libby financial accounting chapter4

Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings

Chapter 04 Adjustments, Financial Statements, and

the Quality of Earnings ANSWERS TO QUESTIONS

1. A trial balance is a list of the individual accounts, usually in financial statement order, with their debit or credit balances. It is used to provide a check on the equality of the debits and credits.

2. Adjusting entries are made at the end of the accounting period to record all revenues and expenses that have not been recorded but belong in the current period. They update the balance sheet and income statement accounts at the end of the accounting period.

3. The four different types are adjustments for: (1) Deferred revenues -- previously recorded liabilities that need to be adjusted at

the end of the period to reflect revenues that have been earned (e.g., Unearned Ticket Revenue must be adjusted for the portion of ticket revenues earned in the current period).

(2) Accrued revenues -- revenues that have been earned by the end of the accounting period but which will be collected in a future accounting period (e.g., recording Interest Receivable for interest revenues not yet collected).

(3) Deferred expenses -- previously recorded assets that need to be adjusted at the end of the period to reflect incurred expenses (e.g., Prepaid Insurance must be adjusted for the portion of insurance expense incurred in the current period).

(4) Accrued expenses -- expenses that have been incurred by the end of the accounting period but which will be paid in a future accounting period (e.g., recording Utilities Payable for utilities expense incurred during the period that has not yet been paid).

4. A contra-asset is an account related to an asset that is an offset or reduction to the asset's balance. Accumulated Depreciation is a contra-account to the equipment and buildings accounts.

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5. The net income on the income statement is included in determining ending retained earnings on the statement of stockholders’ equity and the balance sheet. The change in the cash account on the balance sheet is analyzed and categorized on the statement of cash flows into cash from operating activities, investing activities, and financing activities.

6. (a) Income statement: Revenues (and gains) - Expenses (and losses) = Net Income (b) Balance sheet: Assets = Liabilities + Stockholders' Equity (c) Statement of cash flows: Changes in cash for the period = Cash from

Operations + Cash from Investing Activities + Cash from Financing Activities (d) Statement of stockholders' equity: Ending Stockholders' Equity = (Beginning

Contributed Capital + Stock Issuances - Stock Repurchases) + (Beginning Retained Earnings + Net Income - Dividends Declared)

7. Adjusting entries have no effect on cash. For deferred revenues and deferred expenses, cash was received or paid at some point in the past. For accruals, cash will be received or paid in a future accounting period. At the time of the adjusting entry, there is no cash being received or paid.

8. Earnings per share = Net income ÷ average number of shares of stock outstanding during the period.

Earnings per share measures the average amount of net income for the year attributable to one share of common stock.

9. Net profit margin = Net income ÷ net sales

The net profit margin measures how much of every sales dollar generated during the period is profit.

10. An unadjusted trial balance is prepared after all current transactions have been journalized and posted to the ledger. It does not include the effects of the adjusting entries. The basic purpose of an unadjusted trial balance is to check the equalities of the accounting model (particularly, Debits = Credits) and to provide the data in a form convenient for further processing in the accounting information processing cycle.

In contrast, an adjusted trial balance is prepared after the effects of all of the adjusting entries have been applied to the corresponding (prior) unadjusted trial balance amounts. The basic purpose of an adjusted trial balance is to insure that accuracy has been attained in applying the effect of the adjusting entries. The adjusted trial balance provides a second check in the model equalities (primarily Debits = Credits). It also provides data in a form convenient for further processing.

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11. The closing entry is made at the end of the accounting period to (1) transfer the balances in the temporary income statement accounts to retained earnings and (2) reduce the revenue, gain, expense, and loss accounts to a zero balance so that they can be used for the accumulation process during the next period. A closing entry must be entered into the system through the journal and posted to the ledger accounts to state properly the temporary and permanent account balances (i.e., zero balances in the temporary accounts).

12. (a) Permanent accounts -- balance sheet accounts; that is, the asset, liability, and stockholders’ equity accounts (these are not closed at the end of each period).

(b) Temporary accounts -- income statement accounts; that is, revenues, gains, expenses, and losses (these are closed at the end of each period).

(c) Real accounts -- another name for permanent accounts. (d) Nominal accounts -- another name for temporary accounts.

13. The income statement accounts are closed at the end of the accounting period because, in effect, they are temporary subaccounts to retained earnings (i.e., a part of stockholders' equity). They are used only for accumulation during the accounting period. When the period ends, these accumulated accounts must be transferred (closed) to retained earnings. The closing process serves:

(1) to correctly state retained earnings, and (2) to clear out the balances of the temporary accounts for the year just ended so

that these subaccounts can be used again during the next period for accumulation and classification purposes.

Balance sheet accounts are not closed at the end of the period because they reflect permanent accumulated balances of assets, liabilities, and stockholders' equity. Permanent accounts show the entity's financial position at the end of the period and are the beginning amounts for the next period.

