Module 3: Adjusting the accounts, preparing the statements, and completing the accounting cycle

Transcription

1 Course Schedule Course Modules Review and Practice Exam Preparation Resources Module 3: Adjusting the accounts, preparing the statements, and completing the accounting cycle Overview In Module 2 you studied the fundamental steps in recording accounting information by preparing the trial balance. This module takes you through the additional steps required to prepare proper financial statements and to complete the accounting cycle. You should focus on both the how and the why as you study each step. It is important to have a thorough understanding of this module and Module 2 as these two modules provide a foundation for the remainder of the course. Test your knowledge Begin your work on this module with a set of test-your-knowledge questions designed to help you gauge the depth of study required. Learning objectives 3.1 GAAP and the need for adjustments Explain the need for financial statements and account adjustments at the end of regular accounting periods, and the purpose of the accrual basis of accounting. (Level 1) 3.2 Adjusting the accounts Prepare adjusting entries for prepaid expenses, depreciation, unearned revenues, accrued expenses, and accrued revenues. (Level 1) 3.3 Adjusted trial balance and preparation of financial statements Prepare an adjusted trial balance and use it to prepare financial statements. (Level 1) 3.4 The work sheet Prepare financial statements for a service business from the information in a work sheet. (Level 2) 3.5 Closing entries Prepare closing entries for a service business. (Level 1) 3.6 Post-closing trial balance Prepare a post-closing trial balance. (Level 1) 3.7 The accounting cycle Review the steps in the accounting cycle. (Level 1) 3.8 Classification of balance sheet items Prepare a classified balance sheet. (Level 1) 3.9 Using the information Current ratio Calculate the current ratio and interpret and apply this ratio in decision-making scenarios. (Level 2) Module summary Print this module FA1 - Module 3 Page 1 of 71

2 Assignment reminder: Assignment #1 (see Module 5) is due at the end of week 5 (see Course Schedule). You may wish to take a look at it now in order to familiarize yourself with the requirements and to prepare for any necessary work in advance. FA1 - Module 3 Page 2 of 71

3 Course Schedule Course Modules Review and Practice Exam Preparation Resources Module 3 Test your knowledge a. If an accountant forgot to record depreciation on office equipment at the end of an accounting period, which of the following would be true regarding the statements prepared at that time? 1. The assets are overstated and owner s equity is understated. 2. The assets and owner s equity are both understated. 3. The assets are overstated, net income is understated, and owner s equity is overstated. 4. The assets, net income, and owner s equity are overstated. b. The Crimson Cartage Company purchased a new truck at a cost of $42,000 on July 1, 20X1. The truck is estimated to have a useful life of six years and a salvage value of $6,000. How much depreciation expense will be recorded for the truck during the year ended December 31, 20X1, assuming the straight-line method? 1. $3, $3, $4, $6,000 c. If accrued salaries were recorded on December 31 with a credit to Salaries payable, what would the entry to record payment of these salaries on January 5 include? 1. A debit to Cash and a credit to Salaries payable 2. A debit to Cash and a credit to Prepaid salaries 3. A debit to Salaries payable and a credit to Cash 4. A debit to Salaries payable and a credit to Salaries expense d. On the worksheet, the income statement debit column shows a total of $56,500. The income statement credit column total is $52,500. What is the net income or net loss? 1. The net loss of this business is $3, The net loss of this business is $4, The net income of this business is $4, The net income of this business is $5,000. e. An error is indicated if which of the following accounts has a balance appearing on the postclosing trial balance? 1. Office equipment 2. Accumulated depreciation, office equipment 3. Depreciation expense, office equipment 4. Ted Nash, capital FA1 - Module 3 Page 3 of 71

4 Solutions FA1 - Module 3 Page 4 of 71

5 Course Schedule Course Modules Review and Practice Exam Preparation Resources Module 3 Test your knowledge solutions a. 1. Incorrect. The entry to record depreciation includes a debit to an expense account. If this debit is not recorded, then net income on the income statement will be overstated (too high). If net income is overstated, then, on the balance sheet, equity is also overstated since net income affects equity. If the credit entry to Accumulated depreciation is not recorded, assets will be overstated on the balance sheet. 2. Incorrect. The entry to record depreciation includes a debit to an expense account. If this debit is not recorded, then net income on the income statement will be overstated (too high). If net income is overstated, then, on the balance sheet, equity is also overstated since net income affects equity. If the credit entry to Accumulated depreciation is not recorded, assets will be overstated on the balance sheet. 3. Incorrect. The entry to record depreciation includes a debit to an expense account. If this debit is not recorded, then net income on the income statement will be overstated (too high). If net income is overstated, then, on the balance sheet, equity is also overstated since net income affects equity. If the credit entry to Accumulated depreciation is not recorded, assets will be overstated on the balance sheet. 4. Correct. The entry to record depreciation includes a debit to an expense account. If this debit is not recorded, then net income on the income statement will be overstated (too high). If net income is overstated, then, on the balance sheet, equity is also overstated since net income affects equity. If the credit entry to Accumulated depreciation is not recorded, assets will be overstated on the balance sheet. b. 1. Correct. ($42,000 $6,000) 6 years = $6,000 per year. $3,000 of depreciation expense will be recorded for the truck during the year ended December 31, 20X1, because the truck was purchased on July 1, 20X1, resulting in a partial period of depreciation ($6,000 per year 6/12 = $3,000). 2. Incorrect. $42,000 6 years 6/12 = $3,500; this calculation neglected to account for the salvage value. 3. Incorrect. Salvage value is subtracted and not added to determine the net cost of the asset that must be amortized. 4. Incorrect. $6,000 represents depreciation for a full year; depreciation needs to be recorded from July 1 to December 31, which is six months. c. 1. Incorrect. A debit to Cash means cash is being received, which is not correct. A credit to Salaries payable implies salaries are being accrued; salaries are actually being paid on January 5, not accrued. FA1 - Module 3 Page 5 of 71

6 2. Incorrect. A debit to Cash means cash is being received, which is not correct. A credit to Prepaid salaries implies an asset is decreasing; the only asset decreasing on January 5 is Cash. 3. Correct. The full entry on January 5 would be: Salaries payable... XX Salaries expense... XX Cash... XX 4. Incorrect. A debit to Salaries payable is correct. However, the credit to Salaries expense means expenses are being reduced, which is incorrect. d. 1. Incorrect. The difference between income statement columns on the worksheet is a net loss because expenses (debits) are greater than revenues (credits). However, the loss is equal to the difference of $4, Correct. The net loss of this business is $4,000, calculated as $56,500 less $52,500. Since the debits (expenses) are greater than the credits (revenues), the $4,000 difference represents a net loss. 3. Incorrect. The credit column of the income statement represents revenues and the debit column is expenses; therefore, since revenues are less than expenses, the difference of $4,000 cannot be a net income. 4. Incorrect. The credit column of the income statement represents revenues and the debit column is expenses; therefore, since revenues are less than expenses, the difference cannot be a net income. Moreover, the difference is $4,000. e. 1. Incorrect. Office equipment is an asset account. The post-closing trial balance includes assets because they are permanent accounts. 2. Incorrect. Accumulated depreciation, office equipment, is a contra-asset account. The post-closing trial balance includes contra-assets because they are permanent accounts. 3. Correct. Depreciation expense, office equipment, should not be included on the post-closing trial balance because expenses are temporary accounts, which are closed into Capital. If Depreciation expense, office equipment, appears on the postclosing trial balance, then it was not closed properly during the closing process. 4. Incorrect. Ted Nash, capital, is an equity account, which is a permanent account included on the post-closing trial balance. FA1 - Module 3 Page 6 of 71

