Week 3 Appendix E (Online text)
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Week 3 Appendix E (Online text)

Course Number: XACC 220, Spring 2011

College/University: University of Phoenix

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Appendix A SPECIMEN FINANCIAL STATEMENTS: PepsiCo, Inc. T HE ANNUAL REPORT Once each year a corporation communicates to its stockholders and other interested parties by issuing a complete set of audited financial statements.The annual report, as this communication is called, summarizes the financial results of the companys operations for the year and its plans for the future. Many annual reports are attractive,...

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FINANCIAL Appendix A SPECIMEN STATEMENTS: PepsiCo, Inc. T HE ANNUAL REPORT Once each year a corporation communicates to its stockholders and other interested parties by issuing a complete set of audited financial statements.The annual report, as this communication is called, summarizes the financial results of the companys operations for the year and its plans for the future. Many annual reports are attractive, multicolored, glossy public relations pieces, containing pictures of corporate officers and directors as well as photos and descriptions of new products and new buildings. Yet the basic function of every annual report is to report financial information, almost all of which is a product of the corporations accounting system. The content and organization of corporate annual reports have become fairly standardized. Excluding the public relations part of the report (pictures, products, etc.), the following are the traditional financial portions of the annual report: Financial Highlights Letter to the Stockholders Managements Discussion and Analysis Financial Statements Notes to the Financial Statements Managements Report on Internal Control Management Certification of Financial Statements Auditors Report Supplementary Financial Information In this appendix we illustrate current financial reporting with a comprehensive set of corporate financial statements that are prepared in accordance with generally accepted accounting principles and audited by an international independent certified public accounting firm. We are grateful for permission to use the actual financial statements and other accompanying financial information from the annual report of a large, publicly held company, PepsiCo, Inc. FINANCIAL HIGHLIGHTS Companies usually present the financial highlights section inside the front cover of the annual report or on its first two pages. This section generally reports the total or per share amounts for five to ten financial items for the current year and one or more previous years. Financial items from the income statement and the balance sheet that typically are presented are sales, income from continuing operations, net income, net income per share, net cash provided by operating activities, dividends per common share, and the amount of capital expenditures.The financial highlights section from PepsiCos Annual Report is shown on page A-2. The financial information herein is reprinted with permission from the PepsiCo, Inc. 2005 Annual Report. The complete financial statements are available through a link at the books companion website. A1 A2 Appendix A Specimen Financial Statements: PepsiCo, Inc. Financial Highlights PepsiCo, Inc. and Subsidiaries ($ in millions except per share amounts; all per share amounts assume dilution) Net Revenue Total: $32,562 PepsiCo International 35% 5% Quaker Foods North America Division Operating Profit Total: $6,710 PepsiCo International 24% 8% Quaker Foods North America 28% 32% Frito-Lay North America PepsiCo Beverages North America 30% 38% Frito-Lay North America PepsiCo Beverages North America 2005 Summary of Operations Total net revenue Division operating profit Total operating profit Net income(b) Earnings per share(b) Other Data Management operating cash flow(c) Net cash provided by operating activities Capital spending Common share repurchases Dividends paid Long-term debt $5,852 $1,736 $3,012 $1,642 $2,313 $4,204 $32,562 $6,710 $5,922 $4,536 $2.66 2004 $29,261 $6,098 $5,259 $4,004 $2.32 % Chg(a) 11 10 13 13 15 $3,705 $5,054 $1,387 $3,028 $1,329 $2,397 13 16 25 (0.5) 24 (3.5) (a) Percentage changes above and in text are based on unrounded amounts. (b) In 2005, excludes the impact of AJCA tax charge, the 53rd week and restructuring charges. In 2004, excludes certain prior year tax benefits, and restructuring and impairment charges. See page 76 for reconciliation to net income and earnings per share on a GAAP basis. (c) Includes the impact of net capital spending. Also, see Our Liquidity, Capital Resources and Financial Position in Managements Discussion and Analysis. L ETTER TO THE STOCKHOLDERS Nearly every annual report contains a letter to the stockholders from the chairman of the board or the president, or both. This letter typically discusses the companys accomplishments during the past year and highlights significant events such as mergers and acquisitions, new products, operating achievements, business philosophy, changes in officers or directors, financing commitments, expansion plans, and Financial Statements and Accompanying Notes A3 future prospects. The letter to the stockholders is signed by Steve Reinemund, Chairman of the Board and Chief Executive Officer, of PepsiCo. Only a short summary of the letter is provided below. The full letter can be accessed at the books companion website at www.wiley.com/college/weygandt. MANAGEMENTS DISCUSSION AND ANALYSIS The managements discussion and analysis (MD&A) section covers three financial aspects of a company: its results of operations, its ability to pay near-term obligations, and its ability to fund operations and expansion. Management must highlight favorable or unfavorable trends and identity significant events and uncertainties that affect these three factors. This discussion obviously involves a number of subjective estimates and opinions. In its MD&A section, PepsiCo breaks its discussion into three major headings: Our Business, Our Critical Accounting Policies, and Our Financial Results. PepsiCos MD&A section is 22 pages long. You can access that section at www.wiley.com/college/weygandt. FINANCIAL STATEMENTS AND A CCOMPANYING NOTES The standard set of financial statements consists of: (1) a comparative income statement for 3 years, (2) a comparative statement of cash flows for 3 years, (3) a comparative balance sheet for 2 years, (4) a statement of stockholders equity for 3 years, and (5) a set of accompanying notes that are considered an integral part of the financial statements. The auditors report, unless stated otherwise, covers the financial statements and the accompanying notes. PepsiCos financial statements and accompanying notes plus supplementary data and analyses follow. A4 Appendix A Specimen Financial Statements: PepsiCo, Inc. Consolidated Statement of Income PepsiCo, Inc. and Subsidiaries Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003 (in millions except per share amounts) Net Revenue........................................................................................................................... Cost of sales........................................................................................................................... Selling, general and administrative expenses ........................................................................ Amortization of intangible assets........................................................................................... Restructuring and impairment charges.................................................................................. Merger-related costs............................................................................................................... Operating Profit ..................................................................................................................... Bottling equity income............................................................................................................ Interest expense...................................................................................................................... Interest income....................................................................................................................... Income from Continuing Operations before Income Taxes ................................................. Provision for Income Taxes................................................................................................... Income from Continuing Operations ..................................................................................... Tax Benefit from Discontinued Operations ........................................................................... Net Income ............................................................................................................................ Net Income per Common Share Basic Continuing operations ....................................................................................................... Discontinued operations.................................................................................................... Total .................................................................................................................................. Net Income per Common Share Diluted Continuing operations ....................................................................................................... Discontinued operations.................................................................................................... Total .................................................................................................................................. * Based on unrounded amounts. See accompanying notes to consolidated financial statements. 2005 $32,562 14,176 12,314 150 5,922 557 (256) 159 6,382 2,304 4,078 $ 4,078 $2.43 $2.43 $2.39 $2.39 2004 $29,261 12,674 11,031 147 150 5,259 380 (167) 74 5,546 1,372 4,174 38 $ 4,212 $2.45 0.02 $2.47 $2.41 0.02 $2.44* 2003 $26,971 11,691 10,148 145 147 59 4,781 323 (163) 51 4,992 1,424 3,568 $ 3,568 $2.07 $2.07 $2.05 $2.05 Net Revenue $32,562 $26,971 $29,261 Operating Profit $5,922 $5,259 $4,781 2003 2004 2005 2003 2004 2005 Income from Continuing Operations $4,174 $3,568 Net Income per Common Share Continuing Operations $2.41 $4,078 $2.05 $2.39 2003 2004 2005 2003 2004 2005 Financial Statements and Accompanying Notes A5 Consolidated Statement of Cash Flows PepsiCo, Inc. and Subsidiaries Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003 (in millions) Operating Activities Net income................................................................................................................................. Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization ............................................................................................. Stock-based compensation expense..................................................................................... Restructuring and impairment charges ............................................................................... Cash payments for merger-related costs and restructuring charges ................................... Tax benefit from discontinued operations............................................................................. Pension and retiree medical plan contributions ................................................................... Pension and retiree medical plan expenses.......................................................................... Bottling equity income, net of dividends .............................................................................. Deferred income taxes and other tax charges and credits ................................................... Merger-related costs............................................................................................................. Other non-cash charges and credits, net ............................................................................. Changes in operating working capital, excluding effects of acquisitions and divestitures Accounts and notes receivable........................................................................................ Inventories ...................................................................................................................... Prepaid expenses and other current assets .................................................................... Accounts payable and other current liabilities................................................................ Income taxes payable...................................................................................................... Net change in operating working capital.............................................................................. Other..................................................................................................................................... Net Cash Provided by Operating Activities .............................................................................. Investing Activities Snack Ventures Europe (SVE) minority interest acquisition ....................................................... Capital spending ....................................................................................................................... Sales of property, plant and equipment..................................................................................... Other acquisitions and investments in noncontrolled affiliates ................................................ Cash proceeds from sale of PBG stock ...................................................................................... Divestitures................................................................................................................................ Short-term investments, by original maturity More than three months purchases ................................................................................ More than three months maturities ................................................................................ Three months or less, net ..................................................................................................... Net Cash Used for Investing Activities ..................................................................................... Financing Activities Proceeds from issuances of long-term debt .............................................................................. Payments of long-term debt ...................................................................................................... Short-term borrowings, by original maturity More than three months proceeds................................................................................... More than three months payments ................................................................................. Three months or less, net ..................................................................................................... Cash dividends paid .................................................................................................................. Share repurchases common ................................................................................................. Share repurchases preferred ................................................................................................ Proceeds from exercises of stock options................................................................................... Net Cash Used for Financing Activities .................................................................................... Effect of exchange rate changes on cash and cash equivalents ............................................... Net Increase/(Decrease) in Cash and Cash Equivalents ......................................................... Cash and Cash Equivalents, Beginning of Year ....................................................................... Cash and Cash Equivalents, End of Year ................................................................................. See accompanying notes to consolidated financial statements. 2005 $ 4,078 1,308 311 (22) (877) 464 (411) 440 145 (272) (132) (56) 188 609 337 79 5,852 (750) (1,736) 88 (345) 214 3 (83) 84 (992) (3,517) 25 (177) 332 (85) 1,601 (1,642) (3,012) (19) 1,099 (1,878) (21) 436 1,280 $ 1,716 2004 $ 4,212 1,264 368 150 (92) (38) (534) 395 (297) (203) 166 (130) (100) (31) 216 (268) (313) (24) 5,054 (1,387) 38 (64) 52 (44) 38 (963) (2,330) 504 (512) 153 (160) 1,119 (1,329) (3,028) (27) 965 (2,315) 51 460 820 $ 1,280 2003 $ 3,568 1,221 407 147 (109) (605) 277 (276) (286) 59 101 (220) (49) 23 (11) 182 (75) (101) 4,328 (1,345) 49 (71) 46 (38) 28 (940) (2,271) 52 (641) 88 (115) 40 (1,070) (1,929) (16) 689 (2,902) 27 (818) 1,638 $ 820 A6 Appendix A Specimen Financial Statements: PepsiCo, Inc. Consolidated Balance Sheet PepsiCo, Inc. and Subsidiaries December 31, 2005 and December 25, 2004 (in millions except per share amounts) ASSETS Current Assets Cash and cash equivalents................................................................................................................................... Short-term investments ........................................................................................................................................ Accounts and notes receivable, net....................................................................................................................... Inventories............................................................................................................................................................. Prepaid expenses and other current assets........................................................................................................... Total Current Assets ....................................................................................................................................... Property, Plant and Equipment, net .................................................................................................................... Amortizable Intangible Assets, net ...................................................................................................................... Goodwill................................................................................................................................................................. Other nonamortizable intangible assets................................................................................................................ Nonamortizable Intangible Assets.................................................................................................................. Investments in Noncontrolled Affiliates .............................................................................................................. Other Assets ......................................................................................................................................................... Total Assets................................................................................................................................................ LIABILITIES AND SHAREHOLDERS EQUITY Current Liabilities Short-term obligations .......................................................................................................................................... Accounts payable and other current liabilities...................................................................................................... Income taxes payable............................................................................................................................................ Total Current Liabilities .................................................................................................................................. Long-Term Debt Obligations................................................................................................................................. Other Liabilities .................................................................................................................................................... Deferred Income Taxes ........................................................................................................................................ Total Liabilities ................................................................................................................................................ Commitments and Contingencies Preferred Stock, no par value ............................................................................................................................. Repurchased Preferred Stock ............................................................................................................................. Common Shareholders Equity Common stock, par value 1 2/3 per share (issued 1,782 shares)....................................................................... Capital in excess of par value............................................................................................................................... Retained earnings ................................................................................................................................................. Accumulated other comprehensive loss ................................................................................................................ Less: repurchased common stock, at cost (126 and 103 shares, respectively) ................................................... Total Common Shareholders Equity .............................................................................................................. Total Liabilities and Shareholders Equity ................................................................................................ See accompanying notes to consolidated financial statements. 2005 2004 $ 1,716 3,166 4,882 3,261 1,693 618 10,454 8,681 530 4,088 1,086 5,174 3,485 3,403 $31,727 $ 1,280 2,165 3,445 2,999 1,541 654 8,639 8,149 598 3,909 933 4,842 3,284 2,475 $27,987 $ 2,889 5,971 546 9,406 2,313 4,323 1,434 17,476 41 (110) $ 1,054 5,599 99 6,752 2,397 4,099 1,216 14,464 41 (90) 30 614 21,116 (1,053) 20,707 (6,387) 14,320 $31,727 30 618 18,730 (886) 18,492 (4,920) 13,572 $27,987 Financial Statements and Accompanying Notes A7 Consolidated Statement of Common Shareholders Equity PepsiCo, Inc. and Subsidiaries Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003 (in millions) Common Stock Capital in Excess of Par Value Balance, beginning of year........................................... Stock-based compensation expense............................. Stock option exercises(a) ............................................... Balance, end of year..................................................... Retained Earnings Balance, beginning of year........................................... Net income ................................................................... Cash dividends declared common .......................... Cash dividends declared preferred ......................... Cash dividends declared RSUs ............................... Other ............................................................................ Balance, end of year..................................................... Accumulated Other Comprehensive Loss Balance, beginning of year .......................................... Currency translation adjustment.................................. Cash flow hedges, net of tax: Net derivative gains/(losses) .................................. Reclassification of (gains)/losses to net income .... Minimum pension liability adjustment, net of tax ............................................................... Unrealized gain on securities, net of tax ...................... Other ............................................................................ Balance, end of year..................................................... Repurchased Common Stock Balance, beginning of year........................................... Share repurchases........................................................ Stock option exercises .................................................. Other ............................................................................ Balance, end of year..................................................... Total Common Shareholders Equity ................................ (103) (54) 31 (126) Shares 1,782 2005 Amount $ 30 618 311 (315) 614 18,730 4,078 (1,684) (3) (5) 21,116 (886) (251) 54 (8) 16 24 (2) (1,053) (4,920) (2,995) 1,523 5 (6,387) $14,320 2005 (77) (58) 32 (103) Shares 1,782 2004 Amount $ 30 548 368 (298) 618 15,961 4,212 (1,438) (3) (2) 18,730 (1,267) 401 (16) 9 (19) 6 (886) (3,376) (2,994) 1,434 16 (4,920) $13,572 2004 $4,212 401 (7) (19) 6 $4,593 (60) (43) 26 (77) Shares 1,782 2003 Amount $ 30 207 407 (66) 548 13,489 3,568 (1,082) (3) (11) 15,961 (1,672) 410 (11) (1) 7 1 (1) (1,267) (2,524) (1,946) 1,096 (2) (3,376) $11,896 2003 $3,568 410 (12) 7 1 (1) $3,973 Comprehensive Income Net income .................................................................. Currency translation adjustment.................................. Cash flow hedges, net of tax........................................ Minimum pension liability adjustment, net of tax ....... Unrealized gain on securities, net of tax ...................... Other ............................................................................ Total Comprehensive Income ........................................... (a) Includes total tax benefit of $125 million in 2005, $183 million in 2004 and $340 million in 2003. See accompanying notes to consolidated financial statements. $4,078 (251) 46 16 24 (2) $3,911 A8 Appendix A Specimen Financial Statements: PepsiCo, Inc. Notes to Consolidated Financial Statements Note 1 Basis of Presentation and Our Divisions Basis of Presentation Our financial statements include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates based on our economic ownership interest. We do not control these other affiliates, as our ownership in these other affiliates is generally less than 50%. Our share of the net income of noncontrolled bottling affiliates is reported in our income statement as bottling equity income. Bottling equity income also includes any changes in our ownership interests of these affiliates. In 2005, bottling equity income includes $126 million of pre-tax gains on our sales of PBG stock. See Note 8 for additional information on our noncontrolled bottling affiliates. Our share of other noncontrolled affiliates is included in division operating profit. Intercompany balances and transactions are eliminated. In 2005, we had an additional week of results (53rd week). Our fiscal year ends on the last Saturday of each December, resulting in an additional week of results every five or six years. In connection with our ongoing BPT initiative, we aligned certain accounting policies across our divisions in 2005. We conformed our methodology for calculating our bad debt reserves and modified our policy for recognizing revenue for products shipped to customers by third-party carriers. Additionally, we conformed our method of accounting for certain costs, primarily warehouse and freight. These changes reduced our net revenue by $36 million and our operating profit by $60 million in 2005. We also made certain reclassifications on our Consolidated Statement of Income in the fourth quarter of 2005 from cost of sales to selling, general and administrative expenses in connection with our BPT initiative. These reclassifications resulted in reductions to cost of sales of $556 million through the third quarter of 2005, $732 million in the full year 2004 and $688 million in the full year 2003, with corresponding increases to selling, general and administrative expenses in those periods. These reclassifications had no net impact on operating profit and have been made to all periods presented for comparability. The preparation of our consolidated financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities. Estimates are used in determining, among other items, sales incentives accruals, future cash flows associated with impairment testing for perpetual brands and goodwill, useful lives for intangible assets, tax reserves, stock-based compensation and pension and retiree medical accruals. Actual results could differ from these estimates. See Our Divisions below and for additional unaudited information on items affecting the comparability of our consolidated results, see Items Affecting Comparability in Managements Discussion and Analysis. Tabular dollars are in millions, except per share amounts. All per share amounts reflect common per share amounts, assume dilution unless noted, and are based on unrounded amounts. Certain reclassifications were made to prior years amounts to conform to the 2005 presentation. Our Divisions We manufacture or use contract manufacturers, market and sell a variety of salty, sweet and grain-based snacks, carbonated and non-carbonated beverages, and foods through our North American and international business divisions. Our North American divisions include the United States and Canada. The accounting policies for the divisions are the same as those described in Note 2, except for certain allocation methodologies for stock-based compensation expense and pension and retiree medical expense, as described in the unaudited information in Our Critical Accounting Policies. Additionally, beginning in the fourth quarter of 2005, we began centrally managing commodity derivatives on behalf of our divisions. Certain of the commodity derivatives, primarily those related to the purchase of energy for use by our divisions, do not qualify for hedge accounting treatment. These derivatives hedge underlying commodity price risk and were not entered into for speculative purposes. Such derivatives are marked to market with the resulting gains and losses recognized as a component of corporate unallocated expense. These gains and losses are reflected in division results when the divisions take delivery of the underlying commodity. Therefore, division results reflect the contract purchase price of the energy or other commodities. Division results are based on how our Chairman and Chief Executive Officer evaluates our divisions. Division results exclude certain Corporate-initiated restructuring and impairment charges, mergerrelated costs and divested businesses. For additional unaudited information on our divisions, see Our Operations in Managements Discussion and Analysis. Financial Statements and Accompanying Notes A9 Frito-Lay North America (FLNA) PepsiCo Beverages North America (PBNA) PepsiCo International (PI) Quaker Foods North America (QFNA) 2005 FLNA...................................................................... PBNA..................................................................... PI ......................................................................... QFNA ..................................................................... Total division ........................................................ Divested businesses ............................................. Corporate .............................................................. Restructuring and impairment charges................ Merger-related costs............................................. Total...................................................................... $10,322 9,146 11,376 1,718 32,562 32,562 $32,562 2004 Net Revenue $ 9,560 8,313 9,862 1,526 29,261 29,261 $29,261 2003 $ 9,091 7,733 8,678 1,467 26,969 2 26,971 $26,971 2005 $2,529 2,037 1,607 537 6,710 (788) 5,922 $5,922 2004 Operating Profit $2,389 1,911 1,323 475 6,098 (689) 5,409 (150) $5,259 2003 $2,242 1,690 1,061 470 5,463 26 (502) 4,987 (147) (59) $4,781 Division Net Revenue QFNA 5% FLNA 32% Division Operating Profit QFNA 8% FLNA 38% PI 35% PI 24% PBNA 28% PBNA 30% Divested Businesses During 2003, we sold our Quaker Foods North America Mission pasta business. The results of this business are reported as divested businesses. Corporate Corporate includes costs of our corporate headquarters, centrally managed initiatives, such as our BPT initiative, unallocated insurance and benefit programs, foreign exchange transaction gains and losses, and certain commodity derivative gains and losses, as well as profit-in-inventory elimination adjustments for our noncontrolled bottling affiliates and certain other items. Restructuring and Impairment Charges and Merger-Related Costs See Note 3. A10 Appendix A Specimen Financial Statements: PepsiCo, Inc. Other Division Information 2005 FLNA PBNA PI QFNA Total division Corporate(a) Investments in bottling affiliates $ 5,948 6,316 9,983 989 23,236 5,331 3,160 $31,727 2004 Total Assets $ 5,476 6,048 8,921 978 21,423 3,569 2,995 $27,987 2003 $ 5,332 5,856 8,109 995 20,292 2,384 2,651 $25,327 2005 $ 512 320 667 31 1,530 206 $1,736 2004 Capital Spending $ 469 265 537 33 1,304 83 $1,387 2003 $ 426 332 521 32 1,311 34 $1,345 (a) Corporate assets consist principally of cash and cash equivalents, short-term investments, and property, plant and equipment. Total Assets Capital Spending QFNA 2% Other 27% FLNA 19% Other 12% FLNA 30% Net Revenue Canada 4% United Kingdom 6% Other 19% QFNA 3% PI 31% PBNA 20% PI 38% PBNA 18% Mexico 10% United States 61% FLNA PBNA PI QFNA Total division Corporate 2005 2004 2003 Amortization of Intangible Assets $3 $3 $3 76 75 75 71 68 66 1 1 150 147 145 $150 $147 $145 2004 2003 Net Revenue(a) $19,937 $18,329 $17,377 3,095 2,724 2,642 1,821 1,692 1,510 1,509 1,309 1,147 6,200 5,207 4,295 $32,562 $29,261 $26,971 2005 2005 2004 2003 Depreciation and Other Amortization $ 419 $ 420 $ 416 264 258 245 420 382 350 34 36 36 1,137 1,096 1,047 21 21 29 $1,158 $1,117 $1,076 2005 2004 2003 Long-Lived Assets(b) $10,723 $10,212 $ 9,907 902 878 869 1,715 1,896 1,724 582 548 508 3,948 3,339 3,123 $17,870 $16,873 $16,131 Long-Lived Assets Other 22% Canada 3% United Kingdom 10% United States 60% Mexico 5% U.S. Mexico United Kingdom Canada All other countries (a) Represents net revenue from businesses operating in these countries. (b) Long-lived assets represent net property, plant and equipment, nonamortizable and net amortizable intangible assets and investments in noncontrolled affiliates. These assets are reported in the country where they are primarily used. Financial Statements and Accompanying Notes A11 Note 2 Our Significant Accounting Policies Revenue Recognition We recognize revenue upon shipment or delivery to our customers based on written sales terms that do not allow for a right of return. However, our policy for direct-storedelivery (DSD) and chilled products is to remove and replace damaged and out-ofdate products from store shelves to ensure that our consumers receive the product quality and freshness that they expect. Similarly, our policy for warehouse distributed products is to replace damaged and out-of-date products. Based on our historical experience with this practice, we have reserved for anticipated damaged and outof-date products. For additional unaudited information on our revenue recognition and related policies, including our policy on bad debts, see Our Critical Accounting Policies in Managements Discussion and Analysis. We are exposed to concentration of credit risk by our customers, Wal-Mart and PBG. Wal-Mart represents approximately 9% of our net revenue, including concentrate sales to our bottlers which are used in finished goods sold by them to Wal-Mart; and PBG represents approximately 10%. We have not experienced credit issues with these customers. Sales Incentives and Other Marketplace Spending We offer sales incentives and discounts through various programs to our customers and consumers. Sales incentives and discounts are accounted for as a reduction of revenue and totaled $8.9 billion in 2005, $7.8 billion in 2004 and $7.1 billion in 2003. While most of these incentive arrangements have terms of no more than one year, certain arrangements extend beyond one year. For example, fountain pouring rights may extend up to 15 years. Costs incurred to obtain these arrangements are recognized over the contract period and the remaining balances of $321 million at December 31, 2005 and $337 million at December 25, 2004 are included in current assets and other assets in our Consolidated Balance Sheet. For additional unaudited information on our sales incentives, see Our Critical Accounting Policies in Managements Discussion and Analysis. Other marketplace spending includes the costs of advertising and other marketing activities and is reported as selling, general and administrative expenses. Advertising expenses were $1.8 billion in 2005, $1.7 billion in 2004 and $1.6 billion in 2003. Deferred advertising costs are not expensed until the year first used and consist of: media and personal service prepayments, promotional materials in inventory, and production costs of future media advertising. Deferred advertising costs of $202 million and $137 million at year-end 2005 and 2004, respectively, are classified as prepaid expenses in our Consolidated Balance Sheet. Distribution Costs Distribution costs, including the costs of shipping and handling activities, are reported as selling, general and administrative expenses. Shipping and handling expenses were $4.1 billion in 2005, $3.9 billion in 2004 and $3.6 billion in 2003. Cash Equivalents Cash equivalents are investments with original maturities of three months or less which we do not intend to rollover beyond three months. Software Costs We capitalize certain computer software and software development costs incurred in connection with developing or obtaining computer software for internal use. Capitalized software costs are included in property, plant and equipment on our Consolidated Balance Sheet and amortized on a straight-line basis over the estimated useful lives of the software, which generally do not exceed 5 years. Net capitalized software and development costs were $327 million at December 31, 2005 and $181 million at December 25, 2004. Commitments and Contingencies We are subject to various claims and contingencies related to lawsuits, taxes and environmental matters, as well as commitments under contractual and other commercial obligations. We recognize liabilities for contingencies and commitments when a loss is probable and estimable. For additional information on our commitments, see Note 9. Other Significant Accounting Policies Our other significant accounting policies are disclosed as follows: Property, Plant and Equipment and Intangible Assets Note 4 and, for additional unaudited information on brands and goodwill, see Our Critical Accounting Policies in Managements Discussion and Analysis. Income Taxes Note 5 and, for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis. Stock-Based Compensation Expense Note 6 and, for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis. Pension, Retiree Medical and Savings Plans Note 7 and, for additional unaudited information, see Our Critical Accounting Policies in Managements Discussion and Analysis. Risk Management Note 10 and, for additional unaudited information, see Our Business Risks in Managements Discussion and Analysis. There have been no new accounting pronouncements issued or effective during 2005 that have had, or are expected to have, a material impact on our consolidated financial statements. A12 Appendix A Specimen Financial Statements: PepsiCo, Inc. Note 3 Restructuring and Impairment Charges and Merger-Related Costs 2005 Restructuring Charges In the fourth quarter of 2005, we incurred a charge of $83 million ($55 million aftertax or $0.03 per share) in conjunction with actions taken to reduce costs in our operations, principally through headcount reductions. Of this charge, $34 million related to FLNA, $21 million to PBNA, $16 million to PI and $12 million to Corporate (recorded in corporate unallocated expenses). Most of this charge related to the termination of approximately 700 employees. We expect the substantial portion of the cash payments related to this charge to be paid in 2006. 2004 and 2003 Restructuring and Impairment Charges In the fourth quarter of 2004, we incurred a charge of $150 million ($96 million after-tax or $0.06 per share) in conjunction with the consolidation of FLNAs manufacturing network as part of its ongoing productivity program. Of this charge, $93 million related to asset impairment, primarily reflecting the closure of four U.S. plants. Production from these plants was redeployed to other FLNA facilities in the U.S. The remaining $57 million included employee-related costs of $29 million, contract termination costs of $8 million and other exit costs of $20 million. Employee-related costs primarily reflect the termination costs for approximately 700 employees. Through December 31, 2005, we have paid $47 million and incurred non-cash charges of $10 million, leaving substantially no accrual. In the fourth quarter of 2003, we incurred a charge of $147 million ($100 million after-tax or $0.06 per share) in conjunction with actions taken to streamline our North American divisions and PepsiCo International. These actions were taken to increase focus and eliminate redundancies at PBNA and PI and to improve the efficiency of the supply chain at FLNA. Of this charge, $81 million related to asset impairment, reflecting $57 million for the closure of a snack plant in Kentucky, the retirement of snack manufacturing lines in Maryland and Arkansas and $24 million for the closure of a PBNA office building in Florida. The remaining $66 million included employeerelated costs of $54 million and facility and other exit costs of $12 million. Employee-related costs primarily reflect the termination costs for approximately 850 sales, distribution, manufacturing, research and marketing employees. As of December 31, 2005, all terminations had occurred and substantially no accrual remains. Merger-Related Costs In connection with the Quaker merger in 2001, we recognized merger-related costs of $59 million ($42 million after-tax or $0.02 per share) in 2003. Note 4 Property, Plant and Equipment and Intangible Assets Average Useful Life Property, plant and equipment, net Land and improvements 10 30 yrs. Buildings and improvements 20 44 Machinery and equipment, including fleet and software 5 15 Construction in progress Accumulated depreciation Depreciation expense Amortizable intangible assets, net Brands Other identifiable intangibles Accumulated amortization Amortization expense 5 40 3 15 2005 $ 685 3,736 11,658 1,066 17,145 (8,464) $ 8,681 $1,103 $1,054 257 1,311 (781) $ 530 $150 2004 $ 646 3,605 10,950 729 15,930 (7,781) $ 8,149 $1,062 $1,008 225 1,233 (635) $ 598 $147 $145 $1,020 2003 Depreciation and amortization are recognized on a straight-line basis over an assets estimated useful life. Land is not depreciated and construction in progress is not depreciated until ready for service. Amortization of intangible assets for each of the next five years, based on average 2005 foreign exchange rates, is expected to be $152 million in 2006, $35 million in 2007, $35 million in 2008, $34 million in 2009 and $33 million in 2010. Depreciable and amortizable assets are only evaluated for impairment upon a significant change in the operating or macroeconomic environment. In these circumstances, if an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is based on discounted future cash flows. Useful lives are periodically evaluated to determine whether events or circumstances have occurred which indicate the need for revision. For additional unaudited information on our amortizable brand policies, see Our Critical Accounting Policies in Managements Discussion and Analysis. Financial Statements and Accompanying Notes A13 Nonamortizable Intangible Assets Perpetual brands and goodwill are assessed for impairment at least annually to ensure that discounted future cash flows continue to exceed the related book value. A perpetual brand is impaired if its book value exceeds its fair value. Goodwill is evaluated for impairment if the book value of its reporting unit exceeds its fair value. A reporting unit can be a division or business within a division. If the fair value of an evaluated asset is less than its book value, the asset is written down based on its discounted future cash flows to fair value. No impairment charges resulted from the required impairment evaluations. The change in the book value of nonamortizable intangible assets is as follows: Balance, Beginning 2004 Frito-Lay North America Goodwill PepsiCo Beverages North America Goodwill Brands PepsiCo International Goodwill Brands Quaker Foods North America Goodwill Corporate Pension intangible Total goodwill Total brands Total pension intangible $ 130 2,157 59 2,216 1,334 808 2,142 175 2 3,796 867 2 $4,665 Acquisition $ 29 29 29 $29 Translation and Other $8 4 4 72 61 133 3 84 61 3 $148 Balance, End of 2004 $ 138 2,161 59 2,220 1,435 869 2,304 175 5 3,909 928 5 $ 4,842 Acquisition $ 278 263 541 278 263 $541 Translation and Other $ 7 3 3 (109) (106) (215) (4) (99) (106) (4) $(209) Balance, End of 2005 $ 145 2,164 59 2,223 1,604 1,026 2,630 175 1 4,088 1,085 1 $5,174 A14 Appendix A Specimen Financial Statements: PepsiCo, Inc. Note 5 Income Taxes 2005 Income before income taxes continuing operations U.S.................................................................................................................................................... Foreign.............................................................................................................................................. Provision for income taxes continuing operations Current: U.S. Federal....................................................................................................................... Foreign .............................................................................................................................. State ................................................................................................................................. Deferred: U.S. Federal ....................................................................................................................... Foreign .............................................................................................................................. State ................................................................................................................................. $3,175 3,207 $6,382 $1,638 426 118 2,182 137 (26) 11 122 $2,304 35.0% 1.4 7.0 (6.5) (0.8) 36.1% $ 993 772 863 135 35 169 2,967 608 426 400 342 520 2,296 (532) 1,764 $1,203 $231 $1,434 $564 (28) (4) $532 2004 $2,946 2,600 $5,546 $1,030 256 69 1,355 11 5 1 17 $1,372 35.0% 0.8 (5.4) (4.8) (0.9) 24.7% $ 850 857 669 153 46 157 2,732 666 402 402 379 460 2,309 (564) 1,745 $ 987 $229 $1,216 $438 118 8 $564 $487 (52) 3 $438 2003 $3,267 1,725 $4,992 $1,326 341 80 1,747 (274) (47) (2) (323) $1,424 35.0% 1.0 (5.5) (2.2) 0.2 28.5% Tax rate reconciliation continuing operations U.S. Federal statutory tax rate .......................................................................................................... State income tax, net of U.S. Federal tax benefit.............................................................................. Taxes on AJCA repatriation................................................................................................................ Lower taxes on foreign results .......................................................................................................... Settlement of prior years audit ........................................................................................................ Other, net.......................................................................................................................................... Annual tax rate ................................................................................................................................. Deferred tax liabilities Investments in noncontrolled affiliates ............................................................................................ Property, plant and equipment ......................................................................................................... Pension benefits ............................................................................................................................... Intangible assets other than nondeductible goodwill....................................................................... Zero coupon notes ............................................................................................................................ Other................................................................................................................................................. Gross deferred tax liabilities............................................................................................................. Deferred tax assets Net carryforwards ............................................................................................................................. Stock-based compensation............................................................................................................... Retiree medical benefits................................................................................................................... Other employee-related benefits....................................................................................................... Other................................................................................................................................................. Gross deferred tax assets ................................................................................................................. Valuation allowances........................................................................................................................ Deferred tax assets, net.................................................................................................................... Net deferred tax liabilities ................................................................................................................ Deferred taxes included within: Prepaid expenses and other current assets.................................................................................. Deferred income taxes .................................................................................................................. Analysis of valuation allowances Balance, beginning of year............................................................................................................... (Benefit)/provision........................................................................................................................ Other (deductions)/additions........................................................................................................ Balance, end of year......................................................................................................................... Financial Statements and Accompanying Notes A15 For additional unaudited information on our income tax policies, including our reserves for income taxes, see Our Critical Accounting Policies in Managements Discussion and Analysis. Carryforwards, Credits and Allowances Operating loss carryforwards totaling $5.1 billion at year-end 2005 are being carried forward in a number of foreign and state jurisdictions where we are permitted to use tax operating losses from prior periods to reduce future taxable income. These operating losses will expire as follows: $0.1 billion in 2006, $4.1 billion between 2007 and 2025 and $0.9 billion may be carried forward indefinitely. In addition, certain tax credits generated in prior periods of approximately $39.4 million are available to reduce certain foreign tax liabilities through 2011. We establish valuation allowances for our deferred tax assets when the amount of expected future taxable income is not likely to support the use of the deduction or credit. Undistributed International Earnings The AJCA created a one-time incentive for U.S. corporations to repatriate undistributed international earnings by providing an 85% dividends received deduction. As approved by our Board of Directors in July 2005, we repatriated approximately $7.5 billion in earnings previously considered indefinitely reinvested outside the U.S. in the fourth quarter of 2005. In 2005, we recorded income tax expense of $460 million associated with this repatriation. Other than the earnings repatriated, we intend to continue to reinvest earnings outside the U.S. for the foreseeable future and, therefore, have not recognized any U.S. tax expense on these earnings. At December 31, 2005, we had approximately $7.5 billion of undistributed international earnings. Reserves A number of years may elapse before a particular matter, for which we have established a reserve, is audited and finally resolved. The number of years with open tax audits varies depending on the tax jurisdiction. During 2004, we recognized $266 million of tax benefits related to the favorable resolution of certain open tax issues. In addition, in 2004, we recognized a tax benefit of $38 million upon agreement with the IRS on an open issue related to our discontinued restaurant operations. At the end of 2003, we entered into agreements with the IRS for open years through 1997. These agreements resulted in a tax benefit of $109 million in the fourth quarter of 2003. As part of these agreements, we also resolved the treatment of certain other issues related to future tax years. The IRS has initiated their audits of our tax returns for the years 1998 through 2002. Our tax returns subsequent to 2002 have not yet been examined. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, we believe that our reserves reflect the probable outcome of known tax contingencies. Settlement of any particular issue would usually require the use of cash. Favorable resolution would be recognized as a reduction to our annual tax rate in the year of resolution. Our tax reserves, covering all federal, state and foreign jurisdictions, are presented in the balance sheet within other liabilities (see Note 14), except for any amounts relating to items we expect to pay in the coming year which are included in current income taxes payable. For further unaudited information on the impact of the resolution of open tax issues, see Other Consolidated Results. Note 6 Stock-Based Compensation Our stock-based compensation program is a broad-based program designed to attract and retain employees while also aligning employees interests with the interests of our shareholders. Employees at all levels participate in our stock-based compensation program. In addition, members of our Board of Directors participate in our stockbased compensation program in connection with their service on our Board. Stock options and RSUs are granted to employees under the shareholder-approved 2003 Long-Term Incentive Plan (LTIP), our only active stock-based plan. Stock-based compensation expense was $311 million in 2005, $368 million in 2004 and $407 million in 2003. Related income tax benefits recognized in earnings were $87 million in 2005, $103 million in 2004 and $114 million in 2003. At yearend 2005, 51 million shares were available for future executive and SharePower grants. For additional unaudited information on our stock-based compensation program, see Our Critical Accounting Policies in Managements Discussion and Analysis. SharePower Grants SharePower options are awarded under our LTIP to all eligible employees, based on job level or classification, and in the case of international employees, tenure as well. All stock option grants have an exercise price equal to the fair market value of our common stock on the day of grant and generally have a 10-year term with vesting after three years. Executive Grants All senior management and certain middle management are eligible for executive grants under our LTIP. All stock option grants have an exercise price equal to the fair market value of our common stock on the day of grant and generally have a 10-year term with vesting after three years. There have been no reductions to the exercise price of previously issued awards, and any repricing of awards would require approval of our shareholders. Beginning in 2004, executives who are awarded long-term incentives based on their performance are offered the choice of stock options or RSUs. RSU expense is based on the fair value of PepsiCo stock on the date of grant and is amortized over the vesting period, generally three years. Each restricted stock unit can be settled in a share of our stock after the vesting period. Executives who elect RSUs receive one RSU for every four stock options that would have otherwise been granted. Senior officers do not have a choice and are granted 50% stock options and 50% RSUs. Vesting of RSU awards for senior officers is contingent upon the achievement of pre-established performance targets. We granted 3 million RSUs in both 2005 and 2004 with weighted-average intrinsic values of $53.83 and $47.28, respectively. A16 Appendix A Specimen Financial Statements: PepsiCo, Inc. Method of Accounting and Our Assumptions We account for our employee stock options under the fair value method of accounting using a Black-Scholes valuation model to measure stock-based compensation expense at the date of grant. We adopted SFAS 123R, Share-Based Payment, under the modified prospective method in the first quarter of 2006. We do not expect our adoption of SFAS 123R to materially impact our financial statements. Our Stock Option Activity(a) Our weighted-average Black-Scholes fair value assumptions include: Expected life Risk free interest rate Expected volatility Expected dividend yield 2005 6 yrs. 3.8% 23% 1.8% 2004 6 yrs. 3.3% 26% 1.8% 2003 6 yrs. 3.1% 27% 1.15% Outstanding at beginning of year Granted Exercised Forfeited/expired Outstanding at end of year Exercisable at end of year 2005 Options Average Price(b) 174,261 $40.05 12,328 53.82 (30,945) 35.40 (5,495) 43.31 150,149 42.03 89,652 40.52 Options 198,173 14,137 (31,614) (6,435) 174,261 94,643 2004 Average Price(b) $38.12 47.47 30.57 43.82 40.05 36.41 2003 Options Average Price(b) 190,432 $36.45 41,630 39.89 (25,833) 26.74 (8,056) 43.56 198,173 38.12 97,663 32.56 Stock options outstanding and exercisable at December 31, 2005(a) Range of Exercise Price $14.40 to $21.54 $23.00 to $33.75 $34.00 to $43.50 $43.75 to $56.75 Options Outstanding Options Average Price(b) Average Life(c) 905 $ 20.01 3.56 yrs. 14,559 30.46 3.07 82,410 39.44 5.34 52,275 49.77 7.17 150,149 42.03 5.67 Options Exercisable Options Average Price(b) Average Life(c) 905 $20.01 3.56 yrs. 14,398 30.50 3.05 48,921 39.19 4.10 25,428 49.48 6.09 89,652 40.52 4.45 (a) Options are in thousands and include options previously granted under Quaker plans. No additional options or shares may be granted under the Quaker plans. (b) Weighted-average exercise price. (c) Weighted-average contractual life remaining. Our RSU Activity(a) Outstanding at beginning of year Granted Converted Forfeited/expired Outstanding at end of year (a) RSUs are in thousands. (b) Weighted-average intrinsic value. (c) Weighted-average contractual life remaining. RSUs 2,922 3,097 (91) (259) 5,669 2005 Average Intrinsic Value(b) $47.30 53.83 48.73 50.51 50.70 Average Life(c) 1.8 yrs. RSUs 3,077 (18) (137) 2,922 2004 Average Intrinsic Value(b) $ 47.28 47.25 47.25 47.30 Average Life(c) 2.2 yrs. Other stock-based compensation data Weighted-average fair value of options granted Total intrinsic value of options/RSUs exercised/converted(a) Total intrinsic value of options/RSUs outstanding(a) Total intrinsic value of options exercisable(a) (a) In thousands. 2005 $13.45 $632,603 $2,553,594 $1,662,198 Stock Options 2004 $12.04 $667,001 $2,062,153 $1,464,926 RSUs 2003 $11.21 $466,719 $1,641,505 $1,348,658 2005 $4,974 $334,931 2004 $914 $151,760 At December 31, 2005, there was $315 million of total unrecognized compensation cost related to nonvested share-based compensation grants. This unrecognized compensation is expected to be recognized over a weighted-average period of 1.6 years. Financial Statements and Accompanying Notes A17 Note 7 Pension, Retiree Medical and Savings Plans Our pension plans cover full-time employees in the U.S. and certain international employees. Benefits are determined based on either years of service or a combination of years of service and earnings. U.S. retirees are also eligible for medical and life insurance benefits (retiree medical) if they meet age and service requirements. Generally, our share of retiree medical costs is capped at specified dollar amounts, which vary based upon years of service, with retirees contributing the remainder of the costs. We use a September 30 measurement date and all plan assets and liabilities are generally reported as of that date. The cost or benefit of plan changes that increase or decrease benefits for prior employee service (prior service cost) is included in expense on a straight-line basis over the average remaining service period of employees expected to receive benefits. The Medicare Act was signed into law in December 2003 and we applied the provisions of the Medicare Act to our plans in 2005 and 2004. The Medicare Act provides a subsidy for sponsors of retiree medical plans who offer drug benefits equivalent to those provided under Medicare. As a result of the Medicare Act, our 2005 and 2004 retiree medical costs were $11 million and $7 million lower, respectively, and our 2005 and 2004 liabilities were reduced by $136 million and $80 million, respectively. We expect our 2006 retiree medical costs to be approximately $18 million lower than they otherwise would have been as a result of the Medicare Act. For additional unaudited information on our pension and retiree medical plans and related accounting policies and assumptions, see Our Critical Accounting Policies in Managements Discussion and Analysis. 2005 Weighted-average assumptions Liability discount rate........................................................ Expense discount rate........................................................ Expected return on plan assets ......................................... Rate of compensation increases........................................ Components of benefit expense Service cost....................................................................... Interest cost...................................................................... Expected return on plan assets ........................................ Amortization of prior service cost/(benefit)....................... Amortization of experience loss......................................... Benefit expense................................................................. Settlement/curtailment loss ............................................. Special termination benefits............................................. Total.................................................................................. 2004 U.S. 6.1% 6.1% 7.8% 4.5% Pension 2003 2005 2004 2003 International 6.1% 6.1% 8.0% 3.9% 6.1% 6.4% 8.0% 3.8% Retiree Medical 2005 2004 2003 5.7% 6.1% 7.8% 4.4% 6.1% 6.7% 8.3% 4.5% 5.1% 6.1% 8.0% 4.1% 5.7% 6.1% 6.1% 6.1% 6.1% 6.7% $ 213 296 (344) 3 106 274 21 $ 295 $ 193 271 (325) 6 81 226 4 19 $ 249 $ 153 245 (305) 6 44 143 4 $ 147 $ 32 55 (69) 1 15 34 $ 34 $ 27 47 (65) 1 9 19 1 1 $ 21 $ 24 39 (54) 5 14 $ 14 $ 40 78 (11) 26 133 2 $135 $ 38 72 (8) 19 121 4 $125 $ 33 73 (3) 13 116 $116 A18 Appendix A Specimen Financial Statements: PepsiCo, Inc. 2005 U.S. Change in projected benefit liability Liability at beginning of year Service cost Interest cost Plan amendments Participant contributions Experience loss/(gain) Benefit payments Settlement/curtailment loss Special termination benefits Foreign currency adjustment Other Liability at end of year Liability at end of year for service to date Change in fair value of plan assets Fair value at beginning of year Actual return on plan assets Employer contributions/funding Participant contributions Benefit payments Settlement/curtailment loss Foreign currency adjustment Other Fair value at end of year $4,968 213 296 517 (241) 21 (3) $5,771 $4,783 $4,152 477 699 (241) (1) $5,086 2004 Pension 2005 2004 International $ 952 32 55 3 10 203 (28) (68) 104 $1,263 $1,047 $ 838 142 104 10 (28) (61) 94 $1,099 $(164) 17 474 4 $ 331 $367 1 (41) 4 $331 $194 2 7 (73) (15) (22) $ 93 $(65) $(84) $33 $758 27 47 1 9 73 (29) (2) 1 67 $952 $779 $687 77 37 9 (29) (2) 59 $838 $(113) 13 380 7 $ 287 $294 5 (37) 25 $287 $4 65 4 (12) (9) 26 $ 78 $(191) $(227) $161 Retiree Medical 2005 2004 $4,456 193 271 (17) 261 (205) (9) 18 $4,968 $4,164 $3,558 392 416 (205) (9) $4,152 $ (817) 9 2,013 5 $1,210 $1,572 (387) 25 $1,210 $ 196 65 (67) (81) (5) $108 $1,319 40 78 (8) (45) (74) 2 $1,312 $1,264 38 72 (41) 58 (76) 4 $1,319 $ 74 (74) $ $(1,312) (113) 402 19 $(1,004) $ (1,004) $(1,004) $ 61 (54) (26) (52) $(71) $(1,312) $(1,312) $ $ 76 (76) $ $(1,319) (116) 473 19 $ (943) $ (943) $(943) $ 109 31 (19) (82) $ 39 $(1,319) $(1,319) $ Funded status as recognized in our Consolidated Balance Sheet Funded status at end of year $ (685) 5 Unrecognized prior service cost/(benefit) 2,288 Unrecognized experience loss Fourth quarter benefit payments 5 Net amounts recognized $1,613 Net amounts as recognized in our Consolidated Balance Sheet Other assets $2,068 Intangible assets Other liabilities (479) Accumulated other comprehensive loss 24 Net amounts recognized $1,613 Components of increase in unrecognized experience loss Decrease in discount rate $ 365 57 Employee-related assumption changes 95 Liability-related experience different from assumptions (133) Actual asset return different from expected return (106) Amortization of losses Other, including foreign currency adjustments and 2003 Medicare Act (3) Total $ 275 Selected information for plans with liability for service to date in excess of plan assets Liability for service to date $ (374) $(320) Projected benefit liability $ (815) $(685) Fair value of plan assets $8 $11 Of the total projected pension benefit liability at year-end 2005, $765 million relates to plans that we do not fund because the funding of such plans does not receive favorable tax treatment. Financial Statements and Accompanying Notes A19 Future Benefit Payments Our estimated future benefit payments are as follows: Pension Retiree medical 2006 $235 $85 2007 $255 $90 2008 $275 $90 2009 $300 $95 2010 $330 $100 2011-15 $2,215 $545 These future benefits to beneficiaries include payments from both funded and unfunded pension plans. Pension Assets The expected return on pension plan assets is based on our historical experience, our pension plan investment guidelines, and our expectations for long-term rates of return. We use a market-related value method that recognizes each years asset gain or loss over a five-year period. Therefore, it takes five years for the gain or loss from any one year to be fully included in the value of pension plan assets that is used to calculate the expected return. Our pension plan investment guidelines are established based upon an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments. Our investment objective is to ensure that funds are available to meet the plans benefit obligations when they are due. Our investment strategy is to prudently invest plan assets in high-quality and diversified equity and debt securities to achieve our long-term return expectation. Our target allocation and actual pension plan asset allocations for the plan years 2005 and 2004, are below. Pension assets include approximately 5.5 million shares of PepsiCo common stock with a market value of $311 million in 2005, and 5.5 million shares with a market value of $267 million in 2004. Our investment policy limits the investment in PepsiCo stock at the time of investment to 10% of the fair value of plan assets. Asset Category Equity securities Debt securities Other, primarily cash Total Target Allocation 60% 40% 100% Actual Allocation 2005 2004 60% 60% 39% 39% 1% 1% 100% 100% Retiree Medical Cost Trend Rates An average increase of 10% in the cost of covered retiree medical benefits is assumed for 2006. This average increase is then projected to decline gradually to 5% in 2010 and thereafter. These assumed health care cost trend rates have an impact on the retiree medical plan expense and liability. However, the cap on our share of retiree medical costs limits the impact. A 1 percentage point change in the assumed health care trend rate would have the following effects: 2005 service and interest cost components 2005 benefit liability 1% Increase $3 $38 1% Decrease $(2) $(33) Savings Plans Our U.S. employees are eligible to participate in 401(k) savings plans, which are voluntary defined contribution plans. The plans are designed to help employees accumulate additional savings for retirement. We make matching contributions on a portion of eligible pay based on years of service. In 2005 and 2004, our matching contributions were $52 million and $35 million, respectively. Note 8 Noncontrolled Bottling Affiliates Our most significant noncontrolled bottling affiliates are PBG and PAS. Approximately 10% of our net revenue in 2005, 2004 and 2003 reflects sales to PBG. The Pepsi Bottling Group In addition to approximately 41% and 42% of PBGs outstanding common stock that we own at year-end 2005 and 2004, respectively, we own 100% of PBGs class B common stock and approximately 7% of the equity of Bottling Group, LLC, PBGs principal operating subsidiary. This gives us economic ownership of approximately 45% and 46% of PBGs combined operations at year-end 2005 and 2004, respectively. In 2005, bottling equity income includes $126 million of pre-tax gains on our sales of PBG stock. A20 Appendix A Specimen Financial Statements: PepsiCo, Inc. PBGs summarized financial information is as follows: Current assets Noncurrent assets Total assets Current liabilities Noncurrent liabilities Minority interest Total liabilities Our investment Net revenue Gross profit Operating profit Net income 2005 $ 2,412 9,112 $11,524 $2,598 6,387 496 $9,481 $1,738 $11,885 $5,632 $1,023 $466 2004 $ 2,183 8,754 $10,937 $1,725 6,818 445 $8,988 $1,594 $10,906 $5,250 $976 $457 2003 $10,265 $5,050 $956 $416 Our investment in PBG, which includes the related goodwill, was $400 million and $321 million higher than our ownership interest in their net assets at year-end 2005 and 2004, respectively. Based upon the quoted closing price of PBG shares at year-end 2005 and 2004, the calculated market value of our shares in PBG, excluding our investment in Bottling Group, LLC, exceeded our investment balance by approximately $1.5 billion and $1.7 billion, respectively. PepsiAmericas At year-end 2005 and 2004, we owned approximately 43% and 41% of PepsiAmericas, respectively, and their summarized financial information is as follows: Current assets Noncurrent assets Total assets Current liabilities Noncurrent liabilities Total liabilities Our investment Net revenue Gross profit Operating profit Net income 2005 $ 598 3,456 $4,054 $ 722 1,763 $2,485 $968 $3,726 $1,562 $393 $195 2004 $ 530 3,000 $3,530 $ 521 1,386 $1,907 $924 $3,345 $1,423 $340 $182 2003 $3,237 $1,360 $316 $158 Our investment in PAS, which includes the related goodwill, was $292 million and $253 million higher than our ownership interest in their net assets at year-end 2005 and 2004, respectively. Based upon the quoted closing price of PAS shares at year-end 2005 and 2004, the calculated market value of our shares in PepsiAmericas exceeded our investment balance by approximately $364 million and $277 million, respectively. In January 2005, PAS acquired a regional bottler, Central Investment Corporation. The table above includes the results of Central Investment Corporation from the transaction date forward. Related Party Transactions Our significant related party transactions involve our noncontrolled bottling affiliates. We sell concentrate to these affiliates, which is used in the production of carbonated soft drinks and non-carbonated bever- ages. We also sell certain finished goods to these affiliates and we receive royalties for the use of our trademarks for certain products. Sales of concentrate and finished goods are reported net of bottler funding. For further unaudited information on these bottlers, see Our Customers in Managements Discussion and Analysis. These transactions with our bottling affiliates are reflected in our consolidated financial statements as follows: Net revenue Selling, general and administrative expenses Accounts and notes receivable Accounts payable and other current liabilities Such amounts are settled on terms consistent with other trade receivables and payables. See Note 9 regarding our guarantee of certain PBG debt. In addition, we coordinate, on an aggregate basis, the negotiation and purchase of sweeteners and other raw materials 2005 $4,633 $143 $178 $117 2004 $ 4,170 $114 $157 $95 2003 $3,699 $128 requirements for certain of our bottlers with suppliers. Once we have negotiated the contracts, the bottlers order and take delivery directly from the supplier and pay the suppliers directly. Consequently, these transactions are not reflected in our consolidated financial statements. As the contracting party, we could be liable to these suppliers in the event of any nonpayment by our bottlers, but we consider this exposure to be remote. Financial Statements and Accompanying Notes A21 Note 9 Debt Obligations and Commitments 2005 Short-term debt obligations Current maturities of long-term debt Commercial paper (3.3% and 1.6%) Other borrowings (7.4% and 6.6%) Amounts reclassified to long-term debt Long-term debt obligations Short-term borrowings, reclassified Notes due 2006-2026 (5.4% and 4.7%) Zero coupon notes, $475 million due 2006-2012 (13.4%) Other, due 2006-2014 (6.3% and 6.2%) Less: current maturities of long-term debt obligations The interest rates in the above table reflect weighted-average rates as of year-end. 2004 $ 160 1,287 357 (750) $1,054 $ 750 1,274 321 212 2,557 (160) $2,397 $ 143 3,140 356 (750) $2,889 $ 750 1,161 312 233 2,456 (143) $2,313 At December 31, 2005, approximately 78% of total debt, after the impact of the associated interest rate swaps, was exposed to variable interest rates, compared to 67% at December 25, 2004. In addition to variable rate long-term debt, all debt with maturities of less than one year is categorized as variable for purposes of this measure. Cross Currency Interest Rate Swaps In 2004, we entered into a cross currency interest rate swap to hedge the currency exposure on U.S. dollar denominated debt of $50 million held by a foreign affiliate. The terms of this swap match the terms of the debt it modifies. The swap matures in 2008. The unrecognized gain related to this swap was less than $1 million at December 31, 2005, resulting in a U.S. dollar liability of $50 million. At December 25, 2004, the unrecognized loss related to this swap was $3 million, resulting in a U.S. dollar liability of $53 million. We have also entered into cross currency interest rate swaps to hedge the currency exposure on U.S. dollar denominated intercompany debt of $125 million. The terms of the swaps match the terms of the debt they modify. The swaps mature over the next two years. The net unrecognized gain related to these swaps was $5 million at December 31, 2005. The net unrecognized loss related to these swaps was less than $1 million at December 25, 2004. Short-term borrowings are reclassified to long-term when we have the intent and ability, through the existence of the unused lines of credit, to refinance these borrowings on a long-term basis. At year-end 2005, we maintained $2.1 billion in corporate lines of credit subject to normal banking terms and conditions. These credit facilities support short-term debt issuances and remained unused as of December 31, 2005. Of the $2.1 billion, $1.35 billion expires in May 2006 with the remaining $750 million expiring in June 2009. In addition, $181 million of our debt was outstanding on various lines of credit maintained for our international divisions. Long-Term Contractual Commitments These lines of credit are subject to normal banking terms and conditions and are committed to the extent of our borrowings. Interest Rate Swaps We entered into interest rate swaps in 2004 to effectively convert the interest rate of a specific debt issuance from a fixed rate of 3.2% to a variable rate. The variable weighted-average interest rate that we pay is linked to LIBOR and is subject to change. The notional amount of the interest rate swaps outstanding at December 31, 2005 and December 25, 2004 was $500 million. The terms of the interest rate swaps match the terms of the debt they modify. The swaps mature in 2007. Payments Due by Period Long-term debt obligations(a) .......................................................... Operating leases ............................................................................. Purchasing commitments(b) ............................................................ Marketing commitments.................................................................. Other commitments......................................................................... (a) Excludes current maturities of long-term debt of $143 million which are classified within current liabilities. Total $2,313 769 4,533 1,487 99 $9,201 $ 2006 187 1,169 412 82 $1,850 2007-2008 $1,052 253 1,630 438 10 $3,383 2009-2010 2011 and beyond $ 876 $ 385 132 197 775 959 381 256 6 1 $2,170 $1,798 (b) Includes approximately $13 million of long-term commitments which are reflected in other liabilities in our Consolidated Balance Sheet. The above table reflects non-cancelable commitments as of December 31, 2005 based on year-end foreign exchange rates. A22 Appendix A Specimen Financial Statements: PepsiCo, Inc. Most long-term contractual commitments, except for our long-term debt obligations, are not recorded in our Consolidated Balance Sheet. Non-cancelable operating leases primarily represent building leases. Non-cancelable purchasing commitments are primarily for oranges and orange juices to be used for our Tropicana brand beverages. Non-cancelable marketing commitments primarily are for sports marketing and with our fountain customers. Bottler funding is not reflected in our long-term contractual commitments as it is negotiated on an annual basis. See Note 7 regarding our pension and retiree medical obligations and discussion below regarding our commitments to noncontrolled bottling affiliates and former restaurant operations. Off-Balance Sheet Arrangements It is not our business practice to enter into off-balance sheet arrangements, other than in the normal course of business, nor is it our policy to issue guarantees to our bottlers, noncontrolled affiliates or third parties. However, certain guarantees were necessary to facilitate the separation of our bottling and restaurant operations from us. In connection with these transactions, we have guaranteed $2.3 billion of Bottling Group, LLCs long-term debt through 2012 and $28 million of YUM! Brands, Inc. (YUM) outstanding obligations, primarily property leases, through 2020. The terms of our Bottling Group, LLC debt guarantee are intended to preserve the structure of PBGs separation from us and our payment obligation would be triggered if Bottling Group, LLC failed to perform under these debt obligations or the structure significantly changed. Our guarantees of certain obligations ensured YUMs continued use of certain properties. These guarantees would require our cash payment if YUM failed to perform under these lease obligations. See Our Liquidity, Capital Resources and Financial Position in Managements Discussion and Analysis for further unaudited information on our borrowings. Note 10 Risk Management We are exposed to the risk of loss arising from adverse changes in: commodity prices, affecting the cost of our raw materials and energy, foreign exchange risks, interest rates, stock prices, and discount rates affecting the measurement of our pension and retiree medical liabilities. In the normal course of business, we manage these risks through a variety of strategies, including the use of derivatives. Certain derivatives are designated as either cash flow or fair value hedges and qualify for hedge accounting treatment, while others do not qualify and are marked to market through earnings. See Our Business Risks in Managements Discussion and Analysis for further unaudited information on our business risks. For cash flow hedges, changes in fair value are deferred in accumulated other comprehensive loss within shareholders equity until the underlying hedged item is recognized in net income. For fair value hedges, changes in fair value are recognized immediately in earnings, consistent with the underlying hedged item. Hedging transactions are limited to an underlying exposure. As a result, any change in the value of our derivative instruments would be substantially offset by an opposite change in the value of the underlying hedged items. Hedging ineffectiveness and a net earnings impact occur when the change in the value of the hedge does not offset the change in the value of the underlying hedged item. If the derivative instrument is terminated, we continue to defer the related gain or loss and include it as a component of the cost of the underlying hedged item. Upon determination that the underlying hedged item will not be part of an actual transaction, we recognize the related gain or loss in net income in that period. We also use derivatives that do not qualify for hedge accounting treatment. We account for such derivatives at market value with the resulting gains and losses reflected in our income statement. We do not use derivative instruments for trading or speculative purposes and we limit our exposure to individual counterparties to manage credit risk. Commodity Prices We are subject to commodity price risk because our ability to recover increased costs through higher pricing may be limited in the competitive environment in which we operate. This risk is managed through the use of fixed-price purchase orders, pricing agreements, geographic diversity and derivatives. We use derivatives, with terms of no more than two years, to economically hedge price fluctuations related to a portion of our anticipated commodity purchases, primarily for natural gas and diesel fuel. For those derivatives that are designated as cash flow hedges, any ineffectiveness is recorded immediately. However, our commodity cash flow hedges have not had any significant ineffectiveness for all periods presented. We classify both the earnings and cash flow impact from these derivatives consistent with the underlying hedged item. During the next 12 months, we expect to reclassify gains of $24 million related to cash flow hedges from accumulated other comprehensive loss into net income. Foreign Exchange Our operations outside of the U.S. generate over a third of our net revenue of which Mexico, the United Kingdom and Canada comprise nearly 20%. As a result, we are exposed to foreign currency risks from unforeseen economic changes and political unrest. On occasion, we enter into hedges, primarily forward contracts with terms of no more than two years, to reduce the effect of foreign exchange rates. Ineffectiveness on these hedges has not been material. Interest Rates We centrally manage our debt and investment portfolios considering investment opportunities and risks, tax consequences and overall financing strategies. We may use interest rate and cross currency interest rate swaps to manage our overall interest expense and foreign exchange risk. These instruments effectively change the interest rate and currency of specific debt issuances. These swaps are entered into Financial Statements and Accompanying Notes A23 concurrently with the issuance of the debt that they are intended to modify. The notional amount, interest payment and maturity date of the swaps match the principal, interest payment and maturity date of the related debt. These swaps are entered into only with strong creditworthy counterparties, are settled on a net basis and are of relatively short duration. Stock Prices The portion of our deferred compensation liability that is based on certain market indices and on our stock price is subject to market risk. We hold mutual fund investments and prepaid forward contracts to manage this risk. Changes in the fair value of these investments and contracts are recognized immediately in earnings and are offset by changes in the related compensation liability. Fair Value All derivative instruments are recognized in our Consolidated Balance Sheet at fair value. The fair value of our derivative instruments is generally based on quoted market prices. Book and fair values of our derivative and financial instruments are as follows: 2005 Book Value Assets Cash and cash equivalents(a) .................................................................................. Short-term investments(b) ........................................................................................ Forward exchange contracts(c) ................................................................................. Commodity contracts(d) ............................................................................................ Prepaid forward contract(e) ...................................................................................... Cross currency interest rate swaps(f) ....................................................................... Liabilities Forward exchange contracts(c) ................................................................................. Commodity contracts(d) ............................................................................................ Debt obligations....................................................................................................... Interest rate swaps(g) ............................................................................................... Cross currency interest rate swaps(f) ...................................................................... (a) Book value approximates fair value due to the short maturity. 2004 Fair Value $1,716 $3,166 $19 $41 $107 $6 $15 $3 $5,378 $9 $ Book Value $1,280 $2,165 $8 $7 $120 $ $35 $8 $3,451 $1 $3 Fair Value $1,280 $2,165 $8 $7 $120 $ $35 $8 $3,676 $1 $3 $1,716 $3,166 $19 $41 $107 $6 $15 $3 $5,202 $9 $ Included in our Consolidated Balance Sheet under the captions noted above or as indicated below. In addition, derivatives are designated as accounting hedges unless otherwise noted below. (b) Principally short-term time deposits and includes $124 million at December 31, 2005 and $118 million at December 25, 2004 of mutual fund investments used to manage a portion of market risk arising from our deferred compensation liability. (c) 2005 asset includes $14 million related to derivatives not designated as accounting hedges. Assets are reported within current assets and other assets and liabilities are reported within current liabilities and other liabilities. (d) 2005 asset includes $2 million related to derivatives not designated as accounting hedges and the liability relates entirely to derivatives not designated as accounting hedges. Assets are reported within current assets and other assets and liabilities are reported within current liabilities and other liabilities. (e) Included in current assets and other assets. (f) Asset included within other assets and liability included in long-term debt. (g) Reported in other liabilities. This table excludes guarantees, including our guarantee of $2.3 billion of Bottling Group, LLCs long-term debt. The guarantee had a fair value of $47 million at December 31, 2005 and $46 million at December 25, 2004 based on an external estimate of the cost to us of transferring the liability to an independent financial institution. See Note 9 for additional information on our guarantees. Note 11 Net Income per Common Share from Continuing Operations Basic net income per common share is net income available to common shareholders divided by the weighted average of common shares outstanding during the period. Diluted net income per common share is calculated using the weighted average of common shares outstanding adjusted to include the effect that would occur if in-the-money employee stock options were exercised and RSUs and preferred shares were converted into common shares. Options to purchase 3.0 million shares in 2005, 7.0 million shares in 2004 and 49.0 million shares in 2003 were not included in the calculation of diluted earnings per common share because these options were out-of-the-money. Out-of-themoney options had average exercise prices of $53.77 in 2005, $52.88 in 2004 and $48.27 in 2003. A24 Appendix A Specimen Financial Statements: PepsiCo, Inc. The computations of basic and diluted net income per common share from continuing operations are as follows: 2005 Net income Preferred shares: Dividends Redemption premium Net income available for common shareholders Basic net income per common share Net income available for common shareholders Dilutive securities: Stock options and RSUs ESOP convertible preferred stock Unvested stock awards Diluted Diluted net income per common share (a) Weighted-average common shares outstanding. 2004 Shares(a) Income $4,174 (3) (22) $4,149 $2.45 1,669 35 2 1,706 $4,149 24 $4,173 $2.41 1,696 31 2 1,729 Shares(a) Income $3,568 (3) (12) $3,553 $2.07 $3,553 15 $3,568 $2.05 2003 Shares(a) Income $4,078 (2) (16) $4,060 $2.43 $4,060 18 $4,078 $2.39 1,669 1,696 1,718 1,718 17 3 1 1,739 Note 12 Preferred and Common Stock As of December 31, 2005 and December 25, 2004, there were 3.6 billion shares of common stock and 3 million shares of convertible preferred stock authorized. The preferred stock was issued only for an employee stock ownership plan (ESOP) established by Quaker and these shares are redeemable for common stock by the ESOP participants. The preferred stock accrues dividends at an annual rate of $5.46 per share. At year-end 2005 and 2004, there were 803,953 preferred shares issued and 354,853 and 424,853 shares outstanding, respectively. Each share is convertible at the option of the holder into 4.9625 shares of common stock. The preferred shares may be called by us upon written notice at $78 per share plus accrued and unpaid dividends. As of December 31, 2005, 0.3 million outstanding shares of preferred stock with a fair value of $104 million and 17 million shares of common stock were held in the accounts of ESOP participants. As of December 25, 2004, 0.4 million outstanding shares of preferred stock with a fair value of $110 million and 18 million shares of common stock were held in the accounts of ESOP participants. Quaker made the final award to its ESOP plan in June 2001. 2005 Preferred stock Repurchased preferred stock Balance, beginning of year Redemptions Balance, end of year *Does not sum due to rounding. 2004 Amount $41 $ 90 19 $110* Shares 0.8 0.3 0.1 0.4 Amount $41 $63 27 $90 Shares 0.8 0.2 0.1 0.3 2003 Amount $41 $48 15 $63 Shares 0.8 0.4 0.1 0.5 Note 13 Accumulated Other Comprehensive Loss Comprehensive income is a measure of income which includes both net income and other comprehensive income or loss. Other comprehensive loss results from items deferred on the balance sheet in shareholders equity. Other comprehensive (loss)/income was $(167) million in 2005, $381 million in 2004, and $405 million in 2003. The accumulated balances for each component of other comprehensive loss were as follows: Currency translation adjustment Cash flow hedges, net of tax(a) Minimum pension liability adjustment(b) Unrealized gain on securities, net of tax Other Accumulated other comprehensive loss 2005 $ (971) 27 (138) 31 (2) $(1,053) 2004 $(720) (19) (154) 7 $(886) 2003 $(1,121) (12) (135) 1 $(1,267) (a) Includes net commodity gains of $55 million in 2005. Also includes no impact in 2005, $6 million gain in 2004 and $8 million gain in 2003 for our share of our equity investees accumulated derivative activity. Deferred gains/(losses) reclassified into earnings were $8 million in 2005, $(10) million in 2004 and no impact in 2003. (b) Net of taxes of $72 million in 2005, $77 million in 2004 and $67 million in 2003. Also, includes $120 million in 2005, $121 million in 2004 and $110 million in 2003 for our share of our equity investees minimum pension liability adjustments. Financial Statements and Accompanying Notes A25 Note 14 Supplemental Financial Information 2005 Accounts receivable Trade receivables ..................................................... Other receivables ..................................................... Allowance, beginning of year ................................... Net amounts (credited)/charged to expense ........ Deductions(a) ........................................................ Other(b) ................................................................. Allowance, end of year ............................................. Net receivables ........................................................ Inventory(c) Raw materials.......................................................... Work-in-process ....................................................... Finished goods ......................................................... Accounts payable and other current liabilities Accounts payable ..................................................... Accrued marketplace spending................................ Accrued compensation and benefits ........................ Dividends payable.................................................... Insurance accruals .................................................. Other current liabilities............................................ Other liabilities Reserves for income taxes........................................ Other ........................................................................ Other supplemental information Rent expense............................................................ Interest paid ............................................................ Income taxes paid, net of refunds............................ Acquisitions(d) Fair value of assets acquired............................... Cash paid and debt issued.................................. SVE minority interest eliminated.......................... Liabilities assumed.............................................. (a) Includes accounts written off. (b) Includes collections of previously written-off accounts and currency translation effects. (c) Inventories are valued at the lower of cost or market. Cost is determined using the average, first-in, first-out (FIFO) or last-in, first-out (LIFO) methods. Approximately 17% in 2005 and 15% in 2004 of the inventory cost was computed using the LIFO method. The differences between LIFO and FIFO methods of valuing these inventories were not material. (d) In 2005, these amounts include the impact of our acquisition of General Mills, Inc.s 40.5% ownership interest in SVE for $750 million. The excess of our purchase price over the fair value of net assets acquired is $250 million and is included in goodwill. We also reacquired rights to distribute global brands for $263 million which is included in other nonamortizable intangible assets. 2004 $2,505 591 3,096 105 18 (25) (1) 97 $2,999 $ 665 156 720 $1,541 $1,731 1,285 961 387 131 1,104 $5,599 $1,567 2,532 $4,099 $245 $137 $1,833 $ 78 (64) $ 14 2003 $2,718 618 3,336 97 (1) (22) 1 75 $3,261 $ 738 112 843 $1,693 $1,799 1,383 1,062 431 136 1,160 $5,971 $1,884 2,439 $4,323 $228 $213 $1,258 $ 1,089 (1,096) 216 $ 209 $116 32 (43) $105 $231 $147 $1,530 $178 (71) $107 A26 Appendix A Specimen Financial Statements: PepsiCo, Inc. ADDITIONAL INFORMATION In addition to the financial statements and accompanying notes, companies are required to provide a report on internal control over financial reporting and to have an auditors report on the financial statements. In addition, PepsiCo has provided a report indicating that financial reporting is managements responsibility. Finally, PepsiCo also provides selected financial data it believes is useful. The two required reports are further explained below. Managements Report on Internal Control over Financial Reporting The Sarbanes-Oxley Act of 2002 requires managers of publicly traded companies to establish and maintain systems of internal control over the companys financial reporting processes. In addition, management must express its responsibility for financial reporting, and it must provide certifications regarding the accuracy of the financial statements. Auditors Report All publicly held corporations, as well as many other enterprises and organizations engage the services of independent certified public accountants for the purpose of obtaining an objective, expert report on their financial statements. Based on a comprehensive examination of the companys accounting system, accounting records, and the financial statements, the outside CPA issues the auditors report. The standard auditors report identifies who and what was audited and indicates the responsibilities of management and the auditor relative to the financial statements. It states that the audit was conducted in accordance with generally accepted auditing standards and discusses the nature and limitations of the audit. It then expresses an informed opinion as to (1) the fairness of the financial statements and (2) their conformity with generally accepted accounting principles. It also expresses an opinion regarding the effectiveness of the companys internal controls. All of this additional information for PepsiCo is provided on the following pages. Additional Information A27 Managements Responsibility for Financial Reporting To Our Shareholders: At PepsiCo, our actions the actions of all our associates are governed by our Worldwide Code of Conduct. This code is clearly aligned with our stated values a commitment to sustained growth, through empowered people, operating with responsibility and building trust. Both the code and our core values enable us to operate with integrity both within the letter and the spirit of the law. Our code of conduct is reinforced consistently at all levels and in all countries. We have maintained strong governance policies and practices for many years. The management of PepsiCo is responsible for the objectivity and integrity of our consolidated financial statements. The Audit Committee of the Board of Directors has engaged independent registered public accounting firm, KPMG LLP, to audit our consolidated financial statements and they have expressed an unqualified opinion. We are committed to providing timely, accurate and understandable information to investors. Our commitment encompasses the following: Maintaining strong controls over financial reporting. Our system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in their report titled, Internal Control Integrated Framework. The system is designed to provide reasonable assurance that transactions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the U.S. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal controls are reinforced through our Worldwide Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law. Exerting rigorous oversight of the business. We continuously review our business results and strategies. This encompasses financial discipline in our strategic and daily business decisions. Our Executive Committee is actively involved from understanding strategies and alternatives to reviewing key initiatives and financial performance. The intent is to ensure we remain objective in our assessments, constructively challenge our approach to potential business opportunities and issues, and monitor results and controls. Engaging strong and effective Corporate Governance from our Board of Directors. We have an active, capable and diligent Board that meets the required standards for independence, and we welcome the Boards oversight as a representative of our shareholders. Our Audit Committee comprises independent directors with the financial literacy, knowledge and experience to provide appropriate oversight. We review our critical accounting policies, financial reporting and internal control matters with them and encourage their direct communication with KPMG LLP, with our General Auditor, and with our General Counsel. In 2005, we named a senior compliance officer to lead and coordinate our compliance policies and practices. Providing investors with financial results that are complete, transparent and understandable. The consolidated financial statements and financial information included in this report are the responsibility of management. This includes preparing the financial statements in accordance with accounting principles generally accepted in the U.S., which require estimates based on managements best judgment. PepsiCo has a strong history of doing whats right. We realize that great companies are built on trust, strong ethical standards and principles. Our financial results are delivered from that culture of accountability, and we take responsibility for the quality and accuracy of our financial reporting. Peter A. Bridgman Senior Vice President and Controller Indra K. Nooyi President and Chief Financial Officer Steven S Reinemund Chairman of the Board and Chief Executive Officer A28 Appendix A Specimen Financial Statements: PepsiCo, Inc. Managements Report on Internal Control over Financial Reporting To Our Shareholders: Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) of the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based upon the framework in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that evaluation, our management concluded that our internal control over financial reporting is effective as of December 31, 2005. KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report and, as part of their audit, has issued their report, included herein, (1) on our managements assessment of the effectiveness of our internal controls over financial reporting and (2) on the effectiveness of our internal control over financial reporting. Peter A. Bridgman Senior Vice President and Controller Indra K. Nooyi President and Chief Financial Officer Steven S Reinemund Chairman of the Board and Chief Executive Officer Additional Information A29 Report of Independent Registered Public Accounting Firm Board of Directors and Shareholders PepsiCo, Inc.: We have audited the accompanying Consolidated Balance Sheet of PepsiCo, Inc. and Subsidiaries as of December 31, 2005 and December 25, 2004 and the related Consolidated Statements of Income, Cash Flows and Common Shareholders Equity for each of the years in the three-year period ended December 31, 2005. We have also audited managements assessment, included in Managements Report on Internal Control over Financial Reporting, that PepsiCo, Inc. and Subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). PepsiCo, Inc.s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these consolidated financial statements, an opinion on managements assessment, and an opinion on the effectiveness of PepsiCo, Inc.s internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of PepsiCo, Inc. and Subsidiaries as of December 31, 2005 and December 25, 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with United States generally accepted accounting principles. Also, in our opinion, managements assessment that PepsiCo, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control Integrated Framework issued by COSO. Furthermore, in our opinion, PepsiCo, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control Integrated Framework issued by COSO. KPMG LLP New York, New York February 24, 2006 A30 Appendix A Specimen Financial Statements: PepsiCo, Inc. Selected Financial Data Quarterly Net revenue 2005 2004 Gross profit(a) 2005 2004 2005 restructuring charges(b) 2005 2004 restructuring and impairment charges(c) 2004 AJCA tax charge(d) 2005 Net income(e) 2005 2004 Net income per common share basic(e) 2005 2004 Net income per common share diluted(e) 2005 2004 Cash dividends declared per common share 2005 2004 2005 stock price per share(f) High Low Close 2004 stock price per share(f) High Low Close (in millions except per share amounts, unaudited) First Second Third Fourth Quarter Quarter Quarter Quarter $6,585 $6,131 $3,715 $3,466 $7,697 $7,070 $4,383 $4,039 $8,184 $10,096 $7,257 $8,803 $4,669 $4,139 $5,619 $4,943 $83 Five-Year Summary 2005 2004 2003 Net revenue $32,562 $29,261 $26,971 Income from continuing operations $4,078 $4,174 $3,568 Net income $4,078 $4,212 $3,568 Income per common share basic, continuing operations $2.43 $2.45 $2.07 Income per common share diluted, $2.39 $2.41 $2.05 continuing operations Cash dividends declared per common share $1.01 $0.850 $0.630 $31,727 $27,987 $25,327 Total assets $2,313 $2,397 $1,702 Long-term debt 22.7% 27.4% 27.5% Return on invested capital(a) Five-Year Summary (Cont.) Net revenue Net income Income per common share basic Income per common share diluted Cash dividends declared per common share Total assets Long-term debt Return on invested capital(a) 2002 2001 $25,112 $23,512 $3,000 $2,400 $1.69 $1.35 $1.68 $1.33 $0.595 $0.575 $23,474 $21,695 $2,187 $2,651 25.7% 22.1% $912 $804 $1,194 $1,059 $468 $864 $1,364 $150 $(8) $1,108 $985 $0.54 $0.47 $0.71 $0.62 $0.52 $0.80 $0.66 $0.58 $0.53 $0.46 $0.70 $0.61 $0.51 $0.79 $0.65 $0.58 (a) Return on invested capital is defined as adjusted net income divided by the sum of average shareholders equity and average total debt. Adjusted net income is defined as net income plus net interest expense after tax. Net interest expense after tax was $62 million in 2005, $60 million in 2004, $72 million in 2003, $93 million in 2002, and $99 million in 2001. As a result of the adoption of SFAS 142, Goodwill and Other Intangible Assets, and the consolidation of SVE in 2002, the data provided above is not comparable. $0.23 $0.16 $55.71 $51.34 $52.62 $53.00 $45.30 $50.93 $0.26 $0.23 $57.20 $51.78 $55.52 $55.48 $50.28 $54.95 $0.26 $0.23 $56.73 $52.07 $54.65 $55.71 $48.41 $50.84 $0.26 $0.23 $60.34 $53.55 $59.08 $53.00 $47.37 $51.94 Includes restructuring and impairment charges of: 2005 Pre-tax After-tax Per share Includes Quaker merger-related costs of: 2003 Pre-tax After-tax Per share $59 $42 $0.02 2002 $224 $190 $0.11 2001 $356 $322 $0.18 $83 $55 $0.03 2004 $150 $96 $0.06 2003 $147 $100 $0.06 2001 $31 $19 $0.01 The 2005 fiscal year consisted of fifty-three weeks compared to fifty-two weeks in our normal fiscal year. The 53rd week increased 2005 net revenue by an estimated $418 million and net income by an estimated $57 million or $0.03 per share. Cash dividends per common share in 2001 are those of pre-merger PepsiCo prior to the effective date of the merger. In the fourth quarter of 2004, we reached agreement with the IRS for an open issue related to our discontinued restaurant operations which resulted in a tax benefit of $38 million or $0.02 per share. The first, second, and third quarters consist of 12 weeks and the fourth quarter consists of 16 weeks in 2004 and 17 weeks in 2005. (a) Reflects net reclassifications in all periods from cost of sales to selling, general and administrative expenses related to the alignment of certain accounting policies in connection with our ongoing BPT initiative. See Note 1. (b) The 2005 restructuring charges were $83 million ($55 million or $0.03 per share after-tax). See Note 3. (c) The 2004 restructuring and impairment charges were $150 million ($96 million or $0.06 per share after-tax). See Note 3. (d) Represents income tax expense associated with the repatriation of earnings in connection with the AJCA. See Note 5. (e) Fourth quarter 2004 net income reflects a tax benefit from discontinued operations of $38 million or $0.02 per share. See Note 5. (f) Represents the composite high and low sales price and quarterly closing prices for one share of PepsiCo common stock. Appendix B THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME S PECIMEN FINANCIAL STATEMENTS: The Coca-Cola Company Year Ended December 31, (In millions except per share data) 2005 2004 2003 NET OPERATING REVENUES Cost of goods sold GROSS PROFIT Selling, general and administrative expenses Other operating charges OPERATING INCOME Interest income Interest expense Equity income net Other loss net Gains on issuances of stock by equity investees INCOME BEFORE INCOME TAXES Income taxes NET INCOME BASIC NET INCOME PER SHARE DILUTED NET INCOME PER SHARE AVERAGE SHARES OUTSTANDING Effect of dilutive securities AVERAGE SHARES OUTSTANDING ASSUMING DILUTION $ 23,104 8,195 14,909 8,739 85 6,085 235 240 680 (93) 23 6,690 1,818 $ $ $ 4,872 2.04 2.04 2,392 1 2,393 $ 21,742 7,674 14,068 7,890 480 5,698 157 196 621 (82) 24 6,222 1,375 $ $ $ 4,847 2.00 2.00 2,426 3 2,429 $ 20,857 7,776 13,081 7,287 573 5,221 176 178 406 (138) 8 5,495 1,148 $ $ $ 4,347 1.77 1.77 2,459 3 2,462 Refer to Notes to Consolidated Financial Statements. The financial information herein is reprinted with permission from The Coca-Cola Company 2005 Annual Report. The accompanying Notes are an integral part of the consolidated financial statements. The complete financial statements are available through a link at the books companion website. B1 B2 Appendix B Specimen Financial Statements: The Coca-Cola Company THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, (In millions except par value) 2005 2004 ASSETS CURRENT ASSETS Cash and cash equivalents Marketable securities Trade accounts receivable, less allowances of $72 and $69, respectively Inventories Prepaid expenses and other assets TOTAL CURRENT ASSETS INVESTMENTS Equity method investments: Coca-Cola Enterprises Inc. Coca-Cola Hellenic Bottling Company S.A. Coca-Cola FEMSA, S.A. de C.V. Coca-Cola Amatil Limited Other, principally bottling companies Cost method investments, principally bottling companies TOTAL INVESTMENTS OTHER ASSETS PROPERTY, PLANT AND EQUIPMENT net TRADEMARKS WITH INDEFINITE LIVES GOODWILL OTHER INTANGIBLE ASSETS TOTAL ASSETS LIABILITIES AND SHAREOWNERS EQUITY CURRENT LIABILITIES Accounts payable and accrued expenses Loans and notes payable Current maturities of long-term debt Accrued income taxes TOTAL CURRENT LIABILITIES LONG-TERM DEBT OTHER LIABILITIES DEFERRED INCOME TAXES SHAREOWNERS EQUITY Common stock, $0.25 par value; Authorized 5,600 shares; Issued 3,507 and 3,500 shares, respectively Capital surplus Reinvested earnings Accumulated other comprehensive income (loss) Treasury stock, at cost 1,138 and 1,091 shares, respectively TOTAL SHAREOWNERS EQUITY TOTAL LIABILITIES AND SHAREOWNERS EQUITY $ 4,701 66 2,281 1,424 1,778 10,250 $ 6,707 61 2,244 1,420 1,849 12,281 1,731 1,039 982 748 2,062 360 6,922 2,648 5,786 1,946 1,047 828 $ 29,427 1,569 1,067 792 736 1,733 355 6,252 2,981 6,091 2,037 1,097 702 $ 31,441 $ 4,493 4,518 28 797 9,836 1,154 1,730 352 877 5,492 31,299 (1,669) (19,644) 16,355 $ 4,403 4,531 1,490 709 11,133 1,157 2,814 402 875 4,928 29,105 (1,348) (17,625) 15,935 $ 31,441 $ 29,427 Refer to Notes to Consolidated Financial Statements. Specimen Financial Statements: The Coca-Cola Company B3 THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, (In millions) 2005 2004 2003 OPERATING ACTIVITIES Net income Depreciation and amortization Stock-based compensation expense Deferred income taxes Equity income or loss, net of dividends Foreign currency adjustments Gains on issuances of stock by equity investees Gains on sales of assets, including bottling interests Other operating charges Other items Net change in operating assets and liabilities Net cash provided by operating activities INVESTING ACTIVITIES Acquisitions and investments, principally trademarks and bottling companies Purchases of investments and other assets Proceeds from disposals of investments and other assets Purchases of property, plant and equipment Proceeds from disposals of property, plant and equipment Other investing activities Net cash used in investing activities FINANCING ACTIVITIES Issuances of debt Payments of debt Issuances of stock Purchases of stock for treasury Dividends Net cash used in financing activities EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS CASH AND CASH EQUIVALENTS Net increase (decrease) during the year Balance at beginning of year Balance at end of year $ 4,872 $ 4,847 $ 4,347 932 893 850 324 345 422 (88) 162 (188) (446) (476) (294) 47 (59) (79) (23) (24) (8) (9) (20) (5) 85 480 330 299 437 249 430 (617) (168) 6,423 (637) (53) 33 (899) 88 (28) (1,496) 178 (2,460) 230 (2,055) (2,678) (6,785) (148) (2,006) 6,707 $ 4,701 5,968 (267) (46) 161 (755) 341 63 (503) 3,030 (1,316) 193 (1,739) (2,429) (2,261) 141 3,345 3,362 $ 6,707 5,456 (359) (177) 147 (812) 87 178 (936) 1,026 (1,119) 98 (1,440) (2,166) (3,601) 183 1,102 2,260 $ 3,362 Refer to Notes to Consolidated Financial Statements. B4 Appendix B Specimen Financial Statements: The Coca-Cola Company THE COCA-COLA COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREOWNERS EQUITY Year Ended December 31, (In millions except per share data) 2005 2004 2003 NUMBER OF COMMON SHARES OUTSTANDING Balance at beginning of year Stock issued to employees exercising stock options Purchases of stock for treasury1 Balance at end of year COMMON STOCK Balance at beginning of year Stock issued to employees exercising stock options Balance at end of year CAPITAL SURPLUS Balance at beginning of year Stock issued to employees exercising stock options Tax benefit from employees stock option and restricted stock plans Stock-based compensation Balance at end of year REINVESTED EARNINGS Balance at beginning of year Net income Dividends (per share $1.12, $1.00 and $0.88 in 2005, 2004 and 2003, respectively) Balance at end of year ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance at beginning of year Net foreign currency translation adjustment Net gain (loss) on derivatives Net change in unrealized gain on available-for-sale securities Net change in minimum pension liability Net other comprehensive income adjustments Balance at end of year TREASURY STOCK Balance at beginning of year Purchases of treasury stock Balance at end of year TOTAL SHAREOWNERS EQUITY COMPREHENSIVE INCOME Net income Net other comprehensive income adjustments TOTAL COMPREHENSIVE INCOME 1 2,409 7 (47) 2,369 $ 875 2 877 4,928 229 11 324 5,492 29,105 4,872 (2,678) 31,299 (1,348) (396) 57 13 5 (321) (1,669) (17,625) (2,019) (19,644) $ 16,355 $ $ $ 2,442 5 (38) 2,409 874 1 875 4,395 175 13 345 4,928 26,687 4,847 (2,429) 29,105 (1,995) 665 (3) 39 (54) 647 (1,348) (15,871) (1,754) (17,625) $ 15,935 4,847 647 5,494 $ 2,471 4 (33) 2,442 873 1 874 3,857 105 11 422 4,395 24,506 4,347 (2,166) 26,687 (3,047) 921 (33) 40 124 1,052 (1,995) (14,389) (1,482) (15,871) $ 14,090 $ $ 4,347 1,052 5,399 4,872 $ (321) 4,551 $ Common stock purchased from employees exercising stock options numbered 0.5 shares, 0.4 shares and 0.4 shares for the years ended December 31, 2005, 2004 and 2003, respectively. Refer to Notes to Consolidated Financial Statements. Appendix C OBJECTIVES Time Value of Money STUDY After studying this appendix, you should be able to: 1 Distinguish between simple and compound interest. 