4.
31 800 800
+ – = $800
Dec. 31 920 920
(÷6) ×1=
Supplies Expense
To record supplies used during the year
Insurance ExpenseDec.
$700
Prepaid Insurance
Supplies
a
$1,040
Chapter 3, SE 2.
$460
Chapter 3, SE 1.
Chapter 3, SE 3.
CHAPTER 3—Solutions
MEASURING BUSINESS INCOME
To record insurance expired during the year
101
31 760 760
To record service revenue earned during
August on which advance deposits had
been received
$1,300
$450
200
175
100
25 950
$ 350
$4,300
350
$4,650
175
$4,475
Shimura Company
Statement of Retained Earnings
For the Month Ended December 31, 2011
Less dividends
Retained earnings, December 31, 2011
Unearned Service Revenue
Retained earnings, November 30, 2011
Net income
Subtotal
Net income
Total expenses
Rent expense
Chapter 3, SE 6.
Service Revenue
Shimura Company
Income Statement
Aug.
Chapter 3, SE 7.
Service revenue
For the Month Ended December 31, 2011
Revenue
Expenses
Income taxes expense
Utilities expense
Telephone expense
Wages expense
102
Dec. 31 1,300 1,300
950 450
200
175
100
25
350 350
175 175
Dividends
To close the Dividends account
Retained Earnings
Retained Earnings
To close the Income Summary account
To close the expense accounts
Income Summary
Income Summary
To close the revenue account
Wages Expense
Rent Expense
Telephone Expense
Income Summary
Income Taxes Expense
Utilities Expense
Service Revenue
Chapter 3, SE 8.
Closing entries prepared
103
For the Month Ended October 31, 2011
Cloud Company
Income Statement
Chapter 3, SE 9.
Chapter 3, SE 10.
Chapter 3, SE 11.
2.
3.
4.
1.
2.
3.
3. 6.
in relation to its net income.
of liquidity. It tells how much cash is generated by the company's operations
c
e
the Supplies T account. The amount expended in cash to purchase supplies
Chapter 3, E 1.
4.
1. 17,150 17,150
2. 4,300 4,300
Chapter 3, E 5.
Chapter 3, E 4.
2011
Prepaid Insurance
Prepaid Insurance
1. bcd
$ 217 $196 $ 822
1,191 174 1,928
2. 31 194 194
1. 31 28,000 28,000
2. June 3 42,000
28,000 70,000
$264
52
To accrue salaries owed but not paid at
month end $14,000 per day
Salaries Payable
Chapter 3, E 7.
a
Salaries Payable
Supplies on hand at July 1
Supplies purchased during
the month
July Supplies Expense
$20,000
31 64,500 64,500
31 64,500 64,500
1. Royalty expense and royalty income calculated
2. Adjusting entries recorded
To record royalties owed for the last half of
Royalty Expense
Royalty Payable
Dec.
2011
Dec.
Chapter 3, E 9.
In Bit Comp, Inc.'s records:
In Regina Company's records:
2011 Royalty Receivable
January to June 2011 (payment on November 1)
2011, to be paid on May 1, 2011
Royalty Income
To record royalties earned for the last half
of 2011, to be received on May 1, 2011
110
$14,620
$5,680
2,920
1,200
800
720
580
380
320 12,600
$ 2,020
$11,034
2,020
$13,054
2,000
$11,054
Retained earnings, August 31, 2011
Net income
Income taxes expense
Total expenses
Less dividends
For the Month Ended August 31, 2011
Retained earnings, July 31, 2011
Spark Cleaning Company, Inc.
Statement of Retained Earnings
Subtotal
Janitorial revenue
Wages expense
Rent expense
Chapter 3, E 10.
For the Month Ended August 31, 2011
Spark Cleaning Company, Inc.
Income Statement
Expenses
Net income
Depreciation expense—cleaning equipment
Depreciation expense—truck
Revenue
Gas, oil, and other truck expenses
Insurance expense
Supplies expense
111
$ 4,590
2,592
Accounts receivable
Cash
Chapter 3, E 10. (Continued)
Spark Cleaning Company, Inc.
Assets
Balance Sheet
August 31, 2011
Chapter 3, E 11.
