Porter SM Ch. 04 - 2pp

CHAPTER 4
Income Measurement and

Accrual Accounting
OVERVIEW OF EXERCISES PRO!"EMS A#$ CASES
Estimated
Time in
"earning O%&ecti'e E(ercises Minutes "e'el
)* Explain the significance of recognition and measurement 18* 20 Diff
in the preparation and use of financial statements.
+* Explain the differences between the cash and accrual 18* 20 Diff
bases of accounting.
,* Describe the revenue recognition principle and explain its 1 10 Easy
application in various situations. 18* 20 Diff
4* Describe the matching principle and the various methods 2 10 od
for recogni!ing expenses. 1"* 1# od
20* 1# od
-* $dentify the four ma%or types of ad%ustments and determine & 10 Easy
their effect on the accounting e'uation. ( 10 Easy
# 20 Easy
) 20 Easy
* 1# Easy
8 1# Easy
" 1# Easy
10 1# od
11 1# Easy
12 1# Easy
1& 1# Easy
1( 1# Easy
1# 10 od
1) 1# od
1"* 1# od
20* 1# od
.* Explain the steps in the accounting cycle and the significance 1* # Easy
of each step.
*Exercise+ problem+ or case covers two or more learning ob%ectives
,evel - Difficulty levels. Easy/ oderate 0od1/ Difficult 0Diff1
4/)
4/+ 2$3435$4, 4556738$39 :6,78$63: 4374,
Pro%lems Estimated
and Time in
"earning O%&ecti'e Alternates Minutes "e'el
)* Explain the significance of recognition and measurement
in the preparation and use of financial statements.
+* Explain the differences between the cash and accrual 8* 2# od
bases of accounting.
,* Describe the revenue recognition principle and explain its
application in various situations. 8* 2# od
"* 2# Diff
4* Describe the matching principle and the various methods 8* 2# od
for recogni!ing expenses. "* 2# Diff
-* $dentify the four ma%or types of ad%ustments and determine 1 20 od
their effect on the accounting e'uation. 2 20 od
& 20 od
( 1# od
# 20 od
) 2# od
* 1# od
10* )0 od
.* Explain the steps in the accounting cycle and the significance 10* "0 od
of each step.
; 6riginal problem only
**4lternate problem only
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/,
Estimated
Time in
"earning O%&ecti'e Cases Minutes "e'el
)* Explain the significance of recognition and measurement
in the preparation and use of financial statements. 1* &0 od
+* Explain the differences between the cash and accrual 1* &0 od
bases of accounting. &* &0 od
#* )0 Diff
,* Describe the revenue recognition principle and explain its 1* &0 od
application in various situations. 2 &0 od
&* &0 od
#* )0 Diff
4* Describe the matching principle and the various methods
for recogni!ing expenses. &* &0 od
( 2# od
#* )0 Diff
) (# od
-* $dentify the four ma%or types of ad%ustments and determine #* )0 Diff
their effect on the accounting e'uation.
.* Explain the steps in the accounting cycle and the significance
of each step.
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0 1 E S T I O # S
)* 8he accountant cannot show a stoc?holder or other user the company@s assets+
such as cash and buildings. $nstead+ what the user sees is a representation or
depiction of the real thing. 8he accountant describes with words and numbers the
various items in the financial statements.
+* 4ccountants strive to present financial statements that are both relevant to the
decisions made by users of the statements and also reliable or verifiable.
:ometimes+ however+ there are tradeAoffs. 2or example+ in deciding whether an
asset that a company pledges as collateral for a loan is sufficient+ a ban?er may
be most interested in the current value of the asset. 8hat is+ this amount may be
the most relevant attribute or characteristic of the asset for the ban?er@s needs.
8he accountant+ however+ may be reluctant to present the current value of the
asset on the balance sheet because of the difficulty in measuring the value of the
asset with any degree of reliability. 8he amount paid for the assetBthat is+ its
historical costBmay be more reliable+ although not as relevant to the ban?er@s
decision.
,* 8he realtor will recogni!e revenue from the sale of the home on Culy 8 if the cash
basis is used because this is the date cash is received. >evenue will be
recogni!ed on Cune 12 if the accrual basis is used because this is the date the
sale ta?es place and thus is the date on which the revenue is earned.
4* 8his statement is not entirely accurate. Decause it is based on historical cash
flows+ a statement of cash flows is not necessarily the most accurate source of
information on the future cash flow prospects for a company. 4n income
statement may in fact provide more important information about future cash flows.
2or example+ an income statement includes not only sales on a cash basis this
period but also sales on credit that will generate cash flows in future periods.
:imilarly+ a statement of cash flows reports only expenses that re'uired a cash
outlay in the current period. 4n accrualAbased income statement provides
information on accrued expenses that will result in a cash outlay in future periods.
-* 8he time period assumption is important in accounting because financial
statement users want information about a company as of a particular point in time
and for distinct periods of time. 2or example+ a potential stoc?holder wants to
?now the financial position at the end of the most recent year and the profit of a
business for the most recent year. 7nder an accrual accounting system+ revenues
are recogni!ed when they are earned regardless of when cash is received+ and
expenses are recogni!ed when they are incurred regardless of when cash is
paid. 8he accountant does not wait until all of the cash from a sale has been
collected to report the sale on the income statement. $n this way+ the user of the
statement receives information on a timely basis.
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.* 3o+ the recognition of revenue is not always the result of the ac'uisition of an
asset. 4ssume that a publisher sells a maga!ine subscription and collects cash
from the customer in advance. 4t the time cash is collected+ the publisher incurs a
liability. 4s each month@s maga!ine is mailed to the customer+ a portion of the
liability is satisfied and revenue is recogni!ed. 8hus+ in some instances+ revenue
results from the settlement of a liability.
2* 4 company incurs a cost when it ac'uires an asset. 2or example+ assume that a
retailer buys a product for E100 on 6ctober 21. 6n this date+ it has incurred a
cost of E100 to ac'uire an asset+ namely merchandise inventory. 8he asset will
be removed from the records and an expense recogni!ed+ namely cost of goods
sold+ when the product is sold. $n place of the inventory+ the company will ac'uire
another asset+ either cash or an account receivable. $n summary+ assets are
unexpired costs and expenses are expired costs.
3* Depreciation is the process of allocating the cost of a tangible longAterm asset to
its useful life. 2or example+ the accountant attempts to recogni!e or match the
cost of a machine as an expense over the period of time that the machine is used
to manufacture products.
4* 8he four basic types of ad%ustments are.
a* 8o recogni!e the expired portion of a prepaid expense. 2or example+ an
ad%ustment is needed at the end of each month to recogni!e insurance
expense for the portion of an insurance policy that has expired during the
period.
%* 8o recogni!e the earned portion of a deferred revenue or liability. 2or
example+ a publisher has to ma?e an ad%ustment at the end of each period to
recogni!e the earned portion of a subscription.
c* 8o recogni!e expense at the end of the period before cash is paid. 2or
example+ an ad%ustment is made at the end of the year to recogni!e income
tax expense+ even though the taxes will not be paid until early in the following
year.
d* 8o recogni!e revenue at the end of the period before cash is received. 2or
example+ a landlord will need to ma?e an ad%ustment at the end of the month
for the rent owed by a tenant but not payable until some time during the
following month.
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)5* Dalance sheet accounts are called real accounts because they are permanent
and are not closed at the end of a period. 5onversely+ income statement accounts
are called nominal accounts because they are temporary and are closed at the
end of the period. 2or example+ it would not ma?e sense to close the E'uipment
account at the end of the period. 8he account should stay on the boo?s as long
as the company ?eeps the asset. 6n the other hand+ Depreciation Expense on
the e'uipment is a temporary account that indicates the expense associated with
using the asset during the period and is therefore closed along with all other
income statement accounts at the end of the period.
))* 5losing entries serve two important purposes. 2irst+ the balances in all temporary
or nominal accounts are returned to !ero to start the next accounting period.
:econd+ the net income and the dividends of the period are transferred to the
>etained Earnings account.
E X E R C I S E S
"O ,
EXERCISE 4/) REVE#1E RECO6#ITIO#
5ash collected at toll booth E &+000+000
=asses redeemed 1+*00+000
>evenue recogni!ed E (+*00+000
6nly the amount of passes that have been used should be recogni!ed as revenue. 8he
difference between the E2+000+000 of passes issued and the E1+*00+000 of passes
used is unearned revenue at this point.
"O 4
EXERCISE 4/+ THE MATCHI#6 PRI#CIP"E
)* b
+* c
,* b or c 0would recogni!e immediately if supplies are normally used up within the
period1
4* c
-* a
.* c
2* a
3* c
4* b
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EXERCISE 4/, ACCR1A"S A#$ $EFERRA"S
)* 4, -* DE
+* D> .* D>
,* 44 2* 4,
4* DE 3* 44
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EXERCISE 4/4 OFFICE S1PP"IES
8o record office supplies used.