14. A post-closing trial balance is a listing taken from the ledger after the adjusting and closing entries have been journalized and posted. It is not a necessary part of the accounting information processing cycle but it is useful because it demonstrates the equality of the debits and credits in the ledger after the closing entry has been journalized and posted and that all temporary accounts have zero balances.

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ANSWERS TO MULTIPLE CHOICE 1. c 2. b 3. b 4. a 5. b 6. c 7. c 8. d 9. c

10. a

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EXERCISES

E4–2.

Req. 1 Types Accounts to be Adjusted

Deferred Revenues: Deferred Revenue may need to be

adjusted for any revenue earned during the period

Deferred Revenue (L) and Product Revenue and/or Service Revenue (R)

Accrued Revenues: Interest may be earned on Short-term

Investments

Any unrecorded sales or services provided will need to be recorded

Interest Receivable (A) and Interest Revenue (R)

Accounts Receivable (A) and Product Revenue and/or Service Revenue (R)

Deferred Expenses: Other Current Assets may include

supplies, prepaid rent, prepaid insurance, or prepaid advertising

Any additional use of Property, Plant, and Equipment during the period will need to be recorded

Other Current Assets (A) and Selling, General, and Administrative Expense (E)

Accumulated Depreciation (XA) and Cost of Products and/or Cost of Services (E)

Accrued Expenses: Interest incurred on Short-term Note

Payable and Long-term Debt will need to be recorded

There are likely many other accrued expenses to be recorded, including wages, warranties, and utilities

Income taxes must be computed for the period and accrued

Accrued Liabilities (L) and Interest Expense (E)

Accrued Liabilities (L) and Selling, General, and Administrative Expenses (among other expenses) (E)

Income Tax Payable (L) and Income Tax Expense (E)

Req. 2

Temporary accounts that accumulate during the period are closed at the end of the year to the permanent account Retained Earnings. These include: Product revenue, service revenue, interest revenue, cost of products, cost of services, interest expense, research

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and development expense, selling, general, and administrative expense, other expenses, and income tax expense.

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E4–3.

Req. 1

The annual reporting period for this company is January 1 through December 31, 2011.

Req. 2 (Adjusting entries)

Both transactions are accruals because revenue has been earned and expenses incurred but no cash has yet been received or paid.

(a) 1. Wages expense is incurred. 2. Cash will be paid in the next period to employees who worked in the current

period – an accrued expense needs to be recorded. 3. Amount: $7,000 given

Adjusting entry – Wages expense (+E, −SE)........................... 7,000

Wages payable (+L).............................. 7,000

(b) 1. Interest revenue is now earned. 2. Cash will be received in the future – an accrued revenue needs to be

recorded. 3. Amount: $2,000 given

Adjusting entry – Interest receivable (+A) ............................... 2,000 Interest revenue (+R, +SE)................... 2,000

Req. 3

Adjusting entries are necessary at the end of the accounting period to ensure that all revenues earned and expenses incurred and the related assets and liabilities are measured properly. The entries above are accruals; entry (a) is an accrued expense (incurred but not yet recorded) and entry (b) is an accrued revenue (earned but not yet recorded). In applying the accrual basis of accounting, revenues should be recognized when earned and measurable and expenses should be recognized when incurred in generating revenues.

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E4–4.

Req. 1 Prepaid Insurance is a deferred expense that needs to be adjusted each period for the amount used during the period.

The amount of expense is computed as follows: $3,600 x 3/24 = $450 used

Adjusting entry: Insurance expense (+E, −SE)..................................... 450

Prepaid insurance (−A) .................................... 450

Req. 2 Shipping Supplies is a deferred expense that needs to be adjusted at the end of the period for the amount of supplies used during the period.

The amount is computed as follows: Beginning balance $11,000 Supplies purchased 60,000

Supplies on hand at end (20,000) Supplies used $51,000

Adjusting entry: Shipping supplies expense (+E, −SE) ........................ 51,000

Shipping supplies (−A) ..................................... 51,000

Req. 3 Prepaid Insurance Insurance Expense

10/1 3,600 AJE 450 AJE 450

End. 3,150 End. 450

Shipping Supplies Shipping Supplies Expense Beg. 11,000 Purch. 60,000 AJE 51,000 AJE 51,000End. 20,000 End. 51,000

2011 Income statement: Insurance expense $ 450 Shipping supplies expense $51,000

Req. 4 2011 Balance sheet:

Prepaid insurance $ 3,150 Shipping supplies $20,000

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E4–5. Balance Sheet Income Statement

Transaction Assets Liabilities Stockholders’

Equity Revenues Expenses Net

Income E4–3 (a) NE +7,000 –7,000 NE +7,000 –7,000 E4–3 (b) +2,000 NE +2,000 +2,000 NE +2,000 E4–4 (a) –450 NE –450 NE +450 –450 E4–4 (b) –51,000 NE –51,000 NE +51,000 –51,000

E4–7.