1. 428 428
2. 1,065 1,065
3. 900 900
4. 425 425
5. 375 375
6. 400 400
To record service revenue earned but not billed
Chapter 3, E 12.
Office Supplies
To record supplies consumed during the year
Service Revenue
Beginning balance
$168
114
1 42,000 42,000
2.
31 31,700 31,700
31 23,275 13,500
3,000
2,650
2,525
1,600
31 8,425 8,425
31 7,000 7,000
Dec. Consulting Fees Earned
Office Salaries Expense
Income Summary
Retained Earnings
To close the expense accounts
Advertising Expense
To close the Dividends account
Income Summary
Retained Earnings
Dividends
To close the Income Summary account
Income Summary
Rent Expense
Income Taxes Expense
Cash
been earned. Unearned Legal Fees is a liability of $31,500 on the balance sheet.
Chapter 3, E 14.
Closing entries recorded
Telephone Expense
To close the revenue account
Chapter 3, E 13.
Entries recorded1.
Oct.
115
$52,000
44,000
Retained earnings, December 31, 2010
Statement of retained earnings prepared
Chapter 3, E 15.
Statement of Retained Earnings
For the Year Ended December 31, 2011
Cindy's Beauty Salon, Inc.
Net income
1. $152,700
2. $26,400
3. $229,000
$4,300
$ 3,000
$257,000
242,000
$ 15,000
2010
times1.3
Salaries Expense
Potential cash paid for salaries
$ 2,700
Beginning balance
Ending balance
Beginning balance
Chapter 3, E 17.
117
Income Adjustment
Amount of
(+ or –)Statement Account
a. June 30 26,000 26,000
b. 30 22,440 22,440
( ÷ 5 3 days
=
c.
d. 30 8,824 8,824
+ – = $8,824
e. 30 6,514 6,514
[( ÷
×6
1. Adjusting entries recorded
Interest Expense
$37,400
Interest Payable
To record accrued interest on mortgage
Chapter 3, P 2.
Insurance Expense
$8,230
months ]
$5,800
To record expired insurance
Prepaid Insurance
$3,230 $2,636
12 months )2,900
$3,240
To record supplies used
Salaries Payable
Salaries Expense
To record accrued salaries
days )
Supplies
No entry
Supplies Expense
$22,440 ×
2. User Insight: Revenue recognition discussed
In transaction c, no revenue is recognized because even though a contract has
Chapter 3, P 2. (Continued)
been signed, no services have yet been provided or earned. In transaction h, the
Bal. 9,250 Bal. 1,331 (a) 1,181
(g) 1,550 Bal. 150
Bal. 5,675
Bal. 660 (b) 305 Bal. 4,620
Bal. 355 (c) 263
Bal. 1,033
Bal. 2,970 Bal. 5,500 (f) 902 Bal. 1,485
Bal. 583
Accounts Payable
Accumulated Depreciation—
Income Taxes Payable
Notes Payable
770
Prepaid Rent Office Equipment Office Equipment
Bal. 4,125
2. Adjusting entries posted to the accounts
Bal.
Chapter 3, P 3.
Cash Accounts Receivable Office Supplies
Unearned Service Revenue
Interest Payable Salaries Payable
$ 9,250
5,675
150
355
4,620 $ 1,033
2,970
5,500
583
285
165
Adjusted Trial Balance
Office Supplies
Chapter 3, P 3. (Continued)
3. Adjusted trial balance prepared
Prepaid Rent
December 31, 2011
Financial Service, Inc.
Accounts Receivable
Accumulated Depreciation—Office Equipment
Accounts Payable
Cash
Interest Payable
Unearned Service Revenue
Notes Payable
Office Equipment
Salaries Payable
a.
b.
c.
d.
Balance sheet, income statement, statement of retained earnings
Balance sheet, income statement, statement of retained earnings
Balance sheet, income statement, statement of retained earnings
Balance sheet, income statement, statement of retained earnings
Chapter 3, P 3. (Continued)
4. User Insight: The following financial statements are affected by the adjustments:
Bal. 480 (b) 280
Bal. 200
Bal. 1,560 (a) 1,110 Bal. 14,200 Bal. 1,540
Bal. 450 Bal. 3,130
(e) 438 Bal. 438 (f) 4,860
(d) 42 Bal. —
2. Adjusting entries posted to the accounts
Unearned Tax Fees Revenue
Bal.