!A"A#CE SHEET I#COME STATEME#T
Assets 7 "ia%ilities 8 Stoc9:olders; E<uit=8 Re'enues > E(?enses
#F&1 6ffice :upplies 6ffice :upplies
on <and 01+)&01 Expense 01+)&01
01+(#0 G 1+100
H "201
3et income for the month of ay would be overstated by E1+)&0 if this ad%ustment were
not recogni!ed+ because expenses would be understated.
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EXERCISE 4/- PREPAI$ RE#T@01ARTER"A
A$B1STME#TS
)* E12+000F) months - E2+000 per month.
+* 8o record prepayment of six months@ rent on :eptember 1.

"F1 =repaid
>ent 12+000
5ash 012+0001
,* 8o record one month of rent expense on :eptember &0.

"F&0 =repaid >ent Expense 02+0001
>ent 02+0001
4* $f the accountant forgot to record an ad%ustment on December &1+ net income for
the year would be overstated by E)+000 0E2+000 per month & months1.
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EXERCISE 4/. $EPRECIATIO#
)* 8o record purchase of combine on Culy 1.

*F1 E'uipment 100+000
5ash 0100+0001
+* =urchase price E 100+000
,ess. Estimated salvage value 01)+0001
Depreciable cost E 8(+000
,* onthly depreciation - depreciable costFestimated life - E8(+000F8( months -
E1+000Fmonth.
4* 8o record one month@s depreciation expense on Culy &1.

*F&1 4ccumulated Depreciation
Depreciation 01+0001 Expense 01+0001
-* E'uipment E 100+000
,ess. 4ccumulated depreciation 0) months I
E1+000Fmonth1 0)+0001
5arrying value E "(+000
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EXERCISE 4/2 PREPAI$ I#S1RA#CE@A##1A"
A$B1STME#TS
)* onthly cost. E*2+000F2( months - E&+000.
+* 8o record purchase of 2(Amonth policy on 4pril 1.

(F1 =repaid
$nsurance *2+000
5ash 0*2+0001
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/4
EXERCISE 4/2 CConcludedD
,* 8o record expiration of nine months of insurance on December &1.

12F&1 =repaid $nsurance
$nsurance 02*+0001 Expense
02*+0001

4* 3et income will be overstated by E2*+000 if the accountant forgets to record an
ad%ustment to recogni!e an expense.
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EXERCISE 4/3 S1!SCRIPTIO#S
)* 8o record collection of "00 subscriptions of E&0 each in 4ugust.

4ug. 5ash 2*+000 :ubscriptions
>eceived in
4dvance 2*+000
0"00 &01
+* 8o record subscriptions earned during 4ugust and recorded on 4ugust &1.

8F&1 :ubscriptions :ubscriptions
>eceived in >evenue *+#00
4dvance 0*+#001
0(0+#00 G 2*+000 H )0+0001
,* 3et income for the month would be understated by E*+#00 if the accountant forgot
to ma?e the ad%ustment to recogni!e revenue earned.
4/)5 2$3435$4, 4556738$39 :6,78$63: 4374,
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EXERCISE 4/4 C1STOMER $EPOSITS
)* 8o record on 4pril 1 receipt of customer deposit for three months of legal service.

(F1 5ash "+000 5ustomer
Deposits "+000
+* 8o record on 4pril &0 one month of legal fees earned.

(F&0 5ustomer ,egal 2ees
Deposits 0&+0001 Earned &+000
0"+000F&1
,* $f the 4pril &0 ad%ustment is not recorded+ net income will be understated by E&+000.
"O -
EXERCISE 4/)5 WA6ES PAAA!"E
)* Jee?ly payroll. E10 per hour * hours per day # days #0 employees -
E1*+#00
+* 8o record payment of wee?ly payroll on 6ctober 2*.

10F2* 5ash 01*+#001 Jages Expense 01*+#001
,* 8o record accrual for two days@ wages on 6ctober &1.

10F&1 Jages =ayable *+000 Jages Expense 0*+0001
01*+#00F# days I 2 days1
4* 8o record payment of wee?ly payroll on 3ovember &.

11F& 5ash 01*+#001 Jages =ayable 0*+0001 Jages Expense 010+#001
-* 3et income for 6ctober would be overstated by E*+000 if the company failed to
record accrued wages on 6ctober &1.
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
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EXERCISE 4/)) I#TEREST PAAA!"E
)* 8o record 12K+ "0Aday loan from 2irst 3ational Dan? on arch 1.

&F1 5ash 100+000 3ote =ayable 100+000
+* 8o accrue interest due on note for one month on arch &1.

&F&1 $nterest =ayable 1+000 $nterest Expense 01+0001
0100+000 .12 &0F&)01
8o accrue interest due on note for one month on 4pril &0.

(F&0 $nterest =ayable 1+000 $nterest Expense 01+0001
,* 8o record payment of note and interest at maturity date on ay &0.

#F&0 5ash 010&+0001 3ote =ayable 0100+0001 $nterest Expense 01+0001
$nterest
=ayable 02+0001
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EXERCISE 4/)+ PROPERTA TAXES PAAA!"E@
A##1A" A$B1STME#TS
)* 8o accrue 200* property taxes on December &1.

+552
12F&1 =roperty 8axes =roperty 8ax
=ayable #2+#00 Expense 0#2+#001
0#0+000 1.0#1
4/)+ 2$3435$4, 4556738$39 :6,78$63: 4374,
EXERCISE 4/)+ CConcludedD
+* 8o record payment of 200* property taxes on Cune 1.

+553
)F1 5ash 0#2+#001 =roperty 8axes
=ayable 0#2+#001
"O -
EXERCISE 4/), I#TEREST RECEIVA!"E
)* 8o record 10K+ )0Aday loan to axiDriver $nc. on Cune 1.

)F1 5ash 0)0+0001
3ote
>eceivable )0+000
+* 8o accrue interest due on note for one month on Cune &0.

)F&0 $nterest $nterest
>eceivable #00 $ncome #00
0)0+000 .10 &0F&)01
,* 8o record collection of note and interest at maturity date on Culy &1.

*F&1 5ash )1+000 $nterest $ncome #00
3ote
>eceivable 0)0+0001
$nterest
>eceivable 0#001
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
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EXERCISE 4/)4 1#!I""E$ ACCO1#TS RECEIVA!"E
)* 7nder the revenue recognition principle+ revenue should be recorded when
services are performed+ because this is the point at which revenue is earned.
+* 8o record on Cune &0 unbilled service fees earned during Cune.

)F&0 4ccounts :ervice 2ees
>eceivable (0+000 Earned (0+000
"O -
EXERCISE 4/)- THE EFFECT OF I6#ORI#6 A$B1STME#TS
O# #ET I#COME
)* 6 4* 6
+* 7 -* 6
,* 6 .* 7
"O -
EXERCISE 4/). THE EFFECT OF A$B1STME#TS O# THE
ACCO1#TI#6 E01ATIO#
Assets 7 "ia%ilities 8 Stoc9:olders; E<uit=
)* D 3E D
+* 3E $ D
,* D 3E D
4* 3E D $
-* $ 3E $
.* 3E $ D
"O .
EXERCISE 4/)2 THE ACCO1#TI#6 CAC"E
6rder in the accounting cycle. (+ *+ 1+ #+ &+ )+ 2
4/)4 2$3435$4, 4556738$39 :6,78$63: 4374,
M1"TI/CO#CEPT EXERCISES
"O )+,
EXERCISE 4/)3 REVE#1E RECO6#ITIO# CASH A#$
ACCR1A" !ASIS
)* 4ccrualAbasis income statements.
HATHAWAA HEA"TH C"1!
I#COME STATEME#TS
FOR THE AEARS E#$E$ $ECEM!ER ,)
Aear ) Aear + Aear ,
:ales*E 122+000 E1#2+000 E 182+000
Expenses.
Depreciation** E &&+000 E &&+000 E &&+000
:alaries and wages #0+000 #0+000 #0+000
4dvertising #+000 #+000 #+000
>ent and utilities &)+000 &)+000 &)+000
8otal expenses E 12(+000 E 12(+000 E 12(+000
3et income 0loss1 E 02+0001 E 28+000 E #8+000
*Aear )E E&))+000F& - E122+000 with a threeAyear membership/ only oneAthird of
the total recogni!ed.
Aear +E E122+000 G L010010E"001F&M 0additional threeAyear memberships sold in
second year+ but only oneAthird recogni!ed as revenue1 - E1#2+000.
Aear ,E E122+000 G E&0+000 0additional year of revenue recogni!ed on
memberships sold in year 21 G E&0+000 0additional threeAyear memberships sold
in third year+ but only oneAthird recogni!ed as revenue1 - E182+000.
**0E100+000 H E1+0001F& years - E&&+000 per year.
+* 7nder the revenue recognition principle+ revenue is recogni!ed not when cash is
received but rather when revenue is earned. $t is earned with the passage of time
as members use the facilities over their respective threeAyear membership periods.
4ccrualAbasis income statements allow the reader to focus on the longAterm
profitability of the business rather than simply on the amount of cash received in
any given year.
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"O 4-
EXERCISE 4/)4 $EPRECIATIO# EXPE#SE
)* Depreciation expense for 200*.
8ruc? L0E18+000 H E&+0001F#M "F12 - E2+2#0
5omputer L0E##+000 H E#+0001F10M )F12 - E2+#00
Duilding L0E2#0+000 H E10+0001F&0M &F12 - E2+000
+* 5ertainly+ it would be less costly in terms of the time spent by the accountant to
expense all costs rather than treat certain ones as assets to be written off over their
useful lives. <owever+ this is a violation of the matching principle which re'uires
that costs be allocated to the periods during which they provide benefits+ i.e.+ aid
the generation of revenue. Estimates such as those re'uired to depreciate assets
are a normal and necessary part of an accrual accounting system.
"O 4-
EXERCISE 4/+5 ACCR1A" OF I#TEREST O# A "OA#
)* 8o record twoAmonth+ 12K ban? loan on Culy 1.

