Financial Accounting Module 02

Module 2The Accounting Process

Accounting Equation

The following is the accounting equation:Assets = Liabilities + Owners’ equity

This equation must be in balance at all times. Therefore, if one element in the equation changes, some other elements must also change to maintain the balance. Thus, at least two accounts are affected by every transaction. The term double entry in double entry accounting reflects the requirement that each transaction be recorded in at least two accounts.

For example, if land is purchased, one asset account (Land) has increased. To ensure that the accounting equation is in balance, at least one other account must change. If the land was purchased with cash, an asset account (Cash) must decrease by the same amount as the increase in the land account. If the land was purchased with a signed note, a liability account increases to ensure that the accounting equation stays in balance. (What if the land was purchased by a partial payment of cash with a note for the remainder? Then two accounts other than Land are affected: Cash decreases and Notes Payable increases. Together, these changes must neutralize the effect of the increase in the Land account.)

Journal and Ledger

The JOURNAL is a book in which transactions are recorded in the order that they occur. Each transaction is recorded in the journal after being analyzed to determine which accounts it affects, the amount of the effect, and whether the transaction increases or decreases these accounts.

After the transaction has been recorded in the journal, it is posted to the LEDGER. The general ledger is used to record the impact of transactions on accounts by recording the increases and decreases to each account into columns. These columns form the shape of the letter "T." Thus, accounts in the general ledger are also referred to as T-accounts. One T-account is used for each account in the accounting books.

Both the general journal and the general ledger contain information about accounts and the amount by which these accounts are debited or credited. They differ however in the way information is organized. In the general ledger, the information is organized by account. Thus, accountants use the general ledger to calculate balances in different accounts.

Debits and Credits

The column on the left side of the T-account is called the DEBIT side. The column on the right side is called the CREDIT side. The side used for recording increases is based on the accounting equation:

Assets= Liabilities + Owners' equityAssets are on the left side of the equation. Correspondingly, increases in assets are recorded in the column on the left (the debit) side.

For example, when a firm collects cash, the cash balance increases; this is recorded by posting an entry on the left-hand side of the Cash account; that is, the Cash account is debited for increases in the cash balance. Conversely, when cash is paid, the cash balance decreases; this is recorded by an entry on the opposite, or right-hand side, of the Cash account; that is, the Cash account is credited for decreases.

Liabilities and owners' equity appear on the right side of the accounting equation. Hence, increases in liabilities and owners' equity are recorded on the right (the credit) side.

For example, assume that inventory was purchased on credit. An asset (called inventory) increases, so the Inventory account is debited. However, this purchase has not yet been paid for, so a liability exists. Accounts payable, a liability, has increased. This is recorded by posting an entry on the right-hand side of the Accounts payable account. Conversely, when the supplier is paid later, the liability decreases. This is recorded by an entry on the opposite side (that is, the Accounts Payable account is debited when the supplier is paid, decreasing the liability).

Owners' equity is increased when the business earns revenue. We also know that owners' equity is credited for increases. Thus, revenues are recorded by crediting the appropriate revenue accounts.

Owners' equity is decreased when the business incurs an expense. Owners' equity is debited for decreases. Thus, expenses are recorded by debiting the appropriate expense accounts.

Dividends (or, in the case of a sole proprietorship, drawings) are not expenses; they are simply a return of capital to the shareholders (owners). Thus, dividends also have the effect of decreasing owners’ equity. Hence, dividends are recorded by debiting the Dividends account.

Normal Balances

Assets are increased by debits. Therefore, the normal balance in asset accounts is a debit balance. The Cash account is debited when cash is received, and is credited when cash is paid. A credit balance in the Cash account implies that the organization has a negative amount of cash, which is not possible. Thus, we expect a debit balance in the Cash account.

Liabilities are increased by credits. When amounts owed to creditors or suppliers increase, a liability account is credited. When a payment is made to creditors (suppliers), the liability is debited. Thus, the normal balance in a liability account is a credit balance.

Owners' equity is increased by credits. Corporations record direct owner investments using the Capital Stock account. Since direct owner investments increase owners'

equity, the Capital Stock account is credited. Thus, Capital Stock account has a credit balance.

Distributions to owners are recorded in the Dividends account. When dividends are declared, owners' equity in the business decreases and the Dividends account is debited.

Normally, the Retained Earnings account has a credit balance. However, if a business has had losses, the Retained Earnings account can have a debit balance.

(Note that in the case of a sole proprietorship, an Owners' Equity account is credited to record owner investments. Thus, the normal balance in the Capital account is a credit balance. When a sole proprietor withdraws money, the Drawings account is debited since withdrawals reduce owner's equity. Hence, the normal balance in the Drawings account is a debit balance.)

