· lesson 1 notes 1 2 3 4 5 6 1-1 accounting the language of business have you ever thought that...

Lesson 1 notes

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ACCOUNTINGThe Language of Business

Have you ever thought that you might want to start and run your own business?

Your Own Boss

Take an Idea and Run

Big Money

American Dream

A business is an organization which seeks to provide goods or services to customers.

Three Basic Kinds of Business1. 2.

3.

ManufacturingMerchandising Retail WholesaleService

Some businesses provide a combination of these goods or services to customers

Restaurant:Prepare MealsDeliver Directly to CustomersProvide Services

Idea- A good idea for a product or service that can be sold at a profit.

Capital- Money or resources to bring that product or service to life.

Management Skill- The ability to effectively employ those resources and produce a profit.

Some businesses may be operated on a non-profit basis but they still provide goods or services and require capital and management skills to operate effectively.

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2.

3.

What would a person need to start a successful business?

Besides using your own money or resources, there are only two ways to access capital.

Option 1: Borrow resources from creditors or lenders. (Debt Financing)

Option 2: Contributions from investors/owners. (Equity Financing)

The "financing" of a business has to do with how capital is obtained for a business.

"It takes money to make money" Characteristics of Debt Financing

Borrowed resources/capital must be repaid at specified future dates, usually with interest. Debt is temporary financing.

The consequences of a failure to repay debts and related interest on a timely basis can be harsh (i.e. bankruptcy or foreclosure)

It can be difficult to qualify for.

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3.

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Characteristics of Equity FinancingInvestors contribute resources/capital in exchange for ownership interests in a business. In a corporation this ownership is evidenced by shares of stock. Ownership typically grants the following rights:

Investor contributions of resources are not subject to repayment at a future date and there are no interest charges. Equity financing is permanent financing.

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2.

A. A right to vote or have a say in the affairs of the business.B. A right to share in any profits of the business. This cost of capital could be very expensive.C. A right to share in any remaining resources in the event of business termination.

The Key Advantage of Debt Financing:- No sacrifice of ownership rights (voting, profit sharing)

The Key Advantage of Equity Financing:- No requirement to repay the capital contributed.

How does an owner/investor get their investment back if the business has no obligation to repay the contributed capital?

1. Distributions upon discontinuance of the business - If a business terminates, any excess resources of the business after the payment of all debts are distributed to owners. There is no assurance this distribution will be the same as the amount invested. If it results in a higher or lower amount, the investor realizes a gain or loss on investment, respectively.

Subsequent sale of ownership interests to other investors - Original investors of capital in corporations receive shares of stock as evidence of their ownership interests and rights. This stock can be subsequently sold to other investors, usually through a stock exchange (ie. NYSE, NASDAQ, etc.). The amount received upon sale may be more or less than the amount originally invested resulting in capital gains or losses for the investor.

2.

Sharing in the business operating profits. Distributions of resources created through profitable operations to owners is referred to as a dividend.

Capital gains or losses on the sale of stock or distributions upon the termination of the business.

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2.

The Two Ways Owner/Investors Make a Profit/Loss on Investment

Most Investors and Creditors Require Information for Their Investment Decisions

Creditors want to evaluate a company's credit worthiness. "Will the business be able to repay the debt plus interest on a timely basis?"

Investors want to evaluate the profit potential of an investment in a company's stock. "What are the possibilities that stock will increase in value or that there will be substantial dividends in the future?"

The primary purpose of financial accounting is to provide information that assists investors and creditors in such evaluations.

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Financial Accounting seeks to provide information to current or future providers of capital (investors or creditors) and other interested parties outside of management (ie. government regulatory bodies). This is accomplished through periodic general purpose financial statements which provide summarized historical information on the company's financial position and results of operations.

Managerial Accounting seeks to provide information to assist managers in the effective operation of a business. This is accomplished through customized management reports that tend to be more detailed in nature and may include future budgets and forecasts as well as historical data. These reports are not generally available to the public and seek only to improve management's future performance.

Financial vs. Managerial Accounting

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1. Balance Sheet or Statement of Financial Position

2. Income Statement or Statement of Operations

3. Statement of Cash Flows

These financial statements can be found in a company's annual report which is readily available to the public. To prove this, you are to complete the Financial Statement Review Assignment as noted in the syllabus.

Financial Accounting's Focus is the General Purpose Financial Statements

Two critical conditions must exist for financial statements to be truly useful.

1.2.

ComparabilityCredibility

-Generally accepted accounting principles (GAAP) are the rules and standards of accounting used to create comparable of information.

-This need for GAAP became obvious with the stock market crash of 1929. There were no generally accepted accounting principles or standardized information requirements before the crash.

-In 1973, a new private organization, the Financial Accounting Standards Board was formed to assume the responsibility for establishing GAAP.

-The SEC has the legal authority to determine GAAP for publicly-held companies, but originally delegated that responsibility to the American Institute of Certified Public Accountants (AICPA).

-In response, Congress created the Securities and Exchange Commission (SEC) to regulate the capital transactions of publicly-held companies.

-The FASB is subject to some political pressure given the authority of the SEC.

Two critical conditions must exist for financial statements to be truly useful.

1.2.

ComparabilityCredibility

Credibility refers to the need for the financial statements to provide information that is materially accurate and reliable.

-A company's management is responsible for its accounting system and the preparation of its financial statements.

-Management may have conflicts of interest in the accurate preparation of the statements.

-Materially innacurate financial statements are at best worthless and at worst, may actually deceive and severely damage the user of financial statements.

-As a result, the SEC requires that all financial statements of publicly-held companies be subject to outside independant audit for accuracy by an independent certified public accounting firm (CPA).

-The CPA must issue an auditor's report which must accompany a company's financial statements and clearly state the material reliability of the information and its compliance with GAAP.

UPDATE

At the time this lesson was originally produced there was relatively little going on in the area of international accounting standards. However, today over 100 countries accept and use standards established by the International Accounting Standards Board (“IASB”) operating out of London, England. These standards are referred to as International Financial Reporting Standards or “IFRS” and in some cases they are very different from US GAAP.

Recently, the FASB and IASB joined together recognizing the growing need for common world-wide standards and agreed to participate in a joint effort to reconcile the differences between US GAAP and IFRS. This process, known as convergence, is progressing today on an active basis.

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Federal Agencies

Commission)

SEC(Securities &

Exchange

Investors&

Creditors

Annual Report(and other

information)

Publicly-Held Companies

Service)

IRS(Interal

Revenue

Collect Income Taxes

Private Organizations

Investors&

Creditors


information)


Accountants)

AICPA(American Instituteof Certified Public

CPA's

License and Certify

Audit


Investors&

Creditors


information)


Accountants)


CPA's

Establish Rules of How to Conduct an Audit

RegulateStock & BondTransactions

Federal Agencies

Commission)

SEC(Securities &

Exchange

Investors&

Creditors


information)


UPDATE(Continued)

It is now clear that the world is pushing towards a single set of converged standards that will ultimately be used by all countries including the U.S. In fact, in 2008 the SEC began allowing foreign companies to trade their stocks and bonds on U.S. exchanges using IFRS. In addition, the SEC is considering some future deadline in which all companies will be required to use converged interna-tional standards in their financial reporting.

Fortunately, for this “Introduction to Accounting; The Language of Business” most of the material included in the lessons is the same under both U.S. GAAP and IFRS. When current differences exist they will be noted along the way.

UPDATE(Continued)

It is now clear that the world is pushing towards a single set of converged standards that will ultimately be used by all countries including the U.S. In fact, in 2008 the SEC began allowing foreign companies to trade their stocks and bonds on U.S. exchanges using IFRS. In addition, the SEC is considering some future deadline in which all companies will be required to use converged international standards in their financial reporting.

Fortunately, for this “Introduction to Accounting; The Language of Business” most of the material included in the lessons is the same under both U.S. GAAP and IFRS. When current differences exist they will be noted along the way.

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Studying and understanding the language of business and understanding the kinds of information available to decision makers (investors, creditors and management) is great preparation to become a business decision maker.

Career opportunities in CPA firms. - Partner/Ownership in large international firms or small local firms- Stepping stone to other opportunities:

CFO, CEO and other management positionsEntrepreneurship

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The Value of an Accounting Education

Create GAAP(Standards of Accounting)


Investors&

Creditors


information)


Accountants)


Standards Board)

FASB(Financial

Accounting

Lesson SummaryWhat is a business? (Manufacturing, Merchandising, Service businesses)Successful businesses need:

-Good Idea-Capital-Management Skill

Two ways businesses access capital:1. Borrow it.2. Investment from owners/investors.

Investors and creditors need infromation in making their capital investment decisions.Financial accounting seeks to provide financial statements for investor and creditor use in those decisions.Useful financial statements must be comparable and credible.GAAP, established by the FASB, provides the key to comparable financial statements among differing companies.CPA audits required by the SEC for publicly-held companies seek to insure financial statement credibilty.

1. Exclusive right to perform audits of financial statements.

2. Tax advice and preparation of various kinds of tax returns.

3. Business consulting and advice:1. Information systems design and implementation.2. Performance or operational audit.3. Business valuations.4. Mergers and business acquisitions.5. Fraud auditing and internal control reviews.6. Personal financial planning and investment advice.

What Do CPAs Do?

FYI

In 2002, following a number of highly publicized financial statement frauds, Congress passed the Sarbanes-Oxley Act, known as “Sarbox.” This legislation created a higher level of federal regulation over CPAs and the audits they perform on publicly held companies. That’s done through an organization called the Public Company Accounting Oversight Board or “PCAOB,” which is overseen by the SEC.

This board has a broad mandate to promote audit quality and protect the public interest through its authority to set audit standards, conduct inspections of CPA firms performing audits of publicly held compa-nies, initiate enforcement actions, and impose penalties on those firms not meetings certain standards. In short, Sarbanes-Oxley reduced the role of the AICPA in regulating their member CPAs performing audits of publicly held companies and increased the role of the federal government through the SEC and the PCAOB.

By the way, CPAs are also sometimes called upon to perform audits of privately-held or non-public companies. These companies sometimes require an audit if they have plans to go public in the future or need current financing. Companies planning to go public may need as many as three years of audited financial statements before receiving SEC permission to “go public,” although the SEC does provide certain exceptions for smaller businesses. As far as other financing is concerned some private investors, banks or other lenders may require audited financial statements before making their investment or lending decisions.

For audits of private companies with no immediate plans to go public the federal government has no regulatory authority. Therefore, the AICPA continues to provide standards and oversight of CPAs performing such audits.

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Some students enter directly into business, usually in acompany's accounting, finance, internal audit and information systems department. With time and promotions, management opportunities arise along with opportunities to move within a business to other disciplines.

An accounting education provides a great base for:A career in finance, investment banking, stock brokerage and personal financial planning.Continuing education (Law School, MBA, MPA)A career in teachingGovernment service: FBI, IRS, GAO, other state and local.

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"Overall, an accounting education provides a better foundation for running a business than that of any other profession."

Robert R. Woodson President of John H. Harland Co.

Business Ownership:Three Basic Legal Forms

1. Proprietorship:- One owner.- No legal red tape except if employees hired.- No seperation of business and personal legal liability. (This can be addressed through insurance.)- No separate income taxation.

2. Partnership: Same as proprietorship except there is more than one owner.

- No legal red tape except if employees hired.- A formal partnership agreement is recommended but not required.- No separation of business and personal liability.- No separate income taxation.

3. Corporation: A separate legal entity apart from its owners- Legal red tape in formation and operation imposed by the state.- One or more owners. A corporate form of business greatly facilitates many owners and the transfer of ownership interests.- Separation of business and personal liability of owners.- Seperation of business and personal taxation (double taxation)

Effects of Separate Corporate Taxation$10 millionx 36%$6.4 million

x 40%$3.8 million

ProfitCorporate federal income taxAfter tax corporate profit paid as a dividend to ownersPersonal federal income taxOwners' after tax return on investment

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Example of Double Taxation

Assume that after years of effort a business begins to operate successfully and generates a $1,000,000 profit in the current year. If that business operates as a proprietorship, the $1,000,000 of profit is then included in the owner’s personal income tax return and taxed at his or her personal rate. If we assume a federal income tax rate of 28% and a state rate of 7% then the 35% combined rate would result in a $350,000 tax payable which leaves $650,000 as the net after-tax profit to the owner. By the way, as mentioned previously, partnerships are taxed similar to proprietorships in that their profits are allocated to the partners and then included in their personal income tax returns. There is no separate or additional tax charged to the partnership.

On the other hand, if this business operates as a corporation then its profits are taxed first at a corporate rate before an additional tax is charged to the owners on any distribution of the remaining profits. For example, using the maximum federal corporate income tax rate of 35% and an assumed 7% state income tax rate the combined 42% would result in a $420,000 corporate income tax payable on the $1,000,000 of profit. That leaves $580,000 for the owners which is then taxed again if it’s distributed as a dividend. Dividend income is currently taxed at a 15% federal rate which means an additional $87,000 tax payable by the owners.

Example of Double Taxation (continued)

This is the “double taxation” that comes with operating a business in the form of a corporation. In this example the end result is that only $493,000 is left to the owners after the payment of all taxes.

This raises the following question…. Is there any way to legally avoid some of these taxes --- at least the effect of double taxation associated with corporations? The answer is yes.

One approach is through the use of salaries and bonuses as a way of distributing profits to owners rather than dividends. In other words, if you simply took the $1,000,000 of total profit and paid it all out to the owners as a salaries and bonuses then the business would have zero net income given that such salaries and bonuses are deductible expenses of the business. The $1,000,000 of profit less $1,000,000 of salaries and bonuses to the owners leaves zero net income and zero corporate income tax payable. In that case the only income taxes payable would be the amount due on owners based on salaries and bonuses received.

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Unfortunately, the IRS knows that corporations can do this to avoid the effect of double taxation. As a result, any amount paid to owners for salaries and bonuses must be reasonable relative to the amount of services they provide. In other words, if an owner provides no work or other services to the business then no salary or bonus is allowed. However, these determinations can be subjective and in many cases the final amount allowed is based on a negotiated agreement with the IRS.

Another approach that is commonly used to eliminate the effect of double taxation is referred to as the “Subchapter S Election” under the Internal Revenue Code. This election was originally designed for smaller growing companies and provides for corporations with relatively few shareholders to be taxed as if it were a partnership. In other words you may still operate as a corporation with separate legal liability between the business and the owners but the income of the business is taxed directly to the owners without the imposition of a separate corporate tax. But, again, this Subchapter S Election is limited to only certain companies having relatively few shareholders.


Another possibility is the relatively new and popular form of ownership referred to as Limited Liability Corporations or LLCs. This form of ownership provides separate legal liability for owners but is otherwise treated like a partnership for tax and other purposes. This allows for the avoidance of double taxation but can create some other issues worth considering. For example, the transfer of ownership interests in LLCs are much more problematic than in regular corporations. For example, if a particular owner in an LLC wishes to sell an interest, the transfer of that interest must receive the full approval of all of the other owners. That is not the case in a regular corporation. In addition, if an owner dies the business must then be dissolved and reformatted before it can continue. In short, there are some problems associated with LLCs; however, it is a popular and fast growing form of business ownership in that it creates separate legal liability for owners and avoids the problem of double taxation.

Clearly from this discussion, the choice of a legal form of business can be somewhat complicated. In most cases, additional study and some legal counsel may be necessary before making this decision.

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The Board of Directors acts on behalf of the company in the hiring of senior management personnel and makes other strategic decisions for the business.

Senior Management is accountable to the Board, and therefore the owners, and is responsible for the business operations in an effort to maximize profits for the benefit of the owners. Management may or may not own shares themselves.

Board of Directors (Advise for a fee)

Top Management Personnel (Manage for a salary)

Other Employees (Work for a salary/wage)

Produce Profits for Owners

Elect

Hires

Hires

Shareholders (Invest Capital)

Corporate Ownership, Governanceand Management

States authorize the formation of separate corporate entities.

Articles of Incorporation and By Laws created by the founder(s) and filed with the state determine how the corporation will be governed.

Corporate ownership is evidenced by stock certificates (shares of stock).

Shareholders/Owners have the right subject to the by-laws to vote on corporate matters (one vote per share) and the right to share in dividends on an equal per share basis. (A shareholder's influence and percentage participation in profits depends on how many shares are owned and how many shares are outstanding.)

Corporations are governed on a representative basis through a Board of Directors elected by shareholders. Directors need not be shareholders and are often compensated for their work.

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Respond briefly to the following questions:

A. Why is accounting sometimes referred to as the "language of business"?

B. What is financial accounting as opposed to managerial accounting?

C. Why would an investor considering an investment in the stock market find financial accounting information of value?

D. What is GAAP? Does it apply to managerial or financial accounting or both? Why is GAAP so important?

Problem #1

Respond briefly to the following questions:

A.

B.

C.

D.

What are the SEC, FASB, AICPA and IRS? Describe the general purpose of each.

What kinds of businesses must have external audits performed on their financial statements and why?

Who has exclusive authority to perform external audits?

What advantages would be had for global business if there were international standards for GAAP?

Problem #2

SEC (Securities and Exchange Commission) - Federal agency charged with the responsibility of regulating the capital markets (debt and equity investments) for publicly held businesses.

FASB (Financial Accounting Standard Board) - Private institution which currently determines GAAP.

AICPA (American Institute of Certified Public Accountants) - Private national organization of CPA's. The AICPA assists states in the CPA certification process by administering a national examination, establishes standards of auditing and professional conduct for CPA's and encourages compliance with those standards.

IRS (Internal Revenue Service) - Federal agency charged with the responsibility of federal tax collection.

A. What are the SEC, FASB, AICPA, and IRS? Describe the general purpose of each.

Problem #2The answer

C. Who has exclusive authority to perform external audits?

Certified Public Accounting firms

D. What advantages woud be had for global business if there were international standards for GAAP?

If all countries required the same, high-quality standards of accounting, then financial information for businesses worldwide would be comparable and global capital markets would be improved. Investments of capital worldwide would have lower risk and the cost of capital would be reduced. High quality international GAAP would ultimately improve the worldwide economy.

B. What kinds of businesses must have external audits performed on their financial statements and why?

Businesses which seek to acquire capital from the public must provide audited financial statements. The SEC requires such companies to provide financial statements prepared in accordance with GAAP and subjected to independent audit by a Certified Public Accountant.

Problem #2The answer

Lesson 1 problems/answers

C. Why would an investor considering an investment in the stock market find financial accounting information of value?

In order to make intelligent and informed investment decisions, investors need current information on a company’s financial position and results of operations as a basis for projecting its future investment potential.

D. What is GAAP? Does it apply to managerial or financial accounting or both? Why is GAAP so important?

GAAP stands for "Generally Accepted Accounting Principles," which are the standards by which accounting information is prepared and presented to external users. GAAP applies only to financial accounting information. GAAP is important because it helps create comparable information among companies seeking capital and allows investors and creditors to make more informed investment decisions.

A. Why is accounting sometimes referred to as the "language of business?"

B. What is financial accounting as opposed to managerial accounting?

Financial accounting seeks to provide information to those who are external to the day to day operations of the business. External users include investors and creditors, government regulatory bodies, labor unions, the media and other users external to the management of the business.

Managerial accounting is the providing of information to management, those who are internal to the business.

Accounting is the language of business because it seeks to communi-cate information to those who are interested in a business.

Problem#3 Read the following and respond to the questions provided:

“Fraud Victims” MiniScribe, a computer disk-drive manufacturer was in a mighty big hurry. After seven consecutive quarters of record-breaking profits, and the quintupling of its stock value over the last 18 months, this was a company on a roll. In fact, the company was desperate for more cash in its rush to grow and was expediting efforts to raise $100 million through the issuance of bonds. After a somewhat frantic effort, the requir ed financial statements and forms were completed and filed with regulators along with a clean audit report. The bonds were issued and the future seemed assured. Life was sweet for management and investors alike. Unfortunately, MiniScribe's superlative record was actually more fantasy than fact. Within four years of the bond sale the company was forced to file bankruptcy and liquidate assets ultimately repaying bondholders less than $.50 on each original $1.00 invested. Subsequent investigations revealed that the financial statements previously certified as accurate by the prestigious accounting firm of Coopers & Lybrand had been grossly overstated. Fake sales and phony shipments to phantom customers and other schemes had gone undetected as management p erpetrated a massive fraud on its investors and creditors. Lawsuits filed on behalf of bond and stockholders brought claims totaling hundreds of millions of dollars against MiniScribe's former chairman, Q.T. Wiles; the company's investment bank, Hambrecht & Quist; and Coopers & Lybrand. Malpractice suits against accounting firms are a common event in today’s business world. As more companies fail and stock values plummet investors are looking for someone to blame and cover their financial losses. In re cent years, virtually all of the large international CPA firms have paid out millions to settle investor claims that they were more interested in the companies that paid their audit fees than the investors who relied on their work. Recent settlements over accounting malpractice "call into question the entire audit process," says John Shank, an accounting professor at the Amos Tuck school of business at Dartmouth College. At issue is the ability of auditors to serve the public interest given their inherent conflict of interests. Court documents indicate that the partners at Coopers’ Denver office responsible for the Miniscribe audit were feeling significant economic pressure themselves. With a general economic downturn and settlements on other audits gone wrong, the firm was sensitive to customer satisfaction. MiniScribe was an important office client. As a result, a willingness to “go along” with management or overlook certain accounting irregularities may have prevailed.

Coopers claims it was also deceived by "a massive and collusive fraud" and that "any failures on its part were based on information deliberately misstated by MiniScribe." They deny any wrong doing in the audit and asset that they properly followed all required professional standards in the performance of their work. In fact, an investigation instigated by MiniScribe's outside directors determined that Coopers had indeed been the victim of management fraud. Accountants in the profession agree that auditors must rely on certain management representations and disclosures in the performance of any audit and that collusive management fraud can undermine and mislead even the best audit procedures. By their very nature audits involve subjective analysis and as Coopers’ attorney, James P. Linn, says "there isn't an audit ever done that a good lawyer or the experts he hires couldn't take apart later in court." However, Coopers own work papers indicate that Coopers made a number of judgments in their audit work that other accountants might consider questionable under standard auditing procedures recognized by the profession. "The red flags at MiniScribe . . . were so numerous that only a blind man or someone in on it could miss them," says Paul Regan, a fraud expert hired to testify on behalf of Hambrecht & Quist. Court records indicate that MiniScribe management was actively involved in expediting an unusually high volume of year -end sales and other accounting adjustments to reach a targeted net income figure. It appears that time pressur es and general management resistance were contributing factors in Coopers’ failure to detect much of the fraudulent reporting. Mr. MacFee, the head of the Coopers audit team, testified that MiniScribe’s chairman, Mr. Wiles, once called him and became "agit ated" about Coopers concerns as to what should actually constitute a sale. Mr. MacFee said that at one point he was forced to hold the telephone away from his ear due to Mr. Wiles's rantings. Although Coopers & Lybrand hold to their claim that they too we re victims of a massive and collusive fraud, a jury awarded MiniScribe's bondholders more than $550 million in damages. Of that, $200 million was punitive damages for Coopers & Lybrand's negligence in the conduct of the audit. (Coopers later settled for be tween $45 million and $50 million, according to people familiar with the settlement.) Coopers also reportedly settled with MiniScribe stockholders, bankers and suppliers for a comparable amount. (Elements taken from 5/14/92 Wall Street Journal article entitled “Numbers Game” by Lee Berton.) A. Who sued whom and why? B. What is an auditor's report and why is it important? C. Why should auditors be independent? D. Can auditors be truly independent and why?

Problem #3 Answer A. Who sued whom and why? This article refers to lawsuits filed by bond and stockholders of MiniScribe against the company's management, investment banking company and the CPA firm that audited the financial statements. Bondholders, relying upon the information provided in the financial statements, loaned approximately $100 million to MiniScribe. The financial statements proved to be materially misstated and the bondholders and stockholders ultimately lost a large part of their investment when the company subsequently fai led. B. What is an auditor's report and why is it important? The auditor’s report is an independent verification as to the material accuracy of the financial statements. This report is critical because without it the financial statements have no credibility - no one can rely on them. C. Why should auditors be independent? Auditors need to be independent because investors and creditors are going to rely on the auditor’s opinion relative to the accuracy of the financial statements. D. Can auditors be truly independent and why? Because companies pay their auditors there is always a conflict of interest. Auditors may be tempted to ignore management misstatement of the financial statements to maintain relations with management and secure future audit fees. However, as the MiniScribe article describes, such auditors face the risk of investor lawsuits and sanction or loss of license by the SEC and AICPA.

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Lesson 2

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Lesson 2General Purpose

Financial Statements

Balance Sheet or Statement of Financial Position

Income Statement or Statement of Operations, Statement of Earnings, Statement of Profit and Loss, P&L Statement

Statement of Cash Flows

An Optional Financial Statement(not required under GAAP but typically provided)

Statement of Retained Earnings/Owners' Equity or Statement of Changes in Retained Earnings/Owners' Equity

Supplemental and explanatory footnotes to the financial statements are also required under GAAP to provide additional information to statement users.

General Purpose Financial Statements (required under GAAP)

Assets = Liabilities + Owners' Equity

Basic Accounting Equation

$ 100,000 = $60,000 + $40,000

Balance Sheet

Amount +from Creditors

Amount from Owners

Business =Resources

Assets

Examples: Cash

Inventory (merchandise purchased and held for resale)

Equipment

Accounts Receivable (amounts receivable from customers due to sales made on account)

Office Supplies

Land, Buildings

Patents

Resources (property or rights) that are owned or controlled by a company and provide probable future economic benefit.

Probable future obligations to pay assets (usually cash) or provide services to another entity. Liabilities are a company's debts.

Examples: Accounts Payable (obligation arising from the purchase of inventory on account)

Wages Payable

Utilities Payable

Notes Payable (typically arises from the borrowing of cash)

Warranty Obligations

Liabilities Owners' Equity1. Defined algebraically:

2. Defined from the perspective of the amount of assets provided by the owners.

If A = L + OE A - L = OEthen

A = L + OE

-L -L

(Equity financing)(Debt financing)

= $40,000$100,000

Amount of assets or resources

of the business

Amount of Assets from Creditors

Amount of Assets from Owners

- $60,000

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Owners Provide Assets In Two Possible WaysContributing cash or other assets to the business in exchange for ownership interests evidenced by shares of stock. This amount is referred to as Contributed Capital, or simply as Capital Stock.

Allowing any increase in assets arising from profitable operations to be retained in the business rather than distributed to owners as a dividend. This amount is referred to as Retained Earnings.

OE = Capital + RetainedStock Earnings

Amount of assets created through profits and

retained in the business

Amount of assetscontributed by

owners for stock

= $10,000 + $30,000 $40,000

1.

2.

Steve contributes$100 to start the business

A = L + OE

=

=

=

= =

=

+

+

+

+ +

+

100cash 0 100 capital

contributions

200cash

300 cash

200 notepayable200 notepayable

225 cash

300225 inv.

225 inv. 75 cash

0 0200 notepayable

100 capital contributions

275 cash

350 cash225 inv.50 0

200 notepayable

50

100 50

10 cash340 cash

0200 notepayable

= +

10 dividends

40100

200 notepayable

0

200 cash140 cash

0

0

= 100 capital contributions+

= + { retained

earnings

= +

capital contrib.retained earnings


0

Business borrows$200 from Dad

Business buys $225 of candy

Business sells all the candy for $275 of cash

Steve withdraws $10 of cash for personal use

Steve liquidatesthe business 40

100 capital contrib.retained earnings

Stephen'sSweetShop

Another Way to Define Owners' EquityOwners' equity is the amount of assets that owners have a right to, or interest in, in the event of termination.

The word "equity" means a right to or interest in something. Given this definition the basic equation may be re-characterized as follows:

A = L + OE

Creditors have a legal priority to business assets in the event of business termination. Owners' get the total amount of assets remaining after payment of liabilities.

Therefore: A - L = OE

= $200 + $140$340

Owners' Equity (Amount due owners in the event of termination)

(Amount due creditors in the event of termination)

Creditors' Equity

Problem #4

Respond briefly to the following on a separate sheet of paper.

CashAccounts ReceivableAccounts PayableNotes PayableLandBuildingEquipmentWages Payable

$ 5,000$ 15,000$ 17,000$ 50,000$ 25,000$100,000$ 20,000$ 4,000

A. Identify and describe the purpose of each of the required general purpose financial statements.

B. What is the basic accounting equation?

C. Define assets, liabilities and owner's equity.

D. Given the following information calculate the amount of owner's equity:

What amount of the company's assets were financed through debt and what amount was financed through equity?

Additional question:

Problem #4 - Answer

A. Identify and define each of the required general purpose financial statements.

The Balance Sheet is sometimes referred to as the Statement of Financial Position because it seeks to present a company's financial position (assets, liabilities and owners' equity) at various points in time.

The Income Statement is sometimes referred to as the Statement of Operations, Statement of Earnings, Statement of Profit and Loss or simply PL Statement because it seeks to present a company's results of operations or earnings for various periods of time.

The Statement of Cash Flows seeks to present the major inflows and outflows of cash for a company for various periods of time.

Problem #4 - Answer

B. What is the basic accounting equation?

Assets = Liabilities + Owners' Equity

13 14

15 16

17 18

2-3

Problem #4 - Answer

C. Define assets, liabilities and owners' equity.

Assets are property or rights that have probable future benefit.

Liabilities are probable future obligations to pay cash or other assets or to provide services.

Owners' equity is the amount of assets provided by owners or the amount of owners' rights to, or claims upon, assets in the event of business termination.

Problem #4 - Answer

D. Given the following information calculate the amount of owner's equity:

CashAccounts ReceivableAccounts PayableNotes PayableLandBuildingEquipmentWages Payable

$ 5,000$ 15,000$ 17,000$ 50,000$ 25,000$100,000$ 20,000$ 4,000

A - L = OECashAccounts ReceivableLandBuildingEquipment

Accounts PayableNotes PayableWages Payable

5,000

15,00025,000

100,00020,000

17,000

50,000

4,000

165,000 71,000 94,000

?- =

Problem #4 - Answer

-What amount of the company's assets were financed through debt?

Additional questions:

$71,000

$94,000

-What amount of assets were financed through equity?

$ 20,000

Income Statement

Net Income

Revenues $100,000,000- Expenses 99,980,000

Note: Revenues are not the asset received but simply a description of why we received the asset. Sales revenues of $100 means that $100 worth of assets were received from a customer upon the sale of our product rather than from borrowing or an owner's contribution.

Examples: Sales RevenuesConsulting Fee RevenuesInterest Revenues

Revenues

Revenues are the amount of inflowing assets from the sale or providing of goods or services to customers. This amount is usually reflected as the sale price charged to the customer.

Note: Expense is a term which describes why an asset is given up (or will be given up in the future). Wage expense of $500 means that $500 worth of assets were paid out or will be paid out to employees and represents a cost incurred in operating the business.

Examples: Wage Expense

Cost of Goods Sold (an expense representing the cost of inventory sold to customers)

ExpensesThe amount of outflowing assets (or the incurring of liabilities requiring the future outflow of assets) representing a cost of providing goods or services for sale.

19 20

21 22

23 24

2-4

Problem #5

Respond briefly to the following:

A. How are a company's profits calculated?

B. Define revenues, expenses and dividends.

C. What are the two ways that owners may provide capital to a business?

Problem #5

Given the following information for the year 20X1 calculate the company's net income for the year.

$10,000 $15,000 $14,000$75,000 $35,000

$25,000 $ 2,000

$15,000

Cash Accounts ReceivableWages Payable Sales Revenues Wage Expense Rent Expense Dividends Capital Stock

D.

The term profit is synonymous with earnings or net income.

Revenues - Expenses = Net Income

A. How are a company's profits calculated?

Problem #5 - Answer

Revenues describe the amount of asset inflows from the sale of goods or services to customers. It is typically the sales price or service fee charged to customers.

Expenses describe the amount of asset outlfows (or the amount of obligations incurred requiring the future outflow of assets) that result from costs incurred in operating the business.

Dividends describe the amount of assets distributed to owners (stockholders) from current or previous profits.

B. Define revenues, expenses and dividends.

Problem #5 - Answer

C. What are the two ways that owners may provide capital to a business?

1. Capital Contributions

2. Retained Earnings

Problem #5 - Answer

Steve contributes$100 to start the business

A = L + OE

=

=

=

= =

=

+

+

+

+ +

+

100cash 0 100 capital

contributions

200cash

300 cash

200 notepayable200 notepayable

225 cash

300225 inv.

225 inv. 75 cash

0 0200 notepayable

100 capital contributions

275 cash

350 cash225 inv.50 0

200 notepayable

50

100 50

10 cash340 cash

0200 notepayable

= +

10 dividends

40100

200 notepayable

0

200 cash140 cash

0

0

= 100 capital contributions+

= + { retained

earnings

= +



0

Business borrows$200 from Dad

Business buys $225 of candy

Business sells all the candy for $275 of cash

Steve withdraws $10 of cash for personal use

Steve liquidatesthe business 40

100 capital contrib.retained earnings

Stephen'sSweetShop

25 26

27 28

29 30

2-5

The Basic Accounting EquationExpanded to Reflect Changes Over Time

The basic accounting equation of A = L + OE is embodied in a company's balance sheet.

At any point in time, the amount of assets, liabilities and owners' equity represents the cumulative effect of all the company's transactions from the inception of the business up to that point in time.

$1,000,000 $600,000= $400,000+

$100,000

CapitalContributions

$300,000

Retained Earnings

At the end of the 10th year of operations:

A = L + OECapital

ContributionsRetained Earnings

Comparisons of balance sheet amounts from year to year highlight changes in a company's assets, liabilities and owners' equity as a result of business activities during a particular year.

These annual comparisons can be very useful to investors and creditors in identifying past performance trends and can facilitate projections for the future.

Comparative Balance Sheet

12/31/X1

12/31/X2

A L= +

The change during the year

" "

100,000 75,000 25,000

130,000 85,000

(Capital Stock + R/E)20,000 + 5,000

45,000

25,000 + 20,00020,000

(Capital Stock + R/E)

30,000 10,000

OE

==

++L" " OE" "A" "

220,000 185,000

Revenuesfor the year

Expensesfor the year-

-

35,000 20,000

Net Income for the year

Dividendsfor the year-

-

Income Statement for the year ended 12/31/X2. {

RetainedEarnings

" "

15,000++Capital

Stock" "

5,000

=

= +

+

} }}

} $15,000Net Income

$10,000 $15,000 $14,000$75,000 $35,000 $25,000

$ 2,000$15,000

Cash Accounts ReceivableWages Payable Sales Revenues Wage Expense Rent Expense Dividends Capital Stock

Net Income = Revenues - Expenses

D. Given the following information for the year ended 20X1 calculate the company's net income for the year.

Problem #5 - Answer

Balance Sheet at the end of the 9th year:

Balance Sheet at the end of the 10th year:

$1,000,000 $600,000 $400,000

A = L + OE

Capital Contributions

Retained Earnings

A = L + OE

Capital Contributions

Retained Earnings

$100,000 $300,000

=

=

+

+

$800,000 $550,000 $250,000

$100,000 $150,000

31 32

33 34

35 36

2-6

Problem #6

Given the following information for XYZ Corporation...

AssetsLiabilitiesOwners' Equity

12/31/X1 12/31/X2$100,000 $130,000$ ?$ 40,000

$ ?$ ?

Other information:$250,000$ 35,000$225,000

$ 10,000

Revenues for the year 'X2Dividends for the year 'X2Expenses for the year 'X2Capital contributions made by owners during the year 'X2

...calculate the following:A.B.C.D.

Net income for the year 'X2The increase or decrease in retained earnings during the year 'X2Total owners' equity at 'X2The increase in liabilities the year 'X2

Problem #6 - Answer

A.B.

C.D.

Net income for the year 'X2 = $25,000The increase or decrease in retained earnings durring the year 'X2 = $10,000Total owners' equity at 'X2 = $40,000The increase in liabilities the year 'X2 = $30,000

12/31/X1

12/31/X2

A L= +


" "

$100,000 60,000 40,000

$130,000 90,000 40,000

030,000 30,000

OE

= +

250,000 225,000



-

25,000 35,000



-

RetainedEarnings

" "CapitalStock

" "

10,000 10,000++

=

= +

+

} }}

Assuming assets increased by $25,000 during the year and liabilities amounted to $75,000 and $65,000 at the beginning and end of the year, respectively, calculate revenues for the year assuming the following additional information:

Dividends for the yearCapital contributions during the yearExpenses for the year

$12,000$10,000

$100,000

Problem #7

Statement of Retained Earnings

Retained Earnings, 12/31/X5Net IncomeDividendsRetained Earnings, 12/31/X6

$ 760,000864,600

$ 1,224,600 (400,000)

Income StatementRevenuesExpensesNet Income

$12, 443,000

$ 864,600 (11,578,400)

Net cash flow from operationsNet cash flow from investingNet cash flow from financingNet increase (decrease) in cashBeginning cashEnding cash

$ 973, 500

245,400 $ 30,000

80,000$ 110,000

Statement of Cash Flows

(1,188,900)

Balance Sheet, 12/31/X6Assets:

CashAll other assets

Total

Liabilities and Equity:LiabilitiesCapital stockRetained earnings

Total

$2,860,4001,000,0001,224,600

$5,085,000

$ 110,0004,975,000

$5,085,000

Balance Sheet, 12/31/X5Assets:

CashAll other assets

Total

Liabilities and Equity:LiabilitiesCapital stockRetained earnings

Total

$2,970,000900,000760,000

$4,630,000

$ 80,0004,550,000

$4,630,000

XYZ CorporationBalance Sheet

as of December 31, 20X1 and 20X2

$ 21,000 30,000 36,000 87,000

566,000 235,000 801,000

$ 14,00028,00032,00074,000

445,000143,000588,000

290,000390,000

$888,000

$ 27,00016,00043,000

455,000498,000

$888,000

$ 25,000CashAccounts Receivable Inventory

Long Term Assets -Land and BuildingsEquipment

$662,000Total Assets

Liabilities and Owners' Equity: Current Liabilities -

Accounts Payable Other Payables

12/31/X2

Retained Earnings100,000

Owners' Equity -Capital Stock (10,000 Shares)

180,000 280,000

Total Liabilities & Owners' Equity $662,000

100,000

12/31/X1 12/31/X2Assets: Current Assets -

Notes PayableTotal Liabilities

Long Term Liabilities -

12/31/X1

37,000

382,000

12,000

345,000

Beginning

Ending

A L= +


" "

? 75,000 ?

? 65,000 ?

25,000 10,000

OE

= +

137,000 100,000



-

37,000 12,000



-

RetainedEarnings

" "CapitalStock

" "

10,000 ++

=

= +

+

} }}25,000

35,000

Problem #7 - Answer

37 38

39 40

41 42

2-7

(40,000)(25,000)

XYZ CorporationStatement of Retained Earnings

for the years ended December 31, 20X1 and 20X2

20X1 20X2

$ 180,000Retained Earnings, at beginning of yearAdd: Net Income for yearLess: Dividends for yearRetained Earnings, atend of year $ 180,000 $ 290,000

150,000 75,000 $ 130,000

XYZ Corporation for the years ended December 31, 20X1 and 20X2

Revenues: 20X1 20X2

Sales Revenues Other Revenues

Expenses:Cost of Goods Sold Salary & Wage Expense Office ExpensesOther Expenses

Net Income

$2,540,000 10,000

$3,176,000 12,000

1,760,000 430,000

225,000 60,000

2,475,000

2,090,000 550,000 325,000 73,000 3,038,000

2,550,000 3,188,000

$150,000$15.00

$75,000 $7.50Earnings Per Share

XYZ CorporationStatement of Cash Flows


20X1 20X2

Cash at beginning of yearNet cash flow from operationsNet cash flow from investingNet cash flow from financing

$16,000 $14,000 87,000

33,000

179,000

135,000Cash at the end of year $14,000 $21,000

(307,000) (122,000)

Problem #8

Given the following information for S&W, Inc.:

CashAccounts ReceivableAccounts PayableLand and BuildingsNotes PayableWages PayableUtilities PayableEquipmentSales RevenuesInvestment RevenuesDividendsCost of Goods SoldWage ExpenseOffice SuppliesOffice ExpensesCapital ContributionsRetained Earnings

Prepare:A. A comparative income statement for the years ended 12/31/X1 and 12/31/X2. Assume that there are 7,500 shares of stock outstanding at 12/31/X1 and 12/31/X2.B. A comparative statement of retained earnings for the years ended 12/31/X1 and 12/31/X2. Assume the retained earnings balance was $45,000 at 12/31/X0.C. A comparative balance sheet as of 12/31/X1 and 12/31/X2. (Classify assets and liabilities as either "current" or "long term".)

12/31/X1 12/31/X220,00035,00040,000

250,000175,000

5,0003,000

75,000375,000

5,00020,000

265,00045,000

3,00010,00075,00085,000

15,000?

45,000500,000417,000

7,0005,000

135,000415,000

10,00030,000

272,00050,000

5,00012,00075,000

?

Problem #8 - Answer

S&W, Inc.Income Statement


Expenses: Cost of Goods Sold Wage Expense Office Expenses

Net IncomeEarnings Per Share

265,00045,00010,000

$60,000$8.00

272,00050,00012,000

$91,000$12.10

Revenues: Sales Revenues Investment Revenues

$375,0005,000

380,000

$415,00010,000

425,000

20X1 20X2

A.

320,000 334,000

Problem #8 - Answer

B. S&W, Inc.Statement of Retained Earnings


Retained Earnings, balance at beginning of year $45,000 $85,000

20X1 20X2

Add: Net Income 60,000 91,000

Less: Dividends (20,000) (30,000)Retained Earnings, balance at end of year $146,000$85,000

43

2-8

Problem #8 - Answer

S&W, Inc.Balance Sheet

as of December 31, 20X1 and 20X2

12/31/X1 12/31/X2ASSETS:

Current Assets: Cash Accounts Receivable Office Supplies

Long-Term Assets: Land and Buildings Equipment

Total Assets

$20,00035,000

3,00058,000

250,00075,000

325,000$383,000

$15,00040,000

5,00060,000

500,000135,000635,000

$695,000

LIABILITIES & OWNERS' EQUITY:

Current Liabilities: Accounts Payable Wages Payable Utilities Payable

Long-Term Liabilities: Notes Payable Total Liabilities

Owners' Equity: Capital Contributions Retained Earnings

12/31/X1 12/31/X2

$40,0005,0003,000

48,000

175,000223,000

75,00085,000

160,000

$383,000

$45,0007,0005,000

57,000

417,000474,000

75,000146,000221,000

$695,000

C.

Total Liabilities and Owners' Equity

1 2

3 4

5 6

Lesson 3

3-1

Lesson 3Accounting Cycle Part 1

Accounting seeks to communicate business information.Parties interested in business information:

InvestorsCreditors

General purpose financial statements provide information to investors and creditors.

Two required general purpose financial statements are theBalance SheetIncome Statement

Balance Sheet:

A = L + OE

Accounting is the language of business.......

A real estate developer purchases land for $500,000 cash in the year 20X1, and unsuccessfully tries to rezone it for commercial development. A year later the city council agrees to the rezoning and an appraisal at 12/31/X2 values the land at $900,000.

At what amount should this land be valued on the developer's 12/31/X2 balance sheet?

Balance SheetAssets

Historical Cost $500,000= =

=Historical cost of an asset in an arms-length purchase

=Fair Market Value (FMV) at the time of purchase

Asset Valuation(Dollar Amount of the Assets on the Balance Sheet)

Objective vs. Subjective Approaches GAAP requires an objective approach.Historical Cost Principle: Assets will be valued at the price paid upon acquisition.

Exception to Historical Cost Principle: In the event that an asset purchase was not an arm's-length transaction, then the asset will be valued at its Fair Market Value (FMV), conservatively determined at the date of purchase.

Historical Cost Principle: Assets will be valued at the price paid upon acquisition or the fair market value of the asset at the time of its acquisition or receipt.

7 8

9 10

11 12

3-2

An Accounting System

The First Three Steps in an Accounting System designed to produce financial statements1. Identify each business transaction.2. Analyze each transaction to determine its effect on the

financial position of the business (A = L + OE).3. Record the transactions and their effect on the financial position in a journal (computerized or hard copy record).

A company's accounting system is the means whereby all of a company's transactions and their effect on the company's financial position (A = L + OE) are identified, recorded and summarized so as to periodically produce the general purpose financial statements required under GAAP.

CASH

Left Side Right SideIncreases Decreases

300 20 0

Balance 100

Credit (CR)Debit (DR)

In understanding the process of recording transactions, we need to introduce some

new language and terminology.

For every transactionA = L + OE

DR = CROE

Cash Notes

Payable

100 100 200 200

+ Capital Stock

A = L +

=CRDR DR DRCR CR

+ ++

and

Another exception to Historical Cost Principle: If there is credible evidence that an asset's fair market value is below its historical cost, that cost will usually be reduced to reflect the lower fair market value.Attitude of Conservatism.

Additional principles/concepts to consider:1. Monetary Measurement Principle2. Entity Concept

13 14

15 16

17 18

3-3

Account Name

The Standard Form of Manually Prepared Journal Entries

XXX

Cash 100 Capital Stock 100

Examples:A. 1. Identified transaction - $100 of cash contributed by owners to the company for stock.

2. Analyze effect on:

3. Record through journal entry:

A = L + OECash Capital Stock

DR CRXXX

Account Name XXX

Cash Note Payable

B. 1. Identified transaction: $200 of cash borrowed from Dad.



NotePayable

DR CR

200

CashA = L + OE

200 Inventory 225 Cash 225

C. 1. Identified transaction: $225 of


Inventory (candy)Cash


A = L + OE

DR CR

inventory purchased for cash.

True or False?Debit means increase.

FALSE

True or False?Debit means increase inassets.

TRUE -+++++--

How do you remember the effect of Debits and Credits on the various kinds of accounts?

1. Memorize:DR CR

AssetsLiabilitiesOwners' Equity Capital Stock Retained Earnings Revenues Expenses Dividends

+ - -- - - + +

+ Expenses

2. Equation Approach:L + OE

Capital + Retained Stock Earnings

DR CR DR CR+ - - +

A =

Revenues - Expenses

Net - Dividends Income

AssetsExpensesDividends

LiabilitiesCapital Stock

Retained EarningsRevenues=

+ Dividends + Dividends

+ Expenses

19 20

21 22

23 24

3-4

Payable to Depositor

The bank statement sent to depositors is in fact a representation of the bank's liability account to the depositor.

If the student writes a $200 check on their account to Wal-mart, when the check is honored by the bank sending $200 to Wal-mart, then the bank's accounting will be:

If the student then wished to close their account, the bank would be obligated to pay them $800.

A = L + OECash

2002001,000

800

1,000

800

Inventory 250 Accounts Payable 250

Some additional transactions:F. 1. Identified transaction: Inventory costing $250 is purchased on account.

2. Analyze effect on:A = L + OE

Inventory Accounts Payable

3. Record through journal entry: Accounts Receivable 100 Sales Revenues 100Cost of Goods Sold (expense) 75 Inventory 75

G. 1. Identified transaction: Inventory costing $75 is sold on account to a customer for $100.


RevenuesAccounts Receivable

(100)(100)

Inventory Expenses(75) (75)


D. 1. Identified transaction: Inventory which cost $225 is sold to a customer for $275 of cash.


Expenses(225)

A = L + OECash (275)

Revenues (275)

Inventory(225)


D. 1. Identified transaction: Inventory which cost $225 is sold to a customer for $275 of cash.


Expenses(225)

A = L + OECash (275)

Revenues (275)

Inventory(225)


Common mistake for this transaction:Cash

Inventory

275

225

50

Cash Sales Revenues Cost of Goods Sold (expense) Inventory

275

225

275225

Profit or Net Income or Ret. Earn. or Revenue

Dividends 10 Cash 10

E. 1. Identified transaction- $10 of cash dividend paid to owner.


Cash Dividends


A = L + OE

Cash+

Debit-

CreditWhy does my bank statement show debits as decreases and credits as increases in my cash account? This is opposite from what I am learning and doing here.

If a student opens a checking account at the local bank by depositing $1,000 at the bank, the bank will account for this transaction as follows:

CashPayable to Depositor

1,000 1,000

Bank's perspective

25 26

27 28

29 30

3-5

Example: Stephen receives a bill from Dad for $20 of rent for the month of June on June 30th. The bill is not payable until July 10th. Conventional Approach:

Entry on June 30th:A = L + OE

Rent Payable20

Rent Expense (20)

Entry on July 10th:

A = L + OECash (20)

Rent Payable (20)

Cash (20)

Rent Expense (20)0

No Cash Involved0

A = L + OENet effect:

Lazy Man's Approach:Entry on June 30th: None

Entry on July 10th:

A = L + OECash (20)

RentExpense

(20)

Cash - 20

RentExpense

-20

J. 1. Identified transaction: $20 dollars of cash is paid on June 30th for June's rent


A = L + OE Cash

Rent Expense

Rent Expense

Cash

3. Record through journal entry

2020

that had not been previously recorded.

Cash 100 Accounts Receivable 100

H. 1. Identified transaction: $100 cash collection of customer account receivable.


Cash


AccountsReceivable

Accounts Payable 250 Cash 250

I. 1. Identified transaction: $250 cash payment of accounts payable.


A = L + OECash Accounts

Payable


Is the payment of a bill or an obligation for rent, utilities, salaries or other costs of doing business accounted for as payment of a liability or payment of an expense?

J. 1. Identified transaction: $20 dollars of cash is paid for last month's rent.


Cash RentPayable

RentExpense

It Depends!

31 32

33 34

35 36

3-6

Problem #9 - Answer

Salary & Wage ExpenseCash

7,0007,000

CashAccounts Receivable

37,00037,000

CashAccounts Payable 22,000

22,000

Sales RevenueCash 12,000

12,000Cost of Goods Sold

Inventory7,000

7,000

CashOffice Supplies 1,000

1,000

f.

g.

h.

i.

j.

Problem #9 - Answer

CashTelephone Expense 1,000

1,000

Rent RevenueCash 2,000

2,000

Interest RevenueCash 1,000

1,000

CashIncome Tax Payable 5,000

5,000

CashAdvertising Expense 3,000

3,000

CashDividends 4,000

4,000

k.

l.

m.

n.

o.

p.

1. Identify each business transaction.

2. Analyze each transaction to determine its effect on the financial position of the business.

3. Record the transactions and their effect on the financial position in the journal (computerized or hard copy record).

4. Summarize the effect of all transactions on each account by posting the journal entries to the general ledger.

The First Four Steps in an Accounting System Designed to Produce Financial

Statements

Problem #9 - Answer

CashCapital Stock

10,00010,000

InventoryAccounts Payable

25,00025,000

Utilities PayableCash

1,2501,250

EquipmentCash

70,00015,000

Note Payable 55,000

Accounts ReceivableSales Revenue

55,00055,000

Cost of Goods Sold 30,000Inventory 30,000

a.

b.

c.

d.

e.

