Chapter 3 HW Solutions

CHAPTER 3

Measuring Revenues and Expenses

THINKING BEYOND THE QUESTION

How do we know how much profit our business has earned?

Revenues earned over several fiscal periods usually are allocated to each of the periods involved. Some reasonable basis of allocation is re-quired. Usually, an attempt is made to allocate the revenues in propor-tion to the amount of activity that occurred each period. Activity may be measured by estimating how much of the total service has been provided each period or by how much of the total cost associated with providing the service has been incurred each period. In some cases, revenues are earned each period, and an equal portion of the revenues is allocated to each fiscal period. For example, revenue associated with leasing a facil-ity to a customer usually is allocated proportionately to each period of the lease under the assumption that the value of services provided is the same each period.

QUESTIONS

Q3-1 The flow of cash often predates or follows the economic event to which it is related. If financial reports are supposed to measure the economic activities that occurred during a period, the amount of cash that flowed will often not yield useful measurements. For example, a tenant may pay his rent for six months in advance. To recognize six months’ worth of rent revenue in the period the cash was received will overstate the significance of the economic events occurring then. Similarly, if goods are sold in the current accounting period but the cash will not be received until a subsequent period, cash basis accounting will understate the economic significance of sales activities during the current period.

Q3-2 Agree. While the accrual measurement of revenue and expense is traced to the accounting period in which the economic event occurred, the cash from that same event might flow in an earlier period, in the same period, or in a later period. Over time, however, the total amount of cash flow is equal to the accrual measure. In fact, the accrual measure is based on the amount of cash that is ultimately expected to flow from the event.

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52 Chapter 3

Q3-3 Profitability is reported on the income statement using an accrual measure. It is the difference between revenues earned and expenses consumed. Profit is the amount of cash that is ultimately expected to result after all transactions are complete. In the meantime, however, there could be a severe shortage of cash. For example, sales could be made and recorded on the accrual basis even though the related cash is not scheduled for collection until well into the future. Similarly, certain expenses such as insurance, rent, or advertising could be paid for well in advance of their being used. As a result of these events, net income would be high but cash flow would be very low, or perhaps negative. When a company cannot pay its bills on time it can be forced into bankruptcy and dissolution.

Q3-4 Accounts Receivable links Revenue and Cash by recording the amount owed the company until the customer pays for the merchandise or services provided.

Q3-5 Unearned Revenue is a liability that is reported on a company’s balance sheet. The unearned revenue account records the obligation resulting from receiving cash before revenue has been earned.

Q3-6 • Accrued revenue occurs when revenue is recognized prior to the receipt of cash.

• Deferred revenue is revenue recognized after cash has been received

Q3-7 At the moment the rent is paid, the company has acquired an asset. It has purchased the exclusive right to use the landlord’s property for one month. Therefore, it is reasonable to show the payment as acquisition of an asset (Prepaid Rent). At the end of June when the rent has been “used up,” an adjustment will be necessary to transfer the $900 of Prepaid Rent to Rent Expense.

Q3-8 No expense has been incurred in this transaction. The company is no better off or worse off after the transaction. Prior to the transaction the company had $35,000 of one form of asset (cash), whereas after the transaction it has $35,000 of a different form of asset (inventory).

Q3-9 Subsidiary accounts are used to record the detail associated with an individual item of importance to a company. For example, a separate subsidiary account (Accounts Receivable—Sally Jobers) is maintained for each customer who purchases goods on credit from the company. A collection of subsidiary accounts is called a subsidiary ledger. A control account summarizes the overall total balance of a group of subsidiary accounts. For example, the overall balance of all subsidiary Accounts Receivable accounts is maintained in an Accounts Receivable control

Measuring Revenues and Expenses 53

account. Only the control accounts are reported in the financial statements.

Q3-10 Control accounts summarize the detailed information contained in subsidiary accounts. When decision makers outside the firm make decisions concerning the organization, these summaries are sufficient and appropriate. For example, for external decision making purposes, it is quite sufficient for a decision maker to know only the total cost of a company’s merchandise on hand. External decision makers don’t need (or care) to know what portion of Home Depot’s merchandise on hand is composed of tools, paint, lumber, or shrubbery. The control account balances are sufficient. To internal decision makers, though, detailed subsidiary information is critical. For those decision makers it is critical to monitor the mix of merchandise on hand and available for sale.

Q3-11 Other common examples of period costs are interest, property taxes, rent on office facilities, and management salaries. All of these costs generally occur with the passage of time. In many cases, the company does not ever receive a bill for these items and, even if it did, the billing period often doesn’t coincide with the accounting period. For example, annual property taxes are often billed in July even though the assessment period runs on a calendar year. For another example, the monthly rent payments may be due on the 14th of the month, but the end of the accounting period is usually the end of a month. Similarly, interest on a loan runs from the origination date of the loan, which may not coincide with the end of the company’s fiscal period.

Q3-12 This statement is not true. The numbers reported on a balance sheet are related to the cost of the asset, not its current value. When an asset such as a building or land is acquired, it is entered into the accounting records at its cost (which is probably a good measure of its current value at that date). Subsequently, however, no attempt is made to update those numbers for changes in current value. In the case of land, the original cost is retained in the account until sold. In the case of depreciable assets such as a building, a portion of the asset’s cost is allocated to depreciation expense each period that the asset is used. The difference between the asset’s cost and the balance in the accumulated depreciation account does not represent current value. Instead, this amount is simply the original cost minus the portion of cost that has been allocated to depreciation expense.

Q3-13 The purpose of preparing a trial balance is to make sure the accounting equation is in balance. If the general ledger does not balance, the accounting equation (and financial statements) will not balance.

54 Chapter 3

Q3-14 The closing entries zero out the revenue and expense account balances at the end of a fiscal period. Consequently, the next fiscal period begins with zero balances and accumulates revenues and expenses for the new fiscal period. Closing is necessary to ensure revenues and expenses are reported in the appropriate fiscal period.

Q3-15 No. Payments to owners are considered a return of capital, not an expense. The cash and retained earnings accounts are reduced when a cash payment is made to an owner.

Q3-16 Proper accounting procedures make unethical behavior difficult. The procedures are designed to protect a company’s accounting records and assets.

Q3-17 Good accounting controls protect owners, creditors, and other stakeholders from receiving inaccurate or improperly prepared financial information.

