TEST BANK FUNDAMENTAL FINANCIAL ACCOUNTING CONCEPTS 9TH EDITION EDMONDS chap002 final

Chapter 02 - Understanding the Accounting Cycle -Chapter 02 Accounting for Accruals and Deferrals Answer Key Short Answer Questions Indicate how each event affects the elements of financial statements Use the following letters to record your answer in the box shown below each element You not need to enter amounts Banks Co performed $5,000 of services for customers on account Answer: (I) (N) (I) (I) (N) (I) (N) Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Easy Feedback: Performing services on account increases assets (accounts receivable) and increases revenue, which increases net income and equity (retained earnings) It does not affect the statement of cash flows, as it does not affect cash 2-1 Chapter 02 - Understanding the Accounting Cycle Todd Co collected $2,000 cash from accounts receivable Answer: (N) (N) (N) (N) (N) (N) (I) Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Easy Feedback: Collecting on accounts receivable increases one asset (cash) and decreases another asset (accounts receivable) It does not affect the income statement, but is reported as a cash inflow for operating activities on the statement of cash flows Ingstrom Co provided $2,600 of services for a customer who paid $1,000 cash immediately and promised to pay an additional $1,600 one month later Answer: (I) (N) (I) (I) (N) (I) (I) Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Medium Feedback: This event increases revenue, net income and equity (retained earnings) by $2,600 Cash increases by $1,000 and accounts receivable increases by $1,600, which result in an increase in assets of $2,600 It is reported as a $1,000 cash inflow for operating activities on the statement of cash flows 2-2 Chapter 02 - Understanding the Accounting Cycle Amity Co signed contracts for $25,000 of services to be performed in the future Answer: (N) (N) (N) (N) (N) (N) (N) Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Hard Feedback: This event does not affect the financial statements at all Revenue is recorded when services are performed, not when the contract is signed At the end of the accounting period, Signet Co recognized accrued salaries Answer: (N) (I) (D) (N) (I) (D) (N) Learning Objective: 02-02 Topic Area: Accounting for accrued expense AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Easy Feedback: Accruing salaries expense increases liabilities (salaries payable) and it increases expenses, which decreases net income and equity (retained earnings) It does not affect the statement of cash flows 2-3 Chapter 02 - Understanding the Accounting Cycle Calloway Company received $750 from a customer for services to be performed at a future date Answer: (I) (I) (N) (N) (N) (N) (I) Learning Objective: 02-07 Topic Area: Accounting for unearned revenues AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Easy Feedback: Collecting a payment in advance from a customer increases assets (cash) and increases liabilities (unearned revenue) It does not affect the income statement Revenue will not be recognized until the services are provided It will be reported as a cash inflow from operating activities on the statement of cash flows When is revenue recognized under accrual accounting? Answer: Revenue is recognized when it is earned; i.e when the services are performed Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Remember Level of Difficulty: Easy Feedback: Accrual accounting requires that companies recognize revenue when work is done regardless of when cash is collected What does the balance in accounts receivable represent? Answer: The balance in accounts receivable represents the amount of future cash receipts that are due from customers In other words, it is the amount to be collected from customers who previously received goods or services on account Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Remember Level of Difficulty: Easy 2-4 Chapter 02 - Understanding the Accounting Cycle Feedback: Accounts receivable is an asset account because it represents something that is owed to the company When are expenses recognized under accrual accounting in relation to the payment of cash? Answer: Expenses are recognized when they are incurred, regardless of when cash is paid In accrual transactions, that means that expenses are recorded before cash payments, and in deferral transactions they are recorded after cash payments Learning Objective: 02-02 Learning Objective: 02-05 Learning Objective: 02-06 Topic Area: Accounting for accrued expense Topic Area: Accounting for supplies purchase Topic Area: Accounting for prepaid items AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Expenses are recognized when incurred, regardless of when payment is made 10 What is the effect on the accounting equation of a cash payment to creditors? Answer: Assets decrease; liabilities decrease Learning Objective: 02-02 Topic Area: Accounting for accrued expense AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Making a cash payment to creditors decreases assets (cash) and decreases liabilities (accounts payable) 11 Why are adjusting entries necessary in an accrual accounting system? What are some common examples? Answer: Adjusting entries are necessary to update ledger account balances before preparing financial statements in order to recognize