CHAPTER QUESTIONS The accounting system generates a variety of reports for use by various decision makers Among the most common are general-purpose financial statements, management reports, tax returns, and other reports prepared for government agencies such as the SEC analyzed in terms of their effects on the various asset, liability, owners’ equity, revenue, and expense accounts of the business unit (3) Transactions are posted to the appropriate accounts in the general and subsidiary ledgers The ledger accounts classify and summarize the full effect of all transactions recorded in the journals and can be used in the preparation of financial statements (4) A trial balance may be prepared showing the account balances in the general ledger and reconciling subsidiary ledger balances with respective control account balances The trial balance provides a summary of the information as classified and summarized in the ledgers as well as a verification of the accuracy of recording and posting (5) Adjustments are made to bring the accounts up to date Adjustments are necessary to record all accounting information that has not yet been recorded and to properly recognize all revenues and expenses on an accrual basis If a work sheet is used (an optional step in the cycle), adjustments may be journalized and posted any time prior to closing If statements are prepared directly from ledger balances, however, adjustments must be recorded at this point (6) Financial statements are prepared Financial statements report the results of operations and cash flows for a period of time and show the financial condition of the business unit as of a certain date (7) Closing entries are journalized and posted Balances in nominal accounts are closed into Retained Earnings Operating results as determined in the summary accounts are finally transferred to Retained Earnings (8) A post-closing trial balance may be prepared as an optional step in the cycle A post-closing trial balance is A manual and an automated accounting system are similar in that both are designed to serve the same informationgathering and processing functions Both systems also use the same underlying accounting concepts and principles The differences between a manual and an automated accounting system involve some mechanical aspects, time requirements, and the appearance of records and reports Due to advanced technology and reduced prices, today almost all successful businesses of any size use computers to assist in the various accounting functions The accounting process involves certain procedures used by businesses to produce financial statement data The recording phase of the accounting process consists of those procedures used in the continuing activity of analyzing, recording, and classifying business transactions in the various books of record (journals and ledgers) during the fiscal period The reporting phase of the accounting process consists of those procedures used at the end of the fiscal period to update and summarize data collected during the recording phase Financial statements are prepared from the updated and summarized data The accounting process includes the following steps: (1) Business documents are analyzed Business documents provide detailed information concerning each transaction and establish support for the data recorded in the books of original entry (2) Transactions are recorded in chronological order in books of original entry—the journals Transactions are 27 28 Chapter prepared to check the equality of the debits and credits after posting the adjusting and closing entries The steps in the accounting process are necessary to transform transaction data into useful information as summarized in the financial statements and other accounting reports Some steps are optional, such as preparing a trial balance and preparing a post-closing trial balance These steps help verify or facilitate the accounting process but are not essential Under double-entry accounting, assets, expenses, and dividends are increased by debits and decreased by credits Liabilities, owners’ equity accounts, and revenues are increased by credits and decreased by debits a Real accounts are balance sheet accounts not closed to a zero balance in the closing process Nominal accounts are income statement or temporary owners’ equity accounts closed out in the process of arriving at the net increase or decrease in owners’ equity for a period b A general journal is the most flexible book of original entry It may be used to record all business transactions or simply those that cannot be recorded in one of the special journals Special journals are designed to facilitate the recording of some particular type of frequently occurring transaction, such as sales, purchases, cash receipts, and cash disbursements c The general ledger carries summaries of all accounts appearing on the financial statements Subsidiary ledgers afford additional detail in support of certain general ledger balances Thus, accounts payable appear in total in the general ledger, but individual accounts with each creditor are provided in the accounts payable subsidiary ledger a Adjusting entries are made at the end of an accounting period to update balance sheet accounts and to record accrued expenses and accrued revenues Frequently, adjusting entries are first made on a work sheet and then are recorded in the general journal from which they are posted to the ledger accounts b Closing entries are made after the adjusting entries have been posted They