7 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.1 GAAP and the need for adjustments Learning objective Explain the need for financial statements and account adjustments at the end of regular accounting periods, and the purpose of the accrual basis of accounting. (Level 1) Required reading LEVEL 1 Chapter 4, pages Net income over the entire life of a business is relatively easy to measure. If you started a painting business in May and dissolved it in August, for example, net income would be the difference between the revenues collected and the expenses paid out. Most businesses, however, operate over many years. In fact, the goingconcern principle assumes that a business will continue for an indefinite period. This leads to the need for information about the business resources and its performance during specific periods. The timeliness principle The life of a business is arbitrarily divided into time periods of equal lengths called accounting periods to ensure that the users of financial statements receive timely information. The application of the timeliness principle normally results in financial statements being prepared on an annual basis. Most businesses choose to prepare interim financial reports on a monthly or quarterly basis as well so they can monitor their performance on an ongoing basis. Revenue recognition and matching principles The revenue recognition and matching principles introduced in Module 1 should also be considered. At the end of an accounting period, organizations must ensure that all revenue is recognized and that all expenses are matched to the revenues they helped to earn. Need for adjustments at the end of an accounting period Due to the passage of time and the manner in which a business recognizes revenues and matches expenses with revenues in the normal course, the balances of some accounts appearing on the unadjusted trial balance presented in Module 2 may not be current. Adjusting entries are required to bring a firm s records up-to-date so that its financial statements fairly represent its economic activity. Textbook activities Checkpoint Questions 1 to 4 on page 134 (Solutions on page 151) Quick Study 4-1 and 4-2 on page 161 (Solutions) FA1 - Module 3 Page 7 of 71

8 Quick Study The timeliness principle has been violated since businesses must report at regular intervals which is normally in 1 year intervals or less. 2. The matching principle has been violated because the supplies purchased on September 30 will probably not have been used entirely on that date. Warren has not accurately matched the expense of using the supplies to the accounting period in which they were/will be used. 3. The revenue recognition principle has been violated. Although Mindy has collected the cash it is not a revenue until it has been earned. The $3,000 will not begin to be earned until June 1 therefore it should not be recorded as a revenue on May 3. Therefore, the $3,000 should be recorded as a liability (i.e., unearned revenue). 4. The matching principle has been violated. TelsCo has rented the equipment therefore an expense has been incurred although cash will not be paid until sometime in the future. Quick Study 4-2 Cash basis: Revenues (cash receipts)... $33,000 Expenses (cash payments) ($22,500 $2,250 + $3,750)... 24,000 Net income... $ 9,000 Accrual basis: Revenues (earned)... $39,000 Expenses (incurred)... 22,500 Net income... $16,500 FA1 - Module 3 Page 8 of 71

9 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.2 Adjusting the accounts Learning objective Prepare adjusting entries for prepaid expenses, depreciation, unearned revenues, accrued expenses, and accrued revenues. (Level 1) Required reading LEVEL 1 Chapter 4, pages Appendix 4B, pages Five types of adjustments are presented in the text prepaid expenses, depreciation, unearned revenues, accrued expenses, and accrued revenues. Each adjustment affects both the balance sheet and income statement. It is important that you master these adjustments, so work through the examples in this topic and those in the text carefully. Prepaid expenses A prepaid expense is an economic benefit that has been paid for in advance of its use. There are two methods of recording prepaid expenses. The first, which is covered in Chapter 4, is the asset method. The concept behind the asset method is that the related expenditures are initially recorded as an asset and then subsequently charged to expense as the asset is consumed. This is the method that you are most likely to see in practice. Some companies, however, initially record all prepayments as expenses. If there is any asset remaining at the end of the accounting period, then an adjusting entry is recorded. This manner of treatment is known as the expense method, which is covered in Appendix 4B on pages Note that the asset recorded on your balance sheet and the amount charged to expense for the period will be the same, irrespective of the method chosen. You can see this illustrated on pages in Appendix 4B. This outcome serves to highlight an important point. Specifically, on a day-to-day basis, a company can record entries in any manner it chooses, as GAAP do not specify a firm's method of bookkeeping. In preparing the year-end financial statements, however, a company must prepare the necessary adjustments to ensure that they comply with GAAP. Textbook activities Depreciation Checkpoint Question 5 on page 136 (Solution on page 151) Quick Study 4-3 on page 161 (Solution) Depreciation is an accounting term used in conjunction with the process of assigning the cost of plant and equipment assets (for example, equipment and buildings) to the periods that they contribute to the firm s revenues. It is important to note that depreciation is a method of cost allocation, not asset valuation. A plant and equipment asset whose market value is increasing is still depreciated because while the asset generates FA1 - Module 3 Page 9 of 71

10 revenues, it gradually wears out. (An exception is land, which is never depreciated because it lasts forever.) To match the expense of the asset to the revenues it is generating, the cost of the asset must be spread over its useful life as an expense. Textbook activities Judgement Call on page 138 (solution on page 151) Checkpoint Questions 6 and 7 on page 138 (Solutions on page 151) Quick Study 4-4 on page 161 (Solution) Unearned revenues Unearned revenue (also called deferred revenue) is a liability account. The balance represents payment received in advance for goods or services that have not yet been provided. For example, a magazine may sell a one-year subscription to a subscriber, collecting money in advance. Cash is debited to record the amount received, while unearned revenue is credited in a corresponding amount to reflect the obligation to provide the magazines in the future. Unearned revenue is earned when the goods are delivered or services are provided. In the case of the magazine, and assuming that it publishes one issue per month, 1/12 of the revenue would be earned each month. The term "payable" is typically not used when the obligation is to be settled by the provision of goods or services. Textbook activities Accrued expenses Checkpoint Questions 8 and 9 on page 139 (Solutions on page 151) Quick Study 4-5 on page 161 (Solution) According to the matching principle, expenses must be recorded in the same period as the revenues that were earned as a result of the expenses. Adjusting entries are required when expenses that have not yet been recorded have been incurred during the accounting period. To facilitate this requirement, accrued expenses are recorded by preparing adjusting entries. Two examples of expenses that may not have been recorded during the year are The cost of cellular phone service from a provider such as Fido: This is likely to occur as the invoice for the service provided in December is not usually received until January. Employees wages: This typically occurs when the employees normal payday (such as every second Friday) does not coincide with the company year end. As such, the firm owes the employees' wages for the hours worked between the last payroll and year end. Note: The solution to Checkpoint Question 10 should be changed as follows: The omission of the $6,900 interest utility expense accrual will cause liabilities to be understated by $6,900 and equity to be overstated by $6,900. Textbook activity Checkpoint Questions 10 and 11 on page 142 (Solutions on page 151) FA1 - Module 3 Page 10 of 71

11 Accrued revenues The revenue recognition principle requires that revenue be recorded during the period that it is earned, regardless of when the actual cash is collected. Adjusting entries are required when revenue that has been earned during the accounting period has not yet been recorded. To satisfy this condition, accrued revenues are also recorded by preparing adjusting entries. A business that repairs a furnace on December 31 but does not send the invoice until January 5 would need to accrue revenues at December 31 to reflect the fact that this as yet unrecorded revenue had been earned. Textbook activities Checkpoint Question 13 on page 144 (Solution on page 151) Quick Study 4-8 on page 162 (Solution) Accrued adjustments in later periods Expenses accrued at the end of an accounting period will affect the recording of the related cash payments in the next period. Similarly, the accrued revenues recorded at the end of one period will result in cash receipts in a subsequent period. You should be clear about how these items are journalized in the subsequent accounting period. The Mid-Chapter Demonstration Problem on pages (included in the textbook activities following) is an example. Textbook activities Checkpoint Question 12 on page 142 and question 14 on page 145 (Solutions on pages 151) Quick Study 4-6, 4-7, 4-9, and 4-10 on pages (Solutions) Note: that for part (a), prepaid expenses, consider the effect if the expense portion of the prepaid expense is not transferred to the expense account. Mid-Chapter Demonstration Problem on pages FA1 - Module 3 Page 11 of 71

