounts generally will have (a) debit debit entrie entries s only, only, (b) Credit Credit entries entries only, or (c) both debit and credit credit entries entries (1) Cash (2) Accounts Receivable (3) Owner’s Drawings. (4) Accounts Payable. (5) Salaries and Wages Expense.
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(6) Service Revenue
1 2 3 4 5 6
Cash Accounts Receivable Owner’s Drawings Accounts Payable Salaries and Wages Expense Service Revenue
Both debit and credit entries Both debit and credit entries Debit entries only Both debit and credit entries Debit entries only Credit entries only
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10. What are the basic steps in the recording process? The basic steps steps in the recording recording process process are:Step 1:- To analyze each transaction - In this step, business documents are examined to determine the effects of the transaction on the accounts. Step 2:- To enter each transaction transaction in a journal - This step is called journalizing journalizing and its results in making a chronological record of the transactions. Step 3:- To transfer journal information information to the appropriate account in the ledger – This step step is called called posting. Posting makes it possible to accumulate the effect of journalized transactions on individual accounts.
11. What are the advantages of using a journal in the recording process?
Below are the advantages of using a journal in the recording process: 1. It discloses in one place the complete effects of a transaction. 2. It provides a chronological record of transactions. 3. It helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared 12. (a) When entering a transaction in the journal, should the debit or credit be written first?
The debit account title (that is, the account to be debited) is entered first at the extreme left margin of the column headed “Account Titles and Explanation,”. (b) Which should be indented, the debit or credit? The credit account title (that is, the account to be credited) is indented.
13. Describe a compound entry, and provide an example.
Some transactions, require more than two accounts in journalizing. An entry that requires three or more accounts is a compound entry. An example of a compound entry is the purchase of equipment, part of which is paid for with cash and the remainder is on account To illustrate, assume that on July 1, Butler Company purchases a delivery truck costing $9,000. It pays $6,000 cash now and agrees to pay the remaining $3,000 on account (to be paid later). The compound entry is as follows.
General Journal Account Title and Explanation
Debit
Credit
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01/0 01/07/ 7/20 2012 12 Equi Equipm pmen entt Cash Accounts Payable
9,000 6,000 3,000
(Purchase truck for cash with balance on account)
14. (a) Should business transaction debits and credits be recorded directly in the ledger accounts ?
Yes, it is possible to enter transaction information (debit and credit) directly into the Ledger account without using a Journal but very few businesses do so because in the Ledger information is not arranged in chronological order. Mostly companies arrange the ledger in the sequence in which they present the accounts in financial statement. (b) What are the advantages of first f irst recording transactions in the journal and then posting to the ledger?
Advantage of recording transaction in Journal is that the Journal provides a chronological record of all transactions, transactions, the order in which they occur. In Journal at one place we see the complete effect of a transaction because a separate entry is entered for each transaction with date of transaction, the account and amount to be debited and credited and it also include the brief Explanation of the transaction. Journal also helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared.
15. The account number is entered as the last step st ep in posting the amounts from the journal to the ledger. What is the advantage of this step?
In the reference column of the Journal, we write the account number to which the credit amount was posted and the advantage of writing the account number as the last step is that this account number is used in the Charts of Accounts and this chart lists the accounts and account numbers that identify the location of the account is the ledger. 16. Journalize the following business transactions. (a) Hector Molina invests $9,000 cash in the business. (b) Insurance of $800 is paid for the year. (c) Supplies of $2,000 are purchased on account. (d) Cash of $7,500 $7,500 is received received for services services rendered. rendered.
General Journal A
Account Title and Explanation Cash Owner’s Capital
Debit $ 9,000
Credit
9,000
(Hector Molina invested cash in business)
B
Prepaid Insurance Cash
$ 800 800
(prepaid insurance for the year)
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C
Supplies Accounts Payable
$ 2,000 2,000
(purchased supplies on account)
D
Cash Service Revenue
$ 7,500 7,500
(Received cash for services provided)
17. (a) What is a ledger?
The entire group of accounts maintained by a company is called the ledger. The ledger keeps in one place all the information about changes in specific account balances. Companies may use various kinds of ledgers, but every company has a general ledger. A general ledger contains all the asset, liability, and owner’s equity accounts. (b) What is a chart of accounts and why is it important?
The Chart of Accounts is the backbone of accounting system. A chart of accounts is a list of accounts and the account numbers that identify their location in the ledger. The chart of accounts is important, particularly for a company that has a large number of accounts, because it helps organize the accounts and identify their location in the ledger. The numbering system that identifies the accounts usually starts with the balance sheet accounts and follows with the income statement accounts. 18. What is a trial balance and what are its purposes?
