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CHAPTER 1

Accounting in Action
Solutions to Exercises

Dr.Helmi Hammami,
CBE – QU
Helmi.hammami@qu.edu.qa
For any of your enquiries.

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ANSWERS TO QUESTIONS

 1. Yes, this is correct. Virtually every organization and person in our society uses accounting
information. Businesses, investors, creditors, government agencies, and not-for-profit
organizations must use accounting information to operate effectively.

 2. Accounting is the process of identifying, recording, and communicating the economic events
of an organization to interested users of the information. The first step of the accounting
process is therefore to identify economic activities relevant to a particular organization. Once
identified, the events are recorded to provide a history of the financial activities of the
organization. Recording consists of keeping a chronological diary of these measured events
in an orderly and systematic manner. The information is communicated through the
preparation and distribution of accounting reports, the most common of which are called
financial statements. A vital element in the communication process is the accountant’s ability
and responsibility to analyze and interpret the reported information.

 3. (a) Internal users are managers who plan, organize, and run a business.
(b) To assist management, accounting provides internal reports. Examples include
financial comparisons of operating alternatives, projections of income from new sales
campaigns, and forecasts of cash needs for the next year.

 4. (a) Investors (owners) use accounting information to make decisions to buy, hold, or sell
stock.
(b) Creditors use accounting information to evaluate the risks of granting credit or
lending money.

 5. Bookkeeping usually involves only the recording of economic events and therefore is just
one part of the entire accounting process. Accounting, on the other hand, involves the entire
accounting process, including identification, recording, and communication.

 6. Jackie Remmers Inc. should report the land at $81,000 on its December 31, 2006 balance
sheet. An important concept that accountants follow is the cost principle. The cost principle
states that assets should be recorded at their cost. Cost has an important advantage over
other valuations: it is reliable. Cost can be objectively measured and can be verified.

 7. The monetary unit assumption requires that only transaction data capable of being
expressed in terms of money be included in the accounting records. An important part of the
monetary unit assumption is the added assumption that the unit of measure remains
sufficiently constant over time. The assumption of a stable monetary unit has been
challenged because of the significant decline in the purchasing power of the dollar. The
profession has recognized this problem and encourages companies to disclose the effects of
changing prices.

 8. The economic entity assumption requires that the activities of the entity be kept separate
and distinct from the activities of its owners and all other economic entities.

 9. The three basic forms of business organizations are: (1) proprietorship, (2) partnership, and
(3) corporation.
Questions Chapter 1 (Continued)

10. One of the advantages Teresa Speck would enjoy is that ownership of a corporation is
represented by transferable shares of stock. This would allow Teresa to raise money easily
by selling a part of her ownership in the company. Another advantage is that because
holders of the shares (stockholders) enjoy limited liability, they are not personally liable for
the debts of the corporate entity. Also, because ownership can be transferred without
dissolving the corporation, the corporation enjoys an unlimited life.

11. The basic accounting equation is Assets = Liabilities + Stockholders’ (Owner’s) Equity.

12. (a) Assets are resources owned by a business. Liabilities are claims against assets.
Put more simply, liabilities are existing debts and obligations. Stockholders’ equity is the
ownership claim on total assets.
(b) Stockholders’ equity is affected by stockholders’ investments, dividends, revenues,
and expenses.

13. The liabilities are: (b) Accounts payable and (g) Salaries payable.

14. Yes, a business can enter into a transaction in which only the left side of the accounting
equation is affected. An example would be a transaction where an increase in one asset is
offset by a decrease in another asset. An increase in the Equipment account which is offset
by a decrease in the Cash account is a specific example.

15. Business transactions are the economic events of the enterprise recorded by accountants
because they affect the basic equation.
(a) No. The death of the president of the corporation is not a business transaction as it
does not affect the basic accounting equation.
(b) Yes. Supplies purchased on account is a business transaction as it affects the
basic accounting equation.
(c) No. An employee being fired is not a business transaction as it does not affect the
basic accounting equation.

16. (a) Decrease assets and decrease stockholders’ equity.


(b) Increase assets and decrease assets.
(c) Increase assets and increase stockholders’ equity.
(d) Decrease assets and decrease liabilities.

17. (a) Income statement. (d) Balance sheet.