Problem #9

Prepare general journal entries to record the following transactions for the month of January, 20X1 for XYZ Corporation:

a. Owners contributed $10,000 cash to the company in exchange for 1,000 shares of stock in the company.b. Inventory costing $25,000 was purchased on account from suppliers/vendors.c. A cash payment of $1,250 was paid to Provo Power as payment of a utility bill for the month of December, 20X0. Assume this utility bill was previously recorded as a liability for last December.d. Equipment was purchased for $70,000, paying $15,000 in cash andexecuting a note requiring the payment of $55,000 principal in twoyears plus interest.e. Sold inventory costing $30,000 to customers on account for a price of $55,000.f. Paid salaries and wages not previously recorded to employees forthe month of January amounting to $7,000.g. Collected $37,000 of cash from customer accounts receivable.

Problem #9

h. Paid accounts payable of $22,000.i. Sold inventory costing $7,000 to cash paying customers for $12,000.j. Purchased $1,000 of office supplies with cash.k. Paid previously unrecorded telephone bill of $1,000 for January.l. Received January's rent of $2,000 from a tenant leasing office space in the company's building.m. Received $1,000 of interest for the month of January on a note receivable.n. Paid the previous year's income taxes amounting to $5,000. Assume these taxes had been previously recorded as a liability in the prior year.o. Paid previously unrecorded January advertising costs amounting to $3,000.p. Paid cash dividends to stockholders amounting to $4,000.

Prepare general journal entries to record the following transactions for the month of January, 20X1 for XYZ Corporation:

37 38

39 40

41 42

3-7

Problem #10 - Answer

32,950

Cash Accounts Receivable1/1/X1a. g. i. l. m.

30,20010,00037,00012,0002,0001,000

1,25015,000 7,00022,000 1,000 1,000 5,000 3,000 4,000

c. d. f. h. j. k. n. o. p.

1/1/X1 e.

27,55055,000 37,000 g.

45,550

Inventory 1/1/X1 b. 30,000

29,500

1/31/X1

1/31/X1

41,50025,000 e.

i.7,000 1/31/X1


Accounts Payable

22,000

Notes Receivable1/1/X1 120,000

120,000

Equipment

1/1/X1 d.

350,000 70,000

420,000

Office Supplies

1/1/X1 j.

1,000 1,000

2,000

h.22,00025,000

1/1/X1b.

25,000 1/31/X1

1/31/X1

1/31/X1

1/31/X1


332,000

Capital StockNotes Payable1/1/X1

1/31/X1

Income Taxes Payable1/1/X1

0

Utilities Payable1/1/X1

1/31/X1

1/1/X1

100,000 1/31/X1

c.

55,000 d.

n.

387,000

10,000 a.

5,000 5,000

90,000

1,250 1,250

0 1/31/X1

A company's general ledger is a file in the memory of a computerized accounting system or a book of accounts in a manual system that has a separate record for each kind of asset, liability or owners' equity including each kind of revenue, expense and dividend. Each of these records is commonly referred to as an account. Each account in the general ledger is intended to accumulate the increases and decreases recorded in the journal producing a periodic summarizing balance for the account.

What is a general ledger? 6/1 Cash Capital Stock 6/1 Cash Note Payable 6/1 Inventory Cash 6/1 Cash Sales Revenues Cost of Goods Sold Inventory 6/1 Dividends Cash 6/2 Inventory Accounts Payable 6/2 Accounts Receivable Sales Revenues Cost of Goods Sold Inventory 6/2 Cash Accounts Receivable 6/2 Accounts Payable Cash 6/2 Rent Expense Cash

General Journal

General Ledger:

Beg. Balance

End. Balance

Beg. Balance

End. Balance

0100200275100

Cash

Inventory

170

0225250

22575

175

2251025020

100 100

200200

225225

275275

225225

1010

250250

100100

100100

250250

2020

7575

Problem #10

Balances at 1/1/X1:Cash Accounts Receivable Inventory Office Supplies Equipment Notes Receivable Accounts Payable Utilities Payable Income Taxes Payable Notes Payable Capital Stock (9,000 shares) Retained Earnings Dividends Sales Revenue Rent Revenue Interest Revenue Cost of Goods Sold Utilities Expense Telephone Expense Salary and Wage Expense Advertising Expense Income Tax Expense

30,200 27,550 41,500 1,000 350,000

120,000 22,000 1,250 5,000 332,000 90,000 120,000

570,250

0

Totals: 570,250

DR CR

000000

0 0

Given the following account balances for XYZ Corporation at the start of the year, January 1, 20X1:

0

Prepare a general ledger T-account for each account noting the beginning balance and post all transactions from the preceding problem to the proper accounts to determine the 1/31/X1 balance for each account.

43 44

45 46

47 48

3-8

The Steps of the Accounting System


2. Analyze each transaction to determine its effect on the financial position of the business (A=L+OE).

3. Record the transactions and their effect on financial position in a journal (computerized or hard copy record).


5. Prepare a trial balance.

Designed to Produce Financial Statements

A listing of all assets, liabilities, owners' equity (capital stock, retained earnings, revenues, expenses and dividends) noting their ending general ledger balances.

What is a trial balance?

Debit Credit

20

170175

0

200100

0

0

10 375

300

675675

Cash InventoryAccounts ReceivableAccounts Payable Capital StockNote Payable Retained EarningsDividends Sales RevenuesCost of Goods Sold Rent Expense

Stephen's Sweet Shop - Trial Balance

For every transaction:

DR = CR

This is a self-checking device.

InventoryAccounts Payable 200

200


Rent RevenueSales Revenue

DividendsRetained Earnings1/1/X1 120,000

120,000

0 55,000 12,000

0 4,000

4,000

0 2,000

2,000

1/31/X1

1/1/X1

1/31/X1

1/1/X1

1/31/X1

1/1/X1

1/31/X1 67,000

p.

e.i. l.


Telephone ExpenseUtilities Expense

Cost fo Goods SoldInterest Revenue1/1/X1 0

1,000

0

0 30,000

37,000

0 1,000

1,000

1/31/X1

1/1/X1

1/31/X1

1/1/X1

1/31/X1

1/1/X1

1/31/X1

0

e.m.i.

1,000

k.

7,000


Income Tax Expense

Advertising Expense

Salary & Wage Expense1/1/X1 0

7,000

0

0 3,000

3,000

1/31/X1 1/1/X1

1/31/X1

1/1/X1

1/31/X1 0

o.

f. 7,000

49 50

51 52

53 54

3-9

The Financial Statements can be prepared from the Trial Balance.

675

Debit Credit170175

00

100200

010

375300

20675

CashInventoryAccounts ReceivableAccounts PayableCapital StockNote PayableRetained EarningsDividendsSales RevenuesCost of Goods SoldRent Expense

Stephen's Sweet ShopIncome Statement

for the month of June, 20X1

Revenues:

Less: Expenses

$ 375Sales Revenues

30020

Cost of Goods SoldRent Expense

Net Income $ 55

Stephen's Sweet Shop Statement of Retained Earnings

for the month of June, 20X1 $ 0

$ 45

Retained Earnings, Beginning Balance

Less: Dividends Add: Net Income 55

(10)Retained Earnings, Ending Balance

Computerized accounting systems are programmed to reject any transactions that do not have equal debit and credit amounts.

Problem #11

Prepare a trial balance for XYZ Corporation at 1/31/X1 from the ending balances in the general ledger T-accounts prepared in the preceding problem.


Trial Balance at 1/31/X1

702,000702,000

4,000

25,000 0 0 387,000 100,000

67,000 2,000 1,000

120,000

32,950 45,550 29,500 2,000 420,000 120,000

37,000 0 1,000 7,000 3,000

0

DR CR Cash Accounts ReceivableInventory Office Supplies Equipment Notes Receivable Accounts Payable Utilities Payable Income Taxes Payable Notes Payable Capital Stock Retained Earnings Dividends Sales Revenue Rent Revenue Interest Revenue Cost of Goods Sold Utilities Expense Telephone Expense Salary & Wage Expense Advertising Expense Income Tax Expense

Totals

57 52

53 54

55 56

3-10


XYZ Corporation Income Statement

for the month ending 1/31/X1

Interest RevenueTotal Revenues 70,000

Advertising Expense

Less Expenses:

$67,000 2,000

1,000

Sales RevenueRent Revenue

Cost of Goods SoldTelephone ExpenseSalary & Wage Expense

37,000 1,000 7,000 3,000

Net Income

($22,000 ÷ 10,000 shares)

$22,000$2.20

Revenues:

Earnings per share

Total Expenses 48,000


XYZ CorporationStatement of Retained Earnings

for the month ending 1/31/X1

$138,000

Retained Earnings, 1/1/X1Add: Net IncomeLess: Dividends

Retained Earnings, 1/31/X1

$120,00022,000(4,000)


XYZ Corporation Balance Sheet as of 1/31/X1

Assets:Current Assets:

Cash $32,950Accounts Receivable 45,550Inventory 29,500Office Supplies 2,000

110,000Long Term Assets:

Equipment 420,000Notes Receivable 120,000

540,000Total Assets $650,000

Liabilities and Stockholders' Equity:

Current Liabilities:Accounts Payable $25,000

Long Term Liabilities:Notes Payable 387,000

412,000

Stockholders' Equity

Stockholders' Equity:Capital Stock 100,000Retained Earnings 138,000

238,000

$650,000Total Liabilities and

Stephen's Sweet Shop Balance Sheet

As of June 30, 20X1

Assets:Cash Inventory

$ 345

Liabilities and Owner's Equity:

Note Payable Owner's Equity:

Capital Stock

Total Liabilities and Owners Equity

$ 200

10045Retained Earnings

$ 170 175

$ 345

Liabilities:

Total Assets

Problem #12

Prepare an income statement and statement of retained earnings for the month ending 1/31/X1 along with a balance sheet as of 1/31/X1 for XYZ Corporation. Use the data from the trial balance produced in the preceding problem #11. (Hint: The retained earnings amount for the balance sheet at 1/31/X1 will be the ending balance reflected on the statement of retained earnings.)

(See trial balance on the next page.)

Problem #12

Trial Balance at 1/31/X1

702,000702,000

4,000

25,000 0 0 387,000 100,000

67,000 2,000 1,000

120,000

32,950 45,550 29,500 2,000 420,000 120,000

37,000 0 1,000 7,000 3,000

0

DR CR Cash Accounts ReceivableInventory Office Supplies Equipment Notes Receivable Accounts Payable Utilities Payable Income Taxes Payable Notes Payable Capital Stock Retained Earnings Dividends Sales Revenue Rent Revenue Interest Revenue Cost of Goods Sold Utilities Expense Telephone Expense Salary & Wage Expense Advertising Expense Income Tax Expense

Totals

Lesson 4Accounting Cycle Part 2

Stephen's Sweet ShopTrial Balance

CashInventoryAccounts ReceivableAccounts Payable Notes PayableCapital StockRetained EarningsDividendsSales RevenuesCost of Goods SoldRent Expenses

Debit Credit

0200100

0

375

675

170175

0

10

300 20675

22510

25020

200

Beg. Balance 0100 200275100

End. Balance Liability

Cash

30

Notes Payable 210 Cash 210

Notes Payable 0 Beg. Balance 200210

End. Balance10

Receivable

1 2

3 4

5 6

4-1

Lesson 4

Financial Accounting(Information useful to investors and creditors.)

The primary tool for investors and creditors are the financial statements to be prepared in accordance with generally accepted accounting principles.

Businesses need an accounting system in place that is designed to generate information to be included in the financial statements.

Basic elements in an accounting system -

- Identified- Recorded- Summarized

Create financial statements.

All of the transactions of a business must be:

What kind of a balance, debit or credit, would you typically expect for an asset account at the end of a period?


Retained Earnings is the net result of revenues minus expenses, less dividends. If expenses exceed revenues from inception then there will be a negative or debit balance in retained earnings, which we would call retained losses, cumulative losses, or retained deficit.

D.

6. Journalize and post to the general ledger any necessary adjusting entries at the end of the period.

The Steps of an Accounting System Designed to Produce Financial Statements


2. Analyze each transaction to determine its effect on the financial position of the business (A=L+OE).

3. Record the transactions and their effect on financial position in a journal (computerized or hard copy record).


5. Prepare a trial balance.

Accrual basis accounting deals with the timing of revenues and expenses and comprises the following two principles:

Accrual Basis Accounting

Revenues are to be recognized/recorded in the period in which they are earned, not necessarily when cash is received.

2. Matching Principle: timing of expenses

1. Revenue Recognition Principle: timing of revenues

Expenses are to be recognized in the period in which those costs provide benefit to the business operations. In other words, expenses are to be matched against the revenues that they helped produce and not necessarily in the period in which cash is paid.

Example: Inventory costing $50,000 is purchased on 12/15/X1 with half paid in cash at the date of purchase and half to be paid on 1/1/X2. The inventory is sold to a customer for $90,000 on account on 12/31/X1. Collection of the $90,000 receivable takes place on 1/15/X2. The recording of these transactions would be:

50,000 25,000 25,000

Inventory Cash Accounts Payable

Cash Accounts Receivable

25,000 25,000

12/15/X1

12/31/X1

Accounts Receivable Sales RevenuesCost of Goods Sold Inventory

90,000 90,00050,000 50,000

1/1/X2

Accounts Payable Cash

1/15/X2

90,000 90,000

'X1 'X2

7 8

9 10

11 12

4-2

Problem #13

A. Indicate for the following accounts whether they would typically have a debt or credit balance at the end of an accounting period.

CashAccounts ReceivableAccounts PayableCapital StockRetained EarningsSales RevenueCost of Goods SoldDividends

B. What would cause cash to have a credit balance?C. If cash has a credit balance at the end of the period, is it really an asset?D. Is it possible for retained earnings to have a debit balance? What would cause such a balance?


C.

B. If checks are written on cash checking account in excess of the account balance and the bank honors those checks, then a credit balance will result.

Such a credit balance is not really an asset. In fact, it is a liability because there is an obligation to the bank to deposit sufficient funds in the account to cover those checks.

A. CashAccounts ReceivableAccounts PayableCapital StockRetained EarningsSales RevenueCost of Goods SoldDividends

Typical End of Year BalanceDRDRCRCRCRCRDRDR

Accrual basis accounting deals with the timing of revenues and expenses and comprises the following two principles:

Accrual Basis Accounting

Revenues are to be recognized/recorded in the period in which they are earned, not necessarily when cash is received.

2. Matching Principle: timing of expenses

1. Revenue Recognition Principle: timing of revenues

Expenses are to be recognized in the period in which those costs provide benefit to the business operations. In other words, expenses are to be matched against the revenues that they helped produce and not necessarily in the period in which cash is paid.

12/31/X1:

Adjusting Entries Required to Comply with Accrual Basis Accounting

1. Prepaid Expenses:

Adjusting entry required at year-end:

Example: Assuming a company pays an insurance premium of $1,200 on 10/1/X1 for 12 months of coverage extending through 10/1/X2 the original journal entry would be:

Insurance Expense Prepaid Insurance Expense

300 300

10/1/X1:

Cash1,200

1,200Prepaid Insurance Expense

What should be the balance in the Prepaid Insurance Expense account after the year-end adjusting entry?

Prepaid Insurance Expense 10/1/X1 1,200

What principle of accounting requires the adjusting entry in this case?

1. Assets2. Expenses3. Net Income4. Retained Earnings5. Owners' Equity

OVERUNDEROVEROVEROVER

Adjust 12/31/X1

12/31/X1Balance

900

300

Matching Principle

If the proper adjusting entry had not been made, then the following would have been over or understated?

12/31/X1 Balance 600

Example: Assuming a company pays property taxes of $3,600 on 3/1/X1 for the tax period (1 year) through 2/28/X2, the original journal entry would be:

3/1/X1:


Prepaid Property Tax Expense What should be the balance in the Prepaid Property Tax Expense account after the year-end adjusting entry?

Prepaid Property Tax Expense

3,000 12/31/X1 Adjust

3/1/X1 3,600

3,000

3,600Cash 3,600

Property Tax Expense 3,00012/31/X1:

2 mo. x $300


13 14

15 16

17 18

4-3

$ 40,000Combined Profit for X1 and X2 $ 40,000

Accrual Basis

$ 90,00050,000

$ 40,000

$ 00

$ 0

Income Statements:

20X1:

Sales RevenuesCost of (Inventory) Goods Sold Profit (Loss) on Sale

20X2:

Sales Revenues Cost of (Inventory) Goods Sold Profit on Sale

Cash Basis

$ 025,000

$ (25,000)

$ 90,000

$ 65,00025,000

There are opportunities for income manipulation through cash basis accounting.

Why is accrual basis required for GAAP?

Cash basis accounting is used for personal income taxation.

- Allowed by IRS- Ability to pay concept


2,4008/1/X1 Original Entry:

Prepaid Rent ExpenseCash

12/31/X1 Adjusting Entry:Rent Expense

Prepaid Rent Expense 2,0002,000

2,400

1,20011/1/X1 Original Entry:

Prepaid Insurance ExpenseCash 1,200

200200

12/31/X1 Adjusting Entry:Insurance Expense

Prepaid Insurance Expense

A)i.

A)ii.


Prepaid Rent Expense@ 12/31/X1 = $400

Prepaid Rent Expense8/1/X1 2,400 2,000 12/31/X1Balance 400

or1 month future benefit = 1 x $400 = $400

B.

Prepaid Insurance Expense@ 12/31/X1 = $1,000

Prepaid Insurance Expense11/1/X1 1,200 200 12/31/X1Balance 1,000

or10 months of future benefit = 10 x $100/month = $1,000

Adjust


AssetsExpensesNet IncomeRetained EarningsOwners' EquityLiabilities

OverUnderOverOverOverNo effect

Matching PrincipleC.

D. Over or Understated


12/1/X1:

12/31/X1:

Cash

Unearned Revenues:

3,000

Example: Assuming a company receives $3,000 of cash in advance on 12/1/X1 from a client for consulting services to be provided by the company equally over the next three months, the original entry would be:

Fee Revenues 1,000Unearned Fee Revenues

3,000

1,000

Unearned Fee Revenues

19 20

21 22

23 24

4-4

Problem #14

For the following transactions, prepare the original journal entry and any adjusting entries at 12/31/X1 required to comply with accrual basis accounting. (Assume payments for both transactions are properly recorded as "Prepaid Expenses.")

A)

Rent amounting to $2,400 ($400/per month) is prepaid on 8/1/X1 for the following six months' rental cost and properly accounted for as "Prepaid Rent Expense." (In this problem you are accounting from the perspective of the tenant.)

i.

A one year insurance premium totaling $1,200 is prepaid on 11/1/X1 for insurance coverage through 11/1/X2.

ii.

Problem #14

Determine the correct balance of prepaid rent expense and prepaid insurance expense after adjustment of 12/31/X1.

What principle of accounting required the 12/31/X1 adjusting entries in this case?

If the proper 12/31/X2 adjusting entries had not been made, then the following would have been over or understated:

AssetsExpensesNet IncomeRetained EarningsOwner EquityLiabilities

B)

C)

D)


Example: Assuming a company receives $3,000 of cash in advance on 8/1/X1 from a tenant for six months rent through 1/31/X2, the original entry would be:

Adjusting entry required at year-end?

Unearned Rent Revenue 3,000 12/1/X1

12/31/X1 2,500 Adjust

12/31/X1Balance

8/1/X1:

12/31/X1:

500

Cash3,000

3,000

Unearned Rent Revenue Rent Revenue

2,5002,500

What should be the balance in the Unearned Rent Revenue account following the proper year-end adjusting entry?

Unearned Rent Revenue

Problem #15

A. Prepare the original journal entries and the required 12/31/X1 adjusting entries for the transactions described in the previous problem as noted below from the perspective of the landlord and the insurance company, respectively. Assume the original entries were properly recorded as "unearned revenue".


B. What principle of accounting requires the adjusting entries in these cases?

i. Rent amounting to $2,400 ($400/per month) is received in advance on 8/1/X1 for the following six months' rent.ii. A one year insurance premium totaling $1,200 is received in advance on 11/1/X1 for insurance coverage provided through 11/1/X2.

Problem #15

C. If the proper 12/31/X1 adjusting entries had not been made, then the following would be over or understated for the landlord and insurance company:

AssetsRevenuesNet IncomeRetained EarningsOwner's EquityLiabilities


i. Rent amounting to $2,400 ($400/per month) is received in advance on 8/1/X1 for the following six months' rental cost.

Prepare the original journal entries and the required 12/31/X1 adjusting entries for the transactions described in the previous problem from the perspective of the landlord and the insurance company, respectively. Assume the original entries were properly recorded as "unearned revenue".

A.

12/31/X1 Adjusting Entry:2,000

2,400

8/1/X1 Original Entry:

Unearned Rent Revenue

Unearned Rent RevenueCash

2,400

Rent Revenue 2,000

25 26

27 28

29 30

4-5

If the proper adjusting entry had not been made at year-end, then the following would have been under or overstated?

What should be the balance in the Unearned Fee Revenue account following the proper year-end adjusting entry?

3,000 12/1/X112/31/X1 Adjust

12/31/X12,000

(2 mo. × $1,000)

1. Liabilities 2. Revenues 3. Net Income 4. Retained Earnings 5. Owners' Equity

OVERUNDERUNDERUNDERUNDER

1,000

Balance

Unearned Fee Revenues

A = L + OENo change

What principle of accounting requires the adjusting entry in this case?

Revenue Recognition


12/1/X1:

12/31/X1:

Cash3,000

Fee Revenues 1,000Unearned Fee Revenues

Unearned Fee Revenues 3,000

1,000

Unpaid and Unrecorded Expenses:Example: A company has employees work for the full month of 12/X1 but pays the $10,000 wage payroll for December on 1/15/X2. Assuming that at 12/31/X1 these wages have not been recorded in the company's books or records, what adjusting entry should be made on 12/31/X1?

Adjusting Entry at 12/31/X1:Wage Expense 10,000

Wage Payable 10,000

If the proper adjusting entry had not been made, then the following would have been over or understated?

1. Liabilities2. Expenses3. Net Income4. Retained Earnings5. Owners' Equity

UNDERUNDEROVEROVEROVER

What principle of accounting requires this adjusting entry at the end of the year?

Revenue RecognitionIf the company failed to make this adjustment at the end of the year, then net income would be over or understated?

Understate Revenues = Understate Net Income

Uncollected and Unrecorded Revenues:Example: A company has earned $500 of interest on a loan as of the end of the year X1. What adjusting entry should be made as of 12/31/X1 assuming the interest is unrecorded and collection is expected in X2?Adjusting entry at 12/31/X1:

Interest Receivable 500Interest Income (Revenue) 500

Problem #16

Consulting services were provided to a customer in December. At12/31/X1 these consulting fees amounting to $2,000 had not beenreceived from the customer or recorded in the books.

Utility costs for any month are paid on the 15th of the following month. December's utilities amounted to $10,000 and were unpaid and unrecorded as of 12/31/X1.

Given the following two fact circumstances:

B. What specific accounting principles require the entries for i. and ii., respectively.


i.

ii.

A. Prepare the proper adjusting entries at 12/31/X1 for i. and ii. below tocomply with accrual basis accounting.

C. A failure to make the necessary entry for ii. above would cause net income to be over or understated?


B.

C.

A)i.

ii.

Utilities ExpenseUtilities Payable

Matching Principle and Revenue RecognitionPrinciple, respectively.

Understated.

10,00010,000

2,0002,000

Consulting Fees Receivable Consulting Fee Revenue

31 32

33 34

35 36

4-6


ii. A one year insurance premium totaling $1,200 is prepaid on 11/1/X1 for insurance coverage through 11/1/X2.

Prepare the original journal entries and the required 12/31/X1 adjusting entries for the transactions described in the previous problem from the perspective of the landlord and the insurance company, respectively. Assume the original entries were properly recorded as "unearned revenue".

A.

11/1/X1 Original Entry:

12/31/X1 Adjusting Entry:200

1,200

Unearned Premium Revenue

Unearned Premium RevenueCash

1,200

Premium Revenue 200


Revenue Recognition Principle

C.

AssetsRevenuesNet IncomeRetained EarningsOwners' EquityLiabilities

Over or UnderstatedNo effectUnderUnderUnderUnderOver

If the proper 12/31/X1 adjusting entries had not been made, then the following would be over or understated for the landlord and insurance company:

B. What principle of accounting requires the adjusting entries in these cases?

Sales Revenues

550,000 'X4 Transactions

550,000 12/31/X4

1,200,000 12/31/X5700,000 'X6 Transactions

1,900,000 12/31/X6

0 1/1/X4


Income Statement Accounts 0 6 0 0 07

7 000

Sales Revenues

550,000 'X4 Transactions550,000 12/31/X4

Closing Entry 550,000 0 1/1/X5

650,000 12/31/X5Closing Entry 650,000

0 1/1/X4

0 1/1/X6


Closing Entry at 12/31/X5:

Sales RevenuesRetained Earnings

650,000 650,000

Nominal Account: All income statement accounts (revenues and expenses) and even the dividends account does not maintain a cumulative running balance from inception, but instead accumulates amounts period by period (usually year by year) and, as a result, are referred to as nominal rather than real accounts.

Nominal accounts are closed at the end of an accounting period and their amounts are transferred to Retained Earnings.

37 38

39 40

41 42

4-7

1. Identify each business transaction.2. Analyze each transaction to determine its effect on the financial position of the business (A=L+OE).3. Record the transactions and their effect on financial position in a journal (computerized or hard copy record). 4. Summarize the effect of all transactions on each account by posting the journal entries to the general ledger.5. Prepare a trial balance.6. Journalize and post to the general ledger any necessary adjusting entries at the end of the period.7. Prepare the financial statements.8. Journalize and post closing entries.

The Steps of the Accounting SystemDesigned to Produce Financial Statements

1/1/X4'X4 Transactions

Real vs. Nominal AccountsReal Accounts: All accounts which appear on a balance sheet (assets, liabilities, capital stock, and retained earnings) are referred to as real accounts, meaning that the balance of the account is a cumulative running balance reflecting all transactions affecting that account since the inception of the business.

0102,000 100,000

Cash

2,000130,000

6,000151,000

4,000

12/31/X4'X5 Transactions 126,000

12/31/X5 'X6 Transactions 153,000

12/31/X6

Retained Earnings10,000 1/1/X215,000 Net Income

Dividends 5,00020,000 12/31/X2

Alternative approach to closing entries:Sales Revenues

Cost of Goods SoldWage ExpenseRetained Earnings

Retained EarningsDividends

80,000

5,000

50,00015,00015,000

5,000

Statement of Retained Earnings:

Retained Earnings, 1/1/X2Add: Net Income for 'X2Less: Dividends for 'X2Retained Earnings, 12/31/X2

$10,00015,000(5,000)

$20,000

Problem #17

East Coast Company's first year of operations is in the year 20X1. The company's trial balance as of August 31, 20X2 and 20X1, are shown as follows:

Trial Balance August 31, 20X2 and 20X1

CashAccounts ReceivableInventoryAccounts PayableLandCapital StockDividendsRetained Earnings (Balances at beginning of years)Sales RevenueCost of Goods SoldOffice ExpenseSalaries Expense Totals

20X2 20X1Debits Credits Debits Credits

33,4006,4002,800

500

12,0001,400

10,00066,500

1,900

36,600

6,80021,200

66,500

12,5007,5008,600

14,800

500

16,4001,4008,400

70,100

36,600

-0-33,500

70,100

Required: A. Prepare the journal entries to close the books as of August 31, 20X1. B. In 20X2, the company suffered a net loss, which reduced Retained Earnings. Prepare closing entries as of August 31, 20X2. How much was the loss? Can a company pay dividends even in a year in which there was no profit?

East Coast Company



Retained EarningsCost of Goods Sold

Retained EarningsOffice Expense

Retained EarningsSalaries Expense


33,50033,500

16,40016,400

1,4001,400

8,4008,400

500500

A.

0 Beginning Balance 33,500

16,400 1,400 8,400 500

6,800 8/31/X1 Balance

Retained Earnings

43 44

45 46

47 48

4-8

CE

CE

Wage Expensexxx

15,000

015,000

CE

CE CE

CECLOSINGENTRIES

Sales Revenues



Retained EarningsWage Expense


80,000

50,000

15,000

5,000

80,000

50,000

15,000

5,000

xxx80,000

080,000

Dividendsxxx

5,000

05,000

Cost of Goods Soldxxx

50,000

050,000

Retained Earnings10,000 12/31/X180,000 CE

CE 50,000CE 15,000CE 5,000

20,000 12/31/X2

Closing entries are made at the end of an accounting period to accomplish two objectives:

1. All revenue, expense, and dividend accounts must be reset to zero to start the next accounting period.

2. The Retained Earnings account must be updated to include the amount of net income (revenues - expenses) less dividends for the current year.

Closing Entries Example: Given the following trial balance at 12/31/X2 after adjusting entries at the end of the year, prepare the necessary closing entries before the start of the next accounting period:

CashAccounts ReceivableBuildingsAccounts PayableNotes PayableCapital StockRetained Earnings at 12/31/X1

10,00015,00040,000

135,000

17,00023,000 5,00010,000

135,000

Debits Credits

Ending Adjusted Balances From General Ledger

DividendsSales RevenuesCost of Goods SoldWage Expense

5,000

50,00015,000

80,000


Alternative Approach:Retained EarningsSales Revenues

Cost of Goods SoldOffice ExpenseSalaries Expense


2,20021,200

12,000 1,400

10,000

500 500

6,800 9/1/X1 2,200 500 4,100 8/31/X2

Questions:- The 20X2 loss was $2,200.- A company may pay dividends in a year of losses only if and to the extent there are retained earnings from prior years.

Retained Earnings

COMPUTERIZED ACCOUNTING SYSTEM

1. Identify Transactions2. Interpret Effect of Transactions3. Record the Transactions4. Summarize the Transactions by Account5. Accomodate Adjustments6. Prepare the Financial Statements7. Prepare Closing Entries

B. Cash Collections on Accounts Receivable:

Account AnalysisUnderstanding the transactions that affect various accounts

Beg. Balance 10,000 A. 50,000 45,000 B. End. Balance 15,000

Accounts Receivable 50,000 Sales Revenue 50,000

Accounts Receivable Example:

A. Sales made on account:

Cash 45,000Accounts Receivable 45,000

Example:

Given the following information: Beginning balance of office supplies $2,000 Ending balance of office supplies $2,500 Office supplies purchased during the period Calculate office supplies expense for the period.

Office Supplies Beg. Balance 2,000 A. B. End. Balance 2,500

$4,000

4,0003,500

4,0003,500

3,500

A. Purchased office supplies:4,000

B. Office supplies used up:Office Supplies

Cash (A/P)Office Supplies Expense

Office Supplies

49 50

51 52

53 54

4-9


Sales RevenuesCost of Goods SoldOffice ExpenseSalaries ExpenseRetained Earnings


33,50016,400 1,400 8,400 7,300

500 500

0 Beginning Balance7,300

500 6,800 8/31/X1 Balance

Alternative Approach:

Retained Earnings




Retained EarningsOffice Expense

Retained EarningsSalaries Expense


21,20021,200

12,00012,000

1,400 1,400

10,00010,000

500 500

6,800 9/1/X1 21,200 500

12,000 1,40010,000 500

4,100 8/31/X2

B.

Retained Earnings


Prepaid Insurance1/1/X3 1,500A. 2,000

12/31/X3 1,7001,800 B.

2,000 2,000

1,8001,800

A. B.Prepaid InsuranceCash

Ins. ExpensePrepaid Ins.

Insurance expense in 20X3 = $1,800

Problem #19

Determine the total amount of inventory purchases for 20X3 given the following information:

Inventory at 1/1/X3Inventory at 12/31/X3Cost of Goods Sold for 20X3

$25,000$23,000

$100,000


Inventory1/1/X3 25,000A. 98,000

12/31/X3 23,000100,000 B.

98,000 98,000

100,000100,000

A. B.InventoryCash (A/P)

Cost of Goods SoldInventory

Inventory Purchases in 20X3 = $98,000

55 56

57

4-10

Beg. balance of accounts payable $ 25,000End. balance of accounts payable 23,000Cash payments on accounts payable made during the period 40,000

Example:Given the following information:

Determine the amount of inventory purchases made on account during the period.

A. Payments on Accounts Payable B. Inventory Purchases on Account:Inventory

Accounts Payable Accounts Payable

Cash 40,000 38,000

38,00040,000

23,000 End. Balance

Accounts Payable 25,000 Beg. Balance

B. Purchases of inventory on Account Payments on accounts payable A. 40,000 38,000

Problem #18

Determine the amount of insurance expense in 20X3 if all insurance premiums are prepaid and given the following information:

Prepaid Insurance, 1/1/X3 Prepaid Insurance, 12/31/X3 Premium payments in 20X3

$1,500$1,700$2,000

58

59

1 2

3 4

5 6

Lesson 5

5-1

Lesson 5Sales Revenues

RevenuesDefinition: The amount of inflowing assets from the sale of goods or services to customers. This amount is usually reflected in the sales price charged to the customer.

Timing: Revenues are to be recognized and recorded in the period in which they are earned and not necessarily when cash is received from a customer. Revenues are typically earned when the goods sold have been delivered to the customer or services to be provided have been rendered.

Complicating Revenue Transactions

1. The providing of sales or cash discounts to creditcustomers to encourage early payment onaccount.

2. The acceptance of merchandise returns fromcustomers.

3. The uncollectibility of customer accountsreceivable.

4. The acceptance of payment by credit cards.

Example of Sales (Cash) DiscountA company sells merchandise costing $600 to a customer on account for $1,000 with terms of 2/10, N/30.

2/10, N/30 means that the customer may take a 2% discount off all or any portion of the sales price paid within 10 days of the sale. Any portion of the price not paid within the 10 day discount period is due within the next 20 days (30 days from date of sale) in full.

Entries if not paid within the discount period:At date of sale:

Accounts Receivable Sales Revenues


At date of collection:Cash

Accounts Receivable

1,000 1,000

600600

Most Common Method

1,000 1,000

CashInterest Revenue

XXXXXX

If a penalty or interest is charged to a credit customer for payments received

after 30 days, then:

Calculation of discount with terms of 2/10, N/30:

Date of Sale

10th Day

$980 $1,000$20 Discount Available

20 Days x $1 InterestPer Day

Date of Sale

10th Day 30th Day

Rate x Principal x Time = Interest

10% $980 20xx = $5360

Borrow $980 from bank

Payoff $985to bank

30th Day

$1,000 x 2% = $20 DiscountAvailable

$360 AnnualInterest = $1 of Interest

Per Day

InterestRate x Principal

Amount x TimePeriod = Amount of

Interest

36% x $1,000 x 1 Year = $360 AnnualInterest

7 8

9 10

11 12

5-2

Sales RevenuesLess: Sales Discounts Net Sales Revenues

Income Statement Presentation:

$ 1,000(20)

$ 980

A contra-revenue account is a reduction of revenue account.

DR CR Assets Liabilities Owners' Equity:

Capital Stock Retained Earnings Revenues Expenses Dividends Sales Discounts

Sales Revenues Sales Discounts Increase

+Decrease Dec rease Increase

+

+

++

+

+++

+

Cash Sales Revenues

Accounts Receivable

Cash Sales Discounts

Accounts Receivable

980 20

1,000

At date of collection within discount period:

980 20

1,000

Why use the sales discount account if the net effect on sales revenues and net income is the same?

Sales RevenuesLess: Sales Discounts

Sales Returns and Allowances Net Sales RevenuesLess: Cost of Goods Sold Gross Margin (Profit)

Income Statement Presentation:

$ 1,5000

$ 1,350(900

(150)

(9 Bikes x $50 profit/bike)$ 450

)

Entries if paid within the discount period:

1,000

600

980 20

At date of sale:Accounts Receivable

Sales RevenuesCost of Goods Sold

Inventory

At date of collection within 10 days:Cash

Accounts Receivable

Example of Sales (Cash) Discount A company sells merchandise costing $600 to a customer on account for $1,000 with terms of 2/10, N/30.

1,000

600

1,000Sales Revenues

Accounts ReceivableSales Revenues


Sales Returns and AllowancesAccounts Receivable

InventoryCost of Goods Sold

A company sells 10 bikes which cost $100 each, to a customer on account at a price of $150 each. Two days later the customer returns one bike for credit on his account because he decides he only needs 9 bikes.

Entry at the date of sale:

Entry at the date of return:

Example of Merchandise Returns

1,5001,500

1,0001,000

150150

100100

13 14

15 16

17 18

5-3

What would be the sales price at:

100 % markup on cost?

200 % markup on cost?

What was the cost of the company's return policy which allowed for the return of the one unit?

Gross Margin before return: 10 x $50/unit Gross Margin after return: Cost of return:

$ 500 450

$ 50

Was it worth it to lose $50 to gain a satisfied customer?

==9 x $50/unit

$100 + ($100 x 100%) = $200

$100 + ($100 x 200%) = $300

What if the returned merchandise has no resale value and must be disposed of?

1,5001,500

1,0001,000

150150

00

Accounts Receivable Sales RevenuesCost of Goods Sold Inventory

Sales Returns and Allowances Accounts ReceivableInventory Cost of Goods Sold

Simply exclude the inventory inflow portion of the entry.

What is the effect of such a return on gross margin?

Entry at the date of sale:

Entry at the date of return:

Sales RevenuesLess: Sales Discounts

Net Sales Revenues (9 x $150)Less: Cost of Goods Sold (10 x $100) Gross Margin

The cost of a generous return policy:

Gross margin before return of merchandise (inventory)

Gross margin after return of resalable inventory

Gross margin after return of unusable inventory

$1,5000

$1,350

$ 350

$500

$450

$350

Sales Returns and Allowances (150)

(1,000)

What kind of account is Sales Returns and Allowances?Contra-Revenue

Is it a Real or Nominal Account?Nominal

Why are we using Sales Returns and Allowances, a contra revenue account, rather than debiting SalesRevenues directly?

Better information for management

Problem #20

On April 3, 20X7, Smith, Inc. sold merchandise to Taylor Stores for $100,000 with terms 2/10, n/30. On April 13, Taylor paid one half of the obligation to Smith, paying $49,000 net of the discount. On May 2, Taylor paid $34,000 on account and returned $16,000 of merchandise, claiming that it did not meet contract terms for which Smith agreed to give full credit on account. Assume this returned inventory can be resold.

A. Record the necessary journal entries on Smith's books for the April 3, April 13, and May 2 transactions. Assume the cost of merchandise to Smith, Inc. is 70 percent of its selling price. Determine Smith's ultimate gross margin on this sale to Taylor and the % markup on cost realized.

Net Sales price per unitCost of goods sold per unit

Gross Margin or Markup per unit

Total Gross Margin or Markup on Sale:9 × $50 per unit = $450

Gross Margin or Markup as a % of Sales:

Gross Margin or Markup as a % of Cost:

Gross Margin = Markup$ 150

100$ 50

$450 $50 $1,350 $150

$450 $50 $900 $100

After the customer return of one unit, the net number of units sold were nine (9).

= = 33.3%

50.0%= =

19 20

21 22

23 24

5-4


4/3/X7 Accounts Receivable Sales Revenue

A.

4/13/X7 CashSales Discount (2% x $50,000) Accounts Receivable

49,000 1,000

50,000

Cost of Goods Sold Inventory (70% x 100,000)

100,000100,000

70,00070,000

5/2/X7 Cash Accounts Receivable

Sales Returns and Allowances Accounts Receivable

Inventory (70% x 16,000)Cost of Goods Sold

34,00034,000

16,00016,000

11,20011,200


34,000 34,00016,000 16,000

Sales Revenue Less: Sales Discounts Sales Returns & AllowancesNet Sales RevenuesLess: Cost of Goods SoldGross Margin% Markup on cost ($13,000 / $70,000)

$100,000)

83,000)

$13,000)

Entry if inventory was not resalable:Cash Accounts ReceivableSales Return & Allowances Accounts Receivable

* No entry to record inventory receipt.

Calculation of Gross Margin:

(1,000)(16,000)

(70,000)

19% rounded

B. 7/20/X7

Accounting for Uncollectible Accounts Receivable


C. It would be an easy and accurate representation of the economic effect of these transactions to simply debit sales revenues. However, the use of these contra revenue accounts quickly distinguishes information useful to management.

Calculation of Gross Margin:


Sales RevenueLess: Sales Discounts Sales Returns & Allowances Net Sales RevenuesLess: Cost of Goods Sold Gross Margin% Markup on cost ($24,200 / $58,800)

(16,000)83,000

$100,000

(58,800) $24,200

41% rounded

(1,000)

Problem #20

B. Assuming the returned inventory had not met Taylor's specifications and was a custom order that could not be resold,record the May 2 transaction and determine Smith's gross margin on this sale to Taylor and the resulting % markup on cost realized.

C. Why is it important to have separate accounts for Sales Returns and Allowances and Sales Discounts? Wouldn't it be much easier to directly reduce the Sales Revenue account for these adjustments?

25 26

27 28

29 30

5-5

Jones' 20X4 total sales revenues amounted to $120,000, of which 20% were cash sales and the remainder were sales made on account. The cost of merchandise sold amounted to $70,000.

Cash (20% x $120,000)Accounts Receivable

Sales Revenue


Example: Jones' Wholesale Candy, Inc. started business in January, 20X4.

24,00096,000

120,000

70,00070,000

Prepare journal entries for the following summarized transactions for the year 'X4.

What accounting principle would be violated with such an entry in 20X5?

Bad Debt Expense Accounts Receivable

920920

Matching Principle

How can the matching principle be complied with under the circumstances?

The Allowance Method uses estimation of uncollectible A/R to reflect Bad Debt Expense in the proper period and

is required under GAAP.

Bad Debt Expense Allowance for Uncollectible A/R

Instead, we will use a "contra asset" account to reflect this amount of estimated uncollectible A/R, call it the "Allowance or Reserve for Uncollectible Accounts Receivable."

1,1001,100

12/31/X4

20X4 collections of accounts receivable amounted to $85,000.

Determine the 12/31/X4 balance of accounts receivable before any adjustment for uncollectible accounts.

At 12/31/X4, based on a review of the A/R subsidiary ledger, none of the $11,000 of accounts receivable is known to be uncollectible. However, in the following year it is discovered that a $920 account is hopelessly uncollectible. The following entry would logically be made in 20X5:

85,000 85,000


1/1/X4 0 96,000 12/31/X4 11,000

85,000

Accounts Receivable

Prepare an adjusting entry at 12/31/X4 assuming Jones' best guess at the time is that 10% of the 12/31/X4 balance of A/R will ultimately prove to be uncollectible.

1,1001,100

10% x $11,000 = $1,100

1/1/X4 0 96,000 12/31/X4 11,000

85,000

Accounts Receivable


Why is it improper to directly credit A/R in this entry?

12/31/X4

p. xxxd. xxx

xxx k.r. xxxf. xxx

xxx q.

xxx i.

xxx q.xxx k.

r. xxxp. xxxf. xxx

1/1/X1

1/31/X1

xxx

400

1/1/X1a.

M. Jones - Receivable

Total of all subsidiary ledger accounts mustequal general ledger

balance of $5,000

Accounts ReceivableSubsidiary Ledger

General Ledger Accounts Receivable

xxxxxx

1/1/X1

1/31/X1

xxx

900

S. Longley - Receivable

1/1/X1

1/31/X1

xxx

1,900

J. Moss - Receivable

1/1/X1

1/31/X1

xxx

1,800

B. Oster - Receivable

1/31/X1 5,000xxxa. xxx

xxx c.

xxx c.

b. xxx

b. xxx

d. xxx xxx i.

31 32

33 34

35 36

5-6

The next year...Assume the following summarized transactions take place in the second year of operations, 20X5, and prepare journal entries to record them.

- 20X5 total sales revenues amounted to $210,000, of which 70% were made on account and the remainder for cash. Assume that the cost of goods sold amounted to 60% of total sales revenues.

CashA/R

Sales Revenues


63,000147,000

210,000

126,000126,000

(30% x $210,000) (70% x $210,000)

(60% x $210,000)

920920

- Collections in 20X5 of the $11,000 12/31/X4 balance totaled $10,080 (all but $920 from Bob's Candy Store was collected) and collections of $117,600 of sales made on account in 20X5.



- The unpaid $920 receivable was determined to be hopelessly uncollectible and was written off the books.


10,080

117,600

10,080

117,600

920920

Allowance for Uncollectible A/R Accounts Receivable

What is the effect of this writeoff entry on the Balance Sheet? Zero effect on the Balance Sheet

Accounts Receivable12/31/X4 11,000

147,000

30,320

29,400

10,080117,600

920

Allowance for Uncollectible A/R

9201,100

180

12/31/X4Writeoff of Bob's Acct.

Overestimation of Uncollectible A/R

Balance before writeoff

AfterWriteoff29,400

Balance Sheet

Accounts Receivable Less: Allowance for

Uncollectible Receivables

BeforeWriteoff30,320

(1,100)29,220

(180)29,220

$

$

$

$


UNDERESTIMATED20X4 Uncollectibles

1,100 12/31/X4 adjustment for estimated uncollectibles in 20X4

1,100 12/31/X4 BalanceWriteoffs

during 20X5 of 20X4 actual uncollectibles

920

OVERESTIMATED20X4 Uncollectibles

12/31/X5 Balance before anyadjustment forestimateduncollectibles in 20X5

180

Writeoffs during 20X5 of 20X4 actual uncollectibles

920

12/31/X5 Balance before anyadjustment forestimateduncollectibles in 20X5

180

How should this prior year overestimation of uncollectible A/R be corrected?

- Go back and restate and reprint prior year's financial statements (only if material mistatement).- Compensate for the prior year error in estimation in the current year. If overstated bad debt expense in 20X4 by $180, then understate it by $180 in 20X5.

Prepare the appropriate adjusting entry by Jones at 12/31/X5 for bad debt expense if Jones' best guess at this time of future uncollectible A/R is 8% of the balance of A/R.

8% x $29,400 = $2,352

If compensating for prior year overstatement of expense, then this year's expense should be $2,352 - 180 = $2,172

Balance Sheet

(1,100)9,900

Current Assets:Accounts Receivable 11,000Less: Allowance for

Uncollectible A/R

1/1/X4 0 96,000 12/31/X4 11,000

85,000

Accounts ReceivableAllowance for Uncollectible A/R

Subsidiary Ledger:Total of all individual customer accounts

$11,000

01,1001,100 12/31/X4

1/1/X4(Contra Asset)

Adjusting Entry

General Ledger:Net Realizable Value

37 38

39 40

41 42

5-7

What would the 12/31/X5 adjusting entry have been if the allowance account had actually had a debit balance before adjustment, meaning that the writeoffs must have totaled $1,280 rather than $920, and therefore the 20X4 estimate would have been underestimated rather than overestimated?

1,100 12/31/X4 Writeoffs 1,280 180 _____ 2,352

Bad Debt Expense should be overstated in 20X5 to compensate for the $180 understatement in 20X4.


Bad Debt ExpenseAllowance for Uncollectible A/R

2,5322,532

12/31/X5 Adjustment

(8% x 29,400)?

Underestimated

Aging of Accounts Receivable to Estimate Uncollectibles

Current:Past Due:0 - 30 days30-60 days60-90 days90 + days

Balance of Accounts Receivable at 12/31/X5

Estimated uncollectibles:

Aging of Accounts Receivable:

$29,400

8% × 29,400

Est. % Uncollect. Amount$ 15,000

8,0003,0002,0001,400

5%

8%10%15%20%

$750

640300300280

29,400 2,270

$2,352

Allowance for Uncollectible A/R1,100

2,270

1,280180

12/31/X4

Adjustment

Writeoffs


2,4502,450

($2,270 + 180)

Underestimated

12/31/X52,450

Problem #21

On 1/1X4 the following account balances exist for the Zero Corporation:

Accounts Receivable $246,000Allowance for Uncollectible

Accounts Receivable

DR (CR)

Respond to the following:What kind of account is the "Allowance for Uncollectible Accounts Receivable" account? What does the account represent? Calculate the net realizable value of 1/1/X4 accounts receivable for Zero.

Record the following summarized transactions for Zero Corp. for the year 20X4:

- Sales on account amounted to $700,000. The markup on inventory cost is 100%.- Collections on accounts receivable totaled $680,000.- Writeoffs of uncollectible accounts receivable amounted to $6,800.

Prepare the proper 12/31/X4 adjusting entry for Zero Corp. if management estimates that 3% of the 12/31/X4 balance of accounts receivable will prove to be uncollectible.

A.

B.

C.

(8,400)


A.

Net Realizable Value of Accounts Receivable, 1/1/X4: Accounts Receivable $246,000 Less: Allowance for Uncollectible A/R (8,400) $237,600

Accounts Receivable Sales Revenue Cost of Goods Sold Inventory

Cash Accounts Receivable

Allowance for Uncollectible A/R Accounts Receivable

700,000 700,000350,000 350,000

680,000 680,000

6,800 6,800

"Allowance for Uncollectible Accounts Receivable" is a contra asset account that represents management's estimate for the total uncollectible accounts receivable at that time.

B.


Allowance for Uncollectible A/R 1,100

Writeoffs 920 180

Pre-adjustedbalance

2,172Adjustment

2,352Final Balance

12/31/X4

12/31/X5

12/31/X5

12/31/X5

2,1722,172

12/31/X5 Adjustment:

(8% x $29,400)

43 44

45 46

47 48

5-8


1/1/X4 Balance 246,000 680,000 6,80012/31/X4 Balance 259,200

8,400 1/1/X4 Balance 6,800 1,600 12/31/X4 Balance before adjustment

6,176 Adjustment

7,776 12/31/X4 Balance after adjustment

Estimate of Uncollectible A/R at 12/31/X4: .03 x 259,200 = $7,776

Adjusting Entry:

Bad Debt Expense 6,176 Allow for Uncollectible A/R 6,176

Allowance for Uncollectible Accounts Receivable

Accounts Receivable

700,000

C.

Problem #22

What would the adjusting entry required in A. have been if there had been a debit balance of $700 in the Allowance for Uncollectible Accounts Receivable Account before the adjustment rather than a credit balance?

Determine the net realizable value of accounts receivable after adjustment at 12/31/X4.

Prepare the 20X5 entry to write off a $500 account receivable from Mary Jones that was determined to be hopelessly uncollectible.

If, subsequent to the Mary Jones writeoff, the company unexpectedly receives a check from Mary for $500 as payment in full on her account, what journal entries would be required?

B.

C.

D.

E.

Problem #23

A. The " Allowance for Uncollectible Accounts Receivable" account will always have a credit balance at year end following any adjustment for uncollectible accounts receivable.

The "Allowance for Uncollectible Accounts Receivable" account balance must be closed to retained earnings at the end of an accounting period.

Management's estimate of Uncollectible Accounts Receivable at year end will always equal the amount of "Bad Debt Expense" for the year.

The matching principle requires that "Bad Debt Expense" be accounted for on an estimated basis rather than when uncollectibility of an account receivable is actually determined.

Identify which of the following statements are true:

B.

C.

D.

Problem #22

Given the following information as of 12/31/X4, before any adjusting entry for 20X4 uncollectible accounts expense:

Sales RevenuesSales DiscountsAccounts ReceivableAllowance for Uncollectible Accounts Receivable

(760,000) 3,700 85,000

(700)

DR(CR)

Days Past DueCurrent

1 - 3030 - 6060 - 9090 - 120over 120

% Est. Uncollectible3%5%

10%15%20%50%

A/R$40,000 25,000 8,000

5,000 4,000 3,000

$85,000

Prepare the 12/31/X4 adjusting entry if an aging of accounts receivable is available and the estimate of uncollectible receivables is as noted below:

A.

