Solution manual financial accounting 8e by libby ch04

Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings Chapter Adjustments, Financial Statements, and the Quality of Earnings ANSWERS TO QUESTIONS Adjusting entries are made at the end of the accounting period to record all revenues and expenses that have not been recorded but belong in the current period They update the balance sheet and income statement accounts at the end of the accounting period The four different types are adjustments for: (1) Deferred revenues previously recorded liabilities that need to be adjusted at the end of the period to reflect revenues that have been earned (e.g., Unearned Ticket Revenue must be adjusted for the portion of ticket revenues earned in the current period) (2) Accrued revenues revenues that have been earned by the end of the accounting period but which will be collected in a future accounting period (e.g., recording Interest Receivable for interest revenues not yet collected) (3) Deferred expenses previously recorded assets that need to be adjusted at the end of the period to reflect incurred expenses (e.g., Prepaid Insurance must be adjusted for the portion of insurance expense incurred in the current period) (4) Accrued expenses expenses that have been incurred by the end of the accounting period but which will be paid in a future accounting period (e.g., recording Utilities Payable for utilities expense incurred during the period that has not yet been paid) A contra-asset is an account related to an asset that is an offset or reduction to the asset's balance Accumulated Depreciation is a contra-account to the equipment and buildings accounts Financial Accounting, 8/e 4-1 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings The net income on the income statement is included in determining ending retained earnings on the statement of stockholders’ equity and the balance sheet The change in the cash account on the balance sheet is analyzed and categorized on the statement of cash flows into cash from operating activities, investing activities, and financing activities (a) Income statement: Revenues (and gains) - Expenses (and losses) = Net Income (b) Balance sheet: Assets = Liabilities + Stockholders' Equity (c) Statement of stockholders' equity: Ending Stockholders' Equity = (Beginning Contributed Capital + Stock Issuances - Stock Repurchases) + (Beginning Retained Earnings + Net Income - Dividends Declared) Adjusting entries have no effect on cash For deferred revenues and deferred expenses, cash was received or paid at some point in the past For accruals, cash will be received or paid in a future accounting period At the time of the adjusting entry, there is no cash being received or paid Earnings per share = Net income ÷ average number of shares of stock outstanding during the period Earnings per share measures the average amount of net income for the year attributable to one share of common stock Total asset turnover ratio = Sales (or Operating) Revenues ÷ Average Total Assets The total asset turnover ratio measures sales generated during the period per dollar of assets – how effective the company is at generating sales by utilizing assets The closing entry is made at the end of the accounting period to (1) transfer the balances in the temporary income statement accounts to retained earnings and (2) reduce the revenue, gain, expense, and loss accounts to a zero balance so that they can be used for the accumulation process during the next period A closing entry must be entered into the system through the journal and posted to the ledger accounts to state properly the temporary and permanent account balances (i.e., zero balances in the temporary accounts) 10 (a) Permanent accounts balance sheet accounts; that is, the asset, liability, and stockholders’ equity accounts (these are not closed at the end of each period) (b) Temporary accounts income statement accounts; that is, revenues, gains, expenses, and losses (these are closed at the end of each period) (c) Real accounts another name for permanent accounts (d) Nominal accounts another name for temporary accounts 4-2 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings 11 The income statement accounts are closed at the end of the accounting period because, in effect, they are temporary subaccounts to retained earnings (i.e., a part of stockholders' equity) They are used only for accumulation during the accounting period When the period ends, these accumulated