2 Solve for future value of a single amount. 3 Solve for future value of an annuity. 4 Identify the variables fundamental to solving present value problems. 5 Solve for present value of a single amount. 6 Solve for present value of an annuity. 7 Compute the present value of notes and bonds. 8 Use a financial calculator to solve time value of money problems. Would you rather receive $1,000 today or a year from now? You should prefer to receive the $1,000 today because you can invest the $1,000 and earn interest on it. As a result, you will have more than $1,000 a year from now. What this example illustrates is the concept of the t ime value of money . Everyone prefers to receive money today rather than in the future because of the interest factor. THE NATURE OF INTEREST Interest is payment for the use of another persons money. It is the difference between the amount borrowed or invested (called the principal) and the amount repaid or collected. The amount of interest to be paid or collected is usually stated as a rate over a specific period of time. The rate of interest is generally stated as an annual rate. The amount of interest involved in any financing transaction is based on three elements: 1. Principal (p): The original amount borrowed or invested. 2. Interest Rate (i): An annual percentage of the principal. 3. Time (n): The number of years that the principal is borrowed or invested. Simple Interest Simple interest is computed on the principal amount only. It is the return on the principal for one period. Simple interest is usually expressed as shown in Illustration C-1 on the next page. STUDY OBJECTIVE 1 Distinguish between simple and compound interest. C1 C2 Appendix C Time Value of Money Principal p Rate i Time n Illustration C-1 Interest computation Interest For example, if you borrowed $5,000 for 2 years at a simple interest rate of 12% annually, you would pay $1,200 in total interest computed as follows: Interest pin $5,000 .12 $1,200 2 Compound Interest Compound interest is computed on principal and on any interest earned that has not been paid or withdrawn. It is the return on the principal for two or more time periods. Compounding computes interest not only on the principal but also on the interest earned to date on that principal, assuming the interest is left on deposit. To illustrate the difference between simple and compound interest, assume that you deposit $1,000 in Bank Two, where it will earn simple interest of 9% per year, and you deposit another $1,000 in Citizens Bank, where it will earn compound interest of 9% per year compounded annually. Also assume that in both cases you will not withdraw any interest until three years from the date of deposit. Illustration C-2 shows the computation of interest you will receive and the accumulated year-end balances. Illustration C-2 Simple versus compound interest Bank Two Simple Interest Calculation Year 1 $1,000.00 9 % Year 2 $1,000.00 9 % Year 3 $1,000.00 9 % Simple Interest $ 90.00 90.00 90.00 $ 270.00 Accumulated Year-end Balance $1,090.00 $1,180.00 $1,270.00 $25.03 Difference Citizens Bank Compound Interest Calculation Year 1 $1,000.00 9 % Year 2 $1,090.00 9 % Year 3 $1,188.10 9 % Compound Interest $ 90.00 98.10 106.93 $ 295.03 Accumulated Year-end Balance $1,090.00 $1,188.10 $1,295.03 Note in Illustration C-2 that simple interest uses the initial principal of $1,000 to compute the interest in all three years. Compound interest uses the accumulated balance (principal plus interest to date) at each year-end to compute interest in the succeeding yearwhich explains why your compound interest account is larger. Obviously, if you had a choice between investing your money at simple interest or at compound interest, you would choose compound interest, all other things especially riskbeing equal. In the example, compounding provides $25.03 of additional interest income. For practical purposes, compounding assumes that unpaid interest earned becomes a part of the principal, and the accumulated balance at the Future Value of a Single Amount C3 end of each year becomes the new principal on which interest is earned during the next year. Illustration C-2 indicates that you should invest your money at the bank that compounds interest annually. Most business situations use compound interest. Simple interest is generally applicable only to short-term situations of one year or less. SECTION 1 Future Value Concepts STUDY OBJECTIVE 2 Solve for future value of a single amount. FUTURE VALUE OF A SINGLE AMOUNT The future value of a single amount is the value at a future date of a given amount invested assuming compound interest. For example, in Illustration C-2, $1,295.03 is the future value of the $1,000 at the end of three years. The $1,295.03 could be determined more easily by using the following formula. FV p (1 i) n Illustration C-3 Formula for future value where: FV p i n future value of a single amount principal (or present value) interest rate for one period number of periods FV p (1 i)n $1,000 (1 i)3 $1,000 1.29503 $1,295.03 The $1,295.03 is computed as follows. The 1.29503 is computed by multiplying (1.09 1.09 1.09). The amounts in this example can be depicted in the following time diagram. Illustration C-4 Time diagram i = 9% Present Value (p) Future Value 0 $1,000 1 n = 3 years 2 3 $1,295.03 C4 Appendix C Time Value of Money Another method that can be used to compute the future value of a single amount involves the use of a compound interest table. This table shows the future value of 1 for n periods. Table 1, shown below, is such a table. TABLE 1 Future Value of 1 (n) Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 4% 1.04000 1.08160 1.12486 1.16986 1.21665 1.26532 1.31593 1.36857 1.42331 1.48024 1.53945 1.60103 1.66507 1.73168 1.80094 1.87298 1.94790 2.02582 2.10685 2.19112 5% 1.05000 1.10250 1.15763 1.21551 1.27628 1.34010 1.40710 1.47746 1.55133 1.62889 1.71034 1.79586 1.88565 1.97993 2.07893 2.18287 2.29202 2.40662 2.52695 2.65330 6% 1.06000 1.12360 1.19102 1.26248 1.33823 1.41852 1.50363 1.59385 1.68948 1.79085 1.89830 2.01220 2.13293 2.26090 2.39656 2.54035 2.69277 2.85434 3.02560 3.20714 8% 1.08000 1.16640 1.25971 1.36049 1.46933 1.58687 1.71382 1.85093 1.99900 2.15892 2.33164 2.51817 2.71962 2.93719 3.17217 3.42594 3.70002 3.99602 4.31570 4.66096 9% 1.09000 1.18810 1.29503 1.41158 1.53862 1.67710 1.82804 1.99256 2.17189 2.36736 2.58043 2.81267 3.06581 3.34173 3.64248 3.97031 4.32763 4.71712 5.14166 5.60441 10% 1.10000 1.21000 1.33100 1.46410 1.61051 1.77156 1.94872 2.14359 2.35795 2.59374 2.85312 3.13843 3.45227 3.79750 4.17725 4.59497 5.05447 5.55992 6.11591 6.72750 11% 1.11000 1.23210 1.36763 1.51807 1.68506 1.87041 2.07616 2.30454 2.55803 2.83942 3.15176 3.49845 3.88328 4.31044 4.78459 5.31089 5.89509 6.54355 7.26334 8.06231 12% 1.12000 1.25440 1.40493 1.57352 1.76234 1.97382 2.21068 2.47596 2.77308 3.10585 3.47855 3.89598 4.36349 4.88711 5.47357 6.13039 6.86604 7.68997 8.61276 9.64629 15% 1.15000 1.32250 1.52088 1.74901 2.01136 2.31306 2.66002 3.05902 3.51788 4.04556 4.65239 5.35025 6.15279 7.07571 8.13706 9.35762 10.76126 12.37545 14.23177 16.36654 In Table 1, n is the number of compounding periods, the percentages are the periodic interest rates, and the five-digit decimal numbers in the respective columns are the future value of 1 factors. In using Table 1, the principal amount is multiplied by the future value factor for the specified number of periods and interest rate. For example, the future value factor for two periods at 9% is 1.18810. Multiplying this factor by $1,000 equals $1,188.10, which is the accumulated balance at the end of year 2 in the Citizens Bank example in Illustration C-2. The $1,295.03 accumulated balance at the end of the third year can be calculated from Table 1 by multiplying the future value factor for three periods (1.29503) by the $1,000. The following demonstration problem illustrates how to use Table 1. Future Value of an Annuity C5 John and Mary Rich invested $20,000 in a savings account paying 6% interest at the time their son, Mike, was born. The money is to be used by Mike for his college education. On his 18th birthday, Mike withdraws the money from his savings account. How much did Mike withdraw from his account? Future Value = ? Present Value (p) i = 6% 0 1 $20,000 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 n = 18 years Answer: The future value factor from Table 1 is 2.85434 (18 periods at 6%). The future value of $20,000 earning 6% per year for 18 years is $57,086.80 ($20,000 2.85434). Illustration C-5 Demonstration Problem Using Table 1 for FV of 1 FUTURE VALUE OF AN ANNUITY The preceding discussion involved the accumulation of only a single STUDY OBJECTIVE 3 principal sum. Individuals and businesses frequently encounter situa- Solve for future value of an tions in which a series of equal dollar amounts are to be paid or received annuity. periodically, such as loans or lease (rental) contracts. Such payments or receipts of equal dollar amounts are referred to as annuities. The future value of an annuity is the sum of all the payments (receipts) plus the accumulated compound interest on them. In computing the future value of an annuity, it is necessary to know (1) the interest rate, (2) the number of compounding periods, and (3) the amount of the periodic payments or receipts. To illustrate the computation of the future value of an annuity, assume that you invest $2,000 at the end of each year for three years at 5% interest compounded annually. This situation is depicted in the time diagram in Illustration C-6. Illustration C-6 Time diagram for a threeyear annuity i = 5% Present Value $2,000 $2,000 Future Value = ? $2,000 0 1 n = 3 years 2 3 C6 Appendix C Time Value of Money As can be seen in Illustration C-6, the $2,000 invested at the end of year 1 will earn interest for two years (years 2 and 3), and the $2,000 invested at the end of year 2 will earn interest for one year (year 3). However, the last $2,000 investment (made at the end of year 3) will not earn any interest. The future value of these periodic payments could be computed using the future value factors from Table 1 as shown in Illustration C-7. Illustration C-7 Future value of periodic payments Year Invested 1 2 3 Amount Invested $2,000 $2,000 $2,000 Future Value of 1 Factor at 5% 1.10250 1.05000 1.00000 3.15250 Future Value $ 2,205 2,100 2,000 $6,305 The first $2,000 investment is multiplied by the future value factor for two periods (1.1025) because two years interest will accumulate on it (in years 2 and 3). The second $2,000 investment will earn only one years interest (in year 3) and therefore is multiplied by the future value factor for one year (1.0500). The final $2,000 investment is made at the end of the third year and will not earn any interest. Consequently, the future value of the last $2,000 invested is only $2,000 since it does not accumulate any interest. This method of calculation is required when the periodic payments or receipts are not equal in each period. However, when the periodic payments (receipts) are the same in each period, the future value can be computed by using a future value of an annuity of 1 table. Table 2, shown below, is such a table. TABLE 2 Future Value of an Annuity of 1 (n) Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 4% 1.00000 2.04000 3.12160 4.24646 5.41632 6.63298 7.89829 9.21423 10.58280 12.00611 13.48635 15.02581 16.62684 18.29191 20.02359 21.82453 23.69751 25.64541 27.67123 29.77808 5% 1.00000 2.05000 3.15250 4.31013 5.52563 6.80191 8.14201 9.54911 11.02656 12.57789 14.20679 15.91713 17.71298 19.59863 21.57856 23.65749 25.84037 28.13238 30.53900 33.06595 6% 1.00000 2.06000 3.18360 4.37462 5.63709 6.97532 8.39384 9.89747 11.49132 13.18079 14.97164 16.86994 18.88214 21.01507 23.27597 25.67253 28.21288 30.90565 33.75999 36.78559 8% 1.00000 2.08000 3.24640 4.50611 5.86660 7.33592 8.92280 10.63663 12.48756 14.48656 16.64549 18.97713 21.49530 24.21492 27.15211 30.32428 33.75023 37.45024 41.44626 45.76196 9% 1.00000 2.09000 3.27810 4.57313 5.98471 7.52334 9.20044 11.02847 13.02104 15.19293 17.56029 20.14072 22.95339 26.01919 29.36092 33.00340 36.97351 41.30134 46.01846 51.16012 10% 1.00000 2.10000 3.31000 4.64100 6.10510 7.71561 9.48717 11.43589 13.57948 15.93743 18.53117 21.38428 24.52271 27.97498 31.77248 35.94973 40.54470 45.59917 51.15909 57.27500 11% 1.00000 2.11000 3.34210 4.70973 6.22780 7.91286 9.78327 11.85943 14.16397 16.72201 19.56143 22.71319 26.21164 30.09492 34.40536 39.18995 44.50084 50.39593 56.93949 64.20283 12% 1.00000 2.12000 3.37440 4.77933 6.35285 8.11519 10.08901 12.29969 14.77566 17.54874 20.65458 24.13313 28.02911 32.39260 37.27972 42.75328 48.88367 55.74972 63.43968 72.05244 15% 1.00000 2.15000 3.47250 4.99338 6.74238 8.75374 11.06680 13.72682 16.78584 20.30372 24.34928 29.00167 34.35192 40.50471 47.58041 55.71747 65.07509 75.83636 88.21181 102.44358 Present Value Variables C7 Table 2 shows the future value of 1 to be received periodically for a given number of periods. You can see from Table 2 that the future value of an annuity of 1 factor for three periods at 5% is 3.15250. The future value factor is the total of the three individual future value factors as shown in Illustration C-8. Multiplying this amount by the annual investment of $2,000 produces a future value of $6,305. The demonstration problem in Illustration C-8 illustrates how to use Table 2. Illustration C-8 Demonstration Problem Using Table 2 for FV of an annuity of 1 Henning Printing Company knows that in four years it must replace one of its existing printing presses with a new one. To insure that some funds are available to replace the machine in 4 years, the company is depositing $25,000 in a savings account at the end of each of the next four years (4 deposits in total). The savings account will earn 6% interest compounded annually. How much will be in the savings account at the end of 4 years when the new printing press is to be purchased? i = 6% Present Value $25,000 $25,000 $25,000 Future Value = ? $25,000 0 1 2 n = 4 years 3 4 Answer: The future value factor from Table 2 is 4.37462 (4 periods at 6%). The future value of $25,000 invested at the end of each year for 4 years at 6% interest is $109,365.50 ($25,000 4.37462). SECTION 2 Present Value Concepts PRESENT VALUE VARIABLES The present value is the value now of a given amount to be paid or reSTUDY OBJECTIVE 4 ceived in the future, assuming compound interest. The present value is Identify the variables fundamental based on three variables: (1) the dollar amount to be received (future to solving present value problems. amount), (2) the length of time until the amount is received (number of periods), and (3) the interest rate (the discount rate). The process of determining the present value is referred to as discounting the future amount. In this textbook, we use present value computations in measuring several items. For example, Chapter 11 computed the present value of the principal and interest payments to determine the market price of a bond. In addition, determining the amount to be reported for notes payable involves present value computations. C8 Appendix C Time Value of Money PRESENT VALUE OF A SINGLE AMOUNT STUDY OBJECTIVE 5 Solve for present value of a single amount. To illustrate present value, assume that you want to invest a sum of money that will yield $1,000 at the end of one year. What amount would you need to invest today to have $1,000 one year from now? Illustration C-9 shows the formula for calculating present value. Illustration C-9 Formula for present value Present Value Future Value (1 i )n Thus, if you want a 10% rate of return, you would compute the present value of $1,000 for one year as follows: PV PV PV FV (1 i)n $1,000 (1 .10)1 $1,000 1.10 $909.09 We know the future amount ($1,000), the discount rate (10%), and the number of periods (one). These variables are depicted in the time diagram in Illustration C-10. Illustration C-10 Finding present value if discounted for one period Present Value (?) i = 10% Future Value $909.09 n = 1 year $1,000 If you receive the single amount of $1,000 in two years, discounted at 10% [PV $1,000 (1 .10)2], the present value of your $1,000 is $826.45 [($1,000 1.21), depicted as shown in Illustration C-11 below. Illustration C-11 Finding present value if discounted for two periods Present Value (?) i = 10% Future Value 0 $826.45 1 n = 2 years 2 $1,000 You also could find the present value of your amount through tables that show the present value of 1 for n periods. In Table 3, on the next page, n (represented in Present Value of a Single Amount C9 the tables rows) is the number of discounting periods involved. The percentages (represented in the tables columns) are the periodic interest rates or discount rates. The five-digit decimal numbers in the intersections of the rows and columns are called the present value of 1 factors. When using Table 3 to determine present value, you multiply the future value by the present value factor specified at the intersection of the number of periods and the discount rate. TABLE 3 Present Value of 1 (n) Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 4% .96154 .92456 .88900 .85480 .82193 .79031 .75992 .73069 .70259 .67556 .64958 .62460 .60057 .57748 .55526 .53391 .51337 .49363 .47464 .45639 5% .95238 .90703 .86384 .82270 .78353 .74622 .71068 .67684 .64461 .61391 .58468 .55684 .53032 .50507 .48102 .45811 .43630 .41552 .39573 .37689 6% .94340 .89000 .83962 .79209 .74726 .70496 .66506 .62741 .59190 .55839 .52679 .49697 .46884 .44230 .41727 .39365 .37136 .35034 .33051 .31180 8% .92593 .85734 .79383 .73503 .68058 .63017 .58349 .54027 .50025 .46319 .42888 .39711 .36770 .34046 .31524 .29189 .27027 .25025 .23171 .21455 9% .91743 .84168 .77218 .70843 .64993 .59627 .54703 .50187 .46043 .42241 .38753 .35554 .32618 .29925 .27454 .25187 .23107 .21199 .19449 .17843 10% .90909 .82645 .75132 .68301 .62092 .56447 .51316 .46651 .42410 .38554 .35049 .31863 .28966 .26333 .23939 .21763 .19785 .17986 .16351 .14864 11% .90090 .81162 .73119 .65873 .59345 .53464 .48166 .43393 .39092 .35218 .31728 .28584 .25751 .23199 .20900 .18829 .16963 .15282 .13768 .12403 12% .89286 .79719 .71178 .63552 .56743 .50663 .45235 .40388 .36061 .32197 .28748 .25668 .22917 .20462 .18270 .16312 .14564 .13004 .11611 .10367 15% .86957 .75614 .65752 .57175 .49718 .43233 .37594 .32690 .28426 .24719 .21494 .18691 .16253 .14133 .12289 .10687 .09293 .08081 .07027 .06110 For example, the present value factor for one period at a discount rate of 10% is .90909, which equals the $909.09 ($1,000 .90909) computed in Illustration C-10. For two periods at a discount rate of 10%, the present value factor is .82645, which equals the $826.45 ($1,000 .82645) computed previously. Note that a higher discount rate produces a smaller present value. For example, using a 15% discount rate, the present value of $1,000 due one year from now is $869.57, versus $909.09 at 10%. Also note that the further removed from the present the future value is, the smaller the present value. For example, using the same discount rate of 10%, the present value of $1,000 due in five years is $620.92, versus the present value of $1,000 due in one year, which is $909.09. The two demonstration problems on the next page (Illustrations C-12, C-13) illustrate how to use Table 3. C10 Appendix C Time Value of Money Illustration C-12 Demonstration problem Using Table 3 for PV of 1 Suppose you have a winning lottery ticket and the state gives you the option of taking $10,000 three years from now or taking the present value of $10,000 now. The state uses an 8% rate in discounting. How much will you receive if you accept your winnings now? PV = ? i = 8% $10,000 Now 1 n=3 2 3 years Answer: The present value factor from Table 3 is .79383 (3 periods at 8%). The present value of $10,000 to be received in 3 years discounted at 8% is $7,938.30 ($10,000 .79383). Illustration C-13 Demonstration problem Using Table 3 for PV of 1 Determine the amount you must deposit now in your SUPER savings account, paying 9% interest, in order to accumulate $5,000 for a down payment 4 years from now on a new Chevy Tahoe. PV = ? i = 9% $5,000 Now 1 2 n=4 3 4 years Answer: The present value factor from Table 3 is .70843 (4 periods at 9%). The present value of $5,000 to be received in 4 years discounted at 9% is $3,542.15 ($5,000 .70843). PRESENT VALUE OF AN ANNUITY The preceding discussion involved the discounting of only a single future amount. Businesses and individuals frequently engage in transactions in Solve for present value of an which a series of equal dollar amounts are to be received or paid periodiannuity. cally. Examples of a series of periodic receipts or payments are loan agreements, installment sales, mortgage notes, lease (rental) contracts, and pension obligations. These periodic receipts or payments are annuities. The present value of an annuity is the value now of a series of future receipts or payments, discounted assuming compound interest. In computing the present value of an annuity, you need to know: (1) the discount rate, (2) the number of discount periods, and (3) the amount of the periodic receipts or payments. To illustrate how to compute the present value of an annuity, assume that you will receive $1,000 cash annually for three years at a time when the discount rate is 10%. Illustration C-14 depicts this situation, and Illustration C-15 shows the computation of its present value. STUDY OBJECTIVE 6 Present Value of an Annuity C11 PV = ? $1,000 i = 10% n=3 $1,000 $1,000 Illustration C-14 Time diagram for a threeyear annuity Now 1 2 3 years Future Amount $1,000 (one year away) 1,000 (two years away) 1,000 (three years away) Present Value of 1 Factor at 10% .90909 .82645 . 75132 2.48686 Present Value $ 909.09 826.45 751.32 $2,486.86 Illustration C-15 Present value of a series of future amounts computation This method of calculation is required when the periodic cash flows are not uniform in each period. However, when the future receipts are the same in each period, there are two other ways to compute present value. First, you can multiply the annual cash flow by the sum of the three present value factors. In the previous example, $1,000 2.48686 equals $2,486.86. The second method is to use annuity tables. As illustrated in Table 4 below, these tables show the present value of 1 to be received periodically for a given number of periods. TABLE 4 Present Value of an Annuity of 1 (n) Periods 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 4% .96154 1.88609 2.77509 3.62990 4.45182 5.24214 6.00205 6.73274 7.43533 8.11090 8.76048 9.38507 9.98565 10.56312 11.11839 11.65230 12.16567 12.65930 13.13394 13.59033 5% .95238 1.85941 2.72325 3.54595 4.32948 5.07569 5.78637 6.46321 7.10782 7.72173 8.30641 8.86325 9.39357 9.89864 10.37966 10.83777 11.27407 11.68959 12.08532 12.46221 6% .94340 1.83339 2.67301 3.46511 4.21236 4.91732 5.58238 6.20979 6.80169 7.36009 7.88687 8.38384 8.85268 9.29498 9.71225 10.10590 10.47726 10.82760 11.15812 11.46992 8% .92593 1.78326 2.57710 3.31213 3.99271 4.62288 5.20637 5.74664 6.24689 6.71008 7.13896 7.53608 7.90378 8.24424 8.55948 8.85137 9.12164 9.37189 9.60360 9.81815 9% .91743 1.75911 2.53130 3.23972 3.88965 4.48592 5.03295 5.53482 5.99525 6.41766 6.80519 7.16073 7.48690 7.78615 8.06069 8.31256 8.54363 8.75563 8.95012 9.12855 10% .90909 1.73554 2.48685 3.16986 3.79079 4.35526 4.86842 5.33493 5.75902 6.14457 6.49506 6.81369 7.10336 7.36669 7.60608 7.82371 8.02155 8.20141 8.36492 8.51356 11% .90090 1.71252 2.44371 3.10245 3.69590 4.23054 4.71220 5.14612 5.53705 5.88923 6.20652 6.49236 6.74987 6.98187 7.19087 7.37916 7.54879 7.70162 7.83929 7.96333 12% .89286 1.69005 2.40183 3.03735 3.60478 4.11141 4.56376 4.96764 5.32825 5.65022 5.93770 6.19437 6.42355 6.62817 6.81086 6.97399 7.11963 7.24967 7.36578 7.46944 15% .86957 1.62571 2.28323 2.85498 3.35216 3.78448 4.16042 4.48732 4.77158 5.01877 5.23371 5.42062 5.58315 5.72448 5.84737 5.95424 6.04716 6.12797 6.19823 6.25933 C12 Appendix C Time Value of Money Table 4 shows that the present value of an annuity of 1 factor for three periods at 10% is 2.48685.1 (This present value factor is the total of the three individual present value factors, as shown in Illustration C-15.) Applying this amount to the annual cash flow of $1,000 produces a present value of $2,486.85. The following demonstration problem (Illustration C-16) illustrates how to use Table 4. Illustration C-16 Demonstration problem Using Table 4 for PV of an annuity of 1 Kildare Company has just signed a capitalizable lease contract for equipment that requires rental payments of $6,000 each, to be paid at the end of each of the next 5 years. The appropriate discount rate is 12%. What is the present value of the rental paymentsthat is, the amount used to capitalize the leased equipment? PV = ? $6,000 $6,000 $6,000 i = 12% n=5 2 3 $6,000 $6,000 Now 1 4 5 years Answer: The present value factor from Table 4 is 3.60478 (5 periods at 12%). The present value of 5 payments of $6,000 each discounted at 12% is $21,628.68 ($6,000 3.60478). TIME PERIODS AND DISCOUNTING In the preceding calculations, the discounting was done on an annual basis using an annual interest rate. Discounting may also be done over shorter periods of time such as monthly, quarterly, or semiannually. When the time frame is less than one year, you need to convert the annual interest rate to the applicable time frame. Assume, for example, that the investor in Illustration C-14 received $500 semiannually for three years instead of $1,000 annually. In this case, the number of periods becomes six (3 2), the discount rate is 5% (10% 2), the present value factor from Table 4 is 5.07569, and the present value of the future cash flows is $2,537.85 (5.07569 $500). This amount is slightly higher than the $2,486.86 computed in Illustration C-15 because interest is paid twice during the same year; therefore interest is earned on the first half years interest. COMPUTING THE PRESENT VALUE OF A LONG-TERM NOTE OR BOND STUDY OBJECTIVE 7 Compute the present value of notes and bonds. The present value (or market price) of a long-term note or bond is a function of three variables: (1) the payment amounts, (2) the length of time until the amounts are paid, and (3) the discount rate. Our illustration uses a five-year bond issue. 1 The difference of .00001 between 2.48686 and 2.48685 is due to rounding. Computing the Present Value of a Long-Term Note or Bond C13 The first variabledollars to be paidis made up of two elements: (1) a series of interest payments (an annuity), and (2) the principal amount (a single sum). To compute the present value of the bond, we must discount both the interest payments and the principal amounttwo different computations. The time diagrams for a bond due in five years are shown in Illustration C-17. Illustration C-17 Present value of a bond time diagram Diagram for Principal Present Value (?) Interest Rate (i) n=5 Principal Amount Now 1 yr. 2 yr. 3 yr. 4 yr. 5 yr. Diagram for Interest Present Value (?) Interest Interest Rate (i) Interest Interest n=5 Interest Interest Now 1 yr. 2 yr. 3 yr. 4 yr. 5 yr. When the investors market interest rate is equal to the bonds contractual interest rate, the present value of the bonds will equal the face value of the bonds. To illustrate, assume a bond issue of 10%, five-year bonds with a face value of $100,000 with interest payable semiannually on January 1 and July 1. If the discount rate is the same as the contractual rate, the bonds will sell at face value. In this case, the investor will receive the following: (1) $100,000 at maturity, and (2) a series of ten $5,000 interest payments [($100,000 10%) 2] over the term of the bonds. The length of time is expressed in terms of interest periodsin this case10, and the discount rate per interest period, 5%. The following time diagram (Illustration C-18) depicts the variables involved in this discounting situation. Illustration C-18 Time diagram for present value of a 10%, five-year bond paying interest semiannually Diagram for Principal Present Value (?) i = 5% Principal Amount $100,000 Now 1 2 3 4 5 n = 10 6 7 8 9 10 Diagram for Interest Present Interest Value i = 5% Payments (?) $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 $5,000 Now 1 2 3 4 5 n = 10 6 7 8 9 10 C14 Appendix C Time Value of Money Illustration C-19 shows the computation of the present value of these bonds. Illustration C-19 Present value of principal and interestface value 10% Contractual Rate10% Discount Rate Present value of principal to be received at maturity $100,000 PV of 1 due in 10 periods at 5% $100,000 .61391 (Table 3) Present value of interest to be received periodically over the term of the bonds $5,000 PV of 1 due periodically for 10 periods at 5% $5,000 7.72173 (Table 4) Present value of bonds *Rounded $ 61,391 38,609* $100,000 Now assume that the investors required rate of return is 12%, not 10%.The future amounts are again $100,000 and $5,000, respectively, but now a discount rate of 6% (12% 2) must be used. The present value of the bonds is $92,639, as computed in Illustration C-20. Illustration C-20 Present value of principal and interestdiscount 10% Contractual Rate12% Discount Rate Present value of principal to be received at maturity $100,000 .55839 (Table 3) Present value of interest to be received periodically over the term of the bonds $5,000 7.36009 (Table 4) Present value of bonds $55,839 36,800 $92,639 Conversely, if the discount rate is 8% and the contractual rate is 10%, the present value of the bonds is $108,111, computed as shown in Illustration C-21. Illustration C-21 Present value of principal and interestpremium 10% Contractual Rate8% Discount Rate Present value of principal to be received at maturity $100,000 .67556 (Table 3) Present value of interest to be received periodically over the term of the bonds $5,000 8.11090 (Table 4) Present value of bonds $ 67,556 40,555 $108,111 The above discussion relies on present value tables in solving present value problems. Many people use spreadsheets such as Excel or Financial calculators (some even on websites) to compute present values, without the use of tables. Many calculators, especially financial calculators, have present value ( PV ) functions that allow you to calculate present values by merely inputting the proper amount, discount rate, and periods, and pressing the PV key. The next section illustrates how to use a financial calculator in various business situations. Using Financial CalculatorsPresent Value of a Single Sum C15 SECTION 3 Using Financial Calculators Business professionals, once they have mastered the underlying concepts STUDY OBJECTIVE 8 in sections 1 and 2, often use a financial (business) calculator to solve time Use a financial calculator to solve value of money problems. In many cases, they must use calculators if in- time value of money problems. terest rates or time periods do not correspond with the information provided in the compound interest tables. To use financial calculators, you enter the time value of money variables into the calculator. Illustration C-22 shows the five most common keys used to solve time value of money problems.2 Illustration C-22 Financial calculator keys N I PV PMT FV where N I PV PMT FV number of periods interest rate per period (some calculators use I/YR or i) present value (occurs at the beginning of the first period) payment (all payments are equal, and none are skipped) future value (occurs at the end of the last period) In solving time value of money problems in this appendix, you will generally be given three of four variables and will have to solve for the remaining variable. The fifth key (the key not used) is given a value of zero to ensure that this variable is not used in the computation. PRESENT VALUE OF A SINGLE SUM To illustrate how to solve a present value problem using a financial calculator, assume that you want to know the present value of $84,253 to be received in five years, discounted at 11% compounded annually. Illustration C-23 pictures this problem. Illustration C-23 Calculator solution for present value of a single sum Inputs: 5 N 11 I ? PV 50,000 0 PMT 84,253 FV Answer: The diagram shows you the information (inputs) to enter into the calculator: N 5, I 11, PMT 0, and FV 84,253. You then press PV for the answer: $50,000. As indicated, the PMT key was given a value of zero because a series of payments did not occur in this problem. On many calculators, these keys are actual buttons on the face of the calculator; on others they appear on the display after the user accesses a present value menu. 2 C16 Appendix C Time Value of Money Plus and Minus The use of plus and minus signs in time value of money problems with a financial calculator can be confusing. Most financial calculators are programmed so that the positive and negative cash flows in any problem offset each other. In the present value problem, we identified the $84,253 future value initial investment as a positive (inflow); the answer $50,000 was shown as a negative amount, reflecting a cash outflow. If the 84,253 were entered as a negative, then the final answer would have been reported as a positive 50,000. Hopefully, the sign convention will not cause confusion. If you understand what is required in a problem, you should be able to interpret a positive or negative amount in determining the solution to a problem. Compounding Periods In the problem on page C15, we assumed that compounding occurs once a year. Some financial calculators have a default setting, which assumes that compounding occurs 12 times a year. You must determine what default period has been programmed into your calculator and change it as necessary to arrive at the proper compounding period. Rounding Most financial calculators store and calculate using 12 decimal places. As a result, because compound interest tables generally have factors only up to 5 decimal places, a slight difference in the final answer can result. In most time value of money problems, the final answer will not include more than two decimal points. PRESENT VALUE OF AN ANNUITY To illustrate how to solve a present value of an annuity problem using a financial calculator, assume that you are asked to determine the present value of rental receipts of $6,000 each to be received at the end of each of the next five years, when discounted at 12%, as pictured in Illustration C-24. Illustration C-24 Calculator solution for present value of an annuity Inputs: 5 N 12 I ? PV 21,628.66 6,000 PMT 0 FV Answer: In this case, you enter N 5, I 12, PMT arrive at the answer of $21, 628.66. 6,000, FV 0, and then press PV to USEFUL APPLICATIONS OF THE F INANCIAL CALCULATOR With a financial calculator you can solve for any interest rate or for any number of periods in a time value of money problem. Here are some examples of these applications. Summary of Study Objectives C17 Auto Loan Assume you are financing a car with a three-year loan. The loan has a 9.5% nominal annual interest rate, compounded monthly. The price of the car is $6,000, and you want to determine the monthly payments, assuming that the payments start one month after the purchase. This problem is pictured in Illustration C-25. Illustration C-25 Calculator solution for auto loan payments Inputs: 36 N 9.5 I 6,000 PV ? PMT 192.20 0 FV Answer: To solve this problem, you enter N 36 (12 3), I 9.5, PV 6,000, FV 0, and then press PMT. You will find that the monthly payments will be $192.20. Note that the payment key is usually programmed for 12 payments per year. Thus, you must change the default (compounding period) if the payments are other than monthly. Mortgage Loan Amount Lets say you are evaluating financing options for a loan on a house. You decide that the maximum mortgage payment you can afford is $700 per month.The annual interest rate is 8.4%. If you get a mortgage that requires you to make monthly payments over a 15-year period, what is the maximum purchase price you can afford? Illustration C-26 depicts this problem. Illustration C-26 Calculator solution for mortgage amount Inputs: 180 N 8.4 I ? PV 71,509.81 700 PMT 0 FV Answer: You enter N 180 (12 15 years), I 8.4, PMT 700, FV 0, and press PV. With the payment-per-year key set at 12, you find a present value of $71,509.81 the maximum house price you can afford, given that you want to keep your mortgage payments at $700. Note that by changing any of the variables, you can quickly conduct what-if analyses for different situations. SUMMARY OF STUDY OBJECTIVES 1. Distinguish between simple and compound interest. Simple interest is computed on the principal only, whereas compound interest is computed on the principal and any interest earned that has not been withdrawn. 2. Solve for future value of a single amount. Prepare a time diagram of the problem. Identify the principal amount, the number of compounding periods, and the interest rate. Using the future value of 1 table, multiply the principal amount by the future value factor specified at the intersection of the number of periods and the interest rate. 3. Solve for future value of an annuity. Prepare a time diagram of the problem. Identify the amount of the periodic payments, the number of compounding periods, and the C18 Appendix C Time Value of Money 7. Compute the present value of notes and bonds. To determine the present value of the principal amount: Multiply the principal amount (a single future amount) by the present value factor (from the present value of 1 table) intersecting at the number of periods (number of interest payments) and the discount rate. To determine the present value of the series of interest payments: Multiply the amount of the interest payment by the present value factor (from the present value of an annuity of 1 table) intersecting at the number of periods (number of interest payments) and the discount rate. Add the present value of the principal amount to the present value of the interest payments to arrive at the present value of the note or bond. 8. Use a financial calculator to solve time value of money problems. Financial calculators can be used to solve the same and additional problems as those solved with time value of money tables. One enters into the financial calculator the amounts for all of the known elements of a time value of money problem (periods, interest rate, payments, future or present value) and solves for the unknown element. Particularly useful situations involve interest rates and compounding periods not presented in the tables. interest rate. Using the future value of an annuity of 1 table, multiply the amount of the payments by the future value factor specified at the intersection of the number of periods and the interest rate. 4. Identify the variables fundamental to solving present value problems. The following three variables are fundamental to solving present value problems: (1) the future amount, (2) the number of periods, and (3) the interest rate (the discount rate). 5. Solve for present value of a single amount. Prepare a time diagram of the problem. Identify the future amount, the number of discounting periods, and the discount (interest) rate. Using the present value of 1 table, multiply the future amount by the present value factor specified at the intersection of the number of periods and the discount rate. 6. Solve for present value of an annuity. Prepare a time diagram of the problem. Identify the future amounts (annuities), the number of discounting periods, and the discount (interest) rate. Using the present value of an annuity of 1 table, multiply the amount of the annuity by the present value factor specified at the intersection of the number of periods and the interest rate. GLOSSARY Annuity A series of equal dollar amounts to be paid or received periodically. (p. C5, C10) Compound interest The interest computed on the principal and any interest earned that has not been paid or received. (p. C2) Discounting the future amount(s) The process of determining present value. (p. C7) Future value of a single amount The value at a future date of a given amount invested assuming compound interest. (p. C3) Future value of an annuity The sum of all the payments or receipts plus the accumulated compound interest on them. (p. C5) Interest Payment for the use of anothers money. (p. C1) Present value The value now of a given amount to be invested or received in the future assuming compound interest. (p. C7) Present value of an annuity A series of future receipts or payments discounted to their value now assuming compound interest. (p. C10) Principal The amount borrowed or invested. (p. C1) Simple interest The interest computed on the principal only. (p. C1) BRIEF EXERCISES Use tables to solve Brief Exercises 1-23. Compute the future value of a single amount. (SO 2) BEC-1 Russ Holub invested $4,000 at 5% annual interest, and left the money invested without withdrawing any of the interest for 10 years. At the end of the 10 years, Russ withdrew the accumulated amount of money. (a) What amount did Russ withdraw assuming the investment earns simple interest? (b) What amount did Russ withdraw assuming the investment earns interest compound annually? Use future value tables. (SO 2, 3) BEC-2 For each of the following cases, indicate (1) to what interest rate columns and (2) to what number of periods you would refer in looking up the future value factor. 1. In Table 1 (future value of 1): Annual Rate (a) (b) 8% 5% Number of Years Invested 5 3 Compounded Annually Semiannually Brief Exercises 2. In Table 2 (future value of an annuity of 1): C19 Annual Rate (a) (b) 5% 4% Number of Years Invested 10 6 Compounded Annually Semiannually Compute the future value of a single amount. (SO 2) BEC-3 Racine Company signed a lease for an office building for a period of 10 years. Under the lease agreement, a security deposit of $10,000 is made. The deposit will be returned at the expiration of the lease with interest compounded at 4% per year. What amount will Racine receive at the time the lease expires? BEC-4 Chaffee Company issued $1,000,000, 10-year bonds and agreed to make annual sinking fund deposits of $75,000. The deposits are made at the end of each year into an account paying 6% annual interest. What amount will be in the sinking fund at the end of 10 years? BEC-5 Wayne and Brenda Anderson invested $5,000 in a savings account paying 5% compound annual interest when their daughter, Sue, was born. They also deposited $1,000 on each of her birthdays until she was 18 (including her 18th birthday). How much will be in the savings account on her 18th birthday (after the last deposit)? BEC-6 Ty Ngu borrowed $20,000 on July 1, 2002. This amount plus accrued interest at 6% compounded annually is to be repaid on July 1, 2008. How much will Ty have to repay on July 1, 2008? BEC-7 For each of the following cases, indicate (a) to what interest rate columns and (b) to what number of periods you would refer in looking up the discount rate. 1. In Table 3 (present value of 1): Annual Rate (a) (b) (c) 12% 10% 8% Number of Years Involved 6 15 10 Discounts Per Year Annually Annually Semiannually Compute the future value of an annuity. (SO 3) Compute the future value of a single amount and of an annuity. (SO 2, 3) Compute the future value of a single amount. (SO 2) Use present value tables. (SO 5, 6) 2. In Table 4 (present value of an annuity of 1): Annual Rate (a) (b) (c) 8% 10% 12% Number of Years Involved 20 5 4 Number of Payments Involved 20 5 8 Frequency of Payments Annually Annually Semiannually Determine present values. (SO 5, 6) Compute the present value of a single-sum investment. (SO 5) Compute the present value of a single-sum investment. (SO 5) Compute the present value of an annuity investment. (SO 6) Compute the present value of an annuity investment. (SO 6) Compute the present value of bonds. (SO 5, 6, 7) BEC-8 (a) What is the present value of $20,000 due 8 periods from now, discounted at 8%? (b) What is the present value of $20,000 to be received at the end of each of 6 periods, discounted at 9%? BEC-9 Gonzalez Company is considering an investment that will return a lump sum of $500,000 5 years from now. What amount should Gonzalez Company pay for this investment in order to earn a 10% return? BEC-10 Lasorda Company earns 9% on an investment that will return $875,000 8 years from now. What is the amount Lasorda should invest now in order to earn this rate of return? BEC-11 Bosco Company is considering investing in an annuity contract that will return $30,000 annually at the end of each year for 15 years. What amount should Bosco Company pay for this investment if it earns a 6% return? BEC-12 Modine Enterprises earns 11% on an investment that pays back $120,000 at the end of each of the next 4 years. What is the amount Modine Enterprises invested to earn the 11% rate of return? BEC-13 Midwest Railroad Co. is about to issue $100,000 of 10-year bonds paying a 10% interest rate, with interest payable semiannually. The discount rate for such securities is 8%. How much can Midwest expect to receive from the sale of these bonds? C20 Appendix C Time Value of Money BEC-14 Assume the same information as in BEC-13 except that the discount rate is 10% instead of 8%. In this case, how much can Midwest expect to receive from the sale of these bonds? BEC-15 Lounsbury Company receives a $50,000, 6-year note bearing interest of 8% (paid annually) from a customer at a time when the discount rate is 9%. What is the present value of the note received by Lounsbury Company? BEC-16 Hartzler Enterprises issued 8%, 8-year, $2,000,000 par value bonds that pay interest semiannually on October 1 and April 1. The bonds are dated April 1, 2008, and are issued on that date. The discount rate of interest for such bonds on April 1, 2008, is 10%. What cash proceeds did Hartzler receive from issuance of the bonds? BEC-17 Vinny Carpino owns a garage and is contemplating purchasing a tire retreading machine for $16,280.After estimating costs and revenues,Vinny projects a net cash flow from the retreading machine of $3,000 annually for 8 years. Vinny hopes to earn a return of 11% on such investments. What is the present value of the retreading operation? Should Vinny Carpino purchase the retreading machine? BEC-18 Rodriguez Company issues a 10%, 6-year mortgage note on January 1, 2008, to obtain financing for new equipment. Land is used as collateral for the note. The terms provide for semiannual installment payments of $56,413.What were the cash proceeds received from the issuance of the note? BEC-19 Goltra Company is considering purchasing equipment. The equipment will produce the following cash flows: Year 1, $30,000; Year 2, $40,000; Year 3, $50,000. Goltra requires a minimum rate of return of 12%. What is the maximum price Goltra should pay for this equipment? BEC-20 If Maria Sanchez invests $3,152 now, she will receive $10,000 at the end of 15 years. What annual rate of interest will Maria earn on her investment? (Hint: Use Table 3.) BEC-21 Lori Burke has been offered the opportunity of investing $42,410 now. The investment will earn 10% per year and at the end of that time will return Lori $100,000. How many years must Lori wait to receive $100,000? (Hint: Use Table 3.) BEC-22 Nancy Burns purchased an investment for $12,462.21. From this investment, she will receive $1,000 annually for the next 20 years, starting one year from now. What rate of interest will Nancys investment be earning for her? (Hint: Use Table 4.) BEC-23 Betty Estes invests $7,536.08 now for a series of $1,000 annual returns, beginning one year from now. Betty will earn a return of 8% on the initial investment. How many annual payments of $1,000 will Betty receive? (Hint: Use Table 4.) BEC-24 Reba McEntire wishes to invest $19,000 on July 1, 2008, and have it accumulate to $49,000 by July 1, 2018. Instructions Use a financial calculator to determine at what exact annual rate of interest Reba must invest the $19,000. Compute the present value of bonds. (SO 5, 6, 7) Compute the present value of a note. (SO 5, 6, 7) Compute the present value of bonds. (SO 5, 6, 7) Compute the value of a machine for purposes of making a purchase decision. (SO 7) Compute the present value of a note. (SO 5, 6) Compute the maximum price to pay for the equipment. (SO 7) Compute the interest rate on a single sum. (SO 5) Compute the number of periods of a single sum. (SO 5) Compute the interest rate on an annuity. (SO 6) Compute the number of periods of an annuity. (SO 6) Determine interest rate. (SO 8) Determine interest rate. (SO 8) BEC-25 On July 17, 2008, Tim McGraw borrowed $42,000 from his grandfather to open a clothing store. Starting July 17, 2009, Tim has to make 10 equal annual payments of $6,500 each to repay the loan. Instructions Use a financial calculator to determine what interest rate Tim is paying. Determine interest rate. (SO 8) BEC-26 As the purchaser of a new house, Patty Loveless has signed a mortgage note to pay the Memphis National Bank and Trust Co. $14,000 every 6 months for 20 years, at the end of which time she will own the house. At the date the mortgage is signed the purchase price was $198,000, and Loveless made a down payment of $20,000.The first payment will be made 6 months after the date the mortgage is signed. Instructions Using a financial calculator, compute the exact rate of interest earned on the mortgage by the bank. Brief Exercises BEC-27 Using a financial calculator, solve for the unknowns in each of the following situations. (a) On June 1, 2008, Shelley Long purchases lakefront property from her neighbor, Joey Brenner, and agrees to pay the purchase price in seven payments of $16,000 each, the first payment to be payable June 1, 2009. (Assume that interest compounded at an annual rate of 7.35% is implicit in the payments.) What is the purchase price of the property? (b) On January 1, 2008, Cooke Corporation purchased 200 of the $1,000 face value, 8% coupon, 10-year bonds of Howe Inc. The bonds mature on January 1, 2018, and pay interest annually beginning January 1, 2009. Cooke purchased the bonds to yield 10.65%. How much did Cooke pay for the bonds? BEC-28 Using a financial calculator, provide a solution to each of the following situations. (a) Bill Schroeder owes a debt of $35,000 from the purchase of his new sport utility vehicle. The debt bears annual interest of 9.1% compounded monthly. Bill wishes to pay the debt and interest in equal monthly payments over 8 years, beginning one month hence. What equal monthly payments will pay off the debt and interest? (b) On January 1, 2008, Sammy Sosa offers to buy Mark Graces used snowmobile for $8,000, payable in five equal annual installments, which are to include 8.25% interest on the unpaid balance and a portion of the principal. If the first payment is to be made on December 31, 2008, how much will each payment be? C21 Various time value of money situations. (SO 8) Various time value of money situations. (SO 8) Appendix D OBJECTIVE Payroll Accounting STUDY After studying this appendix, you should be able to: 1. Discuss the objectives of internal control for payroll. 2. Compute and record the payroll for a pay period. 