Problem #22- Answer

A. Estimated uncollectible accounts Receivable:

Adjusting Entry: Bad Debt Expense 5,600 Allowance for Uncollectible A/R 5,600

xxxxxx

.03

.05

.10

.15

.20

.50

= =====

$1,2001,250

800750800

1,500$6,300

$40,00025,000

8,0005,0004,0003,000

$85,000

XX Prior Year Estimate Actual Writeoffs XX Prior Year Overestimation Adjustment 6,300 12/31/X4 Balance


5,600700

Problem #22- Answer

C.

Bad Debt Expense 7,000 Allowance for Uncollectible A/R 7,000

Net Realizable Value of Accounts Receivable:Accounts Receivable $85,000Less: Allowance for Uncollectible A/R (6,300)

Allowance for Uncollectible A/RAccounts Receivable

Accounts Receivable Allowance for Uncollectible A/R


XX Prior Year EstimateActual Writeoffs XX Prior Year 700 Underestimation Adjustment 6,300 12/31/X4 Ending Balance

Allowance for Uncollectible A/RB.

D.

500500

500500

500500

E.

7,000

$78,700

49 50

51 52

53

5-9


A. True. False. B.

C. False.D. True.

Credit Card Sales

NORM'S

BURGERS

Customer's BankRestaurant's Bank

VISSAMember

Credit Card Verification

Credit Check

Bank credits restaurant's account.

Bank charges fee to restaurant.

Electronic transfer of funds to cover the amount

charged on credit card.

Customer pays charges.

Example: A company sells merchandise costing $1,000 to a customer for $2,000. The customer pays by providing a VISA card which is electronically processed at that time. The company has agreed to pay a 4% fee on all VISA sales for the right to accept VISA cards as payment.

CashCredit Card Expense

Sales Revenues


1,920 80

2,000

1,0001,000

Entries at the date of sale:

Credit Card Sales

China Lilly Restaurant accepts VISA credit cards and processes customer payments made with the card electronically at the time of the sale. China Lilly ischarged a 3% fee on any amount paid through the card.

Record the journal entry for a $100 customer charge.

Problem #24

A.

What amount would Lilly actually have to charge the customer if she wished to net $100 after the credit card cost?

B.


A.

B.

CashCredit Card Expense

Sales Revenue

97 3

100

X = Amount to be charged to net $100 cash

X 97% = $100 X = 100/.97 X = $103.09

1 2

3 4

5 6

Lesson 6

6-1

Lesson 6Inventory

Perpetual Inventory AccountingAccounting for inventory perpetually means that every transaction involving an inflow and outflow of inventory is recorded as it happens with a debit or credit to the inventory account. As a result, the inventory account in the general ledger will maintain a running balance of the amount of inventory on hand at any point in time.

Purchases of inventory: Inventory xxx Cash (A/P) xxxSales of inventory: Cash (A/R) xxx Sales Revenues xxx Cost of Goods Sold xxx Inventory xxx

Some Things to Note: -Perpetual inventory accounting has been used in all of our examples to date.

Inventory Inv.-Soup-Tomato xxx xxx xxx xxx xxx xxx xxx xxx 100,000

xxx xxx 200 Inv.-Soup-Mshrm xxx xxx 250

Inv.- Soup- Ckn Nd xxx xxx 175

General Ledger: Subsidiary Ledger:(item-by-item)

Most perpetual inventory accounting systems utilize a subsidiary ledger.

The effect of computerized systems in accounting for inventories:

1. Especially useful in managing seasonal inventories.

2. Can help us discover interesting geographic and demographic trends relative to sales.

3. Can help us identify relationships between different products purchased by similar customers.

On 11/1/X2, Joe's Bicycle Store buys as inventory 20 bicycles for $100 each, terms of 2/10, n/30. Two days later, Joe returns one defective bike to the manufacturer for credit on his account. On 11/9/X2, Joe pays the balance due net of the discount.

Entry at 11/1/X2 to record purchase on account: Inventory 2,000 2,000

Entry at 11/3/X2 to record bicycle return: 100 Inventory 100

Entry at 11/9/X2 to payoff account, net of discount amouting to $38: 1,900 Cash 1,862 Inventory 38

Examples of perpetual inventory accounting given complicating factors of purchase discounts and returns.

Accounts Payable

Accounts Payable

Accounts Payable

(20 x $100)

(98% x $1,900) (2% x $1,900)

($1,900 - 38)

(1 x $100)

The accounting for inventory perpetually requires accounting for the inflow and outflow of the # of units and any increases or decreases in the cost of those units.

19 @ $98 each = $1,862

Inventory

100 Return of 1 unit

38 Discount of 2% x $1,900

2,000

1,862

Original cost of the bicycles: True cost of the bicycles:True inventory balance:

(20 @ $98 each)(20 @ $100 each)

7 8

9 10

11 12

6-2

Problem #25

Mercy Lawn Mower Shop had the following transactions during the first twelve days of March, 20X7:

March 1

2

10

11 12

Purchased 10 lawn mowers on account at $200 each, terms of 2/10, n/30.Returned 1 lawn mower to supplier because the frame was bent; received credit on account for $200.Paid supplier the net amount owed for the lawn mowers purchased on March 1, net of the discount.Sold 5 lawn mowers for $400 each for cash.One of the lawn mowers sold on March 11 was returned; cash was refunded.

Journalize these transactions.


Mercy Lawn Mower Shop had the following transactions during the first twelve days of March, 20X7:

Inventory Accounts Payable

3/1 2,000

3/2 Accounts Payable Inventory

200 200

3/10 Accounts PayableCash (98% x 1800)Inventory (2% x $1800)

1,8001,764

36

3/11 CashSales Revenue

Cost of Goods Sold Inventory (5 x 196 = $980)

2,000 2,000

980 980

2,000

400 400

196 196Cost of Goods Sold

3/12 Sales Returns and AllowancesCash

Inventory

Complications in Accounting for Inventory Cost Flows

Example: Assume you are starting a used car business and buy 3 cars for resale. If you buy an old VW Bug for $2,000, a classic Camaro for $4,000, and an old souped-up Pinto for $6,000, the journal entries to record their purchase would be:

2,000 4,000 6,000 12,000

InventoryInventoryCash

InventoryCash

InventoryCash

2,000

4,000

6,000

2,000

4,000

6,000

Now, assume one car is sold to a customer for $7,000 cash. The entry would be:

Perpetual Specific Identification Method

Cash 7,000 Sales Revenues 7,000Cost of Goods Sold ? Inventory ?

If Pinto:Cost of Goods Sold 6,000 Inventory 6,000

Cost of Goods Sold 2,000 Inventory 2,000

If VW Bug:

Gross Margin/Profit(Revenues - Cost of Goods Sold )

$1,000

Gross Margin/Profit(Revenues - Cost of Goods Sold)

$5,000

Example: Assume you want to start a business that sells jelly beans. Your purchases of inventory are as follows:

20253075

Cash Sales Revenues Cost of Goods Sold Inventory

Inventory10 lbs. @ $2.00/lb. = $2010 lbs. @ $2.50/lb. = $2510 lbs. @ $3.00/lb. = $30

Assume your first customer comes by and buys 1lb. of jelly beans for $4.

?

44

?

Last in first out (LIFO): Cost of Goods Sold 3 Inventory 3

First in first out (FIFO): Cost of Goods Sold 2 Inventory 2

Average cost ($75 ÷ 30 lbs. = $2.50/lb.): Cost of Goods Sold 2.50 Inventory 2.50

Result Comparison: LIFO

$ 4

$ 1

$ 72

FIFO$ 4

( 2) $ 2

$ 73

AVE.Net Sales Revenue Less: Cost of Goods Sold Gross Margin

End Inventory

(2.50)

4 $

( 3) $1.50

$ 72.50

13 14

15 16

17 18

6-3

What method would you use if you had not observed the actual physical flow?

Under GAAP you may use any method regardless of the actual physical outflow of inventory; however, the method selected must be consistently used over time.

What is the likely physical outflow of inventory at a supermarket?

What method would you choose if it was your business?

Net Sales RevenueLess: Cost of

Goods Sold Gross Margin

A. To impress investors?B. To pay less income tax?

Whatever method you use for financial reporting to investors and creditors, you must also use for income tax reporting.

End. Inventory

LIFO$ 4

( 3) $ 1

$ 72

FIFO$ 4

( 2) $ 2

$ 73

AVE.

$72.50

$ 1.50

$ 4

(2.50)

What would be the effect of the different methods on net income in a deflationary environment?

Sales RevenuesLess: Cost of Goods SoldGross Margin

Inventory

LIFO $ 4

FIFO $ 4

AVE

(2.50)1.50

Deflationary times create the opposite result.

10 lbs. @ $3.00/lb. = $3010 lbs. @ $2.50/lb. = $2510 lbs. @ $2.00/lb. = $20

What would be the results in a period of stable costs?

(2)

$ 73

2(3) 1

$ 72 $72.50

$ 4

Problem #26

Joe has a small used car business going. He currently has the following in inventory:

Date Purchased CostGremlin 1/6/X6 $ 650Pinto 1/19/X6 $1,050

On January 25, 20X6 he buys for cash a decent Ford Mustang for $1,850.

a.

b.

c.

Prepare the journal entry to record the sale of the Mustang for $2,750 cash on 1/29/X6

i. Using the specific indentification inventory cost flow.ii. Using a FIFO inventory cost flow assumption.

Determine the gross margin on the Mustang sale under both cost flow methods.

Which cost flow method is appropriate under the circumstances? Why?

Would there have been any difference in the amount of cost of goods sold between the methods if all the inventory had been sold?

Sales RevenueLess: Cost of Goods SoldGross Margin

LIFO $120

(75) $45

FIFO $120

(75) $45

AVE. $120

(75) $45


Cash Sales RevenueCost of Goods Sold Inventory

Cash Sales RevenueCost of Goods Sold Inventory

a. i.

SpecificIdentification FIFO

Sales RevenueCost of Goods SoldGross Margin

$2,750 (1,850)$ 900

$2,750 (650) $2,100

Specific identification is appropriate in this case because of the unique nature of each inventory item.

2,750

1,850

2,750

650

2,750

1,850

2,750

650

c.

ii.

b.

19 20

21 22

23 24

6-4

LIFOFIFO

Jan Feb Mar Apr May June

First costs,older costs,lower costs

Last costs,most recent costs, highercosts

$2-

$4-

$6-

(Time)

(Cost per unitof inventorypurchases)

Taxes LowerHigher

Net IncomeLowerHigher

Cost of Goods Sold

HigherLower

Graph of Inflation

July

Graph of Deflation


First costs,older costs,higher costs

Last costs, most recent costs, lower costs

$2-

$4-

$6-

$2-

$4-

$6-

(Time)

LIFOFIFO

Taxes Net IncomeCost of

Goods SoldHigherLower

LowerHigher

HigherLower


Using these graphs, respond to the following questions:

1. Which inventory cost flow method would produce the highest tax liability in a period of deflation, assuming not all inventory was sold?

Cost of Goods Sold Net Income Taxes LIFO Lower Higher Higher


First costs,older costs,higher costs

Last costs, most recent costs, lower costs

$2-

$4-

$6-

$2-

$4-

$6-

(Time)


2. Which inventory cost flow method would result in the highest ending inventory balance in a period of inflation?


$2-

$4-

$6-


(Time)FIFO

leftover

sold

3. Which inventory cost flow method results in ending inventory that utilizes the most recent costs?

FIFO


First costs,older costs,lower costs

Last costs,most recent costs, highercosts

$2-

$4-

$6-

(Time)

(Ending Inventory)

(Units Sold)

Problem #27Choose between FIFO, LIFO and the Weighted Average inventory cost flow assumptions used on a perpetual basis to respond to the following questions: (Assume under all scenarios that there is a balance of inventory on hand at the end of the period)

a.Which method would produce the highest net income in inflationary times?

b.Which method would produce the highest income tax in deflationary times?

c.Which method would produce the highest ending inventory balance in inflationary times?

d.Which method would produce the lowest ending inventory balance in deflationary times?

e.Which method would produce the highest net income in a period of stable prices?

f.Which method would produce the highest net income in inflationary times assuming there is no balance of inventory at the end of the period?

25 26

27 28

29 30

6-5


a. FIFOb. LIFOc. FIFOd. FIFOe. Same under all methodsf. Same under all methods

Practical Application of FIFO, LIFO, and MovingWeighted Average Inventory Cost Flow Assumptions

Costper Case # of Cases

Beginning Inventory 1,000 $ 205/5 Purchase 300 $ 215/7 Sale 4005/13 Purchase 400 $ 225/19 Sale 5005/23 Purchase 600 $ 235/29 Sale 500

Example: Jimbo’s is a wholesale distributor of hot dogs. The following reflects Jimbo's inventory transactions for May, 20X1:

Calculate the amount of Cost of Goods Sold for the month of May and the balance of ending Inventory at 5/31 under a. FIFO, b. LIFO, and c. Moving Weighted Average inventory cost flows assumptions.

a.FIFO:Cost of Goods Sold Inventory

5/1 1,000 @ 20 = 20,000

5/5 300 @ 21 = 6,300 8,000 8,000 = 400 @ 20 5/7

5/13 400 @ 22 = 8,80010,000 10,000 = 500 @ 20 5/19

5/23 600 @ 23 = 13,800

10,500 10,500 = 100 @ 22300 @ 21100 @ 20

5/29

28,500 20,400

600100

300

400 UnitsSold

500 UnitsSold

500 UnitsSold

b.LIFO:

5/1 1,000 @ 20 = 20,000

5/5 300 @ 21 = 6,300

8,300 = 100 @ 20 8,300300 @ 21

5/75/13 400 @ 22 = 8,800

10,800 = 100 @ 2010,800400 @ 22

5/23 600 @ 23 = 13,800

11,500

30,600 18,300

11,500 = 500 @ 23 5/29

900800

100

5/19

400 CasesSold

500 CasesSold

500 CasesSold

Cost of Goods Sold Inventory

Moving Weighted Average:

5/1 1,000 @ 20 = 20,0005/5 300 @ 21 = 6,300

MWA:26,300 ÷ 1,300 = 20.23

per unit8,092 8,092 = 400 @ 20.23 5/7

5/13 400 @ 22 = 8,800

MWA:900 @ 20.23 = 18,207400 @ 22 = 8,800

1,300 27,007

27,007 ÷ 1,300 = 20.77per unit

10,385 10,385 = 500 @ 20.77 5/19

c.Cost of Goods Sold Inventory

Rounded


10,863

5/23 600 @ 23 = 13,800

MWA:800 @ 20.77 = 16,616600 @ 23 = 13,800

1,400 30,416

30,416 / 1,400 = 21.73per unit

10,863 = 500 @ 21.73 5/29

19,56029,340

Ending Inventory: 900 x 21.73 = 19, 560

(Continued)(Continued)

31 32

33 34

35 36

6-6

Problem #28

Young, Inc. imports leather purses from Korea and sells them to retailers in the United States. The inventory flows and related costs for a particular purse style during the month of January, 20X1 is noted below:

# of UnitsCost

per UnitBeginning Inventory1/3 Purchase1/7 Sale1/11 Purchase1/17 Purchase1/22 Sale1/25 Purchase1/28 Sale

500200250400300350200220

$12$13

$14$15

$15

If these purses sell to retailers for $30/ea., determine the amount of 1/31/X1 inventory and January's cost of goods sold, gross margin and % markup on cost under the following cost flow assumptions.

a. Perpetual FIFOb. Perpetual LIFOc. Moving Weighted Average


a. FIFOCost of Goods Sold Inventory

$3,000

4,300

2,980

1/1 (500 x $12) $6,000

1/3 (200 x $13) 2,600

1/1 (400 x $14) 5,600

1/17 (300 x $15) 4,500

1/25 (200 x $15) 3,000

$3,000 (250 x $12)

(250 x $12)4,300 (100 x $13)

(100 x $13) 2,980 (120 x $14)

Debits - Credits = $11,420$10,280

250

100

280

1/7

1/22

1/28


a. FIFO

Gross margin: Net sales revenue (820 x $30) Less: Cost of goods sold

$24,600(10,280)$14,320

% Markup on cost: $14,320 ÷ $10,280 = 1.39 or 139%



450

350330

b. LIFO

1/7

1/12

1/28

250 Units sold

350 Units sold

220 Units sold

1/1 (500 x $12) $6,000

1/3 (200 x $13) 2,600

1/11 (400 x $14) 5,600

1/17 (300 x $15) 4,500

1/25 (200 x $15) 3,000

$10,020

(200 x $13) ( 50 x $12)

(300 x $15) ( 50 x $14)

(200 x $15) ( 20 x $14)

3,280

3,200

5,200

$3,200

5,200

3,280

$11,680


Gross margin: Net sales revenue Less: Cost of

% Markup on cost:$12,920 ÷ $11,680 = 1.11 or 111%

$24,600(11,680)$12,920

b. LIFO (continued)

goods sold


Cost of Goods Sold Inventoryc. Moving Weighted Average

3,071

4,757

3,05210,880

3,071

4,757

3,052

(500 x $12) (200 x $13)

$8,600 ÷ 700 = $12.29

(300 x $15) 450 x $12.29 = 5,529

400 x $14 = 5,600300 x $15 = 4,500

$15,629 ÷ 1,150 = $13.59

15,629

(200 x $15) 800 x $13.59 = 10,872

200 x $15 = 3,000 1,000

$13,872 ÷ 1,000 = $13.87

10,820

13,872

MWA:

(400 x $14)

MWA:

MWA:

1/111/17

5,6004,500

1/31/1 $6,000

2,600

1/25 3,000 1/12(350 x $13.59)

1/7(250 x $12.29)

1/28 (220 x $13.87)

1,150

37 38

39

6-7


c. Moving Weighted Average:

$24,600

% Markup on cost:$13,720 ÷ $10,880 = 1.261 or 126%

Gross margin:Net sales revenueLess: Cost of

$13,720(10,880)goods sold

What is a physical inventory?

Why is a periodic physical inventory necessary if you maintain a perpetual subsidiary ledger for

inventory?

Pilferage ExpenseInventory

XXXXXX

FYI

FYI

International accounting standards (IFRS) allow both the FIFO and Moving Weighted Average inventory costing methods but disallow the LIFO approach. This reflects the IASB’s emphasis on current value reporting in corporate balance sheets. (Since LIFO reflects older costs in any ending inventory balance it does not reflect current values.)

As the convergence process of IFRS and U.S. accounting standards (GAAP) continues, this difference in acceptable methods will have to be addressed and if LIFO is ultimately disallowed in the U.S. then Congress will also have to address the resulting tax affects of such a change.

Cameron

Text Box

40

1 2

3 4

5 6

Lesson 7

7-1

Lesson 7Operating Expenses

andInternal Controls

Norm's Inc. Income Statement

for the year ending 12/31/X1Sales RevenuesLess: Sales Discounts Sales Returns and Allowances Net Sales RevenuesLess: Cost of Goods Sold Gross Margin Less: Salaries Expense Payroll Tax Expense Utility Expense Property Tax Expense Operating Income

$ xxx (xxx) (xxx) xxx (xxx) xxx

(xxx) (xxx) (xxx) (xxx) xxx

xxx (xxx) xxx (xxx)$ xxx$ xx

Other Revenues and Expenses Interest Revenue Interest Expense Income before inc. tax Income Tax Expense Net Income/Loss Earnings Per Share

Operating Expenses

One of the most common operating expenses is the cost of employee salaries and wages.

To date, in our examples we have simplified this accounting.

Example: We have accounted for the payment of any employee's wage of $1,000 by simply:

Wage Expense xxCash xx

Unfortunately the true accounting for salaries and wages is much more complicated. The major complicating factor is payroll taxes. There are two kinds of payroll taxes that must be considered and accounted for:

1) Employee Payroll Tax Withholding2) Employer's Payroll Taxes

Example: An employee's gross wage for the month is $1,000,however, the employer withholds $70 of FICA taxes, $170 of federal income taxes and $60 of state income taxes before issuing a check to the employee for their net pay of $700.

Payroll TaxesEmployee Payroll Tax Withholdings: - FICA Taxes (Social Security & Medicare) - Federal Income Taxes - State Income Taxes - Union dues, contributions to retirement or investment plans, charitable contributions

Journal entry to record:Wage Expense 1,000 Cash Employee FICA Payable Employee FIT Payable Employee SIT Payable

70070

17060

Employer's Payroll Taxes:- FICA Taxes (equal to employee amount)- Federal Unemployment Insurance (FUI)- State Unemployment Insurance (SUI)

Example: The employer records the employer's payroll tax liability arising from the $1,000 employee payroll in the previous example. Assume FUI and SUI amount to $10 and $5, resepectively.

Payroll Tax Expense Employer's FICA PayableEmployer's FUI PayableEmployer's SUI Payable

8570105

The second form of payroll tax is the: Employer's Have Two Payroll-Related Costs

1. Employee salary/wage expense

2. Employer's payroll tax expense

7 8

9 10

11 12

7-2

State Sales TaxesExample: Joe's Burgers sells a burger to a customer for $.99 but collects $1.05 including state sales tax of $.06. Prepare the journal entry.

Cash Sales Revenue Sales Tax Payable

Upon remittance of the sales tax to the state, the entry would be:

Sales Tax Payable Cash

Whose revenue is the sales tax? State Government

Whose expense is the sales tax? Customer's Expense

1.05.99.06

.06.06

Problem #29

Prepare the 12/31/X2 journal entries required given the following information for the December 20X2 payroll assuming the actual payment of December wages and payroll taxes will not be made until January, 20X3:

EmployeesJim GordonFrank JamesAl Smith

Gross Wage$2,000$1,500$1,200

FICA Rate7.65%7.65%7.65%

FIT Rate20%15%15%

SIT Rate7%5%5%

Employer federal and state unemployment insurance rates are 2% and 3% of the gross wages, respectively.

Employee Witholding:


Payroll Tax Expense Employer FICA Payable Employer FUI Payable Employer SUI Payable

Wage Expense Employee FICA Payable Employee FIT Payable Employee SIT Payable Wage Payable

359.55 805.00 275.003,260.45

359.55 94.00 141.00

Employer Payroll Tax:

$4,700

GrossWage FICA

359.55 .02 $94 .03 $141

FUI SUIRate $ Rate $ TOTAL

$594.55

Employee Withholdings:

GordonJamesSmithTotals

$2,000$1,500$1,200$4,700

.0765

.0765

.0765

$153.00$114.75$ 91.80$359.55

FICAWithholding

FITWithholding

.20

.15

.15

$400$225$180$805

SITWithholding

.07

.05

.05

$140$ 75$ 60$275

EmployeeGrossWage Rate $ Rate Rate$ $

Net Pay

$

$ 1,307.00$ 1,085.25$ 868.20$ 3,260.45

4,700.00

594.55

Problem #30

XYZ Clothing sold merchandise costing $65 to a customer at a price of $100 and collected $107 in cash to include a $7 state sales tax. XYZ subsequently remitted the $7 tax in cash to the state. Prepare the two journal entries to record these transactions.

Why isn't the sales tax collected and remitted to the state reflected as a revenue and offsetting expense on the books of XYZ clothing?


Entry at Sale:

Cash 107 Sales Revenues Sales Tax Payable

Cost of Goods Sold 65 Inventory

Sales Tax Payable 7 Cash

100 7

Entry at Payment of Sales Tax:

65

7

The sales tax is revenue to the state and an expense of the customer. The company rendered no service in exchange for the tax and is simply acting as a collection agent of the state incurring an obligation upon collection and paying that obligation upon remittance of the tax.

The matching principle has to do with timing of expenses and seeks to record expenses in the period in which those costs of doing business contribute to the production of revenues, not necessarily when those costs are paid in cash.

Example: Assume property taxes amounting to $3,600 are prepaid on 11/1/X1 for the year through 10/31/X2.

11/1/X1 Entry:

12/31/X1 Adjusting Entry:

Cash$3,600

$3,600

Property Tax ExpensePrepaid Property Tax

$3,600$3,600


13 14

15 16

17 18

7-3

Example: At 12/31/X1, the utility bill for December has not yet been received or recorded. Based on the previous month's utility bill, utility costs for the month of December are estimated at $1,500.


Utilities ExpenseUtilities Payable

$1,500$1,500

Example: Payment of December's rent amounting to $1,000 paid in cash on 12/31/X1.

Assuming this obligation had not been previously recorded, the entry upon payment would be:

Rent ExpenseCash

$1,000$1,000

Internal ControlsPolicies and procedures implemented by a business that are designed to safeguard assets and ensure accurate accounting records.

Examples: - Fencing around inventory and supplies - Computer passwords - Shoplifting detection procedures

- The risks of employee theft and fraud. Honest people are susceptible.

- Key internal controls in safeguarding cash 1. Separation of duties 2. Authorization procedures 3. Adequate documentation and records 4. Independent checks on performance (bank reconciliation)

- CPA expertise in the area of internal controls

- Management's fiduciary responsibility and Management's Report.

Management's Report on Finanical Information

Management of Sara Lee Corporation is responsible for the preparation and integrity of the financial information included in this annual report. The financial statements have been prepared in accordance with generally accepted accounting principles and, where required, reflect our best estimates and judgments.

It is the corporation's policy to maintain a control-conscious environment through an effective system of internal accounting controls supported by formal policies and procedures communicated throughout the corporation. These controls are adequate to provide reasonable assurance that assets are safeguarded against loss or unauthorized use and to produce the records necessary for the preparation of financial information. There are limits inherent in all systems of internal control based on the recognition that the costs of such systems should be related to the benefits to be derived. We believe the corporation's systems provide this appropriate balance.

The control environment is complemented by the corporation's internal auditors, who perform extensive audits and evaluate the adequacy of and adherence to these controls, policies, and procedures. In addition, the corporation's independent public accountants have developed an understanding of our accounting and financial controls, and have conducted such tests as they consider necessary to support their report below.

The board of directors pursues its oversight role for the financial statements through the Audit Committee, which is composed solely of outside directors. The Audit Committee meets regularly with management, the corporate internal auditors and Arthur Andersen LLP, jointly and separately, to receive reports on management's process of implementation and administration of internal accounting controls, as well as auditing and financial reporting matters. Both Arthur Andersen LLP and the internal auditors have unrestricted access to the Audit Committee.

The corporation maintains high standards in selecting, training and developing personnel to help ensure that management's objectives of maintaining strong, effective internal controls and unbiased, uniform reporting standards are attained. We believe it is essential for the corporation to conduct its business affairs in accordance with the highest ethical standards as expressed in Sara Lee Corporation's Code of Conduct.

John H. BryanChairman of the Boardand Chief Executive Officer

Judith A. SprieserSenior Vice Presidentand Chief Financial Officer

Problem #31

What are internal controls?

Who is ultimately responsible for the quality of and implementation of a business' internal controls?

What are some of the key internal controls associated with safeguarding a business' cash?

Identify some internal controls you might see at a local grocery store.

1.

2.

3.

4.

19

7-4


Policies and p rocedures impl emented by a busin ess t hat are designed to saf eguard as sets and insu re accur ate accounti ng records.

It is management's responsibility; the people who a re actually operating and running the company.

a. separation of dutiesb. proper authorization for transactionsc. adequate documentation and recordsd. independent checks on performance

- customers enter and exit store through designated areas- large checks need management approval to protect business from bad checks- credit card devices; eliminates risk of bad checks- security personnel- rotation of vegetables

1.

2.

3.

4.

1 2

3 4

5 6

Lesson 8

8-1

Lesson 8Long-Term Operating Assets

BALANCE SHEETNORM'S INC.

12/31/X1

LIABILITIES & OWNERS' EQUITY: Current Liabilities: Accounts Payable Salaries and Wages Payable Payroll Taxes Payable Sales Taxes Payable

Long-Term Liabilities: ? Owners' Equity: Capital Stock Retained Earnings Total Liabilities and Equity

$ xxx xxx xxx xxx xxx

xxx

xxx xxx$ xxx

ASSETS: Current Assets: Cash Accounts Receivable Less: Allowance for Uncollectible Accounts Receivable Inventory (FIFO, LIFO, MWA) Prepaid Expenses

Long-Term Assets: ? Total Assets

$ xxx xxx

( xxx) xxx xxx xxx

xxx$ xxx

10 10

.10 .10

Example: 100 pencils are purchased at a cost of $10 ($ .10/ea.):

Capitalized Costs vs. Expenses

Expensing an Expenditure

Pencil Expense Cash

Alternative accounting approach: Capitalizing an Expenditure

Pencil Expense Pencils

As each pencil is used up:

Pencils (Office Supplies)Cash

10 10

Property, Plant and Equipment - includes land, improvements, buildings, machinery and equipment with an expected useful life longer than one year.

Intangible Assets - includes patents, trademarks, copyrights, franchise rights, and goodwill with expected future benefit in excess of one year.

Natural resources - includes oil wells, mineral deposits, timber tracts, etc. with expected future benefits in excess of one year.

Long-Term AssetsNon-Current AssetsOperating AssetsCapital Assets

1.

2.

3.

Recording the acquisition of the asset.

Allocating the cost of the asset to expense over its useful life.

Recording any repairs or improvements to the asset.

Recording the sale or disposal of the asset.

Basic Accounting for Operating Assets

1.

2.

3.

4.

1. Recording the acquisition of an operating asset:

GAAP requires all direct or incidental costs incurred in acquiring an asset and preparing it for its original intended use to be capitalized as part of the cost of the asset.

Example: Assume a delivery truck is purchased on 1/1/X4 for $60,000 paying $20,000 in cash and executing a note payable for the balance. In addition, $1,800 is paid in sales taxes along with $1,200 in shipping and prep costs and $2,000 for a customized paint job.

20,00040,000

5,000

Truck 60,000Cash Note Payable

Truck 5,000Cash

7 8

9 10

11 12

8-2

Depreciation Expense (Property, Plant and Equipment)

2. Allocation of the cost of an asset to expense over its useful life.

ExpenseAsset

xxxxxx

The Matching Principle

Why is allocation of an operating asset's cost over time necessary?

Depletion Expense (Natural Resources)Amortization Expense (Intangibles)

Terms:

6

Example: Assuming the truck purchased in the previous example has an estimated useful life of 6 years with an estimated salvage value at the end of those six years of $5,000, calculate and then prepare the required adjusting entry at 12/31/X4 for depreciation expense for the year using the straight-line method.


Depreciation Expense 10,00010,000

$10,000 per year =

# years of useful lifeCost - Salvage Value Straight-Line

Depreciation =

- =

Accumulated Depreciation

$65,000 $5,000

$65,000 (10,000)$55,000

Accumulated Depreciation is a Contra-Asset Account

Why use a contra-asset account rather than reduce the asset directly?

Long-Term Assets:Balance Sheet

TruckAccumulated Depreciation Book Value

Long-Term Assets:

Balance Sheet

Truck $55,000

What would be the Book Value of the truck at the end of 'X5?

What would be the Book Value of the truck at the end of the 6th year of ownership?

$65,000 (60,000)$ 5,000

$65,000 (20,000)$45,000

TruckLess: Accumulated Depreciation Book Value

TruckAccumulated Depreciation Book Value

10,000 12/31/X410,000 12/31/X520,000


Modify the example's truck purchase from date 1/1/X4 to 4/1/X4 and prepare the adjusting entry for depreciation at 12/31/X4:

$10,000 × 9/12 = $7,500

Depreciation Expense:Yr 1 2 3 4 5

6 7

$ 7,50010,00010,00010,00010,00010,000 2,500

$60,000

Units of Production Method of Calculating Depreciation

Depreciation ExpenseAccumulated Depreciation

7,8007,800

$.60 x 13,000 = $ 7,800

Example: Using the same information for the truck with a capital cost of $65,000 and assuming that instead of an estimated useful life of 6 years, the truck's usefulness is estimated at 100,000 total miles. Now if the truck is actually driven 13,000 miles in 20X4 then the total amount of 'X4 depreciation expense to be recorded will be:

$.60/mile $65,000 - $5,000100,000 miles=

13 14

15 16

17 18

8-3

General Ledger

Equipment Subsidiary Ledger

Accumulated DepreciationSubsidiary Ledger

Equipment Accumulated Depreciation

Truck #1

Truck #5

Truck #4

Truck #3

Truck #2

Accum. Depr.-Truck #1





xxxxxxxxxxxx

xxxxxxxxxxxx

xxxx

xxxx

xxxx

xxxx

xxxx

xxxx

xxxx

xxxx

xxxx

xxxx

Equipment

Depreciation Expense Accumulated Depreciation

XXXX

Example: A tuneup and oil change on the truck costing $250 is paid in cash.

3. Recording of any repairs, maintenance, or improvements to operating assets.

GAAP requires any costs incurred in normal recurring repairs and maintenance of property, plant or equipment to be expensed in the period incurred.

250250

Repair and Maintenance ExpenseCash

Example: In 20X7 the truck's engine gives out and is replaced in a complete overhaul costing $7,000. It is expected that this overhaul will increase the estimated useful life four years beyond the original estimate.

GAAP requires any costs incurred in improvements to property, plant or equipment to be capitalized as an increase in the original cost of the asset. Improvements are costs that significantly increase the original productivity of an asset or extend the useful life beyond what was originally estimated.

TruckCash

7,0007,000

$ 72,000(30,000)$ 42,000

Revised Useful Life:Original LifeIncrease due to Improvement

Revised Capitalized Cost:Original CostCost of Improvement

Revised Book Value:Revised Capitalized CostLess: Accumulated Depreciation

$ 65,0007,000

72,000

6 Years4 Years

10 Years (7 Years Remaining)

Upon sale or disposal of an asset, the book value of the asset must be removed from the accounting records. The difference between the sales price and the book value of the asset will generate a gain or loss on the sale.

Example: Assume the truck purchased in the previous example at 1/1/X4 with a capitalized cost of $65,000 is depreciated on a straight-line basis and no improvements have been made to date. If the truck is sold or disposed of at 1/1/X6, prepare the journal entry to record the sale or disposal under the following three separate scenarios:

4. Recording the sale or disposal of the asset:

19 20

21 22

23 24

8-4

1. Truck sold for $47,000 cash.

Truck Accumulated Depreciation 65,000

What kind of account is "Gain on Sale"?

$47,000 - $45,000 = $2,000Sale Price - Book Value = Gain or Loss

Alternative calculation of the gain:

65,0000

65,000

020,000

20,00010,00010,000

CashAccumulated Depreciation

Truck

47,00020,000

65,000 2,000Gain on Sale of Truck

Norm's Inc.Income Statementfor the year ending

12/31/X1

Sales RevenuesLess: Sales Discounts Sales Returns and Allowances Net Sales RevenuesLess: Cost of Goods Sold Gross MarginLess: Operating Expenses Salaries Expense Payroll Tax Expense Utility Expense Property Tax Expense Operating Income

$ xxx (xxx) (xxx) xxx (xxx) xxx

(xxx) (xxx) (xxx) (xxx) xxx

Other Revenues and Expenses Interest Revenue Interest Expense Gain on Sale of Equipment Income before inc. taxIncome Tax Expense Net Income/Loss

xxx (xxx) xxx xxx (xxx)$ xxx

2. Truck sold for $40,000 cash.

$40,000 - $45,000 = ($ 5,000)Sale Price - Book Value = Gain or Loss

Alternative calculation of Loss:

CashAccumulated Depreciation

Truck

40,00020,0005,000

65,000

What kind of account is "Loss on Sale"?

Loss on sale of Truck

Problem #32

John's Delivery Company purchased a used delivery truck for $20,000 cash on 5/1/X4. Additional costs incurred at the time of purchase and paid in cash were $1,200 of sales tax. John had the truck painted for $1,000 and the engine over-hauled for $1,800 prior to its initial use.

Prepare the journal entry(ies) to record all of the costs to be capitalized as part of the cost of the asset (truck).

Prepare the 12/31/X4 and 12/31/X5 adjusting entries to record the 20X4 and 20X5 depreciation expense on the truck using straight-line depreciation and estimating a 7 year useful life with a $3,000 salvage value. (Remember that depreciation in 20X4 should be for a partial year.)

A.

B.

Problem #32

Calculate the truck's book value at 12/31/X6 if an appraisal shows that the truck could be sold for $14,000.

Prepare the journal entry to record the payment of $250 for an engine tune-up and oil change and, $750 for a new set of tires in 20X6.

What would have been the amount of depreciation in the first year given the units of production method? Estimated use of 60,000 miles with 0 salvage value. Actual use in the first year is 10,000 miles.

C.

D.

E.

3. Truck disposed of with a hauling fee of $500.

$0 - $45,000 = ($45,000)

Accumulated DepreciationLoss on Disposal of Truck

TruckCash

20,00045,500

65,000500

Sales Price - Book Value = Loss on Disposal

25 26

27 28

29 30

8-5


A. TruckCash

TruckCash

Other Capitalized Costs:

Sales TaxPaintEngine Overhaul

20,00020,000

4,000 4,000

$1,2001,0001,800

$4,000


B. Depreciation Calculation:

24,000 - 3,000

$3,000 x 8/12 = $2,000


12/31/X4:

12/31/X5:


720X4:

$2,000 $2,000

$3,000 $3,000

$3,000 per year =


Book Value at 12/31/X6

Book Value:


D.

C.

2,000 12/31/X43,000 12/31/X53,000 12/31/X68,000 12/31/X6

Balance

Truck's Original Cost Less:

$24,000 $8,000$16,000

Repair & Maintenance

Repair and Maintenance Expense Cash

Accumulated

1,0001,000

Depreciation


E. $24,000 - 060,000

$.40 per mile

10,000 x $.40 = $4,000 depreciation

=

Problem #33

Prepare the journal entry to record the 12/31/X6 sale or disposal of the truck described in Problem #32 under the following separate scenarios:

A. The truck is sold for $17,000 cash.

B. The truck is sold for $10,000 cash.

C. The truck is no longer operable and is hauled to an auto/truck junk yard at a cost of $200.


Truck Accum. Depreciation

A. Cash Accumulated Depreciation

17,0008,000

Truck Gain on Sale

24,0001,000

24,000

12/31/X6 24,00024,000

0

Gain/Loss on Sale: Sales Price Less: Book Value

Gain on Sale

X4X5 X6

12/31/X6 8,000

3,0003,0002,000

8,0000

$17,000 (16,000) $1,000

31 32

33 34

35 36

8-6

What do you suppose is Coca-Cola's most valuable asset?

Intangible assets are reflected on the balance sheet only if there is an identifiable historical cost attributable to it.

Trademarks are recorded as an asset only when rights are purchased.Patents are recorded as an asset if patent rights are purchased. Internally developed patents are recorded only to the extent of filing fees and legal costs in aplication.

Under GAAP, research and development costs are to be expensed when incurred even if such costs may contribute to a patentable discovery.

Allocation of the cost of an intangible over its useful life is referred to as amortization. In most cases the life is established by contract or law. Amortization is traditionally calculated on a straight-line basis with no salvage value and recorded with the following entry:

Any capitalized costs of intangibles reflected on the balance sheet must be allocated to expense over its life.

Amortization ExpenseAccumulated Amortization

XXX XXX

Contra Asset Account


B.

C.

Loss on SaleCashAccumulated Depreciation

Truck

6,00010,000 8,000

24,000

Gain/Loss on Sale:Sales PriceLess: Book Value

Loss on Sale

$10,000(16,000)($6,000)

Loss on DisposalAccumulated Depreciation

TruckCash

16,2008,000

24,000200

Most intangible assets represent rights that have future benefit, such as:

Trademark: The right to use a name, logo, picture, sound or any other distinguishing symbol. Trademark rights can be sold or licensed to others.

Intangible Assets

Patent: An exclusive right to use an invention or discovery in the production and sale of goods or services. This right is issued by the Federal government for a 20 year term. A patent can be sold or its use can be licensed.Franchise Rights: An exclusive right to sell a certain product or service within a designated geographic area. These rights are usually purchased from an existing business and the terms of the rights are governed by contact.Copyrights: Exclusive rights that protect the works of authors and other creative persons or businesses against copying or unauthorized use. Copyrights can be sold or licensed to others.

Intangible assets are reflected on the balance sheet only if there is an identifiable historical cost attributable to it.

Franchise rights are recorded at their contract cost in purchasing rights.

Copyrights are recorded only when purchased.

Any legal fees and court costs incurred in the successful defense of any of thses rights should be capitalized to the asset.

FYI

The accounting for research and development costs under international accounting standards (IFRS) is different than it is for U.S. GAAP. Under IFRS, research costs are expensed as they are under GAAP but any development costs are capitalized. In other words, once a company’s research efforts to develop a new product, service or process reaches a point where its technological feasibility is established then all subsequent costs incurred in the actual development effort are capitalized as part of the cost of an asset to be reflected on the company’s balance sheet. The cost of that asset is then expensed over its anticipated useful life. Ultimately it is anticipated that U.S. GAAP will be changed to correspond to the international standard.

37 38

39 40

41 42

8-7

The entry to record this amortization would be:

What would be the book value of the patent at the end of the 2nd year?

CostLess:Accumulated Amortization

50,000

(20,000)30,000

Amortization ExpenseAccumulated Amortization

10,000 10,000

Goodwill exists if the business is actually worth more than the value of its assets less liabilities.

The amount to be recorded is the excess price paid in the purchase of a business above the fair market value of the assets purchased less any liabilities assumed.

Goodwill is recorded as an asset only when a business is purchased.

Goodwill

.

.

TACO SHOPNORM'S

BURGERS

Assets:Liabilities:Owners' Equity:

Net incomethis year:

$335,000(25,000)310,000

$30,000Net incomethis year:

$335,000(25,000)310,000

Assets:Liabilities:Owners' Equity:

$150,000

Example: Assume that the Taco Shop is purchased for $500,000 cash and the assumption of the business liabilities. The current fair market value of the assets purchased and liabilities assumed are as follows:

InventoryLandBuilding Fixtures and Equipment

$ 10,000 50,000 200,000 75,000$ 335,000

Goodwill PurchasedPurchase Price

Net Assets Purchased

$ 190,000$ 500,000$ 310,000

(25,000)Accounts Payable

Entry to record restaurant purchase:InventoryLandBuildingFixtures and Equipment Goodwill Accounts Payable Cash

10,000 50,000 200,000 75,000 190,000

How should goodwill be subsequently accounted for?

25,000 500,000

In the past GAAP required goodwill to be amortized to expense over an estimated life not to exceed 40 years.

For example:Assume a patent with a remaining legal life of 5 years is purchased at a cost of $50,000 cash. The entry to record the purchase would be:

PatentCash

50,000 50,000

$50,0005 years = $10,000 per year

43 44

45 46

8-8

Natural Resources

Recorded at their historical cost:

Oil Rights/WellCash

10,000,00010,000,000

500,000 barrels are extracted and sold in the current year:

$10 million/20 million barrels = $ .50 per barrel.

Example: If geological studies indicate that the oil well has approximately 20 million barrels in reserve, then depletion expense would be calculated at:

Depletion ExpenseAccumulated Depletion

250,000250,000

500,000 × $ .50 = $250,000 depletion expense

Problem #34

Indicate whether the following statements are true or false.

Intangible assets are not reflected on the balance sheet because they have no physical substance and cannot be sold.

Costs of research and development resulting in a patented technology should be capitalized as part of the cost of the patent and amortized over a 17 year life.

Amortization of intangibles and depletion of natural resources are both cost allocations to expense required under the matching principle.

Goodwill is only recorded on the books of a company that purchases another company.

Depletion of natural resources is typically calculated based on a units of production approach.

A.

B.

C.

D.

E.


Intangible assets are not reflected on the balance sheet because they have no physical substance and cannot be sold.

Costs of research and development resulting in a patented technology should be capitalized as part of the cost of the patent and amortized over a 17 year life.

Amortization of intangibles and depletion of natural resources are both cost allocations to expense required under the matching principle.

Goodwill is only recorded on the books of a company that purchases another company.

Depletion of natural resources is typically calculated based on a units of productionapproach.

A.

B.

C.

D.

E.

True

False

False

True

True

Current rules now require an annual comparison of recorded goodwill to its current fair market value. The fair market value refers to the excess price, above the current value of assets less liabilities, that would be paid today if the business unit were available for purchase.

If the amount of goodwill has increased from one year to the next, no gain is reported. If, on the other hand, the amount of goodwill has decreased, a loss is to be recorded in the income statement and the reduction reflected in the goodwill amount on the balance sheet.

Conservatism prevails.

47 48

FYI

Although current U.S. GAAP requires that all operating assets be originally recorded at their historical cost and then depreciated, amortized or depleted over their estimated useful lives, international accounting standards (IFRS) also allow the possible recording of current fair market values, including increases in values for property, plant and equipment and intangible assets.

1 2

3 4

5 6

Lesson 9

9-1

Lesson 9Debt and Equity Financing

Assets:Current Assets:

Cash $ xxxAccounts receivable xxxLess: Allowance for

( xxx)

xxx

Inventories

xxx

Prepaid Expenses

xxx

xxx

Long-Term Assets:Property and Equipment

xxx

Less: Accum. Dep'n. (xxx)

xxx

$ xxxTotal Assets:

Uncollectible A/R

Liabilities and Stockholders' Equity:

Current Liabilities:Accounts Payable $ xxxWages Payable

xxxPayroll Taxes Payable xxx

xxx

Long-Term Liabilities:?

Stockholders' Equity:?

Balance Sheet

xxxIntangibles

Long-Term Notes Payable

Mortgage Notes Payable

Bonds Payable

Long-Term Liabilities

Lease Liabilities

Deferred Income Taxes Payable

Pension Liabilities

Long-Term Liabilities

Long-Term Note Payable:

Example: $100,000 is borrowed from the bank on 9/1/X5. The note

Entry at 9/1/X5:

Cash 100,000Note Payable 100,000

Adjusting entry at 12/31/X5: (Interest: 100,000 x .08 x 4/12 = 2,666.66)

Interest Expense 2,667Interest Payable 2,667

bears 8% annual interest payable every six months and matures in three years.

Entry at 3/1/X6: (Interest: 100,000 x .08 x 6/12 = 4,000.00)(Interest: 100,000 x .08 x 2/12 = 1,333.33)

Interest Payable

2,667

Interest Expense

1,333

Cash4,000

Entry at 9/1/X6: (Interest: 100,000 x .08 x 6/12 = 4,000.00)

Interest Expense

4,000

Cash 4,000

Adjusting entry at 12/31/X6: (Interest: 100,000 x .08 x 4/12 = 2,666.66)

Interest Expense

2,667

Interest Payable

2,667Interest recorded for the entire year 'X6:

3/1/X6: $ 1,3339/1/X6: 4,00012/31/X6: 2,667

$ 8,000 (100,000 x .08 x 1 = $8,000)

Entry at maturity 9/1/X8:

Interest Expense4,000Cash

4,000

Note Payable 100,000Cash 100,000

7 8

9 10

11 12

9-2

Problem #35

On 5/1/X4, $15,000 cash is borrowed from a local bank under a note bearing interest at 12% payable annually on 5/1/X5 and 5/1/X6. The principal amount is due at maturity, 5/1/X6.

a. Prepare all the journal entries required throughout the life of the note assuming all principal and interest payments are made on a timely basis. (Do not forget the adjusting entries required for interest expense at 12/31/X4 and 12/31/X5 in order to properly prepare financial statements on those dates.)

b. Determine the amount of interest expense recognized under the note in each year 20X4, 'X5, and 'X6 along with the total interest expense recognized over the entire term of the note.


5/1/X4:

15,00015,000


Interest Expense Interest Payable 1,200

1,200

($15,000 x .12 x 8/12 = $1,200)

(May 1st - Dec. 31st)

5/1/X5:

Interest PayableInterest Expense

1,200600

1,800Cash

($15,000 x .12 x 12/12 = $1,800) ($15,000 x .12 x 4/12 = $600)

(Date first interest payment due)

CashNote Payable

A.


($15,000 x .12 x 8/12 = 1,200)


Interest ExpenseInterest Payable

1,2001,200

($15,000 x .12 x 12/12 = 1,800)

5/1/X6:

Note PayableCash 15,000

15,000

(Maturity)


1,200600

1,800Cash


20X4

20X5

20X6

$1,200

1,800 600

$3,600

Year Interest Expense

($15,000 x .12 x 24/12 = $3,600)

Interest Expense:B.

(8 mos. 5/1 - 12/31)

(12 mos. 1/1 - 12/31)

(4 mos. 1/1 - 5/1)

Mortgage Note Payable:

A mortgage note payable is a loan or note payable for which real estate (land and/or building) has been pledged as collateral or security through a legal document referred to as a trust deed. A trust deed authorizes a third party to sell the property, in the event of default on the note payable, and disburse the proceeds from the sale to the lender.

Mortgage Notes Payable are usually created in conjunction with the purchase of real estate.

Loan$135,000

Sign Note Payablefor $135,000

DeedSecured by aDeed of Trust

Authorized to sell condo in the

event owner fails to make payments to

the bank.

CondoCondo

BankBank

Trustee

$ 15,000135,000150,000

Your own cashCash borrowed from bankPurchase price paid to seller of condo

$150,000

13 14

15 16

17 18

9-3

New buyer at$160,000

SALE OF CONDO(due to loan default)

FORECLOSURE

$ ExcessCondoCondo

BankBank

Trustee$160,000

$135,000Plus interestand penalties

Any

Common Characteristics of Mortgage Notes Payable:

1. Typically long-term (15, 25 or 30 years)

2. Typically bears a fixed or adjustable rate of interest.

3. Typically requires a monthly payment (fixed in amount or adjustable) which includes not only the monthly interest due, but a portion of the principal such that by maturity, the entire amount of principal will have been repaid in full (fully amortizing note).

4. Most mortgage notes provide that monthly payments be applied first to any interest due at the time of payment with any excess paid to be applied to principal.

Example: On 4/1/X7, real estate is purchased for $300,000 (land and building valued at $50,000 and $250,000, respectively) with the price paid in cash ($30,000) and the execution of a mortgage note payable ($270,000). Record the transaction:

4/1/X7:

LandBuilding

CashMortgage Note Payable

50,000250,000

30,000270,000

2,025.00147.48

Interest ExpenseMortgage Note Payable

Cash

Assume that the $270,000 mortgage note payable is a fully amortizing mortgage over 30 years and bears 9% annual interest compounded monthly, with monthly payments of $2,172.48 payable on the 1st of each month beginning 5/1/X7 for the next 30 years.

Entry for 1st payment at 5/1/X7:(Interest: 270,000 x .09 x 1/12 = 2025.00)

2,172.48

Mortgage Note Payable270,000

147.48269,852.52

Entry for second payment on 6/1/X7:(Interest: 269,852.52 x .09 x 1/12 = 2,023.89)

Mortgage Note Payable 270,000

147.48148.59

269,703.93

Interest ExpenseMortgage Note Payable

Cash

2,023.89148.59

2,172.48

Mortgage Amortization ScheduleBeginningPrincipalBalance

270,000.00269,852.52269,703.93269,554.23

269,403.41269,251.46269,098.37268,944.13

6,420.864,296.542,156.28Totals

InterestPortion2,025.002,023.89 2,022.782,021.662,020.532,019.392,018.242,017.08

48.1632.2216.17

512,093

PrincipalPortion147.48148.59149.70150.82151.95153.09154.24155.40

2,124.322,140.132,156.28270,000

MonthlyPayment

2,172.48

2,172.48 2,172.482,172.482,172.482,172.482,172.482,172.482,172.48

2,172.482,172.48

Month12 345678

358359360

19 20

21 22

23 24

9-4

How do you build equity in real estate?(In this context, equity means the amount of cash left to the

owner in the event of sale of property.)

