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SOLUTIONS TO PRACTICE PROBLEMS for MODULES 1 & 2

PROBLEM 1 Transaction
Investment Equipment purchase Buy supplies on account Pay supplier Buy insurance Customer pays in advance Perform service for this customer Record supplies usage Totals

Assets
+ 75,000 + 60,000 - 60,000 +12,000 - 8,000 +600 - 600 +10,000 - 6,000 $83,000

Liabilities

Equity
+ 75,000

+12,000 - 8,000

+10,000 - 10,000 $4,000

+10,000 - 6,000 $79,000

PROBLEM 2
The violated principle is: a) Revenue Recognition revenue should have been recognized when goods were delivered regardless of when payment is made. b) Going Concern Since the business is not expected to continue there is no point in setting up assets and systematically amortizing them. c) Separate Entity the personal transactions of the owner and the owners business transactions should not be co-mingled. d) Matching the guards total hours worked in the month is the basis for the payroll expense for the month. Expenses are recognized based on incurrence and not payment in the accrual paradigm.

PROBLEM 3 Transaction
Invest cash in the business Obtain bank loan Purchase equipment on credit Pay off a debt Owner withdrew cash Bought capital assets giving down payment and financing the rest Bought parking lot with cash Sold some land and set up a receivable Collections from customers

Assets
+ + + + nc nc nc

Liabilities
nc + + nc + nc nc nc

Equity
+ nc nc nc nc nc nc nc

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Gaber, Hayes & Porporato

2011

PROBLEM 4
Total Assets = (400 +70 +150 - 60 - 40) = $520,000 Total Liabilities = (300 + 90 40) = $350,000 Total Owners Equity = (100 +70) = $170,000 The balance sheet equation at July 31 is $520,000 = $350,000 + $170,000

PROBLEM 5 Transaction
Invest in the business Purchase machine for cash Borrowed money from the bank Buy furniture on credit Partial payment on the furniture Sold typewriter for $25 profit Collection of money owed Record usage of supplies Cash advances from customers Withdraw money for personal use

Assets
+2,000 nc +5,000 +2,000 - 1,000 +25 nc - 700 +7,000 - 600

Liabilities
nc nc +5,000 +2,000 - 1,000 nc nc nc +7,000 nc

Equity
+2,000 nc nc nc nc +25 nc - 700 nc - 600

PROBLEM 6
1T 2T 3F 4T 5T 6T 7T 8T 9F 10 T 11 T 12 T 13 T 14 T 15 T 16 F

PROBLEM 7 - OVERVIEW OF FINANCIAL STATEMENTS AND THE REPORTING PROCESS

a) Financial accounting is concerned with generating accounting reports used by persons outside the firm (for example, shareholders, creditors, income tax department).

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2011

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Managerial accounting is concerned with generating accounting reports used by management and other persons within the firm. Note that the three principal externally directed financial statements still provide management with useful information. For example, current liabilities on the balance sheet indicate the amounts that must be paid within approximately one year. This information might be useful to management in estimating cash requirements. The performance of the operating divisions within the firm might be evaluated in terms of the profits which each division is able to generate and contribute to the overall earnings for the firm. The cash flow statement could be used in assessing whether the operating activities of the firm are providing sufficient funds to replace worn-out buildings and equipment. Such information might be important indecisions whether to obtain additional short- or long-term financing. b) Financial accounting reports are used by a wide range of individuals and entities (creditors, investors, security analysts, governmental agencies) for a broad range of purposes. Furthermore, in todays global economy a firms financial statements might be used anywhere In the world. If each firm selected whatever format and content of financial reports it deemed best, the resulting reporting process would probably be incomprehensible to many users. Managerial accounting reports, on the other hand, are usually prepared to satisfy the information needs of a more limited set of users. Standardization is, therefore, not as necessary. Each company can tailor make its internal reporting structure to best meet its specific needs.

c) A broad set of accounting objectives can serve as a type of constitution or framework to guide the development of more detailed accounting standards. They help ensure that the standard-setting process is directed toward some end, or goal. d) Revenues measure the increase in net assets (assets minus liabilities) and expenses measure the decrease in net assets from selling goods and providing services. An asset such as inventory is generally stated on the balance sheet at acquisition cost while it is held. Thus, the asset valuation remains the same and no revenue is recognized. When the inventory is sold, the inventory item leaves the firm and cash or a receivable from a customer comes in. If more assets flow in than flow out, total assets increase and income (revenue minus expense) is recognized. e) Operating activities generate cash if more cash is received from customers than is paid out to suppliers, employees, and other providers of goods or services. As long as all of the cash from operations is not paid out as dividends to shareholders (that is, the cash is reinvested in the firm), operations are a source of financing. f) No. The unqualified opinion of the CA indicates that the presentation is a fair reflection of the financial position and operating results of the firm. Because the auditor's opinion is based on an audit of only a portion of the transactions occurring during the year, the CA does not vouch for the absolute accuracy of every item in the financial statements. The unreserved opinion has evolved to mean, however, that sufficient disclosures have been made in the statements so they are not misleading. This interpretation of the unreserved opinion suggests that the statements are free of gross misrepresentations. g) The various business types are identified by the owner's equity accounts. The corporate form has Common Stock and Retained Earnings accounts; the partnership