3. Describe and record employer payroll taxes. Payroll and related fringe benefits often make up a large percentage of current liabilities. Employee compensation is often the most significant expense that a company incurs. For example, Costco recently reported total employees of 103,000 and labor and fringe benefits costs that approximated 70% of the companys total cost of operations. Payroll accounting involves more than paying employees wages. Companies are required by law to maintain payroll records for each employee, to file and pay payroll taxes, and to comply with numerous state and federal tax laws related to employee compensation. Accounting for payroll has become much more complex due to these regulations. PAYROLL DEFINED The term payroll pertains to both salaries and wages. Managerial, administrative, and sales personnel are generally paid salaries. Salaries are often expressed in terms of a specified amount per month or per year rather than an hourly rate. Store clerks, factory employees, and manual laborers are normally paid wages. Wages are based on a rate per hour or on a piecework basis (such as per unit of product). Frequently, people use the terms salaries and wages interchangeably. The term payroll does not apply to payments made for services of professionals such as certified public accountants, attorneys, and architects. Such professionals are independent contractors rather than salaried employees. Payments to them are called fees. This distinction is important because government regulations relating to the payment and reporting of payroll taxes apply only to employees. INTERNAL CONTROL OF PAYROLL Chapter 8 introduced internal control. As applied to payrolls, the objecSTUDY OBJECTIVE 1 tives of internal control are (1) to safeguard company assets against unau- Discuss the objectives of internal thorized payments of payroll and (2) to ensure the accuracy and reliability control for payroll. of the accounting records pertaining to payrolls. Irregularities often result if internal control is lax. Methods of theft involving payroll include overstating hours, using unauthorized pay rates, adding fictitious employees to the payroll, continuing terminated employees on the payroll, and distributing duplicate payroll checks. Moreover, inaccurate records will result in incorrect paychecks, financial statements, and payroll tax returns. D1 D2 Appendix D Payroll Accounting Payroll activities involve four functions: hiring employees, timekeeping, preparing the payroll, and paying the payroll. For effective internal control, the company should assign these four functions to different departments or individuals. To illustrate these functions, we will examine the case of Academy Company and one of its employees, Michael Jordan. Hiring Employees Human Resources Hiring Employees The human resources (personnel) department is responsible for posting job openings, screening and interviewing applicants, and hiring employees. From a control standpoint, this department provides significant documentation and authorization. When an employee is hired, the human resources department prepares an authorization form. The one used by Academy Company for Michael Jordan is shown in Illustration D-1. Human Resources department documents and authorizes employment. Illustration D-1 Authorization form prepared by the human resources department ACADEMY COMPANY Employee Name Classification Department Jordan, LAST Michael FIRST MI Starting Date 9/01/06 329-36-9547 Skilled-Level 10 Shipping Classification Rate $ 10.00 New Rate $ Clerk per hour 12.00 Social Security No. Division Entertainment Trans. from Temp. NEW HIRE Salary Grade Level 10 Bonus N/A 9/1/07 Non-exempt x Exempt Effective Date RATE CHANGE Present Rate $ 10.00 Merit x Promotion Previous Increase Date Resignation Discharge Decrease None Retirement Other Amount $ Reason per Type SEPARATION Leave of absence Last Day Worked From to Type APPROVALS BRANCH OR DEPT. MANAGER DATE DIVISION V.P. DATE PERSONNEL DEPARTMENT The human resources department sends the authorization form to the payroll department, where it is used to place the new employee on the payroll.A chief concern of the human resources department is ensuring the accuracy of this form. The reason is quite simple: One of the most common types of payroll frauds is adding fictitious employees to the payroll. The human resources department is also responsible for authorizing changes in employment status. Specifically, they must authorize (1) changes in pay rates and (2) terminations of employment. Every authorization should be in writing, and a copy of the change in status should be sent to the payroll department. Notice in Illustration D-1 that Jordan received a pay increase of $2 per hour. Internal Control of Payroll D3 Timekeeping Another area in which internal control is important is timekeeping. Hourly employees are usually required to record time worked by punching a time clock. The employee inserts a time card into the clock, which automatically records the employees arrival and departure times. Illustration D-2 shows Michael Jordans time card. Timekeeping Supervisors monitor hours worked through time cards and time reports. PAY PERIOD ENDING No. 17 NAME Michael Jordan 1/14/08 REGULAR TIME 8:58 12:00 1:00 5:01 P.M. A.M. 9:00 11:59 12:59 5:00 P.M. A.M. 8:59 12:01 1:01 5:00 P.M. A.M. 9:00 12:00 1:00 5:00 P.M. A.M. 8:57 11:58 1:00 5:01 P.M. A.M. 8:00 1:00 A.M. IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT IN OUT EXTRA TIME 1st Day 2nd Day NOON NOON THIS THIS 5:00 9:00 3rd Day 4th Day 5th Day 6th Day 7th Day NOON NOON SIDE SIDE OU T OU T P.M. A.M. NOON P.M. NOON NOON TOTAL 4 TOTAL 40 Illustration D-2 Time card In large companies, time clock procedures are often monitored by a supervisor or security guard to make sure an employee punches only his or her own card.At the end of the pay period, each employees supervisor approves the hours shown by signing the time card.When overtime hours are involved, approval by a supervisor is usually mandatory. This guards against unauthorized overtime. The approved time cards are then sent to the payroll department. For salaried employees, a manually prepared weekly or monthly time report kept by a supervisor may be used to record time worked. Preparing the Payroll The payroll department prepares the payroll on the basis of two inputs: (1) human resources department authorizations and (2) approved time cards. Numerous calculations are involved in determining gross wages and payroll deductions. Therefore, a second payroll department employee, working independently, verifies all calculated amounts, and a payroll department supervisor then approves the payroll.The payroll department is also responsible for preparing (but not signing) payroll checks, maintaining payroll records, and preparing payroll tax returns. Preparing the Payroll Two (or more) employees verify payroll amounts; supervisor approves. D4 Appendix D Payroll Accounting Paying the Payroll Paying the Payroll The treasurers department pays the payroll. Payment by check minimizes the risk of loss from theft, and the endorsed check provides proof of payment. For good internal control, payroll checks should be prenumbered, and all checks should be accounted for. All checks must be signed by the treasurer (or a designated agent). Distribution of the payroll checks to employees should be controlled by the treasurers department. Many employees have their pay credited electronically to their bank accounts. To control these disbursements, the company provides to employees receipts detailing gross pay deductions and net pay. Occasionally companies pay the payroll in currency. In such cases it is customary to have a second person count the cash in each pay envelope. The paymaster should obtain a signed receipt from the employee upon payment. Treasurer signs and distributes checks. DETERMINING THE PAYROLL STUDY OBJECTIVE 2 Compute and record the payroll for a pay period. Determining the payroll involves computing three amounts: (1) gross earnings, (2) payroll deductions, and (3) net pay. Gross Earnings Gross earnings is the total compensation earned by an employee. It consists of wages or salaries, plus any bonuses and commissions. Companies determine total wages for an employee by multiplying the hours worked by the hourly rate of pay. In addition to the hourly pay rate, most companies are required by law to pay hourly workers a minimum of 112 times the regular hourly rate for overtime work in excess of eight hours per day or 40 hours per week. In addition, many employers pay overtime rates for work done at night, on weekends, and on holidays. For example, assume that Michael Jordan, an employee of Academy Company, worked 44 hours for the weekly pay period ending January 14. His regular wage is $12 per hour. For any hours in excess of 40, the company pays at one-and-a-half times the regular rate.Academy computes Jordans gross earnings (total wages) as follows. Illustration D-3 Computation of total wages Type of Pay Regular Overtime Total wages Hours 40 4 Rate $12 18 Gross Earnings $480 72 $552 This computation assumes that Jordan receives 112 times his regular hourly rate ($12 1.5) for his overtime hours. Union contracts often reBonuses often reward outquire that overtime rates be as much as twice the regular rates. standing individual perAn employees salary is generally based on a monthly or yearly rate. formance, but successful corpoThe company then prorates these rates to its payroll periods (e.g., birations also need considerable teamwork. A challenge is to weekly or monthly). Most executive and administrative positions are motivate individuals while presalaried. Federal law does not require overtime pay for employees in venting an unethical employee such positions. from taking anothers idea for Many companies have bonus agreements for employees. One survey his or her own advantage. found that over 94% of the largest U.S. manufacturing companies offer annual bonuses to key executives. Bonus arrangements may be based on such factors as increased sales or net income. Companies may pay bonuses in cash and/or by granting employees the opportunity to acquire shares of company stock at favorable prices (called stock option plans). ETHICS NOTE Determining the Payroll D5 Payroll Deductions As anyone who has received a paycheck knows, gross earnings are usually very different from the amount actually received. The difference is due to payroll deductions. Payroll deductions may be mandatory or voluntary. Mandatory deductions are required by law and consist of FICA taxes and income taxes. Voluntary deductions are at the option of the employee. Illustration D-4 summarizes common types of payroll deductions. Such deductions do not result in payroll tax expense to the employer. The employer is merely a collection agent, and subsequently transfers the deducted amounts to the government and designated recipients. Federal Income Tax FICA Taxes State and City Income Taxes Gross Pay Net Pay Charity Insurance, Pensions, and/or Union Dues Illustration D-4 Payroll deductions FICA TAXES In 1937 Congress enacted the Federal Insurance Contribution Act (FICA). FICA taxes are designed to provide workers with supplemental retirement, employment disability, and medical benefits. In 1965, Congress extended benefits to include Medicare for individuals over 65 years of age. The benefits are financed by a tax levied on employees earnings. FICA taxes are commonly referred to as Social Security taxes. Congress sets the tax rate and the tax base for FICA taxes. When FICA taxes were first imposed, the rate was 1% on the first $3,000 of gross earnings, or a maximum of $30 per year.The rate and base have changed dramatically since that time! In 2007, the rate was 7.65% (6.2% Social Security plus 1.45% Medicare) on the first $97,500 of gross earnings for each employee.1 For purpose of illustration in this chapter, we will assume a rate of 8% on the first $97,500 of gross earnings, or a maximum of $7,800. Using the 8% rate, the FICA withholding for Jordan for the weekly pay period ending January 14 is $44.16 ($552 8%). 1 The Medicare provision also includes a tax of 1.45% on gross earnings in excess of $97,500. In the interest of simplification, we ignore this 1.45% charge in our end-of-chapter assignment material. We assume zero FICA withholdings on gross earnings above $97,500. D6 Appendix D Payroll Accounting INCOME TAXES Under the U.S. pay-as-you-go system of federal income taxes, employers are required to withhold income taxes from employees each pay period.Three variables determine the amount to be withheld: (1) the employees gross earnings; (2) the number of allowances claimed by the employee; and (3) the length of the pay period. The number of allowances claimed typically includes the employee, his or her spouse, and other dependents. To indicate to the Internal Revenue Service the number of allowances claimed, the employee must complete an Employees Withholding Allowance Certificate (Form W-4). As shown in Illustration D-5, Michael Jordan claims two allowances on his W-4. Illustration D-5 W-4 form Form W-4 Michael Employee's Withholding Allowance Certificate For Privacy Act and Paperwork Reduction Act Notice, see page 2. Last name OMB No. 1545-0010 Department of the Treasury Internal Revenue Service 1 Type or print your first name and middle initial Home address (number and street or rural route) 2 Your social security number 3 4 2345 Mifflin Ave. City or town, State, and ZIP code Jordan Single x Married 329-36-9547 Married, but withhold at higher Single rate. Note: If married, but legally separated, or spouse is a nonresident alien, check the Single box. If your last name differs from that on your social security card, check here and call 1-800-772-1213 for a new card . . . . . 5 5 Total number of allowances you are claiming (from line H above or from the worksheet on page 2 if they apply) 2 6$ 6 Additional amount, if any, you want withheld from each paycheck 7 I claim exemption from withholding for 2006, and I certify that I meet BOTH of the following conditions for exemption: Last year I had a right to a refund of ALL Federal income tax withheld because I had NO tax liability AND This year I expect a refund of ALL Federal income tax withheld because I expect to have NO tax liability. Hampton, MI 48292 If you meet both conditions, enter Exempt here 7 Under penalties of perjury, I certify that I am entitled to the number of withholding allowances claimed on this certificate or entitled to claim exempt status. Employee's signature 8 Employers name and address (Employer: Complete 8 and 10 only if sending to the IRS) Date September 1 , 20 08 9 Office code (optional) 10 Employer identification number Cat. No. 102200 Withholding tables furnished by the Internal Revenue Service indicate the amount of income tax to be withheld. Withholding amounts are based on gross wages and the number of allowances claimed. Separate tables are provided for weekly, biweekly, semimonthly, and monthly pay periods. Illustration D-6 (next page) shows the withholding tax table for Michael Jordan (assuming he earns $552 per week and claims two allowances). For a weekly salary of $552 with two allowances, the income tax to be withheld is $49. In addition, most states (and some cities) require employers to withhold income taxes from employees earnings. As a rule, the amounts withheld are a percentage (specified in the state revenue code) of the amount withheld for the federal income tax. Or they may be a specified percentage of the employees earnings. For the sake of simplicity, we have assumed that Jordans wages are subject to state income taxes of 2%, or $11.04 (2% $552) per week. There is no limit on the amount of gross earnings subject to income tax withholdings. In fact, under our progressive system of taxation, the higher the earnings, the higher the percentage of income withheld for taxes. OTHER DEDUCTIONS Employees may voluntarily authorize withholdings for charitable, retirement, and other purposes. All voluntary deductions from gross earnings should be authorized in writing by the employee. The authorization(s) may be made individually or as part of a group plan. Deductions for charitable organizations, such as the United Way, or for financial arrangements, such as U.S. savings bonds and repayment of Determining the Payroll Illustration D-6 Withholding tax table MARRIED Persons WEEKLY Payroll Period (For Wages Paid in 2008) D7 If the wages are At least 490 500 510 520 530 540 550 560 570 580 590 600 610 620 630 640 650 660 670 680 But less than 500 510 520 530 540 550 560 570 580 590 600 610 620 630 640 650 660 670 680 690 0 1 And the number of withholding allowances claimed is 2 3 4 5 6 7 8 9 10 The amount of income tax to be withheld is 56 57 59 60 62 63 65 66 68 69 71 72 74 75 77 78 80 81 83 84 48 49 51 52 54 55 57 58 60 61 63 64 66 67 69 70 72 73 75 76 40 42 43 45 46 48 49 51 52 54 55 57 58 60 61 63 64 66 67 69 32 34 35 37 38 40 41 43 44 46 47 49 50 52 53 55 56 58 59 61 24 26 27 29 30 32 33 35 36 38 39 41 42 44 45 47 48 50 51 53 17 18 20 21 23 24 26 27 29 30 32 33 35 36 38 39 41 42 44 45 9 10 12 13 15 16 18 19 21 22 24 25 27 28 30 31 33 34 36 37 1 3 4 6 7 9 10 12 13 15 16 18 19 21 22 24 25 27 28 30 0 0 0 0 0 1 2 4 5 7 8 10 11 13 14 16 17 19 20 22 0 0 0 0 0 0 0 0 0 0 1 2 4 5 7 8 10 11 13 14 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 3 5 6 loans from company credit unions, are made individually. Deductions for union dues, health and life insurance, and pension plans are often made on a group basis. We will assume that Jordan has weekly voluntary deductions of $10 for the United Way and $5 for union dues. Net Pay Academy Company determines net pay by subtracting payroll deductions from gross earnings. Illustration D-7 shows the computation of Jordans net pay for the pay period. A LT E R N AT I V E TERMINOLOGY Net pay is also called take-home pay. Illustration D-7 Computation of net pay Gross earnings Payroll deductions: FICA taxes Federal income taxes State income taxes United Way Union dues Net pay $552.00 $44.16 49.00 11.04 10.00 5.00 119.20 $432.80 Assuming that Michael Jordans wages for each week during the year are $552, total wages for the year are $28,704 (52 $552).Thus, all of Jordans wages are subject to FICA tax during the year. In comparison, lets assume that Jordans department head earns $2,000 per week, or $104,000 for the year. Since only the first $97,500 is subject to FICA taxes, the maximum FICA withholdings on the department heads earnings would be $7,800 ($97,500 8%). D8 Appendix D Payroll Accounting RECORDING THE PAYROLL Recording the payroll involves maintaining payroll department records, recognizing payroll expenses and liabilities, and recording payment of the payroll. Maintaining Payroll Department Records To comply with state and federal laws, an employer must keep a cumulative record of each employees gross earnings, deductions, and net pay during the year. The record that provides this information is the employee earnings record. Illustration D-8 shows Michael Jordans employee earnings record. Illustration D-8 Employee earnings record File A Edit B View C Insert D Format E Tools Data F Window G Help H I J K L M N 1 2 3 4 5 6 7 8 9 10 11 12 ACADEMY COMPANY Employee Earnings Record For the Year 2008 Name Social Security Number Date of Birth Date Employed Sex Michael Jordan 329-36-9547 December 24, 1962 September 1, 2003 Male Telephone Date Employment Ended Exemptions 2 Address 2345 Mifflin Ave. Hampton, Michigan 48292 555-238-9051 13 Single x Married 14 Gross Earnings 15 2008 16 Period Total 17 Ending Hours Regular Overtime Total Cumulative 42 480.00 36.00 516.00 516.00 18 1/7 480.00 72.00 552.00 1,068.00 44 19 1/14 43 480.00 54.00 534.00 1,602.00 20 1/21 42 480.00 36.00 516.00 2,118.00 21 1/28 Jan. 22 1,920.00 198.00 2,118.00 Total 23 24 FICA 41.28 44.16 42.72 41.28 Deductions Fed. State United Inc. Tax Inc. Tax Way 43.00 10.32 10.00 49.00 11.04 10.00 46.00 10.68 10.00 43.00 10.32 10.00 42.36 Union Dues 5.00 5.00 5.00 5.00 Total 109.60 119.20 114.40 109.60 Payment Net Check Amount No. 406.40 974 432.80 1028 419.60 1077 406.40 1133 169.44 181.00 40.00 20.00 452.80 1,665.20 Companies keep a separate earnings record for each employee, and update these records after each pay period. The employer uses the cumulative payroll data on the earnings record to: (1) determine when an employee has earned the maximum earnings subject to FICA taxes, (2) file state and federal payroll tax returns (as explained later), and (3) provide each employee with a statement of gross earnings and tax withholdings for the year. (Illustration D-12 on page D13 shows this statement.) In addition to employee earnings records, many companies find it useful to prepare a payroll register. This record accumulates the gross earnings, deductions, and net pay by employee for each pay period. It provides the documentation for preparing a paycheck for each employee. Illustration D-9 (next page) presents Academy Companys payroll register. It shows the data for Michael Jordan in the wages section. In this example, Academy Companys total weekly payroll is $17,210, as shown in the gross earnings column. Note that this record is a listing of each employees payroll data for the pay period. In some companies, a payroll register is a journal or book of original entry; Recording the Payroll D9 File Edit A View B Insert C Format D Tools E Data F Window G Help H I J K L M N O 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 ACADEMY COMPANY Payroll Register For the Week Ending January 14, 2008 Earnings g Total OverEmployee Hours Regular time Office Salaries Arnold, Patricia 40 580.00 Canton, Matthew 40 590.00 Gross 580.00 590.00 FICA 46.40 47.20 Deductions Federal State Income Income United Union Tax Tax Way Dues 61.00 63.00 11.60 11.80 15.00 20.00 Accounts Debited Office Check Salaries Wages Net Pay No. Expense Expense 446.00 448.00 998 999 580.00 590.00 Paid Total 134.00 142.00 Mueller, William Subtotal Wages Bennett, Robin Jordan, Michael 40 42 44 530.00 5,200.00 480.00 480.00 36.00 72.00 530.00 5,200.00 516.00 552.00 42.40 54.00 10.60 11.00 416.00 1,090.00 104.00 120.00 41.28 44.16 43.00 49.00 10.32 11.04 18.00 10.00 5.00 5.00 118.00 412.00 1000 530.00 1,730.00 3,470.00 5,200.00 117.60 119.20 398.40 1025 432.80 1028 516.00 552.00 Milroy, Lee Subtotal Total 43 480.00 54.00 534.00 42.72 46.00 10.68 10.00 5.00 114.40 419.60 1029 534.00 11,000.00 1,010.00 12,010.00 960.80 2,400.00 240.20 301.50 115.00 4,017.50 7,992.50 12,010.00 16,200.00 1,010.00 17,210.00 1,376.80 3,490.00 344.20 421.50 115.00 5,747.50 11,462.50 5,200.00 12,010.00 Illustration D-9 Payroll register postings are made from the payroll register directly to ledger accounts. In other companies, the payroll register is a memorandum record that provides the data for a general journal entry and subsequent posting to the ledger accounts.At Academy Company, the latter procedure is followed. Recognizing Payroll Expenses and Liabilities From the payroll register in Illustration D-9, Academy Company makes a journal entry to record the payroll. For the week ending January 14 the entry is: A L SE 5,200.00 Exp 12,010.00 Exp Jan. 14 Office Salaries Expense Wages Expense FICA Taxes Payable Federal Income Taxes Payable State Income Taxes Payable United Way Payable Union Dues Payable Salaries and Wages Payable (To record payroll for the week ending January 14) 5,200.00 12,010.00 1,376.80 3,490.00 344.20 421.50 115.00 11,462.50 1,376.80 3,490.00 344.20 421.50 115.00 11,462.50 Cash Flows no effect The company credits specific liability accounts for the mandatory and voluntary deductions made during the pay period. In the example, Academy debits Office Salaries Expense for the gross earnings of salaried office workers, and it debits Wages Expense for the gross earnings of employees who are paid at an hourly rate. Other companies may debit other accounts such as Store Salaries or Sales Salaries. The amount credited to Salaries and Wages Payable is the sum of the individual checks the employees will receive. D10 Appendix D Payroll Accounting Recording Payment of the Payroll A company makes payments by check (or electronic funds transfer) either from its regular bank account or a payroll bank account. Each paycheck is usually accompanied by a detachable statement of earnings document.This shows the employees gross earnings, payroll deductions, and net pay, both for the period and for the year-to-date. Academy Company uses its regular bank account for payroll checks. Illustration D-10 shows the paycheck and statement of earnings for Michael Jordan. Illustration D-10 Paycheck and statement of earnings AC Pay to the order of City Bank & Trust P.O. Box 3000 Hampton, MI 48291 For ACADEMY COMPANY 19 Center St. Hampton, MI 48291 $ No. 1028 20 621113 610 Dollars HELPFUL HINT Do any of the income tax liabilities result in payroll tax expense for the employer? Answer: No. The employer is acting only as a collection agent for the government. DETACH AND RETAIN THIS PORTION FOR YOUR RECORDS NAME SOC. SEC. NO. EMPL. NUMBER NO. EXEMP PAY PERIOD ENDING Michael Jordan REG. HRS. O.T. HRS. OTH. HRS. (1) OTH. HRS. (2) REG. EARNINGS 329-36-9547 O.T. EARNINGS 2 1/14/08 GROSS OTH. EARNINGS (1) OTH. EARNINGS (2) 40 FED. W/H TAX 4 FICA STATE TAX LOCAL TAX 480.00 11.04 (1) 72.00 OTHER DEDUCTIONS (2) $552.00 (3) (4) NET PAY 49.00 44.16 10.00 5.00 432.80 FED. W/H TAX FICA STATE TAX LOCAL TAX YEAR TO DATE OTHER DEDUCTIONS (1) 92.00 85.44 21.36 20.00 (2) 10.00 (3) (4) NET PAY $839.20 Following payment of the payroll, the company enters the check numbers in the payroll register. Academy Company records payment of the payroll as follows. A 11,462.50 Cash Flows 11,462.50 L OE 11,462.50 Jan. 14 Salaries and Wages Payable Cash (To record payment of payroll) 11,462.50 11,462.50 When a company uses currency in payment, it prepares one check for the payrolls total amount of net pay. The company cashes this check, and inserts the coins and currency in individual pay envelopes for disbursement to individual employees. Before You Go On... REVIEW IT 1. Identify two internal control procedures that apply to each payroll function. 2. What are the primary sources of gross earnings? 3. What payroll deductions are (a) mandatory and (b) voluntary? 4. What account titles do companies use in recording a payroll, assuming only mandatory payroll deductions are involved? Employer Payroll Taxes D11 DO IT Your cousin Stan is establishing a house-cleaning business and will have a number of employees working for him. He is aware that documentation procedures are an important part of internal control. But he is unsure about the difference between an employee earnings record and a payroll register. He asks you to explain the principal differences, because he wants to be sure that he sets up the proper payroll procedures. Action Plan Determine the earnings and deductions data that must be recorded and reported for each employee. Design a record that will accumulate earnings and deductions data and will serve as a basis for journal entries to be prepared and posted to the general ledger accounts. Explain the difference between the employee earnings record and the payroll register. Solution An employee earnings record is kept for each employee. It shows gross earnings, payroll deductions, and net pay for each pay period, as well as cumulative payroll data for that employee. In contrast, a payroll register is a listing of all employees gross earnings, payroll deductions, and net pay for each pay period. It is the documentation for preparing paychecks and for recording the payroll. Of course, Stan will need to keep both documents. Related exercise material: BED-1, BED-3, and ED-1. EMPLOYER PAYROLL TAXES Payroll tax expense for businesses results from three taxes that governSTUDY OBJECTIVE 3 mental agencies levy on employers. These taxes are: (1) FICA, (2) federal Describe and record employer unemployment tax, and (3) state unemployment tax. These taxes plus such payroll taxes. items as paid vacations and pensions (discussed in the appendix to this chapter) are collectively referred to as fringe benefits. As indicated earlier, the cost of fringe benefits in many companies is substantial. The pie chart in the margin shows the pieces of the benefits pie. BENEFITS FICA Taxes Each employee must pay FICA taxes. In addition, employers must match each employees FICA contribution. The matching contribution results in payroll tax expense to the employer. The employers tax is subject to the same rate and maximum earnings as the employees. The company uses the same account, FICA Taxes Payable, to record both the employees and the employers FICA contributions. For the January 14 payroll, Academy Companys FICA tax contribution is $1,376.80 ($17,210.00 8%). 3% Disability and life insurance 13% Retirement income such as pensions 23% Legally required benefits such as Social Security 24% Medical benefits 37% Vacation and other benefits such as parental and sick leaves, child care Federal Unemployment Taxes The Federal Unemployment Tax Act (FUTA) is another feature of the federal Social Security program. Federal unemployment taxes provide benefits for a limited period of time to employees who lose their jobs through no fault of their own. The FUTA tax rate is 6.2% of taxable wages. The taxable wage base is the first $7,000 of wages paid to each employee in a calendar year. Employers who HELPFUL HINT Both the employer and employee pay FICA taxes. Federal unemployment taxes and (in most states) the state unemployment taxes are borne entirely by the employer. D12 Appendix D Payroll Accounting pay the state unemployment tax on a timely basis will receive an offset credit of up to 5.4%. Therefore, the net federal tax rate is generally 0.8% (6.2%5.4%). This rate would equate to a maximum of $56 of federal tax per employee per year (.008 $7,000). State tax rates are based on state law. The employer bears the entire federal unemployment tax. There is no deduction or withholding from employees. Companies use the account Federal Unemployment Taxes Payable to recognize this liability. The federal unemployment tax for Academy Company for the January 14 payroll is $137.68 ($17,210.00 0.8%). State Unemployment Taxes All states have unemployment compensation programs under state unemployment tax acts (SUTA). Like federal unemployment taxes, state unemployment taxes provide benefits to employees who lose their jobs. These taxes are levied on employers.2 The basic rate is usually 5.4% on the first $7,000 of wages paid to an employee during the year.The state adjusts the basic rate according to the employers experience rating: Companies with a history of stable employment may pay less than 5.4%. Companies with a history of unstable employment may pay more than the basic rate. Regardless of the rate paid, the companys credit on the federal unemployment tax is still 5.4%. Companies use the account State Unemployment Taxes Payable for this liability. The state unemployment tax for Academy Company for the January 14 payroll is $929.34 ($17,210.00 5.4%). Illustration D-11 summarizes the types of employer payroll taxes. Illustration D-11 Employer payroll taxes FICA Taxes Federal Unemployment Taxes State Unemployment Taxes Computation Based on Wages Recording Employer Payroll Taxes Companies usually record employer payroll taxes at the same time they record the payroll. The entire amount of gross pay ($17,210.00) shown in the payroll register in Illustration D-9 is subject to each of the three taxes mentioned above. Accordingly, Academy records the payroll tax expense associated with the January 14 payroll with the entry shown on page D13. 2 In a few states, the employee is also required to make a contribution. In this textbook, including the homework, we will assume that the tax is only on the employer. Filing and Remitting Payroll Taxes Jan. 14 Payroll Tax Expense FICA Taxes Payable Federal Unemployment Taxes Payable State Unemployment Taxes Payable (To record employers payroll taxes on January 14 payroll) 2,443.82 1,376.80 137.68 929.34 A L 1,376.80 137.68 929.34 Cash Flows no effect D13 SE 2,443.82 Exp Note that Academy uses separate liability accounts instead of a single credit to Payroll Taxes Payable. Why? Because these liabilities are payable to different taxing authorities at different dates. Companies classify the liability accounts in the balance sheet as current liabilities since they will be paid within the next year. They classify Payroll Tax Expense on the income statement as an operating expense. FILING AND REMITTING PAYROLL TAXES Preparation of payroll tax returns is the responsibility of the payroll department. The treasurers department makes the tax payment. Much of the information for the returns is obtained from employee earnings records. For purposes of reporting and remitting to the IRS, the Company combines the FICA taxes and federal income taxes that it withheld. Companies must report the taxes quarterly, no later than one month following the close of each quarter. The remitting requirements depend on the amount of taxes withheld and the length of the pay period. Companies remit funds through deposits in either a Federal Reserve bank or an authorized commercial bank. Companies generally file and remit federal unemployment taxes annually on or before January 31 of the subsequent year. Earlier payments are required when the tax exceeds a specified amount. Companies usually must file and pay state unemployment taxes by the end of the month following each quarter.When payroll taxes are paid, companies debit payroll liability accounts, and credit Cash. Employers also must provide each employee with a Wage and Tax Statement (Form W-2) by January 31 following the end of a calendar year. This statement shows gross earnings, FICA taxes withheld, and income taxes withheld for the year. The required W-2 form for Michael Jordan, using assumed annual data, is shown in Illustration D-12. The employer must send a copy of each employees Illustration D-12 W-2 form Form W-2 Wage and Tax Statement OMB No. 1545-0008 Calendar Year 2008 1 Control number 2 Employer's name, address and ZIP code 3 Employer's identification number 4 Employer's State number Academy Company 19 Center St. Hampton, MI 48291 36-2167852 5 Stat. Deceased employee 6 Allocated tips Legal rep. 942 emp. Subtotal Void 7 Advance EIC payment 8 Employee's social security number 9 Federal income tax withheld 10 Wages, tips, other compensation 11 Social security tax withheld 329-36-9547 12 Employee's name, address, and ZIP code $2,248.00 $26,300.00 13 Social security wages $2,104.00 14 Social security tips $26,300.00 16 Michael Jordan 2345 Mifflin Ave. Hampton, MI 48292 17 State income tax 18 State wages, tips, etc. 19 Name of State $526.00 20 Local income tax Michigan 21 Local wages, tips, etc. 22 Name of locality HELPFUL HINT Employers generally transmit their W-2s to the government electronically. The taxing agencies store the information in their computer systems for subsequent comparison against earnings and taxes withheld reported on employees income tax returns. D14 Appendix D Payroll Accounting Wage and Tax Statement (Form W-2) to the Social Security Administration. This agency subsequently furnishes the Internal Revenue Service with the income data required. Before You Go On... REVIEW IT 1. What payroll taxes do governments levy on employers? 2. What accounts are involved in accruing employer payroll taxes? DO IT In January, the payroll supervisor determines that gross earnings for Halo Company are $70,000. All earnings are subject to 8% FICA taxes, 5.4% state unemployment taxes, and 0.8% federal unemployment taxes. Halo asks you to record the employers payroll taxes. Action Plan Compute the employers payroll taxes on the periods gross earnings. Identify the expense account(s) to be debited. Identify the liability account(s) to be credited. The entry to record the employers payroll taxes is: 9,940 5,600 560 3,780 Solution Payroll Tax Expense FICA Taxes Payable ($70,000 8%) Federal Unemployment Taxes Payable ($70,000 0.8%) State Unemployment Taxes Payable ($70,000 5.4%) (To record employers payroll taxes on January payroll) Related exercise material: BED-2, BED-3, BED-4, ED-1, ED-2, ED-3, ED-4, and ED-5. Demonstration Problem Indiana Jones Company had the following selected transactions. Feb. 1 Signs a $50,000, 6-month, 9%-interest-bearing note payable to CitiBank and receives $50,000 in cash. 10 Cash register sales total $43,200, which includes an 8% sales tax. 28 The payroll for the month consists of Sales Salaries $32,000 and Office Salaries $18,000. All wages are subject to 8% FICA taxes. A total of $8,900 federal income taxes are withheld. The salaries are paid on March 1. 28 The following adjustment data are developed. 1. Interest expense of $375 has been incurred on the note. 2. Employer payroll taxes include 8% FICA taxes, a 5.4% state unemployment tax, and a 0.8% federal unemployment tax. Instructions (a) Journalize the February transactions. (b) Journalize the adjusting entries at February 28. Glossary D15 Solution (a) Feb. 1 Cash Notes Payable (Issued 6-month, 9%-interest-bearing note to CitiBank) Cash Sales ($43,200 1.08) Sales Taxes Payable ($40,000 8%) (To record sales and sales taxes payable) Sales Salaries Expense Office Salaries Expense FICA Taxes Payable (8% $50,000) Federal Income Taxes Payable Salaries Payable (To record February salaries) Interest Expense Interest Payable (To record accrued interest for February) Payroll Tax Expense FICA Taxes Payable Federal Unemployment Taxes Payable (0.8% $50,000) State Unemployment Taxes Payable (5.4% $50,000) (To record employers payroll taxes on February payroll) 50,000 50,000 action plan To determine sales, divide the cash register total by 100% plus the sales tax percentage. Base payroll taxes on gross earnings. 10 43,200 40,000 3,200 32,000 18,000 4,000 8,900 37,100 375 375 7,100 4,000 400 2,700 28 (b) Feb. 28 28 SUMMARY OF STUDY OBJECTIVES 1 Discuss the objectives of internal control for payroll. The objectives of internal control for payroll are (1) to safeguard company assets against unauthorized payments of payrolls, and (2) to ensure the accuracy and reliability of the accounting records pertaining to payrolls. 2 Compute and record the payroll for a pay period. The computation of the payroll involves gross earnings, payroll deductions, and net pay. In recording the payroll, Salaries (or Wages) Expense is debited for gross earnings, individual tax and other liability accounts are credited for payroll deductions, and Salaries (Wages) Payable is credited for net pay. When the payroll is paid, Salaries and Wages Payable is debited, and Cash is credited. 3 Describe and record employer payroll taxes. Employer payroll taxes consist of FICA, federal unemployment taxes, and state unemployment taxes. The taxes are usually accrued at the time the payroll is recorded by debiting Payroll Tax Expense and crediting separate liability accounts for each type of tax. GLOSSARY Bonus Compensation to management personnel and other employees, based on factors such as increased sales or the amount of net income. (p. D4). Employee earnings record A cumulative record of each employees gross earnings, deductions, and net pay during the year. (p. D8). Employees Withholding Allowance Certificate (Form W-4) An Internal Revenue Service form on which the employee indicates the number of allowances claimed for withholding federal income taxes. (p. D6). Federal unemployment taxes Taxes imposed on the employer that provide benefits for a limited time period to employees who lose their jobs through no fault of their own. (p. D11). Fees Payments made for the services of professionals. (p. D1). FICA taxes Taxes designed to provide workers with supplemental retirement, employment disability, and medical benefits. (p. D5). Gross earnings Total compensation earned by an employee. (p. D4). D16 Appendix D Payroll Accounting State unemployment taxes Taxes imposed on the employer that provide benefits to employees who lose their jobs. (p. D12). Wage and Tax Statement (Form W-2) A form showing gross earnings, FICA taxes withheld, and income taxes withheld which is prepared annually by an employer for each employee. (p. D13). Wages Amounts paid to employees based on a rate per hour or on a piece-work basis. (p. D1). Net pay Gross earnings less payroll deductions. (p. D7). Payroll deductions Deductions from gross earnings to determine the amount of a paycheck. (p. D5). Payroll register A payroll record that accumulates the gross earnings, deductions, and net pay by employee for each pay period. (p. D8). Salaries Specified amount per month or per year paid to managerial, administrative, and sales personnel. (p. D1). Statement of earnings A document attached to a paycheck that indicates the employees gross earnings, payroll deductions, and net pay. (p. D10). SELF-STUDY QUESTIONS Answers are at the end of the appendix. 1. The department that should pay the payroll is the: a. timekeeping department. b. human resources department. c. payroll department. d. treasurers department. (SO 2) 2. J. Barr earns $14 per hour for a 40-hour week and $21 per hour for any overtime work. If Barr works 45 hours in a week, gross earnings are: a. $560. b. $630. (SO 1) c. $650. d. $665. 3. Employer payroll taxes do not include: a. federal unemployment taxes. b. state unemployment taxes. c. federal income taxes. d. FICA taxes. Go to the books website, www.wiley.com/college/weygandt, for Additional Self-Study questions. (SO 3) QUESTIONS 1. You are a newly hired accountant with Schindlebeck Company. On your first day, the controller asks you to identify the main internal control objectives related to payroll accounting. How would you respond? 2. What are the four functions associated with payroll activities? 3. What is the difference between gross pay and net pay? Which amount should a company record as wages or salaries expense? 4. Which payroll tax is levied on both employers and employees? 5. Are the federal and state income taxes withheld from employee paychecks a payroll tax expense for the employer? Explain your answer. 6. What do the following acronyms stand for: FICA, FUTA, and SUTA? 7. What information is shown on a W-4 statement? On a W-2 statement? 8. Distinguish between the two types of payroll deductions and give examples of each. 9. What are the primary uses of the employee earnings record? 10. (a) Identify the three types of employer payroll taxes. (b) How are tax liability accounts and Payroll Tax Expense classified in the financial statements? BRIEF EXERCISES Identify payroll functions. (SO 1) BED-1 (a) (b) (c) (d) Hernandez Company has the following payroll procedures. Supervisor approves overtime work. The human resources department prepares hiring authorization forms for new hires. A second payroll department employee verifies payroll calculations. The treasurers department pays employees. Identify the payroll function to which each procedure pertains. Exercises BED-2 Sandy Teters regular hourly wage rate is $16, and she receives an hourly rate of $24 for work in excess of 40 hours. During a January pay period, Sandy works 45 hours. Sandys federal income tax withholding is $95, and she has no voluntary deductions. Compute Sandy Teters gross earnings and net pay for the pay period. BED-3 Data for Sandy Teter are presented in BED-2. Prepare the journal entries to record (a) Sandys pay for the period and (b) the payment of Sandys wages. Use January 15 for the end of the pay period and the payment date. BED-4 In January, gross earnings in Yoon Company totaled $90,000. All earnings are subject to 8% FICA taxes, 5.4% state unemployment taxes, and 0.8% federal unemployment taxes. Prepare the entry to record January payroll tax expense. D17 Compute gross earnings and net pay. (SO 2) Record a payroll and the payment of wages. (SO 2) Record employer payroll taxes. (SO 3) EXERCISES ED-1 Betty Williams regular hourly wage rate is $14, and she receives a wage of 112 times the regular hourly rate for work in excess of 40 hours. During a March weekly pay period Betty worked 42 hours. Her gross earnings prior to the current week were $6,000. Betty is married and claims three withholding allowances. Her only voluntary deduction is for group hospitalization insurance at $15 per week. Instructions (a) Compute the following amounts for Bettys wages for the current week. (1) Gross earnings. (2) FICA taxes. (Assume an 8% rate on maximum of $97,500.) (3) Federal income taxes withheld. (Use the withholding table in the text, page D7.) (4) State income taxes withheld. (Assume a 2.0% rate.) (5) Net pay. (b) Record Bettys pay, assuming she is an office computer operator. ED-2 Employee earnings records for Brantley Company reveal the following gross earnings for four employees through the pay period of December 15. C. Mays L. Jeter $83,500 $95,200 D. Delgado T. Rolen $95,700 $97,500 Compute maximum FICA deductions. (SO 2) Compute net pay and record pay for one employee. (SO 2) For the pay period ending December 31, each employees gross earnings is $3,000. Employees are required to pay a FICA tax rate of 8% gross earnings of $97,500. Instructions Compute the FICA withholdings that should be made for each employee for the December 31 pay period. (Show computations.) ED-3 Piniella Company has the following data for the weekly payroll ending January 31. Hours Employee M. Hindi E. Benson K. Estes M 8 8 9 T 8 8 10 W 9 8 8 T 8 8 8 F 10 8 9 S 3 2 0 Federal Income Tax Withholding $34 37 58 Prepare payroll register and record payroll and payroll tax expense. (SO 2, 3) Hourly Rate $11 13 14 Health Insurance $10 15 15 Employees are paid 112 times the regular hourly rate for all hours worked in excess of 40 hours per week. FICA taxes are 8% on the first $97,500 of gross earnings. Piniella Company is subject to 5.4% state unemployment taxes on the first $9,800 and 0.8% federal unemployment taxes on the first $7,000 of gross earnings. Instructions (a) Prepare the payroll register for the weekly payroll. (b) Prepare the journal entries to record the payroll and Piniellas payroll tax expense. D18 Appendix D Payroll Accounting ED-4 Selected data from a February payroll register for Landmark Company are presented below. Some amounts are intentionally omitted. Gross earnings: Regular Overtime Total Deductions: FICA taxes Federal income taxes $8,900 (1) (2) $ 760 1,140 State income taxes Union dues Total deductions Net pay Accounts debited: Warehouse wages Store wages $(3) 100 (4) $7,215 (5) $4,000 Compute missing payroll amounts and record payroll. (SO 2) FICA taxes are 8%. State income taxes are 3% of gross earnings. Instructions (a) Fill in the missing amounts. (b) Journalize the February payroll and the payment of the payroll. Determine employers payroll taxes; record payroll tax expense. (SO 3) ED-5 According to a payroll register summary of Cruz Company, the amount of employees gross pay in December was $850,000, of which $70,000 was not subject to FICA tax and $760,000 was not subject to state and federal unemployment taxes. Instructions (a) Determine the employers payroll tax expense for the month, using the following rates: FICA 8%, state unemployment 5.4%, federal unemployment 0.8%. (b) Prepare the journal entry to record December payroll tax expense. llege /w eygand t Visit the books website at www.wiley.com/college/weygandt, and choose the Student Companion site, to access Exercise Set B. PROBLEMS: SET A Identify internal control weaknesses and make recommendations for improvement. (SO 1) PD-1A The payroll procedures used by three different companies are described below. 1. In Brewer Company each employee is required to mark on a clock card the hours worked. At the end of each pay period, the employee must have this clock card approved by the department manager. The approved card is then given to the payroll department by the employee. Subsequently, the treasurers department pays the employee by check. 2. In Hilyard Computer Company clock cards and time clocks are used. At the end of each pay period, the department manager initials the cards, indicates the rates of pay, and sends them to payroll. A payroll register is prepared from the cards by the payroll department. Cash equal to the total net pay in each department is given to the department manager, who pays the employees in cash. 3. In Hyun-chan Company employees are required to record hours worked by punching clock cards in a time clock. At the end of each pay period, the clock cards are collected by the department manager. The manager prepares a payroll register in duplicate and forwards the original to payroll. In payroll, the summaries are checked for mathematical accuracy, and a payroll supervisor pays each employee by check. Instructions (a) Indicate the weakness(es) in internal control in each company. (b) For each weakness, describe the control procedure(s) that will provide effective internal Use control. the following format for your answer: (a) Weaknesses (b) Recommended Procedures .w i l e y. c o EXERCISES: SET B www m /co Problems: Set A PD-2A Graves Drug Store has four employees who are paid on an hourly basis plus time-anda-half for all hours worked in excess of 40 a week. Payroll data for the week ended February 15, 2008, are presented below. Federal Income Tax Withholdings $? ? 61 52 D19 Prepare payroll register and payroll entries. (SO 2, 3) Employees L. Leiss S. Bjork M. Cape L. Wild Hours Worked 39 42 44 48 Hourly Rate $14.00 $12.00 $12.00 $12.00 United Way $0 5.00 7.50 5.00 Leiss and Bjork are married. They claim 2 and 4 withholding allowances, respectively. The following tax rates are applicable: FICA 8%, state income taxes 3%, state unemployment taxes 5.4%, and federal unemployment 0.8%. The first three employees are sales clerks (store wages expense). The fourth employee performs administrative duties (office wages expense). Instructions (a) Prepare a payroll register for the weekly payroll. (Use the wage-bracket withholding table in the text for federal income tax withholdings.) (b) Journalize the payroll on February 15, 2008, and the accrual of employer payroll taxes. (c) Journalize the payment of the payroll on February 16, 2008. (d) Journalize the deposit in a Federal Reserve bank on February 28, 2008, of the FICA and federal income taxes payable to the government. PD-3A The following payroll liability accounts are included in the ledger of Eikleberry Company on January 1, 2008. FICA Taxes Payable Federal Income Taxes Payable State Income Taxes Payable Federal Unemployment Taxes Payable State Unemployment Taxes Payable Union Dues Payable U.S. Savings Bonds Payable In January, the following transactions occurred. Jan. 10 Sent check for $250.00 to union treasurer for union dues. 12 Deposited check for $1,916.80 in Federal Reserve bank for FICA taxes and federal income taxes withheld. 15 Purchased U.S. Savings Bonds for employees by writing check for $350.00. 17 Paid state income taxes withheld from employees. 20 Paid federal and state unemployment taxes. 31 Completed monthly payroll register, which shows office salaries $17,600, store wages $27,400, FICA taxes withheld $3,600, federal income taxes payable $1,770, state income taxes payable $360, union dues payable $400, United Fund contributions payable $1,800, and net pay $37,070. 31 Prepared payroll checks for the net pay and distributed checks to employees. At January 31, the company also makes the following accrual for employer payroll taxes: FICA taxes 8%, state unemployment taxes 5.4%, and federal unemployment taxes 0.8%. Instructions (a) Journalize the January transactions. (b) Journalize the adjustments pertaining to employee compensation at January 31. $ 662.20 1,254.60 102.15 312.00 1,954.40 250.00 350.00 (a) Net pay $1,786.32; Store wages expense $1,614.00 (b) Payroll tax expense $317.79 Journalize payroll transactions and adjusting entries. (SO 2, 3) (b) Payroll tax expense $6,390.00 D20 Appendix D Payroll Accounting PD-4A For the year ended December 31, 2008, R. Visnak Company reports the following summary payroll data. Gross earnings: Administrative salaries Electricians wages Total Deductions: FICA taxes Federal income taxes withheld State income taxes withheld (2.6%) United Way contributions payable *Hospital insurance premiums Total $180,000 320,000 $500,000 $ 35,200 153,000 13,000 25,000 15,800 $242,000 Prepare entries for payroll and payroll taxes; prepare W-2 data. (SO 2, 3) R. Visnak Companys payroll taxes are: FICA 8%, state unemployment 2.5% (due to a stable employment record), and 0.8% federal unemployment. Gross earnings subject to FICA taxes total $440,000, and unemployment taxes total $110,000. (a) Wages Payable $258,000 (b) Payroll tax expense $38,830 Instructions (a) Prepare a summary journal entry at December 31 for the full years payroll. (b) Journalize the adjusting entry at December 31 to record the employers payroll taxes. (c) The W-2 Wage and Tax Statement requires the following dollar data. Wages, Tips, Other Compensation Federal Income Tax Withheld State Income Tax Withheld FICA Wages FICA Tax Withheld Complete the required data for the following employees. Employee R. Lopez K. Kirk Gross Earnings $60,000 27,000 Federal Income Tax Withheld $27,500 11,000 PROBLEMS: SET B Identify internal control weaknesses and make recommendations for improvement. (SO 1) PD-1B Selected payroll procedures of Wallace Company are described below. 1. Department managers interview applicants and on the basis of the interview either hire or reject the applicants. When an applicant is hired, the applicant fills out a W-4 form (Employees Withholding Allowance Certificate). One copy of the form is sent to the human resources department, and one copy is sent to the payroll department as notice that the individual has been hired. On the copy of the W-4 sent to payroll, the managers manually indicate the hourly pay rate for the new hire. 2. The payroll checks are manually signed by the chief accountant and given to the department managers for distribution to employees in their department.The managers are responsible for seeing that any absent employees receive their checks. 3. There are two clerks in the payroll department. The payroll is divided alphabetically; one clerk has employees A to L and the other has employees M to Z. Each clerk computes the gross earnings, deductions, and net pay for employees in the section and posts the data to the employee earnings records. Instructions (a) Indicate the weaknesses in internal control. (b) For each weakness, describe the control procedures that will provide effective internal control. Use the following format for your answer: (a) Weaknesses (b) Recommended Procedures Problems: Set B PD-2B Lee Hardware has four employees who are paid on an hourly basis plus time-and-a half for all hours worked in excess of 40 a week. Payroll data for the week ended March 15, 2008, are presented below. D21 Prepare payroll register and payroll entries. (SO 2, 3) Employee Joe Coomer Mary Walker Andy Dye Kim Shen Hours Worked 40 42 44 48 Hourly Rate $15.00 13.00 13.00 13.00 Federal Income Tax Withholdings $? ? 60 67 United Way $5.00 5.00 8.00 5.00 Coomer and Walker are married. They claim 0 and 4 withholding allowances, respectively. The following tax rates are applicable: FICA 8%, state income taxes 3%, state unemployment taxes 5.4%, and federal unemployment 0.8%. The first three employees are sales clerks (store wages expense). The fourth employee performs administrative duties (office wages expense). Instructions (a) Prepare a payroll register for the weekly payroll. (Use the wage-bracket withholding table in the text for federal income tax withholdings.) (b) Journalize the payroll on March 15, 2008, and the accrual of employer payroll taxes. (c) Journalize the payment of the payroll on March 16, 2008. (d) Journalize the deposit in a Federal Reserve bank on March 31, 2008, of the FICA and federal income taxes payable to the government. PD-3B The following payroll liability accounts are included in the ledger of Nordlund Company on January 1, 2008. FICA Taxes Payable Federal Income Taxes Payable State Income Taxes Payable Federal Unemployment Taxes Payable State Unemployment Taxes Payable Union Dues Payable $ 760.00 1,204.60 108.95 288.95 1,954.40 870.00 (a) Net pay $1,910.37; Store wages expense $1,757 (b) Payroll tax expense $345.48 Journalize payroll transactions and adjusting entries. (SO 2, 3) U.S. Savings Bonds Payable In January, the following transactions occurred. 360.00 Jan. 10 Sent check for $870.00 to union treasurer for union dues. 12 Deposited check for $1,964.60 in Federal Reserve bank for FICA taxes and federal income taxes withheld. 15 Purchased U.S. Savings Bonds for employees by writing check for $360.00. 17 Paid state income taxes withheld from employees. 20 Paid federal and state unemployment taxes. 31 Completed monthly payroll register, which shows office salaries $21,600, store wages $28,400, FICA taxes withheld $4,000, federal income taxes payable $1,958, state income taxes payable $414, union dues payable $400, United Fund contributions payable $1,888, and net pay $41,340. 31 Prepared payroll checks for the net pay and distributed checks to employees. At January 31, the company also makes the following accrued adjustment for employer payroll taxes: FICA taxes 8%, federal unemployment taxes 0.8%, and state unemployment taxes 5.4%. Instructions (a) Journalize the January transactions. (b) Journalize the adjustments pertaining to employee compensation at January 31. (b) Payroll tax expense $7,100 D22 Appendix D Payroll Accounting PD-4B For the year ended December 31, 2008, Niehaus Electrical Repair Company reports the following summary payroll data. Gross earnings: Administrative salaries Electricians wages Total $180,000 370,000 $550,000 Prepare entries for payroll and payroll taxes; prepare W-2 data. (SO 2, 3) Deductions: FICA taxes $ 38,000 Federal income taxes withheld 168,000 State income taxes withheld (2.6%) 14,300 United Way contributions payable 27,500 *Hospital insurance premiums 17,200 Total $265,000 Niehaus Companys payroll taxes are: FICA 8%, state unemployment 2.5% (due to a stable employment record), and 0.8% federal unemployment. Gross earnings subject to FICA taxes total $475,000, and unemployment taxes total $125,000. (a) Wages payable $285,000 (b) Payroll tax expense $42,125 Instructions (a) Prepare a summary journal entry at December 31 for the full years payroll. (b) Journalize the adjusting entry at December 31 to record the employers payroll taxes. (c) The W-2 Wage and Tax Statement requires the following dollar data. Wages, Tips, Other Compensation Federal Income Tax Withheld State Income Tax Withheld FICA Wages FICA Tax Withheld Complete the required data for the following employees. Employee Anna Hashmi Sharon Bishop Gross Earnings $59,000 26,000 Federal Income Tax Withheld $28,500 10,200 llege /w eygand t Visit the books website at www.wiley.com/college/weygandt, and choose the Student Companion site, to access Problem Set C. BROADENING YOUR PERSPECTIVE FINANCIAL REPORTING AND ANALYSIS llege /w eygand Exploring the Web BYPD-1 The Internal Revenue Service provides considerable information over the Internet. The following demonstrates how useful one of its sites is in answering payroll tax questions faced by employers. Address: www.irs.ustreas.gov/formspubs/index.html, or go to www.wiley.com/college/weygandt Steps 1. Go to the site shown above. 