BAT 4M: Chapter 3 ANSWERS TO QUESTIONS

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1 BAT 4M: Chapter 3 ANSWERS TO QUESTIONS 01. (a) Under the time period assumption, an accountant is required to determine the relevance of each business transaction to specific accounting periods, and its effects on those periods. (b) An accounting time period of one year in length is referred to as a fiscal year. A fiscal year that extends from January 1 to December 31 is referred to as a calendar year. Accounting periods of less than one year are called interim periods. 2. The two generally accepted accounting principles that pertain to adjusting the accounts are: 1. The revenue recognition principle, which states that revenue should be recognized in the time period in which it is earned. 2. The matching principle, which states that efforts (expenses) should be matched with accomplishments (revenues). 03. The law firm should recognize the revenue in April. The revenue recognition principle states that revenue should be recognized in the accounting period in which it is earned (i.e., when the work is done). 04. Expenses of $4,500 ($2,000 + $2,500) should be deducted from the revenues in April. Under the matching principle, efforts (expenses) should be matched with accomplishments (revenues). 05. Information presented on an accrual basis is useful because it reveals relationships that are likely to be important in predicting future results. To illustrate, under accrual accounting, revenues are recognized when earned so they can be related to the economic environment in which they occur. Trends in revenues are thus more meaningful. 06. The balance in total owner s equity should not equal the balance in the cash account. Owner s equity reflects the net amount the owners have invested in the company, which comprises total assets not just cash net of liabilities. 3-1

2 Questions Chapter 3 (Continued) 07. No, adjusting entries are required by the revenue recognition and matching principles. 08. A trial balance may not contain up-to-date information for financial statements because: 1. Some events are not journalized daily because it is unnecessary and inefficient to do so. 2. The expiration of some costs occurs with the passage of time rather than as a result of recurring daily transactions. 3. Some items may be unrecorded because the transaction data are not known. 09. The three categories of adjusting entries are prepayments, accruals, and estimates. Prepayments consist of transactions in which the cash is exchanged in advance resulting in prepaid expenses and unearned revenues. Accruals consist of transactions in which the cash will be exchanged later, resulting in accrued revenues and accrued expenses. Because we don t always know what will happen in the future, estimates are required. One example of an estimate is the allocation of the cost of a capital asset over its estimated useful life. 10. If the original purchase was recorded as an asset, then in the adjusting entry expenses are debited (to increase them) and assets are credited (to decrease them). 11. In the adjusting entry, liabilities are debited (to decrease them) and revenues are credited (to increase them). 12. It may have credited unearned revenue or accounts receivable. 13. Asset and revenue. An asset (a receivable) is debited and revenue is credited. 14. Utilities Expense is debited and Accounts Payable (a liability) is credited. 3-2

3 Questions Chapter 3 (Continued) 15. On the income statement, net income was understated $300. Prior to adjustment, revenues are understated by $900 and expenses are understated by $600. The impact on net income is $300 ($900 $600). On the balance sheet, accounts receivable are understated by $900, accounts payable are understated by $600, and owner s equity understated by $300 (see net income). 16. The entry is: Jan. 9 Salaries Payable... 1,700 Salaries Expense... 3,300 Cash... 5, (a) Accrued revenues. (b) Unearned revenues. (c) Accrued expenses. (d) Accrued expenses, prepaid expenses, or estimates (amortization). (e) Prepaid expenses or estimates (amortization). (f) Accrued revenues or unearned revenues. 18. No. Amortization is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. Amortization results in the presentation of the book value of the asset, not its market value. 19. Amortization expense is an expense account whose normal balance is a debit. This account shows the cost that has expired during the current accounting period. Accumulated amortization is a contra asset account whose normal balance is a credit. The balance in this account is the total of all the amortization that has been recognized from the date of acquisition to the balance sheet date. *20. Equipment... $12,000 Less: Accumulated amortization... 7,000 Net book value... 5,

4 Questions Chapter 3 (Continued) 21. (a) Salaries Payable is credited. (b) Accumulated Amortization is credited. (c) Interest Expense is debited. (d) Supplies Expense is debited. (e) Service Revenue is credited. (f) Service Revenue is credited. 22. Disagree. An adjusting entry affects only one balance sheet account and one income statement account. 23. Financial statements can be prepared from an adjusted trial balance because the balances of all accounts have been adjusted to show the effects of all financial events that have occurred during the accounting period. *24. For Supplies Expense: expenses are overstated and assets (prepaid expense) are understated. The adjusting entry is: Assets (Supplies)... Expenses (Supplies Expense)... XX XX For Rent Revenue: revenues are overstated and liabilities (unearned revenues) are understated. The adjusting entry is: Revenues (Rent Revenue)... Liabilities (Unearned Rent)... XX XX 3-4