revenues and expenses that should be recognized in the current year, but have not yet been recorded Some common adjusting entries include recognizing accrued salaries expense, accrued interest revenue, and deferred expenses, such as prepaid rent, as well as recognizing revenue that had been previously unearned Learning Objective: 02-02 Learning Objective: 02-04 Learning Objective: 02-06 Learning Objective: 02-07 Topic Area: Accounting for accrued expense Topic Area: The matching concept Topic Area: Accounting for prepaid items Topic Area: Accounting for unearned revenue 2-5 Chapter 02 - Understanding the Accounting Cycle AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: The matching concept requires adjusting entries in certain transactions in order to recognize revenues and expenses in the proper accounting period These adjusting entries are made at the end of the period 12 What effect does the recording of revenue normally have on total assets? Answer: The recording of revenue normally has the effect of increasing total assets (usually cash or accounts receivable) Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Easy Feedback: If revenue is earned at the same time cash is collected, cash is increased If revenue is earned on account, and a customer is billed, accounts receivable is increased A less common situation involves earning revenue after cash was received in advance, in which case assets are unaffected (liabilities decrease and equity increases) 13 What effect does providing services on account have on the statement of cash flows? The balance sheet? Answer: There is no effect on the statement of cash flows when services are performed on account Assets and equity will increase on the balance sheet Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Providing services on account does not affect the cash account; therefore the statement of cash flows is unaffected The asset accounts receivable increases as does equity (revenue increases retained earnings) 14 Describe the purpose of the closing process Answer: The purpose of the closing process is to bring the balance of the temporary accounts to zero at the end of an accounting period and to update the retained earnings account By closing temporary accounts, they will be ready to capture revenue, expense, and dividend information for the next period Learning Objective: 02-04 Topic Area: The Closing Process 2-6 Chapter 02 - Understanding the Accounting Cycle AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Closing entries are made after the income statement is prepared Note that retained earnings is only affected by revenues, expenses, and dividends as the result of the closing process 15 Describe the difference between temporary and permanent accounts, and state which ones are closed Answer: Temporary accounts (revenues, expenses and dividends) collect information about a single period only; they are closed at the end of that period Permanent accounts include the balance sheet accounts (assets, liabilities, common stock and retained earnings), and their balances roll forward each year rather than being closed out Learning Objective 02-04 Topic Area: The Closing Process AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Revenue and expense accounts appear on the income statement Dividends is also a temporary account, but is not reported on the income statement It is reported only on the statement of changes in equity All permanent accounts appear on the balance sheet 16 Define the accounting cycle and list the stages of the cycle Answer: The accounting cycle is a series of steps or procedures that occur repeatedly throughout the life of a business The stages described to this point in the course include (1) recording transactions, (2) adjusting the accounts, (3) preparing financial statements, and (4) closing the temporary accounts Learning Objective 02-04 Topic Area: The accounting cycle AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: The accounting cycle repeats every accounting period This is usually annually 2-7 Chapter 02 - Understanding the Accounting Cycle 17 Explain the meaning of the term, "matching concept." Answer: The "matching concept" refers to the process of "matching" the expenses with the revenues that they produce in the appropriate time period This matching is largely done through the adjusting process For example, the accrual of salary expense has the effect of matching the correct portion of salary expense to the accounting period in which the employees contributed to producing revenue Matching means that expenses should be recognized in the same accounting period as the revenues that they helped a business to earn Learning Objective 02-04 Topic Area: The Matching Concept AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: The matching concept is the foundation of accrual accounting – the recognition of revenues as they are earned and expenses as they are incurred, regardless of when cash is exchanged 18 The temporary accounts are closed prior to the start of the next accounting cycle In this closing process, the amounts in each of these accounts are transferred to what other account(s)? Answer: Retained Earnings Learning Objective 02-04 Topic Area: The Closing Process AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Remember Level of Difficulty: Easy Feedback: Closing revenues increases