transfer all nominal account balances to Retained Earnings The company accountant is disregarding the periodic summary process and jeopardizing the company’s audit trail by not entering the adjusting entries in the general journal Adjusting entries are made at the end of the period to bring accounts up to date These entries must be entered first in the general journal and then posted directly to the general ledger If the adjusting entries are not entered first in the general journal, the journals will be incomplete and will not provide the support necessary for an adequate accounting system Examples of contra accounts include Allowance for Bad Debts, Accumulated Depreciation, Discount on Notes Receivable, Discount on Notes Payable, and Discount on Bonds Payable Contra accounts are subtracted from related accounts Hence, they are sometimes referred to as offset accounts Contra accounts are used to adjust accounts when the original balance needs to be preserved For example, adequate disclosure in financial reports requires disclosure of both the original cost and the depreciated cost of assets A contra account, Accumulated Depreciation, is used for this purpose 10 Both methods, if properly applied, result in the same account balances The entries that would be required on December 31 for (a) and (b), assuming that $400 was paid for insurance for one year beginning April 1, are as follows: a Original entry: Insurance Expense 400 Cash 400 Adjusting entry: Prepaid Insurance 100 Insurance Expense b Original entry: Prepaid Insurance 400 Cash Adjusting entry: Insurance Expense 300 Prepaid Insurance 11 A merchandising enterprise using a periodic (physical) inventory system does not maintain book inventory records and thus must take a physical inventory at the end of the accounting period to determine the proper inventory to be reported on the balance sheet and the cost of goods sold to be reported on the income statement The adjusting entry can be made by first debiting or crediting inventory to bring the beginning balance up to date (i.e., to the amount on hand as determined by the physical count of inventory) The purchases account is also credited, and any related accounts are closed to Cost of Goods Sold The balancing debit amount is the Cost of Goods Sold for the period A merchandising enterprise using a perpetual inventory system maintains the inventory and cost of goods sold accounts directly in the ledger, and thus no adjustment is necessary However, it is recommended that a physical inventory be taken periodically to verify the perpetual records and that the records be adjusted to the physical count through a debit or credit to Cost of Goods Sold 12 A work sheet is a multicolumn form designed to facilitate the summarization and organization of accounting data needed to prepare the financial statements The number of columns and the headings used may vary, depending on the needs of a particular business While the work sheet is an optional step in the accounting process, it is a valuable aid in completing the trial balance and adjustment procedures 13 When a work sheet is used as a basis for statement preparation, the adjustments can be formally recorded in the journals and posted to the ledger accounts at any time prior to closing the books However, if a work sheet is not used, financial statements must be prepared directly from the accounts; thus, the adjustments must be recorded and posted prior to statement preparation 100 400 14 a The procedure is acceptable It gives the same results as the standard closing procedures The bookkeeper for Miller Hardware Store simply closes all nominal accounts using a compound entry instead of making 300 29 30 Chapter numerous entries to obtain the same result b An alternative closing procedure is to summarize all revenue and expense items together with the change in inventory position ultimately transferred to Retained Earnings 15 Only the following accounts would be closed, generally with the following debit/credit entries: Rent Expense Credit Depreciation Expense Credit Sales Debit Sales Discounts Credit Purchases Credit Freight-In Credit Interest Revenue Debit Advertising Expense Credit Purchase Discounts Debit Dividends Credit 16 Accrual accounting recognizes revenues and expenses when they are earned and incurred, not necessarily when cash is received or paid Cash-basis accounting recognizes revenues and expenses as cash is received or disbursed, regardless of the earnings process or the matching concept Generally accepted accounting principles require the use of accrual accounting 17 The use of double-entry accrual accounting is more accurate than a cashbasis accounting system primarily because (a) The likelihood of errors and omissions is greatly increased in the absence of double-entry analysis and a trial balance to test the accuracy of the analysis and recording process (b) Recording events under an accrual system as they occur more accurately reflects the effects and timing of an event than does a system that records the events when cash is received or paid, regardless of the earnings process and the matching concept 18 The major advantages offered by computers as compared with manual processing of accounting data are as follows: (a) Computers process large amounts of accounting data at great speeds, thus providing information for decision (b) (c) (d) (e) making on a more timely basis than a manual system would Computers process information accurately with less chance of human error than a