Purchase of property:Cash down (equity) $ 30,000Mortgage note payable 270,000

$ 300,000Cash proceeds upon sale after two months (assume no selling costs):

Sales price $ 300,000Payoff of mortgage note payable (269,704)

Net cash upon sale $ 30,296

Total purchase price

Build up in equity over two months:

Cash invested upon purchaseCash proceeds upon sale

Build up in equity (cash)(30,000)

$ 30,296

$ 296

$ 296 = Principal portion of monthly mortgage payments for two months.

Most build up in equity on real estate comes from appreciation in property value over time.

Net cash upon sale

Build up in Equity for the year:Cash received upon sale $ 38,745Cash invested at purchase (30,000)

Build up in equity $ 8,745

Sales price $ 330,000Less: Selling costs (7%) (23,100)

Net sales price 306,900Payoff of note payable

$ 38,745(268,155)

Assume the property is sold after one year.What caused this $8,745 build up in equity?

Appreciation in value:Net sales price $ 306,900Less: Original cost 300,000

Net appreciation $ 6,900

Plus: Payments of principal on the note during the year:

(270,000 - 268,155) $ 1,845Build up in equity $ 8,745

Problem #36

A building, including the land upon which it sits, is purchased on 7/1/X2 for $400,000 with 10% of the price paid for in cash and the remainder through the execution of a Mortgage Note Payable. The mortgage note bears an 8% fixed interest rate compounding monthly for 30 years and is fully amortizing with monthly payments of $2,641.55 due on the 1st of each month beginning on 8/1/X2.

A. Prepare the journal entry to record the purchase of the land and building on 7/1/X2. (Assume that the land is valued at 20% of the total price.)

B. Why would allocation of the purchase price between land and building be important for financial reporting and income tax purposes?

C. Prepare the 8/1/X2 and 9/1/X2 entries to record the monthly mortgage payments on those dates.

Problem #36

D. Determine the balance of the Mortgage Note Payable on 9/1/X2 following the monthly payment on that date.

E. What would be the effect if monthly payments in excess of $2,641.55 were periodically made?

25 26

27 28

29 30

9-5


A building, including the land upon which it sits, is purchased on 7/1/X2 for $400,000 with 10% of the price paid for in cash and the remainder through the execution of a Mortgage Note Payable. The mortgage note bears an 8% fixed interest rate compounding monthly for 30 years and is fully amortizing with monthly payments of $2,641.55 due on the 1st of each month beginning on 8/1/X2.

A. Prepare the journal entry to record the purchase of the land and building on 7/1/X2. (Assume that the land is valued at 20% of the total price.)

Land Building Mortgage Note Payable Cash

80,000320,000

360,00040,000


B. Why would allocation of the purchase price between land and building be important for financial reporting and income tax purposes?

Land is not depreciable. The greater the allocation to the building, which is depreciable, the higher the depreciation expense and lower resulting net income for financial reporting purposes. This would also result in lower income taxes.


C. Prepare the 8/1/X2 and 9/1/X2 entries to record the monthly mortgage payments on those dates.

8/1/X2:

Interest Expense Mortgage Note Payable Cash

9/1/X2:

Interest Expense Mortgage Note Payable Cash

2,400.00241.55

2,641.55

2,398.39243.16

2,641.55


D. Determine the balance of the Mortgage Note Payable on 9/1/X2 following the monthly payment on that date.

Mortgage Note Payable

8/1/X2 241.559/1/X2 243.16

360,000 7/1/X2

359,515.29


E. What would be the effect if monthly payments in excess of $2,641.55 were periodically made?

The term of the note would be shortened. The note would be paid off in less than 30 years.

BondsBonds are Notes Payable arising from the borrowing of cash from the public.Example: On 11/1/X3, XYZ Corporation issued $1,000,000 of cash through bonds issued at face value, bearing interest at an annual rate of 7% payable semi-annually on 5/1 and 11/1 of each year through maturity at 11/1/X6.

Entry at 11/1/X3:

CashBonds Payable

1,000,0001,000,000

Adjusting Entry at 12/31/X3:(Interest: 1,000,000 x .07 x 2/12 = 11,667)

Interest ExpenseInterest Payable

11,66711,667

31 32

33 34

35 36

9-6

Bonds PayableCash

Interest ExpenseCash

1,000,000

35,000

Entry at Maturity, 11/1/X6:

Entry at 11/1/X4:Interest Expense

Cash35,000

35,000

Entry at 5/1/X4: (Interest: 1,000,000 x .07 x 6/12 = 35,000)(Interest: 1,000,000 x .07 x 4/12 = 23,333)


Cash

11,66723,333

35,000

1,000,000

35,000

Common Terms Associated with BondsBond Indenture: The written contract that spells out the legal terms and conditions of the obligations of the bond issuer and the rights of the bondholders.

Debentures: Unsecured bonds.

Secured or Mortgage-Backed Bonds: Bonds for which property or real estate are specified as collateral.

Junk Bonds: Unsecured bonds issued by companies with low credit ratings.

Senior or Subordinated Bonds: Typically unsecured bonds that are designated as having priority or subordinated rights to other unsecured creditors.

Term Bonds: Bonds that require principal repayment in full at maturity.

Problem #37

On 8/1/X3, a company borrows $10,000,000 cash from the public through the issuance of bonds that mature in three years and bear interest at a rate of 9%. The interest is payable quarterly.

Prepare the journal or adjusting entries required to record:a.

8/1/X3: The issuance of the bonds at their face value of $10,000,000

11/1/X3: The quarterly interest payment

12/31/X3: The adjusting entry for interest expense

2/1/X4: The quarterly interest payment

8/1/X6: The final quarterly interest payment and payoff of the principle amount of the bonds

Problem #37

c. - What is a debenture?- What is a mortgage bond?- What is a junk bond?- What is a serial as opposed to a term bond?- What is a convertible bond?- What is a callable bond?

b. What entry would the company make on their books if a bondholder owning $10,000 of the bond sold that bond to an investor through the New York Bond Exchange at a price of $10,500?

Serial Bonds: Bonds that require principal repayment periodically throughout the term of the bond.

Convertible Bonds: Bonds which may be converted to other securities, such as stock, after a specified period of time, at the option of the bondholder.

Callable Bonds: Bonds which can be paid off prior to maturity at the option of the company issuing the bonds.

Bonds issued at a premium or a discount: Bonds which are issued for cash in an amount greater or less than the face amount or principal of the note.

Bond Exchange: A market where bondholders may sell their bonds to other investors.

a. 8/1/X3:

Cash 10,000,000Bonds Payable 10,000,000

11/1/X3:

Interest Expense 225,000Cash 225,000

(Interest: 10,000,000 x .09 x 3/12 = 225,000)

12/31/X3:

Interest Expense 150,000Interest Payable 150,000

(Interest: 10,000,000 x .09 x 2/12 = 150,000)

The issuance of the bonds at their face value of $10,000,000

The quarterly interest payment

The adjusting entry for interest expense


37 38

39 40

41 42

9-7

(continued)

2/1/X4:

Interest Payable 150,000Interest Expense 75,000

Cash 225,000

(Interest: 10,000,000 x .09 x 1/12 = 75,000)

8/1/X6:

The quarterly interest payment

The final quarterly interest payment and payoff of the principle amount of the bonds

a.

Interest Expense 225,000Bond Payable 10,000,000

Cash 10,225,000


What is a debenture? Unsecured bond.What is a mortgage bond? Bond for which property or real

What is a junk bond? Unsecured bond issued by a company

Term: Bond that requires principal repayment in full at

What is a serial as opposed to a term bond?

What is a convertible bond? Bonds which may be converted

What is a callable bond? Bond which can be paid off prior to maturity at the option of the company issuing the bond.

throughout the term of the bond.

to other securities, such as stock, after a specified period of time, at the option of the bondholder.

Serial: Bond that requires principal repayment periodically

estate is specified as collateral.

with a low credit rating.

maturity.

c.No entry on the company's books.b.


1. Debt Financing (Borrowing): Accounts Payable Notes Payable Bonds Payable Other Payables

2. Equity Financing (Investor/Owners): Capital Contributions (Capital Stock) Retained Earnings

Financing of a Business(Obtaining resources necessary to operate a business)

Common Stock: The basic form of ownership for all corporations. Common stockholders have the right to vote in corporate matters (ie. election of a board of directors), the right to share equally per share in corporate profits paid out as dividends and any distributions to owners in the event of business termination. All companies issue common stock and are controlled or owned by the common stockholders or owners.

Preferred Stock: A supplemental form of ownership which provides certain preferential but limited rights to those of common shareholders. Preferred shareholder's typically have no voting rights but have a limited priority right over common shareholders to dividends and distributions in the event of termination. Many companies do not issue preferred stock, but it is an option available in the financing of a business.

Two Basic Forms of Corporate Ownership or Capital Stock

Common StockExample: A company issues 10,000 shares of $ .01 par value common stock for $50 per share.

Cash 500,000Common Stock, at par ($ .01) per share 100Paid in Capital in Excess of Par, Common Stock 499,900

Balance SheetStockholders' Equity:

Contributed Capital:Common Stock, $.01 Par Value $100Paid in Capital in Excess of Par,

Common Stock 499,900$500,000

Retained Earnings 250,000Total Stockholders' Equity $750,000

Example: A company issues 10,000 shares of $ .01 stated value common stock for $50 per share.

Cash 500,000Common Stock, at Stated Value ($ .01) per share

100

Paid in Capital in Excess of Stated Value, Common Stock 499,900


Contributed Capital:Common Stock, $.01 Stated Value $100Paid in Capital in Excess of Stated

Value, Common Stock 499,900$500,000


43 44

45 46

47 48

9-8

Disadvantages in raising capital through the issuance of common stock:

Others are given a vote and say in the business.

Others are given rights to participate in the monetary benefits of ownership (dividends, increased stock values, and proceeds in the event of liquidation).

Disadvantages of raising capital through debt:

Capital borrowed (principal) must be paid back plus interest at scheduled times regardless of operating performance and ability to pay.

Potential forced liquidation of assets in the event of default.

1.

2.

1.

2.

Preferred Stock is a form of equity ownership that is designed to avoid the disadvantages of common stock without becoming debt that has to be repaid in the future.

1.2.3.

Preferred Stock

typically non-voting,limited in the sharing of dividend distributions,reflected as "owners equity" on the balancesheet because the company is not required to repaythe amount of capital contributed by preferredshareholders except in the event of businesstermination.

Preferred Stock is:

Why would anyone ever make capital contributions to a company in exchange for preferred stock?

Preferred shareholders have dividend limitations but they also have dividend preferences over common shareholders.

Preferred shareholders have preferences in the distribution of assets in the event of business termination.

Some tax benefits to corporate investors.

1.

2.

3.

How is the dividend preference determined?

Example: In addition to 10,000 shares of no par value common stock issued at $50 per share, the company issues 5,000 shares of 7%, $100 par value preferred stock for $105 per share.

CashPreferred Stock

525,000525,000

.07 x $100 = $7 per share, per year

$7$105 = 6.67%

Annual return on investment

Corporation Inc.Investor

$ 105 Investment

$ 7 Dividend

How does a preferred shareholder ever get their money (investment) back?

1. Wait until the business terminates.

2. Sell to other investors.

Example: A company issues 10,000 shares of no par value common stock for $50 each in cash.

Cash 500,000Common Stock (no Par Value) 500,000


Contributed Capital:Common Stock $500,000


49 50

51 52

53 54

9-9

Problem #38

The Asay Co. wishes to raise $100,000 of cash from investors (equity financing). Prepare the journal entry that would be appropriate for each of the following independent scenarios:

Calculate the annual dividend preference for the 5,000 shares of preferred stock under D above.

Issue 10,000 shares of $.01 par value common stock for $100,000 cash.

Issue 10,000 shares of $.01 stated value common stock for $100,000 cash.

Issue 10,000 shares of no par common stock for $100,000 cash.

Issue 5,000 shares of 6% $15 par value preferred stock for $100,000 cash.

a.

b.

c.

d.


a. Cash 100,000Common Stock, Par Value 100Paid-In Capital in Excess of Par, Common Stock 99,900

b. Cash 100,000Common Stock Stated Value 100Paid-In Capital in Excess of Stated Values, Common Stock 99,900

c. Cash 100,000Common Stock 100,000

d. Cash 100,000Preferred Stock, Par Value 75,000Paid-In Capital in Excess of Par, Preferred Stock 25,000

Dividend preference for Preferred Stock: 75,000 x .06 = $4,500 annually

The Process of Dividend Declaration and PaymentExample: On 11/1/X5 the company's Board of Directors meet and declare a total dividend of $100,000 to be paid to shareholders of record as of 12/1/X5 with actual payment to be made on 1/1/X6.

Entry at 11/1/X5 (Date of Declaration):

Dividends, Preferred StockDividends, Common Stock

Dividends Payable

35,00065,000

100,000

Note: Preferred shareholders will receive $7 for every share of stock held and the common shareholders will receive $6.50 ($65,000 ÷ 10,000 shares) for every share held.

Entry at 12/1/X5 (Date of Record):No Entry

Entry at 11/1/X5 (Date of Declaration):

Dividends, Preferred StockDividends, Common Stock

Dividends Payable

35,00065,000

100,000

Entry at 12/1/X5 (Date of Record):No Entry

Closing Entry at 12/31/X5:

Retained EarningsDividends, Preferred StockDividends, Common Stock

100,00035,00065,000

Entry at 11/1/X6 (Date of Payment):

Dividends PayableCash

100,000100,000

Do the preferred shareholders have any ongoing future rights to the $15,000 deficiency in current year dividends?

If preferred stock is designated as "cumulative," shareholders have an ongoing carryover preference for any prior year dividend shortfalls referred to as "dividends in arrears.""Non-cumulative" preferred stock has no carryover rights on dividend shortages in any year.

How are the rights of preferred shareholders to dividends in arrears disclosed in the financial statements?

Dividends in arrears are disclosed in the footnotes to the financial statements.

Assume only $20,000 of dividends had been declared on 11/1/X5Entry at 11/1/X5 (Date of Declaration):Dividends, Preferred Stock

Dividends Payable20,000

20,000

Are they a liability? NO!

Dividend Preference: 7% x $100 x 5,000 shares = $35,000

the prior example amount to $15,000 in 20X5, and declared dividends for 20X6 amount to $75,000, how much would go to the preferred versus common shareholders?

How much goes to the Preferred vs. Common Shareholders if a $10,000,000 dividend was declared?

Preferred - $50,000 Common - $9,950,000

What kind of stock (Preferred vs. Common) would an aggressive investor looking to maximize profits prefer to own?

Preferred Dividend:20X5 arrears of20X6 preference

Total Dividend

Common Dividend:

$ 15,00035,000

$ 50,000

$ 25,000

Common Stock

preferred stock inExample: If dividends in arrears on the cumulative

55 56

57 58

59 60

9-10

Problem #39

Prepare the journal entries for Smith Co. for the following events:

11/1/X7 - The board of directors declares a $100,000 cash dividend payable to common shareholders with a date of record of 12/1/X7 and date of payment scheduled for 1/1/X8.

12/1/X7 - Date of record noted.

12/31/X7 - Closing entry made.

1/1/X8 - payment of $100,000 cash dividend made prorata to all common shareholders.

A.

B.

C.

D.


Dividends, Common Stock

Dividends Payable

100,000

100,000

b.

a.

No entry.

c. Retained Earnings

Dividends, Common Stock

Dividends, Payable

Cash

100,000

100,000

100,000

100,000

d.

Problem #40

Given the following information at year-end, prepare the Stockholders' Equity section of a balance sheet:

Questions:At what average price per share has the company's Common Stock been issued? Preferred Stock?Assuming that no dividends are in appears at the beginning of the year, determine the rate of the dividend preference for preferred stock.

A.

B.

Accounts ReceivableDividends, Common StockCommon Stock, $.01 par value, 20,000 sharesRetained Earnings (Beginning of year)Paid in Capital in Excess of Par, Preferred StockBonds PayableDividends, Preferred StockPreferred Stock, $50 par value, 10,000 sharesPaid in Capital in Excess of Par, Common StockNet Income

$ 150,000350,000

200625,000

30,0003,000,000

50,000500,000900,000550,000


Stockholders' Equity:Contributed Capital -

Preferred Stock, $50 par value,

Common Stock, $.01 par value,

Paid in Capital in Excess of Par,

Paid in Capital in Excess of Par,

Retained EarningsTotal Stockholders' Equity

Retained Earnings,

Add: Net IncomeLess: DividendsRetained Earnings,

$500,000

200

30,000

900,0001,430,200

775,000$2,205,200

$625,000550,000

(400,000)

$775,000

Questions:A. Common Stock = $200 + $900,000

$45.01 per share 20,000 sharesPreferred Stock = $500,000 + $30,000

$53.00 per share 10,000 shares

B. Dividend preference rate

10,000 shares

20,000 shares

Preferred Stock

Common Stock

beginning

ending

Balance Sheet

$50,000$500,000

= 10%

Given the following capital structure for the years 20X3, 20X4, and 20X5:

Calculate the total amount of dividends to be distributed to the preferred vs. common stockholders in each year if the total dividend amounts to $100,000 in 20X3, $50,000 in 20X4 and $500,000 in 20X5 under the following two assumptions:

Question: Should preferred dividends in arrears at the end of an accounting period be reflected as a liability on the balance sheet? Why?

A.B.

The preferred stock is non-cumulative.The preferred stock is cumulative and dividends in arrears at 12/31/X2 amount to $100,000.

Preferred Stock, 7% $20par value, 50,000 shares

Common Stock, $.50par value, 100,000 shares

Paid in Capital in Excess of Par,Preferred Stock

Paid in Capital in Excess of Par,Common Stock

$1,000,000

50,000

100,000

2,000,000

Problem #41

Calculate the total amount of dividends to be distributed to the preferred vs. common stockholders in each year if the total dividend amounts to $100,000 in 20X3, $50,000 in 20X4 and $500,000 in 20X5 under the following two assumptions:A. The preferred stock is non-cumulative.

Preferred stock:Common stock:

20X3 20X4 20X5$70,000$30,000

$50,0000

$70,000$430,000


61

9-11

Answer: Preferred dividends in arrears are not to be reflected as a liability on the balance sheet because a company has no legal obligation to ever pay dividends unless the board of directors officially declares a dividend distribution. The amount of dividends in arrears is typically disclosed in the footnotes to the financial statements.

Calculate the total amount of dividends to be distributed to the preferred vs. common stockholders in each year if the total dividend amounts to $100,000 in 20X3, $50,000 in 20X4 and $500,000 in 20X5 under the following two assumptions:B. The preferred stock is cumulative and dividends in arrears at

12/31/X2 amount to $100,000. 20X3 20X4 20X5

Preferred Stock: ArrearsCurrent Preference

$ 100,000 $ 50,000

$ 90,000

$ 70,000

Common Stock $ 0 $ 0 $ 340,000

Preferred Dividends in Arrears @ Year End $ 70,000

$ 90,000

$ 0

$ 0 $ 0


1 2

3 4

5 6

Lesson 10

10-1

Lesson 10Financial Statement Analysis

Financial Analysis

A process designed to examine a business' current status and future potential so as to determine its worthiness for debt or equity investment.

able to make timely payments of principal and interest on a loan? What are the risks of loss in the event of default, and what are the appropriate terms and conditions for a loan?

Debt Investment: Will the Company be Equity Investment: What are the future prospects for dividends and appreciation in the Company's stock price? Is today's stock price over or under valued relative to the Company's prospects for profitability in the future?

Ratio Analysis

Comparisons of information provided in the financial statements designed to provide insights on a company's financial status and prospects for the future.

(Liquidity refers to a company's ability to meet its short-term obligations.)

20X1:

20X2:

Current Ratio:

Measures of Liquidity

41,81721,015

86,67343,516

Current Assets Current Liabilities

= 1.99

= 1.99

7 8

9 10

11 12

10-2

Acid Test Ratio (Quick Ratio):

Selected Current AssetsCurrent Liabilities

20X1:

20X2:

=

=

1.16

1.2956,12343,516

24,41521,015

Cash Only Acid Test Ratio:

20X1:

20X2:

=

=

0.60

0.50

12,66521,015

21,80843,516

Balance Sheet

CashA/R Inventory

A/P Wage Payable Other Payables Notes Payable

$ 10,000 20,000 40,000

$ 25,000 5,000 5,000 50,000

Current Assets: Current Liabilities:

$ 70,000 $ 85,000

Is it possible for a company to have an acid test ratio, or even a current ratio less than 1 to 1 and still have adequate liquidity for ongoing operations?

Current Liabilities:Accounts PayableSalaries PayableIncome Tax PayableDividend PayableUnearned Rent RevenueUtilities PayableInterest PayableCurrent Portion of Notes Payable

Long-Term Liabilities:Notes Payable

Total LiabilitiesStockholder's Equity: Capital Stock (2,400 and 4,250 shares outstanding)

Retained EarningsTotal Stockholder's Equity

Total Liabilities and Stockholder's Equity

$13,5114,1251,6441,250

0485

0 0

21,015

021,015

24,000 11,502 35,502

$56,517

Hot Cars, Inc.Balance Sheet

December 31, 20X1 and 20X2

Current Assets:CashAccounts ReceivableInventoryOffice SuppliesPrepaid InsurancePrepaid RentNotes Receivable

Long-Term Assets:Warehouse Equipment

Total Assets

$12,66511,75011,432

470350

4,400 750 41,817

14,700$56,517

12/31/X1 12/31/X1

$21,80834,31525,000

750400

4,400 0

86,673

37,394 $124,067

12/31/X2

$22,2500

6,4080

280400178

14,000 43,516

8,000 51,516

42,500 30,051 72,551

$124,067

12/31/X2LIABILITIES & STOCKHOLDER'S EQUITYASSETS

(Leverage is the measure of a company's debt relative to equity financing)

Debt Ratio (Debt to Total Asset Ratio):

Measure of Leverage

20X1:

20X2:

$21,015$56,517 = .37

$51,516$124,067 = .42

Total LiabilitiesTotal Assets

Example: A home is purchased for $300,000 with $30,000 cash downpayment and a $270,000 mortgage note payable.

= = 90% Leverage

= 100% Leverage$300,000$300,000

$270,000$300,000

DebtAsset

Debt to Equity Ratio:

Total LiabilitiesTotal Owners' Equity

20X1:

20X2:

21,01535,502 = .59

51,51672,551 = .71

DebtEquity = 21,015

21,015 = 1.00 or 11Assume:

13 14

15 16

17 18

10-3

20X2:

Measures of Management

20X1:

Control of Accounts Receivable- Accounts Receivable Turnover:

Average Balance of A/R during the Period:

Net Credit Sales RevenuesAverage Balance of A/R during the Period

185,04311,750+11,750

2 )(

261,95011,750+11,750

2 )(

Cumulative Daily Ending Balance of A/R365 Days

= 15.7 times

= 11.37 times

Beginning Balance + Ending Balance of A/R2

Cumulative Monthly Ending Balance of A/R12 Months

A/R

B

alan

ces

12/31/X1 Summer Months1X2

12/31/X2

A/R Balances

Hot Cars, Inc.Income Statement


20X2$261,950

164,02697,924

53,6003,9584,8006,8501,9521,105

32172,58625,338

42052

472178294

25,6326,408

$19,224$4.52

$185,043 111,026 74,017

49,5003,8934,1506,3452,3361,055

298 67,577

6,440

0 135 135 0 1356,575

1,644$4,931

$2.05

20X1Sales RevenueCost of Goods Sold

Gross MarginOperating Expenses:

Salaries ExpenseOffice Supplies ExpenseRent ExpenseUtilities ExpenseMisc. ExpenseInsurance ExpensePostage Expenses

Operating ExpensesOperating Income

Other Revenues and ExpensesRental RevenueInterest Revenue

Other RevenueLess: Interest Expense

Other Revenue (Expenses)Income Before Income Taxes

Less: Income TaxesNet Income (Loss)Earnings Per Share

Days Sales in A/R

365 DaysA/R Turnover

20X1:

20X2:

(Average Collection Period):

= 23.18 days

= 32.10 days36511.37

36515.75

Days Sales in Inventory

20X2:

20X1:

(Average Inventory Holding Period):

365Inventory Turnover

3659.71

3659.01

= 37.59 days

= 40.51 days

Management of InventoryInventory Turnover:

Average Inventory Balance during the Period:

20X2:

20X1:

Beginning + Ending Balance of Inventory2

Cumulative Daily Balance of Ending Inventory365 Days

Cost of Goods Sold Average Inventory Balance during the Period

= 9.71 times$111,026$11,432

= 9.01 times$164,026$11,432 + $25,000

2( (

19 20

21 22

23 24

10-4

Measures of Stock ValueBook Value Per Share:

20X2:

Owners' Equity# Shares of Stock Outstanding

72,5514,250 = $ 17.07 per share

Eric's profit on sale of 1,000 shares:

Percentage of ownership if 1,000 shares is purchased from Eric.

1,000 shares4,250 shares = 23.5%

Is Eric's proposal to issue 1,000 new shares of HCI stock?

Percentage of ownership if 1,000 new shares issued by HCI:

= 19.1%1,000 shares5,250 shares

Sales Price Per ShareLess: Contribution Per ShareProfit Per Share

Eric's Total Profit

$ 601050

x 1,000$50,000

( )

Is Eric's proposal an offer to sell 1,000 shares of the 4,250 shares he already owns? Eric's contribution to the company for these shares was $10 per share. Price Earnings Ratio (P/E Ratio):

Market Price Per ShareEPS

12/31/X2: = 13.27 $60$4.52

1. For every $1 of earnings the stock has a price (value) of $13.27.

2. A stock is selling at a multiple of 13.27 times its most recent earnings.

Net Income as a % of InvestmentEPS

Market Price Per Share

20X2:

20X4:

20X3:

= 7.5%

= 15.1%

= 30.1%$18.08$60

$9.04$60

$4.52$60

Price Earnings Ratio (P/E Ratio)

20X2: = 13.27

The P/E ratio serves as an index of the investor's expectations of a company's earnings potential in the future.

$60$4.52

Market Price Per ShareEPS

Measure of ProfitabilityEarnings Per Share (EPS):

Net Income # of Shares of Stock Outstanding

25 26

27 28

29 30

10-5

Problem #42

Calculate the Current and Acid Test ratios at 12/31/X2 and 12/31/X3 and evaulate the company's current liquidity.

Calculate the % increase (growth) in assets during 20X2 and 20X3. Has the increase in assets over the years been primarily in current or long-term assets?

What was the primary means of financing the company's growth in 20X2 and 20X3? Calculate the debt ratio and debt to equity ratio as of 12/31/X3. What are some of the advantages and disadvantages of a high debt ratio?

A.

B.

C.

Use the financial statements for XYZ corporation found on the following pages to respond to the these questions:

Hot Cars Inc.Income Statements


Sales RevenueCost of Goods Sold








100.060.040.0

26.8 2.1 2.2 3.4 1.3 0.6 0.236.5 3.5

0.0 0.1 0.1 0.0 0.1 3.6 0.9 2.7

%

%

%

20X2$261,950164,026

97,924

53,6003,9584,8006,8501,9521,105

32172,58625,338

42052

472178294

25,6326,408

$19,224$4.52

100.0 62.6 37.4

20.5 1.5 1.8 2.6 0.8 0.4 0.1 27.7 9.7

0.2 0.0 0.2 0.1 0.1 9.8 2.4 7.3

$185,043 111 ,026 74,017

49,5003,8934,1506,3452,3361,055

298 67,577

6,440

0 135 135 0 1356,575

1,644$4,931

$2.05

20X1%

%

%


December 31, 20X1, 20X2 and 20X3

Liabilities & Stockholders' Equity

Current Liabilities:Accounts PayableOther PayablesUnearned RevenueCurrent portion of Notes Payable

Long-Term Liabilities:Notes Payable, net .... of current portion

Stockholders' Equity:

Total Liabilities and... Stockholders' Equity

Assets

Current Assets:CashAccounts Receivable, net of allowance for uncollectibles of $2,000, $3,000, and $7,000, respectivelyInventoryPrepaid Expenses

Long-Term Assets:Land and BuildingsEquipment

Less: Acc/Depreciation

Total Assets

Common Stock, no par, 10,000 shares outstandingRetained Earnings/ (Deficit)

20X1 20X2 20X3 20X1 20X2 20X3

Total Liabilities

$12,000

25,00016,0003,000

56,000

375,00080,000

455,000(21,000)

$490,000434,000

$5,000

28,00020,0002,000

55,000

400,00094,000

494,000(33,000)

$516,000461,000

$15,000

33,00022,0004,000

74,000

550,000125,000675,000(55,000)

$694,000620,000

$54,00017,0007,000

20,00098,000

330,000428,000

100,000

(12,000)88,000

$516,000

$21,00011,0008,000

27,00067,000

515,000582,000

100,000

12,000112,000

$694,000

$25,000)10,000)5,000)

20,000)60,000)

350,000)410,000)

100,000)

(20,000)80,000)

$490,000)

Problem #42

$261,950 - $185,043 = 41.6%$185,043

$14,293 = 290%$4,931



20X2$261,950

164,02697,924

53,6003,9584,8006,8501,9521,105

32172,58625,338

42052

472178294

25,6326,408

$19,224$4.52

$185,043 111,026 74,017

49,5003,8934,1506,3452,3361,055

298 67,577

6,440

0 135 135 0 1356,575

1,644$4,931

$2.05

20X1Sales RevenueCost of Goods Sold








If HCI is a growth company, what is its stock's value?

25 x 4.52 = $113

40 x 4.52 = $180

If EPS projections forEPS

P/E Ratio

20X4: $18.08 x 25 PE = $452

20X3: $9.04

52-WeekHi Lo

Mattel (MAT)

MayDeptStrs (MAY)

Maytag (MYG)

McDermint (MDR)

McDonalds (MCD)

.32

1.27

.721

.20

.36

.9

2.1

1.5

.7

.5

23

18

17

8

29

15499

8978

7625

1235

18800

46.56

70.86

55.75

43.87

74.90

26.50

49.75

30.60

19.25

42.20

35.81

60.25

48.50

28.76

67.25

-0.94

1.25

0.25

-1.12

1.85

Stock (SYM) DivYld% PE

Vol100 Close

NetChg

YTD% Chg

-11.5

5.4

20.6

-25.4

20.7

s

31 32

33 34

35 36

10-6


Calculate the Current and Acid Test ratios at 12/31/X2 and 12/31/X3 and evaulate the company's current liquidity.

A.

Acid Test Ratio = Selected Current AssetsCurrent Liabilities

Current Ratio = Current AssetsCurrent Liabilities

12/31/X2

= 0.56$55,000$98,000

12/31/X3

= 1.10$74,000$67,000

12/31/X2

= 0.34$33,000$98,000

12/31/X3

= 0.72$48,000$67,000


Calculate the % increase (growth) in assets during 20X2 and 20X3. Has the increase in assets over the years been primarily in current or long-term assets?

B.

% Increase in Assets:

Assets atEnd of Year - Assets at

Beginning of YearAssets at Beginning of Year

= 5.3% = 34.5%$694,000-$516,000$516,000

$516,000-$490,000$490,000

20X2 20X3


Growth was financed primarily by long-term debt.

What was the primary means of financing the company's growth in 20X2 and 20X3?

C.

Debt Ratio =

12/31/X3:

Debt to Equity Ratio =

12/31/X3:

Total LiabilitiesTotal Assets

Total LiabilitiesTotal Stockholders' Equity

= 5.2 times$582,000$112,000

= 83.9%$582,000$694,000

Calculate the debt ratio and debt to equity ratio as of 12/31/X3.


What are some of the advantages and disadvantages of a high debt ratio?

Advantages:Using someone else's money to finance assets can increase profits as long as the return on assets exceeds the interest rate charged on the debt.

You don't have to use as much owners' investment if assets are financed by debt and therefore the owners' capital at risk is minimized.

Disadvantages:

Risk of business termination if payments cannot be made.

If return on assets is lower than interest costs it can be disastrous to profits.

Problem #42

XYZ Corp.Statements of Retained Earnings

For the Years Ended December 31, 20X1, 20X2, and 20X3

Retained Earnings (Deficit),Beginning of year

Net Income (Loss)DividendsRetained Earnings (Deficit),

End of Year

20X1 20X2 20X3

($12,000)(8,000)

0

($20,000)

($20,000)8,000

0

($12,000)

($12,000)24,000

0

($12,000)

Problem #42

XYZ CorporationIncome Statement

for the years ended December 31, 20X1, 20X2, and 20X3

Sales RevenuesCost of Goods Sold Gross MarginOperating Expenses: Selling Expenses Administrative Expenses Operating IncomeLess: Interest Expense Income (Loss) Before Income TaxLess: Income Tax Expense Net Income (Loss) Earnings (Loss) Per Share

$725,000450,000275,000

94,000144,000

37,00027,000

10,0002,000

$8,000$.80

$910,000529,000381,000

154,000153,000

74,00042,000

32,0008,000

$24,000$2.40

20X1 20X2 20X3$650,000413,000237,000

72,000140,000

25,00033,000

(8,0000

($8,000($ .80

)

))

37 38

39 40

41 42

10-7


Calculate the accounts receivable turnover and days sales in accounts receivable for 20X2 and 20X3. Has collection of accounts receivable improved? What management efforts do you think might contribute to such an improvement?

A.

Accounts Receivable Turnover:Net Credit Sales Revenues

2

A/R at Beginningof Year

A/R at Endof Year+( (

$ 725,000

2$ 25,000 $ 28,000+( (

$ 910,000

2$ 28,000 $ 33,000+( (

20X2 20X3

= 27.4 times = 29.8 times





End of Year

20X1 20X2 20X3

($12,000)(8,000)

0

($20,000)

($20,000)8,000

0

($12,000)

($12,000)24,000

0

($12,000)

Problem #43




$725,000450,000275,000

94,000144,000

37,00027,000

10,0002,000

$8,000$.80

$910,000529,000381,000

154,000153,000

74,00042,000

32,0008,000

$24,000$2.40

20X1 20X2 20X3$650,000413,000237,000

72,000140,000

25,00033,000

(8,0000

($8,000($ .80

)

))

Problem #43


Days Sales in Accounts Receivable:

365A/R Turnover

20X2 20X3

= 12.2 days36529.8= 13.3 days365

27.4








Assets




Total Assets


20X1 20X2 20X3 20X1 20X2 20X3

Total Liabilities

$12,000

25,00016,0003,000

56,000

375,00080,000

455,000(21,000)

$490,000434,000

$5,000

28,00020,0002,000

55,000

400,00094,000

494,000(33,000)

$516,000461,000

$15,000

33,00022,0004,000

74,000

550,000125,000675,000(55,000)

$694,000620,000

$54,00017,0007,000

20,00098,000

330,000428,000

100,000

(12,000)88,000

$516,000

$21,00011,0008,000

27,00067,000

515,000582,000

100,000

12,000112,000

$694,000

$25,000)10,000)5,000)

20,000)60,000)

350,000)410,000)

100,000)

(20,000)80,000)

$490,000)

Problem #43Problem #43

For XYZ Corp. above, respond to the following:

Calculate the accounts receivable turnover and days sales in accounts receivable for 20X2 and 20X3. Has collection of accounts receivable improved? What management efforts do you think might contribute to such an improvement?

Calculate the inventory turnover and days sales in inventory for 20X2 and 20X3. Why is reduction of days sales in inventory a good management policy as long as it does not affect sales volume?

A.

B.

43 44

45 46

47 48

10-8

Problem #44

Book value per share at 12/31/X3

Price/earnings ratio at stock prices of $12 pershare and $36 per share.

Net income as a % of investment at 12/31/X3 given stockprices of $12 and $36 per share.

Why does a stock's market price typically exceed its book value? What do you think is the most critical factor in determining whether the 12/31/X3 stock price should be valued closer to $12, $36, $72 or more per share?

A.

B.

C.

D.

Calculate the following for XYZ Corp. and respond to the additional questions:




$725,000450,000275,000

94,000144,000

37,00027,000

10,0002,000

$8,000$.80

$910,000529,000381,000

154,000153,000

74,00042,000

32,0008,000

$24,000$2.40

20X1 20X2 20X3$650,000413,000237,000

72,000140,000

25,00033,000

(8,0000

($8,000($ .80

)

))

Problem #44








Assets




Total Assets


20X1 20X2 20X3 20X1 20X2 20X3

Total Liabilities

$12,000

25,00016,0003,000

56,000

375,00080,000

455,000(21,000)

$490,000434,000

$5,000

28,00020,0002,000

55,000

400,00094,000

494,000(33,000)

$516,000461,000

$15,000

33,00022,0004,000

74,000

550,000125,000675,000(55,000)

$694,000620,000

$54,00017,0007,000

20,00098,000

330,000428,000

100,000

(12,000)88,000

$516,000

$21,00011,0008,000

27,00067,000

515,000582,000

100,000

12,000112,000

$694,000

$25,000)10,000)5,000)

20,000)60,000)

350,000)410,000)

100,000)

(20,000)80,000)

$490,000)

Problem #44

Problem #44





End of Year

20X1 20X2 20X3

($12,000)(8,000)

0

($20,000)

($20,000)8,000

0

($12,000)

($12,000)24,000

0

($12,000)


Days Sales in Inventory:

365Inventory Turnover

20X2 20X3

= 14.5 days36525.2= 14.6 days365

25


Calculate the inventory turnover and days sales in inventory for 20X2 and 20X3. Why is reduction of days sales in inventory a good management policy as long as it does not affect sales volume?

B.

Inventory Turnover: Cost of Goods Sold

2

Inventory atBeginning of Year

Inventory atEnd of Year+( (

$ 450,000

2$16,000 $20,000+( (

$ 529,000

2$20,000 $22,000+( (

20X2 20X3

= 25 times = 25.2 times

49 50

51 52

53 54

10-9


Calculate net income as a % of investment at 12/31/X3 given stockprices of $12 and $36 per share.

C.

Net Income as a % of Investment:EPS

Market Price Per Share

At $36/ shareAt $12/ share

= 20%$2.4012

= 6.7%$2.4036


D.

Problem #45

Copy the Income Statement for 20X2 and 20X3 and perform vertical analysis calculating each element of the income statement as a % of that year's Sales Revenues. Then respond to the following questions:

If XYZ is able to triple its Net Income over the next two years and the P/E ratio for a company like XYZ is about 25 times earnings, what would a share of stock be worth in two years?

5.

For XYZ Corp., calculate the % increase in Sales Revenues from 20X1 to 20X2 and from 20X2 to 20X3.

Is the increase in gross margin as a % of Sales Revenues good and what might give rise to such an increase?What might the significant increase in selling expenses as a % of Sales Revenues in 20X3 signify?Does the increase in interest expense in 20X3 make sense given asset growth and the financing of that growth?

Do you think the company's prospects for Net Income growth look good from the information provided? Why?

1.

2.

3.

4.

B.

A.

Problem #45








Assets




Total Assets


20X1 20X2 20X3 20X1 20X2 20X3

Total Liabilities

$12,000

25,00016,0003,000

56,000

375,00080,000

455,000(21,000)

$490,000434,000

$5,000

28,00020,0002,000

55,000

400,00094,000

494,000(33,000)

$516,000461,000

$15,000

33,00022,0004,000

74,000

550,000125,000675,000(55,000)

$694,000620,000

$54,00017,0007,000

20,00098,000

330,000428,000

100,000

(12,000)88,000

$516,000

$21,00011,0008,000

27,00067,000

515,000582,000

100,000

12,000112,000

$694,000

$25,000)10,000)5,000)

20,000)60,000)

350,000)410,000)

100,000)

(20,000)80,000)

$490,000)

Problem #45




$725,000450,000275,000

94,000144,000

37,00027,000

10,0002,000

$8,000$.80

$910,000529,000381,000

154,000153,000

74,00042,000

32,0008,000

$24,000$2.40

20X1 20X2 20X3$650,000413,000237,000

72,000140,000

25,00033,000

(8,0000

($8,000($ .80

)

))


A. Calculate Book Value Per Share at 12/31/X3:

Stockholders' Equity# Shares of Stock

12/31/X3

= $ 11.20 Per Share$ 112,00010,000

Calculate Price/Earnings Ratio at stock prices of $12 pershare and $36 per share.

B.

Price/ Earnings Ratio:(P/E Ratio)

Market Price Per ShareEarnings Per Share (EPS)

Book Value Per Share:

= 15 times$ 362.40= 5 times$ 12

EPS

At $36/ shareAt $12/ share

Problem #44

Book value per share at 12/31/X3

Price/earnings ratio at stock prices of $12 pershare and $36 per share.

Net income as a % of investment at 12/31/X3 given stockprices of $12 and $36 per share.


A.

B.

C.

D.

Calculate the following for XYZ Corp. and respond to the additional questions:

55 56

10-10


The higher selling expenses as a % of sales revenues may signify increased compensation (bonuses/commissions) packages to sales personnel for increased sales volume. This may also arise from increased services to customers in the sales process. For example, better delivery or improved ordering systems may also have contributed to higher selling costs and improved sales revenues.

2.

The increase in gross margin as a % of sales revenues is good and might be attributable to:

1.

prices)Higher sales prices per unit with changes in inventorycosts per unit less than the sales price increases.

a.

b.

Lower inventory costs per unit (deflation in purchase


$7.20 In 3 years.

The large growth in assets and debt to finance that growth in 20X3 explains the increased interest costs.

The company's income trends are good but additional information about the company's product, the market for its goods, the general economy, existing and potential competitors, and management's ability and stability would be helpful in such an analysis.

5.

3.

4.

x 3Current EPS = $2.40

$7.20 x 25 = $180 per share


Sales Revenues:20X2

725,000 - 650,000 = 11.5% 650,000

20X3910,000 - 725,000 = 25.5% 725,000

B.Sales RevenuesCost of Goods Sold Gross MarginOperating Expenses: Selling Expenses Administrative Expenses Operating IncomeInterest Expense Income before TaxIncome Tax Expense Net Income

20X2 20X3$725,000 450,000275,000

94,000 144,000

37,000 27,000

10,000 2,000$8,000

100%62.1%37.9%

13.0%19.9%5.0%3.8%1.4% .3%

1.1%

$910,000529,000381,000

154,000153,00074,000

42,00032,000

8,000$24,000

100%58.1%41.9%

16.9%16.8%8.1%4.6%3.5% .9%

2.6%

A. % Increase:

57

Problem #45





End of Year

20X1 20X2 20X3

($12,000)(8,000)

0

($20,000)

($20,000)8,000

0

($12,000)

($12,000)24,000

0

($12,000)

58

1 2

3 4

5 6

Lesson 11

11-1

Lesson 11Introduction to

Managerial Accounting

Financial accounting provides information designed primarily for users who are not involved in the day to day management of the business.

1.

Financial Accounting

- Providers of capital - investors and creditors. - Government Regulators - SEC, FTC, etc.

Financial accounting information is provided through summarized general purpose financial statements prepared in accordance with GAAP.

Financial statements are subject to independent audit and public dissemination for publicly-held companies.

Financial statements provide information that is historical in its nature.

2.

4.

3.

Managerial accounting provides information designed primarily for use by a company's officers, managers, and employees to improve the business operations.

Managerial accounting has no standardized information requirements.

Managerial accounting information typically includes more detailed information.

Managerial accounting information is not subject to independent audit or public dissemination.

Managerial accounting information commonly includes budgetary information and forecasts.

Managerial Accounting1.

2.

3.

4.

5.

Problem #46

To calculate the P/E ratio for the company's stock at a certain market price based on historical earnings?

To anticipate the amount of borrowings required to support operations over the next six months?

To identify the total gross margin % on all company sales over the last 12 months?

To identify the % markup on cost on each of numerous products sold by a company?

To better understand how individual product lines are selling in various geographic locations?

a.

b.

c.

d.

e.

Given the following information needs, would managerial or financial accounting provide the best source of data to address the need:

Problem #46

To project how many units of sales are required to generate a 20% increase in gross margin for the next year?

To determine the amount of bonuses due certain sales personnel based on the achievement of individual sales quotas?

To understand how a company has generally been financed to date?

To evaluate a company's overall liquidity as of the end of the last fiscal year?

To determine and propose specific job terminations department by department in implementing a cost reduction plan?

f.

g.

h.

i.

j.



To better understand how individual product lines are selling in various geographic locations?

To identify the % markup on cost on each of numerous products sold by a company?

To identify the total gross margin % on all company sales over the last 12 months?

To anticipate the amount of borrowings required to support operations over the next six months?


a.

b.

c.

d.

Managerial

Financial

Managerial

Managerial

7 8

9 10

11 12

11-2


To calculate the P/E ratio for the company's stock at a certain market price based on historical earnings?

To project how many units of sales are required to generate a 20% increase in gross margin for the next year?

To determine the amount of bonuses due certain sales personnel based on the achievement of individual sales quotas?

To understand how a company has generally been financed to date?

f.

e.

h.

g.

Financial

Managerial

Managerial

Financial


To evaluate a company's overall liquidity as of the end of the last fiscal year?

i.

To determine and propose specific job terminations department by department in implementing a cost reduction plan?

j.

Financial

Managerial

Understanding the Costs of Operating a Business

Costs associated with the goods or services offered to customers.

All other costs of operating a business. These costs are generally referred to as "operating expenses," or "selling and administrative expenses."

All businesses (merchandising, manufacturing or service) have two kinds of operating costs: product or period costs.

Product Costs

Period Costs

InventoryCash (A/P)


Selling ExpenseCash or Payable

Merchandising Business

Selling and administrative costs

When the inventory is sold the cost becomes an expense.

The cost of inventory purchased for resale.

xxxxxx

Product Costs:

xxxxxx

xxxxxx

Period Costs:

$ xxx

$ xxx

Income Statement

Operating IncomeSelling & Admin Expense

Operating ExpensesGross Margin Cost of Goods Sold Sales Revenues

InventoryAccounts Receivable Cash

Current Assets:

xxx xxx

xxx(xxx)

xxx(xxx)

Balance Sheet Manufacturing Business

3. Manufacturing Overhead Costs

2. Direct Labor Costs

1. Direct Material Costs

Product Costs: All costs of manufacturing the product to be sold by the business.

Product costs typically include:

13 14

15 16

17 18

11-3

- Production Supplies - Factory Maintenance Supplies

1. Indirect Material Costs

2. Indirect Labor Costs

- Factory Rent, Depreciation, Utilities, Insurance, Property Taxes, Depreciation of Equipment, etc.

3. Other Overhead Costs

- Product Designers and Engineers

- Manufacturing Equipment and Factory Maintenance Personnel

- Quality Control Inspectors - Manufacturing Supervisors

Manufacturing Overhead Costs These product costs are accounted for as part of the cost of "Inventory" until the product is sold, at which time the costs are expensed as "Cost of Goods Sold". There are three categories or phases of inventory in a manufacturing business:

Cost of Goods Sold

Finished Goods Inventory

Work in Process Inventory(WIP)

Raw Materials Inventory

Overhead View of a Manufacturing Facility

Selling andAdministative

Offices

Period Costs Product Costs

Manufacturing Factory/ Facility

Work In Progress(WIP)

Inventory

(Labor and Overhead Costsadded to RawMaterial costs)

MaterialDeliveries

from Suppliers


FinishedGoods

Inventory

Deliveries to Customer

(Cost of Goods Sold)

Balance Sheet

Inventory:

Cash $ xxx Accounts Receivable xxx

Raw Materials xxxWork in Process xxxFinished Goods xxx

Current Assets:

xxx

Income Statement

Net Income Selling & Admin Expenses

Less: Operating Expenses- Gross Margin

Less: Cost of Goods Sold Sales Revenues

xxx

xxx

$ xxx (xxx)

(xxx)

Problem #47

Identify the following as either product or period costs. In the case of product costs note whether the cost would be classified as either a direct material, direct labor or manufacturing overhead cost and at what point that cost would be added to inventory; at the raw material, work in process or finished goods stage?

e. Building rent (80% of building space is used for manufacturing and 20% for selling and administrative offices)

a. Salaries of sales secretarial staff

b. Direct materials used in manufacturing

c. Janitorial supplies for the administrative office space

d. Solvents used to clean manufacturing equipment

19 20

21 22

23

11-4

Problem #47

Depreciation of administrative and office furniture

Manufacturing supervisor salaries Building utility costs Copy machine costs in sales department Property taxes on manufacturing equipment Manufacturing vice president bonus Cost accountant salary CEO salary Factory production line worker's wage Product quality control inspector's salary Depreciation of manufacturing equipment

f.g. h.i.j.k.l.m.n.o.p.


Identify the following as either product or period costs. In the case of product costs note whether the cost would be classified as either a direct material, direct labor or manufacturing overhead cost and at what point that cost would be added to inventory; at the raw material, work in process or finished goods stage.

a. Salaries of sales secretarial staff

b. Direct materials used in manufacturing

c. Janitorial supplies for the administrative office space

Period Cost

Product Cost, Direct Materials, Raw Materials Inventory

Period Cost


e. Building rent (80% of building space is used for manufacturing and 20% for selling and administrative offices)

d. Solvents used to clean manufacturing equipment

f. Depreciation of administrative and office furniture

g. Depreciation of manufacturing equipment

Product Cost, Manufacturing Overhead, Raw Materials Inventory

Period (20%) and Product (80%) Cost, Manufacturing Overhead, WIP Inventory

Period Cost

Product Cost, Manufacturing Overhead, WIP Inventory


k. Cost accountant salary

j. CEO salary

i. Factory production line worker's wage

h. Product quality control inspector's salaryProduct Cost, Manufacturing Overhead, WIP Inventory

Product Cost, Direct Labor, WIP Inventory

Period Cost

It depends on whether the job would be eliminated if the company purchased rather than manufactured its product.


p. Manufacturing supervisor salaries

o. Building utility costs

n. Copy machine costs in sales department

m. Property taxes on manufacturing equipment

l. Manufacturing vice president bonusProduct Cost, Manufacturing Overhead, WIP Inventory


Period Cost

Period and Product Cost based on some method of allocation


1 2

3 4

5 6

Lesson 12

12-1

Lesson 12Manufacturing Product Costs

The Importance of Understanding a Company's Product Costs

Establish product sales price.Understand why the company is profitable or not.Determine which of a variety of products to emphasize in marketing.Consider ways to reduce costs.

A.B.C.

D.

Financial Reporting Purposes: Product costs are reflected as an asset (inventory) rather than an expense until the inventory is sold.

Managerial Purposes: Managers need to know and understand their company's product costs to intelligently-

1.

2.

How can you intelligently operate a business without knowing the cost of your product?

You Can't !!!!

Manufacturing Product Cost Accumulation Methods

Process Costing: A method that is commonly used by companies that manufacture large numbers of standardized product(s).

Manufacturing Costs:Direct MaterialsDirect LaborManufacturing Overhead Total

$ xxxxxxxxx

$ xxx # of boxes produced

cheerios cheerios GeneralMills

General Mills

Cost Per Box

Job Order Costing:A method that is commonly used by companies that make a variety of differing products where a simple averaging of total manufacturing costs of a factory or work center over the number of units produced would not distinguish the unique costs of the different products.

Manufacturing costs are accumulated by separate product orders, runs or batches ("job orders") and averaged only over the number of common units produced within that job.