a* *F1 5ash #0+000 3otes =ayable #0+000
8o accrue oneAmonth interest on ban? loan on Culy &1.

%* *F&1 $nterest =ayable #00 $nterest Expense 0#001
0#0+000 .12 1F121
8o record repayment of principal and interest on ban? loan on 4ugust &1.

c* 8F&1 5ash 0#1+0001 $nterest =ayable 0#001 $nterest Expense 0#001
3otes =ayable 0#0+0001
+* $t would save the time and cost in ma?ing a %ournal entry to s?ip an ad%ustment on
Culy &1 and simply record interest when the loan is repaid on 4ugust &1. <owever+
to do so would violate the matching principle. 6ne of the necessary costs in Culy
was interest+ and it should be matched with the revenues of that period. $f interest
were not accrued at the end of Culy+ the expense for that month would be
understated and the expense for 4ugust would be overstated.
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P R O ! " E MS
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PRO!"EM 4/) A$B1STME#TS
)* 4d%ustments on arch &1+ 200*.
8o accrue interest.

a* &F&1 $nterest =ayable 100 $nterest Expense 01001
01#+000 .08 &0F&)01
8o record supplies used.

%* &F&1 6ffice :upplies :upplies Expense 0))01
on <and 0))01
01+280 G *#0 H 1+&*01
8o record depreciation.

c* &F&1 4ccumulated Depreciation
DepreciationB Expense 08001
6ffice
E'uipment 08001
0)2+)00 H #+0001 1F*2
8o accrue wages.

d* &F&1 Jages =ayable #+*00 Jages Expense 0#+*001
0"#0 )1
8o recogni!e rent earned.

e* &F&1 >ent 5ollected >ent >evenue 2+#00
in 4dvance 02+#001
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/)2
PRO!"EM 4/) CConcludedD
8o record customer deposits earned.

F* &F&1 5ustomer :ervice >evenue 1+200
Deposits 01+2001
0(+800F(1
8o record estimated income taxes.

g* &F&1 $ncome 8ax $ncome 8ax
=ayable &+"00 Expense 0&+"001
+* $ncome before ad%ustments E 2&+000
>ent revenue G 2+#00
:ervice revenue G 1+200
$nterest expense 01001
:upplies expense 0))01
Depreciation expense 08001
Jages expense 0#+*001
$ncome tax expense 0&+"001
4d%usted net income E 1#+#(0
"O -
PRO!"EM 4/+ A##1A" A$B1STME#TS
)* 4d%ustments on December &1+ 200*.
8o record annual depreciation expense.

a* 12F&1 4ccumulated Depreciation
Depreciation 02+"#01 Expense 02+"#01
01#+000 H 2#01F# years
8o record supplies used during the year.

%* 12F&1 :upplies :upplies
on <and 01"+&#01 Expense 01"+&#01
0&+)00 G 1*+)00 H 1+8#01
4/)3 2$3435$4, 4556738$39 :6,78$63: 4374,
PRO!"EM 4/+ CConcludedD
8o record customer deposits earned between 4ugust and December.

c* 12F&1 5ustomer 2ees Earned 20+000
Deposits 020+0001
02(+000F) months1 I # months
8o record rent expense for 3ovember through December.

d* 12F&1 =repaid >ent 0#+(001 >ent Expense 0#+(001
02+*00 I 21
8o accrue interest payable on note.

e* 12F&1 $nterest =ayable &+000 $nterest Expense 0&+0001
0200+000 I .0" I )0F&)01
8o accrue wages payable at yearAend.

F* 12F&1 Jages =ayable #00 Jage Expense 0#001
+* 3et increase 0decrease1 in net income from ad%ustments.
a* Depreciation expense E 02+"#01
%* :upplies expense 01"+&#01
c* 2ees earned 20+000
d* >ent expense 0#+(001
e* $nterest expense 0&+0001
F* Jage expense 0#001
6verstatement of 200* net income E 011+2001
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/)4
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PRO!"EM 4/, REC1RRI#6 TRA#SACTIO#S A#$
A$B1STME#TS
a* 1+ 12+ 1& i* 8+ 1
%* #+ 1 &* 1*+ "
c* *+ 1+ 11 9* 1#+ (
d* &+ 1 l* 1)+ &
e* (+ 8 m* 11+ 1"+ 1
F* 1+ 1( n* 18+ )
g* 1+ 2 o* 20+ 10
:* 2+ 1(
"O -
PRO!"EM 4/4 1SE OF ACCO1#T !A"A#CES AS A
!ASIS FOR A##1A" A$B1STME#TS
8o recogni!e expired insurance.

a* 12F&1 =repaid $nsurance
$nsurance 01+0001 Expense 01+0001
0*+200 #F&)1
8o recogni!e rent earned.

%* 12F&1 >ent 5ollected in >ent >evenue &+#00
4dvance 0&+#001
0)+000 *F121
8o recogni!e interest earned.

c* 12F&1 $nterest $nterest >evenue 1+#00
>eceivable 1+#00
0#0+000 .0" (F121
+* $f ad%ustments were made at the end of each month+ the =repaid $nsurance account
would have been reduced by the monthly expense of E200 0E*+200F&)1 on four
occasions. 4ugust &1+ :eptember &0+ 6ctober &1+ and 3ovember &0. 8hus+ the
balance in the account before the December ad%ustment would be E*+200 H L0(1
0E2001M - E)+(00.
4/+5 2$3435$4, 4556738$39 :6,78$63: 4374,
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PRO!"EM 4/- 1SE OF ACCO1#T !A"A#CES AS A !ASIS
FOR A$B1STME#TS
)* 4d%ustments on 4pril &0+ 200*.
8o recogni!e one month@s insurance expense.

a* =repaid $nsurance 0#01 $nsurance Expense 0#01
8o record supplies used.

%* 6ffice :upplies 0*01 6ffice :upplies
02#0 H 1801 Expense 0*01

c* 4ccumulated Depreciation
DepreciationB Expense 0(1*1
6ffice E'uipA
ment 0(1*1
0#0+000 1F1201

d* 4ccumulated Depreciation
4utomobile 02001
012+000 1F)01
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/+)
PRO!"EM 4/- CConcludedD
8o record commissions earned.

e* 7nearned 5ommissions
5ommissions 0(+#001 Earned (+#00
0"+#00 H #+0001
8o record revenue earned+ not yet collected.

F* 4ccounts 5ommissions
>eceivable 1+#00 Earned 1+#00
8o record interest on note payable.

g* $nterest =ayable 20 $nterest Expense 0201
8o record salaries not yet paid.

:* :alaries =ayable 2+#00 :alaries Expense 02+#001
$nsurance expense E 0#01
6ffice supplies expense 0*01
Depreciation expense 0(1*1
Depreciation expense 02001
5ommissions earned (+#00
5ommissions earned 1+#00
$nterest expense 0201
:alaries expense 02+#001
3et increase in net income E 2+*(&
,* 8he office e'uipment was purchased on 4pril 1+ 200)+ and has been depreciated
for one year before depreciation is recorded for the month of 4pril 200*. 8hus+ if
the e'uipment has a 10Ayear life+ the balance in 4ccumulated Depreciation will be
E#0+000F10 years+ or E#+000.
4/++ 2$3435$4, 4556738$39 :6,78$63: 4374,
"O -
PRO!"EM 4/. RECO#STR1CTIO# OF A$B1STME#TS FROM
ACCO1#T !A"A#CES
)* 8o record insurance expense on Cune &0.