Accounts Payable
2,198
Office Supplies
7,400
Office Equipment
Chapter 3, P 4.
Cash Accounts Receivable Prepaid Insurance
Bal.
1,270 Income Taxes Payable
Bal.
1,590(c)
Office Equipment Accumulated Depreciation—
$ 7,400
2,198
200
450
14,200 $ 3,130
1,312
4,860
7,000
6,878
12,000 44,290
16,600
1,300
4,800
482
280
1,110
1,590
4,860
$67,470 $67,470
Note: Unearned Tax Fees Revenue does not appear on the adjusted trial balance
because it now has a zero balance.
Office Supplies Expense
Depreciation Expense—Office Equipment
Income Taxes Expense
Rent Expense
Accumulated Depreciation—Office Equipment
Cash
Income Taxes Payable
Common Stock
Telephone Expense
Tax Fees Revenue
Insurance Expense
3. Adjusted trial balance, income statement, statement of retained earnings,
Prepaid Insurance
and balance sheet prepared
Chapter 3, P 4. (Continued)
Office Supplies
December 31, 2011
Kazai Tax Service, Inc.
Accounts Receivable
Adjusted Trial Balance
Advertising Expense
Retained Earnings
Dividends
Office Equipment
Office Salaries Expense
Accounts Payable
125
$44,290
$16,600
4,860
Revenue
Expenses
Tax fees revenue
Office salaries expense
Income taxes expense
Kazai Tax Service, Inc.
Chapter 3, P 4. (Continued)
Income Statement
For the Year Ended December 31, 2011
Chapter 3, P 4. (Continued)
4. User Insight: The effect of adjusting entries discussed
By definition, adjusting entries cannot include a debit or a credit to Cash. Because
adjusting entries never involve the Cash account, they never affect cash flows. That
Page 14
Post.
Ref. Debit Credit
2011
a. June 30 514 6,000
117 6,000
b. 30 515 900
118 900
c. 30 518 5,472
119 5,472
d. 30 516 4,647
141 4,647
advance
To record spare parts used during
1. Adjusting entries recorded in the general journal
Date
during the year
Spare Parts Expense
Spare Parts
during the year
Insurance Expense
Prepaid Maintenance
Maintenance Expense
Prepaid Insurance
General Journal
To record insurance that expired
Description
Prepaid Rent
Rent Expense
To expense one year's rent paid in
To record amount of deposit used
Chapter 3, P 5.
Ref. Debit Credit Debit Credit
30 4,906
Ref. Debit Credit Debit Credit
30 7,114
Ref. Debit Credit Debit Credit
30 6,000
30 J14 6,000 —
Ref. Debit Credit Debit Credit
30 2,450
30 J14 900 1,550
Ref. Debit Credit Debit Credit
30 6,000
30 J14 5,472 528
3. Adjusting entries posted from the general journal
Account No. 118
Adjustment
June Balance
2011
Balance
Post.
Adjustment
Date Item
Post.
2011
June Balance
Balance
Date Item
Prepaid Maintenance
Prepaid Insurance
Account No. 119
BalanceJune
Date Post.
Balance
Chapter 3, P 5. (Continued)
Cash
2011
Account No. 111
Post.
2011
June
Balance
Item
Account No. 112
Balance
June
2011
Balance
Account No. 117
Balance
Post.
Accounts Receivable
Date
Item
Prepaid Rent
Item
Adjustment
Date
129
Ref. Debit Credit Debit Credit
30 5,655
30 J14 4,647 1,008
Ref. Debit Credit Debit Credit
30 110,000
Ref. Debit Credit Debit Credit
30 17,500
30 J14 13,750 31,250
Ref. Debit Credit Debit Credit
30 22,500
Ref. Debit Credit Debit Credit
30 15,000
30 J14 6,092 8,908
Ref. Debit Credit Debit Credit
30 J14 5,650 5,650
Balance
2011
June Balance
2011
June Balance
Date Item Post.
Post.