Q3-18 Non-zero balances—asset, liability, and equity accounts

Zero balances—revenue and expense accounts

EXERCISES

E3-1 Definitions of all terms are listed in the glossary.

E3-2 Net Income Net Cash FlowSale of wheat (all cash) $ 650,000 $650,000Operating costs ($532,500 in cash) (585,000) (532,500)Loan payment — (40,000)Net income $ 65,000 Net cash flow $ 77,500

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


E3-3 Received for miles traveled ($4.50 × 2,400 miles) $10,800

Expenses:Gas 500Food 116Lodging 204Helpers 100 Total expenses $ 920 Net income $ 9,880

Cash received = zeroCash outflow = –$920

Accrual accounting recognizes income when earned and expenses when incurred. Thus, Jeni earned $9,880 in June associated with the job, even though her June cash flow is ($920) for the job.

E3-4

Cash Flow

for September

Cash Flow

in Future

Sales Revenue

for September

Cash from prior sales $165,000

Cash from September sales $ 75,000 $147,500 $222,500

Total cash received in September $240,000

E3-5Journal Effect on Accounting Equation

Date Accounts Debits Credits A = L +OE

CC + RE1. Interest Expense 3,600* –3,600

Interest Payable 3,600 +3,600

2. Rent Revenue 4,000** –4,000Unearned Rent 4,000 +4,000

3. Insurance Expense 3,150*** –3,150Prepaid Insurance 3,150 –3,150

4. Depreciation Expense 48,000 –48,000Accumulated

Depreciation 48,000 –48,000

* ($40,000 × 9%)

** (12,000 ÷ 3 months)

*** ($8,400 ÷ 24 months = $350; $350 × 9 months = $3,150)

56 Chapter 3

E3-6

Journal Effect on Accounting Equation


CC + REOct. 1 Merchandise 3,600 +3,600

Accounts Payable 3,600 +3,600

Oct. 3 Cash 900 +900Sales Revenue 900 +900

Cost of Goods Sold 270 –270Merchandise 270 –270

Oct. 6 Accounts Receivable 1,800 +1,800Sales Revenue 1,800 +1,800

Cost of Goods Sold 590 –590Merchandise 590 –590

Oct. 7 Ordering merchandise does not result in a transaction that should be recorded in the accounting system.

Oct. 9 Spoilage Expense 400 –400Merchandise 400 –400

Oct. 10 Accounts Payable 1,800 –1,800Cash 1,800 –1,800

Oct. 16 Cash 1,200 +1,200Accounts Receivable 1,200 –1,200

E3-7Company

ACompany

BCompany

CCash received from customers during 2007 $300,000 $625,000 $242,000Sales revenue for 2007 $352,500 $580,000 $260,000Accounts receivable at beginning of 2007 $31,000 $130,000 $35,000Accounts receivable at end of 2007 $83,500 $85,000 $53,000

CompanyA Revenue was $52,500 more than cash collected. Therefore, accounts

receivable must have increased by $52,500 during the year.B Revenue was $45,000 less than cash collected. Therefore, accounts

receivable must have decreased by $45,000 during the year.C Accounts receivable increased by $18,000 during the year. Therefore,

sales revenue must have been $18,000 more than cash received for the year.


Alternative presentations include:

Company ACash received in 2007 $300,000 Revenue for 2007 $352,500Cash for prior year sales 31,000 Cash for 2007 sales 269,000 Cash for 2007 sales $269,000 Accounts receivable

at end of 2007 $ 83,500 Company BRevenue for 2007 $580,000 Cash received in 2007 $625,000Cash to be collected in 2008 85,000 Cash for 2007 sales 495,000 Cash for 2007 sales $495,000 Accounts receivable

at beginning of 2007 $130,000

Company C Accounts receivableRevenue for 2007 $260,000 at beginning of 2007 $ 35,000Cash to be collected in 2008 53,000 Cash for 2007 sales 207,000 Cash for 2007 sales $207,000 Cash received in 2007 $242,000

E3-8

a.Journal Effect on Accounting Equation


CC + RE1. Wages Expense 7,600 –7,600

Wages Payable 7,600 +7,6002. Office Supplies Inventory 500 +500

Office Supplies Expense 500 +5003. Rent Receivable 2,500 +2,500

Rent Revenue 2,500 +2,5004. Depreciation Expense 11,000 –11,000

Accumulated Deprec. 11,000 –11,000*5. Interest Expense 5,700 –5,700

Interest Payable 5,700 +5,700

*Accumulated Depreciation is a contra account. It is increased each pe-riod when depreciation expense is recognized. It is shown here as a de-duction, because its overall effect on the accounting system is to de-crease total assets.

b. Net income = $72,400 – $7,600 + $500 + $2,500 – $11,000 – $5,700= $51,100

58 Chapter 3

E3-9 a.

Past September Future Total

Revenues

Expenses $1,500 $2,500 $1,000 $5,000

Cash received

Cash paid $5,000 $5,000

b.


Revenues $15,000 $15,000

Expenses

Cash received $9,000 $6,000 $15,000

Cash paid

c.


Revenues

Expenses $7,500 $7,500

Cash received

Cash paid $5,000 $2,500 $7,500

d.


Revenues

Expenses

Cash received $50,000 $50,000

Cash paid $2,500 $47,500 $50,000

e.


Revenues

Expenses $500 $24,500 $25,000

Cash received

Cash paid $25,000 $25,000

E3-10

Cash Flowfor June

Cash Flowin July

WagesExpensefor June

Cash paid for prior wages $5,800

Cash paid for June wages $44,200 $4,200 $48,400

Total cash paid in June for wages $50,000


E3-11

January February MarchTotal forQuarter

Cash paid for interest $0 $0 $3,750 $3,750

Interest expense $1,250 $1,250 $1,250 $3,750

E3-12

2007 2008 2009Total for3 Years

Cash paid for equipment $600,000 $0 $0 $600,000

Depreciation expense $200,000 $200,000 $200,000 $600,000

A cash payment is recorded when cash is paid for the equipment. An ex-pense is recorded on an accrual basis each fiscal period as resources are consumed in the operation of the company. An assumption is made that the equipment benefits the company each year it is used. Therefore, depreciation allocates the cost of the equipment to the periods benefited and matches it with revenues earned in those periods.