retained earnings Closing expenses and dividends decreases retained earnings Note that closing entries are the only transactions that directly involve the retained earnings account 19 What is the "fraud triangle"? Answer: Auditors have identified three elements that are commonly present in instances of criminal and ethical misconduct These three elements are often shown in the form of a triangle The first of these elements is the availability of opportunity without which fraud could not exist Therefore, opportunity is at the top of the triangle The second element is the existence of some kind of pressure leading to an incentive The third element is the capacity to rationalize the behavior Learning Objective: 02-10 Topic Area: Features of Criminal and Ethical Misconduct 2-8 Chapter 02 - Understanding the Accounting Cycle AACSB: Reflective Thinking AACSB: Communication AACSB: Ethics AICPA: BB Legal AICPA: FN Risk Analysis Blooms: Understand Level of Difficulty: Medium Feedback: When working with ethical dilemmas, it is helpful to identify the opportunity, pressure and rationalization associated with that particular situation 20 Discuss the importance of ethics in the accounting profession Answer: Because the users of accounting information depend on that information for making decisions, auditors must be trustworthy and credible to render an opinion on the financial statements The management of a business is ultimately responsible for the financial statements; therefore, the accounting personnel of the business must also conduct themselves in a highly ethical manner Learning Objective: 02-10 Topic Area: Importance of Ethics AACSB: Communication AACSB: Ethics AICPA: BB Industry AICPA: FN Decision Making Blooms: Understand Level of Difficulty: Medium Feedback: The high ethical standards required by the accounting profession state “a certified public accountant assumes an obligation of self-discipline above and beyond requirements of laws and regulations.” The AICPA Code of Professional Conduct and the IMA Standards of Ethical Conduct are among ethics regulations governing the accounting profession 2-9 Chapter 02 - Understanding the Accounting Cycle Multiple Choice Questions 21 Bledsoe Company received $17,000 cash from the issue of stock on January 1, 2016 During 2016 Bledsoe earned $8,500 of revenue on account The company collected $6,000 cash from accounts receivable and paid $5,400 cash for operating expenses Based on this information alone, during 2016, A Total assets increased by $20,100 B Total assets increased by $600 C Total assets increased by $26,100 D Total assets did not change Answer: A Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Hard Feedback: $17,000 (cash) + $8,500 (accounts receivable) + $6,000 (cash) - $6,000 (accounts receivable) - $5,400 (cash) = $20,100 increase 22 Addison Company experienced an accounting event that affected its financial statements as indicated below: Which of the following accounting events could have caused these effects on Addison's statements? A Issued common stock B Earned revenue on account C Earned cash revenue D Collected cash from accounts receivable Answer: B Learning Objective: 02-01 Topic Area: Accounting for accounts receivable AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Medium Feedback: Earning revenue on account increases assets (accounts receivable) and increases revenue, which increases net income and equity (retained earnings) It does not affect cash flows 2-10 Chapter 02 - Understanding the Accounting Cycle 132 Classify each of the following transactions for the purpose of the statement of cash flows as operating activities (OA), investing activities (IA), financing activities (FA), or not reported on the statement of cash flows (NA) 1) _Collected accounts receivable 2) _Made adjusting entry to accrue salary expense at the end of the year 3) _Borrowed funds from the bank 4) _Paid rent for the month 5) _Paid cash to settle accounts payable 6) _Issued common stock for $30,000 cash 7) _Paid cash to acquire land Answer: 1) OA, 2) NA, 3) FA, 4) OA, 5) OA, 6) FA, 7) IA Learning Objective: 02-08 Topic Area: Prepare financial statements Topic Area: Statement of Cash Flows AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium 2-77 Chapter 02 - Understanding the Accounting Cycle 133 Tucker Company shows the following transactions for the accounting period ending December 31, 2016: 1) Sold books to customers for $68,000 on account 2) Collected $56,000 from customers 3) Issued common stock for $16,000 cash 4) Prepaid four months’ rent for $8,800 on October 1, 2016 5) Purchased supplies for $21,000 cash 6) Physical count shows $6,500 of supplies remained on December 31, 2016 7) Recorded adjustment for prepaid rent used Show how the above transactions and year-end adjustments affect the accounting equation Precede the amount with a minus sign if the transaction reduces that section of the equation Enter for items not affected Answer: Learning Objective: 02-01 Learning Objective: 02-05 2-78 Chapter 02 - Understanding the Accounting Cycle Learning Objective: 02-06 Topic Area: Accounting for accounts receivable Topic Area: Accounting for Supplies Topic Area: Accounting for prepaid items AACSB: Knowledge Application AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Apply Level of Difficulty: Medium 2-79 Chapter 02 - Understanding