-

-

Problem #48

Identify for each of the following kinds of manufacturing businesses whether they would use a process or job order cost system for determining the cost of their products.

Home construction companyOil refineryCustom jewelry manufacturerPeach farmAuto manufacturerOriental rug manufacturerDoor manufacturer

a.b.c.d.e.f.g.

7 8

9 10

11 12

12-2


Identify for each of the following kinds of manufacturing businesses whether they would use a process or job order cost system for determining the cost of their products.

Home construction companyOil refineryCustom jewelry manufacturerPeach farmAuto manufacturerOriental rug manufacturerDoor manufacturer

a.b.c.d.e.f.g.

Job order costProcess costJob order costProcess costProcess costJob order costIt depends

Date Started: 01/01/X1 Date Completed:

Job Cost RecordJob Order: # 351 Product Description: 4' x 8' Oak Tables Product Code: # O4811 #of Units: 5

Amount

Direct Materials:

Direct Labor:

Manufacturing Overhead:

Cost Per Unit: ÷ =

RequisitionNumber Amount

Time CardNumber Hours Rate

Amount Labor HoursRate

$

Date

Date

Date

5(total cost)$Total Cost

The Flow of Costs

Materials purchased Direct materials put into production

Direct labor cost incurredManufacturing overhead costs applied Production completed

Products sold

Inventory-RM

xxxxxxxxx

xxx

xxxxxx

xxxxxx

xxx

Inventory-WIP

Inventory-FG

Cost of Goods Sold

Job Cost Record # 351DMDLMO

xxxxxxxxx


xxxxxxxxx


xxxxxxxxx


xxxxxxxxx


xxxxxxxxx

Inventory-WIPDMDLMO

xxxxxxxxx

xxx

xxx

xxx

xxx

xxx

xxx

General Ledger

Subsidiary Ledger

Total

Total

Total

Total

Total

Example: Norm's Furniture manufactures a variety of furniture products and styles and therefore uses a job order cost system to account for its various product costs. For each of the following events prepare the journal entry to record the event and update the job cost sheet where appropriate.

Raw materials totaling $50,000 are purchased on account (direct materials of $40,000 and indirect materials of $10,000) and are placed in the raw materials inventory storage department.

Raw Materials InventoryAccounts Payable

50,000

1.

50,000

Production of Job #351 to build 5 oak tables begins on 1/1/X1 and the employee assigned to build the tables takes an authorized materials requisition form (form #10025) to the raw materials storage department to obtain the required direct materials (lumber, etc.). The cost of these direct materials requisitioned specifically for Job #351 totals $1,500.

2.

WIP InventoryRaw Materials Inventory

1,5001,500

13 14

15 16

17 18

12-3



Amount

Direct Materials:

Direct Labor:


Cost Per Unit: ÷ =




$

Date

Date

Date

Total Cost

01/01/X1 10025 $ 1,500

The employee constructing the 5 oak tables completes the work on 1/15/X1 and submits to the accounting department his semi-monthly time card (#3358) which shows all 80 hours of labor devoted to completion of the tables (Job #351). The employee is paid semi-monthly at a rate of $20 per hour.

3.

WIP InventoryCash (Wage Payable)

1,6001,600



Amount

Direct Materials:

Direct Labor:


Cost Per Unit: ÷ =




$

Date

Date

Date

01/15/X1

01/01/X1 10025 $ 1,500

3358 80 $ 20 $ 1,600

During production of Job #351, the employee also requisitioned (form #10047) from the raw materials storage department various additional direct materials (tube of glue, nails) costing a total of $50 to be used in the construction of the 5 oak tables plus other jobs over the next month.

5.

Raw Materials Inventory50

50

Theoretically correct entry:

WIP Inventory


50

Actual entry:

Manufacturing Overhead

During production of Job #351, the employee also requisitioned (form #10042) from the raw materials storage department various indirect materials (sandpaper, etc) costing a total of $150 to be used in the construction of the 5 oak tables plus other jobs over the next month.

Theoretically correct entry:

Problem: How much of this cost of indirect materials should be allocated to Job #351's Job Cost Sheet?

4.


150150


150Manufacturing Overhead

Actual entry:

xxxManufacturing Overhead CashSalary PayableAccumulated Depreciation

Other manufacturing overhead costs indirectly incurred in the production of Job #351 and all other jobs in process during the month might include the production supervisor's salary, manufacturing utility costs, depreciation of manufacturing equipment, etc. These costs would likewise be included temporarily in this holding account called "Manufacturing Overhead" until we can come up with a method of allocation or application of these costs to the individual jobs.

6.

xxxxxxxxx

19 20

21 22

23 24

12-4

Applying Manufacturing Overhead to WIP Inventory


Indirect Mtls.Indirect Labor Other Overhead

xxxxxxxxx

Direct Mtls.Direct Labor Applied Overhead

WIP

Application of a portion of manufacturing overhead to each individual job and its Job Cost Sheet is done based on an estimated basis using a "Predetermined Overhead Rate".

xxxxxxxxx

xxx

(Actual Costs)

(Applications to WIP, and Job Cost Sheets)

Step 1: Management must first identify some activity which can be separately measured job by job and bears some correlation with (or drives) manufacturing overhead costs.

For example: Direct labor hours is a commonly used activity in the application of manufacturing overhead because it can be measured by job through time cards and often correlates with overhead costs.

How is an Overhead Rate predetermined and then used?

Jan Feb Mar Apr May Jun Jul

$600,000

$300,00040,000 Hrs.

30,000 Hrs.

20,000 Hrs.

ManufacturingOverhead Costs

Direct LaborHours

$360,000

$600,000

$300,000

24,000 Hrs.

40,000 Hrs.

20,000 Hrs.

Jan. $360,000 ÷ 24,000 hrs. = $15/hr.Apr. $600,000 ÷ 40,000 hrs. = $15/hr.

Correlating Relationship:

ManufacturingOverhead Costs

Direct LaborHours



Amount

Direct Materials:

Direct Labor:


Cost Per Unit: ÷ =




$

Date

Date

Date

$Total Cost

01/07/X1 10025 $1,500

01/15/X1 3358 80 $20 $1,600

01/15/X1 $15.20 80 $1,216

4,316$4,316 5 863.20

Budgeted Mfg. Overhead Costsfor the next month

Budgeted Direct Labor Hoursfor the next month

$402,80026,500 hr. = $15.20/hr.

80 hrs. × $15.20 = $1,216

× Direct LaborHours

OverheadRate

Overhead Applied=

Step 2: Calculate an overhead rate for the future based on prospective or budgeted overhead costs and budgeted direct labor hours.

Step 3: This "Predetermined Manufacturing Overhead Rate" of $15.20 per direct labor hour is then used to apply overhead to each job in production based on the actual direct labor hours incurred per job as reported in the employee time cards.

1,216

Application of Manufacturing Overhead to Job #351

WIP InventoryManufacturing Overhead 1,216

7.

25 26

27 28

29 30

12-5

Cost of Goods Sold Finished Goods Inventory

Gross Margin = $1,400 - 863.20 = $536.80

Finished Goods InventoryWIP Inventory


Production is completed on Job #351 and the tables are transferred to the finished goods inventory storage area:

One of the oak chairs from Job #351 is sold to a customer on account for $1,400.

8.

9.

4,3164,316

1,4001,400

863.20863.20



xxxxxxxxx

xxx

(Actual Costs)

(Applications to WIP based on $15.20 per direct labor hour)

Under-applied xxxxxx Adjustment

0Adjustment of manufacturing overhead at year end:

Cost of Goods SoldFinished Goods InventoryWIP Inventory


xxxxxxxxx

xxx

Cost of Goods SoldManufacturing Overhead

xxxxxx

or just

Problem #49

Use the following diagram, and fill in the blanks to identify the flow of product costs in a manufacturing business.

Direct Material Costs Manufacturing Overhead Raw Materials Inventory

xxxxxx xx

xxxx

xxxx

WIP Inventoryxxxxxx xx

Finished Goods Inventoryxx xx

Costs of Goods Soldxx

(A) (B)

(C)Indirect Labor

(D) (E) (F)


Use the following diagram, and fill in the blanks to identify the flow of product costs in a manufacturing business.

Direct Material CostsIndirect Material Costs

Manufacturing Overhead Raw Materials Inventory

xxxxxx xx

xxxx

xxxx

WIP Inventoryxxxxxx xx

Finished Goods Inventoryxx xx

Costs of Goods Soldxx

(A) (B)

(C)

Indirect Material CostsIndirect LaborOther Mfg. Overhead

(D) Direct Material Costs(E) Manufacturing Overhead(F) Direct Labor Costs

Problem #50

In a job order cost system, explain how the following costs are typically determined for each separate manufacturing job:

Direct material costsDirect labor costsManufacturing overhead costs

A.B.C.



xxxxxxxxx

(Actual Costs)

Adjustment of manufacturing overhead at year end:

Adjustment xxx0

Manufacturing OverheadCost of Goods Sold

xxxxxx

xxx (Applications to WIP based on $15.20 per direct labor hour)

xxx Over-applied

31 32

33 34

35 36

12-6


In a job order cost system, explain how the following costs are typically determined for each separate manufacturing job:

Direct material costsMaterial requisition forms noting the amount and cost of raw materials released to each job.

Direct labor costsEmployee time cards noting the number of hours direct laborers worked on each specific job.

Manufacturing overhead costsManufacturing overhead is applied on an estimated basis using a predetermined overhead rate on some activity (direct labor hours, material costs, machine hours) that is measured for each specific job.

A.

B.

C.

Problem #51

Given the following historical data over the last three years, identify the measurable activity that best correlates with manufacturing overhead costs and would therefore serve as the best basis upon which to calculate a predetermined overhead application rate for the upcoming year:

If next year's budgeted manufacturing overhead costs and machine hours are projected at $625,000 and 77,000 hours, respectively, determine the predetermined overhead rate to be used in applying overhead to jobs in work in process for the upcoming year.

If job order #4444 actually utilizes 25 machine hours to be completed, how much manufacturing overhead cost should be applied to the job using the data previously provided in this problem.

A.

B.

C.

Manufacturing Overhead CostsDirect Labor HoursMachine HoursDirect Material Costs

$250,000 76,000 hrs. 30,000 hrs.

$750,000

$300,000 65,000 hrs. 38,000 hrs.

$760,000

$500,000 30,000 hrs. 62,000 hrs.

$800,000

20X2 20X3 20X4


Given the following historical data over the last three years, identify the measurable activity that best correlates with manufacturing overhead costs and would therefore serve as the best basis upon which to calculate a predetermined overhead application rate for the upcoming year:

A.

20X2 20X3 20X4Manufacturing Overhead

Per Direct Labor HoursPer Machine HoursPer Direct Material Costs

$3.29$8.33$ .33

$4.62$7.90$ .39

$16.67$ 8.07$ .63

Manufacturing Overhead CostsDirect Labor HoursMachine HoursDirect Material Costs

20X2 20X3 20X4

Machine hours seem to have the best correlating relationship with manufacturing overhead costs and should therefore be used as the activity basis in determining a predetermined overhead rate.

$250,000 76,000 hrs. 30,000 hrs.

$750,000

$300,000 65,000 hrs. 38,000 hrs.

$760,000

$500,000 30,000 hrs. 62,000 hrs.

$800,000


= $8.12 per hour= $625,000 77,000

Budgeting Manufacturing Overhead Costs Budgeted Machine Hours

(25 machine hrs. x $8.12 per hour) = $203 of manufacturing overhead costs applied to WIP job #4444

If next year's budgeted manufacturing overhead costs and machine hours are projected at $625,000 and 77,000 hours, respectively, determine the predetermined overhead rate to be used in applying overhead to jobs in work in process for the upcoming year.

If job order #4444 actually utilizes 25 machine hours to be completed, how much manufacturing overhead cost should be applied to the job using the data previously provided in this problem.

B.

C.

Problem #52

Jones Custom Furniture Manufacturing, Inc. made the following estimates at the beginning of the year, 20X7:

Jones applies manufacturing overhead to specific job orders on the basis of direct labor hours.

20X7 Budgeted Direct Labor Costs20X7 Budgeted Direct Labor Hours20X7 Budgeted Manufacturing Overhead

$300,000 20,000 hrs.$520,000

A.

B.

Calculate Jones' predetermined manufacturing overhead rate for the year 20X7.

Prepare general journal entries for the events noted below.

During the month of January, the following events transpired for Job #345, an order for 10 custom oak chairs which were manufactured in the first week of January 20X7:

Problem #52

$876 worth of direct materials (lumber, fabric, paint) were requisitioned (requisition #11042) and put into production on Job #345.$154 worth of indirect materials (glue, staples, sandpaper, and equipment grease) were requisitioned (#11045) for use in manufacturing the 10 chairs for job order #345 and other subsequent jobs.Time card #6655 was processed by payroll for Employee #214 indicating that 25 direct labor hours were attributable to the 10 oak chairs (Job #345). Employee #214's wage rate is $15 per hour.Manufacturing overhead at the predetermined rate is applied to the 10 oak chairs (Job #345) based on the actual direct labor hours for the job.The manufacturing supervisor's weekly salary of $1,000 is processed by payroll. This salary is considered indirect labor because the supervisor oversees not only Employee #214 but all jobs in process and does not account for his time on a job by job basis.

1/3/X7:

1/3/X7:

1/7/X7:

1/7/X7:

1/7/X7:

37 38

39 40

41 42

12-7

Problem #52

Create a job cost sheet form, and record the accumulation of costs for Job #345 determining the total cost of manufacturing the 10 oak chairs.

Prepare journal entries to record the following two additional events/transactions

The 10 oak chairs (Job #345) were completed and transferred to the Finished Goods stock room to await shipment to the customer.

The 10 oak chairs (Job #345) were shipped to the customer. The sales invoice reflects sales prices of $3,000 on account.

Determine the gross margin earned on the 10 oak chairs.

C.

D.

E.

1/7/X7:

1/9/X7:

Problem #52

In addition to Job #345, Jones completed 47 other orders in January with 7 others in process at month end. The following information summarizes the manufacturing transactions for Jones for the month of January in addition to those previously noted above relating to Job #345. Prepare the summarized journal entries for Jones for the January events noted below.

Raw materials purchased on account amounted to $102,675.Raw materials requisitioned to specific job orders amounted to $90,430 with 80% representing direct materials and the remainder representing indirect materials not directly attributable to any one specific job.Total direct labor hours for the month totaled 1,640 hours. At an average of $15 per hour, the direct labor wages incurred and paid amounted to $24,600.Manufacturing overhead is applied at the predetermined rate to all jobs in progress on the basis of the actual direct labor hours incurred by job.

F.

a.b.

c.

d.

Problem #52

Supervisory salaries incurred and paid along with other indirect manufacturing labor (i.e. maintenance labor) amounted to $7,000.The following costs associated with the manufacturing process and facility were incurred and paid:

Depreciation of manufacturing equipment for the month amounted to $5,500.The cost of the 47 jobs completed during the month as summarized by their individual job cost sheets amounted to $125,446.All completed jobs were shipped to customers by month end at a total sales price of $200,714 on account.All selling and administrative costs incurred and paid (i.e. admin. salaries, sales commissions, office supplies, office rent, etc.) amounted to $46,514.

e.

f.

g.

h.

i.

j.

Factory RentFactory UtilitiesInsuranceOther Miscellaneous

$ 7,600$ 2,700$ 1,200$ 1,900$13,400

Problem #52

Close the manufacturing overhead account to cost of goods sold (include all entries noted above for Job #345 and all events in part F). What accounts would be debited/credited if manufacturing overhead had been over applied?

G.


Jones Custom Furniture Manufacturing, Inc. made the following estimates at the beginning of the year, 20X7:

Jones applies manufacturing overhead to specific job orders on the basis of direct labor hours.

20X7 Budgeted Direct Labor Costs20X7 Budgeted Direct Labor Hours20X7 Budgeted Manufacturing Overhead

$300,000 20,000 hrs.$520,000

A. Calculate Jones' predetermined manufacturing overhead rate for the year 20X7.

= $26.00 per direct labor hour$520,00020,000 hrs.


B. Prepare general journal entries for the events noted below.

During the month of January, the following events transpired for Job #345, an order for 10 custom oak chairs which were manufactured in the first week of January 20X7:


876876

Manufacturing OverheadRaw Materials Inventory

154154

1/3/X7: $876 worth of direct materials (lumber, fabric, paint) were requisitioned (requisition #11042) and put into production on Job #345.

1/3/X7: $154 worth of indirect materials (glue, staples, sandpaper, and equipment grease) were requisitioned (#11045) for use in manufacturing the 10 chairs for job order #345 and other subsequent jobs.

43 44

45 46

47 48

12-8


1/7/X7: Time card #6655 was processed by payroll for Employee #214 indicating that 25 direct labor hours were attributable to the 10 oak chairs (Job #345). Employee #214's wage rate is $15 per hour.

1/7/X7: Manufacturing overhead at the predetermined rate is applied to the 10 oak chairs (Job #345) based on the actual direct labor hours for the job. ($26 x 25 direct labor hours = $650)

1/7/X7: The manufacturing supervisor's weekly salary of $1,000 is processed by payroll. This salary is considered indirect labor because the supervisor oversees not only Employee #214 but all jobs in process and does not account for his time on a job by job basis.

WIP InventoryWage Payable

375375

WIP InventoryManufacturing Overhead

650650

Manufacturing OverheadSalary Payable

1,0001,000


Create a job cost sheet form, and record the accumulation of costs for Job #345 determining the total cost of manufacturing the 10 oak chairs.

C.


Direct Materials:Date

1/3/X7Requisition #

11042Amount

$876

Emp. #214

Time Card #6655

Hours25

Rate$15

Amount$375

Direct Labor:Date

1/7/X7

25 $375

$876Total

Totals

Job Cost Sheet Job Order # 345 Date Completed: 1/7/X7Description: 10 oak chairs

Date started: 1/3/X7

Overhead Rate26.00

Amount$650

Manufacturing Overhead:Labor Hours

25

Total J ob Cost = $1,901 Cost per Unit = $190.10


Prepare journal entries to record the following two additional events/transactions

1/7/X7: The 10 oak chairs (Job #345) were completed and transferred to the Finished Goods stock room to await shipment to the customer.

1/9/X7: The 10 oak chairs (Job #345) were shipped to the customer. The sales invoice reflects sales prices of $3,000 on account.

D.


1,9011,901

Account ReceivableSales Revenues

Cost of Goods SoldFinished Goods Inventory

3,000

1,9013,000

1,901


Sales RevenuesLess: Cost of Goods SoldGross Margin

$3,0001,901

$1,099

Determine the gross margin earned on the 10 oak chairs.E.


In addition to Job #345, Jones completed 47 other orders in January with 7 others in process at month end. The following information summarizes the manufacturing transactions for Jones for the month of January in addition to those previously noted above relating to Job #345. Prepare the summarized journal entries for Jones for the January events noted below.

Raw materials purchased on account amounted to $102,675.

Raw materials requisitioned to specific job orders amounted to $90,430 with 80% representing direct materials and the remainder representing indirect materials not directly attributable to any one specific job.

F.

a.

b.

Raw Materials InventoryAccounts Payable

102,675102,675



72,34418,086

90,430

49 50

51 52

53

12-9


Total direct labor hours for the month totaled 1,640 hours. At an average of $15 per hour, the direct labor wages incurred and paid amounted to $24,600.

Manufacturing overhead is applied at the predetermined rate to all jobs in progress on the basis of the actual direct labor hours incurred by job.

c.

d.

WIP InventoryCash

24,60024,600


(1,640 x $26/hour = 42,640)

42,64042,640


Supervisory salaries incurred and paid along with other indirect manufacturing labor (i.e. maintenance labor) amounted to $7,000.

The following costs associated with the manufacturing process and facility were incurred and paid:

e.

f.

Factory RentFactory UtilitiesInsuranceOther Miscellaneous

$ 7,600$ 2,700$ 1,200$ 1,900$13,400

Manufacturing OverheadCash

7,0007,000

Manufacturing OverheadCash

13,40013,400


Depreciation of manufacturing equipment for the month amounted to $5,500.

The cost of the 47 jobs completed during the month as summarized by their individual job cost sheets amounted to $125,446.

All completed jobs were shipped to customers by month end at a total sales price of $200,714 on account.

g.

h.

i.

Manufacturing OverheadAccum. Depreciation

5,5005,500


125,446125,446


Cost of Goods SoldFinished Goods Inventory

200,174

125,446200,174

125,446


All selling and administrative costs incurred and paid (i.e. admin. salaries, sales commissions, office supplies, office rent, etc.) amounted to $46,514.

j.

Selling and Admin. ExpensesCash

46,51446,514


Close the manufacturing overhead account to cost of goods sold (include all entries noted above for Job #345 and all events in part F).

G.

Cost of Goods SoldManufacturing Overhead

1,8501,850

Manufacturing Overhead154

1,00018,086

7,00013,400

5,5001,850

under applied

650

42,640

1 2

3 4

5 6

Lesson 13

13-1

Lesson 13Cost Volume Profit Analysis

Managerial AccountingManagers must understand the cost of operating a business:

Two categories of costs:

Product Costs -Merchandising business

Inventory purchasesManufacturing business

Direct materialsDirect laborManufacturing overhead

Period costs - selling and administrative

Volume: The number of units of goods purchased or produced and how many units are sold.

Simplifying Assumption: The amount of or number of units we produce or purchase will be the same as the number we sell.

The Behavior of Costs with Changes in Volume

Variable CostsFixed Costs

Understanding how your costs behave with changes in volume allows management to understand the effect on profits given changes in volume.

CVP Analysis

Cost-Volume-Profit Analysis

Variable Cost: A cost that varies in total with changes in volume but are fixed per unit.

Total Variable Costs

Tota

l Dire

ct M

ater

ial C

osts

Volume (# Units Sold)

$ 80,000

0 1,000 2,000 3,000 4,000

$ 60,000$ 40,000$ 20,000

$ 0

Variable Cost Per Unit


Slope = VC per UnitSlope = rise/run

Dire

ct M

ater

ial C

osts

Per

Uni

t

$20,0001,000

$201

$ 40

0 1,000 2,000 3,000 4,000

$ 30$ 20$ 10$ 0

Other Examples of Variable Costs:

Direct LaborSales Commissions

7 8

9 10

11 12

13-2

Real World Fixed CostsTo

tal R

enta

l Cos

ts/m

onth $30,000

$20,000

$10,000

0 400,000 600,000 infinity

Volume (# units produced/sold per month)

Within the Revelant Range, a fixed cost is assumed to be fixed throughout that range of volume.

RelevantRange

$200,000

$160,000

$120,000

$80,000

$40,000

$010,0000 20,000 30,000 40,000 50,000To

tal S

uper

viso

r Sal

arie

s/ye

ar

Volume (# units sold) per year

Stepped CostsMixed Costs:

(Costs which have a fixed and variable portion)$6,000$5,000

$4,000$3,000$2,000

$0$10,000$0 $20,000 $30,000 $40,000 $50,000

$1,000

Tota

l Ren

tal C

osts

/Mon

th

Volume in sales revenues ($) per month

Slope = VC/Unit$1,000$10,000 = $.10 = 10%

Intersection = Total Fixed Cost Portion

Fixed Costs

Tota

l Ren

tal C

osts

/mon

th

$ 80,000$ 60,000$ 40,000$ 20,000

$ 0


Fixed Costs Per Unit


Ren

tal c

osts

per

uni

t

$ 0

$ 2

$ 4

$ 6

$ 8

$ 1

$ 3

$ 5

$ 7

0 1,000 2,000 3,000 4,000 5,000 6,000500

0 1,000 2,000 3,000 4,000 5,000 6,000

infinity

0Volume (# Units Sold)

Tota

l Dire

ct M

ater

ial C

osts

$0infinity

Relative Range: The range of volume that is reasonably anticipated for operations.

Within the relative range, the slope of the variable cost line is assumed to be linear, or in other words, the VC per unit is assumed to be constant.

Variable Costs

Slope of line = V/C per unit

400,000 600,000

RelevantRange

Fixed Costs: Costs which are fixed or constant regardless of changes in volume, but vary per unit.

13 14

15 16

17 18

13-3

High-Low Method

$25,000$20,000$15,000$10,000

$5,000$0

0

Tota

l Util

ity C

ost

Volume in Thousands (# of Units Produced)

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

VC per unit = Slope =

slope = VC per unit = $1.25 per unit

Fixed CostComponent

= $1.25 per unit

(Jan. $17,000/10,000)(Feb. $14,000/7,000)

(Mar. $24,000/15,000)

(Apr. $15,000/8,000) (May $20,000/13,000)(June $18,000/12,000)

$10,0008,000

High-Low Method

$25,000$20,000$15,000$10,000

$5,000$0

0

Tota

l Util

ity C

ost

Volume in thousands (# of units produced)

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

Total Cost = Variable Cost + Fixed CostAt High Point:

$24,000 = ($1.25 15,000) + FC$24,000 = $18,750 + FC

$24,000 - $18,750 = FC $5,250 = FC

.


Fixed CostComponent = $5,250 (Jan. $17,000/10,000)

(Feb. $14,000/7,000)

(Mar. $24,000/15,000)

(Apr. $15,000/8,000) (May $20,000/13,000)(June $18,000/12,000)

High-Low Method

$25,000$20,000$15,000$10,000

$5,000$0

0

Tota

l Util

ity C

ost

Volume in thousands (# of units produced)

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

Total Cost = Variable Cost + Fixed CostAt Low Point:

$14,000 = ($1.25 x 7,000) + FC$14,000 = $8,750 + FC

$14,000 - $8,750 = FC $5,250 = FC


Fixed CostComponent

(Jan. $17,000/10,000)(Feb. $14,000/7,000)

(Mar. $24,000/15,000)

(Apr. $15,000/8,000) (May $20,000/13,000)(June $18,000/12,000)

= $5,250

Analysis of Mixed CostsWhat portion is fixed and what portion is variable?

1. Scattergraph or Visual-Fit Method2. High-Low Method3. Least Square Method

Example: Management believes its utility costs are mixed in their behavior with changes in volume. Given the data below for the last six months of operations, determine if utility costs are indeed mixed, and, if so, calculate the variable and fixed cost components using first the scattergraph method and then the high-low method.

MonthJan.Feb.Mar.Apr.MayJune

# Units Produced10,000 7,00015,000 8,00013,00012,000

Utility Costs$17,000$14,000$24,000$15,000$20,000$18,000

Total Utility Costs = Variable Costs + Fixed Costs

$24,000 = ($1.40 x 15,000) + FC$24,000 = $21,000 + $3,000

$0$5,000

$10,000$15,000$20,000$25,000

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Scattergraph Method

Tota

l Util

ity C

ost

$3,000


Fixed Cost Component VC/Unit

(Mar. $24,000/15,000)

(Feb. $14,000/7,000)

(Apr. $15,000/8,000) (May $20,000/13,000)(June $18,000/12,000)

(Jan. $17,000/10,000)

Slope = Rise/Run = = $1.40$7,0005,000

19 20

21 22

23 24

13-4

Problem #54

If over the last year, the two months of highest and lowest production volume were April and August, respectively, and the cost of manufacturing supplies in those two months were as follows:

Calculate the fixed cost and variable cost per unit portion of the supplies cost if it is in fact a mixed cost.

What would be the anticipated manufacturing supplies cost in a month where a volume of 20,000 units was projected?

Describe the scattergraph approach to determine the fixed and variable cost per unit components of a mixed cost and explain why it is probably preferable to the method used above.

a.

b.

c.

April

Volume/Units Manufacturing Supplies

$9,00014,000 $12,00026,000

August

$480,000$440,000$400,000$360,000$320,000$280,000$240,000$200,000$160,000$120,000

$80,000$40,000

$0

Tota

l Cos

ts &

Tot

al R

even

ues P

er M

onth

0 1 2 3 4 5 6Volume in Thousands (# of Units Produced and Sold)

CVP or Breakeven Analysis

Breakeven Point:Sales Revenues - Variable Costs - Fixed Costs = 0

$160,000 - $40,000 - $120,000 = 0($80 x 2,000) - ($20 x 2,000) - $120,000 = 0

Sales Revenues

Total CostSlope = Variable Cost

= $20 per unit

Slope = Sales Priceper unit

=$160,0002,000

$801

= $80

($80 x 1,000) - ($20 x 1,000) - $120,000 =

$480,000$440,000$400,000$360,000$320,000$280,000$240,000$200,000$160,000$120,000

$80,000$40,000

$0

0 1 2 3 4 5 6Tota

l Cos

ts &

Tot

al R

even

ues P

er M

onth


Calculating Profit/Loss Graphically

Calculating profit at 1,000 units of volume:Sales Revenues - Variable Costs - Fixed Costs = Net Income

$80,000 - $20,000 - $120,000 = ($60,000)?

Sales RevenuesSlope = 80/1Sales Price = $80

per unit

Total CostSlope = 20/1Variable Cost = $20

per unit

$140,000

Loss = $60,000

Problem #53

Which of the following are true statements?

Fixed costs per unit decrease with increases in volume.

Variable costs per unit are assumed to be fixed within the relevant range.

Direct labor costs are typically a variable cost.

Mixed costs are costs that have both a fixed and variable component.

CVP Analysis requires all costs (product and period) to be distinguished as perfectly variable or perfectly fixed within the relevant range.

a.

b.

c.

d.

e.

($80 x 4,000) - ($20 x 4,000) - $120,000 =

$480,000$440,000$400,000$360,000$320,000$280,000$240,000$200,000$160,000$120,000

$80,000$40,000

$0

0 1 2 3 4 5 6Tota

l Cos

ts &

Tot

al R

even

ues P

er M

onth


Calculating Profit/Loss Graphically

Calculating profit at 4,000 units of volume:Sales Revenues - Variable Costs - Fixed Costs = Net Income

$320,000 - $80,000 - $120,000 = $120,000?

Sales RevenuesSlope = 80/1Sales Price = $80

per unit

Total CostSlope = 20/1Variable Cost = $20

per unit

Profit = $120,000


Which of the following are true statements?

Fixed costs per unit decrease with increases in volume.

Variable costs per unit are assumed to be fixed within the relevant range.

Direct labor costs are typically a variable cost.

Mixed costs are costs that have both a fixed and variable component.

CVP Analysis requires all costs (product and period) to be distinguished as perfectly variable or perfectly fixed within the relevant range.

a.

b.

c.

d.

e.

True

True

True

True

True

25 26

27 28

29 30

13-5

Problem #55

Given the graph presented below provide responses to the following:

$200,000$180,000$160,000$140,000$120,000$100,000

$80,000$60,000$40,000$20,000

$0

0 1 2 3 4 5 6Volume in Thousands (# Units Sold)

Tota

l Sal

es R

even

ues &

Tot

al C

osts

7 8

AB

Calculate the variable cost per unit.Determine the breakeven point in sales dollars and number of units.Determine the total variable costs at a volume of 5,000 units.Determine the net income (loss) at a volume of 2,000 units.

e.f.g.h.


What does line A represent?Line A represents total sales revenues.

Calculate the sales price per unit.Sales price per unit equals the slope of line A.

What does line B represent?Line B represents total costs.

Determine the amount of total fixed costs.Fixed costs equal $80,000, the point of intersection of the total cost line with the vertical axis.

$80,0002,000

$401= = $40

a.

b.

c.

d.


Calculate the fixed cost and variable cost per unit portion of the supplies cost if it is in fact a mixed cost.

a.

Mixed Cost Calculations for Manufacturing SuppliesVariable Cost Per Unit = Slope of Line

Total Costs = Variable Costs + Fixed Costs

RiseRun

$3,00012,000= = $ .25 per unit

At High Point in Volume:$12,000 = ($.25 x 26,000) + FC$12,000 = $6,500 + FC $5,500 = FC

At Low Point in Volume: $9,000 = ($.25 x 14,000) + FC $9,000 = $3,500 + FC $5,500 = FC


TC = VC + FC

TC = ($.25 x 20,000) + $5,500

$10,500 = $5,000 + $5,500

What would be the anticipated manufacturing supplies cost in a month where a volume of 20,000 units was projected?

b.


The scattergraph method identifies each monthly amount of production volume and related cost on a graph. A line is drawn to best fit the resulting relationship between cost and volume. The slope of this line is then calculated and represents the variable cost per unit. The intersection of the line with the vertical (cost) axis of the graph is the fixed cost portion.

The scattergraph may prove a better approximation of the amount of fixed and variable cost per unit components of a mixed cost because more than just two months of data is considered in the approach.

c.

Problem #55

Given the graph presented below provide responses to the following:

$200,000$180,000$160,000$140,000$120,000$100,000

$80,000$60,000$40,000$20,000

$0

0 1 2 3 4 5 6Volume in Thousands (# Units Sold)

Tota

l Sal

es R

even

ues &

Tot

al C

osts

7 8

AB

What does line A represent?Calculate the sales price per unit.What does line B represent?Determine the amount of total fixed costs.

a.b.c.d.

Example: Calculate the amount of sales revenues at breakeven given the following information for last year:

Sales Revenues Net Income CM Ratio

SR - FC - VC CM - FC

(CM Ratio SR) FC FC.25X

$350,000$50,000

- -

25%

= NI= NI= $0= $0

.

First, calculate FC at a different level of volume:

(.25 $350,000)FC = NI CM

FC FC = $50,000

= $50,000 $87,500$87,500 $50,000 = FC

= FC $37,500

----

.

GAAP Income Statement Format

Contribution Margin Format Income Statement

Sales RevenuesLess: Total Variable Costs Contribution MarginLess: Total Fixed Costs Operating Income

Sales RevenuesLess: Cost of Goods Sold Gross MarginLess: Selling & Administrative Expenses Operating Income

$1,000,000 600,000 400,000

350,000$ 50,000

$1,000,000700,000300,000250,000

$ 50,000


Calculate the variable cost per unit.Variable cost per unit equals the slope of line B.

Determine the breakeven point in sales dollars and number of units.3,000 units or $120,000 of sales revenues.

Determine the total variable costs at a volume of 5,000 units.VC per unit = $13.33$13.33 x 5,000 units = $66,667

Determine the net income (loss) at a volume of 2,000 units.

$120,000 - $80,0003,000 - 0

$40,0003,000= = $13.33

e.

f.

g.

h.

SR - VC - FC = NI($40 x 2,000) - ($13.33 x 2,000) - $80,000 = NI

$80,000 - $26,667 - $80,000 = ($26,667)

31 32

33 34

35 36

13-6

CVP analysis can be used with historical information or prospective budgeted information to respond to the following kinds of questions:

CVP Analysis

How many units did we need to sell last year or do we need to sell next year in order to simply breakeven?

How many units did we need to sell last year or do we need to sell next year to generate a certain target net income?

What effect would changes in sales price, costs, or volume have on net income?

.

.

.

An Equational Approach to CVP Analysis

Basic Equation:-

$100,000

= NI

$60,000 $25,000 = $15,000

$25,000 = $15,000

FC

FC NI=$25,000 = $15,000

($10 10,000).

SR

.(SP/Unit # Units)

VC

($6 10,000).(VC/Unit # Units).

---

(VC Ratio SR).(60% $100,000).

--

--

-

(40% $100,000).

CM$40,000

(CM/Unit # Units).($4 10,000).

(CM Ratio SR).CM as % SR or

Example: Given the following information, determine the sales price per unit required at an anticipated sales volume of 10,000 units to achieve net income of $100,000:

Fixed CostsVC Ratio

$25,000

SR FC = NI (70% SP/Unit # Units Sold)

10,000X --

25,00025,00025,0003,000X

= 100,000= 100,000= 100,000

3,000X = 125,0003,000 3,000

X = $41.67per unit

(.70 10,000X)7,000X

VC 25,000 = 100,000

10,000X

(SP/Unit # Units Sold)

- - - - -

- -

. ...

70%

37 38

39 40

41 42

13-7


a. Calculate the breakeven volume in number of units given the following information:

10X - 7X - 39,000 = 0

SR - VC - FC = NI

Fixed costsVariable cost ratioSales price per unit

$39,000 70%

$10

X = 13,000 units

3X = 39,0003 3


b. Calculate the contribution margin per unit given the following information:

Contribution margin per unit:Sales price/unit - Variable cost/unit

OR...

SR - VC - FC = NI

25,000X = 225,00025,000 25,000

25,000X - 175,000 - 50,000 = 0

= $9 sales price per unit

X

$9 - $7 = $2

Breakeven volume 25,000 unitsFixed costs $50,000Variable cost per unit $7


b. Calculate the contribution margin per unit given the following information:

- FC = NISR - VCCM - FC = NI

- FC = 0CM/unit #units sold.

= 50,00025,000

25,000X25,000

= $2 contribution margin per unit

X

-25,000X 50,000 = 0

Breakeven volume 25,000 unitsFixed costs $50,000Variable cost per unit $7

Problem #56

Solve the following problems using the equational approach to CVP analysis:a.

b.

c.

Calculate the breakeven volume in number of units given the following information:Fixed costsVariable cost ratioSales price per unit

Calculate the contribution margin per unit given the following information:Breakeven volumeFixed costsVariable cost per unit

How many units must be sold at $20/unit to generate net income of $100,000 given the following:Fixed costsContribution margin ratio

$39,00070%

$10

25,000 units$50,000

$7

$40,00060%

$37,500

.25X.25

$37,500.25

$150,000

=

FC .25X

- -

= $0= $0

=

(CM Ratio SR).

X

Then insert fixed cost of $37,500 into the original equation, and solve for X.


Fixed costs $40,000Contribution margin ratio 60%

c. How many units must be sold at $20/unit to generate net income of $100,000 given the following:

12X - 40,000 = 100,000

=12X12

140,00012

X = 11,667 units rounded

CM - FC = NI

- FC = 100,000(.60 $20 #units sold). .

- FC = NISR - VC

43 44

45 46

47 48

13-8


ii. Calculate the breakeven point in sales revenues.Sales Revenues

(SP/unit # units sold)$100 400 = $40,000.

.

A.

i. Calculate the breakeven point in # of units.

Given the following:Sales revenues# of units soldFixed costsNet income

$100,000 1,000 units $20,000 $30,000

($100/unit)

=X 400

=50X50

20,00050

50 = 20,000- 20,000 = 050

- - 20,000 = 0100 50- VC - FC = NISR


B. Given the following:Variable cost ratioFixed costs

Calculate the breakeven sales revenue.

65% $14,700

SRX

--

.35X

VC.65X

---

FC14,70014,700.35X.35X.35X

====

=

=

NI00

14,70014,700

.35$42,000


C.

Calculate the # of units which must be sold to produce net income of $20,000.

First, you must determine the amount of fixed costs at breakeven:

NI=FC--SR VC0=FC--500,000 .(60% 500,000)0=FC--500,000 300,000

FC=200,000

Given the following:Breakeven Sales RevenuesContribution Margin RatioSales Price pre UnitContribution Margin per UnitVariable Cost per UnitVariable Cost Ratio

$500,000 40%

$100 $40 $60

60%

Problem #57

A. Given the following:Sales Revenues ($100/unit)# of Units SoldFixed CostsNet Income

i. Calculate the breakeven point in # of units.ii. Calculate the breakeven point in sales revenues.

$100,0001,000 units

$20,000$30,000

A.

B. Given the following:Variable Cost RatioFixed Costs

Calculate the breakeven Sales Revenue.

65%$14,700

Problem #57

C. Given the following:Breakeven Sales RevenuesContribution Margin RatioSales Price pre UnitContribution Margin per UnitVariable Cost per UnitVariable Cost Ratio


$500,00040%$100

$40$60

60%


Then solve the problem:


5,500 units

220,00020,00020,000

NI

220,00040

=

====

=

X

40X200,000200,000

FC

40X40

---

60XVC

40X--

100XSR

49 50

51 52

53 54

13-9

Problem #58

In order to produce any plastic product through an injection molding process (i.e., plastic cups, kitchen utensils or even a plastic jello mold) a metal production mold created from a prototype of the given product must first be manufactured. Assume the cost of creating one production mold of the Salt Lake Temple is $20,000 and such a mold would be capable of producing a maximum of approximately 200,000 jello molds with no salvage value. Depreciation of the $20,000 production mold development costs are to be calculated based on the units of production method. At this time Heber plans to produce only temple jello molds.

Workman’s compensation insurance 10% of direct labor costsbefore payroll taxes

Utilities (80% of total fixed utility costs are manufacturing related and 20% due to selling and administrative office space)

$200 per month plus $.05 per unit produced

Building rent (2,000 total sq. ft. of which 80% of the building space will be for manufacturing and 20% for selling and administrative purposes)

$.70 per sq. ft. per month

Problem #58

Selling and administrative costs are projected as follows:

Heber plans to administer and manage the business and does not plan to pay himself a salary until the business can afford it.

Building Rent (see above)

Utilities (see above)

Telephones, fax

Copy machine rent, paper and other

Other office supplies

General liability insurance

Sales commissions to manufacturer’s sales representative

Accounting services

$300 per month

$250 per month

$150 per month

$.10 per unit sold

$50 per month

$500 per month

Problem #58

Required: PART 1: CVP ANALYSIS

1.

2.

3.

4.

Show the detail and totals of the following anticipated costs:A. Manufacturing (Product) Costs

1. Variable cost per unit (including direct materials, laborand mfg. overhead)

2. Fixed costs per monthB. Selling and Administrative (Period) Costs

1. Variable costs per unit2. Fixed costs per month

Determine the # of jello molds that would have to be sold in any month to simply breakeven.Determine the # of jello molds that would have to be sold in any month in order to provide Heber with a profit of $2,000 for the month.Calculate the sales price per unit that must be charged if Heber wishes to generate a monthly profit of at least $3,000 at a sales volume of 4,000 units per month.

Problem #58

Heber Smith, a college student in Utah, is investigating what he believes is a promising business opportunity. His idea is to manufacture and sell plastic jello molds in the form of the Salt Lake Temple. Heber has a tentative purchase commitment from a book and gift retail chain for 4,000 units over the first three months of initial operations. Based on his personal research and preliminary marketing efforts, he believes that the following is a reasonable estimate of total sales volume at a price of $ 2.50 per unit for the first quarter of operations beginning September 1, 20X1:

Business Feasibility Studyfor

HEAVENLY MOLDS, INC.

Sept. Oct. Nov.

Projected sales in # of units 2,000 3,000 4,000

Problem #58

Heber can lease a used injection molding machine for $2,000 per month plus $.08 per unit of production on a three year lease. Other manufacturing overhead costs expected on a monthly basis include the following:

Heber currently plans to manufacture the jello molds rather than contract out their production. The raw materials required for production of a single jello mold, regardless of design, is 1 lb. of polypropylene which can be purchased from a local supplier for $ .30 per lb.

Direct manufacturing labor costs are projected on a piece rate basis at $.20 per unit produced. Employer payroll taxes are estimated at 10% of the direct labor cost.

Indirect materials (equipment maintenance supplies and other)

$ 300 per month plus $.03 per unit

$ 250 per monthIndirect labor (equipment and mfg. building maintenance)


Direct Materials $.30Direct Labor .20Mfg. Overhead:

Employer Payroll Tax Machine Lease .08Indirect Materials .03Workman's Comp. .02Utilities .05Mold Depreciation .10

TOTAL $.80

.02

1A.1 Manufacturing (Product) Costs:

Variable Costs Per Unit:

55 56

57

13-10


Determine the # of jello molds that would have to be sold in any month to simply breakeven.

2.

SR - VC - FC = NI2.50X - 0.90X - 5,400 = 0

1.60X1.60

5,4001.60=

X = 3,375 units

1.60X - 5,400 = 0


Determine the # of jello molds that would have to be sold in any month in order to provide Heber with a profit of $2,000 for the month.

3.

SR - VC - FC = NI2.50X - 0.90X - 5,400 = 2,000

1.60X1.60

7,4001.60=

X = 4,625 units

1.60X - 5,400 = 2,000


Calculate the sales price per unit that must be charged if Heber wishes to generate a monthly profit of at least $3,000 at a sales volume of 4,000 units per month.

4.

SR - VC - FC = NI4,000X - 3,600 - 5,400 = 3,000

4,000X4,000

12,0004,000=

X = $3.00 per unit

4,000X - 9,000 = 3,000


Mfg. Overhead:

TOTAL $3,830

1A.2 Manufacturing (Product) Costs:

Fixed Costs Per Unit:

1,120Building Rent (80% of fixed rent

costs of $1,400)

Utilities (80% of fixed utility costs of $200) 160

Indirect Labor 250Indirect Materials 300

$2,000Machine Lease


Utilities (20% of fixed utility costs of $200) 40

TOTAL $1,570

1B.1 Selling and Administrative Costs:Variable Costs Per Unit:

$280Building Rent (20% of fixed rent

costs of $1,400)

Copy Machine, Paper 250Telephones, Fax etc. 300

150Other Office Supplies

Sales Commissions $.10

1B.2 Selling and Administrative Costs:Fixed Costs Per Unit:

50General Liability Ins.500Accounting Service

58

59

1 2

3 4

5 6

Lesson 14

14-1

Lesson 14Operational Budgeting

Levels of Business Planning

Strategic Planning:Decisions regarding such long-range questions as which products to make and sell, how to market the products, and how to finance the resources necessary to achieve the organization's goals.

Capital Budgeting:Planning for the acquisition of operational or long-term assets such as property, plant and equipment.

Operational Budgeting:Detailed plans of immediate goals for prospective sales, production, expenses, cash flows and financial statement results.

Personal Budget (Cash Flow)

Budgeted Cash Inflows: Salary/Wage Income Interest Income Parental Subsidy Student Loan ProceedsBudgeted Cash Outflows: Rent Utilities Food Entertainment Tuition Books Insurance- Health Auto Payments Auto Gas & Maint. Insurance- Auto Miscellaneous

Net Cash Flow

Jan. Feb. Mar.The Importance of Budgeting

.

.

.

.

.

.

.

Communication

Setting Goals and Objectives

Problem Resolution

Coordination

Authorization

Performance Evaluation

Motivation

The Benefits of Budgeting for a Business

.

.

.

.

.

.

.

Setting Goals and Objectives

Problem Resolution

Coordination

Authorization

Performance Evaluation

Motivation

Management Communication

Elements and Sequencing of an Operating Budget

- Merchandising Business -

SalesBudget

Selling &Admin. Expense

Budget

InventoryPurchases

Budget

Cash Flow Budget

Pro-formaIncome

Statement

Pro-forma Balance

Sheet

7 8

9 10

11 12

14-2

SalesBudget


BudgetProduction

Budget

DirectMaterials

Budget

DirectLaborBudget

Mfg.Overhead

Budget

Cash Flow Budget

Pro-formaIncome

Statement

Pro-forma Balance

Sheet


-Manufacturing Business-

Example: Given the information and assumptions provided below for PowerPak, Inc., prepare the following budgets for the months noted in 20X3:

PowerPak, Inc. makes and sells a food supplement drink that comes in a one pint carton. One carton of PowerPak is made by mixing plain tap water with a 6 oz. powder mix purchased directly from a manufacturer of nutritional products based on a formula developed by PowerPak.

The product sells for $3.00 a carton and budgeted sales for the months of September, October and November of 20X3 are 20,000, 22,000 and 25,000 units, respectively.

A. Sales Budget (Sept., Oct.,Nov.)B. Production Budget (Sept., Oct.) C. Direct Materials Budget (Sept.)D. Direct Labor Budget (Sept.)E. Cash Flow Budget (Sept.)

Units to be sold

Sales price/unit

Total Sales Revenue

20,000

x 3.00

$60,000

22,000

x 3.00

$66,000

25,000

x 3.00

$75,000

SEPT. OCT. NOV.

SALES BUDGET Management would like to keep a balance of finished inventory on hand equal to 20% of the following month's anticipated sales volume to be able to handle unexpected sales volume. Assume that there are 4,000 units of finished goods on hand at 8/31/X3. Given this information, the Production Budget can be prepared.

PRODUCTION BUDGET

SEPT. OCT. NOV.Units to be soldDesired ending inventory

20,0004,400

24,400

22,0005,000

27,000

25,000

* Calculated based on 20% of the subsequent month's budgeted sales.

(4,000)20,400

(4,400)22,600

Beginning inventoryUnits to be produced

*

The product costs are budgeted to include:

Fixed Mfg. Overhead- Per Month

Variable Costs Per Unit- Direct Materials- 6 oz. Mix Carton Direct Labor Mfg. Overhead

* Amount includes $1,500 of equipment depreciation.

$.90 per unit$.20 per unit$.10 per unit$.30 per unit

$7,000*

Management likes to have on hand inventory of mix and cartons equal to 30% of the following months budgeted materials usage. Assume that there are 6,120 six oz. packets of mix and 6,120 cartons in materials inventory at 8/31/X3. Given this information, the Direct Materials Purchase and the Direct Labor Budget can be prepared.

MATERIALS USAGE BUDGET

Units to be produced

One 6oz. Mix and OneCarton per unit produced

Mix and cartons to be used

SEPT. OCT.20,400

x 1

20,400

22,600

x 1

22,600

13 14

15 16

17 18

14-3

MATERIALS PURCHASE BUDGETSEPT. OCT.

Units of Mix & Cartons to be usedDesired ending inventory*

20,400 22,600

*Calculated based on 30% of subsequent month's budgeted usage.

Beginning InventoryMix and Cartons to purchasePrice per Mix and CartonTotal Material purchases

6,78027,180(6,120)21,060x 1.10

$23,166

??

(6,780)?

x 1.10?

MATERIALS USAGE BUDGET


One 6oz. Mix and OneCarton per unit produced

Mix and cartons to be used

SEPT. OCT.20,400

x 1

20,400

22,600

x 1

22,600

DIRECT LABOR BUDGET

Units to be producedLabor cost per unitTotal Direct Labor

20,400x .10

$2,040

22,600x .10

$2,260

SEPT. OCT.

Budgeted selling and administrative expenses amount to $ .40 per unit of variable costs and $5,000 per month of fixed costs which include $700 of budgeted depreciation expense. Prepare the September Cash Flow Budget given the following additional assumptions:

All sales are made on account and experience shows that about 60% of sales are collected in the month of sale with 40% in the following month. No sales are anticipated to be uncollectible. The A/R balance at 8/31/X3 amounts to $21,000.

.

.

.

.

Direct materials are always purchased on account with 50% paid in the month of purchase and the remainder paid in the following month. The A/P balance at 8/31/X3 amounts to $10,500.

Assume all direct labor, manufacturing overhead costs and selling and administrative costs are paid in the month incurred.

The cash balance at the beginning of the month is $6,000 and assume that PowerPak operates in a world of no income taxes.

CASH FLOW BUDGET$6,000

36,00021,00063,000

11,58310,500

2,040

6,1205,500

8,0004,300

14,9570

$14,957

SEPT.

Calculated at $.30 times the # of units budgeted for production.

**

Calculated at $.40 times the # of units budgeted for sale.

***

Collections of A/R are calculated at 60% in the month of sale and 40% in the subsequent month. Payments on purchases of direct materials, all on account, are calculated at 50% in the month of purchase and 50% in the subsequent month

*

Beginning cashAdd collection of A/R:

Current month* ($60,000 x 60%)Preceding month

Deduct disbursements:Direct materials-

Current month*($23,166 x 50%)Preceding month

Direct laborManufacturing Overhead-

Variable**(20,400 x $.30)Fixed (excluding depreciation of $1,500)

Selling & Administrative-Variable***(20,000 x $.40)Fixed (excluding depreciation of $700)

Cash balance/(deficiency)Cash capitalization requiredEnding cash balance

Problem #59

Jordan Corp. sells cakes for $10 per unit. Budgeted sales volume in # of units for the first 3 months of the year is noted below:

Jordan anticipates that 70% of sales will be made on account and accounts receivables are expected to be collected at the following rates:

25,000 30,000 35,000

Determine the amount of budgeted cash inflows for the month of March.