Revenues increase owners' equity. A revenue account is credited to show this increase in owners' equity. Thus, revenue accounts typically have a credit balance.

Expenses decrease owners' equity. An expense account is debited to record this decrease in owners' equity. Thus, expense accounts typically have a debit balance.

Review Questions 1

1. _______ are debited for increases.

2. _______ are credited for increases.

3. An expense account is _____ when a business pays rent for the period.

4. A revenue account is ______ when goods are sold.

5. ______ is debited when a business repays money to a creditor.

6. _______ is debited when a business borrows money from a creditor.

Answers:1. Assets 2. Liabilities 3. debited4. credited 5. Notes Payable 6. Cash

Adjusting entries–Accrued Expenses and Revenues

ADJUSTING ENTRIES are prepared at the end of a fiscal period. These entries are required when a business uses accrual accounting because of the timing differences between the flow of cash and the recognition of revenues or expenses.

For example, the cost of employee services is recognized as an expense in the period in which the services are provided regardless of when cash is paid to employees. Thus,

salaries earned by employees in April are recorded as expense in April even if the cash is paid in May.

ACCRUED EXPENSES occur when expenses are recognized before cash is paid. Accrual accounting requires expenses incurred during a period to be recorded in that period even if the cash is paid later.

ExampleAssume that a company advertised during December 2002 but has not received a bill or paid for the advertisement, which cost $500. The advertising costs incurred during the year 2002 must be recorded as expense for that year, even if the payment is made in a later period. Hence, advertising expense of $500 is accrued on December 31, 2002. Since a payment of $500 must be made in the future, a liability (Accounts Payable) is recognized for this amount. The journal entry follows:

Account Debit CreditAdvertising Expense $ 500 Accounts Payable $ 500When the payment for the advertisement is made later, the liability will be reduced.

Other examples of accrued expenses include the followingAccrued Salaries: Salaries earned by employees in a period to be paid in a later period are called accrued salaries. Assume that $2,000 of salaries earned by employees in December 2002 will be paid in January 2003. The cost of services provided by employees during 2002 must be recorded as an expense for 2002, even if the payment is made in a later period. Hence, salaries expense of $2,000 is accrued on December 31, 2002. Since salaries of $2,000 must be paid in the future, a liability (Salaries Payable) is recognized for this amount. The journal entry follows:

Account Debit CreditSalaries Expense $ 2,000 Salaries Payable $ 2,000When the salary is paid, the liability will be reduced.

Accrued Interest: Interest is accrued for the use of money borrowed during a period if the cash payment for interest will be made in a future period. This transaction is an example of an accrued expense since the expense is recognized before the cash is paid. (Note: Interest is calculated using the following formula:i = p * t * r / 100p is the principal.r is the annual rate of interest.t is the time in years for which the interest is being calculated.i is the interest for this time period.)

ACCRUED REVENUES occur when revenues are recognized before cash is received.Assume that an organization provided services in the amount of $500 during December 2002. The organization has not billed the customer or recorded the sale of services. Accrual accounting recognizes revenue when goods are provided. Since services were provided in December, revenue must be recognized in December. Thus, an adjusting entry is prepared on December 31, 2002. The journal entry follows:

Account Debit Credit

Accounts Receivable $ 500 Service Revenue $ 500

Deferred Expenses and Revenues

DEFERRED EXPENSES occur when expenses are recognized after cash is paid.Under accrual accounting, expenses incurred during a period must be recorded in that period even if the cash was paid earlier.

For example, when an organization purchases supplies, it records them as an asset. Supplies expense is recognized when the supplies are used not when cash is paid to purchase them. Supplies expense reflects the amount of supplies consumed during a period. An adjusting entry is prepared to record the supplies used. Note that the Supplies account is credited by the amount of supplies used.

ExampleAssume that the inventory of supplies on hand as of January 1, 2002, was $400. During the year, $1,500 of supplies was purchased, and the ending inventory of supplies on December 31, 2002 was $300. We calculate the amount of supplies used during the year as follows: Supplies consumed = Beginning inventory + Purchases – Ending inventory.Thus, the amount of supplies consumed in 2002 = $1,600 ($400 + $1,500 – $300). This must be recognized as an expense for the period. Since expenses reduce owners’ equity, Salaries Expense is debited; since the balance of supplies is reduced when supplies are consumed, the Supplies account is credited. The journal entry follows:

Account Debit CreditSupplies Expense $ 1,600 Supplies $ 1,600

Another example of deferred expense is a prepaid expense. For example, if the rent on a building is paid in advance, an asset called Prepaid Rent is increased. Rent expense is recorded at the end of the period, and the asset Prepaid Rent is reduced by the same amount.