12 Quick Study a) Apr. 1 Prepaid Insurance... 7,680 Cash... 7,680 To record purchase of two-year insurance policy b) Dec. 31 Insurance Expense... 2,880 Prepaid Insurance... 2,880 To record the use of nine months of prepaid insurance; 7,680/24 = 320/month 9 months = 2, c) Dec. 31 Insurance Expense... 3,840 Prepaid Insurance... 3,840 To record the use of 12 months of prepaid insurance; 320/month 12 months = 3,840 OR 7,680/2 = 3,840. d) 3 months or $960 calculated as 3 months $320 = $960. FA1 - Module 3 Page 12 of 71

13 Quick Study Mar. 1 Vehicle... 32,000 Cash... 32,000 To record purchase of vehicle. Dec. 31 Depreciation Expense, Vehicle... 5,000 Accumulated Depreciation, Vehicle... 5,000 To record 10 months of depreciation on the vehicle; 32,000 8,000 = 24,000; 24,000/4 yrs = 6,000/yr; 6,000/12 = 500/month; 500/month 10 months = 5,000 OR 24,000 10/48 = 5, Dec. 31 Depreciation Expense, Vehicle... 6,000 Accumulated Depreciation, Vehicle... 6,000 To record annual depreciation on the vehicle; (32,000 8,000)/4 years. FA1 - Module 3 Page 13 of 71

14 Quick Study Nov. 1 Cash... 12,000 Unearned Revenue... 12,000 To record cash received for services to be performed in the future. Dec. 31 Unearned Revenue... 9,000 Revenue... 9,000 To record amount of advance payment earned. FA1 - Module 3 Page 14 of 71

15 Quick Study 4-8 Debits Credits a. 4 3 b c d. 7 8 e. 4 2 FA1 - Module 3 Page 15 of 71

16 Quick Study Dec. 31 Telephone Expense... 1,840 Accounts Payable or Telephone Payable... 1,840 To accrue the December telephone bill Jan. 14 Accounts Payable or Telephone Payable... 1,840 Cash... 1,840 To record payment of December 31 accrual. Quick Study Mar. 31 Accounts Receivable... 17,000 Revenues... 17,000 To record accrued revenues. Apr. 16 Cash... 12,000 Accounts Receivable... 12,000 To record collection of receivable. Quick Study 4-9 a. Debit Depreciation Expense Income Statement Credit Accumulated Depreciation Balance Sheet b. Debit Wages Expense Income Statement Credit Wages Payable Balance Sheet c. Debit Unearned Revenue Balance Sheet Credit Revenue Account Income Statement d. Debit Insurance Expense Income Statement Credit Prepaid Insurance Balance Sheet e. Debit Accounts Receivable Balance Sheet Credit Revenue Account Income Statement FA1 - Module 3 Page 16 of 71

17 Quick Study 4-10 If adjustment is not recorded: Net income will be overstated, Assets will be overstated, Liabilities will be overstated, Equity will be overstated, understated, or understated, or understated, or understated, or no Type of no effect no effect no effect effect Adjustment a. Prepaid Expenses Overstated Overstated No effect Overstated b. Depreciation Overstated Overstated No effect Overstated c. Unearned Understated No effect Overstated Understated Revenues d. Accrued Overstated No effect Understated Overstated Expenses e. Accrued Revenues Understated Understated No effect Understated FA1 - Module 3 Page 17 of 71

18 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.3 Adjusted trial balance and preparation of financial statements Learning objective Prepare an adjusted trial balance and use it to prepare financial statements. (Level 1) Required reading LEVEL 1 Chapter 4, pages After the adjusting entries have been recorded and posted to the general ledger, a new trial balance is prepared. This report is called an adjusted trial balance to reflect the fact that the account balances now recorded include the required end-of-period adjustments. Exhibit 4.22 on page 147 demonstrates how to prepare the adjusted trial balance using a partial work sheet. The Unadjusted trial balance numbers reflect the balances in the ledger accounts before the adjusting journal entries at the end of the accounting period. The Adjustments columns show the adjustments that must be made to various accounts to bring them to their proper balances. The adjusted trial balance is the result of the unadjusted trial balance and the adjustments. The account balances on the adjusted trial balance are the up-to-date ledger balances (which will be used in the preparation of the income statement), statement of changes in equity, and balance sheet. Accounts are normally arranged in the ledger, and therefore on the trial balance, in the order that they appear in the statements that is, assets, liabilities, owner s equity, revenues, and expenses. Each account on the adjusted trial balance is therefore either a balance sheet account, a statement of changes in equity account, or an income statement account. Exhibit 4.23 on page 148 demonstrates how the accounts from the income statement, the statement of changes in equity, and the balance sheet are created using the adjusted trial balance. The income statement is prepared first because the net income amount is needed to complete the statement of changes in equity. The closing capital balance from this latter statement is in turn carried forward to the balance sheet, which is prepared last. Textbook activities Checkpoint Questions 15 to 17 on page 149 (Solutions on page 152) Quick Study 4-11 on page 162 (Solution) Judgement Call on page 149 (Solution on page 151) Demonstration Problem and solution on pages Take particular note of the Planning the Solution section. FA1 - Module 3 Page 18 of 71

19 Quick Study Oct. 31 Insurance Expense Prepaid Insurance To record expired prepaid insurance. 31 Interest Expense Interest Payable To record accrual of interest. FA1 - Module 3 Page 19 of 71

20 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.4 The work sheet Learning objective Prepare financial statements for a service business from the information in a work sheet. (Level 2) Required reading LEVEL 2 Chapter 5, pages A work sheet is a working paper used by an accountant to organize accounting information for preparing the financial statements and adjusting entries. Preparing work sheets is an optional procedure in the accounting cycle and summarizes steps 4, 5, and 6 shown in Exhibit 5.1 on page 190. Financial statements are used externally and must follow certain formats. Work sheets, however, are informal documents for the accountant s use only and enable the accountant to see the entire accounting process from beginning to end. It s important to note that a worksheet does not eliminate the need to journalize and post adjustments to the ledger. It is merely a tool to assist with the process. When all entries are posted to the ledger, balances should be checked against the worksheet account balances to ensure the adjustments are correct. The benefits of using a work sheet and the required steps to complete them are explained on pages An example illustrating these five steps is provided in Exhibit 5.3 on page 193. Work through this example to help you understand the steps in preparing a work sheet. Textbook activity Checkpoint Questions 1 to 3 on page 194 (Solutions on page 210) Quick Study 5-1 to 5-4 on pages (Solution) FA1 - Module 3 Page 20 of 71

21 Quick Study BS 4. BS 2. BS 5. BS 3. IS 6. IS Quick Study 5-2 Balance Sheet Unadjusted Adjusted & Statement of Trial Balance Adjustments Trial Balance Income Statement Changes in Equity Account Dr Cr Dr Cr Dr Cr Dr Cr Dr Cr Cash Accounts receivable Supplies Ed Wolt, capital Ed Wolt, withdrawals Fees earned Supplies expense Totals Net income Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 1 FA1 - Module 3 Page 21 of 71

22 Quick Study 5-3 Alice Pursley, capital for the December 31, 2011 balance sheet: Beginning capital... $50,000 Add: Net income ($184,000 $125,000)... 59,000 Less: Withdrawals... 32,000 Ending capital... $77,000 Quick Study 5-4 Sam Hascal, Capital for the December 31, 2011, balance sheet: Beginning capital... $165,000 Less: Net loss ($74,000 $115,000)... 41,000 Less: Withdrawals... 32,000 Ending capital... $ 92,000 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 2 FA1 - Module 3 Page 22 of 71