)F&0 =repaid $nsurance 01#01 $nsurance Expense 01#01
0&+)00 H &+(#01
+* 5ost of policy was E1#0 &) months - E#+(00.
,* 8o record depreciation expense on Cune &0.

)F&0 4ccumulated Depreciation
0Depreciation 0801 Expense 0801
01+&)0 H 1+2801
4* Estimated useful life in months. E"+)00FE80 month - 120 months.
-* 8o record interest expense on Cune &0.

)F&0 $nterest =ayable 1(( $nterest Expense 01((1
02+((8 H 2+&0(1
.* $nterest rate. 0E1(( per month 12 months1FE"+)00 - 18K.
8he monthly rate is 18KF12 months - 1.#K.
"O -
PRO!"EM 4/2 1SE OF ACCO1#T !A"A#CES AS A
!ASIS FOR A$B1STME#TS
)* >ecording ad%ustments.
8o record rent expense.

a* =repaid >ent 0)001 >ent Expense 0)001
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/+,
PRO!"EM 4/2 CContinuedD
8o record expense of wornAout videos.

%* Nideo $nventory 02+()01 Nideo Expense 02+()01
8o record depreciation expense on display stands.

Depreciation 01(01 Expense 01(01
8o record unpaid wages and salaries.

d* Jages and Jages and
:alaries :alary
=ayable 1+(#0 Expense 01+(#01
8o record subscription revenue earned.

e* 5ustomer :ubscription
:ubscriptions 02+((01 >evenue 2+((0
8o record accrued income taxes.

F* $ncome 8axes $ncome 8ax
=ayable 8(" Expense 08("1
E(?lanationsE
CaD E*+200F12 months
C%D E2#+)00 H E2&+1(0
CcD 0E8+"00 H E#001F)0 months
4/+4 2$3435$4, 4556738$39 :6,78$63: 4374,
PRO!"EM 4/2 CConcludedD
CFD 5alculation of taxes due.
:ubscription revenue E 2+((0
>ental revenue "+200
Jage and salary expense 0E2+&20 G E1+(#01 0&+**01
7tility expense 01+2(01
4dvertising expense 0)001
>ent expense 0)001
Nideo expense 02+()01
Depreciation expense 01(01
$ncome before tax E 2+8&0
tax rate 0.&0
$ncome tax expense E 8("
+* 6n the basis of the information available+ 2our :tar appears to be a profitable
business. :ubscription revenue and rental revenue together total E11+)(0 for the
month. 3et income for the month is E2+8&0 H E8(" 0taxes1+ or E1+"81. 8his results
in a profit margin of E1+"81FE11+)(0+ or 1*K.
M1 " T I / C O # C E P T P R O ! " E MS
"O +,4
PRO!"EM 4/3 CASH A#$ ACCR1A" I#COME
STATEME#TS FOR A MA#1FACT1RER
)* 5ash revenue. #00+000 components E2 E 1+000+000
,ess. 4mounts not yet received 1#0+000
5ash revenue E 8#0+000
4ccrual revenue. #00+000 components E2 E 1+000+000
+* 7nder the matching principle+ Drysdale should match all expenses to revenues
generated. 8hus+ all expenses should be recogni!ed during the year+ except for the
cost of the truc?. 8he cost of E10+000 should be spread over the estimated useful
life of five years.
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/+-
,* $ncome statement under the accrual basis.
$RAS$A"E COMPA#A
I#COME STATEME#T
FOR THE AEAR E#$E$ XXGXXGXX
:ales revenue E 1+000+000
5ost of goods sold )02+000*
9ross profit E &"8+000
6perating expenses.
:ales and administrative salaries E 100+000
8ruc? depreciation 2+000**
8otal operating expenses E 102+000
3et income E 2")+000
*>ent. E1+000 12 E 12+000
>aw materials (00+000
:alaries and wages 1"0+000
5ost of goods sold E )02+000
**E10+000F# years
"O ,4
PRO!"EM 4/4 REVE#1E A#$ EXPE#SE
RECO6#ITIO#
$ncome statements for Oears 1 and 2.
$AR!A $E"IVERA SERVICE
I#COME STATEME#TS
Aear ) Aear +
:ales revenue CaD E 2&+000 E ()+000
Expenses.
4dvertising C%D E 2+000 E 1+#00
:alaries CcD 1#+000 2(+000
>ent CdD #+000 #+000
8otal expenses E 22+000 E &0+#00
3et income E 1+000 E 1#+#00
4/+. 2$3435$4, 4556738$39 :6,78$63: 4374,
E(?lanationsE
a* ,et P - Oear 1 sales
Oear 1 sales G 20Oear 1 sales1 - E)"+000
&P - E)"+000/
P - E2&+000 - Oear 1 sales
2P - E()+000 - Oear 2 sales
%* 8otal advertising expense E&+#00
,ess promotional portion #00
8otal wee?ly expense E &+000 or E1+#00Fyear
Oear 1 advertising - E#00 G E1+#00 - E2+000
Oear 2 advertising - E1+#00
c* ,et P - one employeeQs annual salary
1st year - P G 0.2#P
2nd year - 2P
P G 0.2#P G 2P - E&"+000
&.2#P - E&"+000/ P - E12+000
1st year - E12+000 G 0.2#0E12+0001 - E1#+000
2nd year - 20E12+0001 - E2(+000
d* :ame rent for two years. E10+000F2 - E#+000
"O -.
PRO!"EM 4/)5 MO#TH"A TRA#SACTIO#S
A$B1STME#TS A#$ FI#A#CIA" STATEME#TS
)* Effects on the accounting e'uation.
8o record issuance of stoc? to owners on Canuary 2.

1F2 5ash )0+000 5apital
0& 20+0001 :toc? )0+000
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/+2
PRO!"EM 4/)5 CContinuedD
8o record purchase of a Nictorian inn on Canuary 2.

1F2 ,and 1#+000
<ouse &#+000
5ash 0#0+0001
8o record issuance of twoAyear+ 12K promissory note on Canuary &.

1F& 5ash &0+000 3otes =ayable &0+000
8o record purchase of furniture for cash on Canuary (.

1F( 2urniture 1#+000
5ash 01#+0001
8o record purchase of 2(Amonth insurance policy on Canuary #.

1F# =repaid
$nsurance )+000
5ash 0)+0001
8o record payment for advertising on Canuary ).

1F) 5ash 0(#01 4dvertising
Expense 0(#01
8o record purchase of cleaning supplies on account on Canuary *.

1F* 5leaning 4ccounts =ayable "#0
:upplies "#0
4/+3 2$3435$4, 4556738$39 :6,78$63: 4374,
8o record payment of wages for first half of month on Canuary 1#.

1F1# 5ash 0(+2&01 Jages Expense 0(+2&01
8o record guestQs prepayment for twoAwee? stay on Canuary 1).

1F1) 5ash "80 >ent >eceived
in 4dvance "80
8o record cash receipts from rentals for Canuary on Canuary &1.

1F&1 5ash 8+&00 >evenue from
>ental of >ooms 8+&00
8o record cash receipts from restaurant for Canuary on Canuary &1.

1F&1 5ash )+)00 >estaurant
>evenue )+)00
8o record payment of dividends for Canuary on Canuary &1.

1F&1 5ash 0)001 Dividends 0)001
0& I 2001
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/+4
+* ,ist of accounts and account balances.
Assets
5ash E 2"+)00
,and 1#+000
<ouse &#+000
2urniture 1#+000
=repaid $nsurance )+000
5leaning :upplies "#0
"ia%ilities
4ccounts =ayable E "#0
3otes =ayable &0+000
>ent >eceived in 4dvance "80
OHners; E<uit=
5apital :toc? E )0+000
4dvertising Expense (#0
Jages Expense (+2&0
>evenue from >ental of >ooms 8+&00
>estaurant >evenue )+)00
Dividends )00
,* 4d%ustments.
8o record depreciation expense on the house.

a* 4ccumulated Depreciation
<ouse 01001
8o record depreciation expense on the furniture.

%* 4ccumulated Depreciation
DepreciationB ExpenseB
2urniture 012#1 2urniture 012#1
8o record interest on the note.

c* $nterest =ayable &00 $nterest Expense 0&001
4/,5 2$3435$4, 4556738$39 :6,78$63: 4374,
8o record expired insurance.

d* =repaid $nsurance 02#01 $nsurance Expense 02#01
8o record earned portion of guest@s deposit.

e* >ent >eceived >evenue from
in 4dvance 0("01 >ental of >ooms ("0
8o record wages earned by employees.