E3-13

April May JuneTotal for3 Months

Cash paid for utilities $850 $1,025 $1,150 $3,025

Utilities expense $850 $1,025 $1,150 $3,025

Cash and accrual basis measures are different when cash is received or paid in one fiscal period but resources are created or consumed in a dif-ferent period. They are the same when cash is received or paid in the same period resources are created or consumed, as in this exercise.

E3-14



CC +

RE

a. Interest Expense 1,200 –1,200Interest Payable 1,200 +1,200

b. Unearned Rent 1,000 –1,000Rent Revenue 1,000 +1,000

c. Insurance Expense 2,000 –2,000Prepaid Insurance 2,000 –2,000

d. Depreciation Expense 35,000 –35,000Accumulated Deprec. 35,000 –35,000*

*Accumulated Depreciation is a contra account. It is increased each period when deprecia-

tion expense is recognized. It is shown here as a deduction, though, because its overall

effect on the accounting system is to decrease total assets.

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E3-15 a. Merchandise—Canvas Material +$20,000Accounts Payable—Ramirez, Inc. +$20,000

b. Merchandise Inventory +$20,000Accounts Payable +$20,000

c. Assets: Merchandise Inventory $155,000Liabilities: Accounts Payable $ 37,000

E3-16 Assets Liabilities Equity Net Income

Year-end amountsbefore correction $7,625 $2,820 $4,805 $1,200

Adjusting entry (a):Decrease Prepaid Insurance (400)Increase Insurance Expense (400) (400)

Adjusting entry (b):Increase Wages Payable 375Increase Wages Expense (375) (375)

Year-end corrected amounts $7,225 $3,195 $4,030 $ 425

E3-17 a. The purpose of closing the books is to empty out all of the revenue and expense accounts. Each of these account balances must be set back to zero before the following year’s data can start being collected by the accounting system.

b.



CC + REDec. 31 Sales Revenue 2,200 –2,200

Retained Earnings 2,200 +2,200Retained Earnings 1,850 –1,850Cost of Goods Sold 900 +900Wages Expense 400 +400Utilities Expense 150 +150Depreciation Expense 50 +50Insurance Expense 100 +100Supplies Expense 150 +150Interest Expense 100 +100

c. $4,525 Original balance of Owners’ Equity $4,175Add: Net income 350 Ending balance of Owners’ Equity $4,525


E3-18 a.




Retained Earnings 3,315 +3,315Retained Earnings 750 –750Rent Expense 400 +400Wages Expense 315 +315Internet Service

Expense 35 +35

b.Account Debit CreditCash 20,600

Accounts Receivable 2,250Equipment 11,000

Wages Payable 250Payable to Internet Service 35Note Payable 17,000

Contributed Capital 13,000Retained Earnings 3,565 Total 33,850 33,850

E3-19 a.Journal Effect on Accounting Equation



Retained Earnings 290,000 +290,000Retained Earnings 273,000 –273,000Cost of Goods Sold 128,000 +128,000Insurance Expense 5,000 +5,000Wages Expense 72,000 +72,000Utilities Expense 40,000 +40,000Interest Expense 8,000 +8,000Depreciation Expense 20,000 +20,000

(continued)

62 Chapter 3

b.Account Debit CreditCash 10,500

Accounts Receivable 25,000Inventory 47,000

Prepaid Insurance 5,000Equipment 300,000Accumulated Depreciation 80,000

Accounts Payable 31,000Notes Payable 130,000Contributed Capital 84,500

Retained Earnings 62,000 Total 387,500 387,500

E3-20 a. The purpose of closing the books is to empty out all of the revenue and expenses accounts and reset their balances to zero. Each of these account balances must be set back to zero before the following year’s data can start being collected by the accounting system.

b.Journal Effect on Accounting Equation



Retained Earnings 7,600 +7,600Retained Earnings 6,385 –6,385

Cost of Goods Sold 2,840 +2,840Wages Expense 1,015 +1,015Utilities Expense 550 +550Depreciation Expense 660 +660Insurance Expense 495 +495Supplies Expense 525 +525Interest Expense 300 +300

c. $12,740 Original balance of Owners’ Equity $11,525Add: Net income ($7,600 − $6,385) 1,215 Ending balance of Owners’ Equity $12,740


PROBLEMS

P3-1 M E M O R A N D U M

DATE: (today’s date)TO: Robin GarrisonFROM: (student’s name)RE: Klinger Realty operating results

Managers (and other parties) are interested in measuring the results of transformation processes that occur during a fiscal period. As with many things, there is more than one way to measure these results. The two re-ports are the result of different measurement systems. Under the cash basis system of measurement, cash receipts are measured and recorded at the point at which cash is received from customers. For example, dur-ing the third quarter of 2007, $300,000 was received in cash for sales commissions. The related services might have been performed in the third quarter or in some previous quarter (or might be performed later). We can’t tell that from a cash basis measurement.

Cash payments are measured and recorded when cash is paid out to suppliers of goods or services to be sold to customers. The difference between cash receipts and cash payments is net cash flow.

Under the accrual basis system of measurement, revenues are measured and recorded when they have been earned, that is, at the point at which goods have been sold to a customer or services have been per-formed for a customer. Revenue is measured and recorded even though the cash has not yet been collected. For example, we know from the ac-crual basis statement that sales services priced at $400,000 were per-formed during the third quarter of 2007. What we don’t know from that statement, however, is how much of the revenue was collected in cash. Similarly, expenses are measured and recorded at the point at which goods or services have been used up in generating revenue.

Accrual basis accounting is generally the preferred measurement because the earning or consumption of resources is an early signal of the cash flows that will occur when all cash flows associated with current-pe-riod operations have been received or paid. Therefore, they provide a more complete measure of operating results than do current period cash flows. At the same time, cash basis reports are not incorrect or wrong. They simply are a different measurement. They can be misleading, how-ever, in certain circumstances. For example, suppose $200,000 of services were performed for customers during a period, but all work was on credit to be collected during the subsequent period. None of the $200,000 would show up on the current cash basis report, though all the work was com-pleted. Thus, performance for the current period might appear poor. Next

64 Chapter 3

(continued)period, when collections are made, the performance would look good though the services had been provided in the prior period.

