2
Review Chapter of the Accounting Process
QUESTIONS FOR REVIEW OF KEY TOPICS
Question 2-1
External events involve an exchange transaction between the company and a separate economic entity. For every external transaction, the company is receiving something in exchange for something else. Internal events do not involve an exchange transaction but do affect the financial position of the company. Examples of external events are the purchase of inventory, a sale to a customer, and the borrowing of cash from a bank. Examples of internal events include the recording of depreciation expense, the expiration of prepaid rent, and the accrual of salary expense.
Question 2-2
According to the accounting equation, there is equality between the total economic resources of an entity, its assets, and the claims to those resources, liabilities and equity. This implies that, since resources must always equal claims, the net effect of any transaction cannot affect one side of the accounting equation differently than the other side.
Question 2-3
The purpose of a journal is to capture, in chronological order, the dual effect of a transaction. A general ledger is a collection of storage areas called accounts. These accounts keep track of the increases and decreases in each element of financial position.
Question 2-4
Permanent accounts represent the financial position of a company, assets, liabilities and owners' equity, at a particular point in time. Temporary accounts represent the changes in shareholders' equity, the retained earnings component of equity for a corporation, caused by revenue, expense, gain and loss transactions. It would be cumbersome to record revenue/expense, gain/loss transactions directly into the permanent retained earnings account. Recording these transactions in temporary accounts facilitates the preparation of the financial statements.
Question 2-5
Assets are increased by debits and decreased by credits. Liabilities and equity accounts are increased by credits and decreased by debits.
Question 2-6
Revenues and gains are increased by credits and decreased by debits. Expenses and losses are increased by debits (thus causing owners' equity to decrease) and decreased by credits (thus causing owners' equity to increase).
Answers to Questions (continued) Question 2-7
The first step in the processing cycle is to identify external transactions affecting the accounting equation. Source documents, such as sales invoices, bills from suppliers and cash register tapes, help to identify the transactions and then provide the information necessary to process the transaction.
Question 2-8
Transaction analysis is the process of reviewing the source documents to determine the dual effect on the accounting equation and the specific elements involved.
Question 2-9
After transactions are recorded in a journal, the debits and credits must be transferred to the appropriate general ledger accounts. This transfer is called posting.
Question 2-10
Transaction 1 records the purchase of $20,000 of inventory on account. Transaction 2 records a credit sale of $30,000 and the corresponding cost of goods sold of $18,000.
Question 2-11
An unadjusted trial balance is a list of the general ledger accounts and their balances at a time before any end-of-period adjusting entries have been recorded. An adjusted trial balance is prepared after adjusting entries have been recorded and posted to the accounts.
Question 2-12
Adjusting entries record the effect on financial position of internal events, those that do not involve an exchange transaction with another entity. They must be recorded at the end of any period when financial statements are prepared to properly reflect financial position and results of operations according to the accrual accounting model.
Question 2-13
Closing entries transfer the balances in the temporary owners' equity accounts to a permanent owners' equity account, retained earnings for a corporation. This is done only at the end of a fiscal year in order to reduce the temporary accounts to zero before beginning the next reporting year.
Question 2-14
Prepaid expenses represent assets recorded when a cash disbursement creates benefits beyond the current reporting period. Examples are supplies on hand at the end of a period, prepaid rent, and the cost of plant and equipment.
Question 2-15
The adjusting entry required when unearned revenues are earned is a debit to the unearned revenue liability and a credit to revenue.
Answers to Questions (continued) Question 2-16
Accrued liabilities are recorded when an expense has been incurred that will not be paid until a subsequent reporting period. The adjusting entry required to record an accrued liability is a debit to an expense and a credit to a liability.
Question 2-17
Income statement - The purpose of the income statement is to summarize the operating activities of the company during a particular period of time. It is a change statement that is reporting the changes in owners' equity that occurred during the period as a result of operating transactions (revenues, expenses, gains and losses). Balance sheet - The purpose of the balance sheet is to present the financial position of the company at a particular point in time. It is an organized array of assets, liabilities, and permanent owners' equity accounts. Statement of cash flows - The purpose of the statement of cash flows is to disclose the events that caused cash to change during the period. Statement of shareholders' equity - The purpose of the statement of shareholders' equity is to disclose the sources of the changes in the various permanent shareholders' equity accounts that occurred during the period.
Question 2-18
A worksheet provides a means of organizing the accounting information needed to prepare adjusting and closing entries and the financial statements. This error would result in an overstatement of revenue and thus net income and retained earnings, and an understatement of liabilities.
Question 2-19
Reversing entries are recorded at the beginning of a reporting period. They remove the effects of some of the adjusting entries made at the end of the previous reporting period. This simplifies the journal entries made during the new period by allowing cash payments or cash receipts to be entered directly into the expense or revenue account without regard to the accrual made at the end of the previous period.