manual processing system Computers require computer-oriented business papers and accounting records that promote clerical organization and efficiency Computers usually require a general centralization of all accounting activities and thus increase the efficiency and cost-effectiveness of the accounting system Computers can process accounting data and transmit such data in direct correspondence with customers and creditors in the form of billings, invoices, checks, and so on 19 The function of the computer is limited to arithmetical and clerical functions It can follow instructions that are provided on a programmed step-by-step basis, but unlike a human, it cannot think for itself While it can serve effectively in recording activities, it cannot replace the accountant, who must still determine what principles are applicable in arriving at financial statements that present fairly the company’s financial position and results of operations 31 PRACTICE EXERCISES PRACTICE 21 Cash Accounts Receivable Sales 3,000 9,000 Cost of Goods Sold Inventory 7,500 12,000 7,500 PRACTICE 22 Equipment Cash Short-Term Notes Payable Long-Term Notes Payable 100,000 10,000 20,000 70,000 PRACTICE 23 Cash Equipment Gain on Sale of Land Land 40,000 75,000 65,000 50,000 PRACTICE 24 Dividends (or Retained Earnings) Cash 12,000 12,000 PRACTICE 25 Wages Expense Land 30,000 30,000 PRACTICE 26 Cash Beginning balance a d Ending balance 10,000 2,775 3,450 8,525 1,500 6,200 b c PRACTICE 27 Accounts Payable b c 6,500 200 8,000 2,700 2,550 Beginning Balance a d 6,550 Ending Balance PRACTICE 28 Cash Inventory Accounts Payable Paid-In Capital Retained Earnings (beginning) Sales Cost of Goods Sold Dividends Total $ Debit 400 4,000 Credit $ 1,100 2,000 1,000 10,000 9,000 700 $14,100 $14,100 Debit $ 800 3,000 Credit PRACTICE 29 Cash Prepaid Rent Expense Unearned Service Revenue Paid-In Capital Retained Earnings (beginning) Service Revenue Salary Expense Rent Expense Total $ 4,700 2,000 1,500 20,000 18,000 6,400 $28,200 $28,200 PRACTICE 210 From Practice 28: Sales Cost of Goods Sold Net Income From Practice 29: Service Revenue Salary Expense Rent Expense Net Loss $10,000 9,000 $ 1,000 $20,000 $18,000 6,400 24,400 $ (4,400) PRACTICE 211 From Practice 28: Assets Cash Inventory Total Assets $ 400 4,000 $4,400 Liabilities Accounts Payable $1,100 Stockholders’ Equity Paid-In Capital Retained Earnings (ending) $2,000 1,300 Total Liabilities and Stockholders’ Equity $4,400 Computation of ending Retained Earnings: $1,000 + ($10,000 – $9,000) – $700 = $1,300 From Practice 29: Assets Cash Prepaid Rent Expense Total Assets $ 800 3,000 $3,800 Liabilities Unearned Service Revenue $ 4,700 Stockholders’ Equity Paid-In Capital Retained Earnings (ending) Total Liabilities and Stockholders’ Equity Computation of ending Retained Earnings: $1,500 + ($20,000 – $18,000 – $6,400) = $(2,900) $ 2,000 (2,900) $ 3,800 PRACTICE 212 Depreciation Expense Accumulated Depreciation 5,500 5,500 PRACTICE 213 Bad Debt Expense Allowance for Bad Debts 1,200 1,200 PRACTICE 214 Interest Expense Interest Payable 693 693 $8,000 0.13 8/12 = $693 PRACTICE 215 Rent Expense Prepaid Rent 1,500 1,500 $3,600/12 = $300 per month; amount used = $300 months = $1,500 PRACTICE 216 Unearned Service Revenue Service Revenue 4,400 4,400 $4,800/12 = $400 per month; amount earned = $400 11 months = $4,400 PRACTICE 217 Sales Retained Earnings Retained Earnings Cost of Goods Sold Retained Earnings Dividends Balance sheet accounts are not closed 10,000 10,000 9,000 9,000 700 700 PRACTICE 218 Service Revenue Retained Earnings 20,000 Retained Earnings Salary Expense Rent Expense 24,400 Balance sheet accounts are not closed 20,000 18,000 6,400 58 Chapter Chapter 2–41 Royal Distributing Co Work Sheet December 31, 2005 Account Cash Accounts Receivable Allowance for Bad Debts Inventory, 12/31/04 Long-Term Investments Land Buildings Accumulated Depreciation—Bldg .37,280 Accounts Payable Mortgage Payable Capital Stock, $5 par Retained Earnings, 12/31/04 Dividends Sales Sales Returns Sales Discounts Purchases Purchase Discounts Freight-In Selling Expenses Office Expenses Insurance Expense Supplies Expense Taxes—Real Estate and Payroll Interest Revenue Interest Expense Cost of Goods Sold Bad Debt Expense Depreciation Expense—Buildings Selling Expenses Payable Supplies Prepaid Insurance Interest Receivable Real Estate and Payroll Taxes Payable Interest Payable Income Taxes Payable Income Tax Expense Trial Balance Debit Credit 35,000 91,000 84,000 27,500 53,400 112,500 1,800 Adjustments Debit Credit (a) 8,000 26,780 (b) 2,000 (c) Income Statement Debit Credit 10,500 47,300 99,500 175,000 14,840 9,670 359,000 12,890 12,890 7,540 7,540 159,000 (a) 159,000 6,780 (a) 6,780 6,300 (a) 6,300 62,350 (d) 8,600 70,950 38,900 38,900 14,000 (f) 4,000 10,000 4,800 (e) 1,250 3,550 9,500 (h) 2,340 11,840 550 (g) 850 3,200 (i) 1,780 4,980 …… …… (a) 150,520 150,520 …… …… (b) 2,000 2,000 …… …… (c) 10,500 .…… …… (d) 8,600 .…… …… (e) 1,250 .…… …… (f) 4,000 .…… …… (g) 850 …… …… .…… …… .…… …… .