F* Jages =ayable #+120 Jages Expense 0#+1201
8o record use of cleaning supplies.

g* 5leaning :upplies 0*201 :upplies Expense 0*201
8o record utility expense.

:* 7tilities =ayable *(0 7tilities Expense 0*(01
8o record income tax expense.

i* $ncome 8ax $ncome 8ax
=ayable 1+00* Expense 01+00*1
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/,)
E(?lanations For ad&usting entr= amountsE
CaD 0E&#+000 H E#+0001F&00 months - E100Fmonth
C%D E1#+000F120 months - E12#Fmonth
CcD E&0+000 12K 1F12 - E&00Fmonth
CdD E)+000F2( months - E2#0Fmonth
CeD E"80F2 wee?s - E("0Fwee?
CFD E#+120 for second half of month
CgD E"#0 H E2&0 - E*20 used
C:D E*(0 due at end of month
CiD 5alculation of tax expense.
>evenue from rental of rooms E 8+*"0
>estaurant revenue )+)00
Jages expense 0"+&#01
4dvertising expense 0(#01
Depreciation on house 01001
Depreciation on furniture 012#1
$nterest expense 0&001
$nsurance expense 02#01
:upplies expense 0*201
7tilities expense 0*(01
$ncome before tax E &+&##
8ax rate 0.&0
$ncome tax expense E 1+00*
4/,+ 2$3435$4, 4556738$39 :6,78$63: 4374,
4* 2inancial statements.
CaD MOO#"I6HT !AA I##
I#COME STATEME#T
FOR THE MO#TH E#$E$ BA#1ARA ,) +552
>evenues.
2rom rental of rooms E 8+*"0
2rom restaurant )+)00
8otal revenues E1#+&"0
Expenses.
4dvertising E (#0
Jages "+&#0
DepreciationBhouse 100
DepreciationBfurniture 12#
$nterest &00
$nsurance 2#0
:upplies *20
7tilities *(0
$ncome taxes 1+00*
8otal expenses 1&+0(2
3et income E 2+&(8

C%D MOO#"I6HT !AA I##
STATEME#T OF RETAI#E$ EAR#I#6S
Deginning balance+ Canuary 1+ 200* E 0
4dd. 3et income 2+&(8
Deduct. 5ash dividends )00
Ending balance+ Canuary &1+ 200* E 1+*(8
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/,,
PRO!"EM 4/)5 CConcludedD
CcD MOO#"I6HT !AA I##
!A"A#CE SHEET
BA#1ARA ,) +552
Assets
5urrent assets.
5ash E 2"+)00
5leaning supplies 2&0
=repaid insurance #+*#0
8otal current assets E &#+#80
=roperty+ plant+ and e'uipment.
,and E 1#+000
<ouse E &#+000
,ess. 4ccumulated
depreciation 100 &(+"00
2urniture E 1#+000
,ess. 4ccumulated
depreciation 12# 1(+8*#
8otal property+ plant+ and
e'uipment )(+**#
8otal assets E 100+&##
"ia%ilities
5urrent liabilities.
4ccounts payable E "#0
$nterest payable &00
Jages payable #+120
$ncome tax payable 1+00*
>ent received in advance ("0
7tilities payable *(0
8otal current liabilities E 8+)0*
,ongAterm debt.
3otes payable &0+000
8otal liabilities E &8+)0*
Stoc9:olders; E<uit=
5apital stoc? E )0+000
>etained earnings 1+*(8
8otal stoc?holders@ e'uity E )1+*(8
8otal liabilities and stoc?holders@
e'uity E 100+&##
-* 8he inn has shown the ability to ma?e a profit. 8he profit margin is
E2+&(8FE1#+&"0+ or approximately 1#K. 8his is an indication that the inn has
been able to generate revenues and control the necessary costs in the process.
8he balance sheet shows a very strong current position for the inn. 8he current
ratio is E&#+#80FE8+)0*+ or over ( to 1. 8he inn has almost enough cash on
hand at the present time to repay the loan. 6n the basis of the financial
statements alone+ it appears that the ban?er should be comfortable with the
loan made.
4/,4 2$3435$4, 4556738$39 :6,78$63: 4374,
A" T E R # AT E P R O ! " E MS
"O -
PRO!"EM 4/)A A$B1STME#TS
)* 4d%ustments on Cune &0+ 200*.
a* 8o accrue interest. E10+000 (K 1F12.

)F&0 $nterest >eceivable && $nterest >evenue &&
%* 8o record supplies used. E(*# G E#+)00 H E#0*.

)F&0 6ffice :upplies :upplies Expense 0#+#)81
on <and 0#+#)81
c* 8o record depreciation. 0E1*0+000 H E2+0001 1F(8.

DepreciationB Expense 0&+#001
achinery 0&+#001
d* 8o record rent expense. E(+)#0F&.

)F&0 =repaid >ent 01+##01 >ent Expense 01+##01
e* 8o accrue wages. E*+000.

)F&0 Jages =ayable )+000 Jages Expense 0)+0001
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/,-
PRO!"EM 4/)A CConcludedD
F* 8o record estimated income taxes.

)F&0 $ncome 8axes $ncome 8ax
=ayable 2+"00 Expense 02+"001
+* $ncome before ad%ustments E&#+000
$nterest revenue &&
:upplies expense 0#+#)81
Depreciation expense 0&+#001
>ent expense 01+##01
Jages expense 0)+0001
$ncome tax expense 02+"001
4d%usted net income E 1#+#1#
"O -
PRO!"EM 4/+A A##1A" A$B1STME#TS
)* 4d%ustments.
a* 8o record annual depreciation expense. 0E2#+000 H E(+0001F* years.

12F&1 4ccumulated Depreciation
Depreciation 0&+0001 Expense 0&+0001
%* 8o record supplies used during year. E1+200 G E12+"00 H E"00.

12F&1 :upplies :upplies
on <and 01&+2001 Expense 01&+2001
c* 8o record customer deposits earned between Culy and December. 0E8+800F8
months1 ) months.

12F&1 5ustomer 2ees Earned )+)00
Deposits 0)+)001
4/,. 2$3435$4, 4556738$39 :6,78$63: 4374,
PRO!"EM 4/+A CConcludedD
d* 8o record rent expense for :eptember through December. E(+000 (.

12F&1 =repaid >ent 01)+0001 >ent Expense 01)+0001
e* 8o accrue interest payable on note. E&0+000 )K )0F&)0.

12F&1 $nterest =ayable &00 $nterest Expense 0&001
F* 8o accrue wages payable at yearAend. E(+1#0F#.

12F&1 Jages =ayable 8&0 Jage Expense 08&01
a* Depreciation expense E 0&+0001
%* :upplies expense 01&+2001
c* 2ees earned )+)00
d* >ent expense 01)+0001
e* $nterest expense 0&001
F* Jage expense 08&01
6verstatement of 200* net income E 02)+*&01
"O -
PRO!"EM 4/,A REC1RRI#6 TRA#SACTIO#S A#$
A$B1STME#TS
a* 1+ 11+ 12 i* 2+ 1&
%* #+ 1 &* 1*+ )
c* 2+ 1 9* 1"+ "
d* (+ * l* 1(+ (
e* 1+ & m* 1#+ &
F* 1+18
g* 1)+1
:* #+ 1+10
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/,2
"O -
PRO!"EM 4/4A 1SE OF ACCO1#T !A"A#CES AS A
!ASIS FOR A##1A" A$B1STME#TS
a* 8o record supplies used. E#+*"0 H E1+#20.

12F&1 :upplies 0(+2*01 :upplies
Expense 0(+2*01
%* 8o recogni!e revenue earned. E1+800 8F12.

12F&1 7nearned :ervice >evenue 1+200
>evenue 01+2001
c* 8o record interest on note. E)0+000 10K (F12.

12F&1 $nterest $nterest Expense 02+0001
=ayable 2+000
+* $f ad%ustments were made at the end of each month+ the 7nearned >evenue
account would have been reduced by the monthly revenue of E1#0 0E1+800F121 at
the end of each of seven months+ beginning on ay &1 and ending on 3ovember
&0. 8hus+ the balance in the account before the December ad%ustment would be
E1+800 H L0*10E1#01M - E*#0.
4/,3 2$3435$4, 4556738$39 :6,78$63: 4374,
"O -
PRO!"EM 4/-A 1SE OF ACCO1#T !A"A#CES AS A
)* 4d%ustments on Cune &0+ 200*.
a* 8o recogni!e one monthQs rent expense.

)F&0 =repaid >ent 0)001 >ent Expense 0)001
%* 8o record supplies used. E1#+210 H E1+2"0.

)F&0 6ffice :upplies
:upplies 01&+"201 Expense 01&+"201
c* 8o record depreciation. 0E()+120 H E)+1201 1F120.