ExampleA company pays $4,800 as one year’s rent in advance on October 1, 2002. This may be recorded as prepaid rent (an asset) at the time of the initial cash payment. The rent for one month is $400 ($4,800/12). Since three months have elapsed from October 1 to December 31, $1,200 of rent expense must be recognized. Thus, the journal entry to record the rent expense is as follows:

Account Debit CreditRent Expense $ 1,200 Prepaid rent $ 1,200

Depreciation is another example of a deferred expense. Accrual accounting recordsresources such as equipment as assets when they are purchased. The cost of the asset is allocated to expense over the life of the asset.

To record depreciation, the Depreciation Expense account is debited to reflect the amount of the cost of the asset allocated during the period. Furthermore, the value of the asset must be reduced by the amount recognized as being allocated as expense for the period. Instead of reducing the asset account directly, the Accumulated Depreciation account is credited. The Accumulated Depreciation account represents the value of the asset allocated to depreciation from the time the asset was acquired.

ExampleAssume that a company purchases equipment for $10,000 on January 1, 1998. The equipment's useful life is 10 years. An adjusting entry is prepared at the end of each year of the asset's useful life. In this example, depreciation expense of $1,000 is recorded every year. The journal entry follows:

Account Debit CreditDepreciation Expense $ 1,000 Accumulated Depreciation $ 1,000The balance in the Accumulated Depreciation account represents the total amount by which the asset has been depreciated. Thus, the balance in the Accumulated Depreciation account at the end of 1999 is $2,000; the balance in the Accumulated Depreciation account at end of year 2002 is $5,000.

DEFERRED REVENUES occur when revenues are recognized after cash has been collected from customers. When cash is collected in advance, the business has not yet provided the goods or services to the customer. Hence, no revenue has been earned. The company owes goods and services to the customer in the future. Thus, a liability (Unearned Revenue) is recorded for the amount of goods or services owed. An adjusting entry is prepared at the end of the period for the amount of goods or services provided during that period.

ExampleA firm receives $4,800 in magazine subscriptions in advance for one year on September 1, 2002. Record the transaction on September 1, 2002, and the adjusting entry on December 31, 2002. On September 1, 2000, the company must record the receipt of cash from customers. However, it has not yet provided the goods or services to this customer so no revenue has been earned. The company owes the customer $4,800 worth of magazines. A liability (Unearned Revenue) must be recognized at the time cash is received. At the end of the year, the company has satisfied its obligations for four of the 12 months (September through December). Thus, the company must reduce its liability (Unearned Revenue) and record Revenue of $1,600 ($4,800 x 4/12). The journal entry follows:

Account Debit CreditUnearned Revenue $ 1,600 Sales Revenue $ 1,600

Closing Entries

The final step in the accounting cycle involves preparing and posting closing entries. Some accounts accumulate information for one accounting period. For example, a revenue account shows the amount of revenue earned during that period. The balance in such accounts must be reset to zero at the beginning of each accounting period. Closing entries are prepared to reset such accounts to zero.

Revenue and expense accounts are first closed to a temporary account called Income Summary. Revenue accounts have a credit balance. To reset the revenue account to zero, it must be debited by an amount equal to its current balance. Income Summary is credited by an equal amount. Expense accounts have a credit balance. To reset an expense account to zero, it must be credited by an amount equal to its current balance. Income Summary is debited by an amount equal to the total expenses.

The balance in the Income Summary account is transferred to the Retained Earnings amount. If the business earned a profit during the period, the Income Summary account has a credit balance equal to the net income for the period after closing the revenue and expense accounts. To close the Income Summary account, it must be debited by the amount of the net income. Retained Earnings is credited by the same amount.

Note that it is not necessary to have the intermediate step of closing the revenue and expense accounts to the Income Summary account and then transferring the balance to the Retained Earnings account. The revenue and expense accounts can be closed directly to the Retained Earnings account.

The final step in the closing process involves the Dividends account. Owners may receive cash payments (dividends) from the business. Corporations use the Dividends account to record distributions to owners during a period. At the end of the period the balance in the Dividends account must also be reset to zero. This balance is subtracted from the Retained Earnings account.

Trial Balance

After all the transactions have been posted, a trial balance is prepared. A trial balance lists each account in the general ledger and its balance (debit or credit) as of a particular date. The total in the debit column must equal the total in the credit column. If the two amounts do not match, there must be an error in the recording. For example, if only the debit part of an entry is posted, the two amounts will not match.