100%

50% in the month of sale35% in the first month following the month of sale10% in the second month following the month of sale

5% uncollectible

JAN. FEB. MAR.MAR.


From January Sales: 25,000 x $10 x 70% x 10% =

From February Sales: 30,000 x $10 x 70% x 35% =

From March Sales: Cash Sales 35,000 x $10 x 30% =

Credit Sales 35,000 x $10 x 70% x 50% =

Total Cash Collections

$17,500

$73,500

$105,000

$122,500

$318,500

March Cash Collections:

19 20

21 22

23 24

14-4

Problem #60

Jordan Corp. has budgeted sales volume in units as follows:

Jordan wishes to maintain an inventory level of finished goods equal to 30% of the following month's budgeted sales. Finished goods inventory at the start of business on Jan. 1st amounts to 7,000 units.

25,000 30,000 35,000Jan. Feb. Mar.

One unit of production requires 3 lbs. of flour which costs $2/lb. Jordan plans to maintain a level of flour inventory (raw materials) constant with the current inventory balance.

If Jordan plans to buy all raw materials on account paying 50% in the month of purchase and 50% in the following month, how much cash outflow for the purchase of flour should be budgeted for in February?


Materials Purchases Budget

Lbs. to be used in productionAdd: Desired Ending InventoryLess: Beginning InventoryBudgeted PurchasesCost per lb.Cost of Materials Purchases

Production Budget

Budgeted SalesAdd: Desired Ending Inventory

Less: Beginning InventoryUnits to be Produced

Materials Usage Budget

Units to be produced(x) 3 lbs. per unitlbs. to be used in production

Mar.35,000

??

?(10,500)

Feb.30,00010,50040,500

31,500(9,000)

Jan.25,000

9,00034,000

27,000(7,000)

Feb.94,500

94,500 lbs.x $2

$189,000

Feb.31,500

x 394,500

Jan.81,000

81,000 lbs.x $2

$ 162,000

Jan.27,000

x 381,000


February Cash Payment on Flour Purchases:

Payments on January Purchases: ($162,000 x .50%)Payments on February Purchases: ($189,000 x .50%)

$81,000

$94,500$175,500


SalesBudget


BudgetProduction

Budget

DirectMaterials

Budget

DirectLaborBudget

Mfg.Overhead

Budget

Cash Flow Budget

Pro-formaIncome

Statement

Pro-forma Balance

Sheet

Business Feasibility Study forHEAVENLY MOLDS, INC.

As noted in the prior lesson, Heber Smith is seriously investigating what he believes is a promising business opportunity. His idea is to manufacture and sell plastic jello molds in the form of famous LDS religious symbols such as the Salt Lake Temple. Based on Heber's personal research and preliminary marketing efforts, he believes that the following is a reasonable estimate of total sales volume at a price of $2.50 per unit for the first quarter of operations beginning September 1, 20X1:

Heber currently plans to manufacture the jello molds rather than contract out their production. The raw materials required for production of a single jello mold, regardless of design, is 1 lb. of polypropylene which can be purchased from a local supplier for $.30 per lb. Direct manufacturing labor costs are projected on a piece rate basis at $.20 per unit produced.

Projected sales in # of units Sept.2,000

Oct.3,000

Nov.4,000

Problem #61

ADDITIONAL BUDGETARY INFORMATION:Following November, 20X1, Heber projects that sales volume

will increase at a rate of 100 units per month. Inventory levels for finished goods are to be budgeted at a level of 25% of the following month's anticipated sales volume. Inventory levels for raw materials are budgeted at a level of 10% of the following month's budgeted materials usage.Required: (Given the above information round all calculations to the nearest whole unit or dollar, as the case may be.)

Given the information above, prepare the following budgets for Heavenly Molds for the months of September through November, 20X1:

A. Sales Budget (using $2.50 sales price per unit)B. Production BudgetC. Materials Usage and Purchases BudgetD. Direct Labor Budget

Problem #61

25 26

27 28

29 30

14-5


4,000

x 2.50

$ 10,000

SALES BUDGET

NOV.Units to be sold

Sales price/unit

Total Sales Revenue

2,000

x 2.50

$ 5,000

3,000

x 2.50

$7,500

DEC. JAN.4,100

x 2.50

$10,250

4,200

x 2.50

$10,500

SEPT. OCT.

PRODUCTION BUDGET

Units to be sold

Add: Desired ending inventory*

Less: Beginning inventory


NOV. DEC.SEPT. OCT.

*Calculated based on 25% of the subsequent month's budgeted sales.

2,000

7502,750

( 0 )

2,750

3,000

1,0004,000

(750)

3,250

4,000

1,0255,025

4,025

(1,000)

4,100

1,0505,150

4,125

(1,025)


MATERIALS USAGE BUDGETNOV.SEPT. OCT.


Polypropylene per unit produced

lbs. to be used

2,750

x 1 lb.

2,750

3,250

x 1 lb.

3,250

4,025

x 1 lb.

4,025

MATERIALS PURCHASE BUDGETNOV.SEPT. OCT.

lbs. to be used

Add: Desired ending inventory*

Less: Beginning inventory

lbs. to purchase

Price per lb.

Total purchases

*Calculated based on 10% of the subsequent month's budgeted usage.

2,750

3253,075

( 0 )

3,075

x .30

$ 923

3,250

4033,653

(325)

3,328

x .30

$ 998

4,025

4134,438

(403)

4,035

x .30

$ 1,211


DIRECT LABOR BUDGET

NOV.SEPT. OCT. Units to be produced

(X) Labor cost per unit

Total direct labor

2,750

x .20

$ 550

3,250

x .20

$ 650

4,025

x .20

$ 805

Problem #62

Given the budgets prepared in the previous problem and the information provided below, prepare a Cash Flow Budget for Heavenly Molds for the months of September through November, 20X1.

Additional Cash Flow Budgeting Information: For cash flow budgeting purposes assume that all sales are expected to be made on account with 30% budgeted for collection in the month of sale and 70% budgeted for collection in the subsequent month (no uncollectible receivables are anticipated). All purchases of raw materials will be made on account with 25% budgeted for payment in the month of purchase with the remainder to be paid in the subsequent month.

On September 1, 20X1, Heavenly Molds will have to make an initial refundable deposit on the building and the injection molding machine leases of $3,000 and $2,000, respectively. In addition, the $20,000 cost of the original production molds will be due upon delivery at September 1, 20X1.

Problem #62For simplicity's sake, all direct labor, manufacturing overhead and selling and administrative costs are budgeted to be paid in the month incurred. Based on the work done in the prior lesson, the following budgeted amounts are also available:

Hint: In the cash flow budget, variable costs of manufacturing should be based on the # of units to be produced while the variable selling and administrative costs would be based on the # of units budgeted for sale in any particular month. Remember that depreciation expense included in the variable manufacturing overhead costs are non-cash costs and should be excluded from the cash flow budget. Assume that any cash flow deficiency will be reflected as "Cash Capitalization Required" and Heber wishes the cash budget to reflect a minimum cash balance of $10,000 to insure adequate cash capitalization throughout the period.

Variable Manufacturing Overhead Costs,Includes $ .10/unit depreciation Fixed Manufacturing Overhead Costs Variable Selling and Administrative Costs Fixed Selling and Administrative Costs

$.30/unit$3,830$.10/unit$1,570

Problem #62 - AnswerCASH FLOW BUDGET

Beginning cashAdd collection of A/R:

Current monthPreceding month

Deduct disbursements:Direct materials

Current monthPreceding month

Direct laborManufacturing Overhead

VariableFixed

Selling & AdministrativeVariableFixed

Deposit onMachine leaseBuilding

Original mold costCash balance/(deficiency)Cash capitalization requiredEnding cash balance

NOV.$10,000

3,0005,250

18,250

303749805

8053,830

4001,570

9,788212

$10,000

OCT.$10,000

2, 2503,500

15,750

250692650

6503,830

3001,570

7,8082,192

$10,000

SEPT.$ 0

1,500

1,500

231

550

5503,830

2001,570

2,0003,000

20,000(30,431)

40,431$10,000

a.a.

b.b.

c.

d.

Run over the letters to see the footnotes( )

31 32

33 34

35 36

14-6

Problem #63

Sales RevenuesLess: Cost of Goods SoldGross MarginLess: Selling and AdministrationNet Income (Loss)

PRO-FORMA INCOME STATEMENTS

a.

b.

Provided below are the pro-forma income statements for the first three months of budgeted operations and the pro-forma balance sheet as of 11/30/X1, prepared from the previously provided budgetary information. Included with these statements are certain footnotes and calculations explaining the source of the amounts. Review these statements to understand how the various elements were determined and then respond to questions which follow.

* a and b see next two pages

NOV.$10,000)

(7,230)$2,770)(1,970)

$800)

OCT.$7,500)(6,098)1,402)

(1,870)($468)

SEPT.$5,000)(4,380)

620)(1,770)

($1,150)

Problem #63

a. Cost of Goods Sold calculation:First, the average budgeted manufacturing cost per unit of production is calculated for each month separately.

Next, calculate Cost of Goods Sold:

Manufacturing costs:Variable @ $.80 per unitFixedTotal Manufacturing cost

Units Produced Per unit cost

..

SEPT. OCT. NOV.

$2,2003,830

$6,0302,750$2.19

$2,6003,830

$6,4303,250$1.98

$3,2203,830

$7,0504,025$1.75

# units sold

cost/unit

Sept.Oct.

2,000 x $2.19 = $4,380

Nov.

750 x $2.19 = $1,6432,250 x $1.98 = $4,455

$6,0983,0001,000 x $1.98 = $1,9803,000 x $1.75 = $5,250

$7,2304,000

Problem #63PRO-FORMA BALANCE SHEET

November 30, 20X1ASSETS

Current Assets:CashAccounts Receivable ($10,000 x 70%)Inventory:

Raw Materials (413 lbs. x $.30)Finished Goods (1,025 x $1.75)

Mold Development costs:Less: Accumulated Depreciation

Deposits: Machine Lease Building Lease Total Assets

LIABILITIES AND OWNER'S EQUITYLiabilities:

Accounts PayableOwner's Equity:

Contributed CapitalRetained Deficit

Total Liabilities and Owner's Equity* $10 difference with total assets due to rounding

*

$10,000 7,000

124 1,794 $18,918 20,000

(1,003)$18,997 2,000 3,000$42,915

$ 908

42,835 (818)

$42,925

Problem #63

As of November 30, 20X1, how much total capital does Heber plan to have invested in the business? How was this amount determined?

Why is the total amount of projected owner's equity at 11/30/X1, less than the planned capital contributions? If the budget were extended an additional three months to 2/28/X2, would you expect owner's equity to increase or decrease and why? (Do not do the actual budget through 2/28/X2, simply identify the relevant trends.)

What is the primary cause of improved budgeted profitability from September to November? Calculate cost of goods sold as a % of sales revenues in each month and generally explain the cause of the change.

Based on your review, is the company using the Fifo or Lifo inventory cost flow assumption? Show how "Accumulated Depreciation" amounting to $1,003 was determined on the 11/30/X1 pro-forma balance sheet. Explain how "Accounts Payable" of $908 was calculated on the same balance sheet.

Given the CVP analysis previously performed and the results of the budgetary process, what is your opinion of Heber's business opportunity and why? How much investment capital do you think is actually at risk? What do you think is the most significant factor in determining Heavenly Molds' ultimate success?

(A)

(B)

(C)

(D)

(E)

Problem #63

Total selling and administrative costs are calculated based on the # of units budgeted for sale.

b.

Variable ($.10/unit)Fixed

SEPT.$ 200

1,570$1,770

OCT.$ 300

1,570$1,870

NOV.$ 400

1,570$1,970


$42,835. This number is reflected on the balance sheet as "Contributed Capital." The amount comes from the combined amount of "Cash Capitalization Required" from the cash flow budget for the first three months of operations.

As of November 30, 20X1, how much total capital does Heber plan to have invested in the business? How was this amount determined?

(A)

37 38

39 40

14-7


Total owner's equity at 11/30/X1 is $818 less than the contributed capital due to retained deficits or the cumulative losses from operations. Over the next three months, owner's equity will increase due to a budgeted trend of profitable operations and cash flows.

Why is the total amount of projected owner's equity at 11/30/X1 less than the planned capital contributions? If the budget were extended an additional three months to 2/28/X2, would you expect owner's equity to increase or decrease and why? (Do not do the actual budget through 2/28/X2, simply identify the relevant trends.)

(B)


Based on your review, is the company using the Fifo or Lifo inventory cost flow assumption? Show how "Accumulated Depreciation" amounting to $1,003 was determined on the 11/30/X1 pro-forma balance sheet. Explain how "Accounts Payable" of $908 was calculated on the same balance sheet.

(D)

Fifo.

Accumulated Depreciation: $.10 x # of units produced .10 x 10,025 = $1,003 rounded

Accounts Payable: Raw material purchases in November amount to $1,211, of which 75% are budgeted for payment in the following month and are therefore payable as of 11/30/X1.


Given the CVP analysis previously performed and the results of the budgetary process, what is your opinion of Heber's business opportunity and why? How much investment capital do you think is actually at risk? What do you think is the most significant factor in determining Heavenly Molds' ultimate success?

(E)

Answer to Part E - Listen to Walk Through for answer


What is the primary cause of improved budgeted profitability from September to November? Calculate cost of goods sold as a % of sales revenues in each month and generally explain the cause of the change.

(C)

This reduction is due to the fixed manufacturing costs which are spread out over more units through increased volume, thus reducing the cost per unit of production and cost of goods sold per unit.

Sept.87.6%

Oct.81.3%

Nov.72.3%

Improved profitability results from increased volume and the resulting lower cost of goods sold per unit. Cost of goods sold, as a % of sales revenues, declines as follows:

1 2

3 4

5 6

Lesson 15

15-1

Lesson 15Non-Routine

Business Decisions

Non-Routine Business Decisions

Examples:1. Whether to make or buy your product.

2. Whether to accept a special customer order.

3. Whether to discontinue or add a product line.

4. Whether to install a new computerized accounting system.

Costs and Revenues Relevant for Non-Routine Business Decisions

Relevant costs and revenues are the costs or revenues which should affect our decision.

Differential costs and revenues are future costs and revenues that vary among decision alternatives. Such costs and revenues are sometimes referred to as direct costs and revenues of a decision alternative and are avoidable if the other option is selected.

RelevantCosts/Revenues

DifferentialCosts/Revenues

=

Opportunity Costs are foregone revenues arising from a decision alternative.

Identifying Relevant Costs/Revenues

Drive to CaliforniaAuto Gas/Wear

Auto Wear in Calif.(500 miles)

Las Vegas FunOpportunity Cost

Fly to CaliforniaAirfare

Airport ParkingCar Rental

miles)1,300 (

Sunk costs are past costs.Past costs are always irrelevant.

1. Whether to make or buy a component part or product.Example: ABC, Inc., a game manufacturing company, is considering contracting out the manufacture of its chess boards. A Malaysian company has agreed to make the boards according to ABC's specifications for $5.10 a unit. ABC's current per unit cost of manufacturing the board themselves is as follows:

The fixed manufacturing overhead cost per unit is calculated, based on a volume of 100,000 units. Therefore, the total fixed manufacturing overhead cost is $50,000. If production is discontinued, then 60% of these fixed overhead costs ($30,000) can be avoided.

Manufacturing Supervisor SalaryRental Cost of Mfg. FacilityFixed Manufacturing Overhead

$30,000$20,000

Direct MaterialsDirect LaborVariable Mfg. OverheadFixed Mfg. Overhead

$2.50$1.50$ .75$ .50$5.25

$ 20,000

} $4.75

Examples of Non-Routine Decisions

7 8

9 10

11 12

15-2

Assume sales/production volume is anticipated at units. Would it be better economically to buy the chess boards from Malaysia or continue to manufacture them ourselves?

Buy Make$408,000Contract Cost ($5.10 × 80,000 )

Fixed Supervisor SalaryVariable Product Costs ($4.75 ×

$ 30,000$380,000

80,000

80,000)$408,000 $410,000

Assume sales/production volume is anticipated at 100,000 units. Would it be better economically to buy the chess boards from Malaysia or continue to manufacture them ourselves?

Buy Make$510,000Contract Cost ($5.10 × 100,000)

Fixed Supervisor SalaryVariable Product Costs ($4.75 × 100,000)

$ 30,000$475,000

$510,000 $505,000

Fixed Supervisor SalaryVariable Product Costs ($4.75 × 100,000)Fixed Supervisor SalaryVariable Product Costs ($4.75 × 100,000)

$ 30,000$475,000


Buy Make$510,000

($10,000)

Contract Cost ($5.10 × 100,000)

Sublease Revenues$500,000 $505,000

Assume sales/production volume is anticipated at 100,000 units. Would it be better economically to buy the chess boards from Malaysia or continue to manufacture them ourselves? Also assume we can sublease the space used to produce the chess boards for $10,000.

or


$ 30,000$475,000

$510,000

$10,000

Contract Cost ($5.10 × 100,000)Fixed Supervisor SalaryVariable Product Costs ($4.75 × 100,000)

Sublease Revenues$510,000 $515,000

Foregone $ 10,000

2. Whether to discontinue or add a product line.Example: ABC, Inc. had net income from operations last year of $85,000 which included the following results from the Checkers product line:

Sales RevenuesVariable Product CostsVariable Period Costs

Contribution MarginDirect Fixed Product and

Period CostsIncome before

Indirect CostsIndirect (allocated) Fixed

Product and Period CostsOperating Income (Loss)

Drop

$ 0000

0

0

(15,000)($15,000)

$150,000 (90,000)(30,000)

30,000

(20,000)

10,000

(15,000)($5,000)

Keep

($10,000)

3. Whether to accept a special order from a customer.

Direct MaterialsDirect LaborVariable Mfg. OverheadVariable Selling and Admin.

$7.00/unit$2.50/unit$1.00/unit$ .20/unit

Example: ABC is considering a large special order from an important customer for 10,000 units of a board game at a discounted price. What would be the lowest price possible before ABC would actually lose money on the sale given the following game costs:

Additional direct fixed manufacturing overhead costs amounting to $2,000 would be incurred as a result of this special order. All other fixed manufacturing overhead and selling and administrative costs would be unaffected by the order (there is sufficient capacity to accommodate the order).

Are there any qualitative issues which should be considered in the decision as to whether to accept such a special order?

Differential Per Unit Costs of Special Order:Direct MaterialsDirect LaborVariable Mfg. OverheadVariable Selling and Admin.Fixed Mfg. Overhead($2,000 ÷ 10,000 units)Total Per Unit Cost

$ 7.00$ 2.50$ 1.00$ .20

$ .20$10.90

13 14

15 16

17 18

15-3

Assume that fixed product and period costs are the same regardless of which product is manufactured and sold. Production volume is based on direct labor hours and it takes three hours to make a bicycle and two hours to make a tricycle. Direct labor hours employable by the company are limited due to factory size and limited available capital for expansion. Which product line yields greater overall profitability to the company?

Sales RevenuesVariable Product and

Period CostsContribution Margin

$50

25$25

Bicycles Tricycles$70

40$30

4. Which product should be emphasized in a situation of limited critical resources.Example: A company which manufactures bicycles and tricycles is extremely successful in marketing their products and can sell as many units as they can produce of either product. The relative contribution margin per unit of the two products is as follows: Contribution Margin Per Unit

Direct Labor HoursRequired To Produce

Contribution Margin Per Hour

$25

÷ 2$12.50

Bicycles Tricycles$30

÷ 3$10

The company is considering the manufacture and sale of a more premium brand of ice cream and has determined that it can be produced by further processing the existing brand with some additional ingredients. The additional per unit processing costs would be as follows:

Direct MaterialsDirect LaborVariable Mfg. Overhead

$1.30.30.10

$1.70 /unit

5. Whether to process a product further creating a higher grade product.

Example: Joe's Ice Cream manufactures and sells an economical ice cream brand at the following per unit profit given a volume of 1 million cartons per year:

Sales RevenuesVariable Product and Period CostsFixed Product & Period Costs (1,000,000 x $.35/unit)

$350,000

Per Unit$2.00)(1.00)(.35)

$ .65)**

500,000 × $.30 = $150,000

Assume this premium brand could be sold for $4.00/unit. No additional selling and administrative expenses or fixed manufacturing overhead costs would be incurred if the premium brand was manufactured in place of the economy brand. What would be the effect on profits if 50% of the 1 million units of volume were converted to premium production?Differential Revenues and Costs for 500,000 units of Premium Brand:

Differential Sales RevenuesDifferential Product CostsDifferential Profit

$2.00 /unit1.70 /unit

$ .30 /unit

Joint Costs: Common costs in the production of two products at different grades.

Problem #64

Jones Company has three divisions with the following operating results:

Jones is considering termination of Division R because of its operating loss. What would be the effect on total operating income with the termination of R assuming that there is no alternative use of the resulting idle capacity?

Sales RevenueVariable CostsContribution MarginDirect Fixed CostsIndirect / Allocated Fixed CostsOperating Income (Loss)

$250,000(137,000)113,000(55,000)(27,000)$31,000

TotalP$75,000 (43,000)

32,000(12,000)

(8,000)$12,000

$125,000(67,000)58,000

(24,000)(12,000)$22,000

Q$50,000(27,000)23,000

(19,000)(7,000)

($3,000)

R

19 20

21 22

23 24

15-4


Total net income would be reduced by $4,000 in the event that Division R is terminated.

Sales RevenuesVariable CostsContribution MarginDirect Fixed CostsIndirect / Allocated

Fixed CostsOperating Income (Loss)

$250,000(137,000) 113,000 (55,000)

(27,000) $31,000

Continue All

$200,000(110,000) 90,000 (36,000)

(27,000) $27,000

Discontinue R

($50,000) 27,000 23,000 19,000

0($4,000)

Revenues/CostsDifferentiated

Problem #65

A convenience store has limited shelf space and is considering replacing boxes of cookies with candy bars in a certain area. The space can hold 10 boxes of cookies for which the contribution margin per unit is $1.00 or 30 candy bars with a contribution margin of $.25 per unit. Management believes that the cookie and candy bar inventory will turnover 4 and 6 times, respectively. Assuming all other things are equal, which product should they stock in this limited space?


The candy bars should be stocked rather than cookies as long as this decision will not have any effect on sales of other products and there are no other differentiating costs.

Contribution margin per unit# of units in inventory/spaceContribution margin per inventory turnInventory turn per monthContribution margin per month

on limited shelf space

$1.00 x 10

$10.00x 4

$40.00

Cookies$.25

x 30$7.50x 6

$45.00

Candy

HEAVENLY MOLDS, INC.Manufacturing (Product) Costs:

Variable Costs Per Unit-Direct MaterialsDirect LaborManufacturing Overhead:

Employer Payroll TaxMachine LeaseIndirect MaterialsWorkman's CompensationUtilitiesMold Depreciation

$ .30.20

.02

.08

.03

.02

.05

.10$ .80

$2,000300250160

1,120$3,830

Fixed Costs Per Month-Machine LeaseIndirect MaterialsIndirect LaborUtilitiesBuilding Rent

Selling and Administrative Costs:

Variable Costs Per Unit-Sales Commissions

Fixed Costs Per Month-Building RentUtilitiesTelephones, Fax, etc.Copy Machine, PaperOther Office SuppliesLiability InsuranceAccounting Service

$.10

$28040

30025015050

500$1,570

Budgeted sales at a price of $2.50 per unit:

Operational Budgets:Cash capitalization of approximately $43,000 required during the first three months of operations.At risk capital is approximately $20,000 (cost of production mold)

CVP Analysis:Breakeven point Units of sales needed to reach$2,000 / month of net income = 4,625 units per month

= 3,375 units per month

Sept.2,000

Oct.3,000

Nov.4,000

25 26

27 28

29 30

15-5

Problem #66

The Provo Pioneer Association offers to buy 1,000 jello molds in September but can only pay $1.80 per unit.

What would be the impact on net income(loss) if there was sufficient excess capacity to produce the additional units with no additional direct fixed manufacturing and selling costs associated with this order except for a $200 finder's fee to the President of the Provo Pioneer Association? (Assume the $.10 per unit sales commission will have to be paid on this order).

Additional Questions:

What would be the lowest per unit price that Heber would be willing to sell these additional 1,000 units for before incurring a loss on this order?

What qualitative issues may exist in this decision to accept this order?

Problem #66




$.30.20

.02

.08

.03

.02

.05

.10$.80

$2,000300250160

1,120$3,830





$.10

$28040

30025015050

500$1,570


Differential Revenues and Expenses in Accepting the Special Order:

In other words, acceptance of this special order would reduce the projected loss by $700.

*This amount, $.80/unit, includes depreciation of the production mold ($.10/unit), however, this inclusion could be disputed. If the straight-line method of calculating depreciation had been used, then the depreciation would have been a fixed cost unrelated to the # of units produced or sold. Whether this cost should be included or not probably depends upon whether the actual deterioration of realizable value of the production mold is time dependent or volume dependent. Assuming it is volume dependent (similar to mileage on a car) it is properly included in this analysis.

Sales Revenues ($1.80 x 1,000 units)Variable Manufacturing* ($.80 x 1,000)Variable Selling ($.10 x 1,000)Finders Fee

Differential income from special order

$1,800(800)(100)(200)

$ 700


Additional Question:

What would be the lowest per unit price that Heber would be willing to sell these additional 1,000 units for before incurring a loss on this order?

What qualitative issues may exist in this decision to accept this order?

(See Walk Through for answer)

Total differential costs of order $1,1001,000

$ 1.10unitsper unit

Heber has spoken to a local injection molding manufacturing business about the possibility of them manufacturing the jello molds for Heavenly Molds, Inc., on a contract basis at a price of $1.50 per unit assuming Heber provided his own production mold. If Heber contracted out the manufacturing of the jello molds, he believes he could operate out of his apartment and avoid all manufacturing costs except depreciation of the production molds and the building rent. (Assume for this problem that Heber has already signed a two-year lease on the building beginning September 1, but he expects that he could sublease it for $1,600 per month and make a $200 per month profit on the sublease if he chose not to use it for his own business). If Heber operated out of his house he would still incur all of the budgeted fixed selling and administrative costs.What would be the net effect on Heber's profitability based on 2,750 units of budgeted production if Heber contracted out the manufacturing of those units?Additional Questions:

What would be the effect on relative costs at higher levels of volume? What might be some qualitative considerations involved in this decision on whether to contract out the manufacturing process?

31 32

33 34

35 36

15-6

Problem #67




$.30.20

.02

.08

.03

.02

.05

.10$.80

$2,000300250160

1,120$3,830


Problem #67




$.10

$28040

30025015050

500$1,570


Differential (Avoidable) Costs of Decision Options:

If Heber contracts out the manufacturing of 2,750 units, net income will improve by $2,110 based on sales of the total 2,750 units.

ManufactureYourself

Contract Out

$4,125

$1,9252,7101,600

$6,235 $4,125

$2,110

Contract Cost (2,750 x $1.50)Manufacturing Costs:

Variable (excluding dep'n)(2,750 x $.70)

Fixed (excluding bldg. rent)Opportunity Cost (sublease)


Additional Questions:

What would be the effect on relative costs at higher levels of volume?

At higher levels of volume, the lower cost of contracting out the manufacture of the jello molds is diminished. In fact, at significantly higher volumes, the decision to manufacture the jello molds yourself becomes preferrable.

What might be some qualitative considerations involved in this decision on whether to contract out the manufacturing process?

Contracting out the manufacture of the jello molds may result in the loss of quality control, timeliness in production, and control of future product costs.

Problem #68

Heber finally comes to the conclusion that the entire market for his jello molds might reach saturation within 2 years and total sales of 100,000 units at a price of $2.50 per unit. Assuming Heber contracted out the manufacturing of the product for $1.50 per unit and decides to sell the product himself and do all of the business accounting, and unavoidable administrative costs would run only about $500 per month, calculate the total two year profit the business would generate under this scenario.

How many units would Heber have to sell over the two years to simply break even?

$34,000 per year of profit available under assumptions provided.

32,000 units=x

32,0001.00

1.00x1.00 =

- =1.00x 32,000 0- - =2.50x 1.50x 32,000 0

SR - VC FC NI=-

Revenues (100,000 x $2.50)Less Expenses:

Cost of Goods Sold (at contract cost, 100,000 x $1.50)Mold DepreciationSelling and Administration ($500/mo. x 24)

$250,000

150,00020,00012,000

$68,000

Problem #68- Answer

1

Financial Practice Set

Purpose: The purpose of this practice set is to bring together in one example the steps of an accounting system designed to produce a company's periodic financial statements. This will serve as an excellent review of the material covered in the course to date.The practice set will also introduce two additional accounting tools (subsidiary ledgers and special journals) which are important elements of a company's accounting system for financial and managerial purposes. In reality, accounting systems today are almost always computerized systems. Manually prepared journals and ledgers are pretty much relics of the past. However, an opportunity to manually prepare journal entries, post those entries to ledgers and prepare financial statements is a valuable learning tool to better understand how computerized accounting systems are designed and operate. The manual bookkeeping system set up for this Practice Set is a fair representation of systems actually used by business' before the advent of computerized systems. Understanding this manual system will facilitate your understanding of most computerized accounting systems you may encounter in today's world. In order to maximize the use of this Practice Set we will also use the financial statements in Lesson 10 where we discuss financial statement analysis. Our ultimate goal in this class is to be able to competently read, understand and analyze financial statements so as to evaluate a company's financial position, operating performance and investment potential. We ultimately hope to determine a fair price for a company's stock for investment consideration.

Business Information: Hot Cars, Inc. (HCI) specializes in the wholesale distribution of miniature model cars. HCI purchases model cars from three Southeast Asian manufacturing companies (Vendors #1, #2, and #3) and sells them to specialty toy stores in the United States. The company is solely owned by Eric McGinn and operates on a calendar year basis. The company has hired you to maintain the accounting records for the month of December 20X2and beyond, depending upon your performance.

The following are all the transactions for HCI during December, 20X2: (The "*" indicates transactions which have already been journalized and posted. This has been done to shorten your work and provide examples of the use of special journals in the recording of transactions. All cash receipt transactions have been journalized in the cash receipts journal and posted to both the subsidiary ledgers as appropriate and the general ledger to provide an example of proper posting from such special journals.)

Paid warehouse and office rent of $4,800 to Capital Property Management with check #2401 for rent due for the period of December 1, 20X2 to November 30, 20X3.

12/2*

Collected note receivable from an employee (David Jones) in the amount of $750 plus interest in the amount of $25 not previously recorded.

12/1*

2

Paid Vendor #2 $840 on account (purchase invoice #3717) with check #2403.

Sold 450 units of RX7 costing $2,250 for $3,000 (sales invoice #34570) on account to Customer #1.

12/8*

12/7*

Borrowed $10,000 from Provo State Bank executing a note payable providing for all principal and interest at a rate of 15% annually to be due 12/7/X3.

12/7*

Received a check from Customer #2 for $3,835 as payment on account (sales invoice #34568).

12/6*

Paid Vendor #1 $1,550 on account (purchase invoice #44657) with check #2402.12/3*

Received a check from Customer #1 for $2,310 representing payment on account (sales invoice #34567).

12/3*

Issued an additional 1,250 shares of stock to the sole shareholder of the company, Eric McGinn, for $12,500 cash.

12/3*

Sold 750 units of F150 costing $7,500 for $12,500 (sales invoice #34571) to Customer #3 on account.

12/12

Purchased some warehouse equipment from Smith's Equipment for $15,000 paying $3,000 down (check #2405) and financing the remainder of the purchase price ($12,000) with a 3-year note due to Smith's Equipment in 3 annual payments of $4,000 on 12/11 of each following year with interest (at 12% on the unpaid balance) payable monthly on the 11th of each month beginning January 11, 20X3.

12/11

Purchased on Account from Vendor #3 (purchase invoice #76855) 250 units of Z28 at $5 per unit.

12/9

Paid Vendor #3 $1,400 on account (purchase invoices #76654 and #76744) with check #2404.

12/9


12/9*

Purchased on account from Vendor #1 (purchase invoice #1446) the following: 300 units of Z28 @ $5 per unit, 500 units of F150 @ $10 per unit, and 400 units of RX7 @ $5 per unit.

12/8*

3

Received and immediately paid the November utility bill to Provo Power for $700 with check #2408.

12/25

Sold 500 units of Z28 costing $2,500 for $3,625 (sales invoice #34573) to Customer #1 on account.

12/23

Purchased on account from Vendor #2 (purchase invoice #3981) 800 units of RX7 at $5 per unit.

12/21

Sold 500 units of Z28 costing $2,500 and 1,200 units of RX7 costing $6,000 at a total price of $12,950, (sales invoice #34572) to Customer #2 on account.

12/16

Bought office supplies amounting to $640 from the Supply Depot paying the full amount with check #2407.

12/15

Paid Vendor #1 $8,500 on account (purchase invoice #1446) with check #2406.

12/13


12/13*

Sold 300 units of F150 costing $3,000 for $4,500 (sales invoice #34574) on account to Customer #2.

12/27

REQUIREMENTS:

You may wish to review the journalizing and posting of several transactions noted with an "*" for purposes of familiarizing yourself with the proper use of the special journals and methods of posting individual transactions to the subsidiary ledgers and general journal as appropriate. This review should help you avoid mistakes and save you time in the long run—that is why these sample transactions have been journalized and posted for you. Also, some of the information in these transactions are necessary in order to prepare the proper adjusting entries in Requirement 5 below.

1.

Purchased on account from Vendor #3 (purchase invoice #77102) 1,200 units of F150 at $10 per unit.

12/31

Paid monthly salaries for the month of December to David Jones ($3,000 - check #2409) and Harvey Dodge ($1,600 - check #2410), the only employees of the company. (Ignore payroll withholdings and payroll taxes in this practice set.)

12/31

Purchased on account from Vendor #1 (purchase invoice #45993) 1,000 units of Z28 at $5 per unit.

12/29

4

From the information provided below, determine and record all appropriate adjusting entries as of 12/31/X2 in the general journal, post all adjustments to the general ledger and complete the partially completed "adjusted" portion of the trial balance.

5.

Check to make sure that all subsidiary ledger ending balances for inventory, A/R, and A/P agree in total to their respective general ledger "control" accounts. If they do not agree, then you probably made a posting error. Then complete the partially completed "pre-adjusted" portion of the trial balance provided.

4.

Post all recorded transactions to the appropriate general and subsidiary ledgers. (For the cash receipts journal all postings have already been made for an example of posting to both subsidiary and general ledgers.)

3.

Journalize all December transactions for HCI in the journals provided (utilize the special journals: cash receipts journal, sales journal, purchases journal or cash disbursements journal for all transactions). The general journal will only be used for adjusting and closing entries.

2.

Income taxes are payable by 3/15/X3 at a rate of 25% of the income before taxes in 20X2. (You must post all of the other adjusting entries and figure out 20X2 net income before tax before you can determine this adjusting entry. Round to the nearest dollar.)

G.

December utilities are estimated to be $400 although the bill has not yet been received.F.

Prepaid rent requires proper adjustment given the facts associated with the prepayment on 12/2.

E.

The company sub-leased a portion of its warehouse space to Fred the Grocer for five months beginning on 10/1/X2 at which time the company received the full amount of the $700 rent in advance recording it as Unearned Rent Revenue. (see 11/30/X2 GeneralLedger balance).

D.

Interest accruing on the notes payable amounts to $178 as of 12/31/X2.C.

A physical count of office supplies reveals that supplies costing $750 are on hand as of 12/31/X2.

B.

An analysis of the company's insurance policies indicates that premiums previously paid amounting to $400 apply to 20X3 coverage. All other prepaid insurance expires in 20X2. (This adjusting entry has already been recorded in the general journal as an example, but the entry has not yet been properly posted to the general ledger. You must post this adjusting entry to the general ledger yourself.)

A.

Data required for 12/31/X2 adjusting entries is provided as follows:

5

The Solution: The solution to this Practice Set is available to you by clicking on "answer". However, this solution should be used judiciously in order to receive the greatest learning value from this experience. A student who does not actually do the Practice Set but merely reviews the solution will have a greatly diminished learning experience and will discover that fact when taking the first exam. The solution has been provided to assist a student who encounters a stumbling block and needs some assistance while progressing through the work. In the end, it will help a student discover any mistakes made and allow them to make the corrections necessary to successfully complete the set.

Comparative balance sheet as of December 31, 20X1 and 20X2 (one statement with a column for each year)

B.

Comparative income statement for the years ended December 31, 20X1 and 20X2 (one statement with a column for each year)

A.

7. Prepare the following for HCI:

Record in the general journal the closing entry(ies) at 12/31/X2 , post the closing entry(ies) to the general ledger and complete the partially completed "post-closing" trial balance.

6.

Enclosed in this packet are the following for Hot Cars, Inc. ("HCI"):

Partially completed 12/31/X2 pre-adjusted, adjusted, and post-closing trial balances. (The partial completion of these trial balances serve as check figures for your work.)

7.

A cash receipts journal, sales journal, purchases journal, cash disbursements journal, and general journal to be used to record all of HCI's transactions for December 20X2 and adjusting and closing entries as of 12/31/X2.

6.

Subsidiary ledgers for Accounts Receivable, Inventory, and Accounts Payable.5.

The general ledger for HCI with balances reflected as of 11/30/X2 (the nominal account balances reflect all activity for the period 1/1/X2-11/30/X2.)

4.

The HCI chart of accounts.3.

An unadjusted trial balance for HCI as of 11/30/X2.2.

A balance sheet for HCI as of 12/31/X1 and an income statement for HCI for the year ended 12/31/X1.

1.

6


December 31, 20X1

ASSETS



Total Assets

$12,66511,75011,432

470350

4,400 750 41,817

14,700$56,517

12/31/X1

LIABILITIES & STOCKHOLDER'S EQUITY

Current Liabilities:Accounts PayableSalaries PayableIncome Tax PayableDividend PayableUtilities PayableUnearned Rent RevenueInterest PayableCurrent Portion of Notes Payable


Total LiabilitiesStockholder's Equity:

Capital Stock (2,400 shares outstanding)



$13,5114,1251,6441,250

48500

021,015

021,015

24,000 11,502

35,502

$56,517

7


for the year ended December 31, 20X1





20X1

$185,043 111,026 74,017

49,5003,8934,1506,3452,3361,055

298 67,577

6,440Other Revenues and Expenses

Rental RevenueInterest Revenue




0 135 135 0 1356,575

1,644$4,931

$2.05

8

9

HCI Chart of Accounts

Assets #110 Cash120 Accounts Receivable130 Inventory140 Office Supplies150 Prepaid Insurance160 Prepaid Rent170 Notes Receivable180 Warehouse Equipment190 Land

Liabilities210 Accounts Payable220 Salaries Payable230 Income Taxes Payable240 Dividend Payable250 Notes Payable260 Unearned Rent Revenue270 Utilities Payable280 Interest Payable

Owner's Equity310 Capital Stock320 Retained Earnings330 Dividends

Revenues410 Sales Revenue420 Interest Revenue430 Rent Revenue

Expenses505 Cost of Goods Sold510 Salaries Expense515 Office Supplies Expense520 Rent Expense525 Utilities Expense530 Misc. Expense535 Insurance Expense540 Postage Expense545 Interest Expense550 Income Tax Expense

10

General Ledger

Account No. General Ledger Account

Date 20X2 AmountDR/CRCreditDebitBalance

DescriptionPostRef.

110 CASH

11/30 Balance DR 13,068December Cash Receipts12/31 CR 1 34,770 47,838DR



DescriptionPostRef.

11/30 Balance DR 9,235December Collections on A/R12/31 CR 1 11,495 (2,260)CR

120 ACCOUNTS RECEIVABLE



DescriptionPostRef.

130 INVENTORY

11/30 Balance DR 18,000



DescriptionPostRef.

11/30 Balance DR 1,250

140 OFFICE SUPPLIES

11

General Ledger



DescriptionPostRef.

150 PREPAID INSURANCE

11/30 Balance DR 905



DescriptionPostRef.

11/30 Balance 0Paid 1 year in advance 12/1/X2 -X312/2 CD 1 4,800 4,800DR

160 PREPAID RENT



DescriptionPostRef.

170 NOTES RECEIVABLE

11/30 Balance DR 750Receipt of Note Payoff12/1 CR 1 750 0



DescriptionPostRef.

11/30 Balance DR 22,394

180 WAREHOUSE EQUIPMENT

12

General Ledger



DescriptionPostRef.

190 LAND

11/30 Balance 0



DescriptionPostRef.

11/30 Balance CR 3,790

210 ACCOUNTS PAYABLE



DescriptionPostRef.

220 SALARIES PAYABLE

11/30 Balance 0



DescriptionPostRef.

11/30 Balance 0

230 INCOME TAXES PAYABLE

13

General Ledger



DescriptionPostRef.

240 DIVIDENDS PAYABLE

11/30 Balance 0



DescriptionPostRef.

11/30 Balance 0Provo State Bank Loan12/7 CR 1 10,000 10,000CR

250 NOTES PAYABLE



DescriptionPostRef.

11/30 Balance 0

270 UTILITIES PAYABLE



DescriptionPostRef.

260 UNEARNED RENT REVENUE

11/30 Balance 700CR

14

General Ledger



DescriptionPostRef.

280 INTEREST PAYABLE

11/30 Balance 0



DescriptionPostRef.

11/30 Balance (3,000 shares) 30,000Issued 1,250 Shares to McGinn12/3 CR 1 12,500 42,500CR

310 CAPITAL STOCK

CR



DescriptionPostRef.

11/30 Balance 675

330 DIVIDENDS

DR



DescriptionPostRef.

320 RETAINED EARNINGS

11/30 Balance from 1/1/X2 11,502CR

15

General Ledger



DescriptionPostRef.

410 SALES REVENUES

11/30 Balance 225,375CR



DescriptionPostRef.

11/30 Balance 27Interest Earned on Note12/1 CR 1 25 52

420 INTEREST REVENUE

CRCR



DescriptionPostRef.

430 RENT REVENUE

11/30 Balance 0



DescriptionPostRef.

11/30 Balance 140,276

505 COST OF GOODS SOLD

DR

16

General Ledger



DescriptionPostRef.

11/30 Balance 2,818

515 OFFICE SUPPLIES EXPENSE

DR



DescriptionPostRef.

510 SALARIES EXPENSE

11/30 Balance 49,000DR



DescriptionPostRef.

520 RENT EXPENSE




DescriptionPostRef.

11/30 Balance 5,750

525 UTILITIES EXPENSE

DR

17

General Ledger



DescriptionPostRef.

530 MISCELLANEOUS EXPENSE




DescriptionPostRef.

11/30 Balance 600

535 INSURANCE EXPENSE

DR



DescriptionPostRef.

540 POSTAGE EXPENSE

11/30 Balance 321DR



DescriptionPostRef.

11/30 Balance 0

545 INTEREST EXPENSE

18

General Ledger

11/30 Balance 0

550 INCOME TAX EXPENSEAccount No. General Ledger Account


DescriptionPostRef.

19

Accounts Receivable Subsidiary Ledger

Inv.# Post Ref.Date BalanceCreditPost Ref.DebitACCT #120.1 - CUSTOMER #1

Balance at 11/30/X2 4,6602,3505,3503,000

0

12/03 34567345703456234570

12/0712/0912/13

3,000CR 1

CR 1CR 1

SJ 1 2,310

2,3503,000

ACCT #120.2 - CUSTOMER #2Inv.# Post Ref.Date BalanceCreditPost Ref.Debit

3,835Balance at 11/30/X2

012/06 34568 CR 1 3,835

Inv.# Post Ref.Date BalanceCreditPost Ref.Debit

740Balance at 11/30/X2

ACCT #120.3 - CUSTOMER #3

20

Accounts Payable Subsidiary Ledger

Balance at 11/30/X2 1,550

8,50012/08 1446 PJ 1 8,500

012/03 44657 CD 1 1,550

ACCT #210.1 - VENDOR #1Inv.# Post Ref.Date BalanceCreditPost Ref.Debit

Inv.# Post Ref.Date BalanceCreditPost Ref.DebitACCT #210.2 - VENDOR #2


012/08 3717 840CD 1

ACCT #210.3 - VENDOR #3

1,400Balance at 11/30/X2


21

Inventory Subsidiary Ledger

Inv.# Post Ref. # Units $ /Unit Total Post Ref. # Units $ /Unit TotalDate Balance

# Units $ /Unit TotalCreditDebit

ACCT #130.1 - PART #F150

11/30 Balance 700 $ 10 7,000

12/08 1446 PJ 1 500 $ 10 5,000 $ 101,200 12,000

ACCT #130.2 - PART #RX7

11/30 Balance 1,500 $ 5 7,50012/07 34570

400 $ 5 2,0001,050 5,250

12/08 1446450 $ 5 2,250

1,450 7,250PJ 1 SJ 1 $ 5

$ 5





ACCT #130.3 - PART #Z28

11/30 Balance 700 $ 5 3,50012/08 1446 1,000 5,000$ 5PJ 1 300 $ 5 1,500

22

Notes Receivable

Provo State Bank

David Jones 775 170 750

Eric McGinnCustomer #1

Customer #2

Customer #1Customer #1

12,5002,310

3,83510,000

2,3503,000

Totals 34,770

A/C 110

120.1

120.2

120.1120.1

12/01

12/0312/03

12/0612/0712/0912/13

2,310

3,835

2,3503,000

11,495

A/C 120

420

310

250

Interest RevenueCapital Stock

Notes Payable

2512,500

10,000

Payor Name Post Ref. Amount (CR)Cash (DR) Post Ref.Date AmountAcct. NameOther AccountsAccounts Receivable

(CR 1)HCI

Cash Receipts Journal

23

HCISales Journal (SJ 1)

SalesRevenue

(CR)PostRef.

PostRef. # Units Total

Cost of Goods sold (DR)/Inventory (CR)

Date Customer Name Inv. # Amount

(DR) Item Cost/Unit

AccountsReceivable

Customer #112/07 34570 120.1 130.2 3,000 3,000 RX7 450 5 2,250

24

Vendor Name Post Ref. ItemInv. # # Units $ Per Unit Total Post Ref. Amounts (CR)Date Inventory (DR) Accounts Payable

HCIPurchases Journal

(Inventory Purchases Only) (PJ 1)

Vendor #112/08 1446 130.2 RX7 400 5 2,000 210.1 8,500130.3 Z28 300 5 1,500

130.1 F150 500 10 5,000

25

Date20X2

Cash(CR)

CheckNo.

PostRef.

AccountsPayable

(DR)PostRef. Account Amount

PayeeName Post

Ref. Account Amount

Other Accounts (CR) Other Accounts (DR)

Capital Property Mgmt.4,800

210.1

1602401 PrepaidRent 4,80012/02

1,550 240212/03 Vendor #1Vendor #2840 240312/08 210.2

1,550840

HCICash Disbursements Journal (CD 1)

26

General Journal (Adjusting and Closing Entries) (GJ 1)

12/31/X2* Insurance Expense 535 505Prepaid Insurance 150 505

(Adjust Prepaid Insurance)

*Entry has not yet been posted

Accounts/Description Post Ref.Date CreditDebit

(CONTINUED ON NEXT PAGE)

27



Trial Balances 12/31/X2

CashAccounts ReceivableInventoryOffice SuppliesPrepaid InsurancePrepaid RentNotes ReceivableWarehouse EquipmentLandAccounts PayableSalaries PayableIncome Tax PayableDividend PayableNotes PayableUnearned Rent Revenue

Pre-AdjustedDR(CR)

AdjustedDR(CR)

Post ClosingDR(CR)

21,80834,315

1,890

(22,250)

0

(22,000)

21,80834,315

750

(22,250)

(6,408)

(22,000)

21,80834,315

750

(22,250)

(6,408)

(22,000)

Utilities PayableInterest PayableCapital StockRetained EarningsDividendsSales RevenueInterest RevenueRent RevenueCost of Goods SoldSalaries ExpenseOffice Supplies ExpenseRent ExpenseUtilities ExpenseMisc. ExpenseInsurance ExpensePostage ExpenseInterest ExpenseIncome Tax Expense

0

(11,502)

(261,950)

164,026

2,818

00

(178)

(11,502)

(261,950)

164,026

3,958

6,408

(178)

(30,051)

0

0

0

00

0 0 0

28

178

Financial Practice Set Solution

Trial Balances 12/31/X2

CashAccounts ReceivableInventoryOffice SuppliesPrepaid InsurancePrepaid RentNotes ReceivableWarehouse EquipmentLandAccounts PayableSalaries PayableIncome Tax PayableDividend PayableNotes PayableUnearned Rent Revenue

Pre-AdjustedDR(CR)

AdjustedDR(CR)

Post ClosingDR(CR)

21,80834,31525,000

1,890905

4,8000

37,3940

(22,250)000

(22,000)(700)

21,80834,31525,000

750400

4,4000

37,3940

(22,250)0

(6,408)0

(22,000)(280)

21,80834,31525,000

750400

4,4000

37,3940

(22,250)0

(6,408)0

(22,000)(280)

Utilities PayableInterest PayableCapital StockRetained EarningsDividendsSales RevenueInterest RevenueRent RevenueCost of Goods SoldSalaries ExpenseOffice Supplies ExpenseRent ExpenseUtilities ExpenseMisc. ExpenseInsurance ExpensePostage ExpenseInterest ExpenseIncome Tax Expense

00

(42,500)(11,502)

675(261,950)

(52)0

164,02653,600

2,8184,4006,4501,952

600321

00

(400)(178)

(42,500)(11,502)

675(261,950)

(52)(420)

164,02653,600

3,9584,8006,8501,9521,105

321178

6,408

(400)(178)

(42,500)(30,051)

00000000000000

0 0 0

1


December 31, 20X1 and 20X2

ASSETS



Total Assets

$12,66511,75011,432

470350

4,400 750 41,817

14,700$56,517

12/31/X1

$21,80834,31525,000

750400

4,400 0

86,673

37,394$124,067

12/31/X2

LIABILITIES & STOCKHOLDER'S EQUITY

Current Liabilities:Accounts PayableSalaries PayableIncome Tax PayableDividend PayableUnearned Rent RevenueUtilities PayableInterest PayableCurrent Portion of Notes Payable


Total LiabilitiesStockholder's Equity:

Capital Stock (2,400 shares outstanding)



$13,5114,1251,6441,250

0485

0 0

21,015

021,015

24,000 11,50235,502

$56,517

12/31/X1

$22,2500

6,4080

280400178

14,000 43,516

8,000 51,516

42,500 30,051 72,551

$124,067

12/31/X2

2

Hot Cars, Inc.

Income Statement






20X1

$185,043 111,026 74,017

49,5003,8934,1506,3452,3361,055

298 67,577

6,440Other Revenues and Expenses

Rental RevenueInterest Revenue




0 135 135 0 1356,575

1,644$4,931

$2.05

20X2

$261,950164,02697,924

53,6003,9584,8006,8501,9521,105

32172,58625,338

42052

472178294

25,6326,408

$19,224$4.52

3

General Ledger



DescriptionPostRef.