Question 2-20
The purpose of special journals is to record, in chronological order, the dual effect of repetitive types of transactions, such as cash receipts, cash disbursements, credit sales and credit purchases. Special journals simplify the recording process in the following ways: (1) journalizing the effects of a particular transaction is made more efficient through the use of specifically designed formats, (2) individual transactions are not posted to the general ledger accounts, but are accumulated in the special journals and a summary posting is made on a periodic basis, and (3) the responsibility for recording journal entries for the repetitive types of transactions is placed on individuals who have specialized training in handling them.
Answers to Questions (concluded) Question 2-21
The general ledger is a collection of control accounts representing assets, liabilities, permanent and temporary shareholders' equity accounts. The subsidiary ledger contains a group of subsidiary accounts associated with a particular general ledger control account. For example, there will be a subsidiary ledger for accounts receivable that will keep track of the increases and decreases in the account receivable balance for each of the company's customers purchasing goods or services on credit. At any point in time, the balance in the accounts receivable control account should equal the sum of the balances in the accounts receivable subsidiary ledger accounts.
BRIEF EXERCISES
Brief Exercise 2-1
1. + 2. 3. + 4. + 5. Assets 165,000 40,000 200,000 120,000 180,000 180,000 145,000 Liabilities + Paid-in Capital + Retained Earnings (inventory) + 165,000 (accounts payable) (cash) - 40,000 (expense) (accounts receivable) + 200,000 (revenue) (inventory) - 120,000 (expense)
(cash) (accounts receivable) (cash) - 145,000 (accounts payable)
=
Brief Exercise 2-2
1. 2. 3. Inventory................................................................. Accounts payable ................................................ Salaries expense ...................................................... Cash ................................................................... Accounts receivable ................................................ Sales revenue ...................................................... Cost of goods sold................................................... Inventory ............................................................. Cash ....................................................................... Accounts receivable ........................................... Accounts payable ................................................... Cash .................................................................... 165,000 165,000 40,000 40,000 200,000 200,000 120,000 120,000 180,000 180,000 145,000 145,000
4. 5.
Brief Exercise 2-3
BALANCE SHEET ACCOUNTS Cash Accounts receivable ___________________________ ____________________________
6/1 Bal. 4. 65,000 180,000 40,000 2. 5. 6/30 Bal. 145,000 _______________ 6/30 Bal. 60,000 6/1 Bal. 3. 43,000 200,000 180,000 4.
______________ 63,000
Inventory ___________________________
6/1 Bal. 1. 6/30 Bal. 0 165,000 120,000 _______________ 45,000 3. 5.
Accounts payable ____________________________
6/1 Bal. 22,000 145,000 165,000 ______________ 42,000 1.
6/30 Bal.
INCOME STATEMENT ACCOUNTS Sales revenue ___________________________
0 200,000 _______________ 200,000 6/1 Bal. 3. 6/30 Bal. 3.
Cost of goods sold ____________________________
6/1 Bal. 0 120,000 ______________
6/30 Bal. 120,000
Salaries expense ___________________________
6/1 Bal. 2. 6/30 Bal. 0 40,000 _______________ 40,000
Brief Exercise 2-4
1. 2. 3. Prepaid insurance .................................................... Cash ................................................................... Note receivable ...................................................... Cash ................................................................... Equipment .............................................................. Cash ................................................................... 12,000 12,000 10,000 10,000 60,000 60,000
Brief Exercise 2-5
1. 2. 3. Insurance expense ($12,000 x 3/12) ............................. Prepaid insurance ............................................... Interest receivable ($10,000 x 6% x 6/12) ..................... Interest revenue ................................................... Depreciation expense .............................................. Accumulated depreciation - equipment ................ 3,000 3,000 300 300 12,000 12,000
Brief Exercise 2-6
Net income would be higher by $14,700 ($3,000 - 300 + 12,000).
Brief Exercise 2-7
1. 2. 3. 4. Service revenue ...................................................... Unearned service revenue ................................... Advertising expense ($2,000 x 1/2) ............................. Prepaid advertising ............................................. Salaries expense ...................................................... Salaries payable .................................................. Interest expense ($60,000 x 8% x 4/12) ........................ Interest payable ................................................... 4,000 4,000 1,000 1,000 16,000 16,000 1,600 1,600
Brief Exercise 2-8
Assets would be higher by $1,000, the amount of prepaid advertising that expired during the month. Liabilities would be lower by $21,600 ($4,000 + 16,000 + 1,600). Shareholders' equity (and net income for the period) would be higher by $22,600.