…… …… (j) 14,692 731,550 731,550 211,312 Net Income (h) 2,340 (i) 1,780 (j) 14,692 211,312 Balance Sheet Debit Credit 35,000 91,000 3,800 92,000 27,500 53,400 112,500 359,000 1,400 10,500 9,670 1,250 4,000 850 47,300 99,500 175,000 14,840 8,600 2,340 1,780 14,692 14,692 338,362 360,400 427,170 405,132 22,038 22,038 360,400 360,400 427,170 427,170 60 2–42 Chapter Chapter Whitni Corporation Work Sheet December 31, 2005 Trial Balance Account Title Cash Notes Receivable Accounts Receivable Allowance for Bad Debts Inventory, December 31, 2005 Land Buildings Accumulated Depreciation—Buildings Furniture and Fixtures Accumulated Depreciation—Furniture and Fixtures Notes Payable Accounts Payable Common Stock, $100 Par Retained Earnings Sales Sales Returns and Allowances Cost of Goods Sold Utilities Expense Property Tax Expense Salaries and Wages Expense Sales Commissions Expense Insurance Expense Interest Revenue Interest Expense Depreciation Expense—Buildings Depreciation Expense—Furniture and Fixtures Bad Debt Expense Sales Commissions Payable Interest Payable Property Taxes Payable Prepaid Insurance Interest Receivable Dividends Payable Income Tax Expense Income Taxes Payable Net Income Debit 40,250 16,500 63,000 94,700 80,000 247,600 15,000 17,000 465,800 16,700 10,200 89,000 73,925 18,000 2,400 1,250,075 Credit 650 18,000 9,000 18,000 72,700 240,000 129,125 760,000 2,600 1,250,075 Adjustments Debit (f1) 3,600 (c3) 6,000 (c1) 700 (c2) 45 (a2) 6,904 (a1) 1,500 (b) 1,850 (d) 3,200 (e) 750 (f2) 15,000 39,549 Credit (b) 1,850 (a2) 6,904 (a1) 1,500 (d) 3,200 (e) 750 (c1) 700 (c2) 45 (c3) 6,000 (f1) 3,600 (f2) 15,000 39,549 Income Statement Debit 17,000 465,800 16,700 16,200 89,000 74,625 14,800 2,445 6,904 1,500 1,850 15,000 721,824 41,526 763,350 Credit 760,000 3,350 763,350 763,350 Balance Debit 40,250 16,500 63,000 94,700 80,000 247,600 15,000 3,200 750 561,000 561,000 Sheet Credit 2,500 24,904 10,500 18,000 72,700 240,000 125,525 700 45 6,000 3,600 15,000 519,474 41,526 561,000 Chapter 2–42 61 (Continued) Adjusting Entries (a1) Depreciation Expense—Furniture and Fixtures Accumulated Depreciation—Furniture and Fixtures ($15,000 0.10 = $1,500) 1,500 1,500 (a2) Depreciation Expense—Buildings 6,904 Accumulated Depreciation—Buildings 6,904 [($97,600 0.04) + ($150,000 0.04 6/12) = $6,904)] (b) Bad Debt Expense Allowance for Bad Debts ($2,500 – $650 = $1,850) 1,850 (c1) Sales Commissions Expense Sales Commissions Payable 700 (c2) Interest Expense Interest Payable 45 (c3) Property Tax Expense Property Taxes Payable 6,000 (d) Prepaid Insurance Insurance Expense 3,200 Interest Receivable Interest Revenue 750 Retained Earnings Dividends Payable ($1.50 2,400 shares = $3,600) 3,600 (e) (f1) (f2) 1,850 700 45 6,000 3,200 750 3,600 Income Tax Expense 15,000 Income Taxes Payable 15,000 62 Chapter Chapter 2–42 (Concluded) Closing Entries Sales 760,000 Interest Revenue 3,350 Sales Returns and Allowances 17,000 Retained Earnings 746,350 Retained Earnings 704,824 Cost of Goods Sold 465,800 Utilities Expense 16,700 Property Tax Expense 16,200 Salaries and Wages Expense 89,000 Sales Commissions Expense 74,625 Insurance Expense 14,800 Interest Expense 2,445 Depreciation Expense—Buildings 6,904 Depreciation Expense—Furniture and Fixtures 1,500 Bad Debt Expense 1,850 Income Tax Expense 15,000 Chapter 63 DISCUSSION CASES Discussion Case 2–43 First of all, many businesses not survive, and poor bookkeeping is a contributor to the demise of many of them Poor bookkeeping leads to a host of problems: trouble collecting accounts, difficulties with suppliers over late payments, problems getting bank loans because of the inability to prove profitability, inability to assemble reliable cost and revenue data in order to make pricing decisions, and general inefficient use of time In addition, poor bookkeeping is often a symptom of a more fundamental laxness that adversely affects all aspects of the business Secondly, some businesses well in spite of their bookkeeping inefficiencies because their fundamental business is doing so well that the inefficiencies stemming from bad recordkeeping only reduce profits instead of eliminating them altogether This often occurs when a business occupies a specialized market niche that competitors have not yet entered Discussion Case 2–44 Recall that journal entries are made to record transactions and that transactions are defined as events that involve the transfer or exchange of goods or services between two or more entities Each of the events listed in this case has potential economic significance However, none of them involve an exchange of goods or services between the business and an outside entity Accordingly, no journal entries are required Discussion Case 2–45 This case provides an opportunity to discuss with students the impact computers are increasingly having on accounting activities Accounting systems are undergoing significant changes as new technology makes it possible to produce a variety of reports in a timely and comprehensive manner not previously practical In many companies, several information systems exist side by side, each producing information for a narrow use The use of more generalized databases that can be queried by different users to meet their needs is a concept that will be increasingly considered Accountants must be willing to work with such systems if they are going to introduce the controls necessary to ensure the integrity of the data Jim’s worry is a real one; however, avoidance of the issue will not make the problem go away If accountants not play an active role in streamlining the system, other professionals with expertise in computer technology will and accountants will be forced to use what they are given Discussion Case 2–46 The cash basis and the accrual basis yield quite different pictures of a firm’s operating performance when levels of assets or liabilities change dramatically from beginning of period to end of period This would be the case, for example, in a growing company In such