A trial balance is a list of accounts accounts and their balances at a given given time. Its primary purpose is to prove the equality of debits and credits after posting. A trial balance also uncovers errors in journalizing and posting and is useful in preparing financial statements
19. Jim Benes is confused about how accounting information flows through the accounting system. He believes the flow of information is as follows. (a) Debits and credits posted to the ledger. (b) Business transaction occurs c) Information entered in the journal. (d) Financial statements are prepared. (e) Trial balance is prepared.
Is Jim correct? If not, indicate to Jim the proper flow of the information. No, Jim is not correct. Below are the correct steps listed in which the accounting information flows through the accounting system. a) Business transaction occurs b) Information entered in the journal. c) Debits and credits posted to the ledger d) Trial balance is prepared
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e) Financial statements are prepared.
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20. Two students are discussing the use of a trial balance. They wonder whether the following errors, each considered separately, would prevent the trial balance from balancing. (a) The bookkeeper debited Cash for $600 and credited credited Salaries and and Wages Expense Expense for $600 for payment of wages .
The trial balance would balance because bookkeeper debited the cash for $600 correctly and salaries and wage expense is credited correctly. (b) Cash collected on account account was debited to Cash for $900 and Service Revenue was credited for $90. What would you tell them?
The trial balance will not balance. balance. Cash and Service Revenue is correctly debited and credited respectively in each column column but the correct dollar amount is not entered either for Cash or Service Revenue and this will prevent trial balance from balancing.
21. What are the normal balances for PepsiCo’s Cash, Accounts Payable, and Interest Expense accounts? In millions
Dec 26’ 2009 Cash Accounts Payable Interest Expense account
$3,943 $2,881 $397
Dec 27’ 2008 $ 2,064 $2,846 $329
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Chapter 3 - Adjusting the Accounts Questions – 1-23, pages 129 – 130 1. (a) How does the time period assumption affect an accountant’s analysis of business transactions?
The time period assumption is also called the periodicity assumption. The Time-period principle implies that the economic activities of an enterprise can be divided into artificial time periods. This assumption allows the accountant to measure the performace of a business for distinct time periods. If time is not divided into distinct periods, the accountant cannot record separate transactions in separate time periods. If transactions are not recorded in separate time periods, the accountant cannot compile and compare transactions against one another to measure various aspects of the business’ activities. (b) Explain the terms fiscal year, calendar year, and interim periods. Interim Period - Interim periods are accounting time periods of less than one year in duration, such as a quarter, a month, or a semi-annual period. Most large companies must prepare both quarterly and annual financial statements. Fiscal Year - An accounting time period that is one year in length is a fiscal year. A fiscal year usually begins with the first day of a month and ends twelve months later on the last day of a month. Companies whose fiscal year differs from the calendar year include Delta Air Lines, June 30, and Walt Disney Disney Productions, September 30. Calendar year – When businesses use the January 1 to December 31 as their accounting period.
2. State two generally accepted accounting principles that relate to adjusting the accounts.
Two generally accepted accounting principles that relate to adjusting the accounts are revenue recognition principle and expense recognition principle. As per the revenue recognition principle - it is is required that companies recognize revenue in the accounting period in which it is earned. As per expense recognition principle/ matching matching principle - expenses should be recorded when incurred such that the expenses are recorded in the same time period as the related revenue. 3. Chris Harris, a lawyer, accepts a legal engagement in March, performs the work in April, and is paid in May. If Harris’s law firm prepares monthly financial statements, when should it recognize revenue from this engagement? Why?
At the time of preparing monthly financial statements, Harris’s Harris’s law firm should recognize revenue in the month of April in which the service is performed under the revenue recognition principle. As per this principle Harris’s law firm earned the revenue in April when the services are performed rather then in May when it receives the cash. On May 31st Harris’s law firm should report a receivable on its balance sheet and revenue in its income statement for the services performed.
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4. Why do accrual-basis financial statements provide more useful information than cash-basis statements?
Information presented on an accrual basis is more useful than on a cash basis because it reveals relationships that are likely to be important in predicting future results. Under the accrual basis, companies record the financial aspect of each economic event in the accounting period in which the event occur. occur. For example, using the accrual accrual basis to determine net income means companies recognize revenues when earned (rather than when they receive cash). It also means recognizing expenses when incurred (rather than when paid). While under the cash-basis accounting, companies record revenue when they receive cash. They record an expense when they pay out cash but it often produces misleading financial statements. It fails to record revenue that a company has earned but for which it has not received the cash. Also, it does not match expenses with earned revenues. 5. In completing the engagement in question 3, Harris pays no costs in March, $2,000 in April, and $2,500 in May (incurred in April). How much expense should the firm deduct from revenues in the month when it recognizes the revenue? Why? Under the matching principle expense should be matched with revenues. All of the expenses that relate to this revenue must be recorded in the same time period so the e xpenses of $4,500 should be deducted from the revenues in April.