accounts must be transferred (closed) to retained earnings The closing process serves: (1) to correctly state retained earnings, and (2) to clear out the balances of the temporary accounts for the year just ended so that these subaccounts can be used again during the next period for accumulation and classification purposes Balance sheet accounts are not closed at the end of the period because they reflect permanent accumulated balances of assets, liabilities, and stockholders' equity Permanent accounts show the entity's financial position at the end of the period and are the beginning amounts for the next period 12 A post-closing trial balance is a listing taken from the ledger after the adjusting and closing entries have been journalized and posted It is not a necessary part of the accounting information processing cycle but it is useful because it demonstrates the equality of the debits and credits in the ledger after the closing entry has been journalized and posted and that all temporary accounts have zero balances Financial Accounting, 8/e 4-3 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings ANSWERS TO MULTIPLE CHOICE 10 4-4 c b b b b c c c c c Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings Authors' Recommended Solution Time (Time in minutes) Mini-exercises No Time 5 3 5 10 11 12 Exercises No Time 10 10 10 15 10 20 20 20 15 10 20 11 10 12 20 13 15 14 15 15 20 16 20 17 20 18 20 19 10 20 15 Problems No Time 15 20 20 20 20 25 30 Alternate Problems No Time 15 20 20 20 20 25 30 Comprehensive Problems No Time 60 60 Cases and Projects No Time 25 25 25 20 25 40 35 50 25 10 * Continuing Case 15 * Due to the nature of this project, it is very difficult to estimate the amount of time students will need to complete the assignment As with any open-ended project, it is possible for students to devote a large amount of time to these assignments While students often benefit from the extra effort, we find that some become frustrated by the perceived difficulty of the task You can reduce student frustration and anxiety by making your expectations clear For example, when our goal is to sharpen research skills, we devote class time to discussing research strategies When we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries Financial Accounting, 8/e 4-5 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings MINI-EXERCISES M4–1 Hagadorn Company Adjusted Trial Balance At June 30, 2014 Debit Cash Accounts receivable Inventories Prepaid expenses Buildings and equipment Accumulated depreciation Land Accounts payable Accrued expenses payable Income taxes payable Unearned fees Long-term debt Common stock Additional paid-in capital Retained earnings Sales revenue Interest income Cost of sales Salaries expense Rent expense Depreciation expense Interest expense Income taxes expense Totals $ Credit 175 420 710 30 1,400 $ 250 300 250 160 50 90 1,460 100 300 150 2,400 60 780 640 460 150 70 135 $ 5,270 $ 5,270 M4–2 (1) D (2) C (3) A (4) D (5) A (6) B (7) B (8) C 4-6 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings M4–3 (1) D (2) C (3) A (4) B M4–4 (a) Rent revenue is now earned Cash was received in the past – a deferred revenue was recorded Amount: $1,200  months = $300 earned Adjusting entry – Unearned rent revenue (L) Rent revenue (+R, +SE) 300 300 (b) Depreciation Expense on the equipment is now incurred Cash was paid in the past when the equipment was purchased a deferred expense was recorded The net book value of the equipment is overstated Accumulated Depreciation (the contra-account) needs to be increased for the amount used during the period Amount: $3,200 given Adjusting entry – Depreciation expense (+E, SE) Accumulated depreciation (+XA, A) 3,200 3,200 (c) Insurance expense was incurred in the period Cash was paid for the insurance in the past – a deferred expense was recorded Amount: $5,000 x 6/24 = $1,250 Adjusting entry – Insurance expense (+E, SE) Prepaid insurance (A) Financial Accounting, 8/e 1,250 1,250 4-7 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings M4–5 Balance Sheet Stockholders’ Liabilities Equity –300 +300 Income Statement Revenues Expenses +300 NE Net Income +300 Transaction a Assets NE b –3,200 NE –3,200 NE +3,200 –3,200 c –1,250 NE –1,250 NE +1,250 –1,250 M4–6 (a) Utilities Expense is incurred Cash will be paid in the future for utilities used in the current period – an accrued expense needs to be recorded Amount: $450 given Adjusting entry – Utilities expense (+E, SE) Utilities