A trial balance can be prepared before or after the closing entries. Note that after the closing entries have been prepared, the revenue, expense, and dividend accounts will have been closed (that is, have zero balance). Thus, a post-closing trial balance has only asset, liability, and owners’ equity accounts.

Financial Statements

An INCOME STATEMENT indicates the profitability of a business over a period of time. It shows the revenue and expense account balances. The difference between revenues earned during a period and the expenses for the period represents the net income for

the period. The heading of the statement shows the name of the organization, the title of the statement, and the period for which the statement is being prepared.

The income statement shows the changes to owners' equity resulting from profitable operations of the business. Retained earnings represents the portion of owners' equity created by earning net income and reinvesting the profits in the business. The net income minus any dividends declared represents the reinvested profits. The reinvested profits are added to the beginning retained earnings balance. This gives the following relationship:Ending retained earnings = Beginning retained earnings + Net income – Dividends

Note that in the case of a corporation, the reinvested profits are added to Retained Earnings, not Common Stock. The Common Stock account is credited only when new shares are issued to stockholders; it represents new investments as opposed to the revinvestment of profits.

A BALANCE SHEET presents the financial position of an organization as of a particular date. It shows the assets, liabilities, and owners' equity balances for a company at the end of a fiscal period. Note that the balance in the Retained Earnings account is the ending balance shown in the statement of retained earnings. The heading of the statement shows the name of the organization, the title of the statement, and the date at which the statement is being prepared.

Review Questions 2

1. ___________ entries are required for accrual accounting because of timing differences between cash flows and the recognition of revenues or expenses.

2. _______ revenues occur when revenues are recognized after cash is collected from customers.

3. ________ expenses occur when expenses are recognized before cash is paid.

4. The final step in the accounting cycle involves preparing and posting the _______ entries.

5. When depreciation expense is recorded, the _____ account is debited.

6. When depreciation expense is recorded, the ______ account is credited.

Answers:1. Adjusting 2. Deferred 3. Accrued4. closing 5. Depreciation Expense 6. Accumulated Depreciation

Glossary

Accounting equation is Assets = Liabilities + Owners’ Equity.

Accrued expenses occur when expenses are recognized before cash is paid.

Accrued revenues occur when revenues are recognized before cash is received.

Adjusting entries, prepared at the end of a fiscal period, are required under accrual accounting because of timing differences between the flow of cash and the recognition of revenues or expenses.

Balance sheet presents the financial position of an organization on a particular date.

Closing entries are the final step in the accounting cycle. The balance in revenue, expense, and dividend accounts must be reset to zero at the beginning of each accounting period. Closing entries are prepared to reset such accounts to zero.

Credit means an entry on the right-hand side of the T-account. Credit entries increase the balance of liabilities, owners’ equity, and revenues and decrease the balance of assets.

Debit means an entry on the left-hand side of the T-account. Debit entries increase the balance of assets and expenses and decrease the balance of liabilities and owners’ equity.

Deferred expenses occur when expenses are recognized after cash has been paid.

Deferred revenues occur when revenues are recognized after cash has been collected from customers.

Income statement indicates the profitability of a business over a period of time and shows the revenues and expenses for a period.

Journal is a book for recording transactions in the order in which they occur after being analyzed to determine which accounts are affected, the amount of the effect, and whether they increase or decrease these accounts.

Ledger is used to record the impact of transactions on accounts.

Trial balance lists each account in the general ledger and its balance (debit or credit) on a particular date. The total of the amounts in the debit column must equal the total amount in the credit column.

Demonstration Problem 1Smith Company

During the month of July 2002, Smith Company had the following transactions. For each of the following types of events, indicate whether a debit or credit to the relevant account is required. (As an example, the first item is marked):

Event Account Debit Credit1. Cash is received from a sale. Cash x2. Inventory is sold. Inventory 3. A loan is obtained from a bank. Notes Payable 4. Services are rendered to a customer who will pay later.

Accounts Receivable

5. Machinery is purchased on credit. Accounts Payable 6. Owners invest money in the business. Owners’ Equity 7. The company paid $500 to a supplier for merchandise purchased earlier on credit.

Accounts Payable

8. Merchandise is sold for cash. Sales Revenue9. Salaries for the month are accrued. Salaries Expense

Solution to Demonstration Problem 1, Smith Company

Transactions

1. When cash is collected, cash increases. Cash is an asset, and an increase in an asset is recorded with a DEBIT.

2. When inventory is sold, inventory decreases. Inventory is an asset, and a decrease in an asset is recorded with a CREDIT.