Req. 1 a. b. c. d. e. f. g.

Accrued revenue Deferred expense Accrued expense Deferred revenue Deferred expense Deferred expense Accrued expense

Req. 2 a. Accounts receivable (+A) .............................

Service revenue (+R, +SE)................. 2,700

2,700

Computations Given

b. Advertising expense (+E, −SE)..................... Prepaid advertising (−A) .....................

900 900

$1,200 x 9/12 = $900 used

c. Interest expense (+E, −SE) .......................... Interest payable (+L) ..........................

5,0005,000

$250,000 x .12 x 2/12 (since last payment) = $5,000 incurred

d. Unearned storage revenue (−L) ................... Storage revenue (+R, +SE) ................

750 750

$4,500 x 1/6 = $750 earned

e. Depreciation expense (+E, −SE) .................. 22,000 Accumulated depreciation (+XA, −A) 22,000

Given

f. Supplies expense (+E, −SE)......................... 50,100 Supplies (−A) ...................................... 50,100

$16,500 + $46,000 – $12,400 = $50,100 used

g. Wages expense (+E, −SE) ........................... Wages payable (+L) ...........................

3,8003,800

Given

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E4–18.

Req. 1

(a) Insurance expense (+E, −SE) .................................... Prepaid insurance (−A) ....................................

4 4

(b) Wages expense (+E, −SE) ......................................... Wages payable (+L).........................................

5 5

(c) Depreciation expense (+E, −SE) ................................ Accumulated depreciation (+XA, −A) ...............

8 8

(d) Income tax expense (+E, −SE)................................... Income tax payable (+L) ..................................

9 9

Req. 2 RED RIVER COMPANY

Trial Balance December 31, 2011

(in thousands of dollars)

Unadjusted Adjustments Adjusted Account Titles Debit Credit Debit Credit Debit Credit Cash 35 35 Accounts receivable 9 9 Prepaid insurance 6 a 4 2 Machinery 80 80 Accumulated depreciation c 8 8 Accounts payable 9 9 Wages payable b 5 5 Income taxes payable d 9 9 Contributed capital 73 73 Retained earnings 4 4 Revenues (not detailed) 84 84 Expenses (not detailed) 32 a 4

c 8 b 5 d 9

58

Totals 166 166 26 26 188 188

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PROBLEMS

P4–1.

Req. 1 Dell Inc.

Adjusted Trial Balance At January 31, 2012

(in millions of dollars)

Debit Credit

Cash $ 8,352 Marketable securities 740 Accounts receivable 6,443 Inventories 867 Property, plant, and equipment Accumulated depreciation Other assets

4,510

7,821 $ 2,233

Accounts payable Accrued expenses payable Long-term debt Other liabilities

8,309 3,788 1,898 8,234

Contributed capital Retained earnings (deficit) Sales revenue

9,396 11,189

61,101 Other income 134 Cost of sales 50,144 Selling, general, and administrative expenses Research and development expense Income tax expense

Totals

7,102 665 846

$ 96,886 $ 96,886

Req. 2

Since debits are supposed to equal credits in a trial balance, the balance in Retained Earnings is determined as the amount in the debit column necessary to make debits equal credits (a “plugged” figure).

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P4–2.

Req. 1

a. Deferred revenue e. Deferred expense b. Accrued expense f. Accrued revenue c. Deferred expense g. Accrued expense d. Deferred revenue h. Accrued expense

Req. 2

a. Unearned rent revenue (−L)......................................... 5,600 Rent revenue (+R, +SE)..................................... 5,600 ($8,400 ÷ 6 months = $1,400 per month x 4 months)

b. Interest expense (+E, −SE) .......................................... 540 Interest payable (+L) ............................................ 540 ($18,000 x .12 x 3/12)

c. Depreciation expense (+E, −SE).................................. 2,500 Accumulated depreciation (+XA, −A) .................. 2,500

d. Unearned service revenue (−L).................................... 500 Service revenue (+R, +SE) ................................. 500 ($3,000 x 2/12)

e. Insurance expense (+E, −SE) ...................................... 1,500 Prepaid insurance (−A)...................................... 1,500

($9,000 ÷ 12 months = $750 per month x 2 months of coverage)

f. Accounts receivable (+A) ............................................. 4,000 Service revenue (+R, +SE) ................................ 4,000

g. Wage expense (+E, −SE)............................................. 14,000 Wages payable (+L) ........................................... 14,000

h. Property tax expense (+E, −SE)................................... 500 Property tax payable (+L)..................................... 500

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libby financial accounting chapter4

Documents

unadjusted trial balance

income tax payable

income tax expense

adjusted trial balance

balance sheet accounts

income statement accounts

future accounting period

trial balance