Generally, interested parties find both cash flow and accrual basis accounting information helpful in assessing the performance of an orga-nization. A company must have both net income and positive cash flow to operate successfully in the long run.

P3-2 Hardy’s reasoning about the revenues is correct. Revenues should be recorded on the accrual basis during the period the sales occur. A complete reporting of the transaction would include Accounts Receivable on a balance sheet noting that $50,000 of the amount was still owed by customers. Hardy’s reasoning about the cost of goods sold is incorrect. Expenses should be recorded on the accrual basis during the period they are incurred. The cost of merchandise should be matched against revenues as an expense for the amount sold during a fiscal period. The fact that cash had not been paid for the merchandise has no effect on the amount of expense. A complete reporting of the transaction would include Accounts Payable on a balance sheet of $45,000.

Hardy is presenting misleading information to the bank by mixing cash and accrual results. An income statement should be prepared on the accrual basis. Hardy is concealing some accrual basis expenses to make his operating results appear better than they really are.

The correct reporting of the effect of these transactions on net in-come would be as follows:

Added to revenues $75,000Added to expenses ($60,000 ÷ 2) 30,000 Added to net income $ 45,000

P3-3 The key to each event is a clear definition of revenue. Revenue is an increase in assets as a result of goods sold or services rendered. Applying this definition to each event yields the following results:1. No revenue. Cash increased, but not as a result of selling goods or

providing services.2. $11,000 of revenue. Accounts Receivable (an asset) increased as a re-

sult of services rendered during the month.3. No revenue. The company did not earn the $25,000. Instead, it was

loaned to the company. No goods were sold, and no services were rendered.

4. No revenue. This transaction involves $6,000 of expenses for November.5. No revenue. Under accrual basis accounting, the revenue was recog-

nized in the month services were performed.


6. $4,500 of revenue. Even though the cash was collected previously, revenue should be recognized when the services are rendered in No-vember.

P3-4Journal Effect on Accounting Equation


CC + REMarch 15 Cash 4,500 +4,500

Unearned Revenue 4,500 +4,500April 30 Unearned Revenue 4,500 –4,500

Sales Revenue 4,500 +4,500Cost of Goods Sold 3,000 –3,000

Merchandise Inventory 3,000 –3,000

Date Cash Unearned Revenue Sales Revenue

Mar. 15 4,500 4,500 0

Apr. 30 0 –4,500 4,500

Net result 4,500 0 4,500

P3-5



CC + REJan. 1 Prepaid Insurance 3,600 +3,600

Cash 3,600 –3,600Dec. 31 Insurance Expense 3,600 –3,600

Prepaid Insurance 3,600 –3,600

Date Cash Prepaid Insurance Insurance Expense

Jan. 1 –3,600 3,600 0

Dec. 31 0 –3,600 –3,600

Net result –3,600 0 –3,600

P3-6 The key to each event is a clear definition of expense. An expense is the consumption of resources in producing or providing goods or services during a period. Applying this definition to the events yields the following:

1. An expense of $950. Even though not yet paid for, resources were consumed during the current month.

2. No expense. Even though paid for, none of the new items were used during the current month.

3. An expense of $3,800. The labor services of the executive director were consumed during the current month.

4. No expense. None of the resources have been consumed yet.

66 Chapter 3

5. No expense. This was an expense of the prior month during which electric service was consumed.

6. Expense of $7,550. The advertising services were consumed during the month of May.

P3-7 a. Because accounts receivable increased during the month, the cash collections were less than the amount of sales. Further, this difference is equal to the increase in accounts receivable. Therefore, cash collections from customers are as follows:

Sales revenue (accrual basis) $95,000Less: Increase in accounts receivable 10,000 Cash collected from customers $85,000

b. Because accounts payable decreased during the month, the company paid for all of this month’s expenses plus some of the prior month’s obligations. This means that cash paid out to suppliers was greater than this month’s accrual basis expenses.

Expenses (accrual basis) $71,000Add: Decrease in accounts payable 7,000 Cash paid out for expenses $ 78,000

c. Net cash flow is the difference between cash collections and cash paid out.

Cash collections $85,000Cash paid out 78,000 Net cash flow $ 7,000

P3-8 Carlyle CompanyIncome StatementFor the First Year

Revenues ($235,000 + $80,000) $315,000Expenses:

Cost of goods sold ($55,000 + $12,000) $ 67,000Wages ($77,500 + $18,000) 95,500Advertising (same as cash basis) 13,000Taxes ($30,000 + $20,000) 50,000 225,500

Net income $ 89,500


P3-9 A. Tinker’s financial report relied improperly on cash basis numbers. Profits should be measured on the accrual basis. Sales should be included during the period of the sale even if cash has not been collected. Cost of goods sold should reflect merchandise sold during the period rather than merchandise purchased. Equipment should be depreciated over its useful life rather than being expensed when purchased. Tinker’s statement confuses cash flow from operations with cash used for investing activities. Therefore, it is not even an accurate report of cash flow from operations.

B. The other partners would be foolish to sell out based on Tinker’s in-come statement. A properly prepared accrual basis income statement shows the business to be highly profitable.

A proper income statement and distribution of profits would show the following:

Tinker, Evers, and ChanceIncome Statement

For Fiscal 2007Revenues $7,600,000

Expenses:Cost of goods sold $3,300,000Depreciation 200,000Other 650,000

Total expenses 4,150,000 Net income $3,450,000Distribution of net income:Increase in owners’ capital:

Tinker $1,150,000Evers 1,150,000Chance 1,150,000

Total distribution of net income $3,450,000

68 Chapter 3

P3-10 A. The Water Fun StoreNet Cash Flow from Operating Activities

For AugustCash receipts:

Collected from customers ($5,350 + $3,700) $ 9,050Cash payments:

Merchandise ($3,000 + $9,200) $12,200Advertising 450Rent (for August and September) 1,950Wages 1,050 Total payments 15,650

Net cash flow from operating activities $ (6,600 )

B. The Water Fun StoreAccrual Basis Income Statement

For AugustSales ($7,350 + $6,350) $13,700Expenses:

Cost of goods sold ($3,600 + $2,400) $6,000Rent (one month only) 975Wages ($1,050 + $1,200) 2,250 Total expenses 9,225

Net income $ 4,475

(continued)


C. Accrual basis income yields a more realistic and complete picture of a period’s activity. This is because cash flows do not always occur at the same time as goods are sold or resources are consumed. Accrual-based financial statements report revenues when earned and expenses when incurred. This gives a more realistic view of a company’s achievement during a given accounting period.