Brief Exercise 2-9
BOWLER CORPORATION Income Statement For the Year Ended December 31, 2006 Sales revenue ............................................. Cost of goods sold ................................... Gross profit ................................................ Operating expenses: Salaries .................................................... Rent ......................................................... Depreciation ............................................ .......................................... Miscellaneous Total operating expenses ............. Net income ................................................. $325,000 168,000 157,000
$45,000 20,000 30,000 12,000 107,000 $ 50,000
Brief Exercise 2-10
BOWLER CORPORATION Balance Sheet At December 31, 2006 Assets Current assets: Cash ........................................................ Accounts receivable ................................. Inventory ................................................. Total current assets ............................. Property and equipment: Machinery and Equipment ....................... Less: Accumulated depreciation ............... Total assets ...................................... $ 5,000 10,000 16,000 31,000
100,000 (40,000)
60,000 $91,000
Liabilities and Shareholders' Equity Current liabilities: Accounts payable ..................................... Salaries payable ....................................... Total current liabilities ........................ Shareholders' equity: Common stock ......................................... Retained earnings ..................................... Total shareholders' equity ................... Total liabilities and shareholders' equity
$ 20,000 12,000 32,000
$50,000 9,000 59,000 $91,000
Brief Exercise 2-11
Sales revenue ................................................................ 850,000 Income summary ....................................................... 850,000 Income summary ........................................................... 815,000 Cost of goods sold ..................................................... 580,000 Salaries expense ........................................................ 180,000 Rent expense ............................................................. 40,000 Interest expense......................................................... 15,000 Income summary ($850,000 - 815,000) .............................. Retained earnings ..................................................... 35,000 35,000
Brief Exercise 2-12
Revenues Expenses: Salaries Utilities Advertising Net Income $428,000* (240,000) (33,000)** (12,000) $143,000
*$420,000 cash received plus $8,000 increase ($60,000 52,000) in amount due from customers: Cash ...................................................................... Accounts receivable (increase in account) ............... Sales revenue (to balance) ................................... 420,000 8,000 428,000
** $35,000 cash paid less $2,000 decrease in amount owed to utility company: Utilities expense (to balance) .................................. Utilities expense payable (decrease in account) ....... Cash ................................................................... 33,000 2,000 35,000
EXERCISES
Exercise 2-1
1. 2. 3. 4. 5. 6. 7. 8. 9. Assets + 300,000 - 10,000 + 40,000 + 90,000 + 120,000 - 70,000 5,000 6,000 + 6,000 - 70,000 + 55,000 - 55,000 1,000 =
(cash) (cash) (equipment) + 30,000 (note payable) (inventory) + 90,000 (accounts payable) (accounts receivable) (inventory) (cash) (cash) (prepaid insurance) (cash) - 70,000 (accounts payable) (cash) (accounts receivable) (accumulated depreciation)
Liabilities + Paid-in Capital + Retained Earnings + 300,000 (common stock)
+ 120,000 - 70,000 5,000
(revenue) (expense) (expense)
-
1,000
(expense)
Exercise 2-7
Account(s) Debited Example: Purchased inventory for cash 3 1. Paid a cash dividend. 10 2. Paid rent for the next three months. 8 3. Sold goods to customers on account. 4,16 4. Purchased inventory on account. 3 5. Purchased supplies for cash. 6 6. Paid employees wages for September. 15 7. Issued common stock in exchange for cash. 5 8. Collected cash from customers for goods sold in 3. 5 9. Borrowed cash from a bank and signed a note. 5 10. At the end of October, recorded the amount of supplies that had been used during the month. 7 11. Received cash for advance payment from customer. 5 12. Accrued employee wages for October. 17 Account(s) Credited 5 5 5 9,3 1 5 5 12 4 11 6 13 15
Exercise 2-8
1. Prepaid insurance ($12,000 x 30/36) ............................. Insurance expense ................................................ 2. Depreciation expense ............................................... Accumulated depreciation ................................... 3. Bad debt expense ($6,500 - 2,000) .............................. Allowance for uncollectible accounts.................... 4. Salaries expense ....................................................... Salaries payable ................................................... 5. Interest expense ($200,000 x 12% x 2/12) ...................... Interest payable .................................................... 6. Unearned rent revenue ............................................. Rent revenue (1/2 x $3,000) ..................................... 10,000 10,000 15,000 15,000 4,500 4,500 18,000 18,000 4,000 4,000 1,500 1,500
Exercise 2-9
1. Interest receivable ($90,000 x 8% x 3/12) ...................... Interest revenue .................................................... 2. Rent expense ($6,000 x 2/3) ........................................ Prepaid rent .......................................................... 3. Rent revenue ($12,000 x 7/12) ...................................... Unearned rent revenue ......................................... 4. Depreciation expense ............................................... Accumulated depreciation .................................... 5. Salaries expense ...................................................... Salaries payable ................................................... 6. Supplies expense ($2,000 + 6,500 - 3,250) .................... Supplies ............................................................... 1,800 1,800 4,000 4,000 7,000 7,000 4,500 4,500 8,000 8,000 5,250 5,250
Exercise 2-10
Requirement 1