Date Item
Accumulated Depreciation—Limousines
Limousines Account No. 142
Date
Adjustment
2011 Item Balance
Item
Adjustment
Balance
Post.
June
Interest Payable
Date
Unearned Passenger Service Revenue Account No. 212
Balance
Balance
Spare Parts Account No. 141
2011
Post.
Date Item
Account No. 143
Chapter 3, P 5. (Continued)
June Balance
Notes Payable Account No. 211
Balance
Post.
ItemDate
June Balance
2011
2011
Adjustment
Account No. 213
June
Post.
Adjustment
Balance
130
Ref. Debit Credit Debit Credit
Income Taxes Payable Account No. 214
Date Item Balance
Chapter 3, P 5. (Continued)
Post.
2011
Chapter 3, P 5. (Continued)
Chapter 3, P 5. (Continued)
$ 4,906
7,114
1,550
528
1,008
110,000
$ 31,250
22,500
8,908
5,650
6,625
20,000
24,106
10,000 220,341
44,650
103,180
13,400
6,000
900
4,647
13,750
5,472
5,650
6,625
$339,380 $339,380
Gas and Oil Expense
Common Stock
Retained Earnings
Interest Payable
Maintenance Expense
Cash
Adjusted Trial Balance
Prepaid Maintenance
June 30, 2011
Elite Livery, Inc.
Interest Expense
and balance sheet prepared
Notes Payable
4. Adjusted trial balance, income statement, statement of retained earnings,
Chapter 3, P 5. (Continued)
Note: Prepaid Rent does not appear on the adjusted trial balance because it now has
Accounts Receivable
Income Taxes Payable
Advertising Expense
Salaries Expense
Limousines
Accumulated Depreciation—Limousines
Passenger Service Revenue
Insurance Expense
Spare Parts Expense
Depreciation Expense—Limousines
Income Taxes Expense
Unearned Passenger Service Revenue
Prepaid Insurance
a zero balance.
Spare Parts
Dividends
Rent Expense
134
$220,341
$103,180
44,650
Chapter 3, P 5. (Continued)
Elite Livery, Inc.
Income Statement
For the Year Ended June 30, 2011
Revenue
Expenses
Salaries expense
Passenger service revenue
Gas and oil expense
5. User Insight: The effect of adjustments discussed
Chapter 3, P 5. (Continued)
Adjusting entries affect net income on the income statement, and therefore they
to decrease.
affect the cash flow yield. After the adjustments have been posted in the previous
parts of the problem, the cash flow yield for the year has increased because the
additional expenses recorded exceed the additional revenues, causing net income
136
Amount of
Adjustment
(+ or –)
a. 30 5,171 5,171
+–
=
b. 30 6,874 6,874
[ ( ÷ 12
×5
[ ( ÷ 36
×2
c. 30 16,000
40,000 16,000
40,000
Chapter 3, P 7.
1. Adjusting entries recorded
Nov.
Depreciation Expense—Buildings
Depreciation Expense—Equipment
months )
Supplies Expense
Supplies
To record supplies used
Prepaid Insurance
$1,397$2,350 $4,218
$5,171
Insurance Expense
To record expired insurance
months ]
$7,272
$4,200
$4,720
1,750
404
$6,874
To record annual depreciation
Accumulated Depreciation—Equipment
Accumulated Depreciation—Buildings
months )
months ]
2. User Insight: Revenue recognition discussed
In transaction e, $7,000 has to be recognized as revenue because services have
Chapter 3, P 7. (Continued)
already been provided and there is an obligation to pay for them. In transaction h,
Bal. 13,786 Bal. 991 (a) 894
(g) 915 Bal. 97
Bal. 25,755
Bal. 1,400 (b) 500 Bal. 7,300
Bal. 900 (c) 720
Bal. 3,320
Bal. 1,820 Bal. 10,000 (d) 600
Accounts Payable
Office Equipment
2. Adjusting entries posted to the accounts
Accumulated Depreciation—
Chapter 3, P 8.
Cash Accounts Receivable Office Supplies
Prepaid Rent Bal.
Unearned Service RevenueSalaries Payable
Interest Payable
Income Taxes Payable
2,600
Notes Payable
24,840
Office Equipment
Bal.