5 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE Prepaid Insurance to recognize insurance expired (expenses) during the period. 2. Accumulated Amortization to allocate the cost of the capital asset to expense over the period it benefits. 3. Unearned Revenue to account for Unearned Revenue received in advance that was earned (revenues) during the period. 4. Interest Payable to recognize interest expense accrued but unpaid on notes payable. 5. Rent Receivable to recognize rent earned (revenues) but not yet collected. BRIEF EXERCISE 3-2 Dec. 31 Advertising Supplies Expense... 7,200 Advertising Supplies... 7,200 Advertising Supplies Advertising Supplies Expense 12/31 8,700 12/31 7,200 12/31 7,200 Balance 1,

6 BRIEF EXERCISE 3-3 July 1 Prepaid Insurance... 10,000 Cash... 10,000 Dec. 31 Insurance Expense ($10,000 x 6/24 mos.).. 2,500 Prepaid Insurance... 2,500 Cash 7/1 10,000 Prepaid Insurance Insurance Expense 7/1 10,000 12/31 2,500 12/31 2,500 12/31 Bal. 7,500 BRIEF EXERCISE 3-4 July 1 Cash... 10,000 Unearned Insurance Revenue... 10,000 Dec. 31 Unearned Insurance Revenue... 2,500 Insurance Revenue ($10,000 x 6/24 mos.)... 2,500 Cash 7/1 10,000 Unearned Insurance Revenue Insurance Revenue 12/31 2,500 7/1 10,000 12/31 2,500 12/31 Bal. 7,

7 BRIEF EXERCISE Dec. 31 Interest Receivable Interest Revenue Accounts Receivable... 1,400 Service Revenue... 1, Salaries Expense Salaries Payable BRIEF EXERCISE 3-6 Dec. 31 Amortization Expense Equipment... 5,000 Accumulated Amortization Equipment... 5,000 Amortization Expense Equipment Accum. Amortization Equipment 12/31 5,000 12/31 5,000 TAI WOO COMPANY Balance Sheet (Partial) December 31 Capital assets Equipment... $25,000 Less: Accumulated amortization ,000 $20,

8 BRIEF EXERCISE 3-7 Transaction Cash Net Income (a) Purchased supplies on hand for cash -$100 $ 0 (b) Recorded the use of supplies 0-50 (c) Performed services on account 0 +1,000 (d) Received from customers payment of their account (e) Purchased office equipment for cash (f) Recorded amortization of office equipment 0-50 BRIEF EXERCISE 3-8 (a) Type of Adjustment Account Relationship (b) Status of Accounts Before Adjustment 1. Prepaid Expenses Assets and Expenses Assets (Supplies) Overstated Expenses (Supplies Expense) Understated 2. Accrued Revenues Assets and Revenues Assets (Accounts Receivable) Understated Revenues (Service Revenue) Understated 3. Accrued Expenses Expenses and Liabilities Expenses (Interest Expense) Understated Liabilities (Interest Payable) Understated 4. Unearned Revenues Liabilities and Revenues Liabilities (Unearned Rent) Overstated Revenues (Rent Earned) Understated 5. Amortization Expenses and Assets (contra account) Expenses (Amortization Expense) Understated Assets (Capital Assets) Overstated 3-8

9 BRIEF EXERCISE 3-9 Account Accounts Receivable Prepaid Insurance Equipment Supplies Interest Payable Unearned Service Revenue Interest Receivable Rent Payable (a) Type of Adjustment Accrued Revenues Prepaid Expenses Estimates Prepaid Expenses Accrued Expenses Unearned Revenues Accrued Revenues Accrued Expenses (b) Related Account Service Revenue Insurance Expense Amortization Expense/Accum. Amortization Supplies Expense Interest Expense Revenue Earned Interest Revenue Rent Expense BRIEF EXERCISE 3-10 KLAR COMPANY Income Statement For the Year Ended December 31, 2003 Revenues Service revenue... $38,400 Expenses Salaries expense... $13,000 Rent expense... 4,000 Insurance expense... 2,000 Amortization expense ,000 Supplies expense Total expenses ,500 Net income... $17,