3. When a loan is obtained from a bank, notes payable increases. Notes Payable is a liability account, and an increase in a liability account is recorded with a CREDIT.

4. When services are rendered on account to a customer, accounts receivable increases. Accounts Receivable is an asset account, and an increase in an asset account is recorded with a DEBIT.

5. When machinery is purchased on credit, accounts payable increases. Accounts Payable is a liability account, and an increase in a liability account is recorded with a CREDIT.

6. When owners invest in a business, owners’ equity increases. An increase in the Owners’ Equity account is recorded with a CREDIT.

7. When an account payable is paid, accounts payable decreases. Accounts Payable is a liability account, and decreases in a liability account are recorded with a DEBIT.

8. When merchandise is sold for cash, sales revenue increases. Sales Revenue is a revenue account, and an increase in a revenue account is recorded with a CREDIT.

9. When salaries are accrued, salaries expense increases. Salaries Expense is an expense account, and an increase in an expense account is recorded with a DEBIT.

Event Account Debit Credit1. Cash is received from a sale. Cash x2. Inventory is sold. Inventory x3. A loan is obtained from a bank. Notes Payable x4. Services are rendered to a customer who will pay later.

Accounts Receivable

x

5. Machinery is purchased on credit. Accounts Payable x6. Owners invest money in the business. Owners’ Equity x7. The company paid $500 to a supplier to pay for merchandise purchased earlier on credit.

Accounts Payable x

8. Merchandise is sold for cash. Sales Revenue x9. Salaries for the month are accrued. Salaries Expense x

Demonstration Problem 2Jackson Company

On December 31, 2002, the records of Jackson Company indicated the following:1. On October 1, 2002, the company had purchased a two-year insurance policy for $4,800 and recorded the purchase as an asset.2. The company had borrowed $200,000 on a three-year, 9% loan from First Bank on July 1, 2002.3. A total of $10,000 has been collected from customers for services to be rendered in the future, and the company satisfied 30% of the obligations for these customers. 4. Employees’ salary of $3,500 for the last week has not yet been paid. 5. Machinery had been purchased last year for $100,000; its estimated useful life was estimated to be 8 years.

Prepare the necessary adjusting entries at the end of the year.

Solution to Demonstration Problem 2, Jackson Company

Item 1: The insurance policy was for $4,800 and two years. From October 1 to December 31, three months have elapsed. Thus, the insurance expense to be recognized is $600 [($4,800/24) x 3].

Account Debit CreditInsurance Expense $ 600 Prepaid Insurance $ 600

Item 2: The loan was borrowed on July1, and six months have elapsed from July 1 to December 31. The interest expense to be recognized is $9,000 [($200,000 x 0.09) x (6/12)].

Account Debit CreditInterest Expense $ 9,000 Interest Payable $ 9,000

Item 3: The company has satisfied 30% of the obligations, so it can recognize revenue of $3,000 (30% of $10,000). Since Unearned Revenue would have been recognized as a liability (by a credit entry to that account), we must now decrease (that is, debit) Unearned Revenue by $3,000.

Account Debit CreditUnearned Revenue $ 3,000 Sales Revenue $ 3,000

Item 4: Salary expense of $3,500 must be recognized now. Since it has not yet been paid, it is a liability, and the Salaries Payable account must be credited.

Account Debit CreditSalaries Expense $ 3,500 Salaries Payable $ 3,500

Item 5: Depreciation for the machines must be recorded. Depreciation expense each year is $12,500 ($100,000/8).

Account Debit CreditDepreciation Expense $ 12,500 Accumulated Depreciation $ 12,500

Demonstration Problem 3Nieman Company

Information about the account balances of Nieman Company as of December 31, 2002, follow. Prepare these items:1. A trial balance.2. Closing entries.

What is the ending balance in Retained Earnings after the closing entries?

Cash $ 4,000 Accounts Payable 7,000Accounts Receivable 12,000Inventory 20,000Sales Revenue 200,000Land 40,000Buildings 80,000Accumulated Depreciation 15,000Cost of Goods Sold 120,000Bonds Payable 30,000Operating Expenses 30,000Common Stock 10,000Retained Earnings ?Interest Expense 3,000Selling Expenses 5,000Income Tax Expense 14,000