23 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.5 Closing entries Learning objective Prepare closing entries for a service business. (Level 1) Required reading LEVEL 1 Chapter 5, pages Accounts are either permanent or temporary in nature. Balance sheet accounts are permanent accounts, while income statement accounts and the withdrawals account are temporary. Permanent accounts are continuous accounts their balances are carried forward from one accounting period to the next. Using cash as an example, the cash account balance fluctuates during the accounting period as deposits and payments are made. The ending cash balance from one period becomes the beginning cash balance for the next period; therefore, the account continues from one period to the next. Temporary accounts are periodic accounts, and at the end of each accounting period their balances are closed (transferred) to owner s equity. The revenue account, for example, is a temporary account. The revenue account for each accounting period begins with a zero balance. Closing entries transfer the balances in the temporary accounts (revenue, expense, and withdrawals accounts) to a balance sheet equity account (owner s capital for a sole proprietorship). The closing process is described and illustrated on pages Work through the example in Exhibits 5.7 to 5.9 and check your understanding of the subject. Textbook activity Checkpoint Questions 4 and 5 on page 201 (Solutions on page 210) Quick Study 5-5 to 5-7 on pages (Solutions) FA1 - Module 3 Page 23 of 71

24 Quick Study 5-5 Income Summary balance after closing revenues and expenses: Revenues: $35,000 + $3, = $38,500 Expenses: $19,000 + $4,000 + $2, = 25,300 Credit balance... = $13,200 Peter Jontil, Capital balance after all closing entries: Beginning balance... $14,000 Peter Jontil, Capital Add: Net income... 13,200 14,000 (Beg. Bal.) Total... $27,200 OR (Withdrawals) 6,000 13,200 (Net income) Less: Withdrawals... 6,000 21,200 (End. Bal.) Ending balance... $21,200 Copyright 2007 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 1 FA1 - Module 3 Page 24 of 71

25 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter Quick Study (1) Apr 30 Revenue Income Summary To close the revenue account. (2) 30 Income Summary Expenses To close the expenses account. (3) 30 Income Summary Capital To close the income summary to capital. (4) 30 Capital Withdrawals To close withdrawals to capital. Assets Liabilities Capital Apr Apr Apr. 30 (4) (3) 220 Balance Withdrawals Revenue Expenses Apr (4) (1) Apr. 30 Apr (2) Balance Balance Balance -0- Income Summary (2) (1) (3) Balance -0- Balance FA1 - Module 3 Page 25 of 71

26 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. 323 Fundamental Accounting Principles, Thirtteenth Canadian Edition Quick Study (1) Oct. 31 Revenue Income Summary To close the revenue account. (2) 31 Income Summary Expenses To close the expenses account. (3) 31 Capital Income Summary To close the income summary to capital. (4) 31 Capital Withdrawals To close withdrawals to capital. Assets Liabilities Capital Oct Oct. 31 (4) Oct. 31 (3) Balance Withdrawals Revenue Expenses Oct (4) (1) Oct. 31 Oct (2) Balance Balance Balance -0- Income Summary (2) (1) Balance (3) Balance -0- FA1 - Module 3 Page 26 of 71

27 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.6 Post-closing trial balance Learning objective Prepare a post-closing trial balance. (Level 1) Required reading LEVEL 1 Chapter 5, pages A final step is needed to ensure that the journalizing and posting of closing entries have been done properly. After the closing entries are journalized and posted, the temporary accounts should have a zero balance. The permanent accounts are still open. The post-closing trial balance is prepared to ensure that total debits still equal total credits in the remaining permanent accounts. The income statement accounts and withdrawals account should have zero balances because they have been closed. Only balance sheet accounts will appear in the post-closing trial balance. Read pages to see how the post-closing trial balance is prepared. Textbook activities Checkpoint Question 6 on page 202 (Solution on page 211) Quick Study 5-8 on page 221 (Solution) FA1 - Module 3 Page 27 of 71

28 Quick Study 5-8 SilverStar Automotive Post-Closing Trial Balance October 31, 2011 Account Debit Credit Cash... $ 40 Accounts receivable Unearned revenue... $ 10 Capital Totals... $ 60 $ 60 FA1 - Module 3 Page 28 of 71

29 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.7 The accounting cycle Learning objective Review the steps in the accounting cycle. (Level 1) Required reading LEVEL 1 Chapter 5, pages You have now completed the nine-steps of the accounting cycle as described on pages You can also refer to Exhibit 2-1. Preparing reversing entries at the beginning of the next fiscal year is not examinable. However, if you are interested, go to Appendix 5A on pages for an overview. Textbook activities Checkpoint Question 7 on page 203 (Solution on page 211) Quick Study 5-9 on page 221 (Solution) Mid-Chapter Demonstration Problem and solution on pages (Remember that the owner s withdrawals are closed directly to the capital account, not to income summary.) FA1 - Module 3 Page 29 of 71

30 Quick Study (f) Journalizing transactions. 2. (g) Posting the transaction entries. 3. (a) Preparing the unadjusted trial balance. 4. (h) Completing the work sheet (optional). 5. (c) Journalizing and posting adjusting entries. 6. (e) Preparing the financial statements. 7. (d) Journalizing and posting closing entries. 8. (b) Preparing the post-closing trial balance. FA1 - Module 3 Page 30 of 71

31 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.8 Classification of balance sheet items Learning objective Prepare a classified balance sheet. (Level 1) Required reading LEVEL 1 Chapter 5, pages Balance sheets can be arranged in account form (see Exhibit 2.4 on page 28) or report form (see the balance sheet in Exhibit 5.4 on page 195). A classified balance sheet is one that shows assets and liabilities grouped in meaningful subclasses, as shown in Exhibit 5.14 on page 207. Classified balance sheets are normally prepared in report form rather than account form. Review the unclassified balance sheet in Exhibit 5.4 on page 195 and compare it to the classified balance sheet in Exhibit 5.14 on page 207. Notice the similarities and the differences. Both of the balance sheets have assets, liabilities, and equity. Both of the balance sheets are in report form. However, the classified balance sheet in Exhibit 5.14 shows groups of assets and groups of liabilities. In a classified balance sheet, assets are grouped into four categories: current assets long-term investments property, plant, and equipment intangible assets Liabilities are grouped into two categories: current liabilities long-term liabilities Owner s equity represents the last subclass, and its format depends on whether the company is a sole proprietorship, a partnership, or a corporation. The text describes the classifications on pages Balance sheets are typically prepared in a classified manner to provide more useful information to the user. For example, the relationship of a firm s current assets to its current liabilities gives creditors some insight into the firm s ability to meet its short-term obligations. This relationship is known as the current ratio. Textbook activities Checkpoint Questions 8 to 10 on page 209 (Solutions on page 211) Quick Study 5-10 to 5-12 on pages (Solutions) Demonstration Problem on pages Work out the problem before looking at the solution to confirm your knowledge of how to prepare financial statements from an adjusted trial balance. FA1 - Module 3 Page 31 of 71

32 Quick Study C 5. B 2. E 6. A 3. A 7. D 4. F Quick Study h. 6. f. 11. c. 16. c. 2. g. 7. e. 12. a. 17. h. 3. a. 8. a. 13. c. 18. a. 4. h. 9. b. 14. d. 19. e. 5. c. 10. e. 15. c. 20. b. Quick Study 5-12 Jardine Servicing Partial Balance Sheet March 31, 2011 Liabilities Current liabilities Accounts payable... $14,000 Unearned fees... 26,000 Notes payable, due February 1, ,000 Current portion of mortgage payable... 56,000 Total current liabilities... $141,000 Long-term liabilities Mortgage payable (less $56,000 current portion)... 59,000 Total liabilities... $200,000 FA1 - Module 3 Page 32 of 71