6. “Adjusting entries are required by the cost principle of accounting.” Do you agree? Explain.
No, adjusting entries are not required by the cost principle. In accounting adjustments are needed to prepare a correct and up-to-date financial statements and adjusting entries are required by revenue and expense recognition principles.
7. Why may a trial balance not contain up-to-date and complete financial information?
Trial balance may not contain up-to-date and complete financial information at the time of the pulling together of the transaction data due to several reasons;
1. Some events are not recorded daily because it is not efficient to do so. Examples are the use of supplies and the earning of wages by employees. 2. Some costs are not recorded during the accounting period because these costs expire with the passage of time rather than as a result of recurring daily transactions. Examples are charges related to the use of buildings and equipment, rent, and insurance. 3. Some items may be unrecorded. An example is a utility service bill that will not be received until the next accounting period.
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8. Distinguish between the two categories of adjusting entries, and identify the types of adjustments applicable to each category.
There are two categories of adjusting entries; 1) Deferrals 2) Accruals. Each of these classes has two subcategories.
Deferrals – A deferral is delay of either an expense that has been paid or a revenue that has been collected. The two types of deferrals are prepaid expenses and unearned revenues. 1. Prepaid expenses: Expenses paid in cash and recorded as assets before they are used or consumed. 2. Unearned revenues: Cash received and recorded as liabilities before revenue is earned. Accruals – An accrual is an expense that has not been paid or a revenue that has not yet been received. The two types of accruals are accrued revenues and accrued expenses. 1. Accrued revenues: Revenues earned but not yet received in cash or recorded. 2. Accrued expenses: Expenses incurred incurred but not yet paid in cash or recorded. recorded. 9. What is the debit/credit effect of a prepaid expense adjusting entry? An adjusting entry for prepaid prepaid expenses results in an increase (a debit) debit) to an expense account and a decrease (a credit) to an asset account.
10. “Depreciation is a valuation process that results in the reporting of the fair value of the asset.” Do you agree? Explain.
No, Depreciation is an allocation concept, not a valuation concept . Depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. Depreciation allocates an asset’s cost to the periods in which it is used. Depreciation results in the presentation of the book value of the asset, not its market
value. 11. Explain the differences between depreciation expense and accumulated depreciation.
Depreciation expense is an expense account whose normal balance is a debit. This account shows the cost that has expired during the current accounting period. Accumulated depreciation is a contra asset account whose n ormal balance is a credit. The balance in this account is the depreciation that has been recognized from the date of acquisition to the balance sheet date.
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12. T. Harris Company purchased equipment for $18,000. By the current balance sheet date, $6,000 had been depreciated. Indicate the balance sheet presentation of the data. Below is the balance sheet presentation of the above data; T. Harris
Assets
Balance Sheet Amount $
Office Equipment Less: Accumulated Depreciation – Equipment
$18,000 ($6,000)
Amount $
$12,000
13. What is the debit/credit effect of an unearned revenue adjusting entry? The adjusting entry for unearned revenues results in a debit to a liability account and credit to a revenue account.
14. A company fails to recognize revenue earned but not yet received. Which of the following accounts are in involved in the adjusting entry: (a) asset, (b) liability, (c) revenue, or (d) expense? For the accounts selected, indicate whether they would be debited or credited in the entry.
Asset and revenue accounts are involved in the adjusting entry. An asset would be debited and a revenue would be credited
15. A company fails to recognize an expense incurred but not paid. Indicate which of the following accounts is debited and which is credited in the adjusting entry: (a) asset, (b) liability, (c) revenue, or (d) expense.
An adjusting entry for accrued expenses results results in increase in below two accounts; accounts; Without this adjusting entry, liabilities and interest expense are understated, and net income and owner’s equity are overstated. Expense Account – Debited (increase in expense account) Liability Account – Credited (increase in liability account)
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16. A company makes an accrued revenue adjusting entry for $900 and an accrued expense adjusting entry for $700. How much was net income understated prior to these entries? Explain.