DepreciationB Expense 0&&&1
E'uipment 0&&&1
d* 8o record interest on note payable.

)F&0 $nterest =ayable #0 $nterest Expense 0#01
e* 8o record salaries not yet paid.

)F&0 :alaries =ayable )20 :alaries Expense 0)201
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/,4
PRO!"EM 4/-A CConcludedD
a* E 0)001
%* 01&+"201
c* 0&&&1
d* 0#01
e* 0)201
3et decrease in net income from ad%ustments E 01#+#2&1
,* 8he office e'uipment was purchased on Cune 1+ 200)+ and has been depreciated
for one year before depreciation is recorded for the month of Cune 200*. 8hus+ if
the e'uipment has a 10Ayear life+ the balance in 4ccumulated Depreciation will be
0E()+120 H E)+120F10 years1+ or E(+000.
"O -
PRO!"EM 4/.A RECO#STR1CTIO# OF A$B1STME#TS
FROM ACCO1#T !A"A#CES
)* 8o record rent expense on Cune &0. E(+000 H E&+000.

)F&0 =repaid >ent 01+0001 >ent Expense 01+0001
+* 4t E1+000 per month+ the original sixAmonth payment and balance of =repaid >ent
on 4pril 1+ 200*+ was E)+000.
,* 8o record depreciation expense on Cune &0. E"00 H E800.

Depreciation 01001 Expense 01001
4* Estimated useful life in months. E"+)00FE100 month - ") months.
-* 8o record interest expense on Cune &0. E8)( H E*)8.

)F&0 $nterest =ayable ") $nterest Expense 0")1
.* $nterest rate. 0E") per month 12 months1FE"+)00 - 12K 0annual rate1. 8he
monthly rate is 12KF12 months - 1K.
4/45 2$3435$4, 4556738$39 :6,78$63: 4374,
"O -
PRO!"EM 4/2A 1SE OF ACCO1#T !A"A#CES AS A
)* 4d%ustments.

a* =repaid >ent 0(001 >ent Expense 0(001

Depreciation 01#01 Expense 01#01

c* 5hemical 5hemical
$nventory 08+1001 Expense 08+1001

d* Jages and Jages and
:alaries :alary
=ayable 1+080 Expense 01+0801

e* $ncome 8axes $ncome 8ax
E(?lanationsE
CaD E(+800F12 months - E(00Fmonth
C%D 0E18+200 H E2001F120 months - E1#0Fmonth
CcD 0E"+(00 H E1+&001 - E8+100
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/4)
PRO!"EM 4/2A CConcludedD
CeD 5alculation of taxes due.
8reatment revenue E (0+)00
Jages and salary expense 02&+#801
7tility expense 01+2(01
4dvertising expense 08)01
>ent expense 0(001
Depreciation expense 01#01
5hemical expense 08+1001
$ncome before tax E )+2*0
8ax rate 0.&0
$ncome tax expense E 1+881
+* 6n the basis of the information available+ ,ewis appears to be a profitable
business. 3et income for the month was E)+2*0 H E1+881 0taxes1+ or E(+&8". Jith
treatment revenue of E(0+)00+ this results in a profit margin of E(+&8"FE(0+)00+ or
approximately 11K.
A" T E R # AT E M1 " T I / C O # C E P T P R O ! " E MS
"O
+,4
PRO!"EM 4/3A CASH A#$ ACCR1A" I#COME
STATEME#TS FOR A MA#1FACT1RER
)* 5ash revenue. #0+000 sandwiches E2 E 100+000
,ess. 4mounts not yet received 2#+000
5ash revenue E *#+000
4ccrual revenue. #0+000 sandwiches E2 E 100+000
+* 4ccountants recogni!e revenue under an accrual accounting system when it is
earned. $n the catering business+ revenue is earned as the sandwiches are
delivered to the vendors. arie@s might consider using the cash method to account
for sales of sandwiches if there is a significant amount of uncertainty about the
collectibility of accounts receivable.
4/4+ 2$3435$4, 4556738$39 :6,78$63: 4374,
PRO!"EM 4/3A CConcludedD
,* $ncome statement under the accrual basis.
MARIE;S CATERI#6
I#COME STATEME#T
FOR THE AEAR E#$E$ XXGXXGXX
:ales revenue E100+000
5ost of goods sold )"+)00*
9ross profit E &0+(00
6perating expenses.
6ffice salaries E 12+000
E'uipment depreciation 1+000**
8ruc? depreciation 2+800***
8otal operating expenses E 1#+800
3et income E 1(+)00
*>ent. E800 12 E "+)00
>aw materials 2#+000
:alaries and wages &#+000
5ost of goods sold E)"+)00
**E10+000F10 years
***E1(+000F# years
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/4,
"O ,4
PRO!"EM 4/4A REVE#1E A#$ EXPE#SE
RECO6#ITIO#
$ncome statements for the first two years.
S1E;S A1$IO !OOI RE#TA"S
I#COME STATEME#TS
Aear ) Aear +
:ales revenue CaD E 21+000 E )&+000
Expenses.
4dvertising C%D E )+000 E (+#00
:alaries 0 12+000
Depreciation CcD 2+#00 2+#00
>ent CdD "+000 "+000
8otal expenses E 1*+#00 E 28+000
3et income E &+#00 E &#+000
E(?lanationsE
a* ,et P - Oear 1 sales.
Oear 1 sales G &0Oear 1 sales1 - E8(+000
(P - E8(+000
P - E21+000 - Oear 1 sales
&P - E)&+000 - Oear 2 sales
%* 8otal advertising expense E10+#00
,ess promotional portion 1+#00
8otal ad expense E "+000 or E(+#00Fyear
Oear 1 advertising - E(+#00 G E1+#00 - E)+000
Oear 2 advertising - E(+#00
c* Depreciation per year - E#+000F2 - E2+#00Fyear
d* >ent per year - E18+000F2 - E"+000Fyear
4/44 2$3435$4, 4556738$39 :6,78$63: 4374,
"O -.
PRO!"EM 4/)5A A$B1STME#TS A#$
FI#A#CIA" STATEME#TS
)* 4d%ustments.