2. Choose View Online, Tax Publications. 3. Choose Publication 15, Circular E, Employers Tax Guide. m /co .w i l e y. c o PROBLEMS: SET C www m /co t www .w i l e y. c o Broadening Your Perspective Instructions Answer each of the following questions. (a) How does the government define employees? (b) What are the special rules for Social Security and Medicare regarding children who are employed by their parents? (c) How can an employee obtain a Social Security card if he or she doesnt have one? (d) Must employees report to their employer tips received from customers? If so, what is the process? (e) Where should the employer deposit Social Security taxes withheld or contributed? D23 CRITICAL THINKING Decision Making Across the Organization BYPD-2 Summerville Processing Company provides word-processing services for business clients and students in a university community. The work for business clients is fairly steady throughout the year. The work for students peaks significantly in December and May as a result of term papers, research project reports, and dissertations. Two years ago, the company attempted to meet the peak demand by hiring part-time help. However, this led to numerous errors and considerable customer dissatisfaction. A year ago, the company hired four experienced employees on a permanent basis instead of using part-time help. This proved to be much better in terms of productivity and customer satisfaction. But, it has caused an increase in annual payroll costs and a significant decline in annual net income. Recently, Valarie Flynn, a sales representative of Davidson Services Inc., has made a proposal to the company. Under her plan, Davidson Services will provide up to four experienced workers at a daily rate of $80 per person for an 8-hour workday. Davidson workers are not available on an hourly basis. Summerville Processing would have to pay only the daily rate for the workers used. The owner of Summerville Processing, Nancy Bell, asks you, as the companys accountant, to prepare a report on the expenses that are pertinent to the decision. If the Davidson plan is adopted, Nancy will terminate the employment of two permanent employees and will keep two permanent employees. At the moment, each employee earns an annual income of $22,000. Summerville Processing pays 8% FICA taxes, 0.8% federal unemployment taxes, and 5.4% state unemployment taxes. The unemployment taxes apply to only the first $7,000 of gross earnings. In addition, Summerville Processing pays $40 per month for each employee for medical and dental insurance. Nancy indicates that if the Davidson Services plan is accepted, her needs for workers will be as follows. Months JanuaryMarch AprilMay JuneOctober NovemberDecember Number 2 3 2 3 Working Days per Month 20 25 18 23 Instructions With the class divided into groups, answer the following. (a) Prepare a report showing the comparative payroll expense of continuing to employ permanent workers compared to adopting the Davidson Services Inc. plan. (b) What other factors should Nancy consider before finalizing her decision? Communication Activity BYPD-3 Ivan Blanco, president of the Blue Sky Company, has recently hired a number of additional employees. He recognizes that additional payroll taxes will be due as a result of this hiring, and that the company will serve as the collection agent for other taxes. D24 Appendix D Payroll Accounting Instructions In a memorandum to Ivan Blanco, explain each of the taxes, and identify the taxes that result in payroll tax expense to Blue Sky Company. Ethics Case BYPD-4 Johnny Fuller owns and manages Johnnys Restaurant, a 24-hour restaurant near the citys medical complex. Johnny employs 9 full-time employees and 16 part-time employees. He pays all of the full-time employees by check, the amounts of which are determined by Johnnys public accountant, Mary Lake. Johnny pays all of his part-time employees in cash. He computes their wages and withdraws the cash directly from his cash register. Mary has repeatedly urged Johnny to pay all employees by check. But as Johnny has told his competitor and friend, Steve Hill, who owns the Greasy Diner, First of all, my part-time employees prefer the cash over a check, and secondly I dont withhold or pay any taxes or workmens compensation insurance on those wages because they go totally unrecorded and unnoticed. Instructions (a) Who are the stakeholders in this situation? (b) What are the legal and ethical considerations regarding Johnnys handling of his payroll? (c) Mary Lake is aware of Johnnys payment of the part-time payroll in cash. What are her ethical responsibilities in this case? (d) What internal control principle is violated in this payroll process? Answers to Self-Study Questions 1. d 2. d 3. c Appendix E OBJECTIVES Subsidiary Ledgers and Special Journals STUDY After studying this appendix, you should be able to: 1. Describe the nature and purpose of a subsidiary ledger. 2. Explain how companies use special journals in journalizing. 3. Indicate how companies post a multi-column journal. SECTION 1 Expanding the Ledger Subsidiary Ledgers NATURE AND PURPOSE OF SUBSIDIARY LEDGERS Imagine a business that has several thousand charge (credit) customers STUDY OBJECTIVE 1 and shows the transactions with these customers in only one general Describe the nature and purpose ledger accountAccounts Receivable. It would be nearly impossible to of a subsidiary ledger. determine the balance owed by an individual customer at any specific time. Similarly, the amount payable to one creditor would be difficult to locate quickly from a single Accounts Payable account in the general ledger. Instead, companies use subsidiary ledgers to keep track of individual balances. A subsidiary ledger is a group of accounts with a common characteristic (for example, all accounts receivable). It is an addition to, and an expansion of, the general ledger. The subsidiary ledger frees the general ledger from the details of individual balances. Two common subsidiary ledgers are: 1. The accounts receivable (or customers) subsidiary ledger, which collects transaction data of individual customers. 2. The accounts payable (or creditors) subsidiary ledger, which collects transaction data of individual creditors. In each of these subsidiary ledgers, companies usually arrange individual accounts in alphabetical order. A general ledger account summarizes the detailed data from a subsidiary ledger. For example, the detailed data from the accounts receivable subsidiary ledger are summarized in Accounts Receivable in the general ledger. The general ledger account that summarizes subsidiary ledger data is called a control account. Illustration E-1 (page E2) presents an overview of the relationship of subsidiary ledgers to the general ledger.There, the general ledger control accounts and subsidiary ledger accounts are in green. Note that cash and owners capital in this E1 E2 Appendix E Subsidiary Ledgers and Special Journals illustration are not control accounts because there are no subsidiary ledger accounts related to these accounts. At the end of an accounting period, each general ledger control account balance must equal the composite balance of the individual accounts in the related subsidiary ledger. For example, the balance in Accounts Payable in Illustration E-1 must equal the total of the subsidiary balances of Creditors X Y Z. Control accounts General Ledger Accounts Receivable Accounts Payable Cash Common Stock Subsidiary Ledgers Customer Customer Customer A B C Creditor X Creditor Y Creditor Z Illustration E-1 Relationship of general ledger and subsidiary ledgers Subsidiary Ledger Example Illustration E-2 provides an example of a control account and subsidiary ledger for Pujols Enterprises. (Due to space considerations, the explanation column in these accounts is not shown in this and subsequent illustrations.) Illustration E-2 is based on the transactions listed in Illustration E-3 (next page). Illustration E-2 Relationship between general and subsidiary ledgers File Edit View ? Go Bookmarks Tools Entries Help Post Closing Reports Tools Help Problem Date 2008 Jan 10 19 Ref. Aaron Co. Debit Credit 6,000 4,000 Branden Inc. Debit Credit 3,000 3,000 Caron Co. Debit Credit 3,000 1,000 Balance 6,000 2,000 Date 2008 Jan 31 31 Accounts Receivable Ref. Debit Credit 12,000 8,000 No. 112 Balance 12,000 4,000 Date 2008 Jan 12 21 Ref. Balance 3,000 -----The subsidiary ledger is separate from the general ledger. Accounts Receivable is a control account. Date 2008 Jan 20 29 Ref. Balance 3,000 2,000 General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl Nature and Purpose of Subsidiary Ledgers Credit Sales Jan. 10 Aaron Co. 12 Branden Inc. 20 Caron Co. $ 6,000 3,000 3,000 $12,000 Collections on Account Jan. 19 Aaron Co. 21 Branden Inc. 29 Caron Co. $ 4,000 3,000 1,000 $ 8,000 Illustration E-3 Sales and collection transactions E3 Pujols can reconcile the total debits ($12,000) and credits ($8,000) in Accounts Receivable in the general ledger to the detailed debits and credits in the subsidiary accounts. Also, the balance of $4,000 in the control account agrees with the total of the balances in the individual accounts (Aaron Co. $2,000 Branden Inc. $0 Caron Co. $2,000) in the subsidiary ledger. As Illustration E-2 shows, companies make monthly postings to the control accounts in the general ledger.This practice allows them to prepare monthly financial statements. Companies post to the individual accounts in the subsidiary ledger daily. Daily posting ensures that account information is current. This enables the company to monitor credit limits, bill customers, and answer inquiries from customers about their account balances. Advantages of Subsidiary Ledgers Subsidiary ledgers have several advantages: 1. They show in a single account transactions affecting one customer or one creditor, thus providing up-to-date information on specific account balances. 2. They free the general ledger of excessive details. As a result, a trial balance of the general ledger does not contain vast numbers of individual account balances. 3. They help locate errors in individual accounts by reducing the number of accounts in one ledger and by using control accounts. 4. They make possible a division of labor in posting. One employee can post to the general ledger while someone else posts to the subsidiary ledgers. Before You Go On... REVIEW IT 1. What is a subsidiary ledger, and what purpose does it serve? 2. What is a control account, and what purpose does it serve? 3. Name two general ledger accounts that may act as control accounts for a subsidiary ledger. Can you think of a third control account? DO IT Presented below is information related to Sims Company for its first month of operations. Determine the balances that appear in the accounts payable subsidiary ledger. What Accounts Payable balance appears in the general ledger at the end of January? Credit Purchases Jan. 5 11 22 Devon Co. Shelby Co. Taylor Co. $11,000 7,000 14,000 Jan. 9 14 27 Cash Paid Devon Co. Shelby Co. Taylor Co. $7,000 2,000 9,000 Action Plan Subtract cash paid from credit purchases to determine the balances in the accounts payable subsidiary ledger. Sum the individual balances to determine the Accounts Payable balance. E4 Appendix E Subsidiary Ledgers and Special Journals Solution Subsidiary ledger balances: Devon Co. $4,000 ($11,000 $7,000) Shelby Co. $5,000 ($7,000 $2,000) Taylor Co. $5,000 ($14,000 $9,000). General ledger Accounts Payable balance: $14,000 ($4,000 $5,000 $5,000). Related exercise material: BEE-4, BEE-5, EE-1, EE-2, EE-4, and EE-5. Expanding the Journal Special Journals SECTION 2 So far you have learned to journalize transactions in a two-column general journal and post each entry to the general ledger. This procedure is satisfacExplain how companies use tory in only the very smallest companies. To expedite journalizing and postspecial journals in journalizing. ing, most companies use special journals in addition to the general journal. Companies use special journals to record similar types of transactions. Examples are all sales of merchandise on account, or all cash receipts. The types of transactions that occur frequently in a company determine what special journals the company uses. Most merchandising enterprises record daily transactions using Illustration E-4 the journals shown in Illustration E-4. STUDY OBJECTIVE 2 Use of special journals and the general journal Sales Journal Used for: All sales of merchandise on account Cash Receipts Journal Used for: All cash received (including cash sales) Purchases Journal Used for: All purchases of merchandise on account Cash Payments Journal Used for: All cash paid (including cash purchases) General Journal Used for: Transactions that cannot be entered in a special journal, including correcting, adjusting, and closing entries If a transaction cannot be recorded in a special journal, the company records it in the general journal. For example, if a company had special journals for only the four types of transactions listed above, it would record purchase returns and allowances in the general journal. Similarly, correcting, adjusting, and closing entries are recorded in the general journal. In some situations, companies might use special journals other than those listed above. For example, when sales returns and allowances are frequent, a company might use a special journal to record these transactions. Special journals permit greater division of labor because several people can record entries in different journals at the same time. For example, one employee may journalize all cash receipts, and another may journalize all credit sales. Also, the use of special journals reduces the time needed to complete the posting process. With special journals, companies may post some accounts monthly, instead of daily, as we will illustrate later in the chapter. On the following pages, we discuss the four special journals shown in Illustration E-4. Sales Journal E5 SALES JOURNAL In the sales journal, companies record sales of merchandise on account. Cash sales of merchandise go in the cash receipts journal. Credit sales of assets other than merchandise go in the general journal. Journalizing Credit Sales To demonstrate use of a sales journal, we will use data for Karns Wholesale Supply, which uses a perpetual inventory system. Under this system, each entry in the sales journal results in one entry at selling price and another entry at cost. The entry at selling price is a debit to Accounts Receivable (a control account) and a credit of equal amount to Sales. The entry at cost is a debit to Cost of Goods Sold and a credit of equal amount to Merchandise Inventory (a control account). Using a sales journal with two amount columns, the company can show on only one line a sales transaction at both selling price and cost. Illustration E-5 shows this two-column sales journal of Karns Wholesale Supply, using assumed credit sales transactions (for sales invoices 101107). HELPFUL HINT Postings are also made daily to individual ledger accounts in the inventory subsidiary ledger to maintain a perpetual inventory. Illustration E-5 Journalizing the sales journalperpetual inventory system File Edit View ? Go Bookmarks Tools Entries Help Post Closing Reports Tools Help Problem Date 2008 May 3 7 14 19 21 24 27 Account Debited Abbot Sisters Babson Co. Carson Bros. Deli Co. Abbot Sisters Deli Co. Babson Co. Invoice No. Ref. 101 102 103 104 105 106 107 Accts. Receivable Dr. Sales Cr. 10,600 11,350 7,800 9,300 15,400 21,210 14,570 , 90,230 , Cost of Goods Sold Dr. Merchandise Inventory Cr. 6,360 7,370 5,070 6,510 10,780 15,900 10,200 , 62,190 , General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl Note several points: Unlike the general journal, an explanation is not required for each entry in a special journal. Also, use of prenumbered invoices ensures that all invoices are journalized. Finally, the reference (Ref.) column is not used in journalizing. It is used in posting the sales journal, as explained next. Posting the Sales Journal Companies make daily postings from the sales journal to the individual accounts receivable in the subsidiary ledger. Posting to the general ledger is done monthly. Illustration E-6 (page E6) shows both the daily and monthly postings. A check mark () is inserted in the reference posting column to indicate that the daily posting to the customers account has been made. If the subsidiary ledger accounts were numbered, the account number would be entered in place of the check mark. At the end of the month, Karns posts the column totals of the sales E6 Appendix E Subsidiary Ledgers and Special Journals File Edit View ? Go Bookmarks Tools Entries Help Post Closing Reports Tools Help Problem Date 2008 May 3 7 14 19 21 24 27 Account Debited Abbot Sisters Babson Co. Carson Bros. Deli Co. Abbot Sisters Deli Co. Babson Co. Invoice Accts. Receivable Dr. Cost of Goods Sold Dr. No. Ref. Sales Cr. Merchandise Inventory Cr. 101 102 103 104 105 106 107 10,600 11,350 7,800 9,300 15,400 21,210 14,570 , 90,230 , (112) / (401) 6,360 7,370 5,070 6,510 10,780 15,900 10,200 , 62,190 , (505) / (120) At the end of the accounting period, the company posts totals to the general ledger. The company posts individual amounts to the subsidiary ledger daily. Accounts Receivable Date Ref. Debit Credit 2008 May 31 S1 90,230 No. 112 Balance 90,230 Date 2008 May 3 y 21 Ref. S1 S1 Abbot Sisters Debit Credit 10,600 15,400 Babson Co. Debit Credit 11,350 14,570 Carson Bros. Debit Credit 7,800 Balance 10,600 26,000 Date 2008 May 7 27 Ref. S1 S1 Balance 11,350 25,920 Merchandise Inventory Date Ref. Debit Credit 2008 May 31 S1 62,190 No. 120 Balance 62,1901 Date Ref. 2008 May 14 S1 Balance 7,800 Date Ref. 2008 May 31 S1 Sales Debit Credit 90,230 No. 401 Balance 90,230 Date Ref. 2008 May 19 S1 24 S1 Deli Co. Debit Credit 9,300 21,210 Balance 9,300 30,510 Date Ref. 2008 May 31 S1 Cost of Goods Sold Debit Credit 62,190 No. 505 Balance 62,190 The subsidiary ledger is separate from the general ledger. 1 Accounts Receivable is a control account. The normal balance for Merchandise Inventory is a debit. But, because of the sequence in which we have posted the special journals, with the sales journals first, the credits to Merchandise Inventory are posted before the debits. This posting sequence explains the credit balance in Merchandise Inventory, which exists only until the other journals are posted. General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl Illustration E-6 Posting the sales journal journal to the general ledger. Here, the column totals are as follows: From the sellingprice column, a debit of $90,230 to Accounts Receivable (account No. 112), and a credit of $90,230 to Sales (account No. 401). From the cost column, a debit of $62,190 to Cost of Goods Sold (account No. 505), and a credit of $62,190 to Merchandise Inventory (account No. 120). Karns inserts the account numbers Cash Receipts Journal E7 below the column totals to indicate that the postings have been made. In both the general ledger and subsidiary ledger accounts, the reference S1 indicates that the posting came from page 1 of the sales journal. Proving the Ledgers The next step is to prove the ledgers. To do so, Karns must determine two things: (1) The total of the general ledger debit balances must equal the total of the general ledger credit balances. (2) The sum of the subsidiary ledger balances must equal the balance in the control account. Illustration E-7 shows the proof of the postings from the sales journal to the general and subsidiary ledger. Postings to General Ledger General Ledger Credits Merchandise Inventory Sales Debits Accounts Receivable Cost of Goods Sold Debit Postings to the Accounts Receivable Subsidiary Ledger Subsidiary Ledger $62,190 90,230 $152,420 $90,230 62,190 $152,420 Abbot Sisters Babson Co. Carson Bros. Deli Co. $26,000 25,920 7,800 30,510 $90,230 Illustration E-7 Proving the equality of the postings from the sales journal Advantages of the Sales Journal Use of a special journal to record sales on account has several advantages. First, the one-line entry for each sales transaction saves time. In the sales journal, it is not necessary to write out the four account titles for each transaction. Second, only totals, rather than individual entries, are posted to the general ledger. This saves posting time and reduces the possibilities of posting errors. Finally, a division of labor results, because one individual can take responsibility for the sales journal. CASH RECEIPTS JOURNAL In the cash receipts journal, companies record all receipts of cash. The most common types of cash receipts are cash sales of merchandise and collections of accounts receivable. Many other possibilities exist, such as receipt of money from bank loans and cash proceeds from disposal of equipment. A one- or two-column cash receipts journal would not have space enough for all possible cash receipt transactions. Therefore, companies use a multiple-column cash receipts journal. Generally, a cash receipts journal includes the following columns: debit columns for Cash and Sales Discounts, and credit columns for Accounts Receivable, Sales, and Other accounts. Companies use the Other Accounts category when the cash receipt does not involve a cash sale or a collection of accounts receivable. Under a perpetual inventory system, each sales entry also is accompanied by an entry that debits Cost of Goods Sold and credits Merchandise Inventory for the cost of the merchandise sold. Illustration E-8 (page E8) shows a six-column cash receipts journal. E8 Appendix E Subsidiary Ledgers and Special Journals Illustration E-8 Journalizing and posting the cash receipts journal File Edit View ? Go Bookmarks Tools Help Post Closing Reports Tools Help Problem Entries Date 2008 May 1 7 10 12 17 22 23 28 Account Credited Common Stock Abbot Sisters Babson Co. Notes Payable Carson Bros. Deli Co. Ref. 311 Cash Dr. 5,000 1,900 10,388 2,600 11,123 6,000 7,644 9,114 , 53,769 , (101) Sales Accounts Other Cost of Goods Discounts Receivable Sales Accounts Sold Dr. Dr. Cr. Cr. Cr. Mdse. Inv. Cr. 5,000 1,900 212 227 156 186 781 (414) 10,600 2,600 11,350 6,000 7,800 9,300 , 39,050 , (112) 1,690 1,240 200 4,500 (401) 2,930 11,000 , (505)/(120) (x ) The company posts individual amounts to the subsidiary ledger daily. At the end of the accounting period, the company posts totals to the general ledger. Date Ref. 2008 May 3 S1 10 CR1 21 S1 Abbot Sisters Debit Credit 10,600 10,600 15,400 Babson Co. Debit Credit 11,350 11,350 14,570 Carson Bros. Debit Credit 7,800 7,800 Deli Co. Balance 10,600 -------15,400 Date Ref. 2008 May 31 CR1 Cash Debit Credit 53,769 No. 101 Balance 53,769 No. 112 Balance 90,230 51,180 No. 120 Balance 62,190 65,120 No. 200 Balance 6,000 No. 311 Balance 5,000 No. 401 Accounts Receivable Date Ref. 2008 May 31 S1 31 CR1 Debit 90,230 39,050 Credit Date Ref. 2008 May 7 S1 17 CR1 27 S1 Balance 11,350 -------14,570 Merchandise Inventory Date Ref. 2008 May 31 S1 31 CR1 Debit Credit 62,190 2,930 Notes Payable Date Ref. 2008 May 22 CR1 Debit Credit 6,000 Common Stock Date Ref. 2008 May 1 CR1 Debit Credit 5,000 Sales Date Ref. 2008 May 14 S1 23 CR1 Balance 7,800 ------- Date Ref. 2008 May 19 S1 24 S1 28 CR1 Debit 9,300 21,210 Credit Balance 9,300 30,510 21,210 9,300 The subsidiary ledger is separate from the general ledger. Accounts Receivable is a control account. Date Ref. 2008 May 31 S1 31 CR1 Debit Credit 90,230 4,500 Balance 90,230 94,730 No. 414 Balance 781 No. 505 Balance 62,190 65,120 Sales Discounts Date Ref. 2008 May 31 CR1 y Debit 781 Cost of Goods Sold Date Ref. 2008 May 31 S1 31 CR1 Debit 62,190 2,930 Credit Credit General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl Cash Receipts Journal E9 Companies may use additional credit columns if these columns significantly reduce postings to a specific account. For example, a loan company, such as Household International, receives thousands of cash collections from customers. Using separate credit columns for Loans Receivable and Interest Revenue, rather than the Other Accounts credit column, would reduce postings. Journalizing Cash Receipts Transactions To illustrate the journalizing of cash receipts transactions, we will continue with the May transactions of Karns Wholesale Supply. Collections from customers relate to the entries recorded in the sales journal in Illustration E-5. The entries in the cash receipts journal are based on the following cash receipts. May 1 Stockholders invested $5,000 in the business. 7 Cash sales of merchandise total $1,900 (cost, $1,240). 10 Received a check for $10,388 from Abbot Sisters in payment of invoice No. 101 for $10,600 less a 2% discount. 12 Cash sales of merchandise total $2,600 (cost, $1,690). 17 Received a check for $11,123 from Babson Co. in payment of invoice No. 102 for $11,350 less a 2% discount. 22 Received cash by signing a note for $6,000. 23 Received a check for $7,644 from Carson Bros. in full for invoice No. 103 for $7,800 less a 2% discount. 28 Received a check for $9,114 from Deli Co. in full for invoice No. 104 for $9,300 less a 2% discount. Further information about the columns in the cash receipts journal is listed below. Debit Columns: 1. Cash. Karns enters in this column the amount of cash actually received in each transaction. The column total indicates the total cash receipts for the month. 2. Sales Discounts. Karns includes a Sales Discounts column in its cash receipts journal. By doing so, it does not need to enter sales discount items in the general journal. As a result, the cash receipts journal shows on one line the collection of an account receivable within the discount period. Credit Columns: 3. Accounts Receivable. Karns uses the Accounts Receivable column to record cash collections on account. The amount entered here is the amount to be credited to the individual customers account. 4. Sales. The Sales column records all cash sales of merchandise. Cash sales of other assets (plant assets, for example) are not reported in this column. 5. Other Accounts. Karns uses the Other Accounts column whenever the credit is other than to Accounts Receivable or Sales. For example, in the first entry, Karns enters $5,000 as a credit to Common Stock.This column is often referred to as the sundry accounts column. Debit and Credit Column: 6. Cost of Goods Sold and Merchandise Inventory. This column records debits to Cost of Goods Sold and credits to Merchandise Inventory. In a multi-column journal, generally only one line is needed for each entry. Debit and credit amounts for each line must be equal. When Karns journalizes the collection from Abbot Sisters on May 10, for example, three amounts are indicated. Note also that the Account Credited column identifies both general ledger and subsidiary ledger account titles. General ledger accounts are illustrated in the May 1 HELPFUL HINT When is an account title entered in the Account Credited column of the cash receipts journal? Register to View Answersubsidiary ledger account is entered when the entry involves a collection of accounts receivable. A general ledger account is entered when the account is not shown in a special column (and an amount must be entered in the Other Accounts column). Otherwise, no account is shown in the Account Credited column. E10 Appendix E Subsidiary Ledgers and Special Journals and May 22 entries. A subsidiary account is illustrated in the May 10 entry for the collection from Abbot Sisters. When Karns has finished journalizing a multi-column journal, it totals the amount columns and compares the totals to prove the equality of debits and credits. Illustration E-9 shows the proof of the equality of Karnss cash receipts journal. Illustration E-9 Proving the equality of the cash receipts journal Debits Cash Sales Discounts Cost of Goods Sold $53,769 781 2,930 $57,480 Credits Accounts Receivable Sales Other Accounts Merchandise Inventory $39,050 4,500 11,000 2,930 $57,480 Totaling the columns of a journal and proving the equality of the totals is called footing and cross-footing a journal. Posting the Cash Receipts Journal Posting a multi-column journal involves the following steps. 1. At the end of the month, the company posts all column totals, except for the Other Accounts total, to the account title(s) specified in the Indicate how companies post a column heading (such as Cash or Accounts Receivable). The company multi-column journal. then enters account numbers below the column totals to show that they have been posted. For example, Karns has posted cash to account No. 101, accounts receivable to account No. 112, merchandise inventory to account No. 120, sales to account No. 401, sales discounts to account No. 414, and cost of goods sold to account No. 505. 2. The company separately posts the individual amounts comprising the Other Accounts total to the general ledger accounts specified in the Account Credited column. See, for example, the credit posting to Common Stock: The total amount of this column has not been posted. The symbol (X) is inserted below the total to this column to indicate that the amount has not been posted. 3. The individual amounts in a column, posted in total to a control account (Accounts Receivable, in this case), are posted daily to the subsidiary ledger account specified in the Account Credited column. See, for example, the credit posting of $10,600 to Abbot Sisters. STUDY OBJECTIVE 3 The symbol CR, used in both the subsidiary and general ledgers, identifies postings from the cash receipts journal. Proving the Ledgers After posting of the cash receipts journal is completed, Karns proves the ledgers. As shown in Illustration E-10 (next page), the general ledger totals agree. Also, the sum of the subsidiary ledger balances equals the control account balance. Purchases Journal E11 Accounts Receivable Subsidiary Ledger General Ledger Debits Illustration E-10 Proving the ledgers after posting the sales and the cash receipts journals $53,769 51,180 781 65,120 $170,850 Abbot Sisters Babson Co. Deli Co. $15,400 14,570 21,210 $51,180 Cash Accounts Receivable Sales Discounts Cost of Goods Sold Credits Notes Payable Common Stock Sales Merchandise Inventory $ 6,000 5,000 94,730 65,120 $170,850 PURCHASES JOURNAL In the purchases journal, companies record all purchases of merchandise on account. Each entry in this journal results in a debit to Merchandise Inventory and a credit to Accounts Payable. Illustration E-11 (page E12) shows the purchases journal for Karns Wholesale Supply. When using a one-column purchases journal (as in Illustration E-11), a company cannot journalize other types of purchases on account or cash purchases in it. For example, using the purchases journal shown in Illustration E-11, Karns would have to record credit purchases of equipment or supplies in the general journal. Likewise, all cash purchases would be entered in the cash payments journal. As illustrated later, companies that make numerous credit purchases for items other than merchandise often expand the purchases journal to a multi-column format. (See Illustration E-14 on page E13.) Journalizing Credit Purchases of Merchandise The journalizing procedure is similar to that for a sales journal. Companies make entries in the purchases journal from purchase invoices. In contrast to the sales journal, the purchases journal may not have an invoice number column, because invoices received from different suppliers will not be in numerical sequence. To ensure that they record all purchase invoices, some companies consecutively number each invoice upon receipt and then use an internal document number column in the purchases journal. The entries for Karns Wholesale Supply are based on the assumed credit purchases listed in Illustration E-12 (page E12). Posting the Purchases Journal The procedures for posting the purchases journal are similar to those for the sales journal. In this case, Karns makes daily postings to the accounts payable ledger; it makes monthly postings to Merchandise Inventory and Accounts Payable in the general ledger. In both ledgers, Karns uses P1 in the reference column to show that the postings are from page 1 of the purchases journal. Proof of the equality of the postings from the purchases journal to both ledgers is shown in Illustration E-13 (page E13). HELPFUL HINT Postings to subsidiary ledger accounts are done daily because it is often necessary to know a current balance for the subsidiary accounts. E12 Appendix E Subsidiary Ledgers and Special Journals File Edit View ? Go Bookmarks Tools Entries Help Post Closing Reports Tools Help Problem Date 2008 May 6 10 14 19 26 29 Account Credited Jasper Manufacturing Inc. Eaton and Howe Inc. Fabor and Son Jasper Manufacturing Inc. Fabor and Son Eaton and Howe Inc. Terms 2/10, n/30 3/10, n/30 1/10, n/30 2/10, n/30 1/10, n/30 3/10, n/30 Merchandise Inventory Dr. Ref. Accounts Payable Cr. 11,000 7,200 6,900 17,500 8,700 12,600 63,900 (120)/(201) The company posts individual amounts to the subsidiary ledger daily. At the end of the accounting period, the company posts totals to the general ledger. Date 2008 May 10 29 Eaton and Howe Inc. Ref. Debit Credit P1 P1 7,200 12,600 Fabor and Son Debit Credit 6,900 8,700 Merchandise Inventory Balance 7,200 19,800 Date Ref. Debit Credit 62,190 2,930 63,900 Accounts Payable Debit Credit 63,900 2008 May 31 S1 31 CR1 31 P1 No. 120 Balance 62,190 65,120 1,220 No. 201 Balance 63,900 Date 2008 May 14 26 Ref. P1 P1 Balance Date 6,900 15,600 2008 May 31 y Ref. P1 Date 2008 May 6 19 Jasper Manufacturing Inc. Ref. Debit Credit Balance P1 P1 11,000 17,500 11,000 28,500 The subsidiary ledger is separate from the general ledger. Accounts Payable is a control account. General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl Illustration E-11 Journalizing and posting the purchases journal Illustration E-12 Credit purchases transactions Date 5/6 5/10 5/14 5/19 5/26 5/29 Supplier Jasper Manufacturing Inc. Eaton and Howe Inc. Fabor and Son Jasper Manufacturing Inc. Fabor and Son Eaton and Howe Inc. Amount $11,000 7,200 6,900 17,500 8,700 12,600 Cash Payments Journal E13 Postings to General Ledger Merchandise Inventory (debit) $63,900 Credit Postings to Accounts Payable Ledger Eaton and Howe Inc. Fabor and Son Jasper Manufacturing Inc. $19,800 15,600 28,500 $63,900 Illustration E-13 Proving the equality of the purchases journal Accounts Payable (credit) $63,900 Expanding the Purchases Journal As noted earlier, some companies expand the purchases journal to include all types of purchases on account. Instead of one column for merchandise inventory and accounts payable, they use a multiple-column format. This format usually includes a credit column for Accounts Payable and debit columns for purchases of Merchandise Inventory, Office Supplies, Store Supplies, and Other Accounts. Illustration E-14 shows a multi-column purchases journal for Hanover Co.The posting procedures are similar to those shown earlier for posting the cash receipts journal. HELPFUL HINT A single-column purchases journal needs only to be footed to prove the equality of debits and credits. Illustration E-14 Multi-column purchases journal File Edit View ? Go Bookmarks Tools Entries Help Post Closing Reports Tools Help Problem Date 2008 June 1 Signe Audio 3 Wight Co. 5 Orange Tree Co. Accounts Merchandise Office Store Other Accounts Payable Inventory Supplies Supplies Dr. Account Ref. Amount Account Credited Ref. Cr. Dr. Dr. Dr. 2,000 1,500 2,600 800 56,600 2,000 1,500 Equipment 157 43,000 7,500 800 1,200 2,600 4,900 30 Sue's Business Forms General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl CASH PAYMENTS JOURNAL In a cash payments (cash disbursements) journal, companies record all disbursements of cash. Entries are made from prenumbered checks. Because companies make cash payments for various purposes, the cash payments journal has multiple columns. Illustration E-15 (page E14) shows a four-column journal. Journalizing Cash Payments Transactions The procedures for journalizing transactions in this journal are similar to those for the cash receipts journal. Karns records each transaction on one line, and for each line there must be equal debit and credit amounts.The entries in the cash payments E14 Appendix E Subsidiary Ledgers and Special Journals File Edit View ? Go Bookmarks Tools Entries Help Post Closing Reports Tools Help Problem Date 2008 May 1 3 8 10 19 23 28 30 Ck. No. 101 102 103 104 105 106 107 108 Account Debited Prepaid Insurance Mdse. Inventory Mdse. Inventory Jasper Manuf. Inc. Eaton & Howe Inc. Fabor and Son Jp Jasper Manuf. Inc. Dividends Accounts Merchandise Other Ref. Accounts Dr. Payable Dr. Inventory Cr. 130 120 120 1,200 100 4,400 11,000 7,200 6,900 17,500 332 500 6,200 (x) 42,600 (201) 220 216 69 350 855 (120) Cash Cr. 1,200 100 4,400 10,780 6,984 6,831 17,150 500 47,945 (101) The company posts individual amounts to the subsidiary ledger daily. At the end of the accounting period, the company posts totals to the general ledger. Date Eaton and Howe Inc. Ref. Debit Credit 7,200 7,200 12,600 Fabor and Son Debit Credit 6,900 6,900 8,700 Balance 7,200 ------12,600 Date Ref. Cash Debit Credit 53,769 47,945 No. 101 Balance 53,769 5,824 No. 120 Balance 100 4,500 57,690 60,620 3,280 2,425 No. 130 Balance 1,200 2008 May 10 P1 19 CP1 29 P1 2008 May 31 CR1 31 CP1 Merchandise Inventory Balance 6,900 ------8,700 Date 2008 May 3 8 31 31 31 31 Ref. CPI CPI SI CRI Pl CPI Debit 100 4,400 62,190 2,930 63,900 855 Prepaid Insurance Debit Credit 1,200 Credit Date Ref. 2008 May 14 P1 23 CP1 26 P1 Date 2008 May 6 P1 10 CP1 19 P1 28 CP1 Jasper Manufacturing Inc. Ref. Debit Credit Balance 11,000 11,000 17,500 17,500 11,000 -------17,500 -------- Date Ref. 2008 May 1 CP1 The subsidiary ledger is separate from the general ledger. Accounts Receivable is a control account. Date Ref. Accounts Payable Debit Credit 63,900 42,600 Dividends Debit Credit 500 No. 201 Balance 63,900 21,300 No. 332 Balance 500 2008 May 31 P1 31 CP1 Date Ref. 2008 May 30 CP1 General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl Illustration E-15 Journalizing and posting the cash payments journal Cash Payments Journal E15 journal in Illustration E-15 are based on the following transactions for Karns Wholesale Supply. May 1 Issued check No. 101 for $1,200 for the annual premium on a fire insurance policy. 3 Issued check No. 102 for $100 in payment of freight when terms were FOB shipping point. 8 Issued check No. 103 for $4,400 for the purchase of merchandise. 10 Sent check No. 104 for $10,780 to Jasper Manufacturing Inc. in payment of May 6 invoice for $11,000 less a 2% discount. 19 Mailed check No. 105 for $6,984 to Eaton and Howe Inc. in payment of May 10 invoice for $7,200 less a 3% discount. 23 Sent check No. 106 for $6,831 to Fabor and Son in payment of May 14 invoice for $6,900 less a 1% discount. 28 Sent check No. 107 for $17,150 to Jasper Manufacturing Inc. in payment of May 19 invoice for $17,500 less a 2% discount. 30 Issued check No. 108 for $500 to stockholders as a dividend. Note that whenever Karns enters an amount in the Other Accounts column, it must identify a specific general ledger account in the Account Debited column. The entries for checks No. 101, 102, 103, and 108 illustrate this situation. Similarly, Karns must identify a subsidiary account in the Account Debited column whenever it enters an amount in the Accounts Payable column. See, for example, the entry for check No. 104. After Karns journalizes the cash payments journal, it totals the columns. The totals are then balanced to prove the equality of debits and credits. Posting the Cash Payments Journal The procedures for posting the cash payments journal are similar to those for the cash receipts journal. Karns posts the amounts recorded in the Accounts Payable column individually to the subsidiary ledger and in total to the control account. It posts Merchandise Inventory and Cash only in total at the end of the month. Transactions in the Other Accounts column are posted individually to the appropriate account(s) affected. The company does not post totals for the Other Accounts column. Illustration E-15 shows the posting of the cash payments journal. Note that Karns uses the symbol CP as the posting reference. After postings are completed, the company proves the equality of the debit and credit balances in the general ledger. In addition, the control account balances should agree with the subsidiary ledger total balance. Illustration E-16 shows the agreement of these balances. Illustration E-16 Proving the ledgers after postings from the sales, cash receipts, purchases, and cash payments journals Accounts Payable Subsidiary Ledger General Ledger Debits Cash Accounts Receivable Merchandise Inventory Prepaid Insurance Dividends Sales Discounts Cost of Goods Sold Credits Notes Payable Accounts Payable Common Stock Sales $ 6,000 21,300 5,000 94,730 $127,030 $ 5,824 51,180 2,425 1,200 500 781 65,120 $127,030 Eaton and Howe Inc. Fabor and Son $12,600 8,700 $21,300 E16 Appendix E Subsidiary Ledgers and Special Journals EFFECTS OF SPECIAL JOURNALS ON THE GENERAL JOURNAL Special journals for sales, purchases, and cash substantially reduce the number of entries that companies make in the general journal. Only transactions that cannot be entered in a special journal are recorded in the general journal. For example, a company may use the general journal to record such transactions as granting of credit to a customer for a sales return or allowance, granting of credit from a supplier for purchases returned, acceptance of a note receivable from a customer, and purchase of equipment by issuing a note payable. Also, correcting, adjusting, and closing entries are made in the general journal. The general journal has columns for date, account title and explanation, reference, and debit and credit amounts. When control and subsidiary accounts are not involved, the procedures for journalizing and posting of transactions are the same as those described in earlier chapters. When control and subsidiary accounts are involved, companies make two changes from the earlier procedures: 1. In journalizing, they identify both the control and the subsidiary accounts. 2. In posting, there must be a dual posting: once to the control account and once to the subsidiary account. Illustration E-17 Journalizing and posting the general journal File Edit View ? Go Bookmarks Tools Entries Help Post Closing Reports Tools Help Problem Date Account Title and Explanation Ref. Debit 500 Credit 2008 201/ May 31 Accounts PayableFabor and Son 120 Merchandise Inventory (Received credit for returned goods) 500 Date Ref. Fabor and Son Debit Credit 6,900 6,900 8,700 500 Balance 6,900 ------8,700 8,200 , Date Merchandise Inventory Ref. Debit Credit 500 No. 120 Balance 500 2008 May 14 P1 23 CP1 26 P1 31 G1 2008 May 31 G1 Date Ref. Accounts Payable Debit Credit 63,900 42,600 500 No. 201 Balance 63,900 21,300 20,800 2008 May 31 P1 31 CP1 31 G1 General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl Effects of Special Journals on the General Journal E17 To illustrate, assume that on May 31, Karns Wholesale Supply returns $500 of merchandise for credit to Fabor and Son. Illustration E-17 shows the entry in the general journal and the posting of the entry. Note that if Karns receives cash instead of credit on this return, then it would record the transaction in the cash receipts journal. Note that the general journal indicates two accounts (Accounts Payable, and Fabor and Son) for the debit, and two postings (201/) in the reference column. One debit is posted to the control account and another debit to the creditors account in the subsidiary ledger. Before You Go On... REVIEW IT 1. What types of special journals do companies frequently use to record transactions? Why do they use special journals? 2. Explain how companies post transactions recorded in the sales journal and the cash receipts journal. 3. Indicate the types of transactions that companies record in the general journal when they use special journals. Demonstration Problem Cassandra Wilson Company uses a six-column cash receipts journal with the following columns: Cash (Dr.) Sales Discounts (Dr.) Accounts Receivable (Cr.) Sales (Cr.) Other Accounts (Cr.) Cost of Goods Sold (Dr.) and Merchandise Inventory (Cr.) Cash receipts transactions for the month of July 2008 are as follows. July 3 Cash sales total $5,800 (cost, $3,480). 5 Received a check for $6,370 from Jeltz Company in payment of an invoice dated June 26 for $6,500, terms 2/10, n/30. 9 Stockholders made an additional investment of $5,000 cash in the business. 10 Cash sales total $12,519 (cost, $7,511). 12 Received a check for $7,275 from R. Eliot & Co. in payment of a $7,500 invoice dated July 3, terms 3/10, n/30. 15 Received a customer advance of $700 cash for future sales. 20 Cash sales total $15,472 (cost, $9,283). 22 Received a check for $5,880 from Beck Company in payment of $6,000 invoice dated July 13, terms 2/10, n/30. 29 Cash sales total $17,660 (cost, $10,596). 31 Received cash of $200 on interest earned for July. action plan Record all cash receipts in the cash receipts journal. The account credited indicates items posted individually to the subsidiary ledger or general ledger. Record cash sales in the cash receipts journalnot in the sales journal. The total debits must equal the total credits. Instructions (a) Journalize the transactions in the cash receipts journal. (b) Contrast the posting of the Accounts Receivable and Other Accounts columns. E18 Appendix E Subsidiary Ledgers and Special Journals Solution (a) CASSANDRA WILSON COMPANY Cash Receipts Journal CR1 Sales Cr. 5,800 Date 2008 7/3 5 9 10 12 15 20 22 29 31 Account Credited Ref. Cash Dr. 5,800 6,370 5,000 12,519 7,275 700 15,472 5,880 17,660 200 76,876 Sales Discounts Dr. Accounts Receivable Cr. Other Accounts Cr. Cost of Goods Sold Dr. Mdse. Inv. Cr. 3,480 Jeltz Company Common Stock R. Eliot & Co. Unearned Revenue Beck Company Interest Revenue 130 6,500 5,000 12,519 7,511 700 15,472 9,283 10,596 200 5,900 30,870 225 7,500 120 6,000 17,660 475 20,000 51,451 (b) The Accounts Receivable column is posted as a credit to Accounts Receivable. The individual amounts are credited to the customers accounts identified in the Account Credited column, which are maintained in the accounts receivable subsidiary ledger. The amounts in the Other Accounts column are posted individually. They are credited to the account titles identified in the Account Credited column. SUMMARY OF STUDY OBJECTIVES 1 Describe the nature and purpose of a subsidiary ledger. A subsidiary ledger is a group of accounts with a common characteristic. It facilitates the recording process by freeing the general ledger from details of individual balances. 2 Explain how companies use special journals in journalizing. Companies use special journals to group similar types of transactions. In a special journal, generally only one line is used to record a complete transaction. 3 Indicate how companies post a multi-column journal. In posting a multi-column journal: (a) Companies post all column totals except for the Other Accounts column once at the end of the month to the account title specified in the column heading. (b) Companies do not post the total of the Other Accounts column. Instead, the individual amounts comprising the total are posted separately to the general ledger accounts specified in the Account Credited (Debited) column. (c) The individual amounts in a column posted in total to a control account are posted daily to the subsidiary ledger accounts specified in the Account Credited (Debited) column. GLOSSARY Accounts payable (creditors) subsidiary ledger A subsidiary ledger that collects transaction data of individual creditors. (p. E1). Accounts receivable (customers) subsidiary ledger A subsidiary ledger that collects transaction data of individual customers. (p. E1). Cash payments (disbursements) journal A special journal that records all cash paid. (p. E13). Cash receipts journal A special journal that records all cash received. (p. E7). Control account An account in the general ledger that summarizes subsidiary ledger. (p. E1). Questions Purchases journal A special journal that records all purchases of merchandise on account. (p. E11). Sales journal A special journal that records all sales of merchandise on account. (p. E5). E19 Special journal A journal that records similar types of transactions, such as all credit sales. (p. E4). Subsidiary ledger A group of accounts with a common characteristic. (p. E1). SELF-STUDY QUESTIONS Answers are at the end of the chapter. (SO 1) (SO 2) 1. Which of the following is incorrect concerning subsidiary ledgers? a. The purchases ledger is a common subsidiary ledger for creditor accounts. b. The accounts receivable ledger is a subsidiary ledger. c. A subsidiary ledger is a group of accounts with a common characteristic. d. An advantage of the subsidiary ledger is that it permits a division of labor in posting. 2. A sales journal will be used for: Credit Cash Sales Sales Sales Discounts a. no yes yes b. yes no yes c. yes no no d. yes yes no 3. Which of the following statements is correct? a. The sales discount column is included in the cash receipts journal. b. The purchases journal records all purchases of merchandise whether for cash or on account. c. The cash receipts journal records sales on account. d. Merchandise returned by the buyer is recorded by the seller in the purchases journal. 4. Which of the following is incorrect concerning the posting of the cash receipts journal? a. The total of the Other Accounts column is not posted. b. All column totals except the total for the Other Accounts column are posted once at the end of the month to the account title(s) specified in the column heading. c. The totals of all columns are posted daily to the accounts specified in the column heading. d. The individual amounts in a column posted in total to a control account are posted daily to the subsidiary (SO 2, 3) (SO 3) ledger account specified in the Account Credited column. 5. Postings from the purchases journal to the subsidiary (SO 3) ledger are generally made: a. yearly. b. monthly. c. weekly. d. daily. 6. Which statement is incorrect regarding the general journal? (SO 2) a. Only transactions that cannot be entered in a special journal are recorded in the general journal. b. Dual postings are always required in the general journal. c. The general journal may be used to record acceptance of a note receivable in payment of an account receivable. d. Correcting, adjusting, and closing entries are made in the general journal. 7. When companies use special journals: (SO 2) a. they record all purchase transactions in the purchases journal. b. they record all cash received, except from cash sales, in the cash receipts journal. c. they record all cash disbursements in the cash payments journal. d. a general journal is not necessary. 8. If a customer returns goods for credit, the selling company (SO 2) normally makes an entry in the: a. cash payments journal. b. sales journal. c. general journal. d. cash receipts journal. Go to the books website, www.wiley.com/college/weygandt, for Additional Self-Study questions. QUESTIONS 1. What are the advantages of using subsidiary ledgers? 2. (a) When do companies normally post to (1) the subsidiary accounts and (2) the general ledger control accounts? (b) Describe the relationship between a control account and a subsidiary ledger. 3. Identify and explain the four special journals discussed in the chapter. List an advantage of using each of these journals rather than using only a general journal. 4. Thogmartin Company uses special journals. It recorded in a sales journal a sale made on account to R. Peters for $435. A few days later, R. Peters returns $70 worth of merchandise for credit. Where should Thogmartin Company record the sales return? Why? 5. A $500 purchase of merchandise on account from Lore Company was properly recorded in the purchases journal. When posted, however, the amount recorded in the E20 Appendix E Subsidiary Ledgers and Special Journals (d) Sales of merchandise on account. (e) Collection of cash on account from a customer. (f) Purchase of office supplies on account. In what journal would the following transactions be recorded? (Assume that a two-column sales journal and a single-column purchases journal are used.) (a) Cash received from signing a note payable. (b) Investment of cash by stockholders. (c) Closing of the expense accounts at the end of the year. (d) Purchase of merchandise on account. (e) Credit received for merchandise purchased and returned to supplier. (f) Payment of cash on account due a supplier. What transactions might be included in a multiple-column purchases journal that would not be included in a singlecolumn purchases journal? Give an example of a transaction in the general journal that causes an entry to be posted twice (i.e., to two accounts), one in the general ledger, the other in the subsidiary ledger. Does this affect the debit/credit equality of the general ledger? Give some examples of appropriate general journal transactions for an organization using special journals. 6. 7. 8. 9. subsidiary ledger was $50. How might this error be discovered? Why would special journals used in different businesses not be identical in format? What type of business would maintain a cash receipts journal but not include a column for accounts receivable? The cash and the accounts receivable columns in the cash receipts journal were mistakenly overadded by $4,000 at the end of the month. (a) Will the customers ledger agree with the Accounts Receivable control account? (b) Assuming no other errors, will the trial balance totals be equal? One column total of a special journal is posted at monthend to only two general ledger accounts. One of these two accounts is Accounts Receivable. What is the name of this special journal? What is the other general ledger account to which that same month-end total is posted? In what journal would the following transactions be recorded? (Assume that a two-column sales journal and a single-column purchases journal are used.) (a) Recording of depreciation expense for the year. (b) Credit given to a customer for merchandise purchased on credit and returned. (c) Sales of merchandise for cash. 10. 11. 12. 13. BRIEF EXERCISES Identify subsidiary ledger balances. (SO 1) BEE-1 Presented below is information related to Kienholz Company for its first month of operations. Identify the balances that appear in the accounts receivable subsidiary ledger and the accounts receivable balance that appears in the general ledger at the end of January. Credit Sales Jan. 7 Agler Co. 15 Barto Co. 23 Maris Co. Identify subsidiary ledger accounts. (SO 1) Identify special journals. (SO 2) Cash Collections $10,000 6,000 9,000 Jan. 17 Agler Co. 24 Barto Co. 29 Maris Co. $7,000 4,000 9,000 BEE-2 Identify in what ledger (general or subsidiary) each of the following accounts is shown. 3. Notes Payable 4. Accounts PayableThebeau 4. Credit sales 5. Purchase of merchandise on account 6. Receipt of cash for services performed 1. Rent Expense 2. Accounts ReceivableChar BEE-3 1. Cash sales 2. Payment of dividends 3. Cash purchase of land Identify the journal in which each of the following transactions is recorded. Identify entries to cash receipts journal. (SO 2) BEE-4 Indicate whether each of the following debits and credits is included in the cash receipts journal. (Use Yes or No to answer this question.) 1. Debit to Sales 2. Credit to Merchandise Inventory 3. Credit to Accounts Receivable 4. Debit to Accounts Payable Identify transactions for special journals. (SO 2) BEE-5 Galindo Co. uses special journals and a general journal. Identify the journal in which each of the following transactions is recorded. (a) (b) (c) (d) Purchased equipment on account. Purchased merchandise on account. Paid utility expense in cash. Sold merchandise on account. Exercises BEE-6 Identify the special journal(s) in which the following column headings appear. 