Net income was understated $200 because prior to adjustment revenues are understated by $900 and expenses are understated by $700. The difference in this case is $200 ($900 – $700). Below listed is the detailed explanation;
Accrued Revenue adjusting adjusting entry for for $900 Asset Account – Debited Revenue Account – Credited
Accrued expense adjusting adjusting entry for for $700 Expense Account – Debited Liability Account – Credited
Assets
Liabili ilitie ties s + = Liab
Accounts Receivable
Accrued revenue adjusting entry Accrued expense adjusting entry
Service Revenue
$ 90 0
Total
Owne Ow ner's r's Equi Equity ty - Expense
$ 900 700 700
(700) 900
(700)
Net Income = Sum of Revenue and Expenses $ 200 = 900 +(700)
17. On January 9, a company pays $5,000 for salaries, of which $2,000 was reported as Salaries and Wages Payable on December 31. Give the entry to record the payment.
The Entry to record the payment is listed below; Date Jan Jan 9
Account Titles & Explanation Sala Salari ries es and and Wag Wages es Paya Payabl ble e Salaries & Wages Expense Cash
Debit $ 3,000 $ 2,000
Credit
$5,000
(Payment of the salaries and salaries payable)
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18. For each of the following items before adjustment, indicate the type of adjusting entry (prepaid expense, unearned revenue, accrued revenue, or accrued expense) that is needed to correct the misstatement. If an item could result in more than on type of adjusting entry, indicate each of the types . (a) Assets are understated. (b) Liabilities are overstated. (c) Liabilities are understated. (d) Expenses are understated (e) Assets are overstated. (f) Revenue is understated.
Below are the type of adjusting entry for each account listed above; a b c d e f
Assets are understated Liabilities are overstated Liabilities are understated Expenses ar are un understated Assets are overstated Revenue is understated
Accrued Revenue Unearned revenue Accrued Expense Prepaid ex expense, Ac Accrued Ex Expense Prepaid expense Unearned revenue, Accrued Revenue
19. One-half of the adjusting entry is given below. Indicate the account title for the other half of the entry. (a) Salaries and Wages Expense is debited. (b) Depreciation Expense is debited. (c) Interest Payable is credited. (d) Supplies is credited. (e) Accounts Receivable is debited. (f) Unearned Service Revenue is debited.
Below are the account titles;
a b c d e f
Account Titles Salaries an and Wa Wages Ex Expense Salaries and Wages Payable Depreciation Expense Accumulated Depreciation Interest Expense Interest Payable Supplies Expense Supplies Accounts Re Receivable Service Revenue Unearned Service Revenue Service Revenue
Debit xxx
Credit
xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx
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20. “An adjusting entry may affect more than one balance sheet or income statement account.” Do you agree? Why or why not?
I do not agree with the above above statement because each adjusting entry only affects one income statement account (a revenue or expense account) and one balance sheet account (an asset or liability account). For example, suppose a company has a $2,000 debit balance in its supplies account at the end of a month, but a count of supplies on hand finds only $600 of them remaining. Since supplies worth $1400 have been used up, the supplies account requires a $1400 adjustment so assets are not overstated, and the supplies expense account requires a $1400 adjustment so expenses are not understated. 21. Why is it possible to prepare financial statements directly from an adjusted trial balance?
Financial statements can be prepared from an adjusted trial balance because the balances of all accounts have been adjusted to show the effects of all financial events that have occurred during the accounting period. period.
* 22. M. Harrison Company debits Supplies Expense for all purchases of supplies and credits Rent Revenue for all advanced rentals. For each type of adjustment, give the adjustment entry .
For Supplies Expense (prepaid expense) - expenses are overstated and assets are understated. Adjusting Entries are as below; Date
Account Title and Explanation
Apr-2013
Supplies Expense Supplies (To record supplies used)
Debit
Credit
xxxx xxxx
For Rent Revenue (unearned revenues) - revenues are overstated and liabilities are understated. Adjusting Entries are as below; Date
Account Title and Explanation
Apr-2013
Unearned Rent Revenue Rent Revenue
Debit
Credit
xxxx xxxx
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(To record rent revenue earned)
Assets (Supplies)...................... (Supplies).................................. ........................ ........................ ........................ ........................ ........................ .................... ........ XX Expenses (Supplies Expense)................... Expense)............................... ........................ ........................ ......................... ................. .... XX
Revenues (Rent Revenue) ....................... .................................. ....................... ......................... ......................... ......................... ............... XX Liabilities (Unearned Rent Revenue)
23. What was PepsiCo’s depreciation and amortization expense for 2009 and 2008?
As per Financial Statements in Appendix “A” “A” PepsiCo’s depreciation and amortization expense for 2009 and 2008 are as below;
In Millions
Depreciation Expense
2009 $1,500
Amortization Expense
$63
2008 $1,422
$64
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