Solution to Demonstration Problem 3, Nieman Company

a. Trial balanceDebit Credit

Cash $ 4,000 Accounts Receivable 12,000Inventory 20,000Land 40,000Buildings 80,000Accumulated Depreciation 15,000Accounts Payable 7,000Bonds Payable 30,000Common Stock 10,000Retained Earnings ?Sales Revenue 200,000Cost of Goods Sold 120,000Operating Expenses 30,000Selling Expenses 5,000Interest Expense 3,000Income Tax Expense 14,000Total $ 328,000 $ 328,000The total of debits must equal credits, thus beginning balance in Retained Earnings must have been $66,000. (Note: (1) The trial balance still includes revenue and expense accounts. (2) Hence, this is a pre-closing trial balance. (3) This means the that this is the beginning balance amount of the Retained Earnings account because the ending balance of Retained Earnings is obtained only after closing entries have been prepared.)

b. Closing entries Debit Credit

Income Summary $200,000 Sales Revenue $200,000

Debit CreditCost of Goods Sold $120,000Operating Expenses 30,000Selling Expenses 5,000Interest Expense 3,000Income Tax Expense 14,000 Income Summary $172,000The Income Summary account has a credit balance of $28,000 after these entries have been made, thus final closing entry follows:

Debit CreditIncome Summary $28,000 Retained Earnings $28,000Thus the amount in the Retained Earnings account at the end of the year is $94,000 ($66,000 + $28,000).

Practice Problem 1Jones Company

During the month of June 2002, Jones Company had the following transactions. For each of the following types of events, indicate whether a debit or credit to the relevant account is required:

Event Account Debit Credit1. Cash is received by issuing bonds. Bonds Payable2. Inventory is purchased on credit. Inventory 3. A loan from the bank is repaid. Cash 4. Services are received from a lawyer, who will be paid later.

Accounts Payable

5. Machinery is purchased on credit. Machinery 6. Dividends are paid to shareholders. Dividends 7. The company received $500 from a customer to whom services had been rendered earlier.

Accounts Receivable

8. Merchandise is sold for credit. Sales Revenue9. Utilities for the month were paid. Utilities Expense

Solution to Practice Problem 1, Jones Company

Transactions

Event Account Debit Credit1. Cash is received by issuing bonds. Bonds Payable x2. Inventory is purchased on credit. Inventory x 3. A loan from the bank is repaid. Cash x 4. Services are received from a lawyer, who will be paid later.

Accounts Payable x

5. Machinery is purchased on credit. Machinery x 6. Dividends are paid to shareholders. Dividends x 7. The company received $500 from a customer to whom services had been rendered earlier.

Accounts receivable

x

8. Merchandise is sold for credit. Sales Revenue x9. Utilities for the month were paid. Utilities Expense x

Practice Problem 2Jemison Company

On December 31, 2002, the records of Jemison Publishing Company indicated the following:1. On July 1, 2002, the company had paid $12,000 as rent for two years and recorded the payment as an asset.2. On November 1, the company had borrowed $500,000 on a two-year, 12% loan from National Bank.3. A total of $9,000 was collected as advance payments from customers for magazines to be sent in the future, and the company satisfied 50% of the obligations for these customers. 4. Bills of $2,000 have been received for utilities expenses but have not yet been paid.5. Machinery worth $250,000 had been purchased in 1999; its useful life of the machines was estimated to be 10 years.


Solution to Practice Problem 2 (Jemison Company)

Item 1: The prepaid rent for two years was for $12,000. From July 1 to December 31, six months have elapsed. Thus, the rent expense to be recognized is $3,000 [($12,000/24) x 6].

Account Debit CreditRent Expense $ 3,000 Prepaid Rent $ 3,000

Item 2: The loan was borrowed on November 1, and two months have elapsed from November 1 to December 31. The interest expense to be recognized is $9,000 [($500,000 x 0.12) x (2/12)].


Item 3: The company has satisfied 50% of the obligations, so it can recognize revenue of $4,500 (50% of $10,000).

Account Debit CreditUnearned Revenue $ 4,500 Subscription Revenue $ 4,500

Item 4: Utilities expense of $2,000 must be recognized now. Since it has not yet been paid, it is a liability, and the Salaries Payable account must be credited.

Account Debit CreditUtilities Expense $ 2,000 Utilities Payable $ 2,000



Practice Problem 3Davis Company

Information about the account balances of Davis Company as of December 31, 2002, follow. Prepare these items1. A trial balance.2. Closing entries.What is the ending balance in Retained Earnings after the closing entries?