110 CASH

11/30 Balance DR 13,068December Cash Receipts12/31 CR 1 34,770 47,838DRDecember Cash Disbursements CD 1 26,030 DR 21,80812/31



DescriptionPostRef.

11/30 Balance DR 9,235December Collections on A/R12/31 CR 1 11,495 (2,260)CRDecember Sales on Account SJ 1 36,575 DR 34,31512/31

120 ACCOUNTS RECEIVABLE



DescriptionPostRef.

130 INVENTORY

11/30 Balance DR 18,000December Inventory Purchases12/31 PJ 1 30,750 48,750DRDecember Inventory Sales SJ 1 23,750 DR 25,00012/31



DescriptionPostRef.

11/30 Balance DR 1,250Purchase Supplies12/15 CD 1 640 1,890DRAdjusting Entry GJ 1 1,140 DR 75012/31

140 OFFICE SUPPLIES

4

General Ledger



DescriptionPostRef.

150 PREPAID INSURANCE

11/30 Balance DR 905Adjusting Entry12/31 GJ 1 505 400DR



DescriptionPostRef.

11/30 Balance 0Paid 1 year in advance 12/1/X2 -X312/2 CD 1 4,800 4,800DRAdjusting Entry GJ 1 400 DR 4,40012/31

160 PREPAID RENT



DescriptionPostRef.

170 NOTES RECEIVABLE

11/30 Balance DR 750Receipt of Note Payoff12/1 CR 1 750 0



DescriptionPostRef.

11/30 Balance DR 22,394Purchase of Equipment12/11 CD 1 15,000 37,394DR

180 WAREHOUSE EQUIPMENT

5

General Ledger



DescriptionPostRef.

190 LAND

11/30 Balance 0



DescriptionPostRef.

11/30 Balance CR 3,790December Purchases on Account12/31 PJ 1 30,750 34,540CR

210 ACCOUNTS PAYABLE

December Payments on Account CD 1 12,290 CR 22,25012/31



DescriptionPostRef.

220 SALARIES PAYABLE

11/30 Balance 0



DescriptionPostRef.

11/30 Balance 0Adjusting Entry12/31 GJ 1 6,408 6,408CR

230 INCOME TAXES PAYABLE

6

General Ledger



DescriptionPostRef.

240 DIVIDENDS PAYABLE

11/30 Balance 0



DescriptionPostRef.

11/30 Balance 0Provo State Bank Loan12/7 CR 1 10,000 10,000CR

250 NOTES PAYABLE

Smith's Equipment Note CD 1 12,000 CR 22,00012/11



DescriptionPostRef.

11/30 Balance 0Adjusting Entry12/31 GJ 1 400 400CR

270 UTILITIES PAYABLE



DescriptionPostRef.

260 UNEARNED RENT REVENUE

11/30 Balance 700CRCR 280Adjusting Entry12/31 GJ 1 420

7

General Ledger



DescriptionPostRef.

280 INTEREST PAYABLE

11/30 Balance 0Adjusting Entry12/31 GJ 1 178 178CR



DescriptionPostRef.

11/30 30,000Issued 1,250 Shares to McGinn12/3 CR 1 12,500 42,500CR

310 CAPITAL STOCK

CR



DescriptionPostRef.

11/30 Balance 675Closing Entry12/31 GJ 2 675 0

330 DIVIDENDS

DR



DescriptionPostRef.

320 RETAINED EARNINGS

11/30 Balance from 1/1/X2 11,502Closing Entry (Net Income)12/31 GJ 2 19,224 30,726CR

CR

Closing Entry (Dividends) GJ 2 675 CR 30,05112/31

8

Balance (3,000 shares) 30,000

General Ledger



DescriptionPostRef.

410 SALES REVENUES

11/30 Balance 225,375December Sales12/31 SJ 1 36,575 261,950CR

CR

Closing Entry GJ 2 261,950 012/31



DescriptionPostRef.

11/30 Balance 27Interest Earned on Note12/1 CR 1 25 52

420 INTEREST REVENUE

CR

Closing Entry GJ 2 52 012/3CR



DescriptionPostRef.

430 RENT REVENUE

11/30 Balance 0Adjusting Entry12/31 GJ 1 420 420CRClosing Entry GJ 2 420 012/31



DescriptionPostRef.

11/30 Balance 140,276December cost of goods sold12/31 SJ 1 23,750 164,026

505 COST OF GOODS SOLD

DR

Closing Entry GJ 2 164,026 012/31DR

9

General Ledger



DescriptionPostRef.

11/30 Balance 2,818Adjusting Entry12/31 GJ 1 1,140 3,958

515 OFFICE SUPPLIES EXPENSE

DR




DescriptionPostRef.

510 SALARIES EXPENSE

11/30 Balance 49,000December Salary - Jones12/31 CD 1 3,000 52,000DRDecember Salary - Dodge CD 1 1,600 53,60012/31

DR

DRClosing Entry GJ 2 53,600 012/31



DescriptionPostRef.

520 RENT EXPENSE

11/30 Balance 4,400Adjusting Entry12/31 GJ 1 400 4,800DRClosing Entry GJ 2 4,800 012/31

DR



DescriptionPostRef.

11/30 Balance 5,750Paid November Bill12/25 CD 1 700 6,450

525 UTILITIES EXPENSE

DR

Adjusting Entry GJ 1 400 6,85012/31DR


10

General Ledger



DescriptionPostRef.

530 MISCELLANEOUS EXPENSE

11/30 Balance 1,952Closing Entry12/31 GJ 2 1,952 0

DR



DescriptionPostRef.

11/30 Balance 600

535 INSURANCE EXPENSE

DRAdjusting Entry GJ 1 505 1,10512/31Closing Entry GJ 2 1,105 012/31

DR



DescriptionPostRef.

540 POSTAGE EXPENSE

11/30 Balance 321Closing Entry12/31 GJ 2 321 0

DR



DescriptionPostRef.

11/30 Balance 0

545 INTEREST EXPENSE

Adjusting Entry GJ 1 178 17812/31Closing Entry GJ 2 178 012/31

DR

10

11



DescriptionPostRef.

General Ledger

11/30 Balance 0

550 INCOME TAX EXPENSE

Adjusting Entry GJ 1 6,408 6,40812/31Closing Entry GJ 2 6,408 012/31

DR

12

Accounts Receivable Subsidiary Ledger

Inv.# Post Ref.Date BalanceCreditPost Ref.DebitACCT #120.1 - CUSTOMER #1

Balance at 11/30/X2 4,6602,3505,3503,000

03,625

12/03 3456734570345623457034573

12/0712/0912/1312/23

3,000

3,625

CR 1

CR 1CR 1

SJ 1

SJ 1

2,310

2,3503,000

ACCT #120.2 - CUSTOMER #2Inv.# Post Ref.Date BalanceCreditPost Ref.Debit

0


12,950

12/06 34568

3457212/16 12,950

CR 1

SJ 1

3,835

17,4503457412/27 4,500SJ 1



13,24012/12 34571 SJ 1 12,500

ACCT #120.3 - CUSTOMER #3

13

Accounts Payable Subsidiary Ledger


8,5000

5,000

12/08 14461446

4599312/1312/29

8,500PJ 1

PJ 1CD 1

8,500

5,000

012/03 44657 CD 1 1,550

ACCT #210.1 - VENDOR #1Inv.# Post Ref.Date BalanceCreditPost Ref.Debit

Inv.# Post Ref.Date BalanceCreditPost Ref.DebitACCT #210.2 - VENDOR #2


0

4,000

12/08 3717

398112/21

840CD 1

4,000PJ 1

ACCT #210.3 - VENDOR #3

1,400Balance at 11/30/X2012/09 76654 CD 1 1,400

1,25012/09 7685513,25012/31 77102

76744

PJ 1

PJ 11,250

12,000


14

Inventory Subsidiary Ledger



ACCT #130.1 - PART #F150

11/30 Balance 700 $ 10 7,000

12/08 1446 PJ 1 500 $ 10 5,000 $ 101,200 12,00012/12 34571 SJ 1 750 $ 10 7,500 450 $ 10

$ 10$ 10

4,500SJ 1 300 $ 10 3,00012/27 34574

12/31 77102 1,200 $ 10 12,000150 1,500

1,350 13,500PJ 1

ACCT #130.2 - PART #RX7

11/30 Balance 1,500 $ 5 7,50012/07 34570

400 $ 5 2,0001,050 5,250

12/08 1446450 $ 5 2,250

1,450 7,2501,200 $ 5 6,00012/16 34572

12/21 3981 800 4,000250 1,250

1,050 5,250

PJ 1 SJ 1

SJ 1PJ 1

$ 5$ 5$ 5$ 5$ 5





ACCT #130.3 - PART #Z28

11/30 Balance 700 $ 5 3,50012/08 1446

250 $ 5 1,2501,000 5,000

12/09 76855 1,250 6,250500 $ 5 2,50012/16 34572

12/23 34573750 3,750250 1,250

PJ 1 SJ 1

$ 5$ 5$ 5$ 5

12/29 45993 1,000 5,000 1,250 6,250PJ 1 $ 5$ 5

PJ 1 300 $ 5 1,500

500 $ 5 2,500SJ 1

15

Notes Receivable

Provo State Bank

David Jones 775 170 750

Eric McGinnCustomer #1

Customer #2


12,5002,310

3,83510,000

2,3503,000

Totals 34,770

A/C 110

120.1

120.2

120.1120.1

12/01

12/0312/03

12/0612/0712/0912/13

2,310

3,835

2,3503,000

11,495

A/C 120

420

310

250

Interest RevenueCapital Stock

Notes Payable

2512,500

10,000

Payor Name Post Ref. Amount (CR)Cash (DR) Post Ref.Date AmountAcct. NameOther AccountsAccounts Receivable

(CR 1)HCI

Cash Receipts Journal

16

SalesRevenue

(CR)PostRef.

PostRef. # Units Total

Cost of Goods sold (DR)/Inventory (CR)

Date Customer Name Inv. # Amount

(DR) Item Cost/Unit

AccountsReceivable

Customer #112/07

12/1212/16

12/2312/27



345703457134572

3457334574

120.1 130.2 120.3

120.2

120.1 120.2 Totals

3,00012,50012,950

3,6254,500

36,575

3,00012,50012,950

3,6254,500

36,575

130.1

130.2 130.3

130.3 130.1

RX7F150RX7Z28

Z28F150

450750

1,200

500300

500

5105

510

5

2,2507,5006,000

2,5003,000

23,750

2,500

Total

HCISales Journal (SJ 1)

A/C 120 410 A/C's 130505

17

Vendor Name Post Ref. ItemInv. # # Units $ Per Unit Total Post Ref. Amounts (CR)Date Inventory (DR) Accounts Payable

HCIPurchases Journal

(Inventory Purchases Only) (PJ 1)

Vendor #112/08 1446 130.2 RX7 400 5 2,000 210.1 8,500130.3 Z28 300 5 1,500

130.1 F150 500 10 5,000Vendor #312/09 130.3 Z28 250 5 1,250 210.3 1,250Vendor #212/21 3981 130.2 RX7 800 5 4,000 210.2 4,000Vendor #112/29 45993 130.3 Z28 1,000 5 5,000 210.1 5,000Vendor #312/31 77102 130.1 F150 1,200 10 12,000 210.3 12,000

76855

Totals 30,750 30,750A/C 130 A/C 210

18

Date20X2

Cash(CR)

CheckNo.

PostRef.

AccountsPayable

(DR)PostRef. Account Amount

PayeeName Post

Ref. Account Amount

Other Accounts (CR) Other Accounts (DR)

Capital Property Mgmt.

Smith's Equipment

HarveyDodge

4,800

26,030 12,290

250

210.1

1602401 PrepaidRent 4,80012/02

1,550 240212/03 Vendor #1Vendor #2Vendor #3

840 240312/081,400 240412/09

3,000 240512/11

8,500 240612/13640 240712/15700 240812/25

3,000 240912/31

1,600 241012/31

NotesPayable 12,000

Supply Depot OfficeSupplies

Total

A/C 110 TotalA/C 210

Vendor #1

Provo PowerDavid Jones

210.2210.3

210.1

1,550840

1,400

8,500

180

140525510

510

WarehouseEquipment

UtilitiesExpenseSalary

Expense

SalaryExpense

15,000

640700

3,000

1,600

HCICash Disbursements Journal (CD 1)

19



12/31/X2* Insurance Expense 535 505Prepaid Insurance 150 505

(Adjust Prepaid Insurance)Office Supplies Expense12/31/X2 515 1,140

Office Supplies 140 1,140(Adjust for Office Supplies Used)

12/31/X2 545Interest ExpenseInterest Payable

Unearned Rent RevenueRent Revenue

(Adjust for Rent Earned)Rent Expense

Prepaid Rent(Adjust for Prepaid Rent)Utilities Expense

Utilities Payable(Adjust for Utilities Payable)Income Tax Expense

Income Tax Payable(Adjust for 20X2 Taxes Payable)Closing Entries on Next Page

280

260430

520160

525270

550230

1,1401,140

(Adjust for Interest Payable)

178178

420420

400400

400400

6,4086,408

12/31/X2

12/31/X2

12/31/X2

12/31/X2

20



12/31/X2 Closing Entries:

Sales RevenuesInterest Revenue 420 52Rent Revenue 430

164,026Cost of Goods Sold510Salaries Expense

Office Supplies Expense

Utilities ExpenseMisc. ExpenseInsurance ExpensePostage ExpenseInterest ExpenseIncome Tax ExpenseRetained Earnings


515

525530

540545

320

330

Rent Expense3,958

1,952

178

261,950

420

53,600

6,850

321

19,224

675

4,800

1,105

6,408

410

505

520

535

675320

550

21

Exam 1Review Topics

Lesson 1:

What is accounting?What is business? Kinds of businesses?Keys to a successful business.Raising capital. Debt vs. Equity financing.Define financial vs. managerial accounting

and note distinguishing characteristics.Characteristics of useful information.What is GAAP? Explain its significance?Role of SEC and the FASB.GAAP and international businessWhat do CPA’s do? Role of AICPA.External audits: who, what and why?Importance of auditor independence.Basic characteristics of proprietorship,

partnership and corporation.

Lesson 2:

The general purpose financial statementsrequired under GAAP.

Basic accounting equation.Understand terms: assets, liabilities, owner’s

equity, contributed capital (capitalstock), retained earnings, revenues,expenses, dividends, EPS (earnings pershare)

The expanded accounting equation over time.Interrelationship of financial statements.Basic format of balance sheet (current vs.

long-term assets and liabilities),income statement (including EPS) andstatement of cash flows.

Lesson 3:

Understand the application of the:a. Historical cost principle.b. Entity concept.c. Monetary measurement principle

Understand the effect of basic transactions on A = L + OE

Debits and credits and their effect on assets,liabilities, owners’ equity, revenues,expenses, and dividends

Understand and implement the first steps ofthe accounting cycle given some basicbusiness transactions:

a. Identify transactions.b. Analyze transactions.c. Journalize transactions.d. Post journal entries to the general

ledger accountsPurpose of a general journal, general ledger

and trial balance.

Lesson 4:

Accrual vs. cash basis accounting?The revenue recognition and matching

principles.The why and how of basic adjusting entries

fora. Unrecorded revenuesb. Unrecorded expensesc. Prepaid expensesd. Unearned revenues

Real vs. nominal accounts.The why and how of closing entries.Account analysis.

Financial Practice Set:

The purpose and use of subsidiary ledgers andspecial journals.

The steps in an accounting system designed toproduce financial statements.

Exam 2Review Topics

Lesson 5:

Accounting for sales discounts and returns.Accounting for uncollectible receivables.Accounting for credit card transactions.

Lesson 6:

Perpetual inventory accounting.Accounting for inventory purchase discounts

and returns.Inventory Cost Flow Methods (Perpetual)

— Specific Identification— FIFO, LIFO, Moving Weighted

AverageEffects of FIFO, LIFO, MWA methods on net

income, income taxes and endinginventory given inflation vs deflation.

Physical inventory.

Lesson 7: Accounting for payroll:

Salaries/wages and employee payrolltax withholdings.

Employer payroll tax expense. Accounting for sales taxes.Other operating expenses.Internal controls: Who, what and why?

Lesson 8: Accounting for acquisition of operating

(capital) assets:— Property, Plant, Equipment— Intangible Assets— Natural Resources

Straight-Line and units of production methodsof depreciation.

Accounting for repairs and improvements.Accounting for sale or disposal of operating

assets

Accounting for intangibles includinggoodwill.Accounting for research and development

costs.Accounting for natural resources.

Lesson 9:

Current vs. Long-term Debt.Accounting for interest bearing note payable.Accounting for mortgage payable (typical

amortizing mortgage).Types & characteristics of bonds.Accounting for bonds issued at face value.Debt vs. Equity Financing.Accounting for issuance of common stock:

par value, stated value, no parAccounting for issuance of preferred stock.Calculating cash dividends payable to

common vs. preferred stockholders.Accounting for declaration and payment of

dividends.

Lesson 10:

Basic financial statement analysis.Ratio calculations and analysisVertical and horizontal analysis of income

statement amounts for purposes offuture projections.

Exam 3 Topic Review Sheet

Lesson 11:

Managerial vs. Financial AccountingTypes of Business - merchandising,

manufacturing, serviceProduct vs. Period Costs in merchandising and

manufacturing businessesProduct costs in a manufacturing business

— Direct materials— Direct labor— Manufacturing overhead

— Indirect materials— Indirect labor— Other overhead costs

Stages of manufacturing product costs— Raw materials inventory— Work in process inventory— Finished goods inventory

Lesson 12:

Job order vs. Process cost systemsJob order cost system basic journal entries and

cost flowsComplications in accounting for

manufacturing overhead costs:— Calculation of a Predetermined

Manufacturing Overhead Rateand applications of overhead toWIP.

— Utilization of the ManufacturingOverhead Account for actualoverhead costs and applicationsto work in process.

— Disposition of over/under appliedoverhead to Cost of GoodsSold

Lesson 13:

Variable vs. Fixed costs definedRelevant range assumptionsMixed costs - fixed vs. variable components

Scattergraph and High-Low methods. Why and how?

Contribution margin income statement formatvs. GAAP functional format

CVP analysis to determine:— Breakeven points in # units, sales $— Target income in # units, sales $— Net income at varying volumes of

production or sales— Other information

Graphs - understanding cost, volume, profit

Lesson 14:

Operating budgets - why?Basic formats and flows of budgetary

informationProduction and Material Purchase budget

complications involving budgetedchanges in inventory

Cash flow budget complications andpreparation

Pro forma financial statements

Lesson 15:

Relevant/Differential costs defined Sunk costs, opportunity costs definedProduct emphasis given a limited critical

resourceWhether to add/drop a product lineWhether to make or buy a product or

component partWhether to sell a product as is or process it

further (Joint Costs)Pricing a special order

SAMPLE EXAM PROBLEMS AND EXAM PREPARATION

These sample exam problems will serve as excellent review for the actual exams. Solutions can be found atthe end of each of the sample exams. The problems included should give students a good idea of the format and rigor of problems to be encountered on the exams. These sample exam problems, however, are not intended to be comprehensive in their coverage of the topics and materials that may be includedon the exams. Simply learning the concepts reflected in these sample problems will not be adequatefor complete exam preparation.

Adequate exam preparation should also include review of all lesson homework problems to the point thatthe student can complete all of the problems on their own without assistance from the CD walk throughs. Exam success requires that students be able to do all of the homework problems with a full and completeunderstanding of the underlying principles involved. Another critical study step would be review of alllesson graphics to identify key terms, definitions, principles and examples. It may be necessary for somestudents to listen to lesson lectures a number of times to gain the understanding necessary for adequateexam preparation. Study hard and good luck!!!!

EXAM #1

SAMPLE PROBLEMS

(Lessons 1-4, Financial Statement Review and Practice Set)

1. Accounting is important in business because it provides information toa. providers of business capital.b. managers of business.c. government regulators of business.d. All of the above.e. a and b only.

2. A retailer is involved in a a. manufacturing business.b. merchandising business.c. wholesale distribution business.d. None of the above.

3. Successful businesses typically requirea. a product or service that can be sold to customers at a profit.b. capital.c. effective management.d. All of the above.

4. Financial accounting providesa. budgets and forecasts of future business operations.b. detailed management reports designed to control and manage company assets.c. information to investors and creditors.d. All of the above are true.e. None of the above are true.

5. GAAPa. applies to financial accounting.b. applies to managerial accounting.c. applies to income tax accounting.d. Both a and b.e. All of the above.

6. The federal agency that is responsible for regulation of public capital markets is the a. IRS.b. FASB.c. AICPA.d. GAO.e. None of the above.

7. CPA’s have exclusive authority to a. perform audits of the financial statements of publicly-held companies.b. prepare tax returns for businesses c. consult on information systems design. d. Both a and b.e. CPA’s have no exclusive authority to perform any services.

8. An external auditor’s report on financial statements expresses an opinion a. as to the fairness of the financial statements.b. as to compliance with GAAP.c. as to the company’s financial prospects for the future.d. Both a and b.e. All of the above are true.

9. A company’s annual report provided to the public will typically includea. an explanation from management summarizing the company’s operating results.b. an external auditor’s report on the financial statements.c. notes to the financial statements providing supplemental information.d. a and b only.e. All of the above.

10. In a corporation, the decision as to who will be hired as the company’s President or CEO is madedirectly by a. the external auditor.b. the stockholders.c. the board of directors.d. state regulators.e. management.

11. In a corporation, responsibility for the preparation of the company's financial statements for public use rests witha. the external auditor.b. the stockholders.c. the board of directors.d. state regulators.e. management.

12. A disadvantage of a general partnership as a legal form of doing business isa. its inability to provide limited legal liability to its owners from claims arising from the

business operationsb. the considerable red tape required in its legal formation.c. the double federal taxation required on the business profits distributed to owners in the

form of a dividend.d. All of the above are true.e. None of the above are true.

13. Which of the following financial statements reflect activity for a period of time (month, quarter oryear)?a. Both the income statement and the balance sheet.b. Only the statement of cash flows.c. Only the income statement.d. Both the income statement and the statement of cash flows.e. Only the balance sheet.

14. The financial statements interrelate in the sense thata. the income statement reports net income for a period of time, and the related balance sheet

portrays the financial position at the end of that period.b. the balance sheet shows the results of operations for a period of time, and the income statement

presents earnings as of the end of that period.c. the balance sheet shows the results of operations for the same time period for which the

financial position is shown on the income statement.d. Both a and c.e. None of these.

15. Given the following balances at the end of the year:

Liabilities $10,000Retained Earnings $ 5,000Capital Stock $ 7,000

Determine the amount of total assets.a. $ 5,000b. $12,000c. $17,000d. $22,000e. Cannot be determined.

16. An owner transfers cash from personal funds to the business bank account as a capital contribution. This transaction is properly recorded on the business' books asa. an increase in one asset and a decrease in another asset.b. an increase in an asset and a decrease in a liability.c. an increase in an asset and an increase in owner's equity.d. an increase in an asset and an increase in a liability.e. None of these.

17. Which of the following events causes a net decrease in total assets?a. The profitable sale of goods to a customer on account.b. Payment of utilities bills not previously recorded as an obligation.c. Cash purchase of furniture.d. Credit purchase of equipment.e. None of these.

18. The purchase of inventory with casha. increases assets and owners’ equity.b. decreases assets and owners’ equity.c. increases assets and liabilities.d. has no net effect on total assets.e. None of the above.

19. A distribution of profits to stockholders of a corporationa. decreases corporate assets and owners’ equity.b. decreases corporate assets and liabilities.c. increases corporate assets and liabilities.d. increases liabilities and owners’ equity.e. None of the above.

20. If assets decreased by $12,000 during a year and owners’ equity increased by $4,000, thenliabilities must havea. increased by $8,000 during the year.b. decreased by $16,000 during the year.c. increased by $16,000 during the year.d. decreased by $12,000 during the year.e. None of the above.

21. For the current accounting year, beginning and ending total liabilities were $15,000 and $31,000,respectively. At year-end, owner's equity amounted to $29,000, and total assets were $21,000larger than at the beginning of the year. If the owner's capital contributions for the year amountedto $5,000 and dividends paid to owners totaled $2,000, net income or net loss for the year wasa. $10,000 net loss.b. $ 5,000 net income.c. $ 2,000 net income.d. $10,000 net income.e. None of these.

22. During the current year, assets increased from $11,000 to $19,000, and liabilities decreased from$9,000 to $7,500. If no additional capital contributions were made during the year, dividendstotaled $4,000, and expenses totaled $21,000, determine total revenues for the year?a. $23,000b. $34,500c. $30,500d. $25,000e. None of these.

23. On December 30, a firm's balance sheet showed assets of $390,000, liabilities of $180,000, andowner’s equity of $210,000. On December 31 the firm (1) paid off Accounts Payable of $49,000,and (2) paid rent of $16,000 due on their building (not previously recorded). If a new balance sheetis prepared after these transactions, assets, liabilities, and owner’s equity, respectively, would bea. $325,000, $131,000, and $194,000.b. $325,000, $115,000, and $210,000.c. $325,000, $180,000, and $145,000.d. $341,000, $131,000, and $210,000.e. None of these.

24. Bruce Manufacturing purchased equipment for $16,000, paying $9,000 cash and executing a$7,000 note payable. The entry for this transaction would result in aa. net increase in total assets of $16,000.b. net increase in total liabilities of $16,000.c. net increase in total assets of $7,000.d. net decrease in total assets of $9,000.e. None of these.

25. Payment of dividends to stockholders is originally recorded with aa. credit to the Dividend account and increases owners’ equity.b. debit to the Capital Stock account and decreases owners’ equity.c. debit to the Dividend account and decreases owners’ equity.d. credit to the Retained Earnings account and increases owners’ equity.e. None of the above.

26. The sale of inventory to a customer on account is recorded with debits to a. Inventory and Cost of Goods Sold.b. Accounts Receivable and Inventory.c. Cost of Goods Sold and Accounts Payable.d. Sales Revenues and Accounts Receivable.e. None of the above.

27. The payment of a prior month’s utility bill that was previously recorded would require a debit toa. Utilities Expense.b. Utilities Payable.c. Cash.d. Prepaid Utilities.e. None of the above.

28. The payment of a prior month’s utility bill that was not previously recorded would require a debittoa. Utilities Expense.b. Utilities Payable.c. Cash.d. Prepaid Utilities.e. None of the above.

29. The collection of accounts receivable requires a credit toa. Sales Revenues.b. Cash.c. Accounts Payable.d. Accounts Receivable.e. None of the above.

30. A building owned by a business would not be classified as a current asset unlessa. it was purchased within the last 12 months.b. management purchased the building with cash or intended to pay off any obligation incurred

in the purchase of the building within 12 months.c. management intends and reasonably expects to sell the building within 12 months.d. a building would never be classified as a current asset.

31. Which of the following is directly reflected in a statement of retained earnings?a. Earnings per Share.b. Dividendsc. Revenuesd. Expensese. None of these.

32. Which of the following is not required under GAAP?a. An objective method is to be used in the valuation of assets.b. Business assets are to be accounted for separately and distinctly from the personal assets of

owners.c. Generally speaking, assets are to be presented on the balance sheet at their cost upon

acquisition or the fair market value upon receipt.d. Assets are to be presented on the balance sheet at fair market values when determinable by

appraisal.e. All of the above are required under GAAP.

33. Which of the following accounts normally has a debit balance before any closing entries?a. Dividendsb. Accounts Payablec. Sales Revenued. Capital Stocke. None of the above.

34. During its first year of operations, Bob’s Company billed credit customers $230,000 for servicesrendered. During the year, Bob’s Company received $185,000 of cash from all customers (bothcash and credit), $65,000 of which was received from cash customers. What amount of revenueshould be shown on the Bob’s Company income statement for the year?a. $185,000b. $295,000c. $250,000d. $165,000e. None of these.

35. Accrual basis accounting has to do with the a. timing of revenues.b. timing of expenses.c. timing of cash flows.d. Both a and b.e. All of the above.

36. Prepaid insurance at January 1, 20X1 was $9,600. Assume no insurance payments were madeduring the year and insurance expense on the income statement for the year is $2,200, as a result ofa proper adjusting entry made at the end of the year. Prepaid insurance on the December 31, 20X1balance sheet should bea. $ 9,600.b. $ 7,400.c. $ 2,200.d. $11,800.e. None of these.

37. Hobbins debited Cash and credited Unearned Rental Revenue for $6,000 on December 1 for rentreceived in advance for December, January, February, March, and April. What necessaryadjustment would be made on December 31?a. Unearned Rental Revenue 4,800

Rental Revenue 4,800b. Unearned Rental Revenue 1,200

Rental Revenue 1,200c. Rental Revenue 4,800

Unearned Rental Revenue 4,800d. Rental Revenue 1,200

Unearned Rental Revenue 1,200e. None of these.

38. Early in the accounting period, a customer paid Detmer Consulting Inc. $2,400 cash in advance forservices to be rendered in the future and Unearned Service Fees was credited for $2,400 on thebooks of Detmer. At the end of the accounting period, three-fourths of the services paid for hadnot yet been performed by Detmer. The proper adjusting entry on the books of Detmer isa. Service Fee Revenue 1,800

Unearned Service Fee Revenues 1,800b. Unearned Service Fee Revenues 1,800

Service Fee Revenues 1,800c. Unearned Service Fee Revenues 600

Service Fee Revenues 600d. Service Fee Revenues 600

Unearned Service Fee Revenues 600e. None of these.

39. The adjusting entry described in problem #38 above is required undera. the revenue recognition principle.b. the matching principle.c. cash basis accounting.d. Both A and B.e. Both A and C.

40. At the end of the accounting period, $3,300 in accounting fees had been earned by Norm’sAccounting Services but not yet billed, recorded or received. The proper year end adjusting entryby Norm would bea. Accounts Receivable 3,300

Accounting Fee Revenues 3,300b. Accounts Receivable 3,300

Unearned Accounting Fee Revenues 3,300c. Unearned Accounting Fee Revenues 3,300

Accounting Fee Revenues 3,300d. Cash 3,300

Accounting Fee Revenues 3,300e. None of these.

41. Mitchell Company paid $27,000 for a three-year insurance policy on September 1 and recorded the$27,000 as a debit to Prepaid Insurance and a credit to Cash. What adjusting entry should Mitchellmake on December 31, the end of the accounting period?a. Insurance Expense 3,000

Prepaid Insurance 3,000b. Prepaid Insurance 3,000

Insurance Expense 3,000c. Insurance Expense 9,000

Prepaid Insurance 9,000d. Prepaid Insurance 24,000

Insurance Expense 24,000e. None of these.

42. Buffo, Inc. has an asset Office Supplies on Hand with a balance at the beginning of the year of$4,900. During the year, purchases of office supplies totaling $6,400 were debited to the OfficeSupplies on Hand account. If only $4,100 worth of office supplies are still on hand at year-end,what is the proper adjusting entry at year-end?a. Office Supplies Expense 4,100

Office Supplies on Hand 4,100b. Office Supplies Expense 7,200

Office Supplies on Hand 7,200c. Office Supplies on Hand 5,600

Office Supplies Expense 5,600d. Office Supplies on Hand 4,100

Office Supplies Expense 4,100e. None of these.

43. Assume December 31 is a Tuesday. Wages are paid every Friday for that week's wages, and theweekly payroll (for five days) amounts to $4,000. To accrue the correct amount of wage expensefor December, the firm should make the following adjusting entry on December 31:a. Wages Payable 1,600

Wages Expense 1,600b. Wages Expense 2,400

Wages Payable 2,400c. Wages Payable 4,000

Wages Expense 4,000d. Wages Expense 1,600

Wages Payable 1,600e. None of these.

44. The adjusting entry described in problem #43 above is required undera. accrual basis accounting.b. the revenue recognition principle.c. the matching principle.d. cash basis accounting.e. Both A and B.f. Both A and C.g. All of the above.

45. In preparing its adjusting entries at the end of this year, Sara Company neglected to record anadjusting entry for employees' wages incurred but not yet paid. This errora. overstates this year's net income, understates liabilities at year-end, and overstates owner's

equity at year-end.b. understates this year's net income and overstates both liabilities and owner's equity at year-end.c. overstates this year's net income and liabilities at year-end, and understates owner's equity at

year-end.d. overstates this year's net income and overstates both liabilities and owner's equity at year-end.e. None of these.

46. Failure to adjust at the end of an accounting period for the portion of supplies recorded as an assetbut used up during the period has the following effect on the financial statements prepared at theend of the period:a. overstates net income.b. understates assets.c. overstates liabilities.d. understates owner's equity.e. None of these.

47. Failure to adjust at the end of an accounting period for revenues that were earned during the periodbut are recorded as unearned revenues a. understates net income and liabilities.b. overstates liabilities and net income.c. understates revenues and overstates net income.d. understates owners’ equity and overstates liabilities.e. None of the above.

48.

a.b.c.

49. Which of the following accounts is typically closed to Retained Earnings at the end of theaccounting period?a. Equipmentb. Dividendsc. Unearned Revenued. Prepaid Expensee. None of these.

require a debit to Utilities Expense

not require any entry to Utilities Expenserequire a credit to Utilities Expense

The closing of the Utilities Expense account at the end of an accounting period would

50. The Sales Revenue account is closed at the end of an accounting perioda. with a debit entry.b. with a credit entry.c. The Sales Revenue account is a real account that is never closed.

51. Which of the following accounts is not affected by closing entries?a. Insurance Expenseb. Retained Earningsc. Prepaid Insuranced. Service Fee Revenuese. None of these.

52. Revenues for the period were $43,000 and expenses totaled $34,000. Retained Earnings had a$17,000 beginning balance and a $21,000 ending balance, subsequent to the closing of all nominalaccounts. What was the amount of dividends paid during the year?a. $2,000b. $3,000c. $4,000d. $7,000e. None of these.

53. In the closing entries, which of the following accounts would be closed with a debit entry.a. Unearned Rent Revenueb. Interest Expensec. Dividendsd. Prepaid Insurancee. None of the above.

54. Which of the following accounting cycle steps occurs only at the end of the accounting period?a. Post transactions from the general journal to the general ledger.b. Analyze transactions from source documents.c. Record transactions in the general journal.d. Prepare a post-closing trial balance.e. None of these.

55. If the beginning Cash account balance was $6,800, the ending balance was $3,200, and total cashreceived during the period was $23,000, what amount of cash was paid out during the period?a. $19,400b. $26,600c. $ 3,200d. $23,000e. None of these.

56. Supplies totaling $5,650 were purchased during the period and debited to Supplies on Hand. TheSupplies on Hand account balance at the beginning of the period was $3,200. A physical countshows $1,075 of Supplies on Hand at the end of the period. The proper adjusting journal entry atthe end of the period isa. Debit Supplies on Hand and credit Supplies Expense for $3,525.b. Debit Supplies Expense and credit Supplies on Hand for $7,775.c. Debit Supplies on Hand and credit Supplies Expense for $7,850.d. Debit Supplies Expense and credit Supplies on Hand for $5,650.e. None of these.

57. The beginning and ending Accounts Payable balance is $7,800 and $11,100, respectively. If thefirm purchased a total of $22,900 of inventory on account for the period, the amount of cashpayments made on Accounts Payable for the period would amount toa. $ 4,000.b. $19,600.c. $22,900.d. $26,200.e. None of these.

58. Which of the following is an advantage of using special journals in a manual accounting system?a. They reduce the number of postings required during an accounting period.b. They eliminate the need for adjusting entries.c. They eliminate the need for control accounts for subsidiary ledgers.d. Both A and B.e. None of these.

59. Which of the following general ledger control accounts has a subsidiary ledger in the Hot Cars, Inc.Practice Set?a. Equipmentb. Cashc. Inventoryd. Capital Stocke. None of the above

60. The cash receipts journal for Hot Cars, Inc. in the Practice Set includes a column fora. Inventory.b. Accounts Receivable.c. Accounts Payable.d. Special journals do not have specific columns for accounts.e. None of the above.

Solutions

1. d

2. b

3. d

4. c

5. a

6. e (SEC- Securities and Exchange Commission)

7. a

8. d

9. e

10. c

11. e

12. a

13. d

14. a

15. d Total Assets = Total Liabilities + Total Owners’ Equity (Capital Stock + Retained Earnings)

$ 22,000 = $10,000 + ( $ 7,000 + $ 5,000 )

16. c

17. b

18. d

19. a

20. b “ ” Total Assets = “ ” Total Liabilities + “ ” Total Owners’ Equity $12,000 = ? + $4,000

$16,000

(This assumes that no obligation to pay dividends has been previously recorded)

21. c ” Assets = ” Liabilities + ” Owners’ Equity $21,000 = $16,000 + ?

$5,000 l

” Capital Contributions + ” Retained Earnings $5,000 + ?

0 l

Net Income for Year - Dividends for Year ? - $ 2,000 $2,000

22. b ” Assets = ” Liabilities + ” Owners’ Equity $8,000 = $1,500 + ?

$9,500 l

Capital Contributions for Year + Retained Earnings 0 + ?

$9,500 l

Net Income for Year - Dividends for Year" ? - $4,000 $13,500 l

Revenues - Expenses ? - $21,000 $34,500

23. a

Assets390,000

<49,000><16,000>325,000

=====

Liabilities180,000

<49,000> 0— 131,000

+++++

Owners' Equity210,000

0<16,000>194,000

24. c

25. c

26. e Accounts Receivable XXX Sales Revenues XXXCost of Goods Sold XXX Inventory XXX

” Retained Earnings

27. b

28. a

29. d

30. c

31. b

32. d

33. a

34. b Sales to customers on account $230,000Sales to cash paying customers 65,000

$295,000

Sales revenues are recognized when earned not necessarily when cash is received. Salesrevenues are earned when the sale takes place regardless of whether the sale was made onaccount or for cash.

35. d

36. b

Prepaid Insurance

Beg. BalancePrepayments

9,600 0

2,200 Insurance Used Up

End. Balance 7,400

37. b $6,000/5 months = $1,200 per month. The entry should account for 1 month’s decrease in theliability Unearned Rental Revenue and record Rental Revenue for one month’s rent..

38. c $2,400 × 1/4 = $600 earned as of year end. Reduce the liability Unearned Service FeeRevenue and record Service Fee Revenues for the $600 earned during the period.

39. a

40. a

41. a $27,000/36 months = $750 of insurance cost per month. Reduce the asset Prepaid Insuranceby $750 x 4 months ($3,000) and record Insurance Expense for the four months of insurancecoverage used up.

42. b

Office Supplies on Hand

Beg. BalanceSupplies Purchased

4,9006,400

? 7,200 Supplies Used Up

End. Balance 4,100

43. d Wages incurred per day amount to $800 ($4,000 ÷ 5 days). The wages incurred and thereforeto be recorded as of Tuesday , December 31st amount to $1,600 ($800 × 2).

44. f The matching principle is an element of accrual basis accounting

45. a The proper adjusting entry would be

Wage Expense XXXWage Payable XXX

Failure to make this entry would understate expenses, which would overstate net income andtherefore overstate retained earnings and owners’ equity. Liabilities would also be understatedif this entry was not properly made.

46. a The proper adjusting entry to record the using up of supplies:

Supplies Expense XXXSupplies XXX

Failure to make this entry would understate expenses and therefore overstate net income.

47. d The proper adjusting entry to record the earning of revenues previously reflected as unearned:

Unearned Revenues XXXRevenues XXX

Failure to make this entry would overstate liabilities and understate revenues, which wouldunderstate net income, retained earnings and owners’ equity.

48. b

49. b

50. a

51. c Prepaid insurance is an asset account and is not closed at the end of an accounting period. Retained earnings is also a real account and is therefore not subject to closing, however, allnominal account balances are closed to retained earnings at the end of an accounting period.

52. e

Retained Earnings

ExpensesDividends

34,0005,000 ?

17,00043,000

Beg. BalanceRevenues

21,000 End. Balance

53. e Dividends and expenses are closed with credits. Revenues are closed with debits.

54. d

55. b

Cash

Beg. BalanceCash Received

6,80023,000

? 26,600 Cash Paid

End. Balance 3,200

56. b

Supplies on Hand

Beg. BalanceSupplies Purchased

3,2005,650

? 7,775 Supplies Used Up

End. Balance 1,075

57. b

Accounts Payable

Payments on Account 19,600 ?

7,80022,900

Beg. BalancePurchases on Account

11,100 End. Balance

58. a

59. c

60. b

EXAM #2

SAMPLE PROBLEMS

(Lessons 5 - 10)

Use the following information to respond to problems 1 - 6 assuming Zee Corp. maintainstheir inventory records on a perpetual basis:

1/12 Zee Corp., a wholesaler of unicycles, buys 20 unicycles on account from asupplier at $100/unit with terms of 2/10,n/30.

1/13 Zee returns one of the unicycles to the supplier because of a defect andreceives credit on their account.

1/22 Zee pays the supplier in full (net of the discount) for the 1/12 purchase.1/24 Zee sells 10 of the unicycles purchased on 1/12 to a customer for $200/unit

on account with terms of 1/10,n/30.1/25 The customer returns one of the unicycles for credit on account (assume the

unicycle is in good condition and can be resold). 2/2 The customer pays in full the net amount due from the 1/24 sale, net of the

discount.

1. Zee’s journal entry to record the 1/12 transaction would bea. Purchases 2,000

Accounts Payable 2,000b. Inventory 2,000

Accounts Payable 2,000c. Purchases 1,960

Accounts Payable 1,960d. Accounts Payable 2,000

Inventory 2,000e. None of the above

2. Zee’s journal entry to record the 1/13 transaction would include a credit to a. Purchases for $98.b. Purchases for $100.c. Accounts Payable for $98.d. Inventory for $100.e. None of the above.

3. Zee’s journal entry to record the 1/22 transaction would include a credit to a. Cash for $1,900.b. Accounts Payable for $1900.c. Inventory for $38.d. Purchases for $38.e. None of the above.

4. Zee’s journal entry to record the 1/24 transaction will include debits toa. Accounts Receivable for $2,000 and Cost of Goods Sold for $1,000.b. Sales Revenues for $2,000 and Inventory for $1,000.c. Accounts Receivable for $1,980 and Cost of Goods Sold for $1,000.d. Accounts Receivable for $2,000 and Cost of Goods Sold for $980.e. None of the above.

5. Zee’s journal entry to record the 1/25 transaction will include debits to a. Sales Returns and Allowances and Inventory.b. Accounts Receivable and Cost of Goods Sold.c. Accounts Receivable and Inventory.d. Sales Revenues and Cost of Goods Sold.e. None of the above.

6. Zee’s journal entry to record the 2/2 transaction will include a debit to a. Cash for $1,800.b. Accounts Receivable for $1,800.c. Sales Discounts for $18.d. Sales Revenues for $18.e. None of the above.

7. Which of the following accounts is a contra asset account?a. Sales Discountsb. Sales Returns and Allowancesc. Unearned Rental Revenued. Both a and b.e. None of the above.

8. Before closing entries at the end of any accounting period, Sales Discounts will typicallyhave a. a debit balance.b. a credit balance.c. no balance.d. Sales discount is not an account that is typically used.

9. Given the following information:Sales Revenues $100,000Sales Returns and Allowances 7,000Sales Discounts 3,000Selling Expenses 20,000Administrative Expenses 15,000

and assuming Cost of Goods Sold as a percentage of Net Sales Revenues equals 40%, thenthe Gross Margin would amount to:a. $19,000.b. $34,000.c. $40,000.d. $54,000.e. $60,000.

10. Sales Discounts and Sales Returns and Allowances are accounts that area. utilized to improve management information on lost revenues due to sales return

policies and discount offers to customers.b. not required under GAAP but are typically utilized by companies in their accounting

for customer returns and discounts.c. deducted from Sales Revenues in the determination of Net Sales Revenues.d. closed to Retained Earnings at the end of an accounting period.e. All of the above are true.

11. An adjustment at the end of an accounting period for uncollectible accounts receivable isnecessary under GAAP to comply with thea. Realization Concept.b. Revenue Recognition Principle.c. Matching Principle.d. Cash Basis of Accounting.e. None of the above.

12. On December 31, before adjusting for Uncollectible Accounts Receivable for the period,Accounts Receivable has a debit balance of $80,000, and the Allowance for UncollectibleAccounts has a credit balance of $2,500. If 6% of ending Accounts Receivable are estimatedto be uncollectible,a. the balance of the Allowance for Uncollectible Accounts should be $2,000 after

adjustment.b. the balance of the Allowance for Uncollectible Accounts should be $1,200 after

adjustment.c. Uncollectible Accounts Expense for the year should be $10,800.d. the balance of the Allowance for Uncollectible Accounts should be $4,800 after

adjustment.e. None of these.

13. If the 12/31/X3 balance of Accounts Receivable is $40,000 and the balance of the Allowancefor Uncollectible Accounts Receivable is a debit balance of $1,500 before any year-endadjustment, the adjusting entry required given uncollectible accounts receivable areestimated a 10% of the balance of Accounts Receivable would require a debit toa. Bad Debt Expense for $4,000.b. Bad Debt Expense for $5,500.c. Bad Debt Expense for $3,500.d. Allowance for Uncollectible Accounts Receivable for $4,000.e. None of the above.

14. The net realizable value of accounts receivable amounts to a. Accounts Receivable less Bad Debt Expense.b. Bad Debt Expense plus the Allowance for Uncollectible Accounts Receivable.c. Accounts Receivable less the Allowance for Uncollectible Accounts Receivable.d. Net Sales Revenues less Bad Debt Expense.e. None of the above.

15. Given the following information at the end of the year:

Days Past Due Accounts Receivable Est. Uncollectible Current $100,000 1% 0 - 30 days $ 50,000 3% 30 - 60 days $ 20,000 5% 60 - 90 days $ 10,000 20% 90 + days $ 8,000 40%

$188,000

And assuming Net Credit Sales Revenues for the year amounted to $800,000 and the balancein the Allowance for Uncollectible Accounts Receivable account is a credit balance of $500before adjustment, then the adjusting entry for Bad Debt Expense at the end of the year willinclude a credit to a. Bad Debt Expense for $8,700.b. Allowance for Uncollectible Accounts Receivable for $9,200.c. Allowance for Uncollectible Accounts Receivable for $8,700d. Bad Debt Expense for $9,200.e. None of the above.

16. At the beginning of the year Jones Company had a $50,000 balance in Accounts Receivable. During the year, total sales made on account amounted to $210,000 and total cash collectionsfrom customers on accounts receivable amounted to $199,000. In addition, $3,000 inuncollectible accounts receivable were actually written off the books. Determine the balanceof accounts receivables before any adjustment for estimated uncollectible accountsreceivable for the year.a. $61,000b. $58,000c. $64,000d. $36,000e. None of these.

17. The entry to record the writeoff of an uncollectible account receivable would bea. Bad Debt Expense xxx

Allowance for Uncollectible A/R xxxb. Allowance for Uncollectible A/R xxx

Accounts Receivable xxxc. Bad Debt Expense xxx

Accounts Receivable xxxd. Sales Revenues xxx

Allowance for Uncollectible A/R xxxe. None of the above.

18. If a company has a debit balance in the Allowance for Uncollectible Accounts Receivablebefore any year-end adjustment and fails to make an adjusting entry to record estimateduncollectible accounts receivable at the end of a period, then this errora. understates assets.b. overstates net income.c. overstates expenses.d. understates owners' equity.e. Both a and b are true.

19. The amount of Bad Debt Expense in any year will alwaysa. equal the amount of estimated uncollectible accounts receivable at the end of the

year.b. equal the balance in the Allowance for Uncollectible Accounts Receivable account at

the end of the year after adjustment.c. equal the amount of estimated uncollectible accounts receivable at the end of the year

plus or minus the prior year’s under or overestimation, respectively, of uncollectibleaccounts receivable.

d. equal the net realizable value of accounts receivable at the end of the year.e. None of the above.

20. A credit balance in the Allowance for Uncollectible Accounts Receivable account at the endof the year prior to any adjusting entry for the current year’s uncollectible accountsreceivable means the prior year’s estimated uncollectible accounts receivables werea. overestimated.b. underestimated.c. has nothing to do with the prior year estimation of uncollectibles.

21. An entry to record a sale to a customer who uses a credit card to pay will typically include a. a credit to Sales Revenues.b. a debit Credit Card Expense.c. a debit to Cash.d. Both a and b.e. All of the above.

The following data represent the beginning inventory and, in order of occurrence, the purchases andsales of Simpson, Inc., for an operating period. Use this information to answer questions 22-24.

Units Unit Cost Total Cost Units Sold

Beginning inventorySale No. 1Purchase No. 1Sale No. 2Purchase No. 2

20

12

14

$ 40

46

36

$ 800

552

504

11

14

Totals 46 $1,856 25

22. Assuming Simpson, Inc., uses FIFO perpetual inventory procedures, it records sale No. 2 asan entry to Cost of Goods Sold fora. $590b. $644c. $504d. $560e. None of these.

23. Assuming ,Simpson Inc., uses LIFO perpetual inventory procedures, sale No. 2 is recorded asan entry to Cost of Goods Sold fora. $504b. $632c. $644d. $590e. None of these.

24. Assuming Simpson, Inc., uses moving weighted average (perpetual) inventory procedures,sale No. 2 is recorded as an entry to Cost of Goods Sold for (round all calculations to thenearest hundredth)a. $591.50b. $595.25c. $602.75d. $608.02e. None of these.

Use this information to respond to questions 25-26. Inventory data for Newport Surfboard Companyfor December consists of the following:

Date Units Cost Total

12/112/512/812/1212/1912/2712/29

Beginning InventoryPurchasedSoldPurchasedSoldPurchasedSold

102518101820 9

$120 130

145

150

$1,200 3,250

1,450

3,000

25. Assuming Newport uses a perpetual inventory system with a LIFO cost flow, what is thevalue of ending inventory on 12/31?a. $1,650b. $2,730c. $3,000d. $6,170e. None of these.

26. Assuming Newport uses a perpetual inventory system with a FIFO cost flow, what is theamount of Cost of Goods Sold for the month of December?a. $1,650b. $2,730c. $3,000d. $6,170e. None of these.

27. Which of the following inventory costing methods most closely matches the actual physicalflow of goods in a grocery store?a. Perpetual FIFOb. Perpetual LIFOc. Moving weighted averaged. Specific identificatione. None of these.

28. In a period of deflation in the prices of inventory purchases throughout the period, whichinventory costing method will yield the lowest income tax liability assuming there is abalance of inventory on hand at the end of the period?a. FIFOb. LIFOc. Moving weighted averaged. They would all yield the same result.

29. In a period of inflation in the prices of inventory purchases throughout the period, whichinventory costing method will yield the lowest net income assuming there is a balance ofinventory on hand at the end of the period?a. FIFOb. LIFOc. Moving weighted averaged. They would all yield the same result.

30. In a period of inflation in the prices of inventory purchases throughout the period, whichinventory costing method will yield the lowest ending inventory balance at the end of theperiod?a. FIFOb. LIFOc. Moving weighted averaged. They would all yield the same result.

31. In a period of stable prices for inventory purchases throughout the period, which inventorycosting method will yield the highest income tax liability assuming there is a balance ofinventory on hand at the end of the period?a. FIFOb. LIFOc. Moving weighted averaged. They would all yield the same result.