10 BRIEF EXERCISE 3-11 KLAR COMPANY Statement of Owner's Equity For the Year Ended December 31, 2003 S. Klar, Capital, January 1... $15,600 Add: Net income ,900 33,500 Less: Drawings ,000 S. Klar, Capital, December $27,500 *BRIEF EXERCISE 3-12 (a) Dec. 31 Advertising Supplies... 1,500 Advertising Supplies Expense... 1,500 Advertising Supplies Advertising Supplies Expense 12/31 1,500 12/31 8,700 12/31 1,500 12/31 Bal. 7,200 (b) The adjusted balances are the same. It does not matter whether the original entry is recorded to an asset or an expenses account as long as the adjustment is done correctly. 3-10

11 *BRIEF EXERCISE 3-13 (a) May 1 Cash Unearned Rental Revenue May 31 Unearned Rental Revenue Rental Revenue (b) May 1 Cash Rental Revenue May 31 No adjustment required (c) The ending balances are the same under either alternative. 3-11

12 SOLUTIONS TO EXERCISES EXERCISE 3-1 (a) Accrual basis accounting records the events that change an entity s financial statements in the periods in which the events occur, rather than in the periods in which the entity receives or pays cash. That is, revenue is recognized when it is earned. Expenses are recognized when services or goods are used or consumed in the production of revenue. Information presented on an accrual basis is useful because it reveals relationships that are likely to be important in predicting future results. Conversely, under the cash basis of accounting, revenue is recorded only when cash is received, and an expense is recognized only when cash is paid. As a result, the cash basis of accounting often leads to misleading financial statements. (b) (c) The government is not using either the cash or accrual basis of accounting. It is using some other basis that is not a generally accepted accounting policy. The government may believe it is appropriate because the commitment to spend the funds has been made. Dear Member of Parliament, It is my understanding that the Federal government is making changes in the method of accounting it uses and is switching from the cash basis of accounting to the accrual basis. I understand in 2001 accrual accounting is fully in use. The government is to be commended for this change. The use of full accrual accounting will provide a more accurate reflection of the true costs of services that government provides and a more complete reflection of its assets and liabilities. This will result in improved information for decision makers and citizens. Sincerely, ACCOUNTING STUDENT 3-12

13 EXERCISE 3-2 (a) Cash Accrual Revenue $22,000 $26,000 Expenses Operating 13,500 15,000 Insurance 2, Net income $ 6,000 $ 11,000 (b) The accrual basis provides the most useful information for decision making as it reflects transactions in the period in which they occur and properly matches revenue and expenses. EXERCISE 3-3 (a) 1. Prepaid Rent... 20,000 Cash... 20,000 To record payment of rent for January 1- May 31, Security Deposit... 5,000 Cash... 5,000 To record payment of security deposit. 3. Prepaid Rent... 30,000 Cash... 30,000 To record payment of rent for June 1- November 30, No entry required. (b) Rent Expense... 55,000 Prepaid Rent... 50,000 Rent Payable... 5,000 See (c) for calculations. 3-13

14 EXERCISE 3-3 (Continued) (c) Rent expense: $20,000 January 1 May 31 ($4,000 x 5 mos.) 30,000 June 1 November 30 ($5,000 x 6 mos.) 5,000 December 1 December 31 ($5,000 x 1 mos. accrual) $55,000 (d) Balance sheet amounts with respect to rent: Assets Security deposit, $5,000 Liabilities Rent payable, $5,000 (for the month of December) 3-14

15 EXERCISE 3-4 (a) July 10 Supplies Cash Cash... 3,000 Service Revenue... 3, Salaries Expense... 1,200 Cash... 1, Cash Unearned Service Revenue (b) July 31 Supplies Expense Supplies Accounts Receivable Service Revenue Salaries Expense... 1,200 Salaries Payable... 1, Unearned Service Revenue Service Revenue

16 EXERCISE 3-5 Answer Calculation (a) Supplies balance = $800 Supplies expense $950) Add: Supplies (1/31/03) 700) Less: Supplies purchased (850) Supplies (12/31/02) $800) (b) Total premium = $4,800 Purchase date = Aug. 1, 2002 Total premium = Monthly premium X 12; $400 X 12 = $4,800 Purchase date: On Jan. 31, there are 6 months coverage remaining ($400 X 6). Thus, the purchase date was 6 months earlier on Aug. 1, (c) Salaries payable = $1,500 Cash paid $2,500 Salaries payable (1/31/03) 800 3,300 Less: Salaries expense 1,800 Salaries payable (12/31/02) $1,500 (d) Unearned revenue = $1,150 Service revenue $2,000 Unearned revenue (1/31/03) 750 2,750 Cash received in Jan. 1,600 Unearned revenue (12/31/02) $1,