Cash $ 12,000 Accounts Payable 21,000Accounts Receivable 18,000Machinery 150,000Inventory 35,000Sales Revenue 600,000Land 40,000Buildings 75,000Accumulated Depreciation, Buildings 45,000Cost of Goods Sold 420,000Administrative expenses 70,000Bonds Payable 75,000Accumulated Depreciation, Machinery 60,000Common Stock 20,000Retained Earnings ?Interest Expense 6,000Selling Expenses 50,000Income Tax Expense 14,000

Solution to Practice Problem 3, Davis Company


Cash $ 12,000 Accounts Receivable 18,000Inventory 35,000Land 40,000Buildings 75,000Accumulated Depreciation, Buildings 45,000Machinery 150,000Accumulated Depreciation, Machinery 60,000Accounts Payable 21,000Bonds Payable 75,000Common Stock 20,000Retained Earnings ?Sales Revenue 600,000Cost of Goods Sold 420,000Selling Expenses 50,000Administrative Expenses 70,000Interest Expense 6,000Income Tax Expense 14,000Total $ 890,000 $ 890,000Since the total of debits must equal credits, the beginning balance in Retained Earnings must have been $69,000.



Debit CreditCost of Goods Sold $420,000Selling Expenses 50,000Administrative Expenses 70,000Interest Expense 6,000Income Tax Expense 14,000 Income Summary $560,000The Income Summary account has a credit balance of $40,000 after these entries have been made, therefore, the final closing entry follows:

Debit CreditIncome Summary 40,000 Retained Earnings 40,000Thus, the amount in the Retained Earnings account at the end of the year is $109,000 ($69,000 + $40,000).

Practice Problem 4

1. During the year 2002, the assets of Abraham Company increased by $10,000, and its liabilities decreased by $3,000. If the beginning balance of the Stockholders’ Equity account was $80,000, the ending balance must bea. $77,000.b. $83,000.c. $87,000.d. $93,000.

2. If total stockholders’ equity increased by $6,000 during a year and total assets increased by $17,000 during the year, the total liabilities must havea. increased by $11,000 during the year.b. decreased by $11,000 during the year.c. increased by $23,000 during the year.d. decreased by $23,000 during the year.

3. The stockholders' equity of Azinger Company is one-third of its total liabilities. If total assets are $240,000, the stockholders' equity isa. $120,000.b. $80,000.c. $60,000.d. $40,000.

4. Which of the following accounts has a normal debit balance?a. Accounts Payableb. Accounts Receivablec. Sales Revenued. Common Stock

5. On July 31, 2002, Costa Company paid $1,000 as rent for the month of July. To record this transactiona. Rent Expense must be credited; Cash must be debited.b. Rent Expense must be debited; Cash must be credited.c. Cash must be debited; Rent Revenue must be credited.d. Cash must be credited; Rent Revenue must be debited.

6. The journal entry to record the payment of cash for inventory purchased on credit earlier is to a. debit Cash and to credit Accounts Receivable.b. debit Cash and to credit Accounts Payable.c. debit Accounts Receivable and to credit Cash.d. debit Accounts Payable and to credit Cash.

7. The list of all the accounts with their ending balances is called thea. trial balance.b. income statement.c. statement of retained earnings.d. balance sheet.

8. Assume that the beginning balances in the Common Stock and Retained Earnings accounts of a company were $10,000 and $1,200, respectively. The company earned revenues of $3,600, incurred expenses of $1,600, and paid dividends of $1,000 for the period. The ending balances in the Capital Stock and Retained Earnings accounts werea. $10,000, $2,200.b. $11,000,$1,200.c. $9,000, $3,200.d. $10,000, $1,200.

Homework Problem 1Brown Company

During the month of August 2002, Brown Company had the following transactions. For each of the following types of events, indicate whether a debit or credit to the relevant account is required:

Event Account Debit Credit1. Cash is received by issuing stock. Capital Stock2. Land is purchased by paying cash. Land 3. A loan from the bank was obtained. Loan Payable 4. Merchandise is purchased on credit. Inventory 5. Inventory is sold on credit. Cost of Goods Sold 6. Inventory is sold for cash. Sales Revenue 7. Salaries are paid. Salaries Expense8. Depreciation is recorded. Depreciation Expense9. Dividends are declared. Dividends Payable

Solution to Homework Problem 1, Brown Company

Transactions

Event Account Debit Credit1. Cash is received by issuing stock. Capital Stock x2. Land is purchased by paying cash. Land x 3. A loan from the bank was obtained. Loan Payable x4. Merchandise is purchased on credit. Inventory x 5. Inventory is sold on credit. Cost of Goods Sold x6. Inventory is sold for cash. Sales Revenue x7. Salaries are paid. Salaries Expense x8. Depreciation is recorded. Depreciation Expense x 9. Dividends are declared. Dividends Payable x

Homework Problem 2Ross Company

On December 31, 2002, the records of Ross Company indicated the following :1. The company had purchased supplies worth $3,000 during the year. The value of supplies on hand was as follows: January 1, 2002, $350; December 31, 2002, $500. 2. On October 1, the company had signed a one-year, 8% note for $200,000.3. Customers had paid $5,000 as advance payments for services to be rendered in the future. Ross Company has not yet performed services to these customers. 4. Sales commissions of $8,000 for December 2002 have not yet been paid.5. Machinery worth $210,000 had been purchased in 2001; its useful life was estimated to be 7 years.