4. Sales Cr. 5. Merchandise Inventory Dr. Identify transactions for special journals. (SO 2) E21 1. Sales Discounts Dr. 2. Accounts Receivable Cr. 3. Cash Dr. BEE-7 Kidwell Computer Components Inc. uses a multi-column cash receipts journal. Indicate which column(s) is/are posted only in total, only daily, or both in total and daily. 1. Accounts Receivable 2. Sales Discounts 3. Cash 4. Other Accounts Indicate postings to cash receipts journal. (SO 3) EXERCISES EE-1 Donahue Company uses both special journals and a general journal as described in this chapter. On June 30, after all monthly postings had been completed, the Accounts Receivable control account in the general ledger had a debit balance of $320,000; the Accounts Payable control account had a credit balance of $77,000. The July transactions recorded in the special journals are summarized below. No entries affecting accounts receivable and accounts payable were recorded in the general journal for July. Sales journal Purchases journal Cash receipts journal Cash payments journal Total sales $161,400 Total purchases $56,400 Accounts receivable column total $131,000 Accounts payable column total $47,500 Determine control account balances, and explain posting of special journals. (SO 1, 3) Instructions (a) What is the balance of the Accounts Receivable control account after the monthly postings on July 31? (b) What is the balance of the Accounts Payable control account after the monthly postings on July 31? (c) To what account(s) is the column total of $161,400 in the sales journal posted? (d) To what account(s) is the accounts receivable column total of $131,000 in the cash receipts journal posted? EE-2 Presented below is the subsidiary accounts receivable account of Jeremy Dody. Explain postings to subsidiary ledger. (SO 1) Date 2008 Sept. 2 9 27 Ref. S31 G4 CR8 Debit 61,000 Credit Balance 61,000 47,000 14,000 47,000 Instructions Write a memo to Andrea Barden, chief financial officer, that explains each transaction. EE-3 On September 1 the balance of the Accounts Receivable control account in the general ledger of Seaver Company was $10,960. The customers subsidiary ledger contained account balances as follows: Ruiz $1,440, Kingston $2,640, Bannister $2,060, Crampton $4,820. At the end of September the various journals contained the following information. Sales journal: Sales to Crampton $800; to Ruiz $1,260; to Iman $1,330; to Bannister $1,100. Cash receipts journal: Cash received from Bannister $1,310; from Crampton $2,300; from Iman $380; from Kingston $1,800; from Ruiz $1,240. General journal: An allowance is granted to Crampton $220. Instructions (a) Set up control and subsidiary accounts and enter the beginning balances. Do not construct the journals. (b) Post the various journals. Post the items as individual items or as totals, whichever would be the appropriate procedure. (No sales discounts given.) Post various journals to control and subsidiary accounts. (SO 1, 3) E22 Appendix E Subsidiary Ledgers and Special Journals (c) Prepare a list of customers and prove the agreement of the controlling account with the subsidiary ledger at September 30, 2008. Determine control and subsidiary ledger balances for accounts receivable. (SO 1) EE-4 Yu Suzuki Company has a balance in its Accounts Receivable control account of $11,000 on January 1, 2008. The subsidiary ledger contains three accounts: Smith Company, balance $4,000; Green Company, balance $2,500; and Koyan Company. During January, the following receivable-related transactions occurred. Credit Sales Smith Company Green Company Koyan Company $9,000 7,000 8,500 Collections $8,000 2,500 9,000 Returns $ -03,000 -0- Instructions (a) What is the January 1 balance in the Koyan Company subsidiary account? (b) What is the January 31 balance in the control account? (c) Compute the balances in the subsidiary accounts at the end of the month. (d) Which January transaction would not be recorded in a special journal? Determine control and subsidiary ledger balances for accounts payable. (SO 1) EE-5 Nobo Uematsu Company has a balance in its Accounts Payable control account of $8,250 on January 1, 2008. The subsidiary ledger contains three accounts: Jones Company, balance $3,000; Brown Company, balance $1,875; and Aatski Company. During January, the following receivable-related transactions occurred. Purchases Jones Company Brown Company Aatski Company $6,750 5,250 6,375 Payments $6,000 1,875 6,750 Returns $ -02,250 -0- Instructions (a) What is the January 1 balance in the Aatski Company subsidiary account? (b) What is the January 31 balance in the control account? (c) Compute the balances in the subsidiary accounts at the end of the month. (d) Which January transaction would not be recorded in a special journal? Record transactions in sales and purchases journal. (SO 1, 2) EE-6 Montalvo Company uses special journals and a general journal. The following transactions occurred during September 2008. Sept. 2 Sold merchandise on account to T. Hossfeld, invoice no. 101, $720, terms n/30. The cost of the merchandise sold was $420. 10 Purchased merchandise on account from L. Rincon $600, terms 2/10, n/30. 12 Purchased office equipment on account from R. Press $6,500. 21 Sold merchandise on account to P. Lowther, invoice no. 102 for $800, terms 2/10, n/30. The cost of the merchandise sold was $480. 25 Purchased merchandise on account from W. Barone $860, terms n/30. 27 Sold merchandise to S. Miller for $700 cash. The cost of the merchandise sold was $400. Instructions (a) Prepare a sales journal (see Illustration E-6) and a single-column purchase journal (see Illustration E-11). (Use page 1 for each journal.) (b) Record the transaction(s) for September that should be journalized in the sales journal and the purchases journal. Record transactions in cash receipts and cash payments journal. (SO 1, 2) EE-7 Pherigo Co. uses special journals and a general journal. The following transactions occurred during May 2008. May 1 2 3 14 I. Pherigo invested $50,000 cash in the business in exchange for common stock. Sold merchandise to B. Sherrick for $6,300 cash. The cost of the merchandise sold was $4,200. Purchased merchandise for $7,200 from J. DeLeon using check no. 101. Paid salary to H. Potter $700 by issuing check no. 102. Exercises 16 22 Sold merchandise on account to K. Kimbell for $900, terms n/30. The cost of the merchandise sold was $630. A check of $9,000 is received from M. Moody in full for invoice 101; no discount given. E23 Instructions (a) Prepare a multiple-column cash receipts journal (see Illustration E-8) and a multiplecolumn cash payments journal (see Illustration E-15). (Use page 1 for each journal.) (b) Record the transaction(s) for May that should be journalized in the cash receipts journal and cash payments journal. EE-8 Wick Company uses the columnar cash journals illustrated in the textbook. In April, the following selected cash transactions occurred. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Made a refund to a customer for the return of damaged goods. Received collection from customer within the 3% discount period. Purchased merchandise for cash. Paid a creditor within the 3% discount period. Received collection from customer after the 3% discount period had expired. Paid freight on merchandise purchased. Paid cash for office equipment. Received cash refund from supplier for merchandise returned. Paid cash dividend to stockholders. Made cash sales. Explain journalizing in cash journals. (SO 2) Instructions Indicate (a) the journal, and (b) the columns in the journal that should be used in recording each transaction. EE-9 Velasquez Company has the following selected transactions during March. Purchased equipment costing $9,400 from Chang Company on account. Received credit of $410 from Lyden Company for merchandise damaged in shipment to Velasquez. Issued credit of $400 to Higley Company for merchandise the customer returned. The returned merchandise had a cost of $260. Journalize transactions in general journal and post. (SO 1, 3) Mar. 2 5 7 Velasquez Company uses a one-column purchases journal, a sales journal, the columnar cash journals used in the text, and a general journal. Instructions (a) Journalize the transactions in the general journal. (b) In a brief memo to the president of Velasquez Company, explain the postings to the control and subsidiary accounts from each type of journal. EE-10 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. Below are some typical transactions incurred by Kwun Company. Indicate journalizing in special journals. (SO 2) Payment of creditors on account. Return of merchandise sold for credit. Collection on account from customers. Sale of land for cash. Sale of merchandise on account. Sale of merchandise for cash. Received credit for merchandise purchased on credit. Sales discount taken on goods sold. Payment of employee wages. Payment of cash dividend to stockholders. Depreciation on building. Purchase of office supplies for cash. Purchase of merchandise on account. Instructions For each transaction, indicate whether it would normally be recorded in a cash receipts journal, cash payments journal, sales journal, single-column purchases journal, or general journal. E24 Appendix E Subsidiary Ledgers and Special Journals EE-11 The general ledger of Sanchez Company contained the following Accounts Payable control account (in T-account form). Also shown is the related subsidiary ledger. Explain posting to control account and subsidiary ledger. (SO 1, 3) GENERAL LEDGER Accounts Payable Feb. 15 General journal 28 ? 1,400 ? Feb. 1 5 11 28 Balance General journal General journal Purchases 26,025 265 550 13,400 9,500 Feb. 28 Balance ACCOUNTS PAYABLE LEDGER Perez Feb. 28 Bal. 4,600 Tebbetts Feb. 28 Bal. ? Zerbe Feb. 28 Bal. 2,300 Instructions (a) Indicate the missing posting reference and amount in the control account, and the missing ending balance in the subsidiary ledger. (b) Indicate the amounts in the control account that were dual-posted (i.e., posted to the control account and the subsidiary accounts). Prepare purchases and general journals. (SO 1, 2) EE-12 Selected accounts from the ledgers of Lockhart Company at July 31 showed the following. GENERAL LEDGER Store Equipment Date July 1 Date July 1 15 18 25 31 Explanation Explanation Ref. G1 Ref. G1 G1 G1 G1 P1 Debit 3,900 Debit Credit 3,900 400 100 200 8,300 Credit No. 153 Balance 3,900 No. 201 Balance 3,900 4,300 4,200 4,000 12,300 Date July 15 18 25 31 Merchandise Inventory Explanation Ref. G1 G1 G1 P1 Debit 400 100 200 8,300 Credit No. 120 Balance 400 300 100 8,400 Accounts Payable ACCOUNTS PAYABLE LEDGER Albin Equipment Co. Date July 1 Explanation Ref. G1 Debit Credit 3,900 Balance 3,900 Date July 14 25 Date July 12 21 Date July 15 Explanation Explanation Explanation Drago Co. Ref. P1 G1 Ref. P1 P1 Debit 200 Debit Credit 500 600 Debit Credit 400 Credit 1,100 Balance 1,100 900 Balance 500 1,100 Balance 400 Brian Co. Date July 3 20 Date July 17 18 29 Explanation Explanation Ref. P1 P1 Debit Credit 2,400 700 Debit 100 1,600 Credit 1,400 Balance 2,400 3,100 Balance 1,400 1,300 2,900 Erik Co. Chacon Corp Ref. P1 G1 P1 Heinen Inc. Ref. G1 Problems: Set A Instructions From the data prepare: (a) the single-column purchases journal for July. (b) the general journal entries for July. EE-13 Kansas Products uses both special journals and a general journal as described in this chapter. Kansas also posts customers accounts in the accounts receivable subsidiary ledger. The postings for the most recent month are included in the subsidiary T accounts below. E25 Determine correct posting amount to control account. (SO 3) Bargo Bal. 340 200 250 Bal. Leary 150 240 150 Carol Bal. 0 145 145 Bal. Paul 120 190 150 120 Instructions Determine the correct amount of the end-of-month posting from the sales journal to the Accounts Receivable control account. EE-14 below. Selected account balances for Matisyahu Company at January 1, 2008, are presented Compute balances in various accounts. (SO 3) Accounts Payable Accounts Receivable Cash Inventory $14,000 22,000 17,000 13,500 Matisyahus sales journal for January shows a total of $100,000 in the selling price column, and its one-column purchases journal for January shows a total of $72,000. The column totals in Matisyahus cash receipts journal are: Cash Dr. $61,000; Sales Discounts Dr. $1,100; Accounts Receivable Cr. $45,000; Sales Cr. $6,000; and Other Accounts Cr. $11,100. The column totals in Matisyahus cash payments journal for January are: Cash Cr. $55,000; Inventory Cr. $1,000; Accounts Payable Dr. $46,000; and Other Accounts Dr. $10,000. Matisyahus total cost of goods sold for January is $63,600. Accounts Payable, Accounts Receivable, Cash, Inventory, and Sales are not involved in the Other Accounts column in either the cash receipts or cash payments journal, and are not involved in any general journal entries. Instructions Compute the January 31 balance for Matisyahu in the following accounts. (a) Accounts Payable. (b) Accounts Receivable. (c) Cash. (d) Inventory. (e) Sales. llege /w eygand t Visit the books website at www.wiley.com/college/weygandt, and choose the Student Companion site, to access Exercise Set B. PROBLEMS: SET A PE-1A Grider Companys chart of accounts includes the following selected accounts. 101 112 120 311 Cash Accounts Receivable Merchandise Inventory Common Stock 401 Sales 414 Sales Discounts 505 Cost of Goods Sold Journalize transactions in cash receipts journal; post to control account and subsidiary ledger. (SO 1, 2, 3) .w i l e y. c o EXERCISES: SET B www m /co E26 Appendix E Subsidiary Ledgers and Special Journals On April 1 the accounts receivable ledger of Grider Company showed the following balances: Ogden $1,550, Chelsea $1,200, Eggleston Co. $2,900, and Baez $1,800. The April transactions involving the receipt of cash were as follows. Apr. 1 Stockholders invested $7,200 additional cash in the business, in exchange for common stock. 4 Received check for payment of account from Baez less 2% cash discount. 5 Received check for $920 in payment of invoice no. 307 from Eggleston Co. 8 Made cash sales of merchandise totaling $7,245. The cost of the merchandise sold was $4,347. 10 Received check for $600 in payment of invoice no. 309 from Ogden. 11 Received cash refund from a supplier for damaged merchandise $740. 23 Received check for $1,500 in payment of invoice no. 310 from Eggleston Co. 29 Received check for payment of account from Chelsea. (a) Balancing totals $21,205 (c) Accounts Receivable $1,430 Journalize transactions in cash payments journal; post to control account and subsidiary ledgers. (SO 1, 2, 3) Instructions (a) Journalize the transactions above in a six-column cash receipts journal with columns for Cash Dr., Sales Discounts Dr., Accounts Receivable Cr., Sales Cr., Other Accounts Cr., and Cost of Goods Sold Dr./Merchandise Inventory Cr. Foot and crossfoot the journal. (b) Insert the beginning balances in the Accounts Receivable control and subsidiary accounts, and post the April transactions to these accounts. (c) Prove the agreement of the control account and subsidiary account balances. PE-2A Ming Companys chart of accounts includes the following selected accounts. 101 120 130 157 Cash Merchandise Inventory Prepaid Insurance Equipment 201 Accounts Payable 332 Dividends 505 Cost of Goods Sold On October 1 the accounts payable ledger of Ming Company showed the following balances: Bovary Company $2,700, Nyman Co. $2,500, Pyron Co. $1,800, and Sims Company $3,700. The October transactions involving the payment of cash were as follows. Oct. 1 3 5 10 15 16 19 29 (a) Balancing totals $12,350 Purchased merchandise, check no. 63, $300. Purchased equipment, check no. 64, $800. Paid Bovary Company balance due of $2,700, less 2% discount, check no. 65, $2,646. Purchased merchandise, check no. 66, $2,250. Paid Pyron Co. balance due of $1,800, check no. 67. Paid cash dividend of $400, check no. 68. Paid Nyman Co. in full for invoice no. 610, $1,600 less 2% cash discount, check no. 69, $1,568. Paid Sims Company in full for invoice no. 264, $2,500, check no. 70. (c) Accounts Payable $2,100 Journalize transactions in multi-column purchases journal; post to the general and subsidiary ledgers. (SO 1, 2, 3) Instructions (a) Journalize the transactions above in a four-column cash payments journal with columns for Other Accounts Dr., Accounts Payable Dr., Merchandise Inventory Cr., and Cash Cr. Foot and crossfoot the journal. (b) Insert the beginning balances in the Accounts Payable control and subsidiary accounts, and post the October transactions to these accounts. (c) Prove the agreement of the control account and the subsidiary account balances. PE-3A The chart of accounts of Lopez Company includes the following selected accounts. 112 120 126 157 201 Accounts Receivable Merchandise Inventory Supplies Equipment Accounts Payable 401 412 505 610 Sales Sales Returns and Allowances Cost of Goods Sold Advertising Expense In July the following selected transactions were completed. All purchases and sales were on account. The cost of all merchandise sold was 70% of the sales price. July 1 2 3 Purchased merchandise from Fritz Company $8,000. Received freight bill from Wayward Shipping on Fritz purchase $400. Made sales to Pinick Company $1,300, and to Wayne Bros. $1,500. Problems: Set A 5 8 13 15 16 18 21 22 24 26 28 30 Purchased merchandise from Moon Company $3,200. Received credit on merchandise returned to Moon Company $300. Purchased store supplies from Cress Supply $720. Purchased merchandise from Fritz Company $3,600 and from Anton Company $3,300. Made sales to Sager Company $3,450 and to Wayne Bros. $1,570. Received bill for advertising from Lynda Advertisements $600. Made sales to Pinick Company $310 and to Haddad Company $2,800. Granted allowance to Pinick Company for merchandise damaged in shipment $40. Purchased merchandise from Moon Company $3,000. Purchased equipment from Cress Supply $900. Received freight bill from Wayward Shipping on Moon purchase of July 24, $380. Made sales to Sager Company $5,600. E27 Instructions (a) Journalize the transactions above in a purchases journal, a sales journal, and a general journal. The purchases journal should have the following column headings: Date, Account Credited (Debited), Ref., Accounts Payable Cr., Merchandise Inventory Dr., and Other Accounts Dr. (b) Post to both the general and subsidiary ledger accounts. (Assume that all accounts have zero beginning balances.) (c) Prove the agreement of the control and subsidiary accounts. PE-4A Selected accounts from the chart of accounts of Boyden Company are shown below. 101 112 120 126 157 201 Cash Accounts Receivable Merchandise Inventory Supplies Equipment Accounts Payable 401 412 414 505 726 Sales Sales Returns and Allowances Sales Discounts Cost of Goods Sold Salaries Expense (a) Purchases journal Accounts Payable $24,100 Sales column total $16,530 (c) Accounts Receivable $16,490 Accounts Payable $23,800 Journalize transactions in special journals. (SO 1, 2, 3) The cost of all merchandise sold was 60% of the sales price. During January, Boyden completed the following transactions. Jan. 3 4 4 5 6 8 9 11 13 13 15 15 17 17 19 20 20 23 24 27 30 31 31 1. 2. Purchased merchandise on account from Wortham Co. $10,000. Purchased supplies for cash $80. Sold merchandise on account to Milam $5,250, invoice no. 371, terms 1/10, n/30. Returned $300 worth of damaged goods purchased on account from Wortham Co. on January 3. Made cash sales for the week totaling $3,150. Purchased merchandise on account from Noyes Co. $4,500. Sold merchandise on account to Connor Corp. $6,400, invoice no. 372, terms 1/10, n/30. Purchased merchandise on account from Betz Co. $3,700. Paid in full Wortham Co. on account less a 2% discount. Made cash sales for the week totaling $6,260. Received payment from Connor Corp. for invoice no. 372. Paid semi-monthly salaries of $14,300 to employees. Received payment from Milam for invoice no. 371. Sold merchandise on account to Bullock Co. $1,200, invoice no. 373, terms 1/10, n/30. Purchased equipment on account from Murphy Corp. $5,500. Cash sales for the week totaled $3,200. Paid in full Noyes Co. on account less a 2% discount. Purchased merchandise on account from Wortham Co. $7,800. Purchased merchandise on account from Forgetta Corp. $5,100. Made cash sales for the week totaling $4,230. Received payment from Bullock Co. for invoice no. 373. Paid semi-monthly salaries of $13,200 to employees. Sold merchandise on account to Milam $9,330, invoice no. 374, terms 1/10, n/30. Boyden Company uses the following journals. Sales journal. Single-column purchases journal. E28 Appendix E Subsidiary Ledgers and Special Journals 3. 4. 5. Cash receipts journal with columns for Cash Dr., Sales Discounts Dr., Accounts Receivable Cr., Sales Cr., Other Accounts Cr., and Cost of Goods Sold Dr./Merchandise Inventory Cr. Cash payments journal with columns for Other Accounts Dr., Accounts Payable Dr., Merchandise Inventory Cr., and Cash Cr. General journal. (a) Sales journal $22,180 Purchases journal $31,100 Cash receipts journal balancing total $29,690 Cash payments journal balancing total $41,780 Journalize in sales and cash receipts journals; post; prepare a trial balance; prove control to subsidiary; prepare adjusting entries; prepare an adjusted trial balance. (SO 1, 2, 3) Instructions Using the selected accounts provided: (a) Record the January transactions in the appropriate journal noted. (b) Foot and crossfoot all special journals. (c) Show how postings would be made by placing ledger account numbers and checkmarks as needed in the journals. (Actual posting to ledger accounts is not required.) PE-5A Presented below are the purchases and cash payments journals for Reyes Co. for its first month of operations. PURCHASES JOURNAL Date July 4 5 11 13 20 P1 Account Credited G. Clemens A. Ernst J. Happy C. Tabor M. Sneezy Ref. Merchandise Inventory Dr. Accounts Payable Cr. 6,800 8,100 5,920 15,300 7,900 44,020 CASH PAYMENTS JOURNAL Account Debited Store Supplies A. Ernst Prepaid Rent G. Clemens Dividends C. Tabor CP1 Cash Cr. 600 8,019 6,000 6,800 2,500 15,147 39,066 Date July 4 10 11 15 19 21 Ref. Other Accounts Dr. 600 Accounts Payable Dr. 8,100 Merchandise Inventory Cr. 81 6,000 6,800 2,500 15,300 9,100 30,200 153 234 In addition, the following transactions have not been journalized for July. The cost of all merchandise sold was 65% of the sales price. July 1 6 7 8 10 13 16 20 21 29 D. Reyes invested $80,000 in cash in exchange for common stock. Sold merchandise on account to Ewing Co. $6,200 terms 1/10, n/30. Made cash sales totaling $6,000. Sold merchandise on account to S. Beauty $3,600, terms 1/10, n/30. Sold merchandise on account to W. Pitts $4,900, terms 1/10, n/30. Received payment in full from S. Beauty. Received payment in full from W. Pitts. Received payment in full from Ewing Co. Sold merchandise on account to H. Prince $5,000, terms 1/10, n/30. Returned damaged goods to G. Clemens and received cash refund of $420. Instructions (a) Open the following accounts in the general ledger. 101 Cash 112 Accounts Receivable 120 Merchandise Inventory 127 Store Supplies 131 Prepaid Rent 201 Accounts Payable Problems: Set A 311 332 401 414 Common Stock Dividends Sales Sales Discounts 505 Cost of Goods Sold 631 Supplies Expense 729 Rent Expense E29 (b) Journalize the transactions that have not been journalized in the sales journal, the cash receipts journal (see Illustration E-8), and the general journal. (c) Post to the accounts receivable and accounts payable subsidiary ledgers. Follow the sequence of transactions as shown in the problem. (d) Post the individual entries and totals to the general ledger. (e) Prepare a trial balance at July 31, 2008. (f) Determine whether the subsidiary ledgers agree with the control accounts in the general ledger. (g) The following adjustments at the end of July are necessary. (1) A count of supplies indicates that $140 is still on hand. (2) Recognize rent expense for July, $500. Prepare the necessary entries in the general journal. Post the entries to the general ledger. (h) Prepare an adjusted trial balance at July 31, 2008. PE-6A The post-closing trial balance for Cortez Co. is as follows. (b) Sales journal total $19,700 Cash receipts journal balancing totals $101,120 (e) Totals $119,520 (f) Accounts Receivable $5,000 Accounts Payable $13,820 (h) Totals $119,520 Journalize in special journals; post; prepare a trial balance. (SO 1, 2, 3) CORTEZ CO. Post-Closing Trial Balance December 31, 2008 Debit Cash Accounts Receivable Notes Receivable Merchandise Inventory Equipment Accumulated DepreciationEquipment Accounts Payable Common Stock $ 41,500 15,000 45,000 23,000 6,450 Credit $ 1,500 43,000 86,450 $130,950 $130,950 The subsidiary ledgers contain the following information: (1) accounts receivableJ. Anders $2,500, F. Cone $7,500, T. Dudley $5,000; (2) accounts payableJ. Feeney $10,000, D. Goodman $18,000, and K. Inwood $15,000. The cost of all merchandise sold was 60% of the sales price. The transactions for January 2009 are as follows. Jan. 3 5 7 11 12 13 14 15 17 18 20 23 24 27 29 30 Sell merchandise to M. Rensing $5,000, terms 2/10, n/30. Purchase merchandise from E. Vietti $2,000, terms 2/10, n/30. Receive a check from T. Dudley $3,500. Pay freight on merchandise purchased $300. Pay rent of $1,000 for January. Receive payment in full from M. Rensing. Post all entries to the subsidiary ledgers. Issued credit of $300 to J. Aders for returned merchandise. Send K. Inwood a check for $14,850 in full payment of account, discount $150. Purchase merchandise from G. Marley $1,600, terms 2/10, n/30. Pay sales salaries of $2,800 and office salaries $2,000. Give D. Goodman a 60-day note for $18,000 in full payment of account payable. Total cash sales amount to $9,100. Post all entries to the subsidiary ledgers. Sell merchandise on account to F. Cone $7,400, terms 1/10, n/30. Send E. Vietti a check for $950. Receive payment on a note of $40,000 from B. Lemke. Post all entries to the subsidiary ledgers. Return merchandise of $300 to G. Marley for credit. E30 Appendix E Subsidiary Ledgers and Special Journals Instructions (a) Open general and subsidiary ledger accounts for the following. 101 112 115 120 157 158 200 201 Cash Accounts Receivable Notes Receivable Merchandise Inventory Equipment Accumulated DepreciationEquipment Notes Payable Accounts Payable 311 401 412 414 505 726 727 729 Common Stock Sales Sales Returns and Allowances Sales Discounts Cost of Goods Sold Sales Salaries Expense Office Salaries Expense Rent Expense (b) Sales journal $12,400 Purchases journal $3,600 Cash receipts journal (balancing) $57,600 Cash payments journal (balancing) $22,050 (d) Totals $139,800 (e) Accounts Receivable $18,600 Accounts Payable $12,350 (b) Record the January transactions in a sales journal, a single-column purchases journal, a cash receipts journal (see Illustration E-8), a cash payments journal (see Illustration E-15), and a general journal. (c) Post the appropriate amounts to the general ledger. (d) Prepare a trial balance at January 31, 2009. (e) Determine whether the subsidiary ledgers agree with controlling accounts in the general ledger. PROBLEMS: SET B Journalize transactions in cash receipts journal; post to control account and subsidiary ledger. (SO 1, 2, 3) PE-1B Darby Companys chart of accounts includes the following selected accounts. 101 112 120 311 Cash Accounts Receivable Merchandise Inventory Common Stock 401 Sales 414 Sales Discounts 505 Cost of Goods Sold On June 1 the accounts receivable ledger of Darby Company showed the following balances: Deering & Son $2,500, Farley Co. $1,900, Grinnell Bros. $1,600, and Lenninger Co. $1,300. The June transactions involving the receipt of cash were as follows. June 1 3 6 7 9 11 15 20 (a) Balancing totals $28,255 Stockholders invested $10,000 additional cash in the business, in exchange for common stock. Received check in full from Lenninger Co. less 2% cash discount. Received check in full from Farley Co. less 2% cash discount. Made cash sales of merchandise totaling $6,135. The cost of the merchandise sold was $4,090. Received check in full from Deering & Son less 2% cash discount. Received cash refund from a supplier for damaged merchandise $320. Made cash sales of merchandise totaling $4,500. The cost of the merchandise sold was $3,000. Received check in full from Grinnell Bros. $1,600. (c) Accounts Receivable $0 Journalize transactions in cash payments journal; post to the general and subsidiary ledgers. (SO 1, 2, 3) Instructions (a) Journalize the transactions above in a six-column cash receipts journal with columns for Cash Dr., Sales Discounts Dr., Accounts Receivable Cr., Sales Cr., Other Accounts Cr., and Cost of Goods Sold Dr./Merchandise Inventory Cr. Foot and crossfoot the journal. (b) Insert the beginning balances in the Accounts Receivable control and subsidiary accounts, and post the June transactions to these accounts. (c) Prove the agreement of the control account and subsidiary account balances. PE-2B Gonya Companys chart of accounts includes the following selected accounts. 101 Cash 120 Merchandise Inventory 130 Prepaid Insurance 157 Equipment 201 Accounts Payable 332 Dividends On November 1 the accounts payable ledger of Gonya Company showed the following balances: A. Hess & Co. $4,500, C. Kimberlin $2,350, G. Ruttan $1,000, and Wex Bros. $1,500. The November transactions involving the payment of cash were as follows. Nov. 1 3 Purchased merchandise, check no. 11, $1,140. Purchased store equipment, check no. 12, $1,700. Problems: Set B 5 11 15 16 19 25 30 Paid Wex Bros. balance due of $1,500, less 1% discount, check no. 13, $1,485. Purchased merchandise, check no. 14, $2,000. Paid G. Ruttan balance due of $1,000, less 3% discount, check no. 15, $970. Paid cash dividend of $500, check no. 16. Paid C. Kimberlin in full for invoice no. 1245, $1,150 less 2% discount, check no. 17, $1,127. Paid premium due on one-year insurance policy, check no. 18, $3,000. Paid A. Hess & Co. in full for invoice no. 832, $3,500, check no. 19. E31 Instructions (a) Journalize the transactions above in a four-column cash payments journal with columns for Other Accounts Dr., Accounts Payable Dr., Merchandise Inventory Cr., and Cash Cr. Foot and crossfoot the journal. (b) Insert the beginning balances in the Accounts Payable control and subsidiary accounts, and post the November transactions to these accounts. (c) Prove the agreement of the control account and the subsidiary account balances. PE-3B The chart of accounts of Emley Company includes the following selected accounts. 112 120 126 157 201 Accounts Receivable Merchandise Inventory Supplies Equipment Accounts Payable 401 412 505 610 Sales Sales Returns and Allowances Cost of Goods Sold Advertising Expense (a) Balancing totals $15,490 (c) Accounts Payable $2,200 Journalize transactions in multi-column purchases journal; post to the general and subsidiary ledgers. (SO 1, 2, 3) In May the following selected transactions were completed. All purchases and sales were on account except as indicated. The cost of all merchandise sold was 65% of the sales price. May 2 3 5 8 10 15 16 17 18 20 23 25 26 28 Purchased merchandise from Younger Company $7,500. Received freight bill from Ruden Freight on Younger purchase $360. Made sales to Ellie Company $1,980, DeShazer Bros. $2,700, and Liu Company $1,500. Purchased merchandise from Utley Company $8,000 and Zeider Company $8,700. Received credit on merchandise returned to Zeider Company $500. Purchased supplies from Rodriquez Supply $900. Purchased merchandise from Younger Company $4,500, and Utley Company $7,200. Returned supplies to Rodriquez Supply, receiving credit $100. (Hint: Credit Supplies.) Received freight bills on May 16 purchases from Ruden Freight $500. Returned merchandise to Younger Company receiving credit $300. Made sales to DeShazer Bros. $2,400 and to Liu Company $3,600. Received bill for advertising from Amster Advertising $900. Granted allowance to Liu Company for merchandise damaged in shipment $200. Purchased equipment from Rodriquez Supply $500. (a) Purchases journal Accounts Payable, Cr. $39,060 Sales column total $12,180 (c) Accounts Receivable $11,980 Accounts Payable $38,160 Journalize transactions in special journals. (SO 1, 2, 3) Instructions (a) Journalize the transactions above in a purchases journal, a sales journal, and a general journal. The purchases journal should have the following column headings: Date, Account Credited (Debited), Ref., Accounts Payable Cr., Merchandise Inventory Dr., and Other Accounts Dr. (b) Post to both the general and subsidiary ledger accounts. (Assume that all accounts have zero beginning balances.) (c) Prove the agreement of the control and subsidiary accounts. PE-4B Selected accounts from the chart of accounts of Litke Company are shown below. 101 112 120 126 140 145 Cash Accounts Receivable Merchandise Inventory Supplies Land Buildings 201 401 414 505 610 Accounts Payable Sales Sales Discounts Cost of Goods Sold Advertising Expense The cost of all merchandise sold was 70% of the sales price. During October, Litke Company completed the following transactions. E32 Appendix E Subsidiary Ledgers and Special Journals Oct. 2 4 5 7 9 10 12 13 14 16 17 18 21 23 25 25 25 26 27 28 30 30 30 Purchased merchandise on account from Camacho Company $16,500. Sold merchandise on account to Enos Co. $7,700. Invoice no. 204, terms 2/10, n/30. Purchased supplies for cash $80. Made cash sales for the week totaling $9,160. Paid in full the amount owed Camacho Company less a 2% discount. Purchased merchandise on account from Finn Corp. $3,500. Received payment from Enos Co. for invoice no. 204. Returned $210 worth of damaged goods purchased on account from Finn Corp. on October 10. Made cash sales for the week totaling $8,180. Sold a parcel of land for $27,000 cash, the lands original cost. Sold merchandise on account to G. Richter & Co. $5,350, invoice no. 205, terms 2/10, n/30. Purchased merchandise for cash $2,125. Made cash sales for the week totaling $8,200. Paid in full the amount owed Finn Corp. for the goods kept (no discount). Purchased supplies on account from Robinson Co. $260. Sold merchandise on account to Hunt Corp. $5,220, invoice no. 206, terms 2/10, n/30. Received payment from G. Richter & Co. for invoice no. 205. Purchased for cash a small parcel of land and a building on the land to use as a storage facility.The total cost of $35,000 was allocated $21,000 to the land and $14,000 to the building. Purchased merchandise on account from Kudro Co. $8,500. Made cash sales for the week totaling $7,540. Purchased merchandise on account from Camacho Company $14,000. Paid advertising bill for the month from the Gazette, $400. Sold merchandise on account to G. Richter & Co. $4,600, invoice no. 207, terms 2/10, n/30. Litke Company uses the following journals. 1. 2. 3. Sales journal. Single-column purchases journal. Cash receipts journal with columns for Cash Dr., Sales Discounts Dr., Accounts Receivable Cr., Sales Cr., Other Accounts Cr., and Cost of Goods Sold Dr./Merchandise Inventory Cr. Cash payments journal with columns for Other Accounts Dr., Accounts Payable Dr., Merchandise Inventory Cr., and Cash Cr. General journal. 4. 5. (b) Sales journal $22,870 Purchases journal $42,500 Cash receipts journal Cash, Dr. $72,869 Cash payments journal, Cash, Cr. $57,065 Journalize in purchases and cash payments journals; post; prepare a trial balance; prove control to subsidiary; prepare adjusting entries; prepare an adjusted trial balance. (SO 1, 2, 3) Instructions Using the selected accounts provided: (a) Record the October transactions in the appropriate journals. (b) Foot and crossfoot all special journals. (c) Show how postings would be made by placing ledger account numbers and check marks as needed in the journals. (Actual posting to ledger accounts is not required.) PE-5B Presented below are the sales and cash receipts journals for Wyrick Co. for its first month of operations. SALES JOURNAL Date Feb. 3 9 12 26 S. Arndt C. Boyd F. Catt M. Didde S1 Cost of Goods Sold Dr. Merchandise Inventory Cr. 3,630 4,290 5,280 4,620 17,820 Account Debited Ref. Accounts Receivable Dr. Sales Cr. 5,500 6,500 8,000 7,000 27,000 Comprehensive Problem: Chapters 3 to 6 and Appendix E E33 CR1 CASH RECEIPTS JOURNAL Cash Dr. 30,000 6,500 5,445 150 6,500 48,595 Date Feb. 1 2 13 18 26 Account Credited Common Stock S. Arndt Merchandise Inventory C. Boyd Ref. Sales Accounts Other Discounts Receivable Sales Accounts Cost of Goods Sold Dr. Dr. Cr. Cr. Cr. Merchandise Inventory Cr. 30,000 6,500 55 5,500 150 6,500 55 12,000 6,500 30,150 4,290 4,290 In addition, the following transactions have not been journalized for February 2008. Feb. 2 7 9 12 15 16 17 20 21 28 Purchased merchandise on account from J. Vopat for $4,600, terms 2/10, n/30. Purchased merchandise on account from P. Kneiser for $30,000, terms 1/10, n/30. Paid cash of $1,250 for purchase of supplies. Paid $4,508 to J. Vopat in payment for $4,600 invoice, less 2% discount. Purchased equipment for $7,000 cash. Purchased merchandise on account from J. Nunez $2,400, terms 2/10, n/30. Paid $29,700 to P. Kneiser in payment of $30,000 invoice, less 1% discount. Paid cash dividend of $1,100. Purchased merchandise on account from G. Reedy for $7,800, terms 1/10, n/30. Paid $2,400 to J. Nunez in payment of $2,400 invoice. Instructions (a) Open the following accounts in the general ledger. 101 112 120 126 157 158 201 Cash Accounts Receivable Merchandise Inventory Supplies Equipment Accumulated DepreciationEquipment Accounts Payable 311 332 401 414 505 631 711 Common Stock Dividends Sales Sales Discounts Cost of Goods Sold Supplies Expense Depreciation Expense (b) Purchases journal total $44,800 Cash payments journal Cash, Cr. $45,958 (e) Totals $71,300 (f) Accounts Receivable $15,000 Accounts Payable $7,800 (b) Journalize the transactions that have not been journalized in a one-column purchases journal and the cash payments journal (see Illustration E-15). (c) Post to the accounts receivable and accounts payable subsidiary ledgers. Follow the sequence of transactions as shown in the problem. (d) Post the individual entries and totals to the general ledger. (e) Prepare a trial balance at February 29, 2008. (f) Determine that the subsidiary ledgers agree with the control accounts in the general ledger. (g) The following adjustments at the end of February are necessary. (1) A count of supplies indicates that $300 is still on hand. (2) Depreciation on equipment for February is $200. Prepare the adjusting entries and then post the adjusting entries to the general ledger. (h) Prepare an adjusted trial balance at February 29, 2008. (h) Totals $71,500 llege /w eygand t Visit the books website at www.wiley.com/college/weygandt, and choose the Student Companion site, to access Problem Set C. COMPREHENSIVE PROBLEM: CHAPTERS 3 TO 6 AND APPENDIX E Packard Company has the following opening account balances in its general and subsidiary ledgers on January 1 and uses the periodic inventory system.All accounts have normal debit and credit balances. .w i l e y. c o PROBLEMS: SET C www m /co E34 Appendix E Subsidiary Ledgers and Special Journals General Ledger Account Number 101 112 115 120 125 130 157 158 201 311 320 Account Title Cash Accounts Receivable Notes Receivable Merchandise Inventory Office Supplies Prepaid Insurance Equipment Accumulated Depreciation Accounts Payable Common Stock Retained Earnings January 1 Opening Balance $33,750 13,000 39,000 20,000 1,000 2,000 6,450 1,500 35,000 70,000 8,700 Accounts Receivable Subsidiary Ledger January 1 Opening Customer Balance R. Draves B. Hachinski S. Ingles $1,500 7,500 4,000 Accounts Payable Subsidiary Ledger January 1 Opening Creditor Balance S. Kosko R. Mikush D. Moreno $ 9,000 15,000 11,000 Jan. 3 5 7 8 9 9 10 11 12 13 15 16 17 18 20 21 21 22 23 25 27 28 31 31 Sell merchandise on account to B. Remy $3,100, invoice no. 510, and J. Fine $1,800, invoice no. 511. Purchase merchandise on account from S. Yost $3,000 and D. Laux $2,700. Receive checks for $4,000 from S. Ingles and $2,000 from B. Hachinski. Pay freight on merchandise purchased $180. Send checks to S. Kosko for $9,000 and D. Moreno for $11,000. Issue credit of $300 to J. Fine for merchandise returned. Summary cash sales total $15,500. Sell merchandise on account to R. Draves for $1,900, invoice no. 512, and to S. Ingles $900, invoice no. 513. Post all entries to the subsidiary ledgers. Pay rent of $1,000 for January. Receive payment in full from B. Remy and J. Fine. Pay cash dividend of $800. Purchase merchandise on account from D. Moreno for $15,000, from S. Kosko for $13,900, and from S. Yost for $1,500. Pay $400 cash for office supplies. Return $200 of merchandise to S. Kosko and receive credit. Summary cash sales total $17,500. Issue $15,000 note to R. Mikush in payment of balance due. Receive payment in full from S. Ingles. Post all entries to the subsidiary ledgers. Sell merchandise on account to B. Remy for $3,700, invoice no. 514, and to R. Draves for $800, invoice no. 515. Send checks to D. Moreno and S. Kosko in full payment. Sell merchandise on account to B. Hachinski for $3,500, invoice no. 516, and to J. Fine for $6,100, invoice no. 517. Purchase merchandise on account from D. Moreno for $12,500, from D. Laux for $1,200, and from S. Yost for $2,800. Pay $200 cash for office supplies. Summary cash sales total $22,920. Pay sales salaries of $4,300 and office salaries of $3,600. Broadening Your Perspective Instructions (a) Record the January transactions in the appropriate journalsales, purchases, cash receipts, cash payments, and general. (b) Post the journals to the general and subsidiary ledgers. Add and number new accounts in an orderly fashion as needed. (c) Prepare a trial balance at January 31, 2008, using a worksheet. Complete the worksheet using the following additional information. (1) Office supplies at January 31 total $700. (2) Insurance coverage expires on October 31, 2008. (3) Annual depreciation on the equipment is $1,500. (4) Interest of $30 has accrued on the note payable. (5) Merchandise inventory at January 31 is $15,000. (d) Prepare a multiple-step income statement and a retained earnings statement for January and a classified balance sheet at the end of January. (e) Prepare and post the adjusting and closing entries. (f) Prepare a post-closing trial balance, and determine whether the subsidiary ledgers agree with the control accounts in the general ledger. E35 (c) Trial balance totals $196,820; Adj. T/B totals $196,975 (d) Net income $9,685 Total assets $126,315 (f) Post-closing T/B totals $127,940 BROADENING YOUR PERSPECTIVE FINANCIAL REPORTING AND ANALYSIS Financial Reporting ProblemMini Practice Set BYPE-1 (You will need the working papers that accompany this textbook in order to work this mini practice set.) Bluma Co. uses a perpetual inventory system and both an accounts receivable and an accounts payable subsidiary ledger. Balances related to both the general ledger and the subsidiary ledger for Bluma are indicated in the working papers. Presented below are a series of transactions for Bluma Co. for the month of January. Credit sales terms are 2/10, n/30. The cost of all merchandise sold was 60% of the sales price. Jan. 3 Sell merchandise on account to B. Richey $3,100, invoice no. 510, and to J. Forbes $1,800, invoice no. 511. 5 Purchase merchandise from S. Vogel $5,000 and D. Lynch $2,200, terms n/30. 7 Receive checks from S. LaDew $4,000 and B. Garcia $2,000 after discount period has lapsed. 8 Pay freight on merchandise purchased $235. 9 Send checks to S. Hoyt for $9,000 less 2% cash discount, and to D. Omara for $11,000 less 1% cash discount. 9 Issue credit of $300 to J. Forbes for merchandise returned. 10 Summary daily cash sales total $15,500. 11 Sell merchandise on account to R. Dvorak $1,600, invoice no. 512, and to S. LaDew $900, invoice no. 513. 12 Pay rent of $1,000 for January. 13 Receive payment in full from B. Richey and J. Forbes less cash discounts. 14 Pay an $800 cash dividend. 15 Post all entries to the subsidiary ledgers. 16 Purchase merchandise from D. Omara $18,000, terms 1/10, n/30; S. Hoyt $14,200, terms 2/10, n/30; and S. Vogel $1,500, terms n/30. 17 Pay $400 cash for office supplies. 18 Return $200 of merchandise to S. Hoyt and receive credit. 20 Summary daily cash sales total $20,100. 21 Issue $15,000 note, maturing in 90 days, to R. Moses in payment of balance due. 21 Receive payment in full from S. LaDew less cash discount. 22 Sell merchandise on account to B. Richey $2,700, invoice no. 514, and to R. Dvorak $1,300, invoice no. 515. 22 Post all entries to the subsidiary ledgers. E36 Appendix E Subsidiary Ledgers and Special Journals 23 Send checks to D. Omara and S. Hoyt in full payment less cash discounts. 25 Sell merchandise on account to B. Garcia $3,500, invoice no. 516, and to J. Forbes $6,100, invoice no. 517. 27 Purchase merchandise from D. Omara $14,500, terms 1/10, n/30; D. Lynch $1,200, terms n/30; and S. Vogel $5,400, terms n/30. 27 Post all entries to the subsidiary ledgers. 28 Pay $200 cash for office supplies. 31 Summary daily cash sales total $21,300. 31 Pay sales salaries $4,300 and office salaries $3,800. Instructions (a) Record the January transactions in a sales journal, a single-column purchases journal, a cash receipts journal as shown on page E8, a cash payments journal as shown on page E14, and a two-column general journal. (b) Post the journals to the general ledger. (c) Prepare a trial balance at January 31, 2008, in the trial balance columns of the worksheet. Complete the worksheet using the following additional information. (1) Office supplies at January 31 total $900. (2) Insurance coverage expires on October 31, 2008. (3) Annual depreciation on the equipment is $1,500. (4) Interest of $50 has accrued on the note payable. (d) Prepare a multiple-step income statement and a retained earnings statement for January and a classified balance sheet at the end of January. (e) Prepare and post adjusting and closing entries. (f) Prepare a post-closing trial balance, and determine whether the subsidiary ledgers agree with the control accounts in the general ledger. llege /w eygand Exploring the Web BYPE-2 Great Plains Accounting is one of the leading accounting software packages. Information related to this package is found at its website. Address: www.microsoft.com/dynamics/gp/product/demos.mspx, or go to www.wiley.com/college/weygandt Steps 1. Go to the site shown above. 2. Choose General Ledger. Perform instruction (a). 3. Choose Accounts Payable. Perform instruction (b). Instructions (a) What are three key features of the general ledger module highlighted by the company? (b) What are three key features of the payables management module highlighted by the company? www t m /co CRITICAL THINKING Decision Making Across the Organization BYPE-3 Hughey & Payne is a wholesaler of small appliances and parts. Hughey & Payne is operated by two owners, Rich Hughey and Kristen Payne. In addition, the company has one employee, a repair specialist, who is on a fixed salary. Revenues are earned through the sale of appliances to retailers (approximately 75% of total revenues), appliance parts to do-it-yourselfers (10%), and the repair of appliances brought to the store (15%). Appliance sales are made on both a credit and cash basis. Customers are billed on prenumbered sales invoices. Credit terms are always net/30 days. All parts sales and repair work are cash only. Merchandise is purchased on account from the manufacturers of both the appliances and the parts. Practically all suppliers offer cash discounts for prompt payments, and it is company policy to take all discounts. Most cash payments are made by check. Checks are most frequently issued to suppliers, to trucking companies for freight on merchandise purchases, and to newspapers, radio, and TV stations for advertising. All advertising bills are paid as received. .w i l e y. c o Broadening Your Perspective Rich and Kristen each make a monthly drawing in cash for personal living expenses. The salaried repairman is paid twice monthly. Hughey & Payne currently has a manual accounting system. Instructions With the class divided into groups, answer the following. (a) Identify the special journals that Hughey & Payne should have in its manual system. List the column headings appropriate for each of the special journals. (b) What control and subsidiary accounts should be included in Hughey & Payne manual system? Why? E37 Communication Activity BYPE-4 Barb Doane, a classmate, has a part-time bookkeeping job. She is concerned about the inefficiencies in journalizing and posting transactions. Jim Houser is the owner of the company where Barb works. In response to numerous complaints from Barb and others, Jim hired two additional bookkeepers a month ago. However, the inefficiencies have continued at an even higher rate. The accounting information system for the company has only a general journal and a general ledger. Jim refuses to install an electronic accounting system. Instructions Now that Barb is an expert in manual accounting information systems, she decides to send a letter to Jim Houser explaining (1) why the additional personnel did not help and (2) what changes should be made to improve the efficiency of the accounting department. Write the letter that you think Barb should send. Ethics Case BYPE-5 Roniger Products Company operates three divisions, each with its own manufacturing plant and marketing/sales force. The corporate headquarters and central accounting office are in Roniger, and the plants are in Freeport, Rockport, and Bayport, all within 50 miles of Roniger. Corporate management treats each division as an independent profit center and encourages competition among them. They each have similar but different product lines. As a competitive incentive, bonuses are awarded each year to the employees of the fastest growing and most profitable division. Jose Molina is the manager of Ronigers centralized computer accounting operation that enters the sales transactions and maintains the accounts receivable for all three divisions. Jose came up in the accounting ranks from the Bayport division where his wife, several relatives, and many friends still work. As sales documents are entered into the computer, the originating division is identified by code. Most sales documents (95%) are coded, but some (5%) are not coded or are coded incorrectly. As the manager, Jose has instructed the data-entry personnel to assign the Bayport code to all uncoded and incorrectly coded sales documents. This is done he says, in order to expedite processing and to keep the computer files current since they are updated daily. All receivables and cash collections for all three divisions are handled by Roniger as one subsidiary accounts receivable ledger. Instructions (a) Who are the stakeholders in this situation? (b) What are the ethical issues in this case? (c) How might the system be improved to prevent this situation? Answers to Self-Study Questions 1. a 2. c 3. a 4. c 5. d 6. b 7. c 8. c Appendix F OBJECTIVE Other Significant Liabilities STUDY After studying this appendix, you should be able to: 1. Describe the accounting and disclosure requirements for contingent liabilities. 2. Contrast the accounting for operating and capital leases. 3. Identify additional fringe benefits associated with employee compensation. In addition to the current and long-term liabilities discussed in Chapter 11, several more types of liabilities may exist that could have a significant impact on a companys financial position and future cash flows. These other significant liabilities will be discussed in this appendix. They are: (a) contingent liabilities, (b) lease liabilities, and (c) additional liabilities for employee fringe benefits (paid absences and postretirement benefits). CONTINGENT LIABILITIES With notes payable, interest payable, accounts payable, and sales taxes STUDY OBJECTIVE 1 payable, we know that an obligation to make a payment exists. But sup- Describe the accounting and pose that your company is involved in a dispute with the Internal Revenue disclosure requirements for Service (IRS) over the amount of its income tax liability. Should you re- contingent liabilities. port the disputed amount as a liability on the balance sheet? Or suppose your company is involved in a lawsuit which, if you lose, might result in bankruptcy. How should you report this major contingency? The answers to these questions are difficult, because these liabilities are dependentcontingentupon some future event. In other words, a contingent liability is a potential liability that may become an actual liability in the future. How should companies report contingent liabilities? They use the following guidelines: 1. If the contingency is probable (if it is likely to occur) and the amount can be reasonably estimated, the liability should be recorded in the accounts. 2. If the contingency is only reasonably possible (if it could happen), then it needs to be disclosed only in the notes that accompany the financial statements. 