17 EXERCISE 3-6 Item (a) Type of Adjustment Accrued Revenues Prepaid Expenses Accrued Expenses Unearned Revenues Accrued Expenses Prepaid Expenses Amortization (b) Accounts Before Adjustment Assets (Accounts Receivable) Understated Revenues (Service Revenue) Understated Assets (Store Supplies) Overstated Expenses (Store Supplies Expenses) Understated Expenses (Utility Expense) Understated Liabilities (Accounts Payable) Understated Liabilities (Unearned Service Revenue) Overstated Revenues (Service Revenue) Understated Expenses (Salaries Expense) Understated Liabilities (Salaries Payable) Understated Assets (Prepaid Insurance) Overstated Expenses (Insurance Expense) Understated Assets (Capital Assets) Overstated Expenses (Amortization Expense) Understated 3-17

18 EXERCISE Mar. 31 Amortization Expense ($400 3)... 1,200 Accumulated Amortization Equipment... 1, Unearned Rent Revenue... 3,100 Rent Revenue ($9,300 1/3)... 3, Interest Expense Interest Payable Supplies Expense... 1,950 Supplies ($2,800 $850)... 1, Insurance Expense ($300 3) Prepaid Insurance EXERCISE Jan. 31 Accounts Receivable Service Revenue Utilities Expense Utilities Payable Amortization Expense... 1,000 Accumulated Amortization Dental Equipment... 1, Interest Expense Interest Payable Insurance Expense ($12,000 12)... 1,000 Prepaid Insurance... 1, Supplies Expense ($1,600 $500)... 1,100 Supplies... 1,

19 EXERCISE Oct. 31 Advertising Supplies Expense... 1,100 Advertising Supplies ($2,500 $1,400).. 1, Insurance Expense Prepaid Insurance Amortization Expense Accumulated Amortization Office Equipment Unearned Service Revenue Service Revenue Accounts Receivable Service Revenue Interest Expense Interest Payable Salaries Expense... 1,500 Salaries Payable... 1,

20 EXERCISE 3-10 Aug. 31 Accounts Receivable Service Revenue Office Supplies Expense... 1,600 Office Supplies... 1, Insurance Expense... 1,500 Prepaid Insurance... 1, Amortization Expense... 1,200 Accumulated Amortization Office Equipment... 1, Salaries Expense... 1,100 Salaries Payable... 1, Unearned Rent Revenue Rent Revenue

21 EXERCISE 3-11 (a) July 31 Insurance Expense Prepaid Insurance Supplies Supplies Expense Amortization Expense Accumulated Amortization Equipment Wages Expense Wages Payable Accounts Receivable Service Revenue (b) VIRMANI CO. Income Statement For the Month Ended July 31, 2003 Revenues Service revenue ($5,500 + $900)... $6,400 Expenses Wages expense ($2,300 + $300)... $2,600 Supplies expense ($1,200 $500) Utilities expense Insurance expense Amortization expense... 0,150 Total expenses... 04,350 Net income... $2,

22 EXERCISE 3-12 LIM COMPANY Income Statement For the Year Ended August 31, 2003 Revenues Service revenue... $34,600 Rent revenue ,800 Total revenues... 46,400 Expenses Salaries expense... $18,100 Rent expense... 15,000 Office supplies expense... 1,600 Insurance expense... 1,500 Amortization expense... 01,200 Total expenses ,400 Net income... $ 9,000 LIM COMPANY Statement of Owner's Equity For the Year Ended August 31, 2003 E. Lim, Capital, August 1, $15,600 Add: Net income ,000 E. Lim, Capital, August 31, $24,

23 EXERCISE 3-12 (Continued) LIM COMPANY Balance Sheet August 31, 2003 Assets Cash... $10,400 Accounts receivable... 9,400 Office supplies Prepaid insurance... 2,500 Office equipment... $14,000 Less: Accumulated amortization office equipment , ,200 Total assets... $32,200 Liabilities and Owner's Equity Liabilities Accounts payable... $05,800 Salaries payable... 1,100 Unearned rent revenue Total liabilities... 7,600 Owner's equity E. Lim, Capital ,600 Total liabilities and owner's equity... $32,