a company, cash needs would exceed net income because of the need to increase working capital and the fixed assets of the company The cash basis and the accrual basis show similar pictures when the levels of assets and liabilities not change from beginning of period to end of period For example, in a firm that has been in existence for quite some time and that has reached a steady state, the levels of receivables, inventory, and payables are often constant Capital expenditures to replace fixed assets in any given year approximate depreciation expense for the year In such a circumstance, cash flow and net income are approximately the same 64 Chapter Chapter Discussion Case 2–47 The possibilities include the following: (1) The annual reports may still be disseminated by mail, but investors might receive a computer disk instead of a paper document This would allow the inclusion of much more information and allow investors to analyze the information more easily It has been suggested that the importance of accounting method choice would diminish because users would be able to generate reports based on any set of accounting assumptions Lenders, for example, might choose a more conservative set of assumptions than a potential corporate raider Dissemination of more detailed data would allow all users to generate tailor-made financial statements (2) Alternatively, the annual report might be disseminated electronically The SEC’s EDGAR program is currently operational for firms making electronic filings; electronic dissemination of EDGAR filings is also possible Both of these developments make sense, because financial statement analysis will increasingly be done using computers It makes sense to eliminate the paper intermediary when the firm’s computer can prepare the financial data in a form your computer can read Ultimately, it might someday be possible for an outsider to track the performance of a firm on an ongoing basis by tapping directly into the firm’s accounting computer system There would be no need for an annual report; users could generate financial statements for any interval they choose Accounting software firms would arise with competing software to best analyze and summarize the raw data available from company accounting records Discussion Case 2–48 Companies are usually very sensitive to requests of their stockholders This concern should be expressed in replying to Julie’s request The company policy in distributing quarterly reports could be conveyed in the reply, along with the latest report The chief accountant could assure Julie that the quarterly reports are prepared using the same generally accepted accounting principles as the annual reports and that the company auditors review the quarterlies for consistency and overall reasonableness The idea of direct access to company records is one that has been suggested by several futurists Certainly, the technology is available to some of this However, companies must also be concerned about premature disclosure of information that might be detrimental to the long-term interest of the company as an entity As chief accountant, you might consider establishing a hotline response system that would be updated weekly and that would provide data to interested stockholders such as Julie The use of computers to access previously unavailable information is certainly going to occur Those companies in the forefront will be perceived as forward looking and will likely be popular with stockholders Chapter 65 SOLUTIONS TO STOP & THINK Stop & Think (p 54): What is the difference between a bookkeeper and an accountant? An accountant is responsible for determining the information to be collected by an accounting information system and how that information is to be summarized and reported to those requiring the information In addition, given their knowledge of the effects of business decisions on the financial status of a business, accountants are often involved in the decision-making process Bookkeepers are responsible for accumulating the results of the transactions of a business and inputting the relevant information into the accounting system Stop & Think (p 59): What types of errors can occur in the posting process? Why is the computer so valuable in this particular phase of the accounting cycle? The most common types of errors that occur in the posting process are (1) posting to the wrong account, (2) posting the wrong amount, and (3) posting a debit as a credit or vice versa Computers not make these types of errors A computer will always post the exact information reflected in a journal entry Stop & Think (p 61): What benefits are there to accumulating depreciation in a separate contra account instead of crediting the asset account directly? Keeping a separate contra account for depreciation allows users of the financial statements to approximate the average age of the company's fixed assets As an example, suppose a company reports a net amount for fixed assets of $100,000 This $100,000 could be the result of a company’s having fixed assets of $110,000 with accumulated depreciation of $10,000 The $100,000 could also be the result of a company’s having fixed assets originally costing $1,000,000 that have been depreciated by $900,000 For the first example, the fixed assets are relatively new For the second example, the fixed assets have been almost entirely written off and could indicate that additional expenditures will be required in the near future More information than just the net balance in