payable (+L) 450 450 (b) Interest revenue is now earned on the note receivable Cash for the interest will be received in the future – an accrued revenue needs to be recorded Amount: $6,000 principal x 14 annual rate x 4/12 of a year = $280 Adjusting entry – Interest receivable (+A) Interest revenue (+R, +SE) 280 280 (c) Wages expense was incurred in the period Cash will be paid in the future to the employees who worked in the current period – an accrued expense needs to be recorded Amount: 10 employees x days x $200 per day = $8,000 Adjusting entry – Wages expense (+E, SE) Wages payable (+L) 4-8 8,000 8,000 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings M4–7 Balance Sheet Stockholders’ Liabilities Equity +450 –450 Income Statement Revenues Expenses NE +450 Net Income –450 Transaction a Assets NE b +280 NE +280 +280 NE +280 c NE +8,000 –8,000 NE +8,000 –8,000 M4–8 ROMNEY’S MARKETING COMPANY Income Statement For the Year Ended December 31, 2015 Operating Revenues: Sales revenue Total operating revenues Operating Expenses: Wages expense Depreciation expense Utilities expense Insurance expense Rent expense Total operating expenses Operating Income Other Items: Interest revenue Rent revenue Pretax Income Income tax expense Net Income $ 38,500 38,500 19,500 1,800 380 750 9,000 31,430 7,070 $ Earnings per share* 100 800 7,970 2,700 5,270 $9.58 * calculated as $5,270  [(300 + 800)  2] = $5,270  550 = $9.58 Average number of shares Financial Accounting, 8/e 4-9 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings M4–9 ROMNEY’S MARKETING COMPANY Statement of Stockholders’ Equity For the Year Ended December 31, 2015 Balance, January 1, 2015 Share issuance Net income Dividends declared Balance, December 31, 2015 4-10 Additional Paid-in Capital $ 670 2,950 Total Common Retained Stockholders’ Stock Earnings Equity $ 30 $ 2,000* $ 2,700 50 3,000 5,270 5,270 (0) (0) $ 80 $ 3,620 $ 7,270 $ 10,970 *From the trial balance Work backwards Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–3 American Eagle Outfitters reported an advertising expense of $73.1 million for the most recent year (Note under Advertising Costs) Urban Outfitters reported $71.7 million of advertising costs for the year (See Note under Advertising) Year Ended 2012 2011 2010 American Eagle Outfitters Advertising Expense / Net Sales 73,100 / 3,159,818 2.3% 64,900 / 2,967,559 2.2% 60,900 / 2,940,269 2.1% Urban Outfitters Advertising Expense / Net Sales 71,684 / 2,473,801 2.9% 58,336 / 2,274,102 2.6% 46,827 / 1,937,815 2.4% Urban Outfitters incurred the higher percentage in all three years Both firms increased advertising expense each year, and both firms also increased advertising expense as a percentage of sales each year Advertising/Sales = Industry Average 5.55% American Eagle Outfitters 2.3% Urban Outfitters 2.9% Both American Eagle and Urban Outfitters are spending less on advertising as a percentage of sales than the average company in the industry This might imply that they are more effective at generating fewer sales per dollar spent on advertising Another interpretation is that they are weak in supporting their brand, and sales will eventually decrease as their brands lose value Both accounting policies are similar indicating that advertising costs are expensed when the marketing campaigns become publicly available Urban Outfitters capitalizes expenses associated with direct-to-consumer advertising (catalogs) and amortizes these expenses over the expected period of future benefits (The policies are disclosed in note in both annual reports) 4-66 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–3 (continued) Year Ended American Eagle Outfitters Urban Outfitters $2,473,801 = 1.530 $1,616,514.5 2012: Total Asset = Turnover Sales Average Total Assets $3,159,818 = 1.650 $1,915,400 2011: Total Asset = Turnover Sales Average Total Assets $2,967,559 = 1.477 $2,009,073 $2,274,102 $1,715,207 = 1.326 2010: Total Asset = Turnover Sales Average Total Assets $2,940,269 = 1.434 $2,050,912 $1,937,815 $1,482,551 = 1.307 Both companies increased their total asset turnover ratios over time, suggesting more efficient management of assets to generate revenues In each year, American Eagle Outfitters has a higher turnover ratio than Urban Outfitters, suggesting more efficiency in asset utilization Total Asset Turnover Ratio = (for fiscal year ended 2012) Industry Average American Eagle Outfitters Urban Outfitters 1.750 1.650 1.530 Both companies, American Eagle Outfitters