(b) Balance sheet. (e) Balance sheet.
(c) Income statement. (f) Balance sheet.

18. No, this treatment is not proper. While the transaction does involve a receipt of cash, it does
not represent revenues. Revenues are the gross increase in stockholders’ equity resulting
from business activities entered into for the purpose of earning income. This transaction is
simply an additional investment made by one of the owners of the business.

19. Yes. Net income does appear on the income statement—it is the result of subtracting expenses
from revenues. In addition, net income appears in the retained earnings statement—it is shown
as an addition to the beginning-of-period retained earnings. Indirectly, the net income of a
company is also included in the balance sheet. It is included in the retained earnings account
which appears in the stockholders’ equity section of the balance sheet.

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Questions Chapter 1 (Continued)

20. (a) Ending stockholders’ equity balance.................................................................. $198,000


Beginning stockholders’ equity balance............................................................. 164,000
Net income......................................................................................................... $ 34,000

(b) Ending stockholders’ equity balance.................................................................. $198,000


Beginning stockholders’ equity balance............................................................. 164,000
  34,000
Deduct: Investment........................................................................................... 8,000
Net income......................................................................................................... $ 26,000

21. (a) Total revenues ($45,000 + $95,000).................................................................. $140,000

(b) Total expenses ($26,000 + $43,000).................................................................  $69,000

(c) Total revenues.................................................................................................... $140,000


Total expenses................................................................................................... 69,000
Net income......................................................................................................... $ 71,000
SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 1-1

(a) $90,000 – $50,000 = $40,000 (Stockholders’ Equity).


(b) $45,000 + $70,000 = $115,000 (Assets).
(c) $94,000 – $65,000 = $29,000 (Liabilities).

BRIEF EXERCISE 1-2

(a) $100,000 + $232,000 = $332,000 (Total assets).


(b) $190,000 – $80,000 = $110,000 (Total liabilities).
(c) $600,000 – 0.5($600,000) = $300,000 (Stockholders’ equity).

BRIEF EXERCISE 1-3

(a) ($870,000 + $150,000) – ($500,000 – $80,000) = $600,000


(Stockholders’ equity).
(b) ($500,000 + $100,000) + ($870,000 – $500,000 – $70,000) = $900,000
(Assets).
(c) ($870,000 – $80,000) – ($870,000 – $500,000 + $120,000) = $300,000
(Liabilities).

BRIEF EXERCISE 1-4

Assets Liabilities Stockholders’ Equity


(a) + + NE
(b) + NE +
(c) – NE –

BRIEF EXERCISE 1-5

Assets Liabilities Stockholders’ Equity


(a) + NE +
(b) – NE –
(c) NE NE NE

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BRIEF EXERCISE 1-6

E (a) Advertising expense A (e) Cash


R (b) Commission revenue R (f) Rent revenue
E (c) Insurance expense E (g) Utilities expense
A (d) Office equipment L (h) Accounts payable

BRIEF EXERCISE 1-7

R (a) Received cash for services performed


NSE (b) Paid cash to purchase equipment
E (c) Paid employee salaries

BRIEF EXERCISE 1-8

GOMEZ COMPANY
Balance Sheet
December 31, 2006

Assets
Cash.................................................................................................. $ 44,000
Accounts receivable........................................................................ 72,500
Total assets.............................................................................. $116,500

Liabilities and Stockholders’ Equity


Liabilities
Accounts payable.................................................................... $ 85,000
Stockholders’ equity
Common stock......................................................................... 31,500
Total liabilities and stockholders’ equity...................... $116,500

BRIEF EXERCISE 1-9

A (a) Accounts receivable A (d) Office supplies


L (b) Salaries payable SE (e) Common stock
A (c) Equipment L (f) Notes payable
BRIEF EXERCISE 1-10

BS (a) Notes payable


IS (b) Advertising expense
BS (c) Common stock
BS (d) Cash
IS (e) Service revenue

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SOLUTIONS TO EXERCISES

EXERCISE 1-1

Asset Liability Stockholders’ Equity


Cash Accounts payable Common stock
Cleaning equipment Notes payable
Cleaning supplies Salaries payable
Accounts receivable

EXERCISE 1-2

1. Increase in assets and increase in stockholders’ equity.


2. Decrease in assets and decrease in stockholders’ equity.
3. Increase in assets and increase in liabilities.
4. Increase in assets and increase in stockholders’ equity.
5. Decrease in assets and decrease in stockholders’ equity.
6. Increase in assets and decrease in assets.
7. Increase in liabilities and decrease in stockholders’ equity.
8. Increase in assets and decrease in assets.
9. Increase in assets and increase in stockholders’ equity.