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2011

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form shows the names of the partners with their respective capital balances; the sole proprietorship form shows the name of the single owner with that owner's equity in the assets of the firm. The corporate form may also be distinguished by the title of the firm, indicating it is a corporation by use of Ltd., Limited, Corp., Corporation, Inc., or Incorporated. The title of the partnership, especially in service and professional types of businesses, often indicates the names of at least some of the partners. The balance sheet of a corporation will usually show a liability for income taxes payable. The balance sheet of a partnership or sole proprietorship ordinarily will not show a liability for income taxes because the taxes are levied directly on the partners or sole proprietor rather than on the enterprise. h) Based on the conservatively reported earnings, a shareholder might sell shares based on the assessment that the firm is not performing as well as it should be. If the economic or "true" earnings of the firm are larger, the shareholder's assessment could have resulted in a poor decision. Or, the management of a firm might be dismissed because shareholders feel that the firm is not performing as well as it should be. It should be emphasized here that the principal objective of accounting reports as currently prepared is to present fairly the results of operations and the financial condition of the firm. When doubt exists as to the treatment of a particular item or transaction, accountants tend to select the procedure resulting in the more conservative measurement of earnings. i) The justification relates to the need for a reasonably high degree of objectivity in the preparation of the financial statements. When there is an exchange between a firm and some other entity, there is market evidence of the economic effects of the transaction. The independent auditor can verify these economic effects by referring to contracts, canceled cheques, and other documents underlying the transaction. If accounting recognized events without such a market exchange (for example, the increase in market value of a firm's assets), increased subjectivity would enter into the preparation of the financial statements. j) The justification relates to the uncertainty of the ultimate economic effects. One of the parties may pull out of the contract, the terms of the final contract my may substantially altered and the benefits and obligations of the contract my not all be clear at the time of signing. Accounting recognition does not begin until one party begins performance under the contract. Footnote disclosure of unexecuted contracts is allowed. k) This relates to the accounting principle that assets should recorded at actual acquisition cost.

PROBLEM 8 (ACCOUNT CLASSIFICATION)

a. b. c. d. e. f. g. h. NCA NI E CA NCA. CA. X (would probably be disclosed in a footnote to the balance sheet). NI

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2011

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i. CA. j. CL. k. X (would not be recognized until the land is sold, but also could be disclosed in footnotes). l. RE. m. CL. n. NCL.

PROBLEM 9 (MATCHING OF TERMS)

1-c 2-b 3-a 4-m 5-e 6-f 7-j 8-i 9-l 10 - 0 11 - h 12 - g 13 - p 14 - k 15 - n

PROBLEM 10 (MULTIPLE CHOICE)

1. d 2. c 3. d 4. d 5. a 6. b 7. b 8. a 9. d 10. c 11. c 12. a 13. b 14. a 15. b

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2011

6 PROBLEM 11 (DRAFTING FINANCIAL STATEMENTS)

DIGITAL ELECTRONICS CORPORATION Comparative Balance Sheet December 31, Year 1 and Year 2 Year 2 ASSETS Current Assets: Cash Accounts Receivable from Customers Merchandise Inventory Total Current Assets Noncurrent Assets: Land Equipment (net of accumulated depreciation) Buildings (net of accumulated depreciation) Total Noncurrent Assets Total Assets LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities: Accounts Payable to Suppliers Salaries Payable Income Taxes Payable Total Current Liabilities Noncurrent Liabilities: Bonds Payable Total Liabilities Shareholders' Equity: Common Shares Retained Earnings Total Shareholders' Equity Total Liabilities and Shareholders' Equity $295,000 15,000 70,000 $380,000 120,000 $500,000 $250,000 10,000 40,000 $300,000 100,000 $400,000 $50,000 320,000 400,000 $770,000 $70,000 220,000 140,000 $430,000 $1,200,000 $30,000 240,000 380,000 $650,000 $60,000 140,000 150,000 $350,000 $1,000,000 Year 1