33 Course Schedule Course Modules Review and Practice Exam Preparation Resources 3.9 Using the information Current ratio Learning objective Calculate the current ratio and interpret and apply this ratio in decision-making scenarios. (Level 2) Required reading LEVEL 2 Appendix 5B, page 216 One advantage of classifying a balance sheet is that important relationships within the balance sheet can be easily obtained and analyzed. One such relationship is the current ratio as a measure of a company s short-term debt-paying ability. This type of information is particularly useful to suppliers and bankers that do business with a firm. The current ratio is determined as follows: Current ratio = Current assets Current liabilities Assume Company A has a current ratio of 1.3, which indicates it has $1.30 of current assets to cover each dollar of current debt. If Company B has a current ratio of 0.75, it means that there may be insufficient current assets to meet short-term obligations as they come due. Comparing the current ratio of Company A against that of Company B shows that not only does Company A have sufficient current assets to cover current liabilities, but that its current ratio is favourable relative to Company B s current ratio. Textbook activities Checkpoint Question 12 on page 216 (Solution on page 217) Quick Study 5-14 on page 222 (Solution) FA1 - Module 3 Page 33 of 71

34 *Quick Study 5-14 Current assets: Accounts receivable... $15,000 Cash... 6,000 Office supplies... 1,800 Prepaid insurance... 2,500 Total... $25,300 Current liabilities: Accounts payable... $10,000 Unearned services revenue... 4,000 Total... $14,000 Current ratio = $25,300 $14,000 = is less than the industry average of 2.2 so compares unfavourably. However, a current ratio of 1.81 is generally considered to be favourable. FA1 - Module 3 Page 34 of 71

35 Course Schedule Course Modules Review and Practice Exam Preparation Resources Module 3 summary Adjusting the accounts, preparing the statements, and completing the accounting cycle Explain the need for financial statements and account adjustments at the end of regular accounting periods, and the purpose of the accrual basis of accounting. The life of a business is divided into accounting periods so that periodic financial reports can be prepared and used to evaluate the financial progress of the business. Before financial statements can be prepared, the accounts must be reviewed to ensure they properly reflect the substance of the economic events as required by GAAP. Adjustments at the end of each period are necessary to update some of the asset, liability, expense, and revenue accounts, and to show the effects of previously unrecorded economic events of the business. Accrual accounting requires adjustments for prepaid expenses, depreciation, unearned revenues, accrued expenses and accrued revenues; Therefore, it reports revenues when earned and expenses when the expiration of benefit is incurred. Cash basis accounting does not make adjustments for prepaid expenses, accrued expenses, unearned revenues, and accrued revenues; revenues are recorded when cash is received and expenses are recorded when cash is paid. The cash basis of accounting is not generally accepted. Prepare adjusting entries for prepaid expenses, depreciation, unearned revenues, accrued expenses, and accrued revenues. Step 5: Adjusting the accounts Adjusting entries are journalized in the general journal and then posted into the general ledger. Adjusting entries are used to charge the expired portion of prepaid expenses to Expense charge the expired portion of plant and equipment assets cost to Depreciation expense accrue expenses and record the related liabilities recognize as revenues the earned portion of unearned revenue liabilities accrue revenues and record the related assets Prepare an adjusted trial balance and use it to prepare financial statements. Steps 6 and 7: The adjusted trial balance and preparation of financial statements The sixth step in the accounting cycle is the preparation of an adjusted trial balance to prove the equality of debits and credits upon completion of the adjustment process. The seventh step in the accounting cycle is preparing the financial statements using the adjusted account balances as summarized on the adjusted trial balance. When accrued expenses are paid early in a new accounting period, the entry to record the payment includes a debit to the previously recorded liability and a debit to expense for the portion that expired during the new period. FA1 - Module 3 Page 35 of 71

36 When payment of accrued revenues is received, the entry includes a credit to the previously recorded asset and a credit to revenue for the portion earned during the new period. Prepare financial statements for a service business from the information in a work sheet. A work sheet is a tool the accountant uses at the end of an accounting period to show the effects of the adjustments and organize the data for use in preparing financial statements and recording the adjusting and closing entries. The work sheet is an internal working paper that incorporates steps 4 (unadjusted trial balance) through 6 of the accounting cycle, resulting in draft financial statements. Prepare closing entries for a service business. Step 8: Closing entries Closing the temporary accounts at the end of each accounting period serves to transfer the effects of these accounts to the proper owner s equity account that appears on the balance sheet. It also gives the revenue, expense, and withdrawal (or dividend for a corporation) accounts zero balances, preparing them for use in the following period. Closing involves the following steps: Revenues are closed to the Income summary account. Expenses are closed to the Income summary account. The balance in the Income summary account is closed to the Owner s capital account. The Owner s withdrawals account is closed to the Owner s capital account. Prepare a post-closing trial balance. Step 9: Post-closing trial balance The two main goals of the post-closing trial balance are to test the equality of debits and credits in the general ledger after the closing entries have been posted; and confirm that all temporary accounts have been closed. Review the steps in the accounting cycle. The nine steps in the accounting cycle are as follows: 1. Analyze transactions. 2. Journalize transactions in the general journal. 3. Post from the general journal to the general ledger. 4. Prepare the unadjusted trial balance. 5. Journalize and post adjusting entries. 6. Prepare the adjusted trial balance. 7. Prepare financial statements. 8. Journalize and post closing entries. 9. Prepare post-closing trial balance. Prepare a classified balance sheet. FA1 - Module 3 Page 36 of 71

37 A classified balance sheet categorizes asset, liability, and equity accounts. Assets are usually grouped into four classes: current assets long-term investments property, plant, and equipment intangible assets Liabilities are classified as current liabilities, or long-term liabilities The equity of a sole proprietorship is reported on one line, while a separate capital account is reported for each partner in a partnership. The equity section on a corporate balance sheet is called Shareholders Equity. Calculate the current ratio and interpret and apply this ratio in decisionmaking scenarios. A company s current ratio describes its ability to meet current liabilities out of current assets. Current ratio = Current assets Current liabilities FA1 - Module 3 Page 37 of 71

38 Course Schedule Course Modules Review and Practice Exam Preparation Resources Module 3 Self-test Question 1 Multiple-choice questions Solution a. The Office supplies account shows a beginning balance of $600 and an ending balance of $400. If office supplies expense for the year is $3,100, what amount of office supplies was purchased during the period? 1. $2, $2, $3, $3,500 b. HCF, a finance company, lends Able Business $2,400 at 5% on December 1, 20X1; the term of the loan is for three months. At the end of the period, $10 of interest has accrued. What should HCF s adjusting entry on December 31, 20X1, include? 1. A debit to Interest earned for $10 2. A credit to Interest receivable for $10 3. A credit to Interest earned for $10 4. A debit to Cash for $10 c. Josh s Computer Business owns computer equipment that cost $6,000 when it was purchased three years ago. Its current book value is $2,400. What is the depreciation expense per year using straight-line depreciation assuming zero salvage value? 1. $ $ 1, $ 1, $ 1,200 d. Which of the following describes the current ratio? 1. It is current assets divided by total liabilities. 2. It helps to assess a company s ability to pay its debts in the near future. 3. It reveals that the business has a very good cash flow position if it is less than It is current liabilities divided by current assets. e. The Jon Godfrey, Capital account has a debit balance of $1,200 before closing entries are made. If total revenues for the year are $55,200, total expenses $39,800, and withdrawals are $9,000, what is the ending balance in the Jon Godfrey, Capital account after all closing entries have been made? 1. $ 5, $ 7, $ 14, $ 16,600 FA1 - Module 3 Page 38 of 71

39 Question 2 Problem 4-7B, page 180 Solution Question 3 Problem 4-17B, pages 185 (Note: Only Part 2 is required.) Solution Question 4 A & R Problem 4-1, page 186 Solution Question 5 The following information was extracted from Auto Doctor, a club that requires its annual subscription fee to be paid in advance. Required Calculate the following: Solution Question 6 a. Subscription income for 20X2 b. Subscription fees for 20X2 received in 20X1 c. Subscription fees for 20X2 received in 20X2 d. Subscription fees received during 20X2 Exercise 5-4, page 224 Solution Question 7 Problem 5-3B, pages FA1 - Module 3 Page 39 of 71