EXERCISE 1-3

1. (c) 5. (d)
2. (d) 6. (b)
3. (a) 7. (e)
4. (b) 8. (f)

EXERCISE 1-4

(a) 1. Stockholders invested $15,000 cash in the business.


2. Purchased office equipment for $5,000, paying $2,000 in cash and
the balance of $3,000 on account.
3. Paid $750 cash for supplies.
4. Earned $6,300 in revenue, receiving $2,600 cash and $3,700 on
account.
5. Paid $1,500 cash on accounts payable.
EXERCISE 1-4 (Continued)

6. Paid $1,000 cash dividends to stockholders.


7. Paid $650 cash for rent.
8. Collected $450 cash from customers on account.
9. Paid salaries of $3,900.
10. Incurred $500 of utilities expense on account.

(b) Investment.................................................................................. $15,000


Service revenue......................................................................... 6,300
Dividends................................................................................... (1,000)
Rent expense............................................................................. (650)
Salaries expense....................................................................... (3,900)
Utilities expense........................................................................ (500)
Increase in stockholders’ equity............................................. $15,250

(c) Service revenue......................................................................... $6,300


Rent expense............................................................................. (650)
Salaries expense....................................................................... (3,900)
Utilities expense........................................................................ (500)
Net income................................................................................. $1,250

EXERCISE 1-5

J. L. KANG & CO.


Income Statement
For the Month Ended August 31, 2006

Revenues
Service revenue........................................................... $6,300
Expenses
Salaries expense......................................................... $3,900
Rent expense............................................................... 650
Utilities expense.......................................................... 500
Total expenses..................................................... 5,050
Net income........................................................................... $1,250

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EXERCISE 1-5 (Continued)

J. L. KANG & CO.


Retained Earnings Statement
For the Month Ended August 31, 2006

Retained Earnings, August 1........................................ $ 0


Add: Net income........................................................... 1,250
1,250
Less: Dividends............................................................. 1,000
Retained Earnings, August 31...................................... $ 250

J. L. KANG & CO.


Balance Sheet
August 31, 2006

Assets
Cash.................................................................................................. $ 8,250
Accounts receivable........................................................................ 3,250
Supplies............................................................................................ 750
Office equipment............................................................................. 5,000
Total assets.............................................................................. $17,250

Liabilities and Stockholders’ Equity


Liabilities
Accounts payable....................................................... $ 2,000
Stockholders’ equity
Common stock............................................................ $15,000
Retained earnings....................................................... 250
Total stockholders’ equity.................................. 15,250
Total liabilities and stockholders’ equity.......... $17,250

EXERCISE 1-6

(a) Stockholders’ equity—12/31/05 ($380,000 – $250,000)........ $130,000


Stockholders’ equity—1/1/05.................................................. 100,000
Increase in Stockholders’ equity........................................... 30,000
Add: Dividends....................................................................... 15,000
Net income for 2005................................................................. $ 45,000
EXERCISE 1-6 (Continued)

(b) Stockholders’ equity—12/31/06 ($460,000 – $310,000)...... $150,000


Stockholders’ equity—1/1/06—see (a)................................. 130,000
Increase in Stockholders’ equity.......................................... 20,000
Less: Additional investment................................................ 50,000
Net loss for 2006..................................................................... $ (30,000)

(c) Stockholders’ equity—12/31/07 ($590,000 – $400,000)...... $190,000


Stockholders’ equity—1/1/07—see (b)................................. 150,000
Increase in Stockholders’ equity.......................................... 40,000
Less: Additional investment................................................ 15,000
25,000
Add: Dividends..................................................................... 30,000
Net income for 2007............................................................... $ 55,000

EXERCISE 1-7

(a) Total assets (beginning of year)........................................... $ 97,000


Total liabilities (beginning of year)....................................... 85,000
Total stockholders’ equity (beginning of year)................... $ 12,000