$100,000 600,000 $700,000 $1,200,000

$100,000 500,000 $600,000 $1,000,000

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2011

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DIGITAL ELECTRONICS CORPORATION Income Statement for Year 2 Sales Less: Cost of Merchandise Sold Gross Profit Rental Revenue Less: Selling and Administrative Expenses Salaries Property Tax Insurance Depreciation Operating Profit Less: Interest Expense Net Income Before Income Tax Income Tax Net Income $1,000,000 (620,000) $380,000 30,000 $135,000 2,000 3,000 40,000

(180,000) $230,000 (10,000) $220,000 (100,000) $120,000

Review note: A single step income statement has condensed format as its priority just list the revenueslist the expensescompute net income. A multiple step income statement attempts to provide information on the nature of expenses and revenues by grouping them by class. You would normally see two headings Selling Expenses and Administrative Expenses. In addition Financing is typically shown at the bottom of the statement (interest income and revenue) as are gains and losses.

DIGITAL ELECTRONICS CORPORATION Retained Earnings Statement for Year 1 Retained Earnings, December 31, Year 1 Plus Net Income Less Dividends Declared and Paid Retained Earnings, December 31, Year 2 $500,000 120,000 (20,000) $600,000

PROBLEM 12 (MATCHING) 1 Y (note that treasury shares are allowed for companies provincially incorporated under the
Ontario Business Corporations Act but not for companies federally incorporated under the Canada Business Corporations Act)

2L 3 T (same restriction as in #1 above. Under the provincial act you can have preferred and
common shares to show different ownership rights but under the federal act the different classes are called Class A, Class B etc.)

4E 5S 6B

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2011

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7 M or E 8O 9A 10 N 11 I or V 12 J 13 D or P 14 U 15 C 16 H 17 Q 18 K 19 R 20 W

PROBLEM 13 (ACCOUNT CLASSIFICATION)

1C 2G 3C 4G 5F 6C 7F 8H 9E 10 A 11 F 12 A 13 B 14 A 15 A 16 E 17 B 18 A 19 A 20 I 21 E 22 reduction of ( I + h + J) 23 A 24 E 25 D 26 C 27 D 28 E 29 A 30 A 31 E 32 F

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2011

9 PROBLEM 14 (MULTIPLE CHOICE)

1d 2 b (GAAP requires Balance Sheet amounts to be at cash equivalent price (net present value)
but for convenience relaxes this requirement for current assets and current liabilities. This topic is introduced in Module 8) 3 b (Historical acquisition cost is irrelevant for this decision. Replacement cost has some potential but what is the replacement cost of a unique subsidiary? The clear choice is net realizable value- the best estimate of what it would sell for. Recall the discussion from Demarco Sports and Jesses Farm on how to value a business unit)

4a 5d 6a 7c 8a 9a 10 a 11 c 12 d 13 b (recall that only provincially incorporated firms use the titles preferred and common shares) 14 d 15 c 16 d 17 a

PROBLEM 15 (BALANCE SHEET EQUATION)

a ( assets + 250,000 and assets 250,000) b ( assets + 1,000 and liabilities + 1,000) c ( assets + 2,100 and assets 2,100) d (assets + 750 and assets 750) e (assets + 30,000 and liabilities + 30,000) f (assets 12,000 and liabilities 12,000. Also liabilities 18,000 and liabilities +18,000) g (assets + 3,500 and assets 3,500) h (assets + 5,500 and assets 3,500) I (assets + 5,000 and liabilities + 5,000) Ending balance sheet totals would be assets( $324,000), liabilities ($24,000) and equity ($300,000)

PROBLEM 16 (ACCOUNT TITLES)

1 debit g and credit k 2 debit b and credit a 3 debit a and credit i 4 debit d and credit a 5 debit c and credit h 6 debit e and credit a

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2011

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7 debit a and credit j 8 debit a and credit k 9 debit f and credit h 10 debit h and credit a

PROBLEM 17 (TRANSACTION ANALYSIS)

Cash Notes Receivable

120,000 40,000 320,000 60,000 100,000

67,200 80,000 320,000 64,000

40,000 Bal 0

40,000

Bal 108,800 60,000 Merchandise Inventory Bal 0

Land

60,000

200,000 120,000 Bal 320,000

Accounts Payable

80,000

80,000 56,000 Bal 56,000

Building Interest Payable

280,000 320,000
3,200 3,200 Bal 0

Bal 600,000

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2011

Notes Payable Common Shares 400,000 100,000 Bal 500,000

11

64,000

64,000 Bal 0

Bonds Payable 80,000 320,000 Bal 400,000

Retained Earnings 72,800 Bal 72,800

Journal Entries
a) dr Cash cr Notes Receivable b) dr Notes Payable dr Interest Payable cr Cash c) dr Accounts Payable cr Cash d) dr Cash cr Bonds Payable e) dr Merchandise Inventory cr Cash cr Accounts Payable f) dr Cash cr Land g) dr Cash cr Common Shares 40,000 40,000 64,000 3,200 67,200 80,000 80,000 320,000 320,000 120,000 64,000 56,000 60,000 60,000 100,000 100,000