3. If the contingency is remote (if it is unlikely to occur), it need not be recorded or disclosed. Recording a Contingent Liability Product warranties are an example of a contingent liability that companies should record in the accounts. Warranty contracts result in future costs that companies may incur in replacing defective units or repairing malfunctioning units. Generally, F1 F2 Appendix F Other Significant Liabilities a manufacturer, such as Black & Decker, knows that it will incur some warranty costs. From prior experience with the product, the company usually can reasonably estimate the anticipated cost of servicing (honoring) the warranty. The accounting for warranty costs is based on the matching principle. The estimated cost of honoring product warranty contracts should be recognized as an expense in the period in which the sale occurs. To illustrate, assume that in 2008 Denson Manufacturing Company sells 10,000 washers and dryers at an average price of $600 each. The selling price includes a one-year warranty on parts. Denson expects that 500 units (5%) will be defective and that warranty repair costs will average $80 per unit. In 2008, the company honors warranty contracts on 300 units, at a total cost of $24,000. At December 31, it is necessary to accrue the estimated warranty costs on the 2008 sales. Denson computes the estimated warranty liability as follows. Illustration F-1 Computation of estimated product warranty liability Number of units sold Estimated rate of defective units Total estimated defective units Average warranty repair cost Estimated product warranty liability 10,000 5% 500 $80 $40,000 The company makes the following adjusting entry. A L 40,000 Cash Flows no effect SE 40,000 Exp Dec. 31 Warranty Expense Estimated Warranty Liability (To accrue estimated warranty costs) 40,000 40,000 Denson records those repair costs incurred in 2008 to honor warranty contracts on 2008 sales as shown below. A 24,000 Cash Flows no effect L 24,000 SE Jan. 1 Dec. 31 Estimated Warranty Liability Repair Parts (To record honoring of 300 warranty contracts on 2008 sales) 24,000 24,000 The company reports warranty expense of $40,000 under selling expenses in the income statement. It classifies estimated warranty liability of $16,000 ($40,000 $24,000) as a current liability on the balance sheet. In the following year, Denson should debit to Estimated Warranty Liability all expenses incurred in honoring warranty contracts on 2008 sales. To illustrate, assume that the company replaces 20 defective units in January 2009, at an average cost of $80 in parts and labor. The summary entry for the month of January 2009 is: A 1,600 Cash Flows no effect L 1,600 SE Jan. 31 Estimated Warranty Liability Repair Parts (To record honoring of 20 warranty contracts on 2008 sales) 1,600 1,600 Disclosure of Contingent Liabilities When it is probable that a company will incur a contingent liability but it cannot reasonably estimate the amount, or when the contingent liability is only reasonably possible, only disclosure of the contingency is required. Examples of contingencies Lease Liabilities F3 that may require disclosure are pending or threatened lawsuits and assessment of additional income taxes pending an IRS audit of the tax return. The disclosure should identify the nature of the item and, if known, the amount of the contingency and the expected outcome of the future event. Disclosure is usually accomplished through a note to the financial statements, as illustrated by the following. YAHOO! INC. Notes to the Financial Statements Contingencies. From time to time, third parties assert patent infringement claims against the company. Currently the company is engaged in several lawsuits regarding patent issues and has been notified of a number of other potential patent disputes. In addition, from time to time the company is subject to other legal proceedings and claims in the ordinary course of business, including claims for infringement of trademarks, copyrights and other intellectual property rights.... The Company does not believe, based on current knowledge, that any of the foregoing legal proceedings or claims are likely to have a material adverse effect on the financial position, results of operations or cash flows. Illustration F-2 Disclosure of contingent liability The required disclosure for contingencies is a good example of the use of the full-disclosure principle. The full-disclosure principle requires that companies disclose all circumstances and events that would make a difference to financial statement users. Some important financial information, such as contingencies, is not easily reported in the financial statements. Reporting information on contingencies in the notes to the financial statements will help investors be aware of events that can affect the financial health of a company. LEASE LIABILITIES A lease is a contractual arrangement between a lessor (owner of a property) STUDY OBJECTIVE 2 and a lessee (renter of the property). It grants the right to use specific Contrast the accounting for property for a period of time in return for cash payments. Leasing is big operating and capital leases. business. U.S. companies leased an estimated $125 billion of capital equipment in a recent year. This represents approximately one-third of equipment financed that year. The two most common types of leases are operating leases and capital leases. Operating Leases The renting of an apartment and the rental of a car at an airport are examples of operating leases. In an operating lease the intent is temporary use of the property by the lessee, while the lessor continues to own the property. In an operating lease, the lessee records the lease (or rental) payments as an expense. The lessor records the payments as revenue. For example, assume that a sales representative for Western Inc. leases a car from Hertz Car Rental at the Los Angeles airport and that Hertz charges a total of $275. Western, the lessee, records the rental as follows: A L Car Rental Expense Cash (To record payment of lease rental charge) 275 275 275 Cash Flows 275 SE 275 Exp F4 Appendix F Other Significant Liabilities The lessee may incur other costs during the lease period. For example, in the case above, Western will generally incur costs for gas. Western would report these costs as an expense. Capital Leases In most lease contracts, the lessee makes a periodic payment and records that payment in the income statement as rent expense. In some cases, however, the lease contract transfers to the lessee substantially all the benefits and risks of ownership. Such a lease is in effect a purchase of the property. This type of lease is a capital lease. Its name comes from the fact that the company capitalizes the present value of the cash payments for the lease and records that amount as an asset. Illustration F-3 indicates the major difference between operating and capital leases. Illustration F-3 Types of leases Operating lease Capital lease Only 3 more payments and this baby is ours! Have it back by 6:00 Sunday. HELPFUL HINT A capital lease situation is one that, although legally a rental case, is in substance an installment purchase by the lessee. Accounting standards require that substance over form be used in such a situation. OK! Lessor has substantially all of the benefits and risks of ownership Lessee has substantially all of the benefits and risks of ownership If any one of the following conditions exists, the lessee must record a lease as an assetthat is, as a capital lease: 1. The lease transfers ownership of the property to the lessee. Rationale: If during the lease term the lessee receives ownership of the asset, the lessee should report the leased asset as an asset on its books. 2. The lease contains a bargain purchase option. Rationale: If during the term of the lease the lessee can purchase the asset at a price substantially below its fair market value, the lessee will exercise this option. Thus, the lessee should report the lease as a leased asset on its books. 3. The lease term is equal to 75% or more of the economic life of the leased property. Rationale: If the lease term is for much of the assets useful life, the lessee should report the asset as a leased asset on its books. 4. The present value of the lease payments equals or exceeds 90% of the fair market value of the leased property. Rationale: If the present value of the lease payments is equal to or almost equal to the fair market value of the asset, the lessee has essentially purchased the asset. As a result, the lessee should report the leased asset as an asset on its books. Additional Liabilities for Employee Fringe Benefits F5 To illustrate, assume that Gonzalez Company decides to lease new equipment. The lease period is four years; the economic life of the leased equipment is estimated to be five years. The present value of the lease payments is $190,000, which is equal to the fair market value of the equipment. There is no transfer of ownership during the lease term, nor is there any bargain purchase option. In this example, Gonzalez has essentially purchased the equipment. Conditions 3 and 4 have been met. First, the lease term is 75% or more of the economic life of the asset. Second, the present value of cash payments is equal to the equipments fair market value. Gonzalez records the transaction as follows. Leased AssetEquipment Lease Liability (To record leased asset and lease liability) 190,000 190,000 Cash Flows no effect A 190,000 L 190,000 SE The lessee reports a leased asset on the balance sheet under plant assets. It reports the lease liability on the balance sheet as a liability. The portion of the lease liability expected to be paid in the next year is a current liability. The remainder is classified as a long-term liability. Most lessees do not like to report leases on their balance sheets. Why? ETHICS NOTE Because the lease liability increases the companys total liabilities. This, in Accounting standard setters turn, may make it more difficult for the company to obtain needed funds are attempting to rewrite from lenders. As a result, companies attempt to keep leased assets and rules on lease accounting because lease liabilities off the balance sheet by structuring leases so as not to meet of concerns that abuse of the curany of the four conditions mentioned on page F4. The practice of keeping rent standards is reducing the liabilities off the balance sheet is referred to as off-balance-sheet financing. usefulness of financial statements. ADDITIONAL LIABILITIES FOR EMPLOYEE F RINGE BENEFITS In addition to the three payroll tax fringe benefits discussed in Appendix STUDY OBJECTIVE 3 D (FICA taxes and state and federal unemployment taxes), employers in- Identify additional fringe benefits cur other substantial fringe benefit costs. Indeed, fringe benefits have been associated with employee growing faster than pay. In a recent year, benefits equaled 38 percent of compensation. wages and salaries. While vacations and other forms of paid leave still take the biggest bite out of the benefits pie, as shown in Illustration F-4, medical costs are the fastest-growing item. Illustration F-4 The fringe benefits pie BENEFITS 3% Disability and life insurance 13% Retirement income such as pensions 23% Legally required benefits such as Social Security 24% Medical benefits 37% Vacation and other benefits such as parental and sick leaves, child care We discuss two of the most important fringe benefitspaid absences and postretirement benefitsin this section. F6 Appendix F Other Significant Liabilities Paid Absences Employees often are given rights to receive compensation for absences when certain conditions of employment are met. The compensation may be for paid vacations, sick pay benefits, and paid holidays. When the payment for such absences is probable and the amount can be reasonably estimated, a liability should be accrued for paid future absences. When the amount cannot be reasonably estimated, companies should instead disclose the potential liability. Ordinarily, vacation pay is the only paid absence that is accrued. The other types of paid absences are only disclosed.1 To illustrate, assume that Academy Company employees are entitled to one days vacation for each month worked. If 30 employees earn an average of $110 per day in a given month, the accrual for vacation benefits in one month is $3,300. The liability is recognized at the end of the month by the following adjusting entry. A L 3,300 Cash Flows no effect SE 3,300 Exp Jan. 31 Vacation Benefits Expense Vacation Benefits Payable (To accrue vacation benefits expense) 3,300 3,300 This accrual is required by the matching principle. Academy would report Vacation Benefits Expense as an operating expense in the income statement, and Vacation Benefits Payable as a current liability in the balance sheet. Later, when Academy pays vacation benefits, it debits Vacation Benefits Payable and credits Cash. For example, if the above benefits for 10 employees are paid in July, the entry is: A 1,100 Cash Flows 1,100 L 1,100 SE July 31 Vacation Benefits Payable Cash (To record payment of vacation benefits) 1,100 1,100 The magnitude of unpaid absences has gained employers attention. Consider the case of an assistant superintendent of schools who worked for 20 years and rarely took a vacation or sick day. A month or so before she retired, the school district discovered that she was due nearly $30,000 in accrued benefits. Yet the school district had never accrued the liability. Postretirement Benefits Postretirement benefits are benefits provided by employers to retired employees for (1) health care and life insurance and (2) pensions. For many years the accounting for postretirement benefits was on a cash basis. Companies now account for both types of postretirement benefits on the accrual basis. The cost of postretirement benefits is getting steep. For example, General Motors pension and health-care costs for retirees in a recent year totaled $6.2 billion, or approximately $1,784 per vehicle produced. The average American has debt of approximately $10,000 (not counting the mortgage on their home) and has little in the way of savings. What will happen at retirement for these people? The picture is not prettypeople are living longer, the future of Social Security is unclear, and companies are cutting back on postretirement benefits. This situation may lead to one of the great social and moral dilemmas this country faces in the next 40 years. The more you know about postThe typical U.S. company provides an average of 12 days of paid vacation for its employees, at an average cost of 5% of gross earnings. 1 Additional Liabilities for Employee Fringe Benefits F7 retirement benefits, the better you will understand the issues involved in this dilemma. POSTRETIREMENT HEALTH-CARE AND LIFE INSURANCE BENEFITS Providing medical and related health-care benefits for retirees was at one time an inexpensive and highly effective way of generating employee goodwill. This practice has now turned into one of corporate Americas most worrisome financial problems. Runaway medical costs, early retirement, and increased longevity are sending the liability for retiree health plans through the roof. Many companies began offering retiree health-care coverage in the form of Medicare supplements in the 1960s. Almost all plans operated on a pay-as-you-go basis. The companies simply paid for the bills as they came in, rather than setting aside funds to meet the cost of future benefits. These plans were accounted for on the cash basis. But, the FASB concluded that shareholders and creditors should know the amount of the employers obligations. As a result, employers must now use the accrual basis in accounting for postretirement health-care and life insurance benefits. PENSION PLANS A pension plan is an agreement whereby an employer provides benefits (payments) to employees after they retire. Over 50 million workers currently participate in pension plans in the United States. The need for good accounting for pension plans becomes apparent when one appreciates the size of existing pension funds. Most pension plans are subject to the provisions of ERISA (Employee Retirement Income Security Act), a law enacted to curb abuses in the administration and funding of such plans. Three parties are generally involved in a pension plan. The employer (company) sponsors the pension plan. The plan administrator receives the contributions from the employer, invests the pension assets, and makes the benefit payments to the pension recipients (retired employees). Illustration F-5 indicates the flow of cash among the three parties involved in a pension plan. Illustration F-5 Parties in a pension plan Employer Contributions Plan Administrator Kear Trust Co. Pension Recipients Benefits Fund Assets: Investments and Earnings An employer-financed pension is part of the employees compensation. ERISA establishes the minimum contribution that a company must make each year toward employee pensions. The most popular type of pension plan used is the 401(k) plan. A 401(k) plan works as follows: As an employee, you can contribute up to a certain percentage of your pay into a 401(k) plan, and your employer will match a percentage of your contribution.These contributions are then generally invested in stocks and bonds through mutual funds. These funds will grow without being taxed and can be withdrawn beginning at age 59-1/2. If you must access the funds earlier, you may be able to do so, but a penalty usually occurs along with a payment of tax F8 Appendix F Other Significant Liabilities on the proceeds. Any time you have the opportunity to be involved in a 401(k) plan, you should avail yourself of this benefit! Companies record pension costs as an expense while the employees are working because that is when the company receives benefits from the employees services. Generally the pension expense is reported as an operating expense in the companys income statement. Frequently, the amount contributed by the company to the pension plan is different from the amount of the pension expense. A liability is recognized when the pension expense to date is more than the companys contributions to date. An asset is recognized when the pension expense to date is less than the companys contributions to date. Further consideration of the accounting for pension plans is left for more advanced courses. The two most common types of pension arrangements for providing benefits to employees after they retire are defined-contribution plans and defined-benefit plans. Defined-Contribution Plan. In a defined-contribution plan, the plan defines the employers contribution but not the benefit that the employee will receive at retirement. That is, the employer agrees to contribute a certain sum each period based on a formula. A 401(k) plan is typically a defined-contribution plan. The accounting for a defined-contribution plan is straightforward: The employer simply makes a contribution each year based on the formula established in the plan. As a result, the employers obligation is easily determined. It follows that the company reports the amount of the contribution required each period as pension expense. The employer reports a liability only if it has not made the contribution in full. To illustrate, assume that Alba Office Interiors Corp. has a defined-contribution plan in which it contributes $200,000 each year to the pension fund for its employees. The entry to record this transaction is: Pension Expense Cash (To record pension expense and contribution to pension fund) 200,000 200,000 A 200,000 Cash Flows 200,000 L SE 200,000 To the extent that Alba did not contribute the $200,000 defined contribution, it would record a liability. Pension payments to retired employees are made from the pension fund by the plan administrator. Defined-Benefit Plan. In a defined-benefit plan, the benefits that the employee will receive at the time of retirement are defined by the terms of the plan. Benefits are typically calculated using a formula that considers an employees compensation level when he or she nears retirement and the employees years of service. Because the benefits in this plan are defined in terms of uncertain future variables, an appropriate funding pattern is established to ensure that enough funds are available at retirement to meet the benefits promised. This funding level depends on a number of factors such as employee turnover, length of service, mortality, compensation levels, and investment earnings. The proper accounting for these plans is complex and is considered in more advanced accounting courses. POSTRETIREMENT BENEFITS AS LONG-TERM LIABILITIES While part of the liability associated with (1) postretirement health-care and life insurance benefits and (2) pension plans is generally a current liability, the greater portion of these liabilities extends many years into the future. Therefore, many companies are required to report significant amounts as long-term liabilities for postretirement benefits. Self-Study Questions F9 Before You Go On... REVIEW IT 1. What is a contingent liability? 2. How are contingent liabilities reported in financial statements? 3. What accounts are involved in accruing and paying vacation benefits? 4. What basis should be used in accounting for postretirement benefits? SUMMARY OF STUDY OBJECTIVES 1 Describe the accounting and disclosure requirements for contingent liabilities. If it is probable that the contingency will happen (if it is likely to occur) and the amount can be reasonably estimated, the liability should be recorded in the accounts. If the contingency is only reasonably possible (it could occur), then it should be disclosed only in the notes to the financial statements. If the possibility that the contingency will happen is remote (unlikely to occur), it need not be recorded or disclosed. 2 Contrast the accounting for operating and capital leases. For an operating lease, lease (or rental) payments are recorded as an expense by the lessee (renter). For a capital lease, the lessee records the asset and related obligation at the present value of the future lease payments. 3 Identify additional fringe benefits associated with employee compensation. Additional fringe benefits associated with wages are paid absences (paid vacations, sick pay benefits, and paid holidays), postretirement health care and life insurance, and pensions. The two most common types of pension arrangements are a defined-contribution plan and a defined-benefit plan. GLOSSARY Capital lease A contractual arrangement that transfers substantially all the benefits and risks of ownership to the lessee so that the lease is in effect a purchase of the property. (p. F4). Contingent liability A potential liability that may become an actual liability in the future. (p. F1). Defined-benefit plan A pension plan in which the benefits that the employee will receive at retirement are defined by the terms of the plan. (p. F8). Defined-contribution plan A pension plan in which the employers contribution to the plan is defined by the terms of the plan. (p. F8). Lease A contractual arrangement between a lessor (owner of a property) and a lessee (renter of the property). (p. F3). Operating lease A contractual arrangement giving the lessee temporary use of the property, with continued ownership of the property by the lessor. (p. F3). Pension plan An agreement whereby an employer provides benefits to employees after they retire. (p. F7). Postretirement benefits Payments by employers to retired employees for health care, life insurance, and pensions. (p. F6). SELF-STUDY QUESTIONS (SO 1) Answers are at the end of the appendix. 1. A contingency should be recorded in the accounts when: a. It is probable the contingency will happen but the amount cannot be reasonably estimated. b. It is reasonably possible the contingency will happen and the amount can be reasonably estimated. c. It is reasonably possible the contingency will happen but the amount cannot be reasonably estimated. d. It is probable the contingency will happen and the amount can be reasonably estimated. 2. At December 31, Anthony Company prepares an adjust- (SO 1) ing entry for a product warranty contract. Which of the following accounts are included in the entry? a. Warranty Expense. b. Estimated Warranty Liability. c. Repair Parts/Wages Payable. d. Both (a) and (b). 3. Lease A does not contain a bargain purchase option, but (SO 2) the lease term is equal to 90 percent of the estimated economic life of the leased property. Lease B does not F10 Appendix F Other Significant Liabilities 4. Which of the following is not an additional fringe benefit? (SO 3) a. Salaries. b. Paid absences. c. Paid vacations. d. Postretirement pensions. transfer ownership of the property to the lessee by the end of the lease term, but the lease term is equal to 75 percent of the estimated economic life of the lease property. How should the lessee classify these leases? Lease A a. b. c. d. Operating lease Operating lease Capital lease Capital lease Lease B Capital lease Operating lease Capital lease Operating lease QUESTIONS 1. What is a contingent liability? Give an example of a contingent liability that is usually recorded in the accounts. 2. Under what circumstances is a contingent liability disclosed only in the notes to the financial statements? Under what circumstances is a contingent liability not recorded in the accounts nor disclosed in the notes to the financial statements? 3. (a) What is a lease agreement? (b) What are the two most common types of leases? (c) Distinguish between the two types of leases. 4. Orbison Company rents a warehouse on a month-tomonth basis for the storage of its excess inventory. The company periodically must rent space when its production greatly exceeds actual sales. What is the nature of this type of lease agreement, and what accounting treatment should be accorded it? 5. Costello Company entered into an agreement to lease 12 computers from Estes Electronics Inc. The present value of the lease payments is $186,300. Assuming that this is a capital lease, what entry would Costello Company make on the date of the lease agreement? 6. Identify three additional types of fringe benefits associated with employees compensation. 7. Often during job interviews, the candidate asks the potential employer about the firms paid absences policy. What are paid absences? How are they accounted for? 8. What are the two types of postretirement benefits? During what years does the FASB advocate expensing the employers costs of these postretirement benefits? 9. What basis of accounting for the employers cost of postretirement health-care and life insurance benefits has been used by most companies, and what basis does the FASB advocate in the future? Explain the basic difference between these methods in recognizing postretirement benefit costs. 10. Identify the three parties in a pension plan. What role does each party have in the plan? 11. Brenna Ottare and Caitlin Wilkes are reviewing pension plans. They ask your help in distinguishing between a defined-contribution plan and a defined-benefit plan. Explain the principal difference to Brenna and Caitlin. Go to the books website, www.wiley.com/college/weygandt, for Additional Self-Study questions. BRIEF EXERCISES Prepare adjusting entry for warranty costs. (SO 1) Prepare entries for operating and capital leases. (SO 2) BEF-1 On December 1, Vina Company introduces a new product that includes a 1-year warranty on parts. In December 1,000 units are sold. Management believes that 5% of the units will be defective and that the average warranty costs will be $60 per unit. Prepare the adjusting entry at December 31 to accrue the estimated warranty cost. BEF-2 Prepare the journal entries that the lessee should make to record the following transactions. 1. 2. The lessee makes a lease payment of $80,000 to the lessor in an operating lease transaction. Zander Company leases a new building from Joel Construction, Inc.The present value of the lease payments is $900,000. The lease qualifies as a capital lease. Record estimated vacation benefits. (SO 3) BEF-3 In Alomar Company, employees are entitled to 1 days vacation for each month worked. In January, 50 employees worked the full month. Record the vacation pay liability for January assuming the average daily pay for each employee is $120. Exercises: Set B F11 EXERCISES EF-1 Boone Company sells automatic can openers under a 75-day warranty for defective merchandise. Based on past experience, Boone Company estimates that 3% of the units sold will become defective during the warranty period. Management estimates that the average cost of replacing or repairing a defective unit is $15. The units sold and units defective that occurred during the last 2 months of 2006 are as follows. Month November December Units Sold 30,000 32,000 Units Defective Prior to December 31 600 400 Record estimated liability and expense for warranties. (SO 1) Instructions (a) Determine the estimated warranty liability at December 31 for the units sold in November and December. (b) Prepare the journal entries to record the estimated liability for warranties and the costs (assume actual costs of $15,000) incurred in honoring 1,000 warranty claims. (c) Give the entry to record the honoring of 500 warranty contracts in January at an average cost of $15. EF-2 Larkin Online Company has the following liability accounts after posting adjusting entries: Accounts Payable $63,000, Unearned Ticket Revenue $24,000, Estimated Warranty Liability $18,000, Interest Payable $8,000, Mortgage Payable $120,000, Notes Payable $80,000, and Sales Taxes Payable $10,000. Assume the companys operating cycle is less than 1 year, ticket revenue will be earned within 1 year, warranty costs are expected to be incurred within 1 year, and the notes mature in 3 years. Instructions (a) Prepare the current liabilities section of the balance sheet, assuming $40,000 of the mortgage is payable next year. (b) Comment on Larkin Online Companys liquidity, assuming total current assets are $300,000. EF-3 1. 2. Presented below are two independent situations. Speedy Car Rental leased a car to Rundgren Company for 1 year. Terms of the operating lease agreement call for monthly payments of $500. On January 1, 2008, Miles Inc. entered into an agreement to lease 20 computers from Halo Electronics. The terms of the lease agreement require three annual rental payments of $40,000 (including 10% interest) beginning December 31, 2008. The present value of the three rental payments is $99,474. Miles considers this a capital lease. Prepare journal entries for operating lease and capital lease. (SO 2) Prepare the current liabilities section of the balance sheet. (SO 1) Instructions (a) Prepare the appropriate journal entry to be made by Rundgren Company for the first lease payment. (b) Prepare the journal entry to record the lease agreement on the books of Miles Inc. on January 1, 2008. EF-4 Bunill Company has two fringe benefit plans for its employees: 1. It grants employees 2 days vacation for each month worked. Ten employees worked the entire month of March at an average daily wage of $80 per employee. 2. It has a defined contribution pension plan in which the company contributes 10% of gross earnings. Gross earnings in March were $30,000. The payment to the pension fund has not been made. Instructions Prepare the adjusting entries at March 31. llege Prepare adjusting entries for fringe benefits. (SO 3) /w eygand t Visit the books website at www.wiley.com/college/weygandt, and choose the Student Companion site, to access Exercise Set B. .w i l e y. c o EXERCISES: SET B www m /co F12 Appendix F Other Significant Liabilities PROBLEMS: SET A Prepare current liability entries, adjusting entries, and current liabilities section. (SO 1) PF-1A On January 1, 2008, the ledger of Shumway Software Company contains the following liability accounts. Accounts Payable $42,500 Sales Taxes Payable 5,800 Unearned Service Revenue 15,000 During January the following selected transactions occurred. Jan. 1 Borrowed $15,000 in cash from Amsterdam Bank on a 4-month, 8%, $15,000 note. 5 Sold merchandise for cash totaling $10,400 which includes 4% sales taxes. 12 Provided services for customers who had made advance payments of $9,000. (Credit Service Revenue.) 14 Paid state treasurers department for sales taxes collected in December 2007 ($5,800). 20 Sold 700 units of a new product on credit at $52 per unit, plus 4% sales tax. This new product is subject to a 1-year warranty. 25 Sold merchandise for cash totaling $12,480, which includes 4% sales taxes. Instructions (a) Journalize the January transactions. (b) Journalize the adjusting entries at January 31 for (1) the outstanding notes payable, and (2) estimated warranty liability, assuming warranty costs are expected to equal 5% of sales of the new product. (c) Prepare the current liabilities section of the balance sheet at January 31, 2008. Assume no change in accounts payable. Analyze three different lease situations and prepare journal entries. (SO 2) PF-2A Presented below are three different lease transactions in which Ortiz Enterprises engaged in 2008. Assume that all lease transactions start on January 1, 2008. In no case does Ortiz receive title to the properties leased during or at the end of the lease term. Lessor Schoen Inc. Type of property Bargain purchase option Lease term Estimated economic life Yearly rental Fair market value of leased asset Present value of the lease rental payments Bulldozer None 4 years 8 years $13,000 $80,000 $48,000 Casey Co. Truck None 6 years 7 years $15,000 $72,000 $62,000 Lester Inc. Furniture None 3 years 5 years $4,000 $27,500 $12,000 Instructions (a) Identify the leases above as operating or capital leases. Explain. (b) How should the lease transaction with Casey Co. be recorded on January 1, 2008? (c) How should the lease transactions for Lester Inc. be recorded in 2008? PROBLEMS: SET B Prepare current liability entries, adjusting entries, and current liabilities section. (SO 1) PF-1B On January 1, 2008, the ledger of Zaur Company contains the following liability accounts. Accounts Payable $52,000 Sales Taxes Payable 7,700 Unearned Service Revenue 16,000 During January the following selected transactions occurred. Jan. 5 Sold merchandise for cash totaling $17,280, which includes 8% sales taxes. 12 Provided services for customers who had made advance payments of $10,000. (Credit Service Revenue.) Broadening Your Perspective 14 Paid state revenue department for sales taxes collected in December 2007 ($7,700). 20 Sold 600 units of a new product on credit at $50 per unit, plus 8% sales tax. This new product is subject to a 1-year warranty. 21 Borrowed $18,000 from UCLA Bank on a 3-month, 9%, $18,000 note. 25 Sold merchandise for cash totaling $12,420, which includes 8% sales taxes. Instructions (a) Journalize the January transactions. (b) Journalize the adjusting entries at January 31 for (1) the outstanding notes payable, and (2) estimated warranty liability, assuming warranty costs are expected to equal 7% of sales of the new product. (Hint: Use one-third of a month for the UCLA Bank note.) (c) Prepare the current liabilities section of the balance sheet at January 31, 2008. Assume no change in accounts payable. PF-2B Presented below are three different lease transactions that occurred for Milo Inc. in 2008. Assume that all lease contracts start on January 1, 2008. In no case does Milo receive title to the properties leased during or at the end of the lease term. Lessor Gibson Delivery Type of property Yearly rental Lease term Estimated economic life Fair market value of leased asset Present value of the lease rental payments Bargain purchase option Computer $ 8,000 6 years 7 years $44,000 $41,000 None Eller Co. Delivery equipment $ 4,200 4 years 7 years $19,000 $13,000 None Louis Auto Automobile $ 3,700 2 years 5 years $11,000 $6,400 None F13 Analyze three different lease situations and prepare journal entries. (SO 2) Instructions (a) Which of the leases above are operating leases and which are capital leases? Explain. (b) How should the lease transaction with Eller Co. be recorded in 2008? (c) How should the lease transaction for Gibson Delivery be recorded on January 1, 2008? llege /w eygand t Visit the books website at w ww.wiley.com/college/weygandt , and choose the Student Companion site, to access Problem Set C. BROADENING YOUR PERSPECTIVE FINANCIAL REPORTING AND ANALYSIS Financial Reporting Problems BYPF-1 Refer to the financial statements of PepsiCo and the Notes to Consolidated Financial Statements in Appendix A to answer the following questions about contingent liabilities, lease liabilities, and pension costs. (a) Where does PepsiCo report its contingent liabilities? (b) What is managements opinion as to the ultimate effect of the various claims and legal proceedings pending against the company? (c) Where did PepsiCo report the details of its lease obligations? What amount of rent expense from operating leases did PepsiCo incur in 2005? What was PepsiCos total future minimum annual rental commitment under noncancelable operating leases as of December 31, 2005? (d) What type of employee pension plan does PepsiCo have? (e) What is the amount of postretirement benefit expense (other than pensions) for 2005? .w i l e y. c o PROBLEMS: SET C www m /co F14 Appendix F Other Significant Liabilities BYPF-2 Presented below is the lease portion of the notes to the financial statements of CF Industries, Inc. CF INDUSTRIES, INC. Notes to the Financial Statements Leases The present value of future minimum capital lease payments and the future minimum lease payments under noncancelable operating leases at December 31, 2006, are: (in millions) Capital Lease Operating Lease Payments Payments 2007 2008 2009 2010 2011 Thereafter Future minimum lease payments Less: Equivalent interest Present value Less: Current portion $ 7,733 6,791 6,730 6,788 6,785 13,441 48,268 11,391 36,877 5,570 $31,307 Rent expense for operating leases was $7.0 million for the year ended December 31, 2006, $5.3 million for 2005, and $5.6 million for 2004. Instructions What type of leases does CF Industries, Inc. use? What is the amount of the current portion of the capital lease obligation? $3,067 2,052 1,056 918 86 6 $7,185 CRITICAL THINKING Decision Making Across the Organization BYPF-3 Presented below is the condensed balance sheet for Express, Inc. as of December 31, 2008. EXPRESS, INC. Balance Sheet December 31, 2008 Current assets Plant assets $ 800,000 1,600,000 Current liabilities Long-term liabilities Common stock Retained earnings Total $1,200,000 700,000 400,000 100,000 $2,400,000 Total $2,400,000 Express has decided that it needs to purchase a new crane for its operations. The new crane costs $900,000 and has a useful life of 15 years. However, Expresss bank has refused to provide any help in financing the purchase of the new equipment, even though Express is willing to pay an above-market interest rate for the financing. The chief financial officer for Express, Lisa Colder, has discussed with the manufacturer of the crane the possibility of a lease agreement. After some negotiation, the crane manufacturer agrees to lease the crane to Express under the following terms: length of the lease 7 years; payments $100,000 per year. The present value of the lease payments is $548,732. Broadening Your Perspective The board of directors at Express is delighted with this new lease. They reason they have the use of the crane for the next 7 years. In addition, Lisa Colder notes that this type of financing is a good deal because it will keep debt off the balance sheet. Instructions F15 With the class divided into groups, answer the following. (a) Why do you think the bank decided not to lend money to Express, Inc.? (b) How should this lease transaction be reported in the financial statements? (c) What did Lisa Colder mean when she said leasing will keep debt off the balance sheet? Answers to Self-Study Questions 1. d 2. d 3. c 4. a PHOTO CREDITS Chapter 1 Page 3: Dinodia Images/Alamy Limited. Page 9: Hai Wen China Tourism Press/Getty Images, Inc. Page 11: Brent Holland/iStockphoto. Page 23: iStockphoto. Page 47: NBAE/Getty Images. Page 56: Koichi Kamoshida/AsiaPac/Getty Images, Inc. Page 58: Mike Stewart/Corbis Sygma Page 70 PhotoDisc, Inc./Getty Images. 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Page 343: Gianni Dagli Orti/Corbis Images. Page 344: Terence John/Retna. Page 346: Nick Koudis/AFP/Getty Images. Page 357: Ingvald Kaldhussaeter/iStockphoto. Chapter 9 Page 385: Jorg Greuel/AFP/Getty Images. Page 388: Alice Millikan/iStockphoto. Page 394: Joe Polillio/Getty Images, Inc. Page 397: Michael Braun/ iStockphoto. Page 402: Jamie Evans/iStockphoto. Chapter 2 Chapter 10 Page 425: David Trood/Getty Images, Inc. Page 429: iStockphoto. Page 438: AFP/Getty Images. Page 445: Andy Lions/Photonica/Getty Images, Inc. Chapter 11 Page 473: Cary Westfall/iStockphoto. Page 478: Catherine dee Auvil/iStockphoto. Page 486: iStockphoto. Page 494: Greg Nicholas/iStockphoto. Page 495: Corbis Stock Market. Chapter 12 Page 533: David Young-Wolf/PhotoEdit. Page 537: Reuters NewMedia Inc/Corbis Images. Page 541: Brandon Laufenberg/iStockphoto. Page 548: Alex Fevzer/Corbis Images. Page 555 Tomasz Resiak/iStockphoto. Page 561: Arpad Benedek/iStockphoto. Chapter 13 Page 595: Warner Bros. David James/The Kobal Collection, Ltd. Page 608: John Lamb/Stone/Getty Images, Inc. Chapter 14 Page 637: Rudi Von Briel/PhotoEdit. Page 641: Elle Wagner and Lisa Gee/John Wiley & Sons. Page 644: Corbis Digital Stock. Page 655: PhotoDisc, Inc./Getty Images. Chapter 15 Page 697: Jeremy Edwards/iStockphoto. Page 700. Don Wilkie/iStockphoto 700 Don Wilkie/iStockphoto. Page 707: Nora Good/Masterfile. Page 715: Royalty-Free/Corbis Images. Page 720: Martina Misar/iStockphoto. Page 724: iStockphoto. Page 724: iStockphoto. Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7 Chapter 8 PC-1 C O M PA N Y I N D E X A ABC, 445 Ace Hardware, 271 Adelphia, 10 Advanced Micro, 540 AIG, 8 Alcatel-Alsthom, 298 Alliance Atlantis Communications Inc., 676 Altria Group, 470, 603, 634 Aluminum Company of America (Alcoa), 581 Amazon.com, 560, 696 America Bank, 412 American Airlines, 102, 479 American Cancer Society, 534 American Eagle Outfitters, 350 American Express, 396, 473 American Standard, 707 America Online (AOL), 470, 595, 597 Anaheim Angels, 604 AOL Time Warner, 597 Apple Computer, 6, 115, 298, 443, 715 Arthur Andersen, 537 AT&T, 4, 603 Avis, 425, 431, 604 B Babies R Us, 604 BankAmerica, 314 Bank of America, 11 Bank One Corporation, 70 Batten Ltd., 325326 Baylor University, 514 Berkshire Hathaway, 470 Best Buy, 9, 104, 140 Bill and Melinda Gates Foundation, 29, 534 Black & Decker Manufacturing Company, 255 Boeing Capital Corporation, 429 Boeing Company, 440, 470, 485, 552, 710 Boise Cascade, 434 Book-of-the-Month Club, 595 Breyer, 470 Bristol-Myers Squibb, 215, 255, 722 Budget, 425 C Cadbury-Schweppes, 10 Campbell Soup Company, 255, 433, 707 Capital Cities/ABC, Inc., 604 Cargill Inc., 535 Caterpillar Inc., 244246, 257, 480, 481, 535 Caterpillar Logistics Services, Inc., 245 Cendant Corp., 314, 604 Century 21, 604 Chase, 70 Chevron, 434 Cisco Systems, 155, 193, 289, 404, 470, 722 Citibank, 409 Citigroup, 11 CNN, 595 Coca-Cola Amatil Limited, B2 The Coca-Cola Company, 3, 5, 10, 11, 42, 43, 87, 100, 137, 163, 191, 215, 240, 243, 289, 333, 381, 421, 468, 470, 480, 528, 589, 618, 632, 692, 744, B1B4 Coca-Cola Enterprises Inc., B2 Coca-Cola FEMSA, S.A. de C.V., B2 Coca-Cola Hellenic Bottling Company S.A., B2 Coldwell Banker, 604 Columbia Sportswear Company, 676 Computer Associates International, 106 ConAgra Foods, 212 Consolidated Edison, 711 Continental Bank, 429 Costco Wholesale Corp., 641, D1 Craig Consumer Electronics, 249 Crane Company, 551 Cypress Semiconductor Corporation, 676 D DaimlerChrysler Corporation, 296, 491 Dairy Queen, 470 DeKalb Genetics Corporation, 626 Dell Computer, 60, 247, 298, 605 Dell Financial Services, 429 Delta Air Lines, 23, 45, 95, 102, 440 Discover, 395 Disney Company, see The Walt Disney Company Disneyland, 604 DisneyWorld, 604 Dun & Bradstreet, 309, 699 Dunkin Donuts, 23, 45 DuPont, 484, 485 Dynegy, Inc., 644, 694 E EarthLink, 552 Eastman Kodak Company, 346, 363, 606, 638 eBay, 357 Enron, 8, 29, 213, 301, 314, 340, 537, 591, 722, 746 ESPN, 445, 470, 604 Este Lauder Companies, Inc., 724725 ExxonMobil, 11, 296, 298, 470, 547 F Fannie Mae, 70, 108 Fidelity Investments, 47, 48 First National Bank, 12 Florida Citrus Company, 718 Ford Motor Company, 4, 11, 198, 258, 296, 532536, 547 Frito-Lay, 315, A9, A10, A12, A13 G GE, see General Electric General Dynamics, 745 General Electric (GE), 7, 10, 204, 213, 298, 301, 341, 470, 535, 597 General Mills, 433 General Motors (GM), 67, 11, 194, 296, 302, 410, 538, 650, 695, 721, 728 Global Crossing, 301, 340 GM, see General Motors Goldman Sachs, 11 Google, 29, 534, 540 Gulf Oil, 538 H Harley-Davidson, 215 Harolds Club, 301, 335 HBO, 595 HealthSouth, 8 Hershey Foods Corp., 552 Hertz, 425, F3 Hewlett-Packard, 298 Hilton, 429 Home Depot, 4, 247, 271, 428 Howard Johnson, 604 I IBM, 71, 213, 242, 298, 535, 539n.2 Imaginarium, 604 Intel Corporation, 325, 535, 555, 560 InterContinental, 429 International Harvester, 3 IT&T, 2 J J. Crew, 350 J.C. Penney Company, Inc., 349, 387, 412413, 641, 698700, 704715 John Deere Capital Corporation, 429 Johnson & Johnson, 310, 325 J.P. Morgan Leasing, 429 K Kellogg Company, 12, 29, 495, 560, 565, 566 Kids R Us, 604 Kmart, 196, 310, 699, 710, 717 Kodak, see Eastman Kodak Company Kohls Corporation, 641 KPMG LLP, A27, A29 Kraft Foods, Inc., 597, 603, 634 Krispy Kreme Doughnuts, 215 Kroger Stores, 198, 255, 310, 710, 711 K2, Inc., 164 L Leslie Fay Cos., 248, 290 The Limited, 296 Limited Brands, 100 Little, Brown & Co., 595 L.L. Bean, 296 Lockheed Martin Corporation, 155, 440, 561 Long Beach City College, 334 Lotus, 71 Lucent Technologies, 314 M McDonalds Corporation, 11, 443, 455, 470, 493, 534 McKesson Corporation, 196, 290 Major League Baseball Players Association, 7 Marriott, 429, 433 Marshall Farms, 626 Massachusetts General Hospital, 11 MasterCard, 395397, 412, 416 Merck, 310 Merrill Lynch, 11 Microsoft Corporation, 6, 11, 56, 89, 204, 295, 302, 443, 470, 547, 555, 636637, 655, 728 Mighty Ducks, 604 Minnesota Mining and Manufacturing Company, see 3M Mitsubishi Motors, 402, 423 Moodys, 529, 699 Morgan Stanley, 608 Morrow Snowboards, Inc., 199 Motorola, 255, 325, 720 N NationsBank, 314 NBC, 470 New York Stock Exchange, 609 Nike, Inc., 4, 100, 542, 552, 553, 558, 705706 Nordstrom, Inc., 166, 397, 423, 732733 Nortel Networks, 394, 715 North American Van Lines, 542 Northern Virginia Community College, 11 Northwest Airlines, 94, 166 I-1 I-2 Company Index Regions Financial Corp., 567 Rent-A-Wreck, 425428, 431, 433, 443, 445, 448, 470 Rent-Way Inc., 293 Republic Carloading, 160 Reynolds Company, 653654 Rhino Foods, Inc., 142144 Robert Half and Co., 30 Royal Dutch/Shell Group, 442, 445 S Safeway, 310, 710 Salvation Army, 534 SAMS CLUB, 261 Samsung Electronics Co., 262, 291 Sears, Roebuck, and Company, 195, 349, 387 Sears Holdings, 296 Shell, see Royal Dutch/Shell Group Snack Ventures Europe, A5 Southern Company, 325 Sports Illustrated, 479 Springfield ReManufacturing Corporation, 24 Standard & Poors, 699 Starbucks, 29, 255, 695 Stephanies Gourmet Coffee and More, 338341, 344, 345 Sunbeam Corporation, 243, 292293 Sunset Books, 595 SunTrust Banks Inc., 346 T Taco Bell, 445, 470 Target Corporation, 196, 247, 355, 641, 739 Tektronix Inc., 561 Texaco Oil Company, 409 3M Company, 411, 518 Tiffany & Co., 710 Time-Life Books, 595 Time Warner, Inc., 7, 164, 298, 470, 547, 594597, 601, 603 TNT, 595 Toys R Us, Inc., 325, 346, 604 Trek, 11 True Value Hardware, 247 Turner Broadcasting, 597, 601, 603 Twentieth Century Fox, 96 Tyco, 340 U U.S. Olympic Committee, 71 United Airlines, 7, 102, 479, 638 United Stationers, 196 USAir, 491 US Bancorp Equipment Finance, 429 USX Corp., 491 V Veritas Software, 71 Verizon Communications, 310 Visa, 395397, 406, 409, 411, 413, 419 W Walgreen Drugs, 196, 255 Wall Street Journal, 8, 537, 541 Wal-Mart Stores, Inc., 11, 58, 90, 194196, 199, 200, 204, 247, 248, 261262, 271, 291, 310, 349, 355, 555, 641, 710, 739, A11 The Walt Disney Company, 7, 23, 45, 95, 295, 470, 560, 603, 604 Warner Bros., 595 Waste Management Company, 70 Wells Fargo Bank, 340 Wendys International, 255, 470 Weyerhaeuser Co., 718 Whirlpool, 707 Whitehall-Robins, 384385, 393 WorldCom, Inc., 8, 29, 93, 301, 314, 340, 438, 470, 644, 694, 722 X Xerox, 93 Y Yahoo! Inc., 163, 696, F3 Yale Express, 160, 193 YUM! Brands, 470, A22 O Office Depot, 196 Oracle Corporation, 655 Owens-Illinois, 446, 447 P PACE Membership Warehouse, 717 PayLess Drug Stores Northwest, 717 PayPal, 357 PepsiAmericas, A20 Pepsi Bottling Group, A19A20, A22, A23 PepsiCo, Inc., 36, 10, 13, 4243, 45, 53, 8687, 90, 95, 100, 104, 137, 140, 168, 190191, 193, 213, 214, 239240, 243, 257, 258, 288289, 291, 298, 315, 333, 336, 365, 380381, 383, 394, 421, 423, 430, 468, 471, 480, 481, 492, 528, 531, 534, 541, 546, 550, 551, 559, 565, 588589, 592, 604, 632, 635, 642, 692, 695, 743744, 747, A1A30, F13 PepsiCo Beverages North America, A9, A10, A12, A13 PepsiCo International, A9, A10, A12, A13 Pfizer, 310 P&G, see Procter & Gamble Company Philip Morris, 470, 597, 603 Pizza Hut, 470 Planet Hollywood, 514 PNC Financial Services Group Inc., 567 Policy Management Systems, 292 Procter & Gamble Company (P&G), 11, 446, 447, 470, 542, 720 Prudential Real Estate, 11 Q Quaker, A24 Quaker Foods, 257, A9, A10, A12, A13, A30 Qualcomm, 538 Qwest, 310 R Radio Shack, 71, 90 Ramada Inn, 604 Red Cross, 29 Reebok International Ltd., 255, 541, 548 SUBJECT INDEX A Absences, paid, F6 Accelerated-depreciation method, 435 Account(s), 4853 chart of, 6061 control, E1E2 T, 48 three-column form of, 58 Accounting: basic activities of, 45 career opportunities in, 2930 Accounting cycle: optional steps in, 162164 required steps in, 161162 Accounting cycle tutorial adjusting entries, 97 preparing financial statements and closing the books, 148 recording process, 61 Accounting data, users of, 67 Accounting principle, changes in, 720 Accounts payable subsidiary ledger, E1 Accounts receivable, 386398 defined, 386 disposing of, 395398 recognizing, 387 types of, 386 valuing, 388395 Accounts receivable subsidiary ledger, E1 Accounts receivable turnover ratio, 403404. See also Receivables turnover Accruals, adjusting entries for, 97, 105110 expenses, accrued, 106109 revenues, accrued, 105106 Accrual-basis accounting, cash-basis vs., 95 Accrued expenses, 106109 Accrued interest, 107108 Accrued revenues, 105106 Acid-test (quick) ratio, 707708 Additional paid-in capital, 564 Additions and improvements, 438 Adjustable-rate mortgages, 493 Adjusted trial balance: preparation of, 112 preparing financial statements from, 113114, 116 Adjusting entries, 97111 for accruals, 105110 expenses, accrued, 106109 revenues, accrued, 105106 classes of, 9798 for deferrals, 98105 prepaid expenses, 98102 unearned revenues, 102103 example of journalizing/posting, 110111 for merchandising operations, 207 preparing, from worksheets, 148, 150, 152, 154 purpose of, 97 Administrative expenses, 211 Affiliated (subsidiary) company, 602 Agents: collection, 476 of corporations, 535 Aging schedule, 393 Aging the accounts receivable, 393 Allowance for Doubtful Accounts, 390, 393 Allowance method, 389394 Alternative accounting methods, 721722 Amortization, 443 of bonds, 506513 straight-line method, 509513 Annual report(s), 71, A1 Annuity(-ies): defined, C5, C10 future value of an, C5C7 present value of an, 502503, C10C12, C16 Assets, 12 depreciable, 431 in double-entry system, 49 return on, 311, 711 Asset turnover ratio, 446447, 710711 Assumptions, accounting, 911, 298299 Auditing, as area of public accounting, 29 Auditors, internal, 345346 Authorized stock, 540 Auto loans, calculating, C17 Available-for-sale securities, 605, 607608 Averages, industry, 699 Average collection period, 404 Average-cost method, 254255, 267268 B Bad Debts Expense, 388, 391 Balance sheet, 2123. See also Classified balance sheet consolidated, 615618 effects of cost flow methods on, 257 effects of inventory errors on, 260261 horizontal analysis of, 700701 investments on, 608609 stockholders equity section of, 564565 vertical analysis of, 703 Bank(s), 355362 deposits to, 355 and writing checks, 355357 Bank accounts, reconciling, 359362 Banking, investment, 540 Bank reconciliation, 355, 359362 entries from, 361362 example of, 360361 procedure for, 359360 Bank service charges, 357 Bank statements, 357358 Basic accounting equation, 1113 expansion of, 5253 using, 1420 Bearer (coupon) bonds, 484 Best-efforts contracts, 540n.3 Blank, Arthur, 4 Bond(s), 482492, 500513 amortization of, 506513 effective-interest method, 506509 straight-line method, 509513 bearer, 484 callable, 484 conversion of, to common stock, 491492 defined, 482 determining market value of, 486 discounting of, 487488, 503504 issuance of: accounting for, 487490 at discount, 488489 at face value, 487 at premium, 489490 procedures for, 484 premiums on, 487488 present value of, 504505 and present value of annuity, 502503 present value of face value of, 500502 pricing of, 500505 recording acquisition of, 598 recording interest from, 598 recording sale of, 598599 redemption of: at maturity, 491 before maturity, 491 registered, 484 retirement of, 489492 secured, 483 trading of, 484485 Bond discount, 488489 amortization of, 506508, 510511 defined, 488 Bonding, 346 Bond premium, 489490 amortization of, 508509, 511513 defined, 488 Bonuses, D4 Bookkeeping, 5 Book value, 102, 431 Book value per share, 571572 Buildings, 428 Business documents, 54, 203 By-laws, 538 C Calculator, using a, C16C17 Calendar year, 95 Callable bonds, 484 Canceled checks, 357 Capital, 305 ability of corporations to acquire, 535 corporate, 542 paid-in, 542 working, 309310, 481, 707 Capital expenditures, 438 Capital leases, F4F5 Capital stock, 564 Careers, accounting, 2930 Carrying (book) value: of convertible bonds, 491492 defined, 489 Carrying (book) value method, 492 Cash: defined, 348 net change in: direct method, 671 indirect method, 652654 reporting, 363, 365366 restricted, 363 Cash-basis accounting, accrual-basis vs., 95 Cash controls, 347355 disbursements, 351355 receipts, 348351 Cash disbursements journal, see Cash payments journal Cash dividends, 51, 552555 Cash equivalents, 363 Cash flow(s): classification of, 639640 free, 654655 statement of, see Statement of cash flows Cash payments journal, E13E15 Cash (net) realizable value, 389, 400 Cash receipts journal, E7E11 Cash register tapes, 203 Cash sales, credit card sales as, 396397 Castle, Ted, 142143 CEO (chief executive officer), 536 Certified public accountants (CPAs), 29 Changes in accounting principle, 720 Channel stuffing, 215, 722 Charter, 538 I-3 I-4 Subject Index characteristics of, 535537 classification of, 534535 defined, 10, 534 formation of, 538 issuance of stock by, 540542 owners equity in, 542543 ownership of, 538539 Correcting entries, 158160 Cost(s): depreciable, 432 expired/unexpired, 300 organization, 538 of plant assets, 427430 research and development, 446 Cost flow assumptions, 251255, 266269 Cost method: and stock investments, 600 for valuation of treasury stock, 547 Cost of goods sold: defined, 196 determining, under periodic system, 216218 and matching principle, 300 Cost principle, 302, 598 Coupon (bearer) bonds, 484 CPAs (certified public accountants), 29 Credit, 49 Credit cards: sales via, 396397 using, 405 Credit memoranda, 358 Creditors, long- vs. short-term, 698 Creditors subsidiary ledger, E1 Credit sales, journalizing, E5 Credit terms, 201202 Cumulative dividend, 551552 Current assets: on classified balance sheet, 162163 and current liabilities, 474 Current liabilities, 474482 changes in, 649 on classified balance sheet, 165166 and current assets, 474 defined, 474 long-term debt, current maturities of, 479480 notes payable, 475476 payroll and payroll taxes payable, 476478 sales taxes payable, 476 statement presentation/analysis of, 480482 unearned revenues, 479 Current maturities of long-term debt, 479480 Current ratio, 309, 706707 Current replacement cost, 258 Customers subsidiary ledger, E1 D Days in inventory, 262 Debenture bonds, 484 Debit, 49 Debit memoranda, 357 Debt investments, 597598 Debt to total assets ratio, 311312, 495, 714715 Declaration date, 553 Declining-balance method, 434435 Deferrals, adjusting entries for, 97105 prepaid expenses, 98102 unearned revenues, 102103 Deficits, 560 Defined-benefit plans, F8 Defined-contribution plans, F8 Depletion, 442 Deposits, bank, 355 Deposits in transit, 359 Depreciable assets, 431 Depreciable cost, 432 Depreciation: declining-balance method of, 434435 defined, 101, 430 of plant assets, 430438 computation, 431432 and income taxes, 436 methods, 432436 revisions in estimate of, 436437 as prepaid expense, 101 straight-line method of, 432433 units-of-activity method of, 433434 Depreciation expense, 646647 Direct method (of preparing statement of cash flows), 644, 665671 investing/financing activities, 670671 net change in cash, 671 operating activities, cash provided/used by, 666670 Direct write-off method, 388389 Disbursements, cash, 351355 and EFT system, 352353 and petty cash fund, 353355 and voucher system, 351352 Discontinued operations, 717718 Discount(s): bonds issued at, 488489, 506508, 510511 purchase, 201202 sales, 205 Discounting the future amount, C7, C12 Discount period, 202 Dishonored notes, 401402 Disposal: of accounts receivable, 395398 of notes receivable, 401402 of plant assets, 439441 retirement, 439440 sale, 440441 of treasury stock, 548550 Dividend(s), 51, 558 cash, 552555 cumulative, 551552 defined, 13, 552 preferred, 712 stock, 556558 stock splits, 558559 Dividends in arrears, 551552 Documentation procedures, 344 Double-declining-balance method, 435 Double-entry system, 49 Dunlap, Chainsaw Al, 292293 Duties, segregation of, 342343 E Earnings: gross, D4 statement of, D10 Earning power, 717 Earnings management, 300 Earnings per share (EPS), 307308, 712713 Economic entity assumption, 10 Effective-interest amortization method, 506509 EFT, see Electronic funds transfers Egypt, ancient, 343 Electronic controls, 344, 345 Electronic funds transfers (EFT), 352353 Employee earnings record, D8 Employee fringe benefits, liabilities for, F5F8 Employee Retirement Income Security Act (ERISA), F7 Employees: bonding of, 346 hiring of, D2 Employees Withholding Allowance Certificate (W-4), D6 The End of Work (Jeremy Rifkin), 194 Endorsements, restrictive, 350 Environmental liabilities, 115 EPS, see Earnings per share Equipment, 428429, 647 Chart of accounts, 6061 Check(s): canceled, 357 outstanding, 359 paying payroll via, D4 writing, 355357 Check register, 352 Chief executive officer (CEO), 536 Classified balance sheet, 161166, 168170, 305306 current assets on, 162163 current liabilities on, 165166 examples of, 168170 intangible assets on, 164 long-term investments on, 163 long-term liabilities on, 166 for merchandising operations, 213, 214 property, plant, and equipment on, 164 stockholders equity on, 166 valuing/reporting of investments on, 610611 Classified financial statements, 305308 Classified income statement, 306308 Closing entries: for merchandising operations, 207 posting of, 153154, 157158 preparation of, 151153, 155157 Closing the books, 154161 defined, 154 and posting of closing entries, 157158 and preparation of closing entries, 155157 and preparation of post-closing trial balance, 159161 Collection agents, 476 Collection period, average, 404 Collusion, 347 Common stock, 50, 538546 cash dividend allocation, 554, 555 issuance of, 540546 and owners equity, 542543 and ownership rights of stockholders, 538539 par-value vs. no-par-value, 544546 for