BLUEBOY CHEESE CORPORATION Income Statement For the Year Ended December 31, 2006 Sales revenue ............................................. Cost of goods sold ................................... Gross profit ................................................ Operating expenses: Salaries ..................................................... Rent .......................................................... Depreciation ............................................ Bad debt .................................................. Total operating expenses ............. Operating income ....................................... Other expense: Interest ..................................................... Net income ................................................. $800,000 480,000 320,000
$120,000 30,000 60,000 5,000 215,000 105,000 4,000 $101,000
Exercise 2-10 (continued)
BLUEBOY CHEESE CORPORATION Balance Sheet At December 31, 2006 Assets Current assets: Cash ........................................................ Accounts receivable ................................. Less: Allowance for uncollectible accounts Inventory .................................................. Prepaid rent ............................................. Total current assets ............................. Property and equipment: Equipment ............................................... Less: Accumulated depreciation ............... Total assets ...................................... $ 21,000 $300,000 (20,000) 280,000 50,000 10,000 361,000
600,000 (250,000)
350,000 $711,000
Liabilities and Shareholders' Equity Current liabilities: Accounts payable ..................................... Salaries payable ....................................... Interest payable ........................................ Note payable ............................................ Total current liabilities ........................ Shareholders' equity: Common stock ......................................... Retained earnings ..................................... Total shareholders' equity ................... Total liabilities and shareholders' equity
$ 40,000 8,000 2,000 60,000 110,000
$400,000 201,000* 601,000 $711,000
*Beginning balance of $100,000 plus net income of $101,000.
Exercise 2-10 (concluded) Requirement 2 December 31, 2006 Sales revenue ................................................................ 800,000 Income summary ....................................................... 800,000 Income summary ........................................................... 699,000 Cost of goods sold ..................................................... 480,000 Salaries expense ........................................................ 120,000 Rent expense ............................................................. 30,000 Depreciation expense ................................................ 60,000 Interest expense......................................................... 4,000 Bad debt expense ...................................................... 5,000 Income summary ($800,000 - 699,000) .............................. 101,000 Retained earnings ...................................................... 101,000
Exercise 2-11
December 31, 2006 Sales revenue ................................................................ 750,000 Interest revenue ............................................................. 3,000 Income summary ....................................................... 753,000 Income summary ........................................................... 576,000 Cost of goods sold ..................................................... 420,000 Salaries expense ........................................................ 100,000 Rent expense ............................................................. 15,000 Depreciation expense ................................................ 30,000 Interest expense......................................................... 5,000 Insurance expense ..................................................... 6,000 Income summary ($753,000 - 576,000) .............................. 177,000 Retained earnings ..................................................... 177,000
Exercise 2-14
Unadjusted net income Adjustments: a. Only $2,000 in insurance should be expensed b. Sales revenue overstated c. Supplies expense overstated d. Interest expense understated ($20,000 x 12% x 3/12) Adjusted net income $30,000 + 4,000 - 1,000 + 750 - 600 $33,150
Exercise 2-17
Requirement 1 June 30 - adjusting entry Wages expense ($10,000 x 3/5) ........................................ Wages payable ..........................................................
6,000 6,000
July 1 - reversing entry Wages payable .............................................................. Wages expense ..........................................................
6,000 6,000
July 2 - payment of salaries Wages expense ............................................................. Cash .......................................................................... Requirement 2 June 30 - adjusting entry Wages expense ............................................................. Wages payable ..........................................................
10,000 10,000
6,000 6,000
July 2 - payment of salaries Wages expense ............................................................. Wages payable .............................................................. Cash ..........................................................................
4,000 6,000 10,000
Problem 2-8
1. Depreciation expense ($75,000 8 years) .................... Accumulated depreciation .................................... 2. Wage expense ($4,500 - 3,000) ................................... Wages payable ..................................................... 3. Bad debt expense .................................................... Allowance for uncollectible accounts.................... [($32,500 x 2%) - $100] ........................................... 4. Interest expense ($30,000 x 10% x 4/12) ....................... Interest payable .................................................... 5. Supplies ................................................................... Supplies expense .................................................. 6. Prepaid rent .............................................................. Rent expense ........................................................ 9,375 9,375 1,500 1,500 550 550 1,000 1,000 500 500 1,000 1,000