$ 13,786
25,755
97
900
7,300 $ 3,320
1,820
10,000
600
230
1,410
Notes Payable
Office Equipment
Interest Payable
Unearned Service Revenue
Salaries Payable
Accumulated Depreciation—Office Equipment
Accounts Payable
Cash
Chapter 3, P 8. (Continued)
3. Adjusted trial balance prepared
Prepaid Rent
December 31, 2011
Sigma Consultants Corporation
Accounts Receivable
Adjusted Trial Balance
Office Supplies
a.
b.
c.
d.
Chapter 3, P 8. (Continued)
4. User Insight: The following financial statements are affected by the adjustments:
Balance sheet, income statement, statement of retained earnings
Balance sheet, income statement, statement of retained earnings
Balance sheet, income statement, statement of retained earnings
Balance sheet, income statement, statement of retained earnings
Bal. 195 (b) 130
Bal. 65
Bal. 610 (a) 430 Bal. 6,800 Bal. 670
Bal. 180 Bal. 1,320
(e) 315 Bal. 315 (f) 2,385
(d) 45 Bal. —
650(c)
970
Office EquipmentOffice Supplies Office Equipment
Income Taxes Payable
Bal. Bal.3,650
Chapter 3, P 9.
Cash Accounts Receivable Prepaid Insurance
2. Adjusting entries posted to the accounts
Travel Fees RevenueAccounts Payable
Accumulated Depreciation—
590
Unearned
Bal
.
$ 3,650
970
65
180
6,800 $ 1,320
635
2,385
3,300
3,117
4,200 20,394
8,300
585
2,350
456
130
430
650
2,385
$31,151 $31,151
Advertising Expense
Retained Earnings
Dividends
Office Equipment
Office Salaries Expense
Accounts Payable
Chapter 3, P 9. (Continued)
Office Supplies
December 31, 2011
Angel Travel, Inc.
Accounts Receivable
Adjusted Trial Balance
3. Adjusted trial balance, income statement, statement of retained earnings,
Prepaid Insurance
and balance sheet prepared
Common Stock
Telephone Expense
Travel Fees Revenue
Insurance Expense
Note: Unearned Travel Fees Revenue does not appear on the adjusted trial balance
because it now has a zero balance.
Office Supplies Expense
Depreciation Expense—Office Equipment
Income Taxes Expense
Rent Expense
Accumulated Depreciation—Office Equipment
Cash
Income Taxes Payable
144
$20,394
$8,300
2,385
Chapter 3, P 9. (Continued)
Angel Travel, Inc.
Income Statement
For the Year Ended December 31, 2011
Income taxes expense
Expenses
Office salaries expense
Revenue
Travel fees revenue
4. User Insight: The effect of adjusting entries discussed
By definition, adjusting entries cannot include a debit or a credit to Cash. Because
adjusting entries never involve the Cash account, they never affect cash flows.
Chapter 3, P 9. (Continued)
Page 14
Post.
Ref. Debit Credit
2011
a. June 30 514 11,000
117 11,000
b. 30 515 1,400
118 1,400
c. 30 518 9,879
119 9,879
d. 30 516 12,520
141 12,520
1. Adjusting entries recorded in the general journal
Spare Parts Expense
during the year
To record insurance that expired
General Journal
Prepaid Insurance
during the year
To record amount of deposit used
Date
Maintenance Expense
Spare Parts
Prepaid Maintenance
Description
Insurance Expense
Chapter 3, P 10.
Prepaid Rent
Rent Expense
To expense one year's rent paid in
advance
Ref. Debit Credit Debit Credit
30 8,120
Ref. Debit Credit Debit Credit
30 13,270
Ref. Debit Credit Debit Credit
30 11,000
30 J14 11,000 —
Ref. Debit Credit Debit Credit
30 3,700
30 J14 1,400 2,300
Ref. Debit Credit Debit Credit
30 11,000
30 J14 9,879 1,121
3. Adjusting entries posted from the general journal
Date
Adjustment
Balance
Date
June
Prepaid Rent
Accounts Receivable
ItemDate
Post.
Balance
BalanceJune
2011
Balance
Account No. 117
Balance
Item
Account No. 112
Balance
Post.