Solution to Homework Problem 2, Ross Company

Item 1: Supplies expense = $2,850 ($350 + $3,000 – $500). Account Debit Credit

Supplies Expense $ 2,850 Supplies $ 2,850

Item 2: The note was signed on October 1, and three months have elapsed from October 1 to December 31. The interest expense to be recognized is $4,000 [($200,000 x o.08) x (3/12)].


Item 3: No journal entry.

Item 4: Commission expense of $8,000 must be recognized now. Since it has not yet been paid, it is a liability, and the Commission Payable account must be credited.

Account Debit CreditCommission Expense $ 8,000 Commission Payable $ 8,000



Homework Problem 3Stice Company

Information about the account balances of Stice Company as of December 31, 2002 follows. Prepare these items:1. Trial balance.2. Closing entries.What is the ending balance in Retained Earnings after the closing entries?

Cash $ 2,000 Accounts Payable 9,000Accounts Receivable 4,000Inventory 15,000Sales Revenue 160,000Land 30,000Buildings 55,000Accumulated Depreciation, Buildings 22,000Cost of Goods Sold 101,000Administrative expenses 15,000Notes Payable 17,000Common Stock 12,000Retained Earnings ?Interest Expense 2,000Selling Expenses 12,000Income Tax Expense 10,000

Solution to Homework Problem 3, Stice Company


Cash $ 2,000 Accounts Receivable 4,000Inventory 15,000Land 30,000Buildings 55,000Accumulated Depreciation, Buildings 22,000Accounts Payable 9,000Notes Payable 17,000Common Stock 12,000Retained Earnings ?Sales Revenue 160,000Cost of Goods Sold 101,000Selling Expenses 12,000Administrative Expenses 15,000Interest Expense 2,000Income Tax Expense 10,000Total $ 246,000 $ 246,000Since the total of debits must equal credits, the beginning balance in Retained Earnings must have been $26,000.



Debit CreditCost of Goods Sold $101,000Selling Expenses 12,000Administrative Expenses 15,000Interest Expense 2,000Income Tax Expense 10,000 Income Summary $140,000Since the Income Summary account has a credit balance of $20,000 after these entries have been made, the final closing entry follows:

Debit CreditIncome Summary $20,000 Retained Earnings $20,000Thus, the amount in the Retained Earnings account at the end of the year is $46,000 ($26,000 + $20,000).

Homework Problem 4

1. During the year 2002, the assets of Murray Company decreased by $20,000, and its liabilities decreased by $7,000. If the ending balance of the Stockholders’ Equity account was $70,000, the beginning balance must be:a. $57,000.b. $83,000.c. $87,000.d. $97,000.

2. If total stockholders’ equity decreased by $5,000 during a year and total liabilities increased by $14,000 during the year, the total assets must havea. increased by $19,000 during the year.b. decreased by $19,000 during the year.c. increased by $9,000 during the year.d. decreased by $9,000 during the year.

3. The total assets of Brennan Company equals three times its total liabilities. If the stockholders' equity is $120,000, the total assets must bea. $60,000.b. $180,000.c. $240,000.d. $360,000.

4. Which of the following accounts has a normal credit balance?a. Accounts Payableb. Accounts Receivablec. Salaries Expensed. Dividends

5. Daniels Company paid $500 to buy supplies. To record this transaction, a. Supplies Expense must be credited.b. Supplies Expense must be credited.c. Supplies must be credited.d. Supplies must be debited.

6. The journal entry to record the collection of cash for items sold on credit earlier isa. debit Cash and to credit Accounts Receivable.b. debit Cash and to credit Accounts Payable.c. debit Accounts Receivable and to credit Cash.d. debit Accounts Payable and to credit Cash.

7. For a corporation, which of the following is subtracted from the beginning owner's equity to calculate the ending owner's equity?a. Net Incomeb. Dividendsc. Owner, Capitald. Drawings

8. Assume that a company had a beginning balance in Retained earnings of $12,000. The company earned revenues of $3,600 and incurred expenses of $1,600. The ending balance in Retained Earnings wasa. $10,000.b. $13,600.c. $14,000.d. $15,200.

Financial Accounting Module 02

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Transcript of Financial Accounting Module 02