P3-11 A. Based on the income statement and changes in the balance sheet, the following transactions must have occurred:

1. Revenue from services rendered totaled $840,000. It was billed and collected in cash.

2. The bonds payable were paid off in full. (Because no interest ex-pense is recorded, the bonds must have been paid off on the first day of October.)

3. Supplies costing $39,200 ($65,700 − $26,500) were consumed.4. Depreciation expense totaling $8,900 was recorded on the equip-

ment and the building.5. The company’s employees earned $410,000 of wages that were

paid in cash.

B. Explanation of the changes in cash:

Beginning cash balance $ 43,725Sale of services for cash 840,000Payoff of bonds payable (470,000)Payment of wages (410,000 )Ending cash balance $ 3,725

P3-12 A. Caldwell Furniture RepairIncome Statement

For MarchRevenues $7,600Expenses:

Supplies 2,400Rent 1,200Interest 150Depreciation 250Electricity 332Water 78

Net income $3,190

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B. Explanation of the cash account:

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

C. At the end of March there is an incomplete transformation cycle. A transformation cycle begins when resources are acquired via a fi-nancing transaction, continues when those resources are invested into other resources (i.e., trucks, buildings, inventory), and ends when those resources are either used up or converted into cash.

In this problem, the cycle is incomplete because not all resources have been converted back into cash. At the end of March, there are a variety of resources that have not been converted into cash, such as accounts receivable, supplies, prepaid rent, tools, and equipment. The existence of assets other than cash is evidence that the trans-formation cycle is incomplete.

P3-13 A.

EventRevenue,

Expense, or Cash Flow?

Month of February

Month of March

Month ofApril

Month ofMay

Month ofJune

1. ExpenseCash Flow

00

$1,2000

$1,200$3,600

$1,2000

00

2. RevenueCash Flow

00

00

$7,5000

$7,500$22,500

$7,5000

3. ExpenseCash Flow $15,000

$300($15,000 ×

0.02)$1,300

$280($14,000 ×

0.02)$1,280

$260($13,000 ×

0.02)$1,260

$240($12,000 ×

0.02)$1,240

4. ExpenseCash Flow

0$10,000

$6,0000

$4,0000

$3,600$12,000

$8,4000

5. RevenueCash Flow

$45,000$9,000

0$18,000

0$13,500

0$4,500

00

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

(continued)


C. Because the patterns between them are so different, managers need both types of information to manage their firms effectively. Accrual-basis measures are necessary to report on the success (or lack thereof) of the company’s earning activities during a specific period. Cash flow measures are necessary to be sure that the company can meet its obligations and pay its bills on time.

P3-14 A. Desert Harbor InnIncome Statement

For the Year Ended December 31, 2007

Revenue from room rentals $165,000Revenue from parking and other services 35,000

Total revenue $200,000

Expenses:Staff wages $49,000Utilities 10,400Supplies used 4,300Depreciation 5,000Interest 4,700Cost of goods sold by gift shop 11,000Miscellaneous 3,300

Total expenses 87,700 Net income $112,300

Desert Harbor InnStatement of Cash Flows

For the Year Ended December 31, 2007

Cash flow from operating activities:Collected from customers $187,000Paid to employees ($49,000 − $890) (48,110)Paid for utilities (10,400)Paid for supplies (800)Paid for interest (4,700)Paid to suppliers of gift shop (11,000)Paid for miscellaneous expenses (3,300 ) $

108,690Cash flow for investing activities: 0Cash flow for financing activities:

Repayment on loan $(35,000)Withdrawal by owners (45,000 ) (80,000 )

Net increase in cash $ 28,690Add: Cash balance on January 1 4,900 Ending cash balance $ 33,590

72 Chapter 3

Desert Harbor InnBalance Sheet

December 31, 2007

Assets Liabilities and Owners’ Equity

Cash $ 33,590 Wages payable $ 890Accounts receivable 13,000 Notes payable 21,500Supplies on hand 5,300*Furniture and equipment 25,000Buildings 95,000Accumulated depreciation (15,000) Investment by owners 60,000Land 12,000 Retained earnings 86,500 **Total assets $168,890 $168,890

*$8,800 − $4,300 + $800 = $5,300**$19,200 + $112,300 − $45,000 = $86,500

B. From a financial perspective, this appears to be an attractive busi-ness. It generated net income of $112,300 on a beginning-of-the-year Owners’ Equity balance of $79,200 ($60,000 + $19,200). This is an im-pressive 142% return on investment ($112,300 ÷ $79,200). While the owners withdrew only $45,000 in cash from the company for living ex-penses, they could have withdrawn more without hurting the com-pany. If this year’s results are typical of this company, it would be an attractive company to own from a financial perspective.

P3-15 A. Zorditch.comIncome Statement

End of the First Year

Sales revenue ($173,400 + $18,200)* $191,600Expenses:

Depreciation expense $ 5,700Office supplies 1,560Rent 12,000Wages 36,200Advertising and promotion 12,140Miscellaneous 11,300 Total expenses 78,900

Net income $112,700

*Because this is the company’s first year, all accounts receivable arose from sales made during the period.

(continued)


B. Item Justification of change

1. Money I contributed to firm This is not an expense. It represents Owners’ Equity and should be re-ported on the balance sheet.

2. Purchase of furnishings and equipment

Purchase of assets does not create an expense. Only 1/5 of the assets’ lives have been used up. Therefore, depreciation expense of $5,700 should be recorded ($28,500 ÷ 5 years).

3. Rent on office space The original amount includes $1,000 that does not apply to the accounting period just ended.

4. Loan from the bank A loan is a liability, not an expense.

5. Advertising and promotion Only half of the amount is for ex-penses during the period just ended.

C. 1. Don’t close the business, especially if the future looks bright. Companies often have a tough time during the startup phase. Yours appears to have done just fine.

2. Get some competent accounting help. You nearly abandoned a very profitable business because you were using bad accounting information.

P3-16 A.