the Accounting Cycle 134 For each of the following transactions, indicate the type by entering "AS" for asset source transaction, "AU" for asset use transaction, "AE" for asset exchange transaction, and "CE" for claims exchange transaction 1) Paid $10,000 for a plot of land 2) Recorded the accrual of $1,000 in salaries to be paid the following week 3) Issued common stock for $20,000 in cash 4) Incurred operating expense on account 5) Paid off its accounts payable 6) Earned revenue to be collected at a future date 7) Paid $2,000 in dividends to its stockholders 8) Received cash from customers in #6 above 9) Paid the salaries accrued in #2 above 10) _Borrowed money from a local bank Answer: 1) AE 2) CE 3) AS 4) CE 5) AU 6) AS 7) AU 8) AE 9) AU 10) AS Learning Objective: 02-09 Topic Area: Transaction classification AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Medium 2-80 Chapter 02 - Understanding the Accounting Cycle 135 Determine whether each of the following events are asset source (AS), asset use (AU), asset exchange (AE), or claims exchange (CE) transactions _1) Borrowed $6,000 from creditors _2) Issued common stock to investors for $8,000 cash _3) Paid one year's rent in advance _4) Provided services to customers and received $35,000 cash _5) Paid creditors $10,000 _6) Received $3,000 of revenue in advance _7) Provided services to customers on account, $12,000 _8) Collected $2,000 from accounts receivable _9) Recognized accrued salary expense of $2,000 _10) Adjusted the records for supplies used of $800 Answer: 1) AS 2) AS 3) AE 4) AS 5) AU 6) AS 7) AS 8) AE 9) CE 10) AU Learning Objective: 02-09 Topic Area: Transaction classification AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Medium Feedback: 1) Borrowing cash is an asset source transaction that increases cash 2) Issuing common stock is an asset source transaction that increases cash )Paying rent in advance is an asset exchange transaction that increases prepaid rent and decreases cash 4) Providing services for cash is an asset source transaction that increases cash 5) Paying creditors is an asset use transaction that decreases cash 6) Receiving an advance payment is an asset source transaction that increases cash 7) Providing services on account is an asset source transaction that increases accounts receivable 8) Collecting on accounts receivable is an asset exchange transaction that increases cash and decreases accounts receivable 9) Accruing salary expense is a claims exchange transaction that increases accounts payable and decreases retained earnings 10) Recognizing supplies expense is an asset use transaction that decreases supplies Chapter Appendix For questions 136-138: Indicate how each event affects the elements of financial statements Use the following letters to record your answer in the box shown below each element You not need to enter amounts 2-81 Chapter 02 - Understanding the Accounting Cycle 136 Carson Company accrued $100 of interest expense Answer: (N) (I) (D) (N) (I) (D) (N) Learning Objective: 02-12 Topic Area: Accounting for Interest Expense AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Easy Feedback: Accruing interest expense increases liabilities (interest payable) and decreases equity (interest expense decreases retained earnings) It increases expenses and decreases net income It does not affect cash flows 137 Venture Company paid $50 of accrued interest expense Answer: (D) (D) (N) (N) (N) (N) (D) Learning Objective: 02-12 Topic Area: Accounting for Interest Expense AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Easy Feedback: Paying accrued interest expense decreases assets (cash) and decreases liabilities (interest payable) It does not affect the income statement, but is reported as a cash outflow for operating activities on the statement of cash flows 138 Cason Company recorded $2,000 of depreciation expense on a delivery van Answer: (D) (N) (D) (N) (I) (D) (N) Learning Objective: 02-11 Topic Area: Accounting for Depreciation Expense 2-82 Chapter 02 - Understanding the Accounting Cycle AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Easy Feedback: Recording depreciation expense decreases assets (increases the contra-asset accumulated depreciation) and decreases equity (depreciation expense decreases retained earnings) It increases expenses and decreases net income It does not affect cash flows Multiple Choice Questions - Appendix 139 Joseph Company purchased a delivery van on January 1, 2016 for $35,000 The van is estimated to have a 5-year useful life and a $5,000 salvage value How much expense should Joseph recognize in 2016 related to the use of the van? A $6,000 B $7,000 C $30,000 D $5,000 Answer: A Learning Objective: 02-11 Topic Area: Accounting for Depreciation Expense AACSB: Knowledge Application AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Apply Level of Difficulty: Easy Feedback: ($35,000 cost - $5,000 salvage value)/5 year useful life = $6,000 depreciation expense 140 Which of the following events involves a deferral? A Recording interest that has been earned but not received B Recording revenue that has been earned but not yet collected in cash C Recording supplies that have been purchased with cash but not yet used D Recording salaries owed to employees at the end of the year that will be paid during the following year Answer: C Learning Objective: 