and Urban Outfitters, have lower Total Asset Turnover ratios than the average company in their industry This suggests both companies are less effective at utilizing total assets to generate sales This ratio is affected by growth strategies in which companies invest in additional property and equipment or other assets, but the new assets are not yet generating sales levels of established stores Financial Accounting, 8/e 4-67 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–4 2014 Balance $510,000 Financial Statement Income statement Salary expense 73,000 Income statement  70,000 Maintenance supplies expense 13,000 Income statement No effect Rent receivable 10,000 Balance sheet No effect Receivables from employees 2,000 Balance sheet  2,000 Maintenance supplies 2,000 Balance sheet  8,000 14,000 Balance sheet +14,000 3,000 Balance sheet  6,000 Account Rent revenue Unearned rent revenue Salaries payable (1) Rent Revenue 500,000 (a) 10,000 (b) 510,000 (4) Rent Receivable (b) 10,000 (2) Salary Expense (e) 70,000 (f) 3,000 73,000 13,000 (6) Maintenance Supplies (h) 7,000 (i) 8,000 13,000 used (j) 2,000 2,000 (7) Unearned Rent Revenue 14,000 (c) 14,000 (8) Salaries Payable (d) 6,000 6,000 Bal 3,000 (f) 3,000 (a) from renters (c) from renters 4-68 (3) Maintenance Supplies Expense Used 13,000 (5) Receivables from Employees (g) 2,000 10,000 Cash 500,000 6,000 14,000 70,000 2,000 8,000 Effect on Cash Flows + $500,000 Inferred (d) to employees (e) to employees (g) to employees (i) to suppliers Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–5 Req Account Cash Maintenance supplies Service equipment Accumulated depreciation, service equipment Remaining assets Note payable, 6% Interest payable Income taxes payable Wages payable Unearned revenue Common stock Additional paid-in capital Retained earnings Service revenue Expenses Unadjusted Trial Balance Debit Credit 25,000 800 90,000 Adjusted Trial Balance Debit Credit 25,000 300 90,000 21,000 44,800 30,000 44,800 10,000 320,600 30,000 44,800 10,000 600 13,020 400 3,600 10,000 40,000 12,000 224,000 13,600 10,000 40,000 12,000 214,000 160,000 320,600 Post-Closing Trial Balance Debit Credit 25,000 300 90,000 183,520 343,620 343,620 10,000 600 13,020 400 3,600 10,000 40,000 52,480 0 160,100 160,100 Ending Retained Earnings = Beg., $12,000 + Net income, ($224,000 - $183,520) Req (a) To record the amount of supplies used during 2014, $500, and to reduce the supplies account to the amount remaining on hand at the end of 2014 (b) To accrue interest expense for 2014 (the interest is payable in 2015, computed as $10,000 x 06 = $600) and to record interest payable (c) To reduce unearned revenue for the amount of revenue earned during 2014 $10,000 (d) To record depreciation expense for 2014, $9,000 (e) To record 2014 wages of $400 that will be paid in 2015 (f) To record 2014 income tax and the related liability, $13,020 Financial Accounting, 8/e 4-69 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–5 (continued) Req Closing Entry on December 31, 2014: Service revenue (from the adjusted trial balance) (R) 224,000 Retained earnings (+SE) 40,480 Expenses (from the adjusted trial balance) (E) 183,520 Req Pretax income x ($224,000 - 170,500) x $53,500 x Average income tax rate = Income tax expense ? = $13,020 ? = $13,020 ? = 24.3% Req Number of shares issued x 10,000 x 4-70 Average issue price = Total issue amount ? = $10,000 + $40,000 ? = $5.00 per share Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–6 Transaction (a): This transaction will affect Carey’s financial statements for 14 years (from 2014 through 2027) in conformity with the matching principle [$14,000 ÷ $1,000 per year = 14 years] Income statement: Depreciation expense, as given Balance sheet at December 31, 2016: Assets: Office equipment Less: Accumulated depreciation* Net book (carrying) value *$1,000 x years = $3,000 $1,000 each year $14,000 3,000 $11,000 An adjusting entry each year over the life of the asset would be recorded to reflect the allocation of the cost of the asset when used to generate revenues: 1,000 Depreciation expense (+E, SE) 1,000 Accumulated depreciation (+XA, A) Transaction (b): This transaction will affect Carey’s financial statements for years 2016 and 2017-because four month’s rent revenue was earned in 2016, and two months' rent revenue will be earned in 2017 The 2016 income statement should report rent revenue earned of $20,000 ($30,000 x 4/6) Occupancy was provided for only months in 2016 