(b) Total stockholders’ equity (end of year).............................. $ 40,000


Total stockholders’ equity (beginning of year)................... 12,000
Increase in stockholders’ equity.......................................... $ 28,000

Total revenues........................................................................ $215,000


Total expenses....................................................................... 175,000
Net income.............................................................................. $ 40,000

Increase in stockholders’ equity..................... $ 28,000


Less: Net income............................................. $(40,000)
Add: Dividends............................................... 24,000) (16,000)
Additional investment...................................... $ 12,000

(c) Total assets (beginning of year)........................................... $129,000


Total stockholders’ equity (beginning of year)................... 75,000
Total liabilities (beginning of year)....................................... $ 54,000

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EXERCISE 1-7 (Continued)

(d) Total stockholders’ equity (end of year).............................. $130,000


Total stockholders’ equity (beginning of year)................... 75,000
Increase in stockholders’ equity.......................................... $ 55,000

Total revenues........................................................................ $100,000


Total expenses....................................................................... 55,000
Net income.............................................................................. $ 45,000

Increase in stockholders’ equity..................... $55,000


Less: Net income............................................. $(45,000)
Additional investment.......................... (25,000) (70,000)
Dividends.......................................................... $15,000

EXERCISE 1-8

KARIN WEIGEL CO.


Income Statement
For the Year Ended December 31, 2006

Revenues
Service revenue...................................................... $62,500
Expenses
Salaries expense..................................................... $28,000
Rent expense.......................................................... 10,400
Utilities expense..................................................... 3,100
Advertising expense............................................... 1,800
Total expenses................................................ 43,300
Net income...................................................................... $19,200

KARIN WEIGEL CO.


Retained Earnings Statement
For the Year Ended December 31, 2006

Retained earnings, January 1........................................................... $10,000


Add: Net income.............................................................................. 19,200
29,200
Less: Dividends................................................................................ 5,000
Retained earnings, December 31..................................................... $24,200
EXERCISE 1-9

SANCULI COMPANY
Balance Sheet
December 31, 2006

Assets
Cash.................................................................................................. $16,500
Accounts receivable........................................................................ 8,500
Supplies............................................................................................ 8,000
Equipment........................................................................................ 46,000
Total assets.............................................................................. $79,000

Liabilities and Stockholders’ Equity


Liabilities
Accounts payable....................................................... $20,000
Stockholders’ equity
Common stock............................................................ $50,000
Retained earnings ($17,500 – $8,500)....................... 9,000
Total stockholders’ equity.................................. 59,000
Total liabilities and stockholders’ equity.......... $79,000

EXERCISE 1-10

(a) Camping fee revenues............................................................ $192,000


General store revenues........................................................... 65,000
Total revenue.................................................................... 257,000
Expenses.................................................................................. 180,000
Net income................................................................................ $ 77,000

(b) GRISWOLD INC.


Balance Sheet
December 31, 2006

Assets
Cash.......................................................................................... $ 7,000
Supplies.................................................................................... 2,500
Equipment................................................................................ 109,000
Total assets...................................................................... $118,500

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EXERCISE 1-10 (Continued)

Liabilities and Stockholders’ Equity


Liabilities
Notes payable.................................................... $45,000
Accounts payable............................................. 11,000
Total liabilities............................................ $ 56,000
Stockholders’ equity
Common stock.................................................. 50,000
Retained earnings.............................................. 12,500**
Total stockholders’ equity........................ 62,500*
Total liabilities and stockholders’
equity........................................................... $118,500

$118,500 – $56,000
*
$62,500 – $50,000
**

EXERCISE 1-11
DEBRA-JOAN CRUISE COMPANY
Income Statement
For the Year Ended December 31, 2006

Revenues
Ticket revenue.................................................... $335,000
Expenses
Salaries expense................................................ $142,000
Maintenance expense........................................ 97,000
Property tax expense......................................... 10,000
Advertising expense.......................................... 3,500
Total expenses........................................... 252,500
Net income.................................................................. $ 82,500
EXERCISE 1-12
DOUGLAS, INC.
Retained Earnings Statement
For the Year Ended December 31, 2006

Retained Earnings, January 1.................................................. $150,000


Add: Net income...................................................................... 208,000*
358,000
Less: Dividends........................................................................ 52,000
Retained Earnings, December 31............................................ $306,000
*Legal service revenue earned $420,000

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Total expenses 212,000
Net income $208,000
SOLUTIONS TO PROBLEMS

PROBLEM 1-1A

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PROBLEM 1-1A (Continued)

Key to Retained Earnings column on previous page.