24 *EXERCISE 3-13 (a) Jan. 02 Insurance Expense... 2,400 Cash... 2, Supplies Expense... 1,700 Cash... 1, Cash... 5,100 Service Revenue... 5,100 Insurance Expense 1/2 2,400 1/10 1,700 Supplies Expense Cash 1/15 5,100 1/2 2,400 1/10 1,700 Service Revenue 1/15 5,100 (b) Jan. 31 Prepaid Insurance ($ months)... 2,200 Insurance Expense... 2, Supplies Supplies Expense Service Revenue... 3,600 Unearned Service Revenue... 3,

25 *EXERCISE 3-13 (Continued) (b) (Continued) Cash Service Revenue 1/15 5,100 1/2 2,400 1/31 3,600 1/15 5,100 1/10 1,700 Bal. 1,000 Bal. 1,500 Insurance Expense Supplies Expense 1/2 2,400 1/31 2,200 1/10 1,700 1/ Bal. 200 Bal. 900 Prepaid Insurance Supplies Unearned Service Revenue 1/31 2,200 1/ /31 3,600 (c) Cash... $1,000 Prepaid insurance... 2,200 Supplies Unearned service revenue... 3,600 Service revenue... 1,500 Insurance expense Supplies expense

26 SOLUTIONS TO PROBLEMS PROBLEM 3-1A 3 (a) Record interest on note payable. 4 (b) Record interest on note receivable. 5 (c) Allocate cost of capital asset over its useful life. 4 (d) Record revenue that has been earned but not billed or collected. 2 (e) Record revenue that has been earned that was previously received in advance. (f) Record hiring of employees. 3 (g) Record salaries owed. 1 (h) Record supplies used. 3-26

27 PROBLEM 3-2A 1. Jan. 1 Office Supplies... 4,500 Cash... 4,500 Dec. 31 Supplies Expense ($4,500 $900)... 3,600 Office Supplies... 3, Sept. 1 Prepaid Insurance... 3,600 Cash... 3,600 Dec. 31 Insurance Expense ($3, x 4)... 1,200 Prepaid Insurance... 1, Nov. 15 Cash... 1,200 Unearned Service Revenue... 1,200 Dec. 31 Unearned Service Revenue... 1,200 Service Revenue... 1, Dec. 15 Cash Unearned Rent Revenue Dec. 31 Unearned Rent Revenue ($460 2) Rent Revenue

28 PROBLEM 3-3A Students may find this to be a fairly challenging problem, so here are a few points that should help: Under the CASH BASIS, revenues are recorded when they are collected (received in cash), even if they were earned (the sale was made) earlier; Under the ACCRUAL BASIS of accounting, revenues are recorded when they are earned (the sale is made) even if the cash is not collected until later, or is received prior to the revenue being earned. Under the CASH BASIS, expenses are recorded when the cash is paid out; and Under the ACCRUAL BASIS of accounting, expenses are recorded when the cost has expired or been used up, which is not always in the same time period as when the cash is paid out. For example, Under the CASH BASIS, Supplies are recorded as expenses as soon as they are purchased and paid for; Under the ACCRUAL BASIS of accounting, Supplies are not recorded as expenses until they have been used up. While the supplies are still on hand, they are recorded as assets because they have future benefits; Under the CASH BASIS, amounts such as Unpaid Wages Owing at the end of 2002 would not be considered expenses until they are actually paid out in 2003; and Under the ACCRUAL BASIS of accounting, Unpaid Wages Owing at the end of 2002 would be considered expenses in 2002, because the cost was incurred or used up during 2002 even though the cash will not be paid out until

29 PROBLEM 3-3A (Continued) $35,190 Cash basis income +3,400 Accounts Receivable arise from sales that have been made, thus revenue must be recognized. -2,500 Accounts Receivable collected in 2003 from sales that were made (and revenue that was earned) in ,300 Supplies are not recorded as expenses until used up). -1,160 Supplies from 2002 that were used up (and an expense incurred) in ,200 Which is an expense because the cost was incurred during ,400 For 2002 wages expense that were paid in ,440 Which is an expense because the cost was incurred during ,600 For 2002 expenses that were paid in cash in $37,590 Accrual basis income 3-29