a* =repaid $nsurance Expense 0*#01
$nsurance 0*#01

Jarehouse 01#01 Jarehouse 01#01

8ruc? 2leet 0&+12#1 8ruc? 2leet 0&+12#1

d* $nterest =ayable &*# $nterest Expense 0&*#1

e* 5ustomer 2reight >evenue (+#00
Deposits 0(+#001

F* Jages and Jages and
:alaries :alary

g* $ncome 8axes $ncome 8ax
=ayable "+2&* Expense 0"+2&*1
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/4-
PRO!"EM 4/)5A CContinuedD
E(?lanations For ad&usting entr= amountsE
CaD E18+000F2( months - E*#0Fmonth
C%D 0E(0+000 H E(+0001F2(0 months - E1#0Fmonth
CcD 0E2(0+000 H E1#+0001F*2 months - E&+12#Fmonth
CdD 0E#0+000 "K1 1F12 - E&*#
CgD 5alculation of income tax expense.
2reight revenue E 1*0+1*0
9as and oil expense 0#*+&&01
aintenance expense 02)+(001
Jage and salary expense 0#1+2#01
$nsurance expense 0*#01
Depreciation on warehouse 01#01
Depreciation on truc? fleet 0&+12#1
$nterest expense 0&*#1
$ncome before tax E &0+*"0
8ax rate 0.&0
$ncome tax expense E "+2&*
+* 2inancial statements.
CaD TE#FO1R TR1CII#6 COMPA#A
I#COME STATEME#T
2reight revenue E 1*0+1*0
Expenses.
9as and oil E #*+&&0
aintenance 2)+(00
Jages and salaries #1+2#0
$nsurance *#0
DepreciationBwarehouse 1#0
DepreciationBtruc? fleet &+12#
$nterest &*#
$ncome taxes "+2&* 1(8+)1*
3et income E 21+##&
C%D TE#FO1R TR1CII#6 COMPA#A
STATEME#T OF RETAI#E$ EAR#I#6S
Deginning balance+ Canuary 1+ 200* E(0+(*0
4dd. 3et income 21+##&
E)2+02&
Deduct. 5ash dividends 20+000
Ending balance+ Canuary &1+ 200* E (2+02&
4/4. 2$3435$4, 4556738$39 :6,78$63: 4374,
PRO!"EM 4/)5A CContinuedD
CcD TE#FO1R TR1CII#6 COMPA#A
!A"A#CE SHEET
BA#1ARA ,) +552
Assets
5urrent assets.
5ash E 2*+&(0
4ccounts receivable (1+#00
=repaid insurance 1*+2#0
8otal current assets E 8)+0"0
,and E 20+000
Jarehouse E (0+000
,ess. 4ccumulated
depreciation 21+*#0 18+2#0
8ruc? fleet E 2(0+000
,ess. 4ccumulated
depreciation 11#+)2# 12(+&*#
8otal property+ plant+ and
e'uipment 1)2+)2#
8otal assets E 2(8+*1#
"ia%ilities
4ccounts payable E &2+880
3otes payable #0+000
$nterest payable (+8*#
5ustomer deposits 1+#00
Jages and salaries payable 8+200
$ncome tax payable "+2&*
8otal current liabilities E 10)+)"2
8otal liabilities E 10)+)"2
5apital stoc? E 100+000
>etained earnings (2+02&
8otal stoc?holders@ e'uity 1(2+02&
8otal liabilities and stoc?holders@
e'uity E 2(8+*1#
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/42
PRO!"EM 4/)5A CConcludedD
,* 5urrent ratio - 5urrent assetsF5urrent liabilities
E8)+0"0FE10)+)"2 - 0.81 to 1
8enfour may have difficulties in meeting all of its current obligations. Especially
noteworthy is the significantly higher amount of accounts receivable at yearAend
compared with cash 0cash and accounts receivable constitute &2K and (8K of the
current assets+ respectively1. $t is also worth noting that the other 20K of the
current assets consists of prepaid insurance+ an asset that will not be converted
into cash and thus will not help in any way to pay the current liabilities.
4* 8enfour cannot compute a gross profit ratio because it does not report cost of
sales. $t is a service business rather than a product company. 6ne possible
measure of profitability for any company is the profit margin+ which is net income
divided by sales. 2or 8enfour+ this ratio is E21+##&FE1*0+1*0 or 12.*K. any
service businesses calculate ratios that are specific to their type of business. 2or
example+ a truc?ing firm might compute the ratio of revenues to miles driven.
$ E C I S I O # C AS E S
REA$I#6 A#$ I#TERPRETI#6 FI#A#CIA" STATEME#TS
"O )+,
$ECISIO# CASE 4/) COMPARI#6 TWO COMPA#IES I# THE SAME I#$1STRAE
FI#ISH "I#E A#$ FOOT "OCIER
)* 4ccording to 3ote 1 in its annual report+ 2inish ,ine recogni!es revenue when the
customer receives the merchandise. 2oot ,oc?er indicates in its 3ote 1 that revenue
from stores is recogni!ed when the product is delivered to customers. 8he
companies have essentially the same policy for the recognition of revenue.
+* 6n its 2ebruary 2#+ 200)+ balance sheet+ 2inish ,ine reports 4ccounts receivable+
net of E11+"""+000. 8his comprises only E11+"""+000FE)2*+81)+000+ or 1."K of the
company@s total assets. 8he reason that this percentage is so small is because
customers in a store such as 2inish ,ine usually pay with either cash or a credit
card.
,* $n 2oot ,oc?er@s annual report+ 3ote 8+ titled R6ther 5urrent 4ssetsS includes R3et
receivablesS of E("+000+000 at Canuary 28+ 200) 0the note also reports the R5urrent
portion of 3orthern 9roup note receivableS of E1+000+0001. 8hese receivables
together represent only E#0+000+000FE&+&12+000+000+ or 1.#K of total assets on this
date.
4/43 2$3435$4, 4556738$39 :6,78$63: 4374,
$ECISIO# CASE 4/) CConcludedD
4* 8he two approaches differ in that 2oot ,oc?er chooses to report a single =roperty
and E'uipment account on its balance sheet with 3ote " showing the individual
amounts for the items+ such as furniture+ fixtures+ and e'uipment+ which ma?e up
this asset. 5ompanies have flexibility as to whether they report this information
directly on the balance sheet or instead in one of the notes to the statements.
"O ,
$ECISIO# CASE 4/+ REA$I#6 A#$ I#TERPRETI#6 SEARS
ROE!1CI;S #OTES@REVE#1E RECO6#ITIO#
)* 7nder the accrual basis+ revenue should be recogni!ed when it is earned rather
than when cash is received. 6ver the life of a service contract+ the retailer will incur
costs to repair damaged merchandise. 8he retailer earns revenue over the life of
the service contract.
+* >evenue to be recogni!ed each year.
Aear ) Aear + Aear , Total
:ales revenue E2+&20* E 0 E 0 E 2+&20
:ervice contract revenue )0** )0 )0 180
8otal revenue E 2+&80 E )0 E )0 E 2+#00
*E2+#00 H E180
**E180F& years
Jhen a retailer sells a service contract+ it receives cash and at the same time
incurs a liability to provide service in the future. 8hus+ on its balance sheet+ it will
report a liability account for wor? to be performed under service contractsBa form
of unearned revenue. 8his account tells the reader the amount of revenue to be
recogni!ed in the future under service contracts.
$n this particular example+ the liability account would contain E120 and E)0 at
the end of Oears 1 and 2+ respectively+ to report the amount of unearned revenue.
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/44
MAII#6 FI#A#CIA" $ECISIO#S
"O +,4
$ECISIO# CASE 4/, THE 1SE OF #ET I#COME
A#$ CASH F"OW TO EVA"1ATE A COMPA#A
)* $1IE I#C*
STATEME#T OF CASH F"OWS
FOR THE AEAR E#$E$ $ECEM!ER ,) +552
O?erating Acti'itiesE
5ash received from services
provided to clients E 1+020+000*
5ash paid for.
:alaries and wages E ((0+000**
:upplies 100+000
7tilities &0+000
>ent 180+000*** *#0+000
3et increase in cash E 2*0+000
*E1+2#0+000 H E2&0+000
**E(80+000 H E(0+000
***E10+000 18 months
#ote to InstructorE Oou may want to point out to students that the net increase in cash
is also the net cash provided by operating activities for the year. 8hat is+ there are no
investing or financing activities because the ac'uisition of the computer system by the
signing of a promissory note did not result in any net change in cash+ if it is assumed
that the note was signed directly with the computer vendor. 8he transaction would not
appear directly on a statement of cash flows but instead on a supplementary schedule.
+* 6ne important 'uestion to be as?ed is whether it is possible for the company to
continue to generate service revenues in succeeding years at the level attained in
its first year. 8he ability to collect the revenues billed in 200*+ but not yet collected
0E2&0+0001+ should also be a concern. 6n the basis of the cash flows generated in
the first year+ the business appears to be worth strong consideration. 6ne ma%or
concern+ however+ is whether the company will be able to repay the note in 2010. $t
must generate sufficient cash flows over the next three years 0this includes the year
%ust concluded1 to repay E1+*2#+000 in principal and E(1(+000 0E1&8+000 per year
& years1 in interest. 8his may be very difficult to do unless more cash flow is
generated from operations or the company is able to negotiate an extension of the
due date for the loan.
4/-5 2$3435$4, 4556738$39 :6,78$63: 4374,
"O 4
$ECISIO# CASE 4/4 $EPRECIATIO#
8he decision to purchase or lease longAterm assets is a difficult one for all businesses
and re'uires an analysis of all the relevant facts. >apidly changing technology may
ma?e it less ris?y to lease computer e'uipment than to purchase it. 8his is certainly a
?ey consideration in this particular case. Cenner also needs to consider maintenance
costs. 8he case does not indicate whether Cenner would be responsible for
maintenance if it leases the e'uipment. 4nother relevant factor would be whether the
e'uipment would have any salvage value at the end of its useful life.
#ote to InstructorE 8his may be an opportune time to raise the issue whether certain
leases should be capitali!ed as assets. 9iven the students@ understanding of the nature
of an asset+ do they thin? some longAterm leases possess the characteristics to 'ualify
for treatment as assetsT
Depreciation is the process of allocating the cost of a longAterm tangible asset over its
useful life. Decause of rapidly changing technology+ computer e'uipment presents a
challenge to the accountant in determining economic life. Even though the e'uipment
may last for 10 to 20 years before it physically wears out+ its economic life may be
much shorter than that because of technological obsolescence. $n this particular case+
a life of three to five years+ possibly four years+ seems to be warranted.
ETHICA" $ECISIO# MAII#6
"O +,4-
$ECISIO# CASE 4/- REVE#1E RECO6#ITIO# A#$
THE MATCHI#6 PRI#CIP"E
)* $f sales are recorded but the commissions associated with these sales are not
recorded during the month of Cune+ net income will be larger by the understatement
of commissions expense. 8he failure to record advertising expense for the month of
Cune will also result in an understatement of expense and an overstatement or
increase in net income. 2inally+ an increase in the estimated useful life of the
automobiles will result in a decrease in the amount of depreciation expense and
thus an increase in net income.
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/-)
$ECISIO# CASE 4/- CConcludedD
+* 8he first suggestion+ to delay recording the (K commission expense until Culy+ is a
clear violation of the matching principle. >egardless of when the sales staff is paid
commissions+ it is wrong to record the revenues in Cune but not record the expense
associated with earning that revenueBi.e.+ commissionsBuntil Culy. ,i?ewise+
deferring the recognition of the advertising bill as an expense until Culy also
violates the matching principle. 7nder the matching principle+ this cost should be
recogni!ed as an expense in the period in which it provides benefits 0in this case+
the month of Cune1+ regardless of when cash is paid. 2inally+ the change in
estimated useful life for the automobiles is also 'uestionable from an accounting
point of view. 5ompanies are allowed under generally accepted accounting
principles to change estimated useful lives of depreciable assets+ but the changes
must be %ustified on sound economic grounds. 2or example+ changes in technology
might prompt a company to decrease the estimated useful lives of its computers.
8he need to increase the net income for the year is certainly not an acceptable
reason under 944= to change the estimated useful lives of depreciable assets.
8he changes suggested result in financial statements that do not faithfully
represent what they claim to represent and are not merely minor boo??eeping
changes. >eaders assume that the statements are prepared on an accrual basis
rather than a cash basis. 4lso+ they assume that the company is consistent in the
way it depreciates assets from one period to the next.
,* Each of the three suggestions involves a 'uestion of ethics. 4ll three involve an
attempt to consciously overstate income for the purpose of obtaining a loan+ and
the decisions made by the owners provide information that is biased toward ma?ing
the company loo? better. 8here is an attempt on the part of the viceApresident of
sales to deceive a user of the accounting information. 8he ban?er relies on the
trustworthiness of the company to accurately report its income+ and each of the
three suggestions would violate that trust. 8he company would not be acting in
good faith if it were to report income as has been suggested. 8he viceApresident
has suggested changes that are intended to overstate net income for the purpose
of receiving the loan.
4* 8he controller may benefit in the shortAterm by ma?ing the proposed changes 0he
gets to ?eep his %ob and his 5adillac1. Dut in the longAterm his professional
reputation will be harmed when the ban? reali!es that he misstated income to
mislead the ban? and receive the loan. $f the ban? approves the loan based on
overstated net income+ the ban? will be harmed. 8he interest rate of the loan will
not properly reflect the ris? of the company. 4ny outsiders who rely on the financial
statements will be harmed. Jhen net income is overstated+ future cash flows are
also overstated and outsiders who rely upon the incorrect financial statements may
ma?e the wrong decisions about the company 0e.g.+ extend credit when they should
not1.
4/-+ 2$3435$4, 4556738$39 :6,78$63: 4374,
"O 4
$ECISIO# CASE 4/. A$VICE TO A POTE#TIA" I#VESTOR
8he financial statements contain two ma%or errors that prevent them from being in
accordance with generally accepted accounting principles. 2irst+ if the normal balance
of supplies on hand is E1+000+ 5entury should recogni!e supplies expense on its
income statement for E1)+#00 0the amount of supplies on its balance sheet1 less
E1+000+ or E1#+#00. :econd+ it should also recogni!e depreciation expense of E&#+000
over seven years+ or E#+000+ on the e'uipment. 8hese two ad%ustments would result in
revised net income as follows.