(a) Rent Expense


(b) Advertising Expense
(c) Service Revenue
(d) Dividends
(e) Salaries Expense

(b) Service revenue........................................................ $7,500


Expenses
Salaries.............................................................. $2,200
Rent.................................................................... 400
Advertising........................................................ 300 2,900
Net income................................................ $4,600
PROBLEM 1-2A

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PROBLEM 1-2A (Continued)

(b) MANDY ARNOLD, ATTORNEY AT LAW


Income Statement
For the Month Ended August 31, 2006

Revenues
Service revenue.............................................. $7,500
Expenses
Salaries expense............................................. $3,000
Rent expense................................................... 900
Advertising expense....................................... 350
Utilities expense.............................................. 250
Total expenses........................................ 4,500
Net income............................................................... $3,000

MANDY ARNOLD, ATTORNEY AT LAW


Retained Earnings Statement
For the Month Ended August 31, 2006

Retained Earnings, August 1................................................... $ 800


Add: Net income...................................................................... 3,000
3,800
Less: Dividends........................................................................ 550
Retained Earnings, August 31................................................. $3,250
PROBLEM 1-2A (Continued)

MANDY ARNOLD, ATTORNEY AT LAW


Balance Sheet
August 31, 2006

Assets
Cash............................................................................................ $ 2,500
Accounts receivable................................................................. 4,600
Supplies...................................................................................... 500
Office equipment....................................................................... 6,000
Total assets........................................................................ $13,600

Liabilities and Stockholders’ Equity


Liabilities
Notes payable.................................................................... $ 2,000
Accounts payable.............................................................. 2,350
Total liabilities............................................................ 4,350
Stockholders’ equity
Common stock...................................................... $6,000
Retained earnings................................................ 3,250
Total stockholders’ equity........................... 9,250
Total liabilities and stockholders’ equity... $13,600

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PROBLEM 1-3A

(a) DIVINE COSMETICS CO.


Income Statement
For the Month Ended June 30, 2006

Revenues
Service revenue............................................. $5,500
Expenses
Supplies expense.......................................... $1,600
Gas and oil expense...................................... 800
Advertising expense..................................... 500
Utilities expense............................................ 300
Total expenses....................................... 3,200
Net income............................................................. $2,300

DIVINE COSMETICS CO.


Retained Earnings Statement
For the Month Ended June 30, 2006

Retained Earnings, June 1................................... $ 0


Add: Net income.................................................. 2,300
2,300
Less: Dividends.................................................... 1,700
Retained Earnings, June 30................................. $ 600

DIVINE COSMETICS CO.


Balance Sheet
June 30, 2006

Assets
Cash............................................................................................ $10,000
Accounts receivable................................................................. 4,000
Cosmetic supplies..................................................................... 2,000
Equipment.................................................................................. 25,000
Total assets........................................................................ $41,000
PROBLEM 1-3A (Continued)

DIVINE COSMETICS CO.


Balance Sheet (Continued)
June 30, 2006

Liabilities and Stockholders’ Equity


Liabilities
Notes payable.................................................................... $13,000
Accounts payable.............................................................. 1,200
Total liabilities............................................................  14,200
Stockholders’ equity
Common stock...................................................... $26,200
Retained earnings................................................ 600
Total stockholders’ equity...........................  26,800
Total liabilities and stockholders’ equity... $41,000

(b) DIVINE COSMETICS CO.


Income Statement
For the Month Ended June 30, 2006

Revenues
Service revenue ($5,500 + $800).................. $6,300
Expenses
Supplies expense.......................................... $1,600
Gas and oil expense ($800 + $100).............. 900
Advertising expense..................................... 500
Utilities expense............................................ 300
Total expenses....................................... 3,300
Net income............................................................. $3,000

DIVINE COSMETICS CO.