40 (Note: Refer to Exhibit 5.3 on page 193 for an example of a 10-column work sheet.) Solution Question 8 Problem 5-9A, page 236 Solution Complete the following Mini Cases to develop your analytic and decision making skills. Remember the suggested solution is just a guide; there is not a single right answer. Use your own judgement. Refer to the Critical Thinking Model in the front cover of your textbook. Question 9 Critical Thinking Mini Case, Chapter 4, pages 187 and 188 Solution Question 10 Critical Thinking Mini Case, Chapter 5, pages Solution Question 11 Problem 5-13A pages Solution FA1 - Module 3 Page 40 of 71

41 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 1 Multiple-choice a. b. 1. Incorrect. A beginning balance of $600 plus office supplies purchased during the year less office supplies used (expensed) for the year of $3,100 equals the ending balance of $400 ($600 $3,100 + x = $400). Solving for x, office supplies purchased during the period was $2, Correct. A beginning balance of $600 plus office supplies purchased during the year less office supplies used (expensed) for the year of $3,100 equals the ending balance of $400 ($600 $3,100 + x = $400). Solving for x, office supplies purchased during the period was $2, Incorrect. $600 + $3,100 $400 = $3,300, which is incorrect because the $3,100 was used (expensed) and not purchased. 4. Incorrect. The beginning balance of $600 must be subtracted from the supplies available since these were not purchased during this accounting period. 1. Incorrect. A debit to Interest earned for $10 would reduce it when an increase is the desired result. 2. Incorrect. A credit to Interest receivable for $10 would reduce it when an increase is the desired result. 3. Correct. The full entry on December 31, 20X1, would be: 4. Incorrect. A debit to Cash for $10 means cash is collected on December 31, 20X1; cash will not be received until the note matures. c. 1. Incorrect. $2,400 3 years = $800, but $2,400 is the remaining undepreciated capital cost of the asset. 2. Incorrect. Cost less Accumulated depreciation = Book value; or Cost less Book value = Accumulated depreciation. Therefore, $3,600 3 years = $1,200 depreciation per year. 3. Incorrect. Cost less Accumulated depreciation = Book value; or Cost less Book value = Accumulated depreciation. Therefore, $3,600 3 years = $1,200 amortization per year. 4. Correct. Cost less Accumulated depreciation = Book value; or Cost less Book value = Accumulated depreciation. Therefore, $3,600 3 years = $1,200 amortization per year. d. 1. Incorrect. It should be current assets divided by total current liabilities. 2. Correct. The current ratio helps to assess a company s ability to pay its debts in FA1 - Module 3 Page 41 of 71

42 the near future. 3. Incorrect. If the current ratio is less than 1, it calls into question the company s ability to pay its debts in the near future (that is, if the current ratio is 0.9, that would indicate that the company has $0.90 of current assets to cover each $1.00 of current debt). 4. Incorrect. Current liabilities divided by current assets is the current ratio formula inverted; the current ratio is current assets divided by current liabilities. e. 1. Correct. The normal balance for Capital is a credit; therefore, the beginning debit balance of $1,200 in Jon Godfrey, Capital represents a negative amount. You know that the beginning balance of Capital of $1,200 plus net income of $15,400 (calculated as revenues of $55,200 less expenses of $39,800) less withdrawals of $9,000 equals an ending Capital balance of $5, Incorrect. The $1,200 is a debit balance and should be subtracted and not added to arrive at the correct answer. 3. Incorrect. Withdrawals must be subtracted to arrive at the post-closing balance in capital. 4. Incorrect. Withdrawals must be subtracted to arrive at the post-closing balance in capital; the $1,200 beginning balance is a debit (negative) and must also be subtracted. FA1 - Module 3 Page 42 of 71

43 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 2 FA1 - Module 3 Page 43 of 71

44 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 3 Part 2 Entries that initially recognize expenses and revenues: Year-end adjusting entries: FA1 - Module 3 Page 44 of 71

45 Note: The entries for Part 2 have been posted to T-accounts to help the student see the effects more clearly. The entries for Part 1 have also been posted to T-accounts in Part 1 of this question to help the student see that the results are the same regardless of which approach is used. Part 2 Analysis Component There are no differences between the two methods in terms of the amounts that appear on the financial statements. In both cases, the financial statements reflect the following: FA1 - Module 3 Page 45 of 71

46 When prepaid expenses and unearned revenues are recorded in balance sheet accounts, the related adjusting entries are designed to generate the correct asset, expense, liability, and revenue account balances. When prepaid expenses and unearned revenues are recorded in income statement accounts, the related adjusting entries are designed to accomplish exactly the same result. FA1 - Module 3 Page 46 of 71

47 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 4 1. $388, $22, $398,120 $22,520 = $375, ($388,400 + $22,520) $398,120 = $12,800 OR 388, ,600 = 12,800. Ethics Challenge 1. GAAP requires that annual depreciation accumulate in the contra-asset account, Accumulated Depreciation. While plant and equipment assets are often shown at their net value on the balance sheet (as in WestJet s and Danier s balance sheets in Appendix I), the cost of the equipment along with its related accumulated depreciation can be ascertained from the notes. Jackie is correct with her journal entry recommendation. 2. One strength of Bob s method would be the ease of preparing the balance sheet. The equipment balance in the adjusted trial balance would be directly transferable to the balance sheet if the preparer desired to show the amount at net, which it would be. Bob s approach carries considerable weaknesses since financial statement users would not be able to ascertain the original cost of the equipment or be able to know how much of the original cost had been allocated to date to depreciation. 3. While both approaches would lead to the same total for assets on the balance sheet, GAAP requires Jackie s approach. As a professional accountant, Jackie is required to uphold the standards of her profession and thus the decision is an ethical one for her. FA1 - Module 3 Page 47 of 71

48 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 5 Advance subscriptions $ 40,000 (b) Subscriptions applied 70,000 (a) (30,000) (c) Balance, December 31, 20X2 50,000 (given) Collected $ 80,000 (d) a. $70,000 b. $40,000 c. $30,000 d. $80,000 FA1 - Module 3 Page 48 of 71

49 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 6 FA1 - Module 3 Page 49 of 71

50 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 7 Part 1 Problem 5-3B (continued) Part 2 FA1 - Module 3 Page 50 of 71

51 Problem 5-3B (continued) Part 2 FA1 - Module 3 Page 51 of 71

52 Part 3 Problem 5-3B (continued) Part 3 FA1 - Module 3 Page 52 of 71

53 Problem 5-3B (concluded) Analysis component: a. This error enters the wrong amount in the correct accounts. The ending balance of the Prepaid FA1 - Module 3 Page 53 of 71

54 Insurance account should be $1,550, but the entry reduces that account by $1,550. Because its unadjusted balance was $7,300, the adjusted balance will be $5,750 (= $7,300 $1,550), which is $4,200 greater than the correct $1,550 balance. In addition, the Insurance Expense account balance will be only $1,550 instead of $5,750. The adjusted trial balance columns in the work sheet will be equal, but the error will cause the work sheet s net income to be overstated by $4,200 because of the understatement of the expense. In addition, the balance sheet columns will include the overstated balance for the Prepaid Insurance account. The Rusty Webster, Capital account will also be overstated. This error is not likely to be detected as a result of completing the work sheet. If it is not, the income statement will overstate net income by $4,200, and the balance sheet will overstate the cost of the unexpired insurance and equity by $4,200. b. This error inserts a debit in the balance sheet columns instead of the income statement columns. In the unlikely event that this error is not immediately detected, it will cause the work sheet measure of net income to be overstated because the total debits will incorrectly omit the $3,350 expense for repairs. In all likelihood, the error will be discovered in the process of drafting the balance sheet because the accountant will realize that repairs expense is not an asset. If it is detected and corrected, the financial statements will be unaffected. However, if the repairs expense is erroneously included on the balance sheet, the reported net income will be overstated by $3,350. On the balance sheet, a nonexistent asset will be reported for the repairs expense and equity will be overstated by $3,350. FA1 - Module 3 Page 54 of 71