This is in conformity with the revenue principle This transaction created a $10,000 liability ($30,000 - $20,000 = $10,000) as of December 31, 2016, because at that date Carey "owes'' the renter two more months' occupancy for which it has already collected the cash Yes, an adjusting entry must be made to (a) increase the Rent Revenue account by $10,000 for two months’ rent earned in 2017 and (b) to decrease the liability to $0 representing no future occupancy owed (in conformity with the revenue principle) December 31, 2017 Adjusting entry: Unearned Rent Revenue (L) 10,000 Rent Revenue (+R, +SE) 10,000 Financial Accounting, 8/e 4-71 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–6 (continued) Transaction (c): This transaction will directly affect Carey’s financial statements for two years, with the expense incurred in 2016 and the cash payment in 2017 The $7,500 should be reported as wage expense in the 2016 income statement and as a liability on the 2016 balance sheet On January 5, 2017, the liability will be paid Therefore, the 2017 balance sheet will reflect a reduced cash balance and reduced liability balance The transaction will not directly affect the 2017 income statement (unless the adjusting entry was not made) Yes, an adjusting entry must be made to (a) record the $7,500 as an expense in 2016 (matching principle) and (b) to record the liability which will be paid in 2017 December 31, 2016 Adjusting entry: Wage expense (+E, SE) 7,500 Wages payable (+L) 7,500 Note: On January 5, 2017, the liability, Wages Payable, of $7,500 will be paid Wage expense for 2017 will not include this $7,500 The 2017 related entry will debit (decrease) Wages Payable, and credit (decrease) Cash, $7,500 Transaction (d): Yes, service revenue of $45,000 (i.e., $60,000 x 3/4) should be recorded as earned by Carey in conformity with the revenue principle Service revenue is recognized as the service is performed Recognition of revenue earned but not collected by the end of 2016 requires an adjusting entry This adjusting entry is necessary to (a) record the revenue earned (to be reported on the 2016 income statement) and (b) record the related account receivable (an asset to be reported on the 2016 balance sheet) The adjusting entry on December 31, 2016 is: Accounts receivable (+A) 45,000 Service revenue (+R, +SE) 45,000 ($60,000 total price x 3/4 completed) February 15, 2017 Completion of the last phase of the service contract and cash collected in full: Cash (+A) 60,000 Accounts receivable (A) 45,000 Service revenue (+R, +SE) 15,000 4-72 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–7 Req CRYSTAL’S DAY SPA AND SALON, INC Income Statement For the Year Ended December 31, 2015 Items Revenues: Spa fees Expenses: Office rent Utilities Telephone Salaries Supplies Miscellaneous Depreciation Total expenses Net income * ** Cash Basis Per Crystal’s Statement Explanation of Changes Corrected Basis $1,215,000 See * below $1,102,000 130,000 43,600 12,200 562,000 31,900 12,400 792,100 $ 422,900 120,000 43,600 11,800 563,500 29,825 12,400 20,500 801,625 $ 300,375 Exclude rent for Jan 2016 ($130,000 ÷ 13) (g) No change See ** below Add December 2015 salary ($18,000 ÷ 12) (e) See *** below No change Given for 2015 (c) Cash collected for spa fees Fees earned in prior years (a) Fees earned in 2015 but not yet collected (b) Fees earned in 2015 $1,215,000 -142,000 + 29,000 $1,102,000 $12,200 telephone paid + $1,400 December 2015 telephone bill - $1,800 December 2014 bill paid in 2015 = $11,800 *** Beg Purchases End Financial Accounting, 8/e Supplies (d) 3,125 31,900 29,825 5,200 Used 4-73 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–7 (continued) Req Memo to Crystal Mullinex should include the following: (1) Net income was overstated by $122,525 because of inappropriate recognition of revenue (overstated by $113,000) and expenses (understated by $9,525) Revenue should be recognized when earned, not when the cash is collected Similarly, expenses should be matched against revenue in the period when the services or materials were used (including depreciation expense) (2) Some other items the parties should consider in the pricing decision: (a) A correct balance sheet at December 31, 2015 (b) Collectability of any receivables (if they are to be sold with the business) (c) Any liabilities of the spa to be assumed by the purchaser (d) Current employees how will they be affected? (e) Adequacy of the rented space is there a long-term noncancellable lease? (f) Characteristics of Crystal’s spa practices (g) Expected future cash flows of the business What is the present value of those expectations? 