Retained Earnings Statement
For the Month Ended June 30, 2006

Retained Earnings, June 1................................... $ 0


Add: Net income.................................................. 3,000
3,000
Less: Dividends.................................................... 1,700
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Retained Earnings, June 30................................. $1,300
PROBLEM 1-4A

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PROBLEM 1-4A (Continued)

(b) STINER CONSULTING, INC.


Income Statement
For the Month Ended May 31, 2006

Revenues
Service revenue ($3,000 + $3,300)................. $6,300
Expenses
Salaries expense............................................. $3,000
Rent expense................................................... 800
Utilities expense.............................................. 150
Advertising expense....................................... 50
Total expenses........................................ 4,000
Net income............................................................... $2,300

(c) STINER CONSULTING, INC.


Balance Sheet
May 31, 2006

Assets
Cash............................................................................................ $12,800
Accounts receivable................................................................. 1,300
Supplies...................................................................................... 500
Office equipment....................................................................... 2,400
Total assets........................................................................ $17,000

Liabilities and Stockholders’ Equity


Liabilities
Notes payable.................................................................... $ 5,000
Accounts payable.............................................................. 2,400
Total liabilities............................................................ 7,400
Stockholders’ equity
Common stock....................................................... $8,000
Retained earnings................................................. 1,600
Total stockholders’ equity............................ 9,600
Total liabilities and stockholders’ equity. . . $17,000
PROBLEM 1-5A

(a) Winger Selara Delta Hindi


Company Company Company Company
(a) $25,000 (d) $40,000 (g) $129,000 (j) $
50,000
(b) 95,000 (e) 55,000 (h) 80,000 (k) 220,000
(c) 10,000 (f) 18,000 (i) 408,000 (l) 465,000

(b) WINGER COMPANY


Retained Earnings Statement
For the Year Ended December 31, 2006

Retained Earnings, January 1.............................. $ 0


Add: Net income.................................................. 15,000
15,000
Less: Dividends.................................................... 10,000
Retained Earnings, December 31........................ $ 5,000

(c) The sequence of preparing financial statements is income


statement, retained earnings statement, and balance sheet. The
interrelationship of the retained earnings statement to the other
financial statements results from the fact that net income from the
income statement is reported in the retained earnings statement
and ending retained earnings reported in the retained earnings
statement is the amount reported in stockholders’ equity on the
balance sheet.

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PROBLEM 1-1B
PROBLEM 1-1B (Continued)

(b) Service revenue ($3,100 + $850)............................. $3,950


Expenses
Salaries.............................................................. $1,000
Rent.................................................................... 400
Advertising........................................................ 250
Utilities............................................................... 140 1,790
Net income................................................ $2,160

OR

Increase in retained earnings ($1,160 –$0)............................. $1,160


Add: Dividends........................................................................ 1,000
Net income................................................................................. $2,160

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PROBLEM 1-2B
PROBLEM 1-2B (Continued)

(b) NASHVILLE CORPORATION


Income Statement
For the Month Ended September 30, 2006

Revenues
Service revenue................................................... $6,300
Expenses
Salaries expense................................................. $1,700
Rent expense....................................................... 900
Advertising expense........................................... 300
Utilities expense.................................................. 170
Total expenses............................................. 3,070
Net income................................................................... $3,230

NASHVILLE CORPORATION
Retained Earnings Statement
For the Month Ended September 30, 2006

Retained Earnings, September 1............................................. $ 700


Add: Net income...................................................................... 3,230
3,930
Less: Dividends........................................................................ 600
Retained Earnings, September 30........................................... $3,330

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PROBLEM 1-2B (Continued)

NASHVILLE CORPORATION
Balance Sheet
September 30, 2006

Assets
Cash............................................................................................ $15,600
Accounts receivable................................................................. 4,200
Supplies...................................................................................... 600
Office equipment....................................................................... 8,100
Total assets........................................................................ $28,500

Liabilities and Stockholders’ Equity


Liabilities
Notes payable.................................................................... $10,000
Accounts payable.............................................................. 2,170
Total liabilities............................................................ 12,170
Stockholders’ equity
Common stock...................................................... $13,000
Retained earnings................................................ 3,330
Total stockholders’ equity........................... 16,330
Total liabilities and stockholders’ equity... $28,500
PROBLEM 1-3B

(a) SKYWARD FLYING SCHOOL INC.