CC + REDec. 31 Interest Expense 6,250 –6,250

Interest Payable 6,250 +6,250($7,500 ÷ 6 months × 5 months = $6,250)

Dec. 31 Insurance Expense 5,000 –5,000Prepaid Insurance 5,000 –5,000

($10,000 × 6/12 = $5,000)Dec. 31 Depreciation Expense 12,500 –12,500

Accumulated Depreciation 12,500 –12,500

($50,000 ÷ 4 = $12,500)Dec. 31 Rent Receivable 7,500 +7,500

Rent Revenue 7,500 +7,500($15,000 × 3/6 = $7,500)

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

74 Chapter 3

cause the balance sheet to be out of balance. It would balance, but with incorrect amounts.

C. The adjusting entries would affect the balance sheet and income statement information as follows:

Assets ($625,000 − $5,000 − $12,500 + $7,500) $615,000Liabilities ($250,000 + $6,250) $256,250Owners’ equity ($337,500 + 37,500* − $16,250**) $358,750Revenues ($150,000 + $7,500) $157,500Expenses ($112,500 + $6,250 + $5,000 + $12,500) $136,250

* from transfer of original net income to owners’ equity** from adjusting entry effects on net income

P3-17 A. and B.

Account Balance Before Adjustment

AdjustmentsAccount

Balance After Adjustment

Cash 52,500 52,500Accounts receivable 35,250 35,250Supplies 19,200 (4) –9,150 10,050Prepaid insurance 4,050 (2) –1,350 2,700Equipment 468,000 468,000Accumulated depreciation—

equipment(129,000) (6) –4,500 (133,500)

Buildings 649,500 649,500Accumulated depreciation—

buildings(85,500) (6) –1,800 (87,300)

Land 58,500 58,500 Total assets 1,072,500 1,055,700

Unearned revenues 36,000 (3) –12,000 24,000Accounts payable 27,900 27,900Interest payable 6,000 (5) 3,000 9,000Wages payable 0 (1) 4,350 4,350Notes payable 420,000 420,000Common stock 300,000 300,000Retained earnings 224,100 224,100 Total liabilities &

stockholders’ equity1,014,000 1,009,350

Rent revenues 100,500 (3) 12,000 112,500Wages expense (36,000) (1) –4,350 (40,350)Supplies expense 0 (4) –9,150 (9,150)Insurance expense 0 (2) –1,350 (1,350)Interest expense (6,000) (5) –3,000 (9,000)Depreciation expense 0 (6) –6,300 (6,300 )Net income 58,500 46,350

(continued)


C. The net income earned during the year has not yet been transferred to retained earnings. This is true for both the unadjusted account bal-ance column (column 1) and for the adjusted account balance column (column 3).

D. The closing entries need to be identified. Closing entries have the ef-fect of transferring all revenue and expense account balances (i.e., net income) to Retained Earnings. When this is done, the total of all asset accounts will equal the total of liability and equity accounts.

Total assets before closing entries $1,055,700Total liabilities and equity before

closing entries $1,009,350Add: Net income 46,350 1,055,700 Difference $ 0

E. Net income before adjustments $58,500Actual net income 46,350

Misstatement in dollars $12,150

Misstatement in percent ($12,150 ÷ $46,350) = 26.2%

P3-18 a.

Account TypeA. Prepaid Insurance AssetB. Retained Earnings Owners’ equityC. Accumulated Depreciation Asset (negative)D. Wages Expense ExpenseE. Commissions Revenue RevenueF. Interest Payable LiabilityG. Supplies AssetH. Insurance Expense ExpenseI. Unearned Rent LiabilityJ. Prepaid Advertising AssetK. Notes Payable LiabilityL. Cost of Goods Sold ExpenseM. Machinery AssetN. Owners’ Capital Owners’ equityO. Accounts Receivable AssetP. Bonds Payable LiabilityQ. Supplies Expense ExpenseR. Depreciation Expense Expense

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

76 Chapter 3

P3-19 Mary should be suspicious. The procedures being used permit the sales rep to receive commissions the rep has not earned. Some of the sales reported for the customer are fictitious. Rather than reducing sales revenue when the sales are canceled, an expense is recorded. This procedure overstates revenues and overstates expenses. Because the rep is paid a commission on sales, the rep is defrauding the company by claiming more sales than were made. Apparently, the supervisor is colluding with the rep and perhaps sharing in the ill-gotten gain.

A problem with the accounting system is that the supervisor is permitted to override the appropriate recording of transactions. A standard format should exist for recording transactions that would inform Mary of the proper way of handling these transactions. In addition, special authoriza-tion should be needed for unusual transactions that would require some-one outside of the sales department to note these events. Perhaps Mary needs additional training so she is better able to determine when inap-propriate transactions are recorded. The system should provide reports of customer activity that are reviewed by managers who are not directly engaged in selling activities. These reports should identify unusual activ-ities that may indicate improper behavior.

Mary should report these events to the vice president of finance. An anonymous letter could solve the problem if Mary is concerned about her own job.

P3-20 MEMO

TO: Flora WiserFROM: (Student’s Name)SUBJECT: Processing accounting information

I have been asked to provide a summary of accounting information pro-cesses to help you obtain a better understanding of accounting systems and how they convert data to useful information. In this memo, I will summarize the basic purpose of accounting systems and the processes used to accomplish this purpose. I will be pleased to meet with you to answer questions or to discuss other related matters.

The purpose of accounting systems is to convert data about economic events into information that is useful to decision makers. Therefore, in all accounting systems, analysis of events is necessary to determine trans-actions that should be recorded in the system. Converting accounting data into useful information requires systematic processing. The conver-sion can be thought of as involving five interrelated steps: (1) examining business activities, (2) recording transactions, (3) updating account bal-ances, (4) making fiscal period-end adjustments, and (5) preparing finan-cial reports.

(continued)


Business activities occur in the day-to-day operations of a company. Data about a company’s business activities are recorded in a company’s information system. Some of these data are in the form of financial measures. These financial measures are recorded in the company’s ac-counting system by identifying specific accounts that are affected by the activities.