4-74 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CRITICAL THINKING CASES CP4–8 Req 2015 12/31 (a) (b) (c) (d) (e) (f) Adjusting Entries Debit Supplies expense (+E, SE)………………… Supplies (A)……………………………… ($4,000 - $1,800 = $2,200) 2,200 Insurance expense (+E, SE)…………………… Prepaid insurance (A)…………………… ($6,000 ÷ years) 3,000 Depreciation expense (+E, SE)………………… Accumulated depreciation (+XA, A)…… 8,000 Salaries expense (+E, SE)………………………… Salaries payable (+L)……………………… 3,200 Transportation revenue (R, SE) ……… Unearned transportation revenue (+L)…… Transportation revenue is too high and needs to be reduced and an Unearned Revenue account created for the appropriate amount 7,000 Income tax expense (+E, SE)………………… Income tax payable (+L)…………………… To record 2014 income tax computation: Transportation revenue: $85,000  $7,000 = $78,000 Expenses: $47,000 + $2,200 + $3,000 + $8,000 + $3,200 = 63,400 Pretax income $14,600 Income tax expense: $14,600 x 35% = $ 5,110 5,110 Financial Accounting, 8/e Credit 2,200 3,000 8,000 3,200 7,000 5,110 4-75 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–8 (continued) Req STOSCHECK MOVING CORPORATION Corrections to 2015 Financial Statements Amounts Reported 2015 Income Statement: Revenue: Transportation revenue Expenses: Salaries expense Supplies expense Other expenses Insurance expense Depreciation expense Income tax expense Total expenses Net income December 31, 2015, Balance Sheet Assets: Current Assets: Cash Receivables Supplies Prepaid insurance Total current assets Equipment Less: Accumulated deprec Remaining assets Total assets Liabilities: Current Liabilities: Accounts payable Salaries payable Unearned transportation revenue Income tax payable Total current liabilities Stockholders' Equity Common stock Retained earnings Total stockholders' equity Total liabilities and stockholders' equity 4-76 Changes Debit Credit Corrected Amounts $ 85,000 e 7,000 $ 78,000 17,000 12,000 18,000 0 47,000 $ 38,000 d a 3,200 2,200 b c f 3,000 8,000 5,110 20,200 14,200 18,000 3,000 8,000 5,110 68,510 $ 9,490 $ 2,000 3,000 4,000 6,000 15,000 40,000 27,000 $82,000 $ 9,000 0 9,000 35,000 38,000 73,000 $82,000 a b 2,200 3,000 c 8,000 d e f 3,200 7,000 5,110 $ 2,000 3,000 1,800 3,000 9,800 40,000 (8,000) 27,000 $68,800 $ 9,000 3,200 7,000 5,110 24,310 35,000 9,490 44,490 $68,800 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–8 (continued) Req Omission of the adjusting entries caused: (a) Net income to be overstated by $28,510 (b) Total assets to be overstated by $13,200 (c) Total liabilities to be understated by $15,310 Req (a) Earnings per share: Unadjusted $38,000 net income  10,000 shares = $3.80 per share Adjusted $ 9,490 net income  10,000 shares = $0.95 per share (b) Total asset turnover: Unadjusted $85,000 revenue  [($0 + $82,000)/2] average total assets = 2.073 Adjusted $78,000 revenue  [($0 + $68,800)/2] average total assets = 2.267 Each of the ratios was affected by inclusion of the adjustments with net income, revenue, and assets decreasing  For earnings per share, the numerator net income decreased while the denominator did not, resulting in a significantly lower figure  For the total asset turnover ratio, both the numerator and denominator decreased, but the denominator average total assets decreased more than the numerator revenues, causing an increase in the ratio Financial Accounting, 8/e 4-77 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–8 (continued) Req To the Stockholders of Stoscheck Moving Corporation: We regret to inform you that your request for a $30,000 loan has been denied Our review showed that various adjustments were required to the original set of financial statements provided to us The original (unadjusted) financial statements overstated net income for 2015 by $28,510 (i.e., $38,000 - $9,490) This overstatement was caused by incorrectly including $7,000 of revenue collected in advance that had not been earned in 2015 Further, all of the expenses were understated and income tax expense had been incorrectly excluded Total assets were overstated by $13,200 (i.e., $82,000 - $68,800) Supplies was overstated by $2,200, prepaid insurance was overstated by $3,000, and the net book value of the equipment was overstated by $8,000 because annual depreciation was not properly recognized Further, total liabilities were