Post.
2011
June
Chapter 3, P 10. (Continued)
Cash
2011
Account No. 111
Post.
Item
Account No. 119
Item
Date Item
Prepaid Maintenance Balance
Date
2011
June Balance
Adjustment
Account No. 118
June Balance
2011
Adjustment
Balance
Post.
Prepaid Insurance
148
Ref. Debit Credit Debit Credit
30 15,100
30 J14 12,520 2,580
Ref. Debit Credit Debit Credit
30 190,000
Ref. Debit Credit Debit Credit
30 25,000
30 J14 23,750 48,750
Ref. Debit Credit Debit Credit
30 48,000
Ref. Debit Credit Debit Credit
30 29,500
30 J14 15,965 13,535
Ref. Debit Credit Debit Credit
30 J14 11,800 11,800
Spare Parts Account No. 141
Balance
Date Balance
Post.
June Balance
2011
Notes Payable Account No. 211
Item
Adjustment
Post.
Date Item Balance
2011
June Balance
Account No. 143
Chapter 3, P 10. (Continued)
Balance
Account No. 213
Post.
June
2011
June
Interest Payable
Unearned Service Revenue Account No. 212
Balance
Balance
Accumulated Depreciation—Vehicles
Post.
Adjustment
2011 ItemDate
Date Item
Adjustment
Adjustment
Account No. 142Vehicles
Post.
Date Item Balance
Post.
2011
2011
June Balance
June
Date Item
Balance
149
Ref. Debit Credit Debit Credit
30 J14 12,980 12,980
2011
June Adjustment
Post.
Common Stock Account No. 311
Chapter 3, P 10. (Continued)
Income Taxes Payable Account No. 214
Date Item Balance
Chapter 3, P 10. (Continued)
Chapter 3, P 10. (Continued)
$ 8,120
13,270
2,300
1,121
2,580
190,000 $ 48,750
48,000
13,535
11,800
12,980
27,000
53,650
19,000 435,125
95,600
214,320
21,200
11,000
1,400
12,520
23,750
9,879
11,800
12,980
$650,840 $650,840
Dividends
Rent Expense
Income Taxes Expense
Service Revenue
Insurance Expense
Spare Parts Expense
Depreciation Expense—Vehicles
Note: Prepaid Rent does not appear on the adjusted trial balance because it now has
a zero balance.
Unearned Service Revenue
Accumulated Depreciation—Vehicles
4. Adjusted trial balance, income statement, statement of retained earnings,
Notes Payable
Spare Parts
Cash
Chapter 3, P 10. (Continued)
Income Taxes Payable
Advertising Expense
Salaries Expense
Vehicles
and balance sheet prepared
Prepaid Maintenance
June 30, 2011
Ray Heating & Cooling, Inc.
Accounts Receivable
Adjusted Trial Balance
Prepaid Insurance
Gas and Oil Expense
Common Stock
Retained Earnings
Maintenance Expense
Interest Expense
Interest Payable
153
$435,125
$214,320
95,600
Revenue
Expenses
Salaries expense
Service revenue
Gas and oil expense
Ray Heating & Cooling, Inc.
Income Statement
For the Year Ended June 30, 2011
Chapter 3, P 10. (Continued)
affect the cash flow yield. After the adjustments have been posted in the previous
parts of the problem, the cash flow yield for the year has increased because the
come and thus increasing cash flow yield.
additional expenses recorded exceed the additional revenues, decreasing net in-
Adjusting entries affect net income on the income statement, and therefore they
5. User Insight: The effect of adjustments discussed
Chapter 3, P 10. (Continued)
155
a.
b.
America Online (AOL) recognized advertising as an asset. However, advertising
Chapter 3, C 1.
Lucent Technologies recognized revenue. However, collectibility was not rea-
decisions. In other words, whenever Never Flake sold a rust-prevention coating,
there was an associated warranty expense that the company could expect to pay in
According to the concepts of accrual accounting and the matching rule, the ac-
countant must estimate and record (accrue) the expenses associated with a sale
expense undoubtedly led to poor management decisions and, eventually, to the
sonably assured. Therefore, Lucent Technologies violated the matching rule.