services or noncash assets, 545546 Common stockholders equity, return on, 311, 566, 711712 Comparability of accounting information, 296 Comparative analysis, 698699 Compensating balances, 363 Compound entries, 5556 Compound interest, C2C3 Comprehensive income, 610, 720 Computer controls, 344 Conceptual framework, 295 Conservatism, 258, 304 Consigned goods, 249 Consistency, of accounting information, 296 Consistency principle, 257258 Consolidated balance sheet, 615618 Consolidated income statement, 618 Constraints, accounting, 303304 Consumerism, 194, 195 Consumption, 194195 Contingent liabilities, F1F3 Continuous life (of corporation), 536 Contra asset accounts, 101, 488 Contracts, best-efforts, 540n.3 Contractual interest rate, 484, 488 Contra-revenue accounts, 204 Contra stockholders equity account, 547548 Controls, internal, see Internal control(s) Control accounts, E1E2 Controller, 536 Controlling interest, 603 Convertible bonds, 484, 491492 Copyrights, 444 Corporate capital, 542 Corporation(s), 532543 book value per share of, 571572 Subject Index Equity: stockholders, 1213 trading on the, 712 Equity method, 601602 ERISA (Employee Retirement Income Security Act), F7 Errors: on bank statements, 359360 in inventory, 259261 balance sheet effects, 260261 income statement effects, 259260 Ethics: in financial reporting, 89 in personal financial reporting, 25 Exchange of intangible assets, 452454 gain treatment, 453454 loss treatment, 452453 Expense(s), 51 accrued, 106109 administrative, 211 defined, 13 operating, 210211 prepaid, 98102, 118119 selling, 211 Expired costs, 300 External transactions, 14 External users of accounting data, 6 Extraordinary operations, 718720 F Face value, 488 of bonds, 484, 487 of notes receivable, 400 present value of, 500502 Factors, 395396 FAFSA form, 25 Fair value, 605607 FASB, see Financial Accounting Standards Board Federal Bureau of Investigation (FBI), 4 Federal Insurance Contribution Act (FICA), D5 Federal unemployment taxes, D11D12 Federal Unemployment Tax Act (FUTA), D11 FICA (Federal Insurance Contribution Act), D5 FICA taxes: employer contribution for, D11 payroll deduction for, D5D6 FIFO method, see First-in, first-out method Financial accounting, database concept of, 302 Financial Accounting Standards Board (FASB), 9, 294295, 297, 313 Financial calculator, using a, C16C17 Financial statement presentation and analysis: of intangible assets, 446447 Financial statements, 5, 2124, 294 analysis of, 308312, 698726 classified, 305308 for Coca-Cola Company, B1B4 current liabilities on, 480482 and determination of earning power, 717 elements of, 297 and global economy, 312313 horizontal analysis of, 699703 inventories on: cost flow methods, 255257 presentation and analysis, 261262, 264 irregular items on, 717720 long-term liabilities on, 494495, 497498 for merchandising operations, 209214 classified balance sheet, 213, 214 multiple-step income statement, 209213 single-step income statement, 213, 214 operating guidelines for preparation of, 297 for PepsiCo, Inc., A1A30 preparing, from adjusted trial balance, 113114, 116 preparing, from worksheets, 148, 152, 153 and quality of earnings, 721722, 724726 ratio analysis of, 705717 receivables on, 403404 retained earnings on, 564566 retained earnings statement, 562563 tools for, 699 vertical analysis of, 703705 Financing activities, cash inflow/outflow from, 639, 640 direct method, 670671 indirect method, 651652 Finished goods inventory, 246 First-in, first-out (FIFO) method, 252253, 266 Fiscal year, 95 Fixed assets, 426. See also Plant assets Fixed-rate mortgages, 493 FOB (free on board), 200, 248 FOB destination, 200, 248, 249 FOB shipping point, 200, 248, 249 Ford, Henry, 533534 For Deposit Only, 350 Forensic accounting, 30 Form W-2 (Wage and Tax Statement), D13D14 Form W-4 (Employees Withholding Allowance Certificate), D6 Franchises, 445 Free Application for Federal Student Aid (FAFSA) form, 25 Free cash flow, 654655 Free on board (FOB), 200, 248 Freight costs, 200201 Fringe benefits, liabilities for, F5F8 Full disclosure principle, 301, F3 FUTA (Federal Unemployment Tax Act), D11 Future value, C3C7 of an annuity, C5C7 of a single amount, C3C5 G GAAP, see Generally accepted accounting principles Geneen, Harold, 2 General journal, 54, E16E17 General ledger (ledger), 5761 Generally accepted accounting principles (GAAP), 9, 294 and allowance method, 389 and alternative accounting methods, 721, 722 and cash-basis accounting, 95 and materiality, 303 Global economy, and financial statement presentation, 312313 Going concern assumption, 298299, 431 Goods in transit, 248249 Goodwill, 445446 Government, accounting career opportunities in, 30 Government regulation, of corporations, 537 Gross earnings, D4 Gross profit, 210 Gross profit method (for estimating inventories), 270271 Gross profit rate, 210 H Health insurance, cost of, 496 Held-to-maturity securities, 605 Hiring employees, D2 Home-equity loans, 567 Honor (of notes receivable), 401 Horizontal analysis, 699703 of balance sheet, 700701 of income statement, 701702 of retained earnings statement, 702703 Human resources (HR), 344, D2 I-5 I IASB, see International Accounting Standards Board Identity theft, 364 Imprest system, 353 Improper recognition, 722 Improvements: additions and, 438 land, 427428 Income: comprehensive, 610, 720 pro forma, 722 Income statement, 21, 22 classified, 306308 consolidated, 618 effects of cost flow methods on, 255257 effects of inventory errors on, 259260 horizontal analysis of, 701702 for merchandising operations, 209214 multiple-step income statement, 209213 single-step income statement, 213, 214 vertical analysis of, 703705 Income taxes (income taxation): on classified income statement, 306307 of corporations, 537 and depreciation of plant assets, 436 effects of cost flow methods on, 257 payroll deduction for, D6 remitting, D13 Independent internal verification, 344346 Indirect method (of preparing statement of cash flows), 643654 investing/financing activities, 651652 net change in cash, 652654 operating activities, cash provided/used by, 646650 worksheets, using, 659664 Industry averages (norms), 699 Information, accounting, 295297 Insurance, as prepaid expense, 100 Intangible assets, 443447 accounting for, 443446 amortization of, 443 on classified balance sheet, 164 copyrights, 444 exchange of, 452454 gain treatment, 453454 loss treatment, 452453 franchises and licenses, 445 goodwill, 445446 patents, 444 research and development costs, 446 statement presentation/analyis of, 446447 trademarks and trade names, 444 Intercompany comparisons, 699 Intercompany eliminations, 615, 616, 618 Intercompany transactions, 615, 618 Interest, C1C3 accrued, 107108 on checking accounts, 358 compound, C2C3 defined, C1 on notes receivable, 400 simple, C1C2 Interest rate, C1 Interim periods, 95 Internal auditors, 345346 Internal control(s), 340347 defined, 340 and documentation procedures, 344 and establishment of responsibility, 341, 342 and independent internal verification, 344346 limitations of, 346347 for payroll, D1D4 physical/mechanical/electronic controls, 344, 345 and Sarbanes-Oxley Act, 341 and segregation of duties, 342343 I-6 Subject Index J JIT (just-in-time) inventory, 247 Johnson, Matthew, 715 Journal, 5457 Journalizing, 5455, 6768, 110111 Just-in-time (JIT) inventory, 247 K Knight, Phil, 4 L Land, 427 Land improvements, 427428 Large stock dividend, 556 Last-in, first-out (LIFO) method, 253254, 267 LCM (lower-of-cost-or-market), 258 Leases, F3F5 capital, F4F5 operating, F3F4 Lease liabilities, F3F5 Ledger, see General ledger Legal capital, 541 Letter to the stockholders, A2A3 Leverage, 712 Leveraging, 712 Liabilities, 12, 472499 contingent, F1F3 current, 474482 long-term debt, current maturities of, 479480 notes payable, 475476 payroll and payroll taxes payable, 476478 sales taxes payable, 476 statement presentation/analysis of, 480482 unearned revenues, 479 in double-entry system, 49 for employee fringe benefits, F5F8 environmental, 115 lease, F3F5 long-term, 482495, 497498 bonds, 482492, 500513 notes payable, long-term, 492493 statement presentation/analysis of, 494495, 497498 Licenses, 445 LIFO conformity rule, 257 LIFO method, see Last-in, first-out method Limited liability, of corporate stockholders, 535 Liquidating dividend, 553 Liquidation preference, 552 Liquidity, 309310, 481 Liquidity ratios, 706710 acid-test ratio, 707708 current ratio, 706707 inventory turnover, 709710 receivables turnover, 708709 Long-term debt, current maturities of, 479480 Long-term debt due within one year, 480 Long-term investments, 163, 608, 609 Long-term liabilities, 482495, 497498 bonds, 482492, 500513 on classified balance sheet, 166 notes payable, long-term, 492493 postretirement benefits as, F8 present value of, C12C15 statement presentation/analysis of, 494495, 497498 Long-term notes payable, 492493 Lower-of-cost-or-market (LCM), 258 Lucas, George, 96 M MACRS (Modified Accelerated Cost Recovery System), 436 Mail receipts, 350351 Maker, 398 Management (of corporation), 536 Management consulting, as area of public accounting, 29 Managements discussion and analysis (MD&A), A3 Managerial accounting, 6, 29 Market interest rate, 486, 488 Market value: book value vs., 102, 572 of stock, 541 Marshall, John, 534 Matching principle, 9596, 300 Materiality (materiality principle), 303, 438 Maturity date (of promissory note), 399 MD&A (managements discussion and analysis), A3 Mechanical controls, 344, 345 Medicare, D5n.1 Merchandising operations, 194224 completing the accounting cycle for, 206208 adjusting entries, 207 closing entries, 207 cost of goods sold in, 216218 financial statements for, 209214 classified balance sheet, 213, 214 multiple-step income statement, 209213 single-step income statement, 213, 214 inventory systems in, 197199 periodic system, 198 perpetual system, 197198, 219222 operating cycles in, 196197 recording purchases of merchandise in, 199203 freight costs, 200201 purchase discounts, 201202 purchase returns and allowances, 201 recording sales of merchandise in, 203205 sales discounts, 205 sales returns and allowances, 204205 Merchandising profit, 210 Mintenko, Stephanie, 338339 MNCs (multinational corporations), 312 Modified Accelerated Cost Recovery System (MACRS), 436 Monetary unit assumption, 10, 298 Mortgage bonds, 483 Mortgage loans, calculating, C17 Mortgage notes payable, 493 Multinational corporations (MNCs), 312 Multiple-step income statement, 209213 N Natural resources, 442443 Net change in cash: direct method, 671 indirect method, 652654 Net pay, D7 Net (cash) realizable value, 389, 400 Net sales, 209210 Net worth, 167 Noncash activities, significant, 640641 Noncash current assets, changes in, 647648 Nonoperating activities, 211213 No-par-value stock, 542, 544545 Norms, industry, 699 Normal balance, 50 Notes payable, 475476 Notes receivable, 398403 computing interest for, 400 defined, 386 disposing of, 401402 maturity date of, 399 recognizing, 400 valuing, 400401 Not-for-profit corporations, 534 NSF (not sufficient funds), 358 Internal Revenue Service (IRS), 436 Internal transactions, 14 Internal users of accounting data, 6 International Accounting Standards Board (IASB), 9, 313 Intracompany comparisons, 699 Inventory(-ies), 244272 classification of, 246247 costing of: average-cost method for, 254255, 267268 balance sheet effects, 257 and consistency principle, 257 and cost flow assumption, 251252 FIFO method for, 252253, 266 financial statement effects, 255257 LIFO method for, 253254, 267 lower-of-cost-or-market method for, 258 and quality of earnings, 721 specific identification method for, 250251 tax effects, 257 days in, 262 determining quantities of, 247249 and ownership of goods, 248249 physical inventory, 247248 errors in, 259261 balance sheet effects, 260261 income statement effects, 259260 estimating, 269272 gross profit method for, 270271 retail inventory method for, 271272 finished goods, 246 just-in-time, 247 in merchandising operations, 197199, 219222 periodic inventory system, 198 perpetual inventory systems, 197198, 219222, 266269 statement presentation and analysis of, 261262, 264 taking, 247248 theft of, 263 Inventory turnover, 261262, 709710 Investee, 600 Investing activities, cash inflow/outflow from, 639, 640 direct method, 670671 indirect method, 651652 Investments, 594614 debt, 598599 purchase of, by corporations, 596597 short- vs. long-term, 608609 stock, 600605 between 20% and 50%, holdings, 601602 less than 20%, holdings of, 600601 more than 50%, holdings of, 602603 valuing/reporting of, 605611, 613 available-for-sale securities, 607608 on balance sheet, 608609 on classified balance sheet, 610611 realized/unrealized gain/loss presentation, 609610, 613 trading securities, 605607 Investment banking, 540 Investment portfolio, 600 Investments, long-term, see Long-term investments Invoice(s): purchase, 199, 200 sales, 203 Irregular items, 717720 changes in accounting principle, 720 comprehensive income, 720 discontinued operations, 717718 extraordinary operations, 718720 IRS (Internal Revenue Service), 436 Subject Index O Obsolescence, 431 Off-balance-sheet financing, F5 Open-book management, 3 Operating activities, cash inflow/outflow from, 639, 640 direct method, 666670 indirect method, 646650 Operating cycles, in merchandising operations, 196197 Operating expenses, 210211, 300 Operating leases, F3F4 Ordinary repairs, 438 Organization costs, 538 Other expenses and losses, 211 Other receivables, 386 Other revenues and gains, 211 Outstanding checks, 359 Outstanding stock, 548 Over-the counter receipts, 349350 P Paid absences, F6 Paid-in capital, 542, 564 Paper (phantom) profit, 256 Parent company, 602603 Partnerships, 10 Par-value stock, 541, 544, 546 Passwords, computer, 344 Patents, 444 Payee, 398 Payment date (dividends), 554 Payout ratio, 713714 Payroll, D1D15 defined, D1 determining, D4D7 internal control of, D1D4 recording, D8D10 Payroll and payroll taxes payable, 476478 Payroll deductions, D5D7 for FICA taxes, D5 for income taxes, D6 Payroll register, D8D9 Payroll taxes, 476, D11D15 federal unemployment taxes, D11D12 FICA, D11 filing/remitting, D13D15 recording, D12D13 state unemployment taxes, D12 PCAOB (Public Company Accounting Oversight Board), 341 Pension plans, F7F8 P-E ratio, see Price-earnings ratio Percentage-of-receivables basis, 393394 Percentage-of-sales basis, 392393 Periodic inventory system, 198, 219222 merchandise purchases in, 220221 merchandise sales in, 221222 Permanent accounts, 150151, 154155 Perpetual inventory system(s), 197198 inventory cost flow methods in, 266269 periodic vs., 219222 Personal annual report, 71 Personal financial reporting, ethics in, 25 Petty cash fund, 353355 establishment of, 353 making payments from, 353354 replenishment of, 354355 Phantom (paper) profit, 256 Physical controls, 344, 345 Pickard, Thomas, 4 Plan administrator (pensions), F7 Plant and equipment, see Plant assets Plant assets, 426441 buildings, 428 defined, 426 depreciation of, 430438 computation, 431432 and income taxes, 436 methods, 432436 revisions in estimate of, 436437 determining cost of, 427430 disposal of, 439441 retirement, 439440 sale, 440441 equipment, 428429 exchange of, 452454 gain treatment, 453454 loss treatment, 452453 expenditures during useful life of, 438 land, 427 land improvements, 427428 loss on sale of, 647 Post-closing trial balance, 155157, 159161 Posting, 5960, 6768, 110111 Postretirement benefits, F6F8 Preferred dividend, 712 Preferred stock, 550552, 554555 Premium, bonds issued at, 488490 Prepaid expenses (prepayments), 98102, 118119 Present value, C7C16 of an annuity, 502503, C10C12, C16 and bond pricing, 500505 defined, C7 of a long-term note or bond, C12C15 and market value of bonds, 486 of a single amount, C8C10, C1516 variables affecting, C7 Present value of 1 factors, C9 Price-earnings (P-E) ratio, 307n.4, 713 Principal, C1 Principle(s) of accounting, 294295, 299303 cost principle as, 302 full disclosure as, 301 matching as, 300 revenue recognition as, 299300 Prior period adjustments, 562 Private accounting, 29. See also Managerial accounting Privately held corporations, 535 Profit: gross, 210 as purpose of corporation, 534 Profitability, 310 Profitability ratios, 710714 asset turnover, 710711 earnings per share, 712713 payout ratio, 713714 price-earnings ratio, 713 profit margin, 710 return on assets, 711 return on common stockholders equity, 711712 Profit margin (profit margin percentage), 310, 710 Pro forma income, 722 Promissory notes, 398 Property, plant, and equipment, 164. See also Plant assets Proprietorships, 10 Public accounting, 29 Public Company Accounting Oversight Board (PCAOB), 341 Publicly held corporations, 534535 Purchase allowances, 201 Purchase discounts, 201202 Purchase invoices, 199, 200 Purchase returns, 201 Purchases, recording, 199203 discounts, 201202 freight costs, 200201 returns and allowances, 201 Purchases journal, E11E13 Purchasing activities, and segregation of duties, 342 I-7 Q Quality of earnings, 721722, 724726 and alternative accounting methods, 721722 and improper recognition, 722 and pro forma income, 722 Quick (acid-test) ratio, 707708 R Ratio analysis, 699, 705717 liquidity ratios, 706710 profitability ratios, 710714 solvency ratios, 714715 summary of ratios, 716 Raw materials, 246 R&D (research and development) costs, 446 Receipts, cash, 348351 mail receipts, 350351 over-the counter receipts, 349350 Receivables, 384408 accounts receivable, 386398 disposing of, 395398 recognizing, 387 types of, 386 valuing, 388395 defined, 386 notes receivable, 398403 computing interest for, 400 disposing of, 401402 maturity date of, 399 recognizing, 400 valuing, 400401 statement presentation/analysis for, 403404 trade, 386 Receivables turnover, 708709. See also Accounts receivable turnover ratio Recessions, inventory fraud during, 260 Recognition, improper, 722 Reconciliation, see Bank reconciliation Record date (dividends), 554 Recording process, 4674 and accounts, 4853 illustrated example of, 6168 for payroll, D8D10 for payroll taxes, D12D13 steps in, 5361 journalizing, 5457 ledger, transfer to, 5761 transaction analysis, 1520 and trial balance, 6870, 7273 Registered bonds, 484 Relevance, of accounting information, 296 Reliability, of accounting information, 296 Reporting: of cash, 363, 365366 ethics in, 89 Research and development (R&D) costs, 446 Responsibility, establishment of, 341, 342 Restricted cash, 363 Restrictive endorsements, 350 Retailers, 196 Retail inventory method, 271272 Retained earnings, 51, 542543, 560565 defined, 560 and prior period adjustments, 562 restrictions on, 560561 statement of, 562563 statement presentation/analysis of, 564566 Retained earnings restrictions, 561 Retained earnings statement, 2123, 562563 horizontal analysis of, 702703 statement presentation/analysis of, 564565, 568 Retirement, of plant assets, 439440 I-8 Subject Index State income taxes, D6 Statement of cash flows, 21, 22, 24, 638671 classification of cash flows on, 639640 direct method of preparing, 644, 665671 investing/financing activities, 670671 net change in cash, 671 operating activities, 666670 evaluating a company using, 654655, 657658 format of, 641 indirect method of preparing, 643654 investing/financing activities, 651652 net change in cash, 652654 operating activities, 646650 worksheets, using, 659664 preparation of, 642643 preparing, from worksheets, 659664 and significant noncash activities, 640641 usefulness of, 638639 Statement of earnings, D10 State unemployment taxes, D12 State unemployment tax acts (SUTA), D12 Stock: authorized, 540 book value of, 571572 deciding to invest in, 723 issuance of, 540546 market value of, 541, 572 par vs. no-par-value, 541542, 544546 preferred, 550552 treasury, 546550 disposal of, 548550 purchase of, 547548 Stock certificate, 538 Stock dividends, 556558 Stockholders: financial statement analysis by, 698 letter to the, A2A3 limited liability of, 535 ownership rights of, 538539 Stockholders equity, 1213 on classified balance sheet, 166 return on common stockholders equity, 311, 566, 711712 Stockholders equity account, 557 Stockholders equity statement, 565, 570571 Stock investments, 600605 between 20% and 50%, holdings, 601602 less than 20%, holdings of, 600601 more than 50%, holdings of, 602603 Stock splits, 558559 Straight-line method, 432433, 509513 Su, Vivi, 384385 Subsidiary (affiliated) company, 602 Subsidiary ledger(s), E1E4 advantages of, E3 defined, E1 example, E1E2 Supplies, as prepaid expense, 99 SUTA (state unemployment tax acts), D12 T T account, 48 Taking inventory, 247248 Taxes and taxation. See also Income taxes (income taxation); Payroll taxes as area of public accounting, 29 burden of, 478 corporate, 537 sales taxes payable, 476 Temporary accounts, 150, 154 Term bonds, 484 Theft, inventory, 263 Three-column form of account, 58 Time cards, D3 Timekeeping, D3 Time periods, and discounting of bonds, 503504 Time period assumption, 94, 298 Times interest earned ratio, 495, 715 Time value of money, C1C18 and discounting, C12 future value, C3C7 and interest, C1C3 and market value of bonds, 486 present value, C7C16 and use of financial calculator, C16C17 Timing issue(s), 9496 accrual- vs. cash-basis accounting as, 95 fiscal/calendar years as, 95 recognizing revenues/expenses as, 9596 selection of accounting time period as, 94 Trademarks and trade names, 444 Trade receivables, 386 Trading on the equity, 712 Trading securities, 605607 Transactions, 14 Transaction analysis, 1520 Transfer, of corporate ownership rights, 535 Transit, goods in, 248249 Transposition errors, 70 Treasurer, 536 Treasury stock, 546550 disposal of, 548550 purchase of, 547548 Trend analysis, see Horizontal analysis Trial balance, 6870, 7273 defined, 68 limitations of, 69 locating errors in, 6970 post-closing, 155157, 159161 steps in preparation of, 69 use of dollar signs in, 70 Trustee (of bond), 484 Turnover: asset, 446447, 710711 inventory, 261262, 709710 receivables, 403404, 708709 U Uncollectible accounts: allowance method for, 389394 direct write-off method for, 388389 Underwriting, of stock issues, 540 Unearned revenues, 102103, 119120, 479 Unemployment taxes: federal, D11D12 state, D12 Unexpired costs, 300 Units-of-activity method, 433434, 442 Unsecured bonds, 484 Useful life, 101, 431, 432, 438 V Valuation: of accounts receivable, 388395 of notes receivable, 400401 Vertical analysis, 699, 703705 of balance sheet, 703 of income statement, 703705 Virtual close, 155 Vouchers, 351, 352 Voucher register, 352 Voucher systems, 351352 W W-2 (Wage and Tax Statement), D13D14 W-4 (Employees Withholding Allowance Certificate), D6 Wages, D1 Wages and salaries payable, 476 Wage and Tax Statement (Form W-2), D13D14 Return on assets, 311, 711 Return on common stockholders equity, 311, 566, 711712 Returns and allowances: merchandise purchases, 201 for merchandise sales, 204205 Revenue(s), 51 accrued, 105106 defined, 13 sales, 196 unearned, 102103, 119120, 479 Revenue expenditures, 438 Revenue recognition principle, 95, 299300 Reversing entries, 158, 171173 Rifkin, Jeremy, 194 Rowling, J. K., 443 Rubino, Carlos, 696697 S Salaries, 108109, D1, D4 Sale(s): of bonds, 598599 credit card, 396397 net, 209210 of plant assets, 440441, 647 of receivables, 395396 recording, 203205 discounts, 205 returns and allowances, 204205 Sales activities, and segregation of duties, 342343 Sales invoices, 203 Sales journal, E5E7 Sales revenue, 196 Sales taxes payable, 476 Salvage value, 431, 432 Sarbanes-Oxley Act of 2002 (SOX; Sarbox), 8, 29, 341 and human resources, 344 and identity theft, 364 and restatements, 159 Saving, personal, 612 SEC, see Securities and Exchange Commission Secured bonds, 483 Securities and Exchange Commission (SEC), 9, 294, 537 Segregation of duties, 342343 Selling expenses, 211 Semiannually payable interest, C12, C13 Serial bonds, 484 Service charges, bank, 357 Short-term investments, 608609 Short-term paper, 609n.4 Significant noncash activities, 640641 Simple entries, 55 Simple interest, C1C2 Single-step income statement, 213, 214 Sinking fund bond, 483 Small stock dividend, 556 Social Security taxes, see FICA taxes Solvency, 311 Solvency ratios, 714715 debt to total assets ratio, 714715 times interest earned, 715 SOX, see Sarbanes-Oxley Act of 2002 Special journals, E4E18 cash payments journal, E13E15 cash receipts journal, E7E11 effects of, on general journal, E16E17 purchases journal, E11E13 sales journal, E5E7 usefulness of, E4 Specific identification method, 250251 Stack, Jack, 2 Star Wars, 96 Stated value, 542, 544545 Subject Index Wear and tear, 431 Weighted-average unit cost, 254 Wholesalers, 196 Withholding taxes, 476. See also Payroll taxes Working capital, 309310, 481, 707 Working capital ratio, 707 Work in process, 246 Worksheet(s), 144154 defined, 144 for merchandising company, 222224 preparing adjusting entries from, 148, 150, 152, 154 preparing consolidated balance sheets from, 616617 I-9 preparing financial statements from, 148, 152, 153 preparing statement of cash flows from, 659664 steps in preparation of, 144152 Z Zero-interest bonds, 486 RAPID REVIEW Chapter Content BASIC ACCOUNTING EQUATION (Chapter 2) Basic Equation Expanded Basic Equation Debit/Credit Effects Assets = Liabilities + Stockholders Equity INVENTORY (Chapters 5 and 6) Ownership Freight Terms FOB Shipping point FOB Destination Ownership of goods on public carrier resides with: Buyer Seller Assets Dr. Cr. + = Liabilities Dr. Cr. + + ADJUSTING ENTRIES (Chapter 3) Type Deferrals 1. Prepaid expenses 2. Unearned revenues 1. Accrued revenues 2. Accrued expenses Adjusting Entry Dr. Expenses Dr. Liabilities Dr. Assets Dr. Expenses Cr. Assets Cr. Revenues Cr. Revenues Cr. Liabilities Common Stock Dr. Cr. + + Retained Earnings Dr. Cr. + Dividends Dr. + Cr. + Revenues Dr. Cr. + Expenses Dr. + Cr. Perpetual vs. Periodic Journal Entries Event Purchase of goods Perpetual Inventory Cash (A/P) Inventory Cash Cash (or A/P) Inventory Cash (or A/R) Sales Cost of Goods Sold Inventory No entry Periodic* Purchases Cash (A/P) Freight-In Cash Cash (or A/P) Purchase Returns and Allowances Cash (or A/R) Sales No entry Accruals Freight (shipping point) Note: Each adjusting entry will affect one or more income statement accounts and one or more balance sheet accounts. Interest Computation Interest Face value of note Annual interest rate Time in terms of one year Return of goods Sale of goods CLOSING ENTRIES (Chapter 4) Purpose: (1) Update the Retained Earnings account in the ledger by transferring net income (loss) and dividends to retained earnings. (2) Prepare the temporary accounts (revenue, expense, dividends) for the next periods postings by reducing their balances to zero. Process 1. 2. Debit each revenue account for its balance (assuming normal balances), and credit Income Summary for total revenues. Debit Income Summary for total expenses, and credit each expense account for its balance (assuming normal balances). STOP AND CHECK: Does the balance in your Income Summary Account equal the net income (loss) reported in the income statement? 3. 4. Debit (credit) Income Summary, and credit (debit) Retained Earnings for the amount of net income (loss). Debit Retained Earnings for the balance in the Dividends account and credit Dividends for the same amount. STOP AND CHECK: Does the balance in your Retained Earnings account equal the ending balance reported in the balance sheet and the retained earnings statement? Are all of your temporary account balances zero? End of period Cost Flow Methods Specific identification First-in, first-out (FIFO) Closing or adjusting entry required Weighted average Last-in, first-out (LIFO) CONCEPTUAL FRAMEWORK OF ACCOUNTING (Chapter 7) Characteristics Relevance Comparability Reliability Assumptions Monetary unit Economic entity Time period Going concern Principles Revenue recognition Matching Full disclosure Cost Constraints Materiality Conservatism INTERNAL CONTROL AND CASH (Chapter 8) Principles of Internal Control Establishment of responsibility Segregation of duties Documentation procedures Bank Reconciliation Physical, mechanical, and electronic controls Independent internal verification Other controls ACCOUNTING CYCLE (Chapter 4) 1 Analyze business transactions Bank Balance per bank statement Add: Deposit in transit Deduct: Outstanding checks Adjusted cash balance Books Balance per books Add: Unrecorded credit memoranda from bank statement Deduct: Unrecorded debit memoranda from bank statement Adjusted cash balance 9 Prepare a post-closing trial balance 2 Journalize the transactions 8 Journalize and post closing entries 3 Post to ledger accounts Note: 1. Errors should be offset (added or deducted) on the side that made the error. 2. Adjusting journal entries should only be made on the books. STOP AND CHECK: Does the adjusted cash balance in the Cash account equal the reconciled balance? 7 Prepare financial statements: Income statement Retained earnings statement Balance sheet 4 Prepare a trial balance *Items with an asterisk are covered in a chapter-end appendix. 5 Journalize and post adjusting entries: Prepayments/Accruals 6 Prepare an adjusted trial balance Optional steps: If a worksheet is prepared, steps 4, 5, and 6 are incorporated in the worksheet. If reversing entries are prepared, they occur between steps 9 and 1 as discussed below. EP-1 RAPID REVIEW Chapter Content RECEIVABLES (Chapter 9) Methods to Account for Uncollectible Accounts STOCKHOLDERS EQUITY (Chapter 12) No-Par Value vs. Par Value Stock Journal Entries No-Par Value Cash Common Stock Par Value Cash Common Stock (par value) Paid-in Capital in Excess of Par Value Direct write-off method Record bad debts expense when the company determines a particular account to be uncollectible. At the end of each period estimate the amount of credit sales uncollectible. Debit Bad Debts Expense and credit Allowance for Doubtful Accounts for this amount. As specific accounts become uncollectible, debit Allowance for Doubtful Accounts and credit Accounts Receivable. At the end of each period estimate the amount of uncollectible receivables. Debit Bad Debts Expense and credit Allowance for Doubtful Accounts in an amount that results in a balance in the allowance account equal to the estimate of uncollectibles. As specific accounts become uncollectible, debit Allowance for Doubtful Accounts and credit Accounts Receivable. Allowance methods: Percentage-of-sales Comparison of Dividend Effects Cash Cash dividend Stock dividend Stock split No effect No effect Common Stock No effect No effect Retained Earnings No effect Percentage-of-receivables Debits and Credits to Retained Earnings Retained Earnings Debits (Decreases) 1. Net loss 2. Prior period adjustments for overstatement of net income 3. Cash dividends and stock dividends 4. Some disposals of treasury stock Credits (Increases) 1. Net income 2. Prior period adjustments for Understatement of net income PLANT ASSETS (Chapter 10) Presentation Tangible Assets Property, plant, and equipment Intangible Assets Intangible assets (Patents, copyrights, trademarks, franchises, goodwill) Natural resources INVESTMENTS (Chapter 13) Comparison of Long-Term Bond Investment and Liability Journal Entries Event Investor Debt Investments Cash Cash Interest Revenue Investee Cash Bonds Payable Interest Expense Cash Computation of Annual Depreciation Expense Cost Salvage value Useful life (in years) Depreciable cost Useful life (in units) Units of activity during year Straight-line Units-of-activity Declining-balance Purchase / issue of bonds Interest receipt / payment Book value at beginning of year Declining balance rate* *Declining-balance rate 1 Useful life (in years) Note: If depreciation is calculated for partial periods, the straight-line and decliningbalance methods must be adjusted for the relevant proportion of the year. Multiply the annual depreciation expense by the number of months expired in the year divided by 12 months. Comparison of Cost and Equity Methods of Accounting for Long-Term Stock Investments Event Acquisition Cost Stock Investments Cash No entry Equity Stock Investments Cash Stock Investments Investment Revenue Cash Stock Investments BONDS (Chapter 11) Premium Face Value Discount Market interest rate Market interest rate Market interest rate Contractual interest rate Contractual interest rate Contractual interest rate Investee reports earnings Investee pays dividends Cash Dividend Revenue Computation of Annual Bond Interest Expense Interest expense Interest paid (payable) (OR Amortization of discount Amortization of premium) Trading and Available-for-Sale Securities Trading Available-forsale Report at fair value with changes reported in net income. Report at fair value with changes reported in the stockholders equity section. Straight-line amortization Effective-interest amortization (preferred method) Bond discount (premium) Number of interest periods Bond interest expense Carrying value of bonds at beginning of period Effective interest rate Bond interest paid Face amount of bonds Contractual interest rate EP-2 RAPID REVIEW Chapter Content STATEMENT OF CASH FLOWS (Chapter 14) Cash flows from operating activities (indirect method) Net income Add: Losses on disposals of assets Amortization and depreciation Decreases in noncash current assets Increases in current liabilities Deduct: Gains on disposals of assets Increases in noncash current assets Decreases in current liabilities Net cash provided (used) by operating activities $X X X X (X) (X) (X) $X Cash flows from operating activities (direct method) Cash receipts (Examples: from sales of goods and services to customers, from receipts of interest and dividends on loans and investments) $X Cash payments (Examples: to suppliers, for operating expenses, for interest, for taxes) (X) Cash provided (used) by operating activities $X PRESENTATION OF NON-TYPICAL ITEMS (Chapter 15) Prior period adjustments (Chapter 12) Discontinued operations Statement of retained earnings (adjustment of beginning retained earnings) Income statement (presented separately after Income from continuing operations) Income statement (presented separately after Income before extraordinary items) In most instances, use the new method in current period and restate previous years results using new method. For changes in depreciation and amortization methods, use the new method in the current period, but do not restate previous periods. Extraordinary items Changes in accounting principle EP-3 RAPID REVIEW Financial Statements Order of Preparation Statement Type 1. Income statement 2. Retained earnings statement 3. Balance sheet 4. Statement of cash flows Date For the period ended For the period ended As of the end of the period For the period ended Retained Earnings Statement Name of Company Retained Earnings Statement For the Period Ended Retained earnings, beginning of period Add: Net income (or deduct net loss) Deduct: Dividends Retained earnings, end of period $X X X X $X Income Statement (perpetual inventory system) Name of Company Income Statement For the Period Ended Sales revenues Sales Less: Sales returns and allowances Sales discounts Net sales Cost of goods sold Gross profit Operating expenses (Examples: store salaries, advertising, delivery, rent, depreciation, utilities, insurance) Income from operations Other revenues and gains (Examples: interest, gains) Other expenses and losses (Examples: interest, losses) Income before income taxes Income tax expense Net income Income Statement (periodic inventory system) Name of Company Income Statement For the Period Ended Sales revenues Sales Less: Sales returns and allowances Sales discounts Net sales Cost of goods sold Beginning inventory Purchases $X Less: Purchase returns and allowances X Net purchases X Add: Freight in X Cost of goods purchased Cost of goods available for sale Less: Ending inventory Cost of goods sold Gross profit Operating expenses (Examples: store salaries, advertising, delivery, rent, depreciation, utilities, insurance) Income from operations Other revenues and gains (Examples: interest, gains) Other expenses and losses (Examples: interest, losses) Income before income taxes Income tax expense Net income STOP AND CHECK: Net income (loss) presented on the retained earnings statement must equal the net income (loss) presented on the income statement. Balance Sheet $X X X $X X X Name of Company Balance Sheet As of the End of the Period Assets Current assets (Examples: cash, short-term investments, accounts receivable, merchandise inventory, prepaid expenses) Long-term investments (Examples: investments in bonds, investments in stocks) Property, plant, and equipment Land Buildings and equipment $X Less: Accumulated depreciation X Intangible assets Total assets Liabilities and Stockholders Equity Liabilities Current liabilities (Examples: notes payable, accounts payable, accruals, unearned revenues, current portion of notes payable) Long-term liabilities (Examples: notes payable, bonds payable) Total liabilities Stockholders equity Common stock Retained earnings Total liabilities and stockholders equity $X X $X X X X $X X X X X X X X $X $X X X X X $X $X X X $X X STOP AND CHECK: Total assets on the balance sheet must equal total liabilities and stockholders equity; and, ending retained earnings on the balance sheet must equal ending retained earnings on the retained earnings statement. X X X X X Statement of Cash Flows Name of Company Statement of Cash Flows For the Period Ended Cash flows from operating activities Note: May be prepared using the direct or indirect method Cash provided (used) by operating activities Cash flows from investing activities (Examples: purchase / sale of long-term assets) Cash provided (used) by investing activities Cash flows from financing activities (Examples: issue / repayment of long-term liabilities, issue of stock, payment of dividends) Net cash provided (used) by financing activities Net increase (decrease) in cash Cash, beginning of the period Cash, end of the period X X X X X X X $X $X X X X X $X STOP AND CHECK: Cash, end of the period, on the statement of cash flows must equal cash presented on the balance sheet. EP-4 RAPID REVIEW Using the Information in the Financial Statements Ratio Liquidity Ratios 1. Current ratio Current assets Current liabilities Cash Short-term investments Receivables (net) Current liabilities Net credit sales Average net receivables Cost of goods sold Average inventory Measures short-term debt-paying ability. Formula Purpose or Use 2. Acid-test (quick) ratio Measures immediate short-term liquidity. 3. Receivables turnover Measures liquidity of receivables. 4. Inventory turnover Measures liquidity of inventory. Profitability Ratios 5. Profit margin Net income Net sales Net sales Average assets Net income Average total assets Net income Average common stockholders equity Net income Weighted average common shares outstanding Market price per share of stock Earnings per share Cash dividends Net income Measures net income generated by each dollar of sales. Measures how efficiently assets are used to generate sales. Measures overall profitability of assets. 6. Asset turnover 7. Return on assets 8. Return on common stockholders equity 9. Earnings per share (EPS) Measures profitability of stockholders investment. Measures net income earned on each share of common stock. Measures the ratio of the market price per share to earnings per share. Measures percentage of earnings distributed in the form of cash dividends. 10. Price-earnings (P-E) ratio 11. Payout ratio Solvency Ratios 12. Debt to total assets ratio Total debt Total assets Income before income taxes and interest expense Interest expense Cash provided by operating activities Capital expenditures Cash dividends Measures percentage of total assets provided by creditors. Measures ability to meet interest payments as they come due. Measures the amount of cash generated during the current year that is available for the payment of additional dividends or for expansion. 13. Times interest earned 14. Free cash flow EP-5

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University of Phoenix - XACC - 220
Axia College MaterialAppendix D Adjusting Entries, Posting, and Preparing an Adjusted Trial BalanceAdjusting EntriesUse this General Journal to record adjusting entries on June 30, 2008 for Masasi Company, Inc. The first few lines are completed for you
University of Phoenix - XACC - 220
Axia College MaterialAppendix C Journalizing, Posting, and Preparing a Trial BalanceJournalizing the TransactionsUse this template to journalize the transactions for Jane Kent, Inc. The first two lines are completed for you. You might not require all t
University of Phoenix - XACC - 220
Brittney Bryson March 20, 2011 XACC280 Week 2 Appendix C Summary After I completed this weeks course work of appendix c, I learned how to balance a general journal, Ledger accounts and a trial balance sheet. At first I was confused and it took me a bit to
University of Phoenix - XACC - 220
Axia College MaterialAppendix B Debits and CreditsConsider the information presented in PhxKlips Debits and Credits. Pay particular attention to the meaning of debits and credits and their effects on accounts. Then follow the instructions below. 1. Writ
University of Phoenix - XACC - 220
7 Accounting PrinciplesChapterSTUDY OBJECTIVESAfter studying this chapter, you should be able to: 1 Explain the meaning of GAAP and identify the key items of the conceptual framework. 2 Describe the basic objectives of financial reporting. 3 Discuss th
University of Phoenix - XACC - 220
2 The Recording ProcessChapterSTUDY OBJECTIVESAfter studying this chapter, you should be able to: 1 Explain what an account is and how it helps in the recording process. 2 Define debits and credits and explain their use in recording business transactio
University of Phoenix - XACC - 220
1 Accounting in ActionChapterSTUDY OBJECTIVESAfter studying this chapter, you should be able to: 1 Explain what accounting is. 2 Identify the users and uses of accounting. 3 Understand why ethics is a fundamental business concept. 4 Explain generally a
University of Phoenix - XACC - 220
University of Phoenix - XACC - 220
Axia College MaterialAppendix E Preparing a Financial Statement WorksheetComplete the 10-column worksheet for Briscoe Company. Your totals will be verified.BRISCOE COMPANY Work Sheet For the Month Ended June 30, 2008Account Cash Accounts Receivable Su
University of Phoenix - XACC - 220
Adjusting Entry 31-Oct Salaries Expense Salaries Payable Reversing Entry 1-Nov Salaries Payable Salaries Expense1400 14001400 1400
University of Phoenix - XACC - 220
Axia College MaterialAppendix F Closing Entries and a Post-closing Trial BalanceJournalize Closing EntriesUse this template to journalize the closing entries for Goode Company at April 30, 2008.GOODE COMPANY Closing Entries at April 30, 2008DATEApr
Troy - ACT - 101
CHAPTER12Developing and Managing Brand and Product Categories Chapter Objectives1 Explain the benefits of category and brand management. 2 Identify the different types of brands. 3 Explain the strategic value of brand equity. 4 Discuss how companies 7 L
Troy - ACT - 1101
CHAPTER13Marketing Channels and Supply Chain Management Chapter Objectives1 Describe the types of marketing channels and the roles they play in marketing strategy. 4 Identify and describe the 7 Compare the major different vertical modes of transportatio
Troy - ACCOUNTING - 1011
CHAPTER15Integrated Marketing Communications Chapter Objectives1 Explain how integrated marketing communications relates to the development of an optimal promotional mix. 2 Describe the communication process and how it relates to the AIDA concept. 3 Exp
Troy - ACCOUNTING - 1122
CHAPTER18Pricing Concepts Chapter Objectives1 Outline the legal constraints on pricing. 2 Identify the major categories of pricing objectives. 3 Explain price elasticity and its determinants. 4 List the practical 7 Explain the use of yield problems invo
Troy - ACT - 1101
Principles of Marketing Final Exam Review Sheet(NOTE: We will still have class Monday for those of you who have questions about the exam or missing grades). Chapter 11 (Approx. 9 questions) Characteristics of Services Types of Products (Unsought, special
Troy - ACCOUNTING - 1111
SECURITY CHALLENGES & VULNERABILITIES Figure 7-1, p. 232 WHY SYSTEMS ARE VULNERABLE E ,E ,E System Complexity E Computerized Procedures Not Always Read or Audited Extensive E Effect of Disaster E (Electrical Problems, Power Failures, Flood, Fires, Natur
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ACHIEVEING H OPERATIONAL HCHAPTER 8 EXCELLENCE & CUSTOMER INTIMACY H H APPLICATIONS H ENTERPRISE H SOFTWARE ENTERPRISE Ww SOFTWARE: ENTERPRISESet of Integrated H S/W Modules H Data May Be Used By Multiple H Functions & Business Processes Includes analy
Troy - ACT - 1211
IS 330012. ETHICAL AND SOCIAL ISSUES IN THE DIGITAL FIRM ETHICS 2 : Principles of Right and Wrong Used By Individuals as Free Moral Agents X g u 2 Behavior 2 LAW & ETHICS Legality 2 vs. Ethicality 27 7 vs. Chapter 12to Guide 2 I = Ethical & Legal II
Troy - ACT - 1111
CHAPTER 9 E-COMMERCE H : DIGITAL H MARKETS, DIGITAL GOODS INTERNET IT INFRASTRUCTURE: Provides H Universal H & Easy-to-use Set Of Technologies & Technology Standards That Can Be Adopted H By All Organizations E-COMMERCE TODAY E-commerce: Use of Internet
Troy - ACT - 1111
Chapter2 QuestionsandProblems 1.Question1(pp.55) Whatisanopportunitycost?HowisthisconceptusedinTVManalysis, andwhereisitshownonatimeline?Isasinglenumberusedinall situations?Explain. A:OpportunityCostistherateofreturnyoucouldearnonanalternative investmento
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Authentication 4 8 Basic Concepts (Accountability, Responsibility, and Liability) Best practices Biometric authentication Bull whip effect Candidate for Ethical Principals Churn rate Controls: General Controls, Administrative Controls, S/W controls, H/W c
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Chapter4Questions 1. Whyisthecurrentratiothemostcommonlyusedtomeasureof shorttermliquidity? Becausethecurrentratioiscalculatedbydividingcurrentassetsbycurrent liabilities.Itindicatestheextenttowhichcurrentliabilitiesarecoveredby thoseassetsexpectedtobecon
Troy - ACT - 1111
Chapter5Questions 1. Brieflythemethodsoftransferringcapitalinoreconomy.Thistransferofcapitalcantakeplaceinthethreedifferentways. a.Directtransfersofmoneyandsecurities.Thebusinessdeliversits securitiestosavers,whointurngivethefirmthemoneyitneeds,without g
Troy - ACT - 1111
Chapter 6 Questions (You may skip section 6.6) 1. Briefly explain the four factors that influence the cost of money. a. production opportunities: The investment opportunities in productive (cashgenerating) assets. b. time preferences for consumption: The
Troy - ACT - 1111
Chapter7Questions1. Question7.5pp.239 Ifyoubuyacallablebondandinterestratesdecline,willthevalueof yourbondrisebyasmuchasitwouldhaverisenifthebondhadnot beencallable?Explain. Ifinterestratesdeclinesignificantly,thevaluesofcallablebondswillnotrise byasmuch
Troy - ACCOUNTING - 1111
Chapter3Questions1.Whatisthebalancesheetandwhatinformationdoesitprovide?A:Balancesheet:astatementofthefirmsfinancialpositionataspecificpointin time. Theleftsideofthebalancesheetshowstheassets:currentassets(cashand equivalents,accountsreceivable,andinve
Troy - ACT - 2291
Chapter8Questions1.Explainwhyaprobabilitydistributionisusedtoestimateriskand return.Riskyassetsrarelyproducttheirratesofreturngenerally,riskyassetsearn eithermoreorlessthanwasoriginallyexpected.Investmentriskisrelatedto theprobabilityofactuallyearninga
City University of Hong Kong - BCH - 1048
Vocabularies & main conceptsDNA(Deoxyribonucleic acid) (Deoxyribonucleic ()DNA structure DNADNA structure DNA DNA is not a single molecule, but rather a pair of molecules joined by hydrogen bond () and they usually exist in the form of double helix (
City University of Hong Kong - BCH - 1048
Gene cloning Gene ( )Gene donorPlasmid () donorIsolation of bacterial plasmid Plasmid opened with restriction enzyme () DNA ligase () binds ends togetherIsolated geneTransformation () of fresh bacteriumRecombinant () DNA molecule Chromosome ()Donor
City University of Hong Kong - BCH - 1048
Three basic shapes of bacteriaSpherical coccus (cocci)Rod-shaped bacillus (bacilli)()()Spiral spirillum (spirilla)()Gram-staining ()() ()() ()Blue-purple() ()PinkGram-staining ()()() ()Fermentation of lactose ()LactaseLactoseGlucose()
City University of Hong Kong - BCH - 1048
The Cytoskeleton and Related StructuresThe cells internal skeleton helps The internal organize its structure and activities Eukaryotic cells contain a meshwork of protein fibers, protein collectively called the cytoskeleton, extending cytoskeleton throu
City University of Hong Kong - BCH - 1048
Movement and Locomotion MovementSkeletons function in support, movement, and protection movement, Hydrostatic skeletons ( ) Consists of fluid held under pressure in a closed body compartment. body Most animals with hydrostatic skeletons are soft and fl
City University of Hong Kong - BCH - 1048
BCH1048 Life Sciences Mid-term QuizPart A: Multiple Choice QuestionsNucleoid region ( C Nucleoid P)Codons (3-letter words C ) in a gene specify the amino acid sequence ( H ) of a polypeptideEcoRI site11+1Cilia on cells lining the respiratory tra
City University of Hong Kong - BCH - 1048
Why do large animals need a circulatory system? Diffusion is too slow to keep up with respiration and effectively move materials over distances larger than a few cell diameters.The circulatory system connects with all body tissues with Capillaries ( m
City University of Hong Kong - BCH - 1048
The Heartbeat TheNodal tissue: has both muscular & nervous characteristics Excitation impulseThe rhythmic contraction of the heart is due to the cardiac conduction system. cardiacElectrocardiogram (EGC) ] h \ Electrocardiogram HVentricles are recoveri
City University of Hong Kong - CS - 1301
Programming and JavaScript ProgrammingWhat is Computer Programming Brief History of JavaScript How to Include JavaScript in an HTML How to Display Message to Users How to Input Data from Users Numbers and Strings[Please switch off your phone]Overviewof
City University of Hong Kong - CS - 1301
Program Structure IFunctions and VariablesIntroduction to Functions Example: Marks to Grade Conversion Parameters and Return Statement Flowchart Comments Example: Find Highest Mark Use of Local Variables and Global Variables Example: Counter[Please sw
City University of Hong Kong - CS - 1301
Program Structure IIInsertion of Semicolons (;) Location of JavaScript Blocks Names of Variables and Functions Enclose statements in Braces cfw_ and Assignment Statements Data Types (Numbers, Strings, Booleans) and Operations[Please switch off your pho
City University of Hong Kong - CS - 1301
Program Structure IIITransfer of control Sequence, selection, repetition structures Selection structure if if-else if else if Code formatting Repetition structure while-loop for-loop [Please switch off your phone]Nested control structures(CS1301) Intr
City University of Hong Kong - CS - 1301
JavaScript JavaScript Global Functions and Objects GlobalIntroduction to JavaScript Objects and HTML Element Objects Global Functions: isFinite, isNaN, escape/unescape, eval Creation of Objects: the new operator and constructor functions Commonly used ob
City University of Hong Kong - CS - 1301
Programming Concepts[Please switch off your phone](CS1301) Introduction to Computer Programming City Univ of HK / Dept of CS / Helena Wong http:/www.cs.cityu.edu.hk/~helena6. Programming Concepts - 1Programming LanguagesEarliest form of computer lang
City University of Hong Kong - AP - 1200
AP1200 1. Mechanics Concepts1.1 Mechanical principlesMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Learning objectives for mechanicsYou should become able to:describe the physical principles of gr
City University of Hong Kong - AP - 1200
AP1200 1. Mechanics Concepts1.2 Vectors and kinematicsMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Vectors Vectors are very useful in physics Definition:a vector quantity is a quantity that has
City University of Hong Kong - AP - 1200
AP1200 1. Mechanics Concepts1.3 DynamicsMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1InertiaInertia is the tendency for an object to resist change in its velocityinertia is responsible for many a
City University of Hong Kong - AP - 1200
AP1200 1. Mechanics Concepts1.4 EquilibriumMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Equilibrium: avoid collapse!Forth Bridge Scotland (1890)27EquilibriumA body in equilibrium has no acceler
City University of Hong Kong - AP - 1200
AP1200 Foundation PhysicsLimited wisdom and incorrect predictions: Heavier-than-air flying machines are impossible. - Lord Kelvin, President, Royal Society, London, 1895. "Airplanes are interesting toys but of no military value." - Marchal Ferdinand Foch
City University of Hong Kong - AP - 1200
AP1200 Foundation PhysicsChapter 2:2.1Order of Magnitude and UncertaintyRough estimatesVery often, whether in daily life or professional work, we need or wish to make quick and rough estimates for a wide variety of quantities. These may be called gue
City University of Hong Kong - AP - 1200
AP1200 2. Order of Magnitude and Uncertainty 2. Concepts ConceptsMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Orders of magnitude distancesWatch as we approach Earth in stepsSecret Worlds: The Uni
City University of Hong Kong - AP - 1200
AP1200 2. Uncertainty - SupplementMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Uncertainty in polling / votingAn opinion poll asks a relatively small group of N people the same question, to try to
City University of Hong Kong - AP - 1200
AP1200 2. Uncertainty - SupplementMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Uncertainty in polling / votingAn opinion poll asks a relatively small group of N people the same question, to try to
City University of Hong Kong - AP - 1200
AP1200 3. Waves Concepts 3.1 IntroductionMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Learning objectives for wavesYou should become able to:describe and contrast the physical mechanisms of differ
City University of Hong Kong - AP - 1200
AP1200 3. Waves Concepts 3.2 Wave principlesMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Human waves in sports stadiumThe wave La Olathis is one wave pulse28Lets perform the CityU wave pulse! Le
City University of Hong Kong - AP - 1200
AP1200 3. Waves Concepts 3.3 Wave mechanismsMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1How do waves work? Human waveswavelength spaceType: usually transverse (can be longitudinal?) Medium: hu
City University of Hong Kong - AP - 1200
AP1200 3. Waves Concepts 3.4 Wave interference, 3.4 reflection and transmission reflectionMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1How do waves interact with each other? InterferenceTwo waves s
City University of Hong Kong - AP - 1200
AP1200 3. Waves Concepts 3.5 Wave refraction and diffraction, beats and Doppler effectMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Wave refraction A wave front behaves like a row of people in which
City University of Hong Kong - AP - 1200
AP1200 Foundation PhysicsLimited wisdom and incorrect predictions: "The wireless music box has no imaginable commercial value. Who would pay for a message sent to nobody in particular?" - David Sarnoff's associates in response to his urgings for investme
City University of Hong Kong - AP - 1200
AP1200 4. Optics Concepts 4.1 Light PropertiesMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Learning objectives for opticsYou should become able to: describe the physical laws governing optics exp
City University of Hong Kong - AP - 1200
AP1200 4. Optics Concepts 4.2 RefractionMichel A. Van HoveWARNING: PRINTING THIS DOCUMENT WILL USE MUCH INK AND WILL NOT SHOW ANIMATIONS.1Refraction of lightLight is refracted (changes its direction) when it crosses any change of medium i.e. when i
City University of Hong Kong - AP - 1200
AP1200 Foundation PhysicsLimited wisdom and incorrect predictions: "Everything that can be invented has been invented." - Charles H. Duell, Commissioner, U.S. Office of Patents, 1899.Chapter 4: OpticsThe properties of light have been of interest for ma
City University of Hong Kong - AP - 1200
ElectricityLecture1LearningObjectivesYoushouldbecomeableto:describethepropertiesofelectriccharge, force,field,energy&currents relateelectricalcurrent,potential,resistance andpower28ReadingandResearch Consultourlecturenotes,andtherecommendedtextboo