55 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 8 FA1 - Module 3 Page 55 of 71

56 Analysis component: Brenner Climbing Adventures might be tempted to report the notes receivable as a current asset on the March 31, 2011 balance sheet because total current assets would then be greater than total current liabilities giving the misimpression that Brenner is in a position to cover its current obligations. FA1 - Module 3 Page 56 of 71

57 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 9 Problem(s): Goal(s)*: Adjusting entries are required at Scotia Bank s October 31, 2011 year end to comply with the matching principle To correctly record adjusting entries based on the information available to ensure financial statements comply with GAAP (assuming that the personnel director wants to comply with GAAP) Assumption(s)/Principle(s): Facts: That the furniture was recorded as an asset when purchased on March 1, 2009, and that depreciation has been recorded correctly to date using the straight-line method; that the insurance is recorded as a prepaid when purchased each March 1; that interest on the furniture loan is paid annually with each $100,000 payment; and that adjustments are recorded at year end only The matching principle requires that expenses be allocated to the appropriate accounting period; also, the prudence principle prohibits the overstatement of income and assets if adjusting entries are not recorded, income and assets could be overstated as presented Conclusion(s)/Consequence(s): as a minimum, the following adjusting entries will have to be recorded based on the information provided (calculations rounded to the nearest whole dollar for simplicity): 2011 Oct 31 Insurance Expense 8,000 Prepaid insurance 8,000 To adjust prepaid insurance; 2,667 used for first 4 months; 8,000 x 8/12 = 5,333 used for remaining 8 months. *The goal is highly dependent on perspective. 31 Interest expense 5,333 Interest payable 5,333 To record accrued interest; (400, , ,000) x 4% x 8/12 = 5, Depreciation Expense, Furniture 136,000 FA1 - Module 3 Page 57 of 71

58 Accumulated Depreciation, Furniture 136,000 To record depreciation on furniture; (700,000-20,000)/5 = 136,000. FA1 - Module 3 Page 58 of 71

59 Course Schedule Course Modules Review and Practice Exam Preparation Resources Solution 10 Problem(s): Goal(s)*: Delton Property Rentals cannot pay employees in March and the bank will not lend it money From the perspective of the bank, the bank needs to follow internal policies and procedures regarding to whom it is appropriate to lend cash Assumption(s)/Principle(s): Facts: That a decision to lend money will be based on the balance sheet prepared below As presented in balance sheet below prepared from information provided Conclusion(s)/Consequence(s): The balance sheet was weakened significantly from 2010 to 2011 given that liabilities were 32% of total assets (240, , ) in 2010 and 98% in 2011 (2,780,000 2,850, ). It appears that the increase was caused by a note payable used to purchase land and buildings. The $2,440,000 note payable requires a $200,000 annual payment and current assets on hand as of March 31, 2011 total $98,000 (75, , ,000); it appears that Delton Property Rentals will be unable to make the payment. Given that accounts receivable have decreased significantly from 2010 to 2011, it could be assumed that sales have decreased in a corresponding manner Accounts payable have increased from $7,000 in 2010 to $340,000 in 2011 yet there are current assets on hand as of March 31, 2011 totalling $98,000 (75, , ,000); it appears that Delton Property Rentals will be unable to pay its creditors. The 2011 current ratio is: (75, , ,000) 540,000 = $0.18:$1.00 which indicates that Delton will have difficulty meeting its short-term obligations; the 2010 current ratio was: (215, , ,000) (7, , ,000) = $1.29:$1.00 which indicates a dramatic deterioration in Delton s liquidity. If the bank lends Delton money, it risks noncollection; on the assumption that the $2,440,000 loan is with the same bank and that it is secured by the land and building, the bank should not lend Delton the money. *The goal is highly dependent on perspective. CT 5-1 (concluded) FA1 - Module 3 Page 59 of 71

60 Delton Property Rentals Balance Sheet March 31 Assets Current assets Cash $15,000 $40,000 Accounts receivable 75, ,000 Supplies 8,000 50,000 Total current assets $98,000 $305,000 Property, plant and equipment Land $675,000 $150,000 Buildings 2,112, ,000 Accumulated depreciation, buildings -165, ,000 Equipment 45,000 45,000 Accumulated depreciation, equipment -35,000-30,000 Total property, plant and equipment $2,632,000 $445,000 Long-term investments Notes receivable, due Nov. 30, ,000 0 Total assets $2,850,000 $750,000 Liabilities Current liabilities Accounts payable $340,000 $7,000 Unearned fees 0 29,000 Current portion of Notes Payable 200, ,000 Total current liabilities 540, ,000 Long-term liabilities Notes payable 2,440,000 4,000 Total liabilities 2,780, ,000 Equity Teal Delton, capital 70, ,000 Total liabilities and equity $2,850,000 $750,000 FA1 - Module 3 Page 60 of 71

61 NOTE: The general ledger accounts are shown at the end of the solution (in both balance column and T-account format) as they would appear after all entries have been posted. Transactions for June (The account numbers in the PR column below would be included only during the posting of these journal entries into the ledger accounts in Part 2 of Problem 5-13A): General Journal Page G1 Date Account Titles and Explanations PR Debit Credit 2011 June 1 Cash ,000 Furniture ,000 Computer Equipment ,000 Sam Near, Capital ,000 To record the owner s initial investment. 2 Rent Expense ,200 Cash ,200 Paid one month of rent. 3 Office Supplies ,400 Cash ,400 Acquired office supplies. 10 Prepaid Insurance ,200 Cash ,200 Paid one year s premium in advance. 14 Salaries Expense ,600 Cash ,600 Paid two weeks salary. 24 Cash ,600 Commissions Earned ,600 Collected commissions from airlines. 28 Salaries Expense ,600 Cash ,600 Paid two weeks salary. 29 Telephone Expense ,500 Cash ,500 Paid the telephone bill. 30 Repairs Expense Accounts Payable Repaired the computer on account. 30 Sam Near, Withdrawals ,850 Cash ,850 Owner s withdrawal of cash. Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 1 FA1 - Module 3 Page 61 of 71

62 Problem 5-13A (continued) Part 3 General Journal Page G2 Date Account Titles and Explanations PR Debit Credit 2011 Adjusting entries: a) June 30 Insurance Expense Prepaid Insurance To record expired insurance (2/3 $600 per month). b) 30 Office Supplies Expense Office Supplies To record the cost of consumed supplies ($2,400 $1,600). c) 30 Depreciation Expense, Furniture Accumulated Depreciation, Furniture To record depreciation. 30 Depreciation Expense, Computer Equip ,650 Accumulated Depreciation, Computer Equip ,650 To record depreciation. d) 30 Salaries Expense Salaries Payable To record accrued salaries. e) 30 Accounts Receivable ,500 Commissions Earned ,500 To record accrued commissions. Note: The account numbers in the PR column above would be included only during the posting of these journal entries into the ledger accounts in Part 3 of Problem 5-13A. Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 2 FA1 - Module 3 Page 62 of 71

63 Problem 5-13A (continued) Part 4 TOURS-FOR-LESS Income Statement For Month Ended June 30, 2011 Revenues: Commissions earned... $17,100 Operating expenses: Salaries expense... $7,520 Telephone expense... 3,500 Rent expense... 3,200 Depreciation expense, computer equipment... 1,650 Office supplies expense Repairs expense Depreciation expense, furniture Insurance expense Total operating expenses... 18,170 Net loss... $ 1,070 TOURS-FOR-LESS Statement of Changes in Equity For Month Ended June 30, 2011 Sam Near, capital, June 1... $ 0 Add: Investment by owner ,000 Total... $105,000 Less: Withdrawals by owner... $2,850 Net loss... 1,070 3,920 Sam Near, capital, June $101,080 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 3 FA1 - Module 3 Page 63 of 71