Once financial data are recorded in individual accounts, the account bal-ances are updated periodically. Two primary levels of detail are main-tained in an accounting system’s accounts: subsidiary and control. Subsidiary accounts record financial data about individual items of im-portance to a company, such as transactions for individual customers, suppliers, or products. Thus, when goods are sold to a customer on credit, the system records customer and product identification data. A separate subsidiary account is maintained for each customer so a com-pany is able to bill that customer for sales and keep track of payments from the customer. Control accounts are summary accounts that main-tain totals for all subsidiary accounts of a particular type. For example, the balance of the Accounts Receivable control account is the sum of the balances of all Accounts Receivable subsidiary accounts for each of the company’s customers.

A company maintains subsidiary accounts for management purposes. It reports control account balances in financial statements to external users and in reports for higher level management decisions. Accord-ingly, account balances must be updated on a regular basis and sub-sidiary balances must be summarized in control accounts. Control ac-count balances are maintained in a company’s general ledger. A general ledger is an accounting record of individual (control) accounts and the balances of each account.

In addition to updating account balances as transactions occur, an ac-counting system must adjust these accounts periodically for activities that are not part of normal business processes. Many of these adjust-ments relate to period costs (costs associated with a particular period rather than product-related costs). For example, depreciation expense is recorded at the end of a fiscal period to adjust the Accumulated Depreci-ation and Depreciation Expense for the use of plant assets during that fiscal period. In addition, net income is transferred to Retained Earnings at the end of each fiscal period to bring the balance sheet into balance. Revenue and expense accounts are formally closed to Retained Earnings at the end of each fiscal year.

Once all account balances have been updated at the end of a fiscal pe-riod, these balances are used to prepare financial statements. Financial statements are summaries of account balances prepared in specific for-mats to make them more useful to decision makers. General-purpose fi-

78 Chapter 3

nancial statements (those reported to external parties) usually do not list all account balances. Instead, they combine certain types of accounts.

Accordingly, an accounting system records financial measures of eco-nomic events and converts these data into useful information by record-ing the effects of the events in separate accounts, summarizing and up-dating the account balances, and reporting the balances in financial statements. Financial statements are summaries of business events.

P3-21 See Excel spreadsheet on pages 82–83.

P3-22

1 2 3 4 5 6 7 8 9 10

b a c a a a b d b d

CASES

C3-1

This sales plan has manipulation, distortion, and fraud written all over it. In gen-eral, very little is favorable. The underlying motivation for each aspect of this plan appears to be temporary personal enrichment of Flash and his (her?) re-gional sales directors. This is not a sales improvement plan that can be repeated in following years.

The company is in a powerful position concerning its distributors in that the dis-tributorships are very profitable and very desirable. Flash has exploited that po-sition by pressuring the distributors to buy inventory they did not need, had no room for, could not pay for, and at higher than normal prices. For only a tempo-rary gain (by Flash and cohorts), the company is risking the goodwill and favor-able relationships with its distribution channel. Unhappy distributors could cause a lot of financial pain in future years.

If these “forced sales” are not reported explicitly as such, creditors and in-vestors will be misled as to the true amount of this year’s sales and profits. Also, some distributors have been told they may return these “special” purchases that remain unsold. At minimum, this is likely to cause unhappiness if returns cannot be made. This technique cannot be used again next year because distributors will already be overburdened with excess inventory and cash payments stem-ming from Flash’s plan. In fact, sales can be expected to drop precipitously next year as distributors work off the extra inventory they were forced to buy earlier. This will be a shock to the creditors and investors who were misled into thinking that the company had increased sales by 12% in the face of an impending reces-sion.


(continued)

Flash’s plan has negative cash flow implications for the company. While the firm will record the higher sales revenue (and profit), the resulting cash inflows will not occur in 30 days as is customary, but over the next 12 months. The company will need extra cash to finance these receivables. This is exacerbated by the company’s need to pay for storing these goods at third-party warehouses.

Lastly, Flash’s suggestion to hold the books open for a few days after the end of the year “to obtain maximum benefit of the new sales program” is outright fraud. It is an intentional procedure designed to mislead users of the financial state-ments into believing that the financial results were better than they actually were. This is fraud.

C3-2

Students will first have to decide what information they wish to provide before analyzing the data in the problem. Based on the chapter discussion, students might reasonably prepare some or all of the following:

a. Summary of all cash flows b. Summary of cash flows segmented into operating activities, investing ac-

tivities, and financing activities c. Report of net cash flow from operating activitiesd. Income statemente. Balance sheet

Each of these items is shown below. Because the results of these analyses are so different, a useful discussion might ensue regarding why certain of these items are more helpful than others. For example, net cash flow from operations was $7,950 while net income was ($1,610). Students might be asked to defend their choice of reports they prepared. For example, why did they prepare a net cash flow report and not an income statement or vice versa?

Interesting questions might include the following:

1. Why are the measurements for net cash flow ($20,950), net cash flow from operations ($7,950), and net income (loss of $1,610) so different?

2. Did Softech.com have a good first quarter? 3. What are the financial prospects for the second quarter?

80 Chapter 3

a. Summary of Cash Flows:

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

b. Summary of Cash Flows Segmented byFinancing, Investing, and Operating Activities

Financing activities:Loan from bank $ 4,000Sell new shares of stock 2,000Pay dividends (1,500 )

Net cash flow from financing activities $ 4,500Investing activities:

Buy new office furniture $ (500)Sale of land 9,000

Net cash flow from investing activities 8,500Operating activities:

Pay wages and salaries $ (3,200)Collection of accounts receivable 6,800Collections from current sales 10,800Purchase of inventory ($10,500 × 10%) (1,050)Payment of rent ($900 × 6 months) (5,400 )

Net cash flow from operating activities 7,950 Net cash flow for the first quarter $20,950Beginning cash balance (January 1) 4,240 Ending cash balance (March 31) $ 25,190

(continued)


c. Net Cash Flow from Operating Activities

Cash receipts:From accounts receivable $ 6,800From current sales 10,800

Total cash receipts $17,600Cash payments:

Purchase of inventory ($10,500 × 10%) $ 1,050Wages and salaries 3,200Rent ($900 × 6 months) 5,400

Total cash payments 9,650 Net cash from operations $ 7,950

d. Income Statement

Revenues:Sales $18,000

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

Net income $ (1,610 )

e. Balance Sheet

Assets Liabilities and Stockholders’ EquityCash $25,190 Accounts payable2 $ 9,450Accounts receivable 7,200 Advertising payable 1,000Inventory5 12,700 Loan payable 4,000Prepaid rent1 2,700 Capital stock3

Office furniture 500 (owner’s investment) 35,000Buildings & equipment 16,780 Retained earnings4 10,490 Accumulated depreciation (5,130 ) Total liabilities and

Total assets $ 59,940 stockholders’ equity $ 59,940

1 $900 × 3 months2 $10,500 × 90%3 $33,000 + $2,0004 $13,600 − $1,610 loss − $1,500 dividends5 15,200 − $13,000 cost of goods sold + $10,500

82 Chapter 3

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COMPREHENSIVE REVIEW 1

a. Favorite Cookie CompanyIncome Statement

For the Month Ended February 28, 2007

Sales revenue $ 17,160Cost of goods sold (11,440)Wages expense (1,000)Rent expense (600)Depreciation expense (520)Supplies expense (400)Utilities expense (220)Interest expense (200 )Net income $ 2,780

b.