understated by $15,310 A review of key financial ratios indicates that the adjustments caused earnings per share to decline, although total asset turnover increased from 2.073 to 2.267 The adjusted ratios, however, would need to be compared to those of other start-up companies in the same industry We require that there be sufficient collateral pledged against the loan before we can consider it The current market value of the equipment may be able to provide additional collateral against which the loan could be secured Your personal investments may also be considered viable collateral if you are willing to sign an agreement pledging these assets as collateral for the loan This is a common requirement for small start-up businesses If you would like us to reconsider your application, please provide us the current market values of any assets you would pledge as collateral Regards, (your name) Loan Application Department,Your Bank CP4–9 Req Cash from Operations: $36,000 Req Subscriptions Revenue for fiscal year ended March 31, 2016 ($36,000 x 7/36): $7,000 Req March 31, 2016, Unearned Subscriptions Revenue ($36,000 x 29/36) = $29,000 or $36,000 - $7,000 = $29,000 4-78 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CP4–9 (continued) Req Adjusting entry (cash receipt credited to Unearned Subscriptions Revenue): Unearned Subscriptions Revenue (L) 9/1 36,000 AJE 7,000 End 29,000 Subscriptions Revenue (R) Unearned subscriptions revenue (L) Subscriptions revenue (+R, +SE) AJE End 7,000 7,000 7,000 7,000 Req a $9,000 revenue target based on cash sales: This target is not clearly defined Does management mean any cash subscriptions received during the period? Your region generated $36,000 in cash subscriptions By this assumption, your region far exceeded the company’s target You may be entitled to a generous bonus due to your strong performance On the other hand, management may mean any sales revenue earned that has also been received in cash during the period Under this assumption, sales revenue earned and received in cash is $7,000 (the accrual accounting basis amount) If this is the company’s intention of its target, then your region did not meet the goal, only generating 77.8% of the target You may need to provide an analysis to management regarding this below par performance This example demonstrates the need for clear communication of expectations by management b $9,000 revenue target based on accrual accounting: This situation is the same as the second assumption under a Your region earned $2,000 less than expected by the company FINANCIAL REPORTING AND ANLYSIS PROJECT CP4–10 The solutions to this project will depend on the company and/or accounting period selected for analysis CONTINUING CASE Financial Accounting, 8/e 4-79 © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part Find more at www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings CC4-1 Adjusting Entries: Debit a b c d e f g h i 4-80 Wages expense (+E, -SE) Wages payable (+L) 7,500 Unearned revenue (-L) Cleaning service revenue (+R, +SE) Amount: $24,000 x 2/12 = $4,000 earned 4,000 Utilities expense (+E, -SE) Utilities payable (+L) Interest expense (+E, -SE) Interest payable (+L) Amount: $30,000 principal x 10 x 8/12 months 7,500 4,000 520 520 2,000 2,000 Accounts receivable (+A) Cleaning service revenue (+R, +SE) 800 Insurance expense (+E, -SE) Prepaid insurance (-A) Amount: $4,200 x 5/24 months 875 Supplies expense (+E, -SE) Supplies (-A) Amount: $2,400 beginning + $23,000 purchased - $3,100 ending = $22,300 used Depreciation expense (+E, -SE) Accumulated depreciation (+XA, -A) Interest receivable (+A) Interest revenue (+R, +SE) Credit 800 875 22,300 22,300 8,300 8,300 110 110 Solutions Manual © 2014 by McGraw-Hill Global Education Holdings, LLC This is proprietary material solely for authorized instructor use Not authorized for sale or distribution in any manner This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part ... www.downloadslide.com Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings ANSWERS TO MULTIPLE CHOICE 10 4-4 c b b b b c c c c c Solutions Manual © 2014 by McGraw-Hill Global Education... we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries Financial Accounting, 8/e 4-5 © 2014 by McGraw-Hill Global Education Holdings,... basis of accounting, revenues should be recognized when earned and measurable and expenses should be recognized when incurred in generating revenues Financial Accounting, 8/e 4-15 © 2014 by McGraw-Hill