64 Problem 5-13A (continued) Part 4 TOURS-FOR-LESS Balance Sheet June 30, 2011 Assets Current assets: Cash... $27,250 Accounts receivable... 3,500 Office supplies... 1,600 Prepaid insurance... 6,800 Total current assets... $39,150 Property, plant and equipment: Computer equipment... $60,000 Less: Accumulated depreciation... 1,650 $58,350 Furniture... $ 5,000 Less: Accumulated depreciation ,600 Total property, plant and equipment... 62,950 Total assets... $102,100 Liabilities Current liabilities Accounts payable... $ 700 Salaries payable Total liabilities... $1,020 Equity Sam Near, capital ,080 Total liabilities and equity... $102,100 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 4 FA1 - Module 3 Page 64 of 71

65 Problem 5-13A (continued) Part 5 General Journal Page G3 Date Account Titles and Explanation PR Debit Credit 2011 Closing entries: June 30 Commissions Earned ,100 Income Summary ,100 To close the revenue account to the Income Summary account. 30 Income Summary ,170 Depreciation Expense, Furniture Depreciation Expense, Computer Equipment ,650 Salaries Expense ,520 Insurance Expense Rent Expense ,200 Office Supplies Expense Repairs Expense Telephone Expense ,500 To close the expenses to the income summary. 30 Sam Near, Capital ,070 Income Summary ,070 To close the Income Summary to capital. 30 Sam Near, Capital ,850 Sam Near, Withdrawals ,850 To close withdrawals to capital. Note: The account numbers in the PR column above would be included only during the posting of these journal entries into the ledger accounts in Part 5 of Problem 5-13A. Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 5 FA1 - Module 3 Page 65 of 71

66 Problem 5-13A (continued) Part 6 TOURS-FOR-LESS Post-Closing Trial Balance June 30, 2011 Acct. No. Account 101 Cash... $ 27, Accounts receivable... 3, Office supplies... 1, Prepaid insurance... 6, Furniture... 5, Accumulated depreciation, furniture... $ Computer equipment... 60, Accumulated depreciation, computer equipment... 1, Accounts payable Salaries payable Sam Near, capital ,080 Totals... $104,150 $104,150 Parts 1, 2, 3, 5 Ledger as of June 30 (using the balance column format): Cash Acct. No. 101 Date Explanation PR Debit Credit Balance 2011 June 1 G1 40,000 40,000 2 G1 3,200 36,800 3 G1 2,400 34, G1 7,200 27, G1 3,600 23, G1 13,600 37, G1 3,600 33, G1 3,500 30, G1 2,850 27,250 Accounts Receivable Acct. No. 106 Date Explanation PR Debit Credit Balance 2011 June 30 G2 3,500 3,500 Office Supplies Acct. No. 124 Date Explanation PR Debit Credit Balance 2011 June 3 G1 2,400 2,400 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 6 FA1 - Module 3 Page 66 of 71

67 30 G ,600 Problem 5-13A (continued) Parts 1, 2, 3, 5 Prepaid Insurance Acct. No. 128 Date Explanation PR Debit Credit Balance 2011 June 10 G1 7,200 7, G ,800 Furniture Acct. No. 160 Date Explanation PR Debit Credit Balance 2011 June 1 G1 5,000 5,000 Accumulated Depreciation, Furniture Acct. No. 161 Date Explanation PR Debit Credit Balance 2011 June 30 G Computer Equipment Acct. No. 167 Date Explanation PR Debit Credit Balance 2011 June 1 G1 60,000 60,000 Accumulated Depreciation, Computer Equipment Acct. No. 168 Date Explanation PR Debit Credit Balance 2011 June 30 G2 1,650 1,650 Accounts Payable Acct. No. 201 Date Explanation PR Debit Credit Balance 2011 June 30 G Salaries Payable Acct. No. 209 Date Explanation PR Debit Credit Balance 2011 June 30 G Sam Near, Capital Acct. No. 301 Date Explanation PR Debit Credit Balance 2011 June 1 G1 105, , G3 1, , G3 2, ,080 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 7 FA1 - Module 3 Page 67 of 71

68 Problem 5-13A (continued) Parts 1, 2, 3, 5 Sam Near, Withdrawals Acct. No. 302 Date Explanation PR Debit Credit Balance 2011 June 30 G1 2,850 2, G3 2,850 0 Commissions Earned Acct. No. 405 Date Explanation PR Debit Credit Balance 2011 June 24 G1 13,600 13, G2 3,500 17, G3 17,100 0 Depreciation Expense, Furniture Acct. No. 610 Date Explanation PR Debit Credit Balance 2011 June 30 G G Depreciation Expense, Computer Equipment Acct. No. 612 Date Explanation PR Debit Credit Balance 2011 June 30 G2 1,650 1, G3 1,650 0 Salaries Expense Acct. No. 622 Date Explanation PR Debit Credit Balance 2011 June 14 G1 3,600 3, G1 3,600 7, G , G3 7,520 0 Insurance Expense Acct. No. 637 Date Explanation PR Debit Credit Balance 2011 June 30 G G Rent Expense Acct. No. 640 Date Explanation PR Debit Credit Balance 2011 June 2 G1 3,200 3, G3 3,200 0 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 8 FA1 - Module 3 Page 68 of 71

69 Problem 5-13A (continued) Parts 1, 2, 3, 5 Office Supplies Expense Acct. No. 650 Date Explanation PR Debit Credit Balance 2011 June 30 G G Repairs Expense Acct. No. 684 Date Explanation PR Debit Credit Balance 2011 June 30 G G Telephone Expense Acct. No. 688 Date Explanation PR Debit Credit Balance 2011 June 29 G1 3,500 3, G3 3,500 0 Income Summary Acct. No. 901 Date Explanation PR Debit Credit Balance 2011 June 30 G3 17,100 17, G3 18,170 1, G3 1,070 0 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 9 FA1 - Module 3 Page 69 of 71

70 Problem 5-13A (continued) Parts 1, 2, 3, 5 Ledger as of June 30 (using the T-account format): Accum. Deprec., Com Cash 101 Accounts Receivable 106 Office Supplies Jun 1 40,000 3,200 Jun 2 Jun 30 3,500 Jun 3 2, ,600 2,400 3 Bal. 1,600 7, , Prepaid Insurance 128 Furniture 3, Jun 1 5, Jun 30 Jun 1 5,000 3, Bal. 6,800 2, Bal. 27,250 Accum. Dep., Furniture 161 Computer Equipment 167 Equipment 400 Jun 30 Jun 1 60,000 1,650 Accounts Payable 201 Sam Near, Capital 301 Sam Near, Withdrawa 700 Jun 30 Jun 30 1, ,000 Jun 1 Jun 30 2,850 2, , ,080 Bal. Bal. -0- Salaries Payable Jun 30 Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 10 FA1 - Module 3 Page 70 of 71

71 Problem 5-13A (concluded) Parts 1, 2, 3, 5 Commissions Earned 405 Deprec. Expense, Furniture 610 Deprec. Expense, Computer Equip. Jun 30 17,100 13,600 Jun 24 Jun Jun 30 Jun 30 1,650 1, 3, Bal. Bal. -0- Bal. -0- Salaries Expense 622 Insurance Expense 637 Rent Expense Jun 14 3,600 7,520 Jun 30 Jun Jun 30 Jun 2 3,200 3, 28 3,600 Bal. -0- Bal Bal. -0- Office Supplies Expense 650 Repairs Expense 684 Telephone Expense Jun Jun 30 Jun Jun 30 Jun 29 3,500 3, Bal. -0- Bal. -0- Bal. -0- Income Summary 901 Jun 30 18,170 17,100 Jun 30 Bal. 1,070 1, Bal. -0- Copyright 2010 by McGraw-Hill Ryerson Limited. All rights reserved. Solutions Manual for Chapter 5 11 FA1 - Module 3 Page 71 of 71