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2011

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Watson Limited Trial Balance @ Jan 31, 19X1 Account Dr Cash $108,800 Merchandise Inventory 320,000 Building 600,000 Accounts Payable Bonds Payable Common Shares Retained Earnings Totals $1,028,800

Cr

$56,000 400,000 500,000 72,800 $1,028,800

PROBLEM 18 (ASSET RECOGNITION)

1. no 2. yes 3. no 4. yes 5. yes 6. no 7. yes 8. no 9. no 10. yes

PROBLEM 19 (LIABILITY RECOGNITION)

1. no 2. yes 3. no 4. yes 5. no 6. yes 7. no 8. no 9. no 10. yes

Modules 1 & 2 Solutions

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2011

13 PROBLEM 20 (BALANCE SHEET PRESENTATION)

Balance Sheet Tommys Memorial Park Inc. December 31, 19X1 ASSETS Current Assets Cash Temporary Investments Accounts Receivable Inventory Prepaid Insurance Total Current Assets Non Current Assets Portfolio Investments Investment in Shares Investment in Bonds Capital Assets Land Building Accumulated Depn Intangible Assets Patent Goodwill $28,000 12,000 $100,000 $50,000 (10,000) $8,000 15,000 40,000 23,000 163,000 203,000 $294,000 $5,000 15,000 40,000 30,000 1,000 $91,000

40,000

Total Capital Assets Total Noncurrent Assets Total Assets LIABILITIES Current Liabilities Accounts Payable Notes Payable Property Taxes Payable Withheld Income Tax Payable Total Current Liabilities Non Current Liabilities Bonds Payable Total Liabilities $31,000 22,000 6,000 2,200

$61,200 80,000 $141,200

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SHAREHOLDERS EQUITY Common Shares Contributed Surplus Retained Earnings Total Shareholders Equity $50,000 25,000 77,800 $152,800 $294,000

Total Liabilities and Shareholders Equity

PROBLEM 21 (THE ACCOUNTING CYCLE)

General Journal for Electronics Appliance Corporation Date Sept 1 Account Cash Common Stock
(Issuance of 4,000 no par shares @$12/share)

Dr 48,000

Cr 48,000

Sept 2

Organization Costs Common Stock

(Issuance of 600 shares in settlement of $7,200 legal bill re incorporation)

7,200 7.200

Sept 5

Prepaid Rent Cash

(Prepayment of October & November rent)

10,000 10,000

Sept 12

Raw Material Inventory Accounts Payable

(Raw materials purchased on account)

6.100 6,100

Sept 15

Cash Advances from Customers

(Deposit received from customer)

900 900

Sep 20

Equipment Cash
(Equipment purchase subject to $25 discount)

925 925

Sept 28

Advance to Employee Cash

(Cash advance given to new employee)

200 200

Sept 30

Equipment Cash Mortgage Payable

27,500 5,000 22,500

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Sept 30 Equipment Cash
(Installation cost on equipment)

450 450

Advances to Employees

Cash

200

48,000 900

10,000 925 200 5,000 450

Bal 32,325

Raw Materials Inventory 925 27,500 450

Equipment

6,100

Bal 28,875 Organization Costs

Prepaid Rent

7,200 10,000

Advances from Customers

Accounts Payable 6,100

900

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Mortgage Payable

Common Stock

22,500

48,000 7,200 Bal 55,200

Electronics Appliance Corporation Balance Sheet September 30 ASSETS Current Assets Cash Advances to Employees Raw Materials Inventory Prepaid Rent Total Current Assets Non Current Assets Capital Assets Equipment Intangibles (Organization Costs) Total Non Current Assets Total Assets $28,875 7,200 36,075 $84,700 $32,325 200 6,100 10,000 $48,625

LIABILITIES AND SHAREHOLDERS EQUITY Current Liabilities Accounts Payable Advances from Customers Total Current Liabilities $6,100 900 $7,200

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Non Current Liabilities Mortgage Payable Total Liabilities

22,500 29,500 55,200 $84,700

Shareholders Equity Common Shares (4,600 no par shares issued and outstanding) Total Liabilities and Shareholders Equity

Modules 1 & 2 Solutions

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2011