CC + REJan. 31 Sales Revenue 17,160 –17,160

Retained Earnings 17,160 +17,160Retained Earnings 14,380 –14,380Cost of Goods Sold 11,440 +11,440Wages Expense 1,000 +1,000Rent Expense 600 +600Depreciation Expense 520 +520Supplies Expense 400 +400

Utilities Expense 220 +220Interest Expense 200 +200

86 Chapter 3

Ledger

Retained Earnings Sales RevenueDate Debit Credit Balance Date Debit Credit Balance

3,000 17,160Jan. 31 17,160 20,160 Feb. 28 17,160 0Feb. 28 14,380 5,780

Cost of Goods Sold Wages ExpenseDate Debit Credit Balance Date Debit Credit Balance

11,440 1,000Feb. 28 11,440 0 Feb. 28 1,000 0

Rent Expense Depreciation ExpenseDate Debit Credit Balance Date Debit Credit Balance

600 520Feb. 28 600 0 Feb. 28 520 0

Supplies Expense Utilities ExpenseDate Debit Credit Balance Date Debit Credit Balance

400 220Feb. 28 400 0 Feb. 28 220 0

Interest ExpenseDate Debit Credit Balance

200Feb. 28 200 0

(continued)


c. Favorite Cookie CompanyPost-Closing Trial Balance

February 28, 2007

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

88 Chapter 3

d. Favorite Cookie CompanyBalance Sheet

At February 28, 2007

AssetsCash $ 7,740Accounts receivable 4,100Merchandise inventories 7,520Supplies 60Prepaid rent 1,200Equipment 31,000Accumulated depreciation (1,040 )

Total assets $50,580

Liabilities and Owners’ EquityAccounts payable $ 1,400Unearned revenue 3,000Interest payable 400Notes payable 30,000

Total liabilities $34,800Contribution by owners 10,000Retained earnings 5,780

Total liabilities and owners’ equity $50,580

(continued)


COMPREHENSIVE REVIEW 2

a. Additional Transactions and Adjustments

Debit Credit A = L+CC+ RE

A. Accounts Receivable 8,400 +

Sales Revenue 8,400 +

Cost of Goods Sold 4,300 ─

Merchandise Inventory 4,300 ─

B. Cash 7,600 +

Accounts Receivable 7,600 ─

C. Supplies 3,200 +

Accounts Payable 3,200 +

D. Accounts Payable 2,100 ─

Cash 2,100 ─

E. Prepaid Rent 1,800 +

Cash 1,800 ─

F. Wages Payable 600 ─

Wages Expense 3,700 ─

Cash 4,300 ─

G. Interest Payable 900 ─

Cash 900 ─

H. Supplies Expense 700 ─

Supplies 700 ─

I. Wages Expense 800 ─

Wages Payable 800 +

J. Interest Expense 1,000 ─

Interest Payable 1,000 +

K. Depreciation Expense 570 ─

Accumulated Depreciation 570 ─

b. Closing Entries

Accounts Debit Credit A = L+ CC+ RE

Sales Revenue 206,400 ─

Cost of Goods Sold 109,300 +

Wages Expense 46,500 +

Rent Expense 16,000 +

Supplies Expense 6,600 +

Depreciation Expense 4,270 +

Interest Expense 7,300 +

Retained Earnings 16,430 +

90 Chapter 3

c. Trial Balance

Pre-Closing Post-ClosingAccount Debit Credit Debit Credit

Assets:Cash 3,500 3,500Accounts Receivable 8,800 8,800Merchandise Inventory 52,700 52,700Supplies 6,100 6,100Prepaid Rent 3,600 3,600Property and Equipment 183,000 183,000Accumulated Depreciation 37,070 37,070Liabilities:Accounts Payable 7,200 7,200Wages Payable 2,400 2,400Interest Payable 1,000 1,000Notes Payable, Long-Term 76,400 76,400Owners’ Equity:Contributed Capital 80,000 80,000Retained Earnings 37,200 53,630Sales Revenue 206,400Cost of Goods Sold 109,300Wages Expense 46,500Rent Expense 16,000Supplies Expense 6,600Depreciation Expense 4,270Interest Expense 7,300Totals 447,670 447,670 257,700 257,700

d. Income Statement and Balance Sheet

Orlando Co.Income Statement

For the Year Ended October 31, 2007

Sales Revenue $ 206,400Cost of Goods Sold (109,300 )

Gross Profit 97,100 Operating Expenses:Wages Expense (46,500)Rent Expense (16,000)Supplies Expense (6,600)Depreciation Expense (4,270 )

Income from Operations 23,730Interest Expense (7,300 )

Net Income $ 16,430

(continued)


Orlando Co.Balance Sheet

October 31, 2007

AssetsCash $ 3,500Accounts Receivable 8,800Merchandise Inventory 52,700Supplies 6,100Prepaid Rent 3,600

Current Assets 74,700 Property and Equipment 183,000Accumulated Depreciation (37,070 )

Total Assets $ 220,630

Liabilities & Owners’ EquityAccounts Payable $ 7,200Wages Payable 2,400Interest Payable 1,000

Current Liabilities 10,600Notes Payable, Long-Term 76,400

Total Liabilities 87,000 Contributed Capital 80,000Retained Earnings 53,630

Total Owners’ Equity 133,630 Total Liabilities & Equity $ 220,630

Chapter 3 HW Solutions

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