02-12 Topic Area: Accounting for Interest Expense AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Recording the purchase of supplies constitutes a deferral because it involves the payment of cash before an expense (in this case, supplies expense) is recognized 2-83 Chapter 02 - Understanding the Accounting Cycle 141 The entry to recognize depreciation expense incurred on equipment involves which of the following? A A decrease in assets B An increase in liabilities C An increase in assets D A decrease in liabilities Answer: A Learning Objective: 02-11 Topic Area: Accounting for Depreciation Expense AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Recognizing depreciation expense involves a decrease in assets due to an increase in the contra-asset accumulated depreciation and a decrease in equity due to recognizing depreciation expense 142 The following accounts and balances were drawn from the records of Barnes Company: Based on this information alone the amount of Barnes's retained earnings is A $11,600 B $17,200 C $5,200 D None of these answers is correct Answer: C Learning Objective: 02-11 Topic Area: Accounting for Depreciation Expense AACSB: Knowledge Application AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Apply Level of Difficulty: Medium Feedback: Assets ($4,500 + $2,700 + $10,000 - $3,200) = Liabilities ($2,800) + Equity ($6,000 + Retained Earnings); Retained Earnings = $5,200 2-84 Chapter 02 - Understanding the Accounting Cycle 143 Which of the following would be included in the "cash flow from operating activities" section of the statement of cash flows? A Accrual of salary expense at year-end B Purchase of equipment for cash C Payments of cash dividends to the owners of the business D Cash paid for interest on a note payable Answer: D Learning Objective: 02-12 Topic Area: Accounting for Interest Expense AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Paying or receiving interest is considered an operating activity Accruing salary expense is not a cash flow Paying dividends is a financing activity, and purchasing equipment is an investing activity 144 Chester Company began 2016 with a note payable of $20,000 and interest payable of $800 During the year, the company accrued an additional $400 of interest expense, and paid off the note with interest On the company’s 2016 income statement, cash flows for financing activities related to the note would be: A $1,200 outflow B $20,000 outflow C $20,400 outflow D $21,200 outflow Answer: B Learning Objective: 02-12 Topic Area: Accounting for Interest Expense AACSB: Knowledge Application AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Apply Level of Difficulty: Medium Feedback: Only the $20,000 principle would be considered an outflow for financing activities The $1,200 interest paid is considered an operating activity 145 For which of the following would net income on the accrual basis be different (either higher or lower) from "cash provided by operating activities" on the statement of cash flows? A Recognized depreciation expense on equipment B Incurred operating expenses on account C Paid interest that was accrued in a prior year D All of these answer choices would affect the income statement in a different period from the statement of cash flows Answer: D Learning Objective: 02-11 Learning Objective: 02-12 Topic Area: Accounting for Depreciation Expense Topic Area: Accounting for Interest Expense 2-85 Chapter 02 - Understanding the Accounting Cycle AACSB: Analytical Thinking AICPA: BB Critical Thinking AICPA: FN Measurement AICPA: FN Measurement Blooms: Analyze Level of Difficulty: Medium Feedback: Recognizing depreciation expense reduces net income, but does not affect cash flows for operating activities Incurring operating expenses on account also reduces net income, but does not affect cash flows for operating activities Paying interest that was accrued in a prior year will reduce cash flows for operating activities, but will not affect net income 146 Alabama Company purchased a machine on January 1, 2016 for $26,000 cash The machine has an estimated useful life of years and a $6,000 salvage value What would be the book (carrying) value of the machine reported on Alabama’s December 31, 2016 balance sheet? A $26,000 B $19,500 C $21,000 D $15,000 Answer: C Learning Objective: 02-11 Topic Area: Accounting for Depreciation Expense AACSB: Knowledge Application AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Apply Level of Difficulty: Medium Feedback: The amount of assets related to the machine on December 31 would be the machine’s book (carrying) value (cost minus accumulated depreciation) ($26,000 cost - $6,000 salvage value)/4 year useful life = $5,000 annual depreciation expense Book value = $26,000 - $5,000 = $21,000 True / False Questions - Appendix 147 Recognition of depreciation expense is an asset use transaction Answer: True Learning Objective: 02-11 Topic Area: Accounting for Depreciation Expense AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium Feedback: Recognition of depreciation expense is an asset use transaction that decreases the book (carrying) value of the depreciated asset and decreases equity 148 Recognition of depreciation expense on equipment decreases the equipment account Answer: False Learning Objective: 02-11 Topic Area: Accounting for Depreciation Expense AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Understand Level of Difficulty: Medium 2-86 Chapter 02 - Understanding the Accounting Cycle Feedback: Recognition of depreciation expense increases the contra-asset accumulated depreciation which decreases the book (carrying) value of the asset on the balance sheet It does not decrease the equipment account itself 149 When a company purchases a depreciable asset, it must estimate the asset’s useful life and salvage value Answer: True Learning Objective: 02-11 Topic Area: Accounting for Depreciation Expense AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Remember Level of Difficulty: Easy Feedback: It is necessary to estimate an asset’s useful life and salvage value in order to calculate depreciation expense associated with the use of that asset 150 Payment of interest is classified as a financing activity on the statement of cash flows Answer: False Learning Objective: 02-12 Topic Area: Accounting for Interest Expense AACSB: Reflective Thinking AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Remember Level of Difficulty: Medium Feedback: Payment of interest is classified as an operating activity on the statement of cash flows Essay Questions - Appendix 2-87 Chapter 02 - Understanding the Accounting Cycle 151 Thurston Company started its business on January 1, 2016 by issuing $15,000 of common stock On January 1, the company purchased equipment for $10,500 The equipment is estimated to have a 3-year useful life and a $1,500 salvage value On March 1, Thurston issued a $27,000, 6% 5-year note to Community Bank Customers paid Thurston $54,000 for services performed in 2016 The company paid $33,000 for operating expenses, and paid a $900 dividend to the stockholders At year-end, Thurston recognized interest expense on the note and depreciation expense on the computer Required: a) What is the amount of interest expense Thurston will recognize in 2016? b) What is the book (carrying) value of the computer at the end of 2016? c) What is the net income for 2016? d) Prepare a balance sheet for 2016 Answer: a) $27,000 x 6% x 10/12 = $1,350 interest expense b) Depreciation expense = ($10,500 - $1,500)/3 = $3,000; Book value = $10,500 - $3,000 = $7,500 c) $54,000 - $33,000 - $3,000 - $1,350 = $16,650 Net income d) Learning Objective: 02-08 Learning Objective: 02-11 2-88 Chapter 02 - Understanding the Accounting Cycle Learning Objective: 02-12 Topic Area: Prepare financial statements Topic Area: Balance Sheet Topic Area: Accounting for Depreciation Expense Topic Area: Accounting for Interest Expense AACSB: Knowledge Application AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Apply Level of Difficulty: Hard 152 The following events apply to Jason’s Lawn Service for 2016 1) Issued stock for $14,000 cash 2) On January 1, purchased equipment for $12,000 The equipment has an estimated 5-year useful life and a $2,000 salvage value 3) On May 1, issued a $3,000, 5% 3-year note to a local bank 4) Performed services of $18,400 and received cash 5) Paid $15,000 of operating expenses 6) At December 31, adjusted the records to recognize expense associated with use of the equipment and accrued interest Required: Record the effects of the above events under the appropriate account headings in the accounting formula below Precede the amount with a minus sign if the transaction reduces that section of the equation Enter for items not affected 2-89 Chapter 02 - Understanding the Accounting Cycle Answer: Learning Objective: 02-11 Learning Objective: 02-12 Topic Area: Accounting for Depreciation Expense Topic Area: Accounting for Interest Expense AACSB: Knowledge Application AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Apply Level of Difficulty: Hard 2-90 Chapter 02 - Understanding the Accounting Cycle 153 Osage Corporation began business operations and experienced the following transactions during 2016: 1) Issued common stock for $25,000 cash 2) Issued a $20,000, 6% 4-year note to the bank on February 3) Provided services to customers for $80,000 cash 4) Paid $38,000 for operating expenses 5) Accrued interest expense on the note 6) Paid a $4,000 dividend to shareholders Required: Record the above transactions on a horizontal statements model to reflect their effect on Osage's financial statements Precede the amount with a minus sign if the transaction reduces that section of the equation Enter for items not affected Precede a cash outflow amount with a minus sign In the last column, enter OA, IA, FA for the type of cash flow activity, or NA if there is no activity Answer: Learning Objective: 02-12 Topic Area: Accounting for interest expense AACSB: Knowledge Application AICPA: BB Critical Thinking AICPA: FN Measurement Blooms: Apply Level of Difficulty: Medium 2-91 ... Area: Accounting for accrued expense Topic Area: The matching concept Topic Area: Accounting for prepaid items Topic Area: Accounting for unearned revenue 2-5 Chapter 02 - Understanding the Accounting. .. 02-03 Topic Area: Accounting for accounts receivable Topic Area: Accounting for accrued expense Topic Area: Prepare financial statements 2-19 Chapter 02 - Understanding the Accounting Cycle AACSB:... the accounting period, then adjusted accounts at the end of the period Next, the company prepares financial statements, and finally, it closes temporary accounts in order to begin the next accounting