the fixed assets account is required for users to make an informed decision Stop & Think (p 67): Note that every adjusting entry made at the end of a period involves at least one balance sheet account and one income statement account Why is that? Note also that one account is conspicuously absent from all adjusting entries What account is that and why? Adjusting entries are needed because certain transactions or events are not accounted for in the regular day-to-day operations of a business Without adjusting entries, both the balance sheet and the income statement will be incorrect An example of a common adjusting entry is the use of office supplies An entry is not made to record the use of each piece of paper by the office staff Instead, an adjusting entry is made at the end of the period to reflect the use of the asset during the period Another example relates to wages An entry is not made for each day that employees work Instead, an entry is made at the end of the pay period When the accounting period ends prior to the end of a pay period, an adjusting entry is required to ensure that the proper amount of expense and liability is reported One account that does not appear in an adjusting entry is Cash Cash is not used in an adjusting entry because either (1) cash has already been exchanged (as is the case with office supplies—they have already been paid for) or (2) cash will be exchanged in the future (as is the case with wages—cash will be paid to employees at the end of the pay period) 66 Chapter Chapter SOLUTIONS TO STOP & RESEARCH Stop & Research (p 58): Since 1947, France has had a standardized “chart of accounts” to be used by French companies Use your favorite Web search engine and find out the name of this French “chart of accounts.” The French chart of accounts (Plan Comptable Général) contains accounting definitions and principles that industrial and commercial firms must obey in the keeping of accounts Companies have an obligation to maintain a journal, a ledger and a balance sheet book The first two must be kept on a monthly basis in accordance with the chart of accounts See http://www.investinfrance.org/DoingBusiness/accounting.html Stop & Research (p 68): Cisco Systems claims it has refined its financial statement preparation process to the point that the books can be closed within one hour Use the SEC’s EDGAR system (at http://www.sec.gov) to find out how many days elapsed between the end of Cisco’s most recent fiscal year and the filing of the company’s financial statements with the SEC Also check the date on the audit opinion associated with those financial statements On September 24, 2001, Cisco filed its 10-K report with the SEC for the fiscal year ended July 28, 2001 Thus, almost two months had elapsed The audit report associated with those financial statements was signed on August 7, 2001 Accordingly, it took just a little over a week to close the books and complete the audit Chapter 67 SOLUTIONS TO NET WORK EXERCISES Net Work Exercise (p 63) Oldest discovered evidence of writing: Dateline: December 15, 1998 Earliest Known Writing Uncovered in Egypt The subject: Accounting SUHAG PROVINCE, EGYPT - Clay tablets just unearthed from the tomb of Egyptian King Scorpion I represent what is claimed to be the oldest discovered evidence of writing German archaeologists say carbon dating places the age of the tablets at 3300 BC to 3200 BC More than two-thirds of the translated hieroglyphic writings, on small pieces of clay tablets and the sides of jars, are tax accounting records The discovery was met with interest by historians, who have generally regarded the Sumerians of the Mesopotamian Valley (present-day Iraq) as the first people to employ writing—also for accounting purposes (see main text) The oldest existing Sumerian writings are believed to have been made sometime before 3000 BC Although Oxford University Professor of Egyptology John Baines views the Germans’ discovery as “very important,” he was quoted by the Associated Press as saying, “I would say it is likely that writing was invented in both places (Egypt and Mesopotamia).” Most of the writings were accounts of linen and oil delivered to King Scorpion I in taxes, short notes, numbers, lists of kings’ names, and institutions While hieroglyphic symbols are employed, it is considered true writing because each symbol represents a consonant for the spoken word In the century following its publication, Pacioli’s work was translated into five languages Net Work Exercise (p 75) As of May 1, 2002, the total public debt outstanding was $5,974,320,868,797.23 The two broad groups of “investors” that hold the public debt of the United States are labeled debt held by the public and intragovernmental holdings The intragovernmental holdings and U.S government securities are held by government agencies, such as the Social Security Trust Fund 68 Chapter Chapter SOLUTIONS TO BOXED ITEMS Russian Accounting (p 64) The old Soviet system is attractive from an efficiency standpoint With all information needs served from a single database, there is a minimum of duplicated effort Also, with all users accessing the same database, misunderstandings can be reduced For example, in the United States, one constant source of confusion among financial statement users is that taxable income and net income reported in the financial statements are not the same thing The U.S system has the advantage of being adaptable to specific needs For example, the income tax system is designed for the efficient