3et income reported E 10+#00
:upplies expense 01#+#001
Depreciation expense 0#+0001
>evised net income 0loss1 E 010+0001
8he company was able to generate significant revenues from its services during the
first year. 9iven this level of revenues+ however+ it was not able to control its costs+
particularly its salaries and wages. 6n the basis of these financial statements alone+ it
would be difficult to advise anyone to invest in the company. $n addition to the
information given+ the investor would want to ?now more about the nature of the
companyQs business 0its mar?ets+ customers+ pricing structure+ etc.1 and the industry in
which it operates.
REA" WOR"$ PRACTICE 4*)
2oot ,oc?er reports in 3ote 8 R=repaid expenses and other current assetsS of
E(*+000+000 and E()+000+000 at the end of 200( and 200#+ respectively. 8he types of
prepaid expenses a company such as this might have include various prepayments+
such as insurance and rent+ and various types of supplies+ such as cleaning and office
supplies.
REA" WOR"$ PRACTICE 4*+
4ccording to 3ote 11 R4ccrued ,iabilitiesS in 2oot ,oc?er@s report+ the largest item at
the end of 200( was R6ther operating costsS and the amount was E##+000+000. 4t the
end of 200#+ the largest item was R=ension and postretirement benefitsS of
E*2+000+000. 8he account R4ccrued and other liabilitiesS appears as a current liability
on the balance sheet. 8he total amounts for accrued liabilities in the note are
E28#+000+000 and E&0#+000+000 at the end of 200( and 200#+ respectively. 8hese
same amounts appear on the balance sheets at the end of the two years.
5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/-,
SO"1TIO# TO I#TE6RATIVE PRO!"EM
Part )
)* Effects on the accounting e'uation are as follows.

a* :alary and :alary and
Jages =ayable (+000 Jages Expense 0(+0001

%* edical :upplies
:upplies 0)(+&(*1 Expense 0)(+&(*1

4utomobiles 0&0+0001 4utomobiles 0&0+0001

d* 4ccumulated Depreciation
Duilding 010+0001 Duilding 010+0001

e* Extended Extended Jarranty
Jarranty 0&+0001 Expense 0&+0001

F* Dillings >eceivable+ edical :ervices
3et 1)+000 >evenue 1)+000

g* $nterest =ayable &+000 $nterest
Expense &+000
4/-4 2$3435$4, 4556738$39 :6,78$63: 4374,
I#TE6RATIVE PRO!"EM CContinuedD
+* MO1#TAI# HOME HEA"TH I#C*
I#COME STATEME#T
FOR THE AEAR E#$E$ $ECEM!ER ,) +55.
>evenues.
edical services revenue E #))+000
Expenses.
:alary and wages expense E2"2+000
:upplies expense )(+&(*
9asoline expense 1&*+#00
7tilities expense 12+000
$nterest expense &+000
Depreciation expenseBautomobiles &0+000
Depreciation expenseBbuilding 10+000
Extended warranty contract expense &+000
##1+8(*
3et income E 1(+1#&
MO1#TAI# HOME HEA"TH I#C*
RETAI#E$ EAR#I#6S STATEME#T
FOR THE AEAR E#$E$ $ECEM!ER ,) +55.
Deginning balance E ""+"00
4dd. 3et income 1(+1#&
Deduct. Dividends 010+0001
Ending balance E 10(+0#&

5<4=8E> ( $356E E4:7>EE38 43D 455>74, 4556738$39
4/--
I#TE6RATIVE PRO!"EM CContinuedD
,* MO1#TAI# HOME HEA"TH I#C*
!A"A#CE SHEET
AS OF $ECEM!ER ,) +55.
Assets
5urrent assets.
5ash E **+(00
Dillings receivable+ net 1)*+000
edical supplies 8+)#&
8otal current assets E 2#&+0#&
Duilding E 200+000
,ess. 4ccumulated depreciation 0)0+0001 1(0+000
8otal assets E &"&+0#&
"ia%ilities and Stoc9:olders; E<uit=
4ccounts payable E 22+000
$nterest payable &+000
:alary and wages payable (+000
Dividend payable 10+000
8otal current liabilities E &"+000
,ongAterm liabilities.
ortgage payable 100+000
8otal liabilities E 1&"+000
5apital stoc? E 100+000
4dditional paidAin capital #0+000
>etained earnings 10(+0#&
8otal stoc?holders@ e'uity 2#(+0#&
8otal liabilities and stoc?holders@ e'uity E &"&+0#&
4* a* Jor?ing capital. E2#&+0#& H E&"+000 - E21(+0#&
%* 5urrent ratio. E2#&+0#&FE&"+000 - ).# to 1
-* Dy their nature+ all ad%ustments cause a difference between the amount of income
recogni!ed on an accrual basis and that recogni!ed on a cash basis. 8he
ad%ustment for wages and salaries+ and interest+ result in decreases in income in
the current period with a delay in the outflow of cash until a later period. :imilarly+
the ad%ustment for service revenue represents revenue earned currently but
delayed until a later period in the receipt of cash. 5onversely+ the ad%ustments for
depreciation+ warranties+ and supplies used represent the recognition of expense in
the current period for cash outlays in an earlier period.
4/-. 2$3435$4, 4556738$39 :6,78$63: 4374,
I#TE6RATIVE PRO!"EM CConcludedD
.* :upply of cash needed.
:alaries. E800 per day * days per wee? * wee?s - E &"+200
:upplies. E1+#00 per wee? * wee?s - 10+#00
9asoline. E&*# per day * days per wee? * wee?s - 18+&*#
:upply of cash needed for * wee?s - E )8+0*#

Porter SM Ch. 04 - 2pp

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CHAPTER 4

Income Measurement and

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