30 PROBLEM 3-4A (a) 1. Cash... 9,000 Fees Receivable... 9, Unearned Fees Revenue... 22,000 Fees Revenue... 22, Cash... 30,000 Unearned Fees Revenue... 30,000 Unearned Fees Revenue ($30,000 $17,000)... 13,000 Fees Revenue... 13, Fees Receivable ,000 Fees Revenue ($153,000 $22,000 $13,000) 118, Cash ,000 Fees Receivable ($118,000 $12,000) ,000 (b) Cash received with respect to fees = $9,000 + $106,000 + $30,000 = $145,000 T accounts (not required) Fees Receivable 9,000 (4) 118,000 (1) 9,000 (5) 106,000 12,000 Fees Revenue (2) 22,000 (3) 13,000 (4) 118, ,000 (3) 13,000 Cash (1) 9,000 (3) 30,000 (5) 106, ,000 17,000 Unearned Fees Revenue 22,000 (2) 22,000 (3) 30,

31 PROBLEM 3-5A 1. (a) July 1 Office Supplies... 1,560 Cash... 1,560 (b) Dec. 31 Supplies Expense ($1,560 + $640 $740) 1,460 Office Supplies... 1, (a) Jan. 1 Cash... 10,000 Note Payable... 10,000 (b) Dec. 31 Interest Expense Interest Payable ($10,000 X 6%) (b) Dec. 31 Telephone Expense Accounts Payable (a) Jan. 1 Truck... 18,000 Cash... 18,000 (b) Dec. 31 Amortization Expense... 3,600 Accumulated Amortization Truck... 3, (a) Dec. 26 Wages Expense... 3,000 Cash... 3,000 (b) Dec. 31 Wages Expense... 1,800 Wages Payable ($3,000 5 x 3)... 1,800 Note to Instructors: The January 3, 2003 journal entry follows for information: Jan. 3 Wages Expense... 1,200 Wages Payable... 1,800 Cash... 3,

32 PROBLEM 3-6A 1. Dec. 31 Advertising Expense... 5,200 Prepaid Advertising... 5,200 A650 $6,000 / 12 = $500 per month for 8 months = $4,000 B974 $7,200 / 24 = $300 per month for 4 months = 0 1,200 $5, Dec. 31 Unearned Rent Revenue ,000 Rent Revenue ,000 5 $4,000 2 = $ 40,000 4 $8,500 2 = 68,000 Total rent earned $108,000 Note that the $369,000 balance in Unearned Rent Revenue includes the security deposits. 3. Dec. 31 Interest Expense... 3,733 Interest Payable... 3,733 $80,000 8% 7/12 mos. = $3, Dec. 31 Salaries Expense... 2,000 Salaries Payable... 2,000 5 x $700 x 2/5 days = $1,400 3 x $500 x 2/5 days = 600 Total $2,

33 PROBLEM 3-2B 1. Jan. 1 Office Supplies... 2,800 Cash... 2,800 Dec. 31 Supplies Expense ($2,800 $500)... 2,300 Office Supplies... 2, Aug. 1 Prepaid Insurance... 3,600 Cash... 3,600 Dec. 31 Insurance Expense ($3, x 5)... 1,500 Prepaid Insurance... 1, Nov. 15 Cash... 1,200 Unearned Service Revenue... 1,200 Dec. 31 Unearned Service Revenue ($400 x 2) Service Revenue Dec. 15 Prepaid Rent... 4,500 Cash... 4,500 Dec. 31 No entry required 3-33

34 BYP 3-5 COLLABORATIVE LEARNING ACTIVITY (a) RV WORLD Income Statement For the Quarter Ended March 31, 2003 Revenues Rental fees ($95,000 $30,000)... $65,000 Expenses Wages expense [$29,800 + ($400 2)]... $30,600 Advertising expense ($5,200 + $110)... 5,310 Supplies expense ($5,200 $1,300)... 3,900 Repair expense ($4,000 + $260)... 4,260 Insurance expense ($7,200 3/12)... 1,800 Utilities expense ($900 + $180)... 1,080 Amortization expense Interest expense ($12,000 8% 3/12)... 00,240 Total expenses ,990 Net income... $17,010 (b) (1) The generally accepted accounting principles pertaining to the income statement that were not recognized by Michel were the revenue recognition principle and the matching principle. The revenue recognition principle states that revenue is recognized when it is earned. The fees of $30,000 for summer rentals have not been earned and, therefore, should not be reported in income for the quarter ended March 31. The matching principle dictates that efforts (expenses) be matched with accomplishments (revenues). This means that the expenses should include amounts incurred in March but not paid until April, and any other costs related to the operations of the business during the period January March. (2) The difference in expenses was $7,290 ($47,990 $40,700). The overstatement of revenues ($30,000) plus the understatement of expenses ($7,290) equals the difference in reported income of $37,290 ($54,300 $17,010). 3-34

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