collection of tax revenue This objective differs drastically from the goal of fair measurement of firm performance, so it seems reasonable to use different accounting systems for these two different purposes In addition, the U.S system recognizes that not all circumstances are the same and that the books of all firms cannot be shoehorned into a rigid and uniform framework Rigid rules, without room for human judgment, cannot capture the complexity of the business world Because accountants in the former Soviet system were primarily “form fillers,” their position lacked prestige The prestige of accountants (as opposed to bookkeepers) in the West stems from the responsibility they have to exercise judgment in analyzing complex transactions and designing complex systems Why Doesn't the United States Government Use Accrual Accounting? (p 74) Using the historical cost accounting model, assets are recorded at their historical acquisition cost For many of the assets controlled by the U.S government, the acquisition cost, in monetary terms, is close to zero For example, the federal government owns up to 80% of several Western states (e.g., Nevada and Utah) but paid little to acquire those holdings (some would claim the government got exactly what it paid for) These vast holdings would be recorded at only a nominal value in the federal balance sheet On the other hand, one very significant item is excluded from the liability side of the federal balance sheet—the Social Security obligation Because Social Security is not considered to be a bona fide pension plan, it is not listed However, a note disclosure in the 2001 U.S government annual report indicates that, as of January 1, 2002, the present value of the projected future resources needed over the next 75 years to fund Social Security and Medicare totals $9.688 trillion With the cash basis, the way to manipulate the reported deficit is to manipulate the timing of cash payments For example, the savings and loan debacle of the 1980s did not increase the deficit when it occurred but instead impacted the reported deficit in later periods as the mess was cleaned up With the accrual basis, politicians would be able to manipulate the reported deficit by changing useful life estimates and by classifying expenditures as purchases of assets instead of as expenses Chapter 69 COMPETENCY ENHANCEMENT OPPORTUNITIES Deciphering 2–1 (The Walt Disney Company) The Walt Disney Company Adjusted Trial Balance September 30, 2001 (dollars in millions) Cash and Cash Equivalents Receivables Inventories Television Costs—Current Deferred Income Taxes Other Assets—Current Film and Television Costs—Long-Term Investments Attractions, Buildings, and Equipment Accumulated Depreciation Projects in Progress Land Intangible Assets, Net Other Assets—Long-Term Accounts Payable and Other Accrued Liabilities Current Portion of Borrowings Unearned Royalties and Other Advances Borrowings Deferred Income Taxes Other Long-Term Liabilities, Unearned Royalties, and Other Advances Minority Interests Common Stock Retained Earnings Accumulated Other Comprehensive Income Treasury Stock Shares Held by TWDC Stock Compensation Fund II Dividends Revenues Costs and Expenses Amortization of Intangible Assets Gain on Sale of Businesses Net Interest Expense and Other Equity in the Income of Investees Restructuring and Impairment Charges Income Taxes Minority Interests Cumulative Effect of Accounting Changes Totals Debits $ 618 3,343 671 1,175 622 600 5,235 2,061 19,089 Credits $ 7,728 911 635 14,540 1,927 4,603 829 787 8,940 2,730 2,756 382 12,096 12,767 10 1,395 210 438 25,269 21,670 767 22 417 300 1,454 1,059 104 278 $79,219 $79,219 Remember that the retained earnings balance on the September 30, 2001 balance sheet reflects the fact that all nominal accounts have been closed To prepare a trial balance that includes nominal accounts, net income for the period must be subtracted and dividends must be added (obtained from the statement of stockholders’ equity) from the end-of-year balance to arrive at the beginning-of-year balance 70 Chapter Chapter Writing Assignment: I am going to be an accountant—not a bookkeeper! Students should consider the following points in their assignment: An understanding of how information from a transaction is entered into the accounting system, processed by the system, and accumulated into a report will aid accountants and others as they use the information If an error occurs in the accounting system, an understanding of how the system works will facilitate the correction of the error An understanding of the mechanics enables individuals to better understand the concepts For example, the journal entries associated with a perpetual inventory system assist one in understanding how goods flow through a business Journal entries force individuals to be concise and precise in their thinking One cannot be sloppy when it comes to journal entries Thus, another benefit of journal entries and T-accounts is that they assist the individual in becoming a better thinker Research Project: How have computers changed the accounting process? Students will find that computers have a different impact on each business For some businesses, computers have been used to simply automate the accounting process That is, journal entries are entered into a computer, and the computer posts the entries and produces financial statements very quickly For other businesses, computers are being used to provide information in addition to that provided by a