Chapter 3, C 2.
even though cash may not be paid out until future years. This procedure enables
which sales were made, Never Flake's management would have realized that it was
management to tell whether a company is earning an income and to make informed
company's bankruptcy.
either charging too little for the rust-prevention service or being too generous in
the period covered by the warranty. The failure to properly estimate the warranty
future years. If warranty expenses had been estimated correctly in the years in
4. Matching rule discussed
3. T accounts set up to record the amount expensed (in millions)
The matching rule attempts to allocate the costs of films and television programs
to the accounting periods in which the revenues associated with the costs are rec-
ognized. For example, a common way of determining the amount to expense in a
Chapter 3, C 4.
1. Film and television costs defined
1.
2.
3.
$3,212.0
$178
than that of Southwest in 2009. CVS is steady even though less in 2009.
CVS is steadier even though its cash flow yield decreased in 2009 and was less
flows in the lower portion of the statement where net income is reconciled to
= -8.5 or
-8.5
long-term assets like property and equipment can require adjustments to allo-
Chapter 3, C 5.
of depreciation expense depends on several estimates, such as the estimated
erally accepted accounting principles (GAAP). This means that management
has to make estimates and assumptions. For instance, determining the amount
times
1.2
158
the following year.
may receive an incorrect view of the company's progress and pay too high a price
for stock or lend too much money to the company. One must also ask what man-
agement's stake is in this issue. Is compensation tied to net income? Could man-
agers possibly lose their jobs if the financial results are not positive? The goal of
This question raises the issue of whether it would be unethical not to follow good
accounting practice. In answering this question, one must recognize who benefits
and who is harmed when good practices are not followed. If management's recom-
mendation is accepted, earnings will be overstated in 2011. Perhaps this overstate-
Students may suggest an alternative method: immediately recording the cash re-
ceived as revenue, but recording the estimated cost as an expense through an ad-
ment will hurt no one. But the likelihood is that various people with stakes in the
company will be hurt. For example, stockholders and creditors, such as banks,
is received, and because it is difficult to estimate the amount of the future expense.
To apply accrual accounting, the accountant must assume that it is possible to di-
vide the life of the business into time periods (periodicity) and that the business
will be a going concern long enough for the transactions and service contracts to
be resolved.
It is not appropriate to record the cash received for the service contracts as reve-
nues in the current year because policy coverage does not begin until the second
year of ownership. This would overstate net income in the first year when cash is
received. The expenses associated with these receipts will not be incurred for one
credit the Service Contract Revenue account for one year's worth or a portion of
a year's worth of the service contract. The remaining amount would be adjusted
actually provided, which is after the regular warranty period expires. At that time,
an entry would be made to debit the Unearned Service Revenue account and to
Chapter 3, C 7.
year or more from the date of receipt. This would cause the net income to be under-
justing entry. This method does not work as well because the service is provided
in the years in which the service contract applies, not in the year in which the cash
stated in the two years the policy actually covered—years 2 and 3 of ownership. To
give management a clear view of how the business is doing, accrual accounting
and the matching rule should be applied. This can be done by recording the cash
received as deferred revenue (a liability) until the period in which the service is
a. 22,500 22,500
$40,000 – =
b. 25,000 25,000
$17,500 $22,500
To record supplies used
Depreciation Expense—Equipment
To record depreciation on equipment
Printing Supplies
Printing Supplies Expense
Accumulated Depreciation—Equipment
Chapter 3, C 8.
1. Adjusting entries prepared
Before After
$432,500 (e) 6,750 $439,250
352,500 (a) 22,500
(b) 25,000
(c) 11,750
(d) 13,500 425,250
2. Financial statement amounts recast
3. Results discussed
nues ($80,000 ÷ $432,500) and 37.2 percent on assets ($80,000 ÷ $215,000), the firm
Expenses
equity is only $89,000 ($155,000 – $66,000). Instead of earning 18.5 percent on reve-
The performance of the company is much less favorable than Rak's original figures
suggest. As a result of the adjustments, net income is $66,000 ($80,000 – $14,000)
less than Rak's initial determination. The lower net income means that stockholders'
Chapter 3, C 8. (Continued)
Adjustments
Revenues
162