32. For Unique Antiques, Inc. which carries an inventory of one of a kind antique items, whichof the following perpetual inventory methods should be used?a. LIFO b. FIFOc. Specific Identificationd. Moving Weighted Averagee. A periodic rather than perpetual inventory method should be used.

33. Internal controls are policies and proceduresa. designed to safeguard a company’s assets.b. designed to ensure accurate accounting records.c. designed and implemented by the company’s external auditors.d. Both a and b.e. All of the above.

34. Which of the following policies or procedures should be included in a system of internalaccounting controls over cash?a. Monthly bank reconciliations are to be prepared by a person not involved in the

handling of cash.b. All cash disbursements are to be made by pre-numbered, sequenced checks.c. All receipts are deposited daily in the bank.d. Cash handling responsibilities are separated from those responsible for the recording

of cash transactions.e. All of the above are part of a good system of internal accounting control over cash.

35. Payroll information for the week is:Gross wages $10,000Employee FICA withholding 600Employee FIT withholding 1,800Employee SIT withholding 900Employee Union Dues withheld 300Net wages $ 6,400

Employer FICA $ 600Employer Fed. Unemployment Insurance 120Employer State Unemployment Insurance 80

Given the above, the journal entry to record the obligation for all payroll related costs for theweek would include a debit to:a. Wage Expense for $6,400.b. Payroll Tax Expense for $800.c. Wages Payable for $6,400.d. Employee FIT Expense for $1,800.e. Both a and b.

36. Chang's Chinese Restaurant accepts a VISA card payment from a customer for $20electronically processed for immediate credit to their bank account. Chang is charged a 3%fee on an processed transaction. The journal entry to record this receipt would include adebit toa. Cash for $20.b. Sales Revenues for $20.c. Credit Card Expense for $ .60.d. Accounts Receivable for $19.40.e. None of the above.

37. A $100 sale of merchandise requires collection of a state sales tax of $7. If the full $107 isreceived from the customer in cash, the journal entry on the merchant's books would includea credit to:a. Sales Revenues for $107.b. Sales Taxes Payable for $7.c. Cash for $107.d. Sales Tax Revenues for $7.e. None of the above.

38. A used truck is purchased for $20,000 ($5,000 cash down and execution of a note payable for$15,000) with additional cash acquisition costs of $1,200 for state sales tax. In addition,$2,000 is incurred and paid for engine overhaul deemed necessary prior to the truck’s initialuse. $1,000 of insurance on the truck is prepaid for one year’s coverage. The totalcapitalized cost for the truck isa. $ 8,200.b. $20,000.c. $21,200.d. $23,200.e. $24,200.

Use the following information for problems 39 and 40. On July 1, 20X1, ABC, Inc., acquired a newmachine for $70,000. Its estimated useful life is ten years with an expected salvage value of $3,100.

39. Assuming straight-line depreciation, 20X1 depreciation expense isa. $3,500.b. $7,000c. $3,345.d. $6,690.e. None of these.

40. Assuming straight-line depreciation, the balance of accumulated depreciation at 12/31/X2would bea. $ 7,000.b. $10,500.c. $ 6,690.d. $13,380e. None of the above.

41. Using the information provided for problem #39 above and assuming the total anticipatedproduction of the machine during its useful life is 100,000 units of production with the same$3,100 salvage value, what would the 12/31/X1 book value of the machine be using the unitsof production method of calculating depreciation and assuming 10,000 units of actualproduction in 20X1?a. $63,310b. $60,210c. $63,000d. $59,900e. None of the above.

42. A truck which originally cost $25,000 has an estimated salvage value of $5,000 at the end ofits 10 year estimated useful life and accumulated depreciation after 3 years of $6,000. Assuming that at the end of 3 years the truck's appraised fair market value is $21,000, thenthe net amount to be reflected on the balance sheet for the truck would bea. $19,000b. $20,000c. $21,000d. $25,000e. None of the above.

43. Normal repair and maintenance costs incurred in the recurring maintenance of equipmentshould bea. capitalized in the period incurred.b. expensed in the period incurred.c. allocated to expense in the future periods of benefit.d. Both a and c.e. None of the above.

44. Major equipment refurbishment costs that extend the equipment’s original anticipated usefullife should bea. capitalized in the period incurred.b. expensed in the period incurred.c. allocated to expense in the future periods of benefit.d. Both a and c.e. None of the above.

45. On January 1, 20X2, Wilbur Company purchased equipment for $82,000. Wilbur usesstraight-line depreciation and estimates a sixteen-year useful life and a $6,000 salvage valuefor the equipment. On December 31, 20X9, Wilbur sells the equipment for $40,000. Inrecording this sale, Wilbur should reflecta. a $2,000 gain.b. an $8,000 loss.c. a $4,000 loss.d. no gain or loss.e. None of these.

46. If equipment which originally cost $50,000 has accumulated depreciation of $25,000 throughthe date of its resale at a price of $27,000, the journal entry to record this resale wouldinclude a a. credit to Equipment for $25,000.b. credit to Gain on Sale for $2,000.c. credit to Accumulated Depreciation for $25,000.d. Both a and b.e. None of the above.

47. If fully depreciated equipment that had no salvage value is disposed of at no additional cost,then the journal entry to reflect the disposal would include aa. debit to Accumulated Depreciation.b. debit to Loss on Disposal.c. debit to Equipment.d. credit to Gain on Disposal.e. None of the above.

48. The allocation of an intangible asset’s capitalized cost to expense over its anticipated usefullife is referred to as a. amortization.b. depreciation.c. depletion.d. matching.e. None of the above.

49. The research and development costs incurred by a company in the development oftechnology that results in a patent that has probable future benefit should be a. capitalized as part of the cost of the asset (“Patent”).b. expensed in the the period incurred.c. expensed in the future when the benefits of the patent are realized.d. None of the above.

50. Goodwill is initially recorded on a company’s balance sheet a. at the cost associated with the purchase of another business in excess of the fair market value of that business’ acquired assets less any liabilities assumed. b. when the value of the company exceeds the book value of its net assets. c. and then amortized to expense over its estimated useful life. d. Both a and c are true. e. None of the above.

51. The following information is available for a company currently considered for potentialacquisition:

AppraisedBook Value Fair Market Value

Assets $550,000 $900,000Liabilities $350,000 $350,000

Determine the amount of goodwill to be recorded on the acquiring company’s books if all ofthis business’ assets were acquired and liabilities were assumed at a price of $1,000,000cash.a. $ 100,000b. $ 200,000c. $ 450,000d. $ 550,000e. None of the above.

52. On 4/1/X7 ABC Corp. borrows $1,000,000 under a note payable to a bank due in two yearswith interest at an annual rate of 8% all due at maturity. Interest expense under this note forthe calendar years 20X7, 20X8, and 20X9, respectively would be:a. $0, $0, $160,000b. $60,000, $80,000, $20,000c. $80,000, $80,000, $0d. $0, $0, $1,160,000e. None of the above.

53. On 10/1 Jones borrowed $70,000 on a 30-year, fully amortizing mortgage note from Zion'sBank at a fixed annual interest rate of 8%, compounding monthly, with monthly payments of$513.64 due on the 31st of each month. Assuming payments are made on a timely basis, thejournal entry to be made with the second monthly payment on 11/30 would include a debit toa. Interest Expense for $466.46.b. Interest Expense for $513.64.c. Mortgage Payable for $46.97.d. Mortgage Payable for $47.29.e. None of the above.

54. Given the information in problem #54, the balance in the Mortgage Note Payable followingthe second monthly payment made on 11/30 would amount to a. $69,533.54b. $69,486.36c. $69,999.53d. $69,952.71e. None of the above.

55. Bonds are issued by a company:a. to raise capital through equity financing.b. to raise capital from the sale of ownership interests in the company.c. to invest excess funds in financial markets.d. to borrow funds from financial markets.e. to secure themselves against legal liability for their actions.

56. Debentures area. secured or mortgage-backed bonds.b. convertible bonds.c. the terms governing a bond issuance.d. unsecured bonds.e. serial bonds.

57. The par value of a company’s common stock reflectsa. the fair market value of the stock at the date of issuance.b. the fair market value at the date of financial statement preparation.c. the amount of cash received upon the issuance of the stock.d. None of the above.

58. River, Inc. issued for $13 per share 6,000 shares of $1 par value common stock. The journalentry to record this transaction isa. Cash 78,000

Common Stock, par value 6,000Gain on Sale of Stock 72,000

b. Cash 78,000Common Stock 78,000

c. Cash 78,000Common Stock, par value 6,000Retained Earnings 72,000

d. Cash 78,000Common Stock, par value 6,000Paid-in Capital in Excess of Par Value 72,000

59. The issuance of preferred stock at a price above its par value would result in total capitalcontributions reflected on the balance sheet equal to the number of shares issued times thea. par value.b. issuance price.c. either the par value or issuance price, whichever is lower.d. None of the above.

60. Benji, Inc. has outstanding 5,000 shares of 5% $100 par value, cumulative preferred stock,and 10,000 shares of $50 par value common stock. If dividends in arrears amount to$25,000, and the total cash dividend declared this year is $110,000, the total amountsdistributed to preferred and common stockholders are, respectively,a. $25,000 and $85,000.b. $50,000 and $60,000.c. $35,000 and $75,000.d. $36,667 and $73,333.e. None of these.

61. Dividends in arrears applies only to a. common stock.b. cumulative preferred stock.c. non-cumulative preferred stock.d. Both a and b.e. All of the above.

62. Which of the following sequences of dividend-related dates is in the correct chronologicalorder (earliest date first)?a. Declaration date, payment date, record dateb. Payment date, declaration date, record datec. Record date, declaration date, payment dated. Declaration date, record date, payment datee. None of these.

63. Dividends in arrears on preferred stock are recorded as a liabilitya. in each year the arrearage is created.b. on the date dividends are declared sufficient to pay the arrears.c. on the date of record for dividends declared to pay the arrears.d. dividends in arrears are never recorded as a liability.

64. Given the following information:


20X6 $10,000$ 5,000

20X7 $30,000$10,000

the increase in sales revenues from 20X6 to 20X7 are said to havea. increased by 200%.b. increased by 300%.c. doubled.d. tripled.e. Both a and c.f. Both a and d.

65. Vertical analysisa. is typically used on the balance sheet rather than the income statement.b. eliminates the effects of changes in volume in analyzing the relationship of income

statement categories.c. is not commonly used by financial analysts.d. reflects the percentage changes from one year to the next in categories of the

financial statements.

66. If gross margin as a percentage of sales revenues decreases over the year and the cost per unitof inventory purchases was stable throughout the year (no inflation or deflation in inventorycosts), then a. sales prices per unit must have decreased during the year.b. sales volume must have decreased during the year.c. sales prices per unit must have increased during the year.d. sales volume must have increased during the year.

The following is to be used to respond to problems 67-76.

XYZ Corp.Balance Sheet

As of December 31, 20X6 & 20X7

Assets: Current Assets— Cash Accounts Receivable Inventories Total Current Assets Operating Assets— Total Assets

Liabilities & Stockholders' Equity: Current Liabilities Accounts Payable Other Payables Total Current Liabilities Long Term Liabilities Total Liabilities Stockholders' Equity: Common Stock (10,000 shares outstanding, no par) Retained Earnings Total Liabilities and Stockholders' Equity

20X6

$10,000 25,000 15,000 50,000 30,000$80,000

$15,000 10,000 25,000 19,000 44,000

25,000 11,000$80,000

20X7

$ 12,000 32,000 20,000 64,000 40,000$104,000

$ 16,000 14,000 30,000 29,000 59,000

25,000 20,000$104,000

XYZ Corp.Income Statement

For the years ended December 31, 20X6 & 20X7


Selling and Administrative ExpensesNet Income

20X6 $250,000 175,000 75,000 70,000$ 5,000

20X7 $325,000 234,000 91,000 82,000$ 9,000

67. Calculate the percentage increase in total assets from 12/31/X6 to 12/31/X7.a. 23% increase.b. 30% increase.c. 130% increase.d. None of the above.

68. Calculate the 20X7 current ratio (round to the nearest tenth).a. .4b. 1.5c. 1.8d. 2.1e. None of the above.

69. Calculate the 20X7 acid test ratio (round to the nearest tenth).a. .4b. 1.5c. 1.8d. 2.1e. None of the above.

70. Calculate the 20X7 number of days sales in receivables (average receivable collectionperiod) assuming all sales are made on account (round to the nearest tenth of day).a. 10.2b. 11.4c. 32.0d. 35.8e. None of the above.

71. Calculate the 20X7 inventory turnover (round to the nearest tenth).a. 11.7b. 13.4c. 15.6d. 18.6e. None of the above.

72. Calculate the debt to total asset ratio at 12/31/X7 (round to the nearest tenth).a. .3b. .6c. 1.3d. 1.8

73. Calculate the total debt to total equity ratio at 12/31/X7 (round to the nearest tenth).a. .4b. .6c. .7d. 1.3e. None of the above.

74. Calculate the book value per share at 12/31/X7.a. $ 4.50 per share.b. $ 5.90 per share.c. $10.40 per share.d. None of the above.

75. Calculate the P/E ratio (price/earnings) at 12/31/X7 for the XYZ, Corp. common stock if it istrading at a price of $18.00 per share on that date (round to the nearest tenth).a. 10b. 20c. 30d. 40e. None of the above.

76. Calculate the market price of a share of XYZ Corp. common stock at 12/31/X7 at a P/E ratioof 30.a. $ 9b. $18c. $27d. $36e. None of the above.

77. Generally speaking, improved efficiency in managing inventory will be reflected in theinventory turnover ratio bya. a decrease in the ratio from one period to the next.b. an increase in the ratio from one period to the next.c. no change in the ratio from one period to the next.d. The inventory turnover ratio does not reflect management efficiency.

78. The current ratio measures a company’sa. profitability.b. leverage.c. liquidity.d. value.e. None of the above.

79. Increased volume of credit sales will alwaysa. increase the accounts receivable turnover ratio.b. decrease gross margin as a percentage of sales revenues.c. decrease the number of days sales in inventory.d. Both a and c.e. None of the above.

SOLUTIONS

1. b Inventory 2,000Accounts Payable 2,000

2. d Accounts Payable 100Inventory 100

3. c Accounts Payable 1,900Cash 1,862Inventory 38

4. d Accounts Receivable 2,000Sales Revenues 2,000

Cost of Goods Sold 980Inventory 980

5. a Sales Returns and Allowances 200Accounts Receivable 200

Inventory 98Cost of Goods Sold 98

6. c Cash 1,782 Sales Discounts 18

Accounts Receivable 1,800

7. e Sales Returns and Allowances and Sales Discounts are both contra-revenueaccounts.

8. a

9. d Sales RevenuesLess: Sales Returns and Allow. Sales Discounts

Net Sales Revenues Less: Cost of Goods Sold

( .4 × 90,000) Gross Margin

$100,000 (7,000) (3,000)$ 90,000

(36,000)$ 54,000

10. e

11. c

12. d

Allowance forUncollectible Accounts

2,500

2,300

Balance beforeadjustment

Adjustment

4,800a Balance after adjustment

a Accounts Receivable × Est. Uncollectible Accounts80,000 × .06 = 4,800

13. b


1,500

5,500


Adjustment

4,000a Balance after adjustment

a Accounts Receivable Balance × % Est. Uncollectible Accounts($40,000 × .10 = $4,000)

Bad Debt Expense 5,500Allowance for Uncollectible A/R 5,500

14. c

15. e Calculation of Estimated Uncollectible A/R:

Days Past Due Accounts Receivable Est. Uncollectible Amount Current $1,000 0 - 30 days $1,500

30 - 60 days 60 - 90 days $2,000

$1,000

90 + days

1%

5% 3%

20% 40% $3,200

$100,000 $ 50,000 $ 20,000 $ 10,000

$ 8,000 $188,000 $8,700


500

8,200


Adjustment

8,700 Balance after adjustment

Bad Debt Expense 8,200Allowance for Uncollectible A/R 8,200

16. b

Accounts Receivable

Beg. BalanceSales on A/R

50,000 210,000

199,000 3,000

Collections on A/RWriteoffs of A/R

End. Balance 58,000

17. b

18. b A failure to make an adjusting entry for

Bad Debt Expense xxx Allowance for Uncollectible A/R xxx

Would overstate assets and understate expenses and therefore overstate net income.

19. c

20. a

Allowance for UncollectibleA/R

Actual writeoffs incurrent year

xxx

xxx Prior year’s estimate ofuncollectible A/R

xxxPrior yearoverestimation

Balance before adjustmentat the end of the currentyear

21. e Cash 97Credit Card Expense 3 Sales Revenues 100

22. a FIFO: 9 units @ $40/ea. = $3605 units @ $46/ea. = $230

14 units $590

23. b LIFO: 12 units @ $46/ea. = $552 2 units @ $40/ea. = $ 80

14 units $632

24. d Moving Weighted Average: 9 units @ $40/ea. = $360

12 units @ $46/ea. = $55221 units $912

Average Cost: $912 ÷ 21 = $ 43.43/ea.

Sale #2- 14 units × $43.43 = $608.02

25. b

Inventory

Beg. BalancePurchase

Purchase

Purchase

1,200 3,250

1,450

3,000

2,340

2,480

1,350

Sale (18@ $130)

Sale (10@ $145) ( 7@ $130) ( 1@ $120)

Sale ( 9@ $150)

End. Balance 2,730

26. e

Cost of Goods Sold

12/5 Sale: (10@ $120) ( 8@ $130)

12/19 Sale: (17@ $130) ( 1@ $145)

12/29 Sale: ( 9@$145)

2,240

2,355

1,305

5,900

27. a Oldest inventory is sold first.

28. a Method Cost of Goods Sold Net Income Tax Liability FIFO Higher Lower Lower LIFO Lower Higher Higher

29. b Method Cost of Goods Sold Net Income FIFO Lower Higher LIFO Higher Lower

30. b Method Cost of Goods Sold Ending Inventory FIFO Lower Higher LIFO Higher Lower

31. d

32. c

33. d

34. e

35. b Wage Expense 10,000Employee FICA WH Payable 600Employee FIT WH Payable 1,800Employee SIT WH Payable 900Employee Union Dues Payable 300Wages Payable 6,400

Payroll Tax Expense 800Employer FICA Payable 600FUI Payable 120SUI Payable 80

36. c Cash 19.40Credit Card Expense .60

Sales Revenues 20.00

37. b Cash 107Sales Revenues 100Sales Tax Payable 7

38. d The $1,000 of prepaid insurance is reflected as a separate asset “Prepaid Insurance”rather than capitalized as part of the cost of the truck.

39. c Partial year depreciation in 20X1 (purchased on 7/1/X1):$70,000 - $3,100 = $6,690 depreciation per year 10

Partial year = $6,690 × ½ year = $3,345

40. e


3,345 6,690

20X1 Depreciation20X2 Depreciation

10,035 12/31/X2 Balance

41. a 20X1 Depreciation: $70,000 - $3,100 = $ .669/per unit 100,000 units depreciation

20X1 units of production = 10,000 units × $ .669 = $6,690 depreciation

Book Value @ 12/31/X1: Cost $ 70,000

42. a Book value is to be reflected on the balance sheet. Book Value: Cost $ 25,000

Less: Accumulated Depreciation 6,690$ 63,310

Less: Accumulated Depreciation 6,000$ 19,000

43. b

44. d

45. c Book value at the date of sale:Cost $82,000Less: Accumulated Depreciation

$82,000 - $6,000 × 8 yrs. 38,00016 yrs.

$44,000

Gain(Loss) on sale is calculated as:Sales Price $40,000Less: Book Value 44,000

Loss on Sale $( 4,000)

Cash 40,000Accumulated Depreciation 38,000Loss on Sale 4,000 Equipment 82,000

46. b Cash 27,000Accumulated Depreciation 25,000 Equipment 50,000 Gain on Sale 2,000

47. a Accumulated Depreciation xxx Equipment xxx

48. a

49. b

50. a The cost of goodwill in the purchase of a business is not amortized to expense over time. Instead, the value of recorded goodwill is reevaluated at the end of each year with any decrease in value recorded as a loss. Subsequent increases in value are not recorded.

51. c Purchase Price for Business $1,000,000Less; FMV of Assets less Liabilities:

Assets $900,000Liabilities ( 350,000)

Net AssetsPurchased 550,000

Goodwill purchased $ 450,000

52. b 20X7 1,000,000 × 8% × 9/12 = $60,00020X8 1,000,000 × 8% × 12/12 = 80,00020X9 1,000,000 × 8% × 3/12 = 20,000

53. d 10/31/97 payment:Interest = 70,000 × 8% × 1/12 = 466.67Principal = 513.64 - 446.64 = 46.97

11/30/97 paymentInterest = 69,953.03 × 8% × 1/12 = 466.35Principal = 513.64 - 446.35 = 47.29

entry:Interest Expense 466.35Mortgage Payable 47.29

Cash 513.64

54. e

Mortgage Note Payable

Payment 10/31Payment 11/30

46.97 47.29

70,000 Beg. Balance

69,905.74 Balance @ 11/30

55. d

56. d

57. d

58. d

59. b Total capital contributions equal any par value contributed plus paid in capital in excessof par.

60. b Preferred CommonPreferred: Arrears $25,000

Current (5% × 5,000 × $100) x 2 years $25,000Remainder to Common $60,000

$50,000 $60,000

61. b

62. d

63. b Companies are never obligated to declare dividends to preferred or common shareholders. As a result, dividends in arrears (cumulative preferred shareholders’ priority rights to dividends carried over from previous years) are not recorded as liabilities unless and until a dividend declaration is made by the company’s board of directors. At the date of declaration the amount of dividends declared then becomes a liability of the company and to the extent that amount includes dividends in arrears those arrears are then included in the liability. Otherwise, dividends in arrears are disclosed only in a company’s footnotes to the financial statements.

64. f % increase = 30,000 - 10,000 = 2.0 or 200% 10,000

65. b

66. a

67. b % increase = 104,000 - 80,000 = .3 or 30% 80,000

68. d Current Assets = 64,000 = 2.1 Current Liabilities 30,000

69. b Quick Assets = 12,000 + 32,000 = 1.5 Current Liabilities 30,000

70. c

365=

365= 32.01

A/R Turnover 11.4

A/R Turnover = = = 11.4Sales Revenues 325,000

Ave. A/R Balance ( 25,000 + 32,000 )2

71. b

InventoryTurnover

= = = 13.4Cost of Goods Sold 234,000

Ave. Inv. Balance ( 15,000 + 20,000 )2

72. b Total Liabilities = 59,000 = .57 Total Assets 104,000

73. d Total Liabilities = 59,000 = 1.31Total Stockholder’s Equity 45,000

74. a

Book Value Per Share =Total Owners’ Equity

=45,000

= $ 4.50# of Shares of Stock 10,000

75. b

Price/Earnings Ratio =Market Price per Share

=$18.00

= 20EPS $ .90

EPS =Net Income

=9,000

= .90# Shares Common Stock 10,000

76. c Market Price Per Share = EPS × P/E Ratio27 = .90 × 30

77. b

78. c

79. e Increased credit sales will not necessarily increase the turnover ratio if the averagebalance of accounts receivable also increases significantly.

EXAM #3

SAMPLE PROBLEMS

(Lessons 11 - 15)

1. Managerial accounting informationa. is prepared primarily for investors and creditors and is generally available to the

public.b. is governed by GAAP.c. tends to be different from business to business based on management needs.d. focuses on historical transactions excluding any budgets or forecasts for the future.e. All of the above are true.

2. Which of the following is not a product cost?a. Administrative office supplies.b. Manufacturing equipment maintenance supplies.c. Freight costs associated with raw material purchases.d. Both a and c.e. All of the above are product costs.

3. Product costs of a merchandising business includea. freight costs on the shipment of goods to customers.b. the cost of inventory purchases.c. freight costs associated with inventory purchases from suppliers.d. Both b and c.e. All of the above are product costs.

4. Period costs include alla. selling expenses.b. administrative expenses.c. production costs.d. Both a and b.e. All of the above as long as they are incurred in the period for which the financial

statements are prepared.

5. Which of the following costs are not found in a merchandising business?a. Selling expenses.b. Period costs.c. Product costs.d. Direct labor costs.e. None of the above.

6. A service business never hasa. product costs.b. period costs.c. A service business has both of these kinds of costs.d. A service business has neither of these kinds of costs.

7. An example of manufacturing overhead costs would bea. direct material costs.b. factory production line wage costs.c. indirect material costs.d. utility costs for administrative offices.e. Both c and d.

8. The salary costs of manufacturing supervisors would be included ina. direct labor costs.b. manufacturing overhead costs.c. direct material costs.d. indirect material costs.e. None of the above.

9. Factory utility costs should be included as part ofa. period costs.b. direct labor costs.c. direct material costs.d. indirect material costs.e. None of the above.

10. Period costs for a manufacturing business would be included ina. work in process inventory.b. finished goods inventory.c. cost of goods sold.d. selling and administrative expenses.e. Answers a, b, & c above are all correct.

11. All product costs are included in Cost of Goods Sold whena. production is initiated.b. the costs are incurred in the production process.c. production is completed.d. raw materials are purchased.e. None of the above.

12. The balance sheet of a manufacturing business will reflect inventory which includesa. finished goods inventory.b. work in process inventory.c. raw materials inventory.d. All of the above.e. None of the above.

13. A home construction company specializing in custom homes would probably accumulateproduct costs througha. a process cost system.b. a job order cost system.c. a periodic cost system.d. a cash basis cost system.

14. In a job order cost system, job cost sheets may serve as a a. subsidiary ledger for WIP inventory.b. record which accumulates all product costs associated with the production of specific

job orders.c. subsidiary ledger for finished goods inventory.d. All of the above.e. None of the above.

15. In a job order cost system, the journal entry to record the purchase of direct materials onaccount would include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

16. In a job order cost system, the journal entry to record the purchase of indirect materials onaccount would include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

17. In a job order cost system, the journal entry to record the requisition of direct materials intoproduction for a specific job order would include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

18. In a job order cost system, the journal entry to record the requisition of indirect materials intoproduction would include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

19. In a job order cost system, the journal entry to record the incurring of direct labor costswould include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

20. In a job order cost system, the journal entry to record the incurring of indirect labor costswould include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

21. In a job order cost system, the journal entry to record the incurring of miscellaneousproduction costs such as equipment maintenance costs would include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

22. In a job order cost system, the journal entry to record the application of manufacturingoverhead costs using a predetermined manufacturing overhead rate would include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

23. In a job order cost system, the journal entry to record the completed production of a specificjob order would include aa. debit to WIP Inventory.b. debit to Manufacturing Overhead.c. debit to Raw Materials Inventory.d. debit to Cost of Goods Sold.e. debit to Finished Goods Inventory.

24. Which of the following journalized transactions would not be posted directly to a job costsheet?a. Requisition of raw materials to production.b. Incurring of direct labor costs.c. Incurring of indirect labor costs.d. All of the above require an entry to a job cost sheet.e. None of the above require an entry to a job cost sheet.

25. Gart Company anticipates the following costs and expenses during the coming year:Direct Material $30,000Direct Labor (@ $15/hr) 90,000Indirect Material 12,000Indirect Labor 18,000Administrative Office Expenses 15,000Selling Expenses 24,000Factory Depreciation 36,000Other Manufacturing Overhead 21,000

If manufacturing overhead is applied on the basis of direct labor hours, what is thepredetermined manufacturing overhead rate per direct labor hour to be used for the comingyear?a. $14.50b. $17.00c. $12.08d. $11.50e. None of these.

26. Actual manufacturing overhead costs for the period amount to $4,750. The predeterminedoverhead rate to be used is $2.50 per direct labor hour. What journal entry would record theapplication of manufacturing overhead in a period during which 2,000 direct labor hourshave been worked?a. Work in Process Inventory 4,750

Overapplied Overhead 250Manufacturing Overhead 5,000

b. Work in Process Inventory 5,000Manufacturing Overhead 5,000

c. Work in Process Inventory 4,750Manufacturing Overhead 4,750

d. Work in Process Inventory 5,000Overapplied Overhead 250Manufacturing Overhead 4,750

e. None of these.

27. Assume the following information regarding manufacturing overhead costs: depreciation forthe period, $1,400; utility bill for the period received but not yet paid, $600; property taxesfor the period due at year-end but not yet paid, $1,200. What journal entry would recordthese costs?a. Manufacturing Overhead 3,200

Work in Process Inventory 3,200b. Work in Process Inventory 3,200

Accumulated Depreciation 1,400Property Taxes Payable 1,200Utilities Payable 600

c. Manufacturing Overhead 3,200Accumulated Depreciation 1,400Utilities Payable 600Property Taxes Payable 1,200

d. Manufacturing Overhead 3,200Depreciation Expense 1,400Utilities Expense 600Property Tax Expense 1,200

e. None of these.

28. Total actual manufacturing overhead costs incurred during the year were $14,400. Ifoverhead is applied at $17 per direct labor hour and 1,100 actual direct labor hours wereworked during the period, what would be the entry to close the manufacturing overheadaccount to cost of goods sold at the end of the year?a. Debit Manufacturing Overhead and credit Cost of Goods Sold for $4,300.b. Debit Cost of Goods Sold and credit Manufacturing Overhead for $4,300.c. Debit Cost of Goods Sold and credit Manufacturing Overhead for $14,400.d. Debit Manufacturing Overhead and credit Cost of Goods Sold for $14,400.e. None of these.

29. A credit balance in the Manufacturing Overhead account at the end of a period before anyentry to close the account means thata. actual manufacturing overhead costs exceeded applications to WIP.b. actual manufacturing overhead costs must have been less than budgeted.c. applied manufacturing overhead exceeded actual manufacturing overhead costs for

the period.d. Both a and b.e. Both b and c.

30. Failure to correct an underapplication of manufacturing overhead will result in a. overstatement of net income.b. overstatement of cost of goods sold.c. understatement of net income.d. None of the above.

31. On September 1, the work in process inventory account totaled $4,200. ThroughoutSeptember, manufacturing costs totaling $21,300 were charged to work in process inventory. If on September 30, work in process inventory should only be $3,200, what entry records theproduction completed during September?a. Finished Goods Inventory 25,500

Work in Process Inventory 25,500b. Cost of Goods Sold 22,300

Work in Process Inventory 22,300c. Finished Goods Inventory 22,300

Work in Process Inventory 22,300d. Work in Process Inventory 25,500

Finished Goods Inventory 25,500e. None of these.

32. Variable costsa. vary per unit and in total within the relevant range.b. vary per unit and are fixed per unit within the relevant range.c. vary in total and are fixed per unit within the relevant range.d. None of the above.

33. Which of the following costs would most likely be a fixed cost?a. Direct material costs.b. Direct labor costs.c. Building rental costs.d. Both a and c.e. All of the above.

34. The slope of the total cost line in a cost, volume, profit graph reflectsa. total fixed costs.b. total variable costs.c. variable costs per unit.d. fixed costs per unit.e. contribution margin.

35. The point of intersection of the total cost line with the vertical axis in a cost, volume, profitgraph reflectsa. total fixed costs.b. total variable costs.c. variable costs per unit.d. fixed costs per unit.e. contribution margin.

36. The slope of the sales revenue line in a cost, volume, profit graph reflectsa. total sales revenues.b. total variable costs.c. variable costs per unit.d. sales price per unit.e. contribution margin.

37. As the volume of units sold decreases within the relevant range, the fixed cost per unit solda. increases.b. decreases.c. remains the same.

38. As the volume of units sold increases within the relevant range, the variable cost per unitsold typicallya. increases.b. decreases.c. remains the same.

39. Assume that total mixed manufacturing overhead costs are $600,000 at 63,000 unitsproduced and $280,000 at 23,000 units produced. Both operating levels are within therelevant range. What is the apparent total fixed portion of mixed manufacturing overheadcosts using the information provided?a. $ 96,000b. $100,000c. $110,000d. Not determinable.e. None of these.

40. Total utility costs amount to $111,500 at 7,500 units produced and $71,000 at 3,900 unitsproduced at the high and low levels of activity. What total utility cost should be expected at5,000 units produced?a. $54,250b. $79,500c. $83,375d. $91,750e. None of these.

41. The scatter-graph method refers to an approach used to a. perform CVP analysis.b. determine fixed and variable components of a mixed cost.c. determine the breakeven point at varying levels of volume.d. determine the fixed cost per unit at varying levels of productivity.e. None of the above.

42. Given the following graph:

The net income at a volume of units sold equal to B would produce net income equal toa. Ab. Cc. Dd. A-Ce. None of the above.

43. Given the following budgeted amounts for the year 20X1:

Sales Revenues $150,000Less: Cost of Goods Sold (95,000)*

Gross Margin 55,000Less: Selling & Admin. Expenses (40,000)**

Net Income $ 15,000

*Cost of Goods Sold:Direct Materials $ 40,000Direct Labor 30,000Manufacturing Overhead-

Variable 10,000Fixed 15,000

$ 95,000

**Selling & Admin. Expenses:Variable $ 20,000Fixed 20,000

$ 40,000

Calculate the budgeted contribution margin for the year.a. $ 15,000b. $ 50,000c. $ 55,000d. $120,000e. None of the above.

44. Using the information provided in problem #43 and assuming the budgets were based on avolume of 20,000 units of production and sales, calculate the number of of units whichwould have to be sold in order to reach breakeven.a. 10,000b. 14,000c. 20,000d. 24,000e. None of the above.

45. If total fixed costs are $58,500, the break-even point is 3,900 units, and the variable cost perunit is $8, what is the contribution margin per unit for this product?a. $35b. $15

c. $28d. $ 7e. None of these.


Sales price per unit $10Sales volume at breakeven 5,000 unitsVariable costs per unit $ 6

calculate the number of units to be sold to produce net income equal to $60,000.a. 12,000b. 20,000c. 30,000d. 50,000e. None of the above.

47. A certain product has a sales price of $36 per unit and a per unit contribution margin of $12. If total fixed costs are $42,600, what is the break-even dollar sales volume?a. $108,000b. $127,800c. $ 85,200d. $ 42,600e. None of these.

48. A firm sells its only product for $10 per unit and has total fixed costs of $36,000. If thevariable cost per unit is $6, what sales volume is needed to earn $59,000 net income?a. 15,833 unitsb. $158,333c. 23,750 unitsd. $217,333e. None of these.


Variable cost per unit $8Fixed costs $40,000

calculate the sales price per unit required to generate breakeven with an expected salesvolume of 10,000 units.a. 4b. 8c. 10d. 24e. None of the above.

50. If breakeven sales revenues amount to $200,000 at a sales price per unit of $10 and totalfixed costs amount to $40,000, then the business' variable cost ratio equalsa. 40%b. 60%c. 80%d. 100%e. None of the above.

51. Given the following:

Sales price per unit $7Variable cost per unit $3

If an increase in advertising bearing a cost of $50,000 would yield a 20,000 unit increase inthe volume of sales, what would be the impact on the company’s net income of suchincreased advertising?a. $ 30,000b. $ 60,000c. $ 80,000d. None of the above.

52. How many additional units must be sold at a contribution margin of $6 per unit to produce a$24,000 increase in net income?a. 2,000 unitsb. 4,000 unitsc. 6,000 unitsd. Cannot be determined from the information provided.

53. If breakeven was achieved at a $10/unit sales price and 10,000 units of sales volume, whatvolume of sales will produce net income of $100,000 if fixed costs amount to $25,000.a. 10,000 unitsb. 12,500 unitsc. 25,000 unitsd. 50,000 unitse. Cannot be determined from the information provided.

54. The typical first step in the development of an operating budget is to a. identify and estimate all product costs.b. identify and estimate all selling and administrative expenses.c. prepare pro-forma financial statements.d. project sales volume of goods or services at anticipated sales price.e. identify all sources and uses of cash.

55. Beginning inventory and expected sales of product B are 21,000 units and 69,000 units,respectively. If the desired ending inventory of product B is 9,000 units, how many units ofproduct B should be produced?a. 39,000b. 30,000c. 57,000d. 81,000e. None of these.

56. During May, a company expects cash receipts (excluding borrowing) of $65,000 and cashdisbursements of $90,000. If the budgeted ending cash account balances for April and Mayare to be $21,000 and $26,000, respectively, then plans should be made to borrow a. $30,000b. $25,000c. $22,000d. $36,000e. None of these.

57. For January, February, and March, Edberg Company expects unit sales of its final product tobe 7,000, 10,000, and 12,000, respectively. (1) Edberg's policy is to have 20% of nextmonth's final product sales on hand at the end of the month; (2) each unit sold requires 2units of material costing $6 each; (3) materials inventory is to remain constant; and (4) 80%of each month's purchases are paid during the month and 20% are paid in the followingmonth. Cash payments in February for purchases of materials should bea. $116,160b. $118,080c. $143,040d. $ 97,920e. None of these.

58. Willy Corporation manufactures products X and Y in department #2 and department #10. Each unit of product X requires 1.5 direct labor hours in department #2 and 6 direct laborhours in department #10. For product Y, these requirements are 3 hours and 2 hours,respectively. If Willy plans to produce 30,000 units of product X and 50,000 units of productY and the average hourly wage rates are $6.50 and $4.00 in departments #2 and #10,respectively, the total budgeted direct labor cost would bea. $2,387,500b. $2,512,500c. $1,375,000d. $1,861,000e. None of these.

59. Assume that all sales are made on account and total sales are as follows: July, $500,000;August, $420,000; and September, $190,000. Cash collections are budgeted as follows:

(1) Of any month's sales, 20% are collected in the month of sale and a 5% cash discount isgiven.

(2) Of any month's sales, 50% are collected the following month with no cash discount.(3) Of any month's sales, 25% are collected the second month following sale with no cash

discount (the balance is bad debts).

What total amount of cash would be collected during the month of September?a. $428,500b. $386,000c. $407,200d. $361,000e. None of these.

60. Finished goods inventory on a pro-forma balance sheet would require that the number ofunits of budgeted ending inventory be identified from thea. production budget.b. sales budget.c. materials purchases budget.d. cash flow budget.e. None of the above.

61. The balance of accounts payable on a pro-forma balance sheet would be available from thea. direct labor budget.b. production budget.c. sales budget.d. selling and administrative expense budget.e. None of the above.

62. Relevant costs in non-routine decision making area. future costs that vary among decision alternatives.b. future costs that are common under decision alternatives.c. any unrecoverable past cost.d. joint costs under decision alternatives.e. future costs that are unavoidable under decision alternatives.

63. Assume the following unit cost data for the production of a product:

Direct material $13Direct labor 8Variable manufacturing overhead (avoidable) 2Fixed manufacturing overhead 6*

*Amount reflects unavoidable fixed costs reflected here on a per unit basis based on apredetermined rate calculated based on a budgeted volume of production.

If a customer placed a special order for 900 units at a sales price of $27 each, how muchprofit (loss) would be made on the special order if accepted, assuming that sufficient unusedproduction capacity exists to produce the order?a. $1,800 loss.b. $3,600 profit.c. $5,400 profit.d. $6,000 profit.e. None of these.

64. Swiss Company produces 6,000 units of a needed component, incurring per-unit costs asfollows: direct material, $7; direct labor, $11; variable manufacturing overhead, $2. Totalfixed manufacturing overhead costs amount to $54,000. The purchasing department can buycomparable units for $22 per unit. Assuming one-half of the fixed costs are direct and couldbe avoided if the component is purchased rather than manufactured and no alternative usecould be made of the production capacity released by purchasing the components, purchaseof the units would result ina. a savings of $15,000.b. a loss of $15,000.c. a savings of $12,000.d. a loss of $12,000.e. None of these.

65. ZZZ Company has total income from all departments of $55,000. Department Q reports thefollowing information for this year:

Revenue $625,000Variable cost of goods sold 350,000Fixed cost of goods sold 70,000Variable selling expense 225,000Fixed selling expenses 50,000

Net Income (Loss) $ (70,000)

Assuming that 50% of department Q's fixed costs and expenses are direct and could havebeen avoided, what would the firm's total net income have been if Department Q had beendiscontinued at the beginning of this year's operations?a. $75,000b. $45,000c. $65,000d. $55,000e. None of these.

66. Dakota Company makes its standard model, which sells for $96 per unit, with the followingvariable per unit costs:

Direct material $20Direct labor 32Variable manufacturing overhead (25% of direct labor cost) 8

Total fixed manufacturing overhead amounts to $25,000. To use part of its existing excess capacitywithout incurring additional fixed manufacturing overhead costs, Dakota plans to process thestandard model further by adding an additional finish, which would raise the selling price to $120. Additional unit costs would include direct material, $10, direct labor, $8 and variable manufacturingoverhead. The increase (decrease) in profit per unit from processing the product further should be:

a. $ 1b. $ 4c. $ 6d. ($9)e. None of these.

67. Pixie, Inc., manufactures products 1, 2, and 22 with the following information per unit:

1 2 22Sales Price $60 $80 $40Variable costs 20 50 16Machine hours required 10 6 4

Machine hours are a constraining resource for Pixie's operation. If Pixie has excess capacity,the company should emphasize:a. product 22 because it has the lowest fixed cost per unit.b. product 22 because it has the highest contribution margin per unit of constraining

resource.c. product 1 because it has the highest contribution margin per unit of product.d. product 2 because it has the highest unit sales price.e. None of these.

68. Sunk costs in decision alternatives are alwaysa. relevant.b. irrelevant.c. avoidable.d. None of the above.

69. In a decision on whether to buy a new car or maintain an existing one, the resale value of theexisting car is a(n)a. opportunity cost.b. sunk cost.c. irrelevant cost.d. indirect cost.e. None of the above.

70. A company has an noncancellable lease on equipment with three years remaining on theoriginal lease at a cost of $1,000 per year. The equipment cannot be subleased or sold andhas no anticipated residual value at the end of the lease. Given these circumstances, thefuture lease payments under any decision which contemplates the purchase of newerreplacement equipment should be characterized as a(an)a. opportunity cost.b. differentiating cost.c. sunk cost.d. direct cost.e. avoidable cost.

SOLUTIONS

1. c

2. a

3. d

4. d

5. d

6. c

7. c

8. b

9. e Factory utility costs are a part of manufacturing overhead costs which are product costs.

10. d

11. e Product costs are included in Cost of Goods Sold when finished goods are sold tocustomers.

12. d

13. b

14. d

15. c

16. c

17. a

18. b

19. a

20. b

21. b

22. a

23. e

24. c

Total Budgeted Manufacturing25. a Predetermined Manufacturing = Overhead

Overhead Rate Per Direct Labor Hour Total Budgeted Direct Labor Hours

= $87,000 = $ 14.50 per 6,000 hours Direct Labor Hour

Total Budgeted Manufacturing Overhead Costs:Indirect Materials $12,000Indirect Labor 18,000Factory Depreciation 36,000Other Manufacturing Overhead 21,000

$87,000

Total Budgeted Direct Labor Hours:Budgeted Direct Labor Costs $90,000÷ Labor Cost Per Hour ÷ $ 15 per hour

6,000 hours

26. b Application of Overhead: Rate × Measurable Activity$ 2.50 × 2,000 direct labor hours = $5,000

27. c

28. a


Actual Costs 14,40018,700

Applications to WIP: ($17 × 1,100 hrs.)

Entry to Close 4,300 4,300 Overapplied Overhead

Manufacturing Overhead 4,300Cost of Goods Sold 4,300

29. c (Clearly the actual costs and actual measurable activity did not exactly equal the originalbudgets, but answer b is not necessarily appropriate because more goes into thepredetermined overhead rate calculation than just budgeted costs. Budgeted measurableactivity also affects the rate calculation and its ultimate accuracy.)

30. a Underapplication means that insufficient costs were applied to WIP Inventory, Finished Goods Inventory and Cost of Goods Sold. Understatement of Cost of GoodsSold causes Net Income to be overstated.

31. c

WIP Inventory

Beg. Balance

Charges to WIP

4,200

21,300 ? (22,300) Transfers out of WIP(Completed Production)

End. Balance 3,200

32. c

33. c

34. c

35. a

36. d

37. a

38. c

39. aHigh $600,000 63,000 hoursLow 280,000 23,000 hours

$ 320,000 40,000 hours

Variable Cost Per Unit = Rise/Run = $320,000/40,000 hrs. = $8/unit

Fixed Cost Portion:Total Cost VC + FC$600,000 ($8 × 63,000) + FC

$600,000 - $504,000 FC $96,000 FC

===

40. cHigh $111,500 7,500 hoursLow 71,000 3,900 hours

$ 40,500 3,600 hours

Variable Cost Per Unit = Rise/Run = $40,500/3,600 hrs. = $11.25/unit

Fixed Cost Portion:Total Cost VC + FC$111,500 ($11.25 × 7,500) + FC

$111,500 - $84,375 $27,125 FC

Total Cost at 5,000 units:

VC + FC = Total Cost ($11.25 × 5,000) + 27,125 =

56,250 + 27,125 = 83,375

41. b

42. d

43. b Sales Revenues $150,000Less: Variable Costs:-

Direct Materials 40,000 Direct Labor 30,000

Manufacturing Overhead 10,000 Selling & Administrative 20,000

Contribution Margin $ 50,000

44. b

SR - VC - FC = NI(SP/unit x # units) - (VC/units x #units) - FC = NI (7.50 x # units) - (5.00 x #units) - 35,000 = 0

7.5X - 5X - 35,000 = 002.5X - 35,000 =

2.5X = 35,000 2.5 2.5

X = 14,000 units

= =

= =

FC

45. bSR - VC - FC = NI

CM - FC = NI(CM per unit × 3,900 units) = 0

3,900X - 58,500 = 0 3,900X = 58,500 3,900 3,900

X = $15 contribution margin per unit

46. b

First calculate fixed costs at breakeven:SR - VC - FC = NI

(10 × 5,000) - (6 × 5,000) - FC = 0 50,000 - 30,000 - FC = 0

20,000 = FC

Then solve for the # of units to be sold to reach NI = $60,000:SR - VC - FC = NI

(10 × #units) - (6 × #units) - 20,000 10X - 6X - 20,000

= 60,000= 60,000

4X = 80,000 4 4 X = 20,000 units

47. bFirst calculate the # of units to be sold to reach breakeven:SR - VC - FC = NI

CM - FC = NI (CM Ratio × #units) - FC = NI

12X - 42,600 = 0 12X = 42,600 12 12 X = 3,550 units

SR at breakeven = $36 per unit × 3,550 units = 127,800

48. cSR - VC - FC = NI

(10 × #units) - (6 × #units) - 36,00010X - 6X - 36,000

= 59,000= 59,000

4X = 95,000 4 4 X = 23,750 units

- 58,500

49. e SR - VC - FC = NI

(SP/unit x # units) - (VC/unit x # units) - FC = NI

SP/unit x 10,000 - (8 x 10,000) - 40,000 = 0

10,000x - 80,000 - 40,000 = 0

10,000x = 120,000

10,000 10,000

x = $12

50. c SR - VC - FC = NI

(SP/unit x # units) - (VC/unit x # units) - FC = NI

(10 x 20,000) - (VC/unit x 20,000) - 40,000 = 0

200,000 - 20,000x - 40,000 = 0

160,000 = 20,000x

20,000 20,000

8 = x

VC ratio =VC/unit

=8

= 80%SP/unit 10

51. a” SR ” VC ” FC ” NI

($7 × 20,000 units) ($3 × 20,000 units) 50,000 ” NI 140,000 60,000 50,000 ” NI

30,000 ” NI

52. b” SR - ” VC ” FC ” NI

” CM ” FC ” NI ($6 × ” # units) 0 24,000

6X 0 24,000 6X 24,000

6 6 X = 4,000 units

= = = =

---

---

=====

--

--

53. dFirst determine the VC per unit at breakeven volume:

SR - VC - FC = NI (10 × 10,000) - ( VC/unit×10,000) - 25,000 = 0

100,000 - 10,000X - 25,000 = 0 75,000 = 10,000X

10,000 10,000 7.50 = VC/Unit

Then solve the problem:

SR ---

VC - FC = NI (10 × # units) (7.5 × # units) 25,000 = 100,000

10X - 7.5X - 25,000 = 100,0002.5X - 25,000 = 100,000

2.5X = 125,000 2.5 2.5 X = 50,000 units

54. d

55. c

Production Budget

Expected Sales+ Desired Ending Inventory

69,000 9,000

– Beginning Inventory78,000

<21,000>

Units to Be Produced 57,000

56. a

Beginning Budgeted Cash for May $ 21,000Add: Budgeted Cash Receipts 65,000Less: Budgeted Cash Disbursements (90,000)Budgeted Cash Before Financing (4,000)Budgeted Borrowing 30,000Ending Budgeted Cash for May $ 26,000

57. b

Production Budget January February March

Expected Sales+ Desired Ending Inventory (at 20% of next month sales)

7,000

2,000

10,000

2,400

12,000

?

- Beginning Inventory9,000

<1,400>12,400 <2,000>

? <2,400>

# Units to Be Produced 7,600 10,400 ?

Material Usage Budget January February March

# Units to Be Produced 7,600 10,400

(x) Required Materials x 2 x 2

15,200 20,800

Materials Purchase Budget January February

Material Required for Production 15,200 20,800

+ Desired Ending Inventory- Beginning Inventory } “ª” 0 “ª” 0 if constant

Materials to be Purchasedx Cost per Unit

15,200 x 6

20,800 x 6

91,200 124,800

February Cash Payments:

20% x 91,200 =80% x 124,800 =

18,240 99,840

118,080

58. aProduct X:(1.5 x $6.50) + (6 x $4) = $33.75 per unit

Product Y: (3 x $6.50) + (2 x $4) = $27.50 per unit

($33.75 x 30,000) + ($27.50 x 50,000) = $2,387,500

59. e Collections in September:

Sept. Sales $190,000 x 20% x 95% = $ 36,100Aug. Sales $420,000 x 50% = 210,000July Sales $500,000 x 25% = 125,000

$371,10060. a

61. e (Materials Purchases Budget)

62. a

63. bSelling Price $ 27 per unit- Direct Avoidable Costs:

Direct Materials (13)Direct Labor ( 8)Variable Mfg. Overhead ( 2) Differential Per Unit $ 4

Profit from Special Order:900 Units × $4/unit = $3,600

64. a

Make Buy

Direct materialDirect laborVariable overheadPurchase cost

$7112

$22

Units$20

× 6,000$22

× 6,000

Fixed overhead$120,000

54,000$132,000

27,000

Total $174,000 $159,000

174,000 - 159,000 = $15,000

65. c

Q

RevenueVariable costs

$625,000 575,000

Contribution margin $ 50,000

Avoidable fixed costs (50%) < 60,000>

Avoidable loss from Q $ 10,000

Net income + avoidable loss from Q = possible net income$55,000 + $10,000 = $65,000

66. b Differential Revenues and Costs for Premium Product:Sales Revenues Per Unit $ 24Less: Direct Materials (10)

Direct Labor ( 8)Variable Mfg. Overhead

(25% × 8) (2) $ 4

67. b

1 2 22

-

÷

Sales priceVariable costsContribution marginMachine hours requiredCM per units of capacity

$60 <20>

$40 ÷ 10

$ 4

$80 <50>

$30 ÷ 6 $ 5

$40 <16>

$24 ÷ 4 $ 6

68. b

69. a

70. c

· lesson 1 notes 1 2 3 4 5 6 1-1 accounting the language of business have you ever thought that...

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