traditional accounting system For many businesses, the accounting information system produces information to be used by managers in allocating resources and pricing products The Debate: No more debits and credits! The following points might be made during this discussion between the student groups The terms debit and credit have meaning to a lot of people Doing away with these terms will force many people to unnecessarily learn new terminology These terms provide much information in a few words For example, when someone says "debit Cash," it means that Cash increased Likewise, "credit Wages Payable" indicates that a liability increased The required equality of debits and credits ensures checks and balances within the accounting system Removing these terms may also eliminate necessary checks and balance The flip side of point (2) is that it is just as easy to say "Cash increased" as it is to say "debit Cash." Everyone understands the term increase An education is required to understand the term debit Debit and credit are artifacts of a 500-year-old system Current technology allows us to achieve the same objectives with an accounting information system without using these ancient terms Ethical Dilemma: The art of making adjusting entries It should be apparent to students that the adjusting process requires significant judgment on the part of an accountant Few guidelines exist to dictate the appropriateness of estimates However, users of financial information require unbiased information with which to make quality decisions If accounting information is biased so as to not reflect the economic realities of a business, poor resource allocation decisions can be made The accountant must exercise caution in ensuring that estimates are reasonable While incentives may exist that cause the accountant to consider using overly optimistic estimates, incentives also exist to ensure that the accountant remains unbiased For example, if an investor or creditor suffers a loss as a result of relying on information contained in the financial statements of a company, accountants may find themselves in a court of law trying to justify their estimates Accounting is one part science and one part art While the mechanics of accounting may seem relatively straightforward, such is not the case Bookkeeping is straightforward and requires little judgment; accounting requires significant judgment Chapter 71 Cumulative Spreadsheet Analysis See Cumulative Spreadsheet Analysis solutions CD-ROM, provided with this manual Internet Search Operating profitability calculations, by fiscal quarter, for fiscal 2001, fiscal 2000, and fiscal 1985 (the earliest year available) are as follows Revenue Cost of revenue Research and development Sales and marketing General and administrative Operating income Losses on equity investees and other Investment income Noncontinuing items Provision for taxes Income before accounting change Cumulative effect of accounting change Net income Operating income/Revenue Revenue Cost of revenue Research and development Sales and marketing General and administrative Operating income Losses on equity investees and other Investment income Noncontinuing items Provision for taxes Income before accounting change Net income Operating income/Revenue Q1 $ 5,766 (825) (956) (1,038) (170) $ 2,777 (52) 1,127 (1,271) $ 2,581 (375) $ 2,206 48.2% Q1 $ 5,384 (712) (813) (922) (148) $ 2,789 (19) 550 (1,129) $ 2,191 $ 2,191 51.8% Fiscal 2001 Q2 Q3 $ 6,550 $ 6,403 (864) (899) (990) (1,069) (1,290) (1,198) (212) (239) $ 3,194 $ 2,998 (28) (46) 751 706 0 (1,293) (1,207) $ 2,624 $ 2,451 $ 2,624 $ 2,451 48.8% Q4 $ 6,577 (867) (1,364) (1,359) (236) $ 2,751 (33) (2,620) (32) $ 66 $ 66 46.8% 41.8% Fiscal 2000 Q2 Q3 $ 6,112 $ 5,656 (756) (752) (898) (974) (1,013) (1,010) (514) (185) $ 2,931 $ 2,735 (10) (4) 770 882 0 (1,255) (1,228) $ 2,436 $ 2,385 $ 2,436 $ 2,385 Q4 $ 5,804 (782) (1,087) (1,181) (203) $ 2,551 (24) 1,124 (1,242) $ 2,409 $ 2,409 48.0% 48.4% 44.0% 72 Chapter Chapter Revenue Cost of revenue Research and development Sales and marketing General and administrative Other expenses Operating income Investment income Provision for taxes Income before accounting change Net income Operating income/Revenue Q1 $26 (6) (4) (7) (2) $7 (3) $4 $4 26.9% Fiscal 1985 Q2 Q3 $ 37 $ 40 (9) (7) (4) (3) (11) (12) (2) (3) $ 11 $ 15 0 (5) (7) Q4 $ 37 (8) (6) (13) (2) $ (4) $ $ $ $ $ $ 29.7% 37.5% 21.6% In each year, the fourth quarter has the lowest operating profitability This may be because of some sort of seasonal factor; Microsoft’s fiscal fourth quarter covers the months of April, May, and June Alternatively, this result may be because of loose interim assumptions that are carefully reviewed during the fourth quarter The annual results are the only results audited, so the fourth quarter represents a “settling up” when all of the assumptions made during the year must be approved by the auditor ... verify or facilitate the accounting process but are not essential Under double-entry accounting, assets, expenses, and dividends are increased by debits and decreased by credits Liabilities, owners’... concept Generally accepted accounting principles require the use of accrual accounting 17 The use of double-entry accrual accounting is more accurate than a cashbasis accounting system primarily... concept 18 The major advantages offered by computers as compared with manual processing of accounting data are as follows: (a) Computers process large amounts of accounting data at great speeds, thus