Income Statement
For the Month Ended May 31, 2006

Revenues
Lesson revenue............................................. $8,600
Expenses
Fuel expense.................................................. $2,500
Rent expense................................................. 1,200
Advertising expense..................................... 500
Insurance expense........................................ 400
Repair expense.............................................. 400
Total expenses....................................... 5,000
Net income............................................................. $3,600

SKYWARD FLYING SCHOOL INC.


Retained Earnings Statement
For the Month Ended May 31, 2006

Retained Earnings, May 1.................................... $ 0


Add: Net income.................................................. 3,600
3,600
Less: Dividends.................................................... 1,700
Retained Earnings, May 31.................................. $1,900
SKYWARD FLYING SCHOOL INC...................Balance Sheet May 31,
2006

Assets
Cash............................................................................................ $ 6,500
Accounts receivable................................................................. 7,200
Equipment.................................................................................. 64,000
Total assets........................................................................ $77,700

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PROBLEM 1-3B (Continued)
SKYWARD FLYING SCHOOL INC.Balance Sheet (Continued) May 31,
2006

Liabilities and Stockholders’ Equity


Liabilities....................................................................... Notes payable
$30,000................................................................... Accounts payable
800...................................................................
Total liabilities.............................................................. 30,800
Stockholders’ equity................................................................. Common
stock $45,000
Retained earnings................................................ 1,900
Total stockholders’ equity
46,900 Total
liabilities and stockholders’ equity $77,700(b) SKYWARD FLYING
SCHOOL INC.Income Statement
For the Month Ended May 31, 2006

Revenues
Lesson revenue ($8,600 + $900).................. $9,500
Expenses
Fuel expense ($2,500 + $1,500).................... $4,000
Rent expense................................................. 1,200
Advertising expense..................................... 500
Insurance expense........................................ 400
Repair expense.............................................. 400
Total expenses....................................... 6,500
Net income............................................................. $3,000
SKYWARD FLYING SCHOOL INC.
Retained Earnings StatementFor the Month Ended May 31, 2006

Retained Earnings, May 1.................................... $ 0


Add: Net income.................................................. 3,000
3,000
Less: Dividends................................................... 1,700
Retained Earnings, May 31.................................. $ 1,300
PROBLEM 1-4B

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PROBLEM 1-4B (Continued)(b) DONAHUE DELIVERIES, INC.
Income Statement For the Month Ended June 30,
2006

Revenues.................................................................... Service revenue


($2,400 + $1,500)................................................................ $3,900
Expenses.................................................................... Salaries expense
$1,000.......................................................................... Rent expense
500 ................................................. Utilities expense 250
Gasoline expense............................................... 100
Total expenses........................................... 1,850
Net income.................................................................. $2,050

(c) DONAHUE DELIVERIES, INC.


Balance Sheet
June 30, 2005

Assets
Cash............................................................................................ $ 7,700
Accounts receivable................................................................. 1,650
Supplies...................................................................................... 150
Delivery van............................................................................... 10,000
Total assets........................................................................ $19,500

Liabilities and Stockholders’ Equity


Liabilities
Notes payable....................................................... $ 7,500
Accounts payable................................................. 150
Total liabilities............................................... 7,650
Stockholders’ equity
Common stock...................................................... $10,000
Retained earnings................................................ 1,850
Total stockholders’ equity........................... 11,850
Total liabilities and stockholders’ equity... $19,500
PROBLEM 1-5B

(a) Karma Molly McCain Bodie


Company Company Company Company
(a) $ 39,000 (d) $50,000 (g) $115,000 (j) $
80,000
(b) 115,000 (e) 72,000 (h) 70,000 (k) 240,000
(c) 16,000 (f) 38,000 (i) 436,000 (l) 445,000

(b) KARMA COMPANY


Retained Earnings Statement
For the Year Ended December 31, 2006

Retained Earnings, January 1............................ $ 0


Add: Net income................................................ 30,000
30,000
Less: Dividends.................................................. 25,000
Retained Earnings, December 31...................... $ 5,000

(c) The sequence of preparing financial statements is income


statement, retained earnings statement, and balance sheet. The
interrelationship of the retained earnings statement to the other
financial statements results from the fact that net income from the
income statement is reported in the retained earnings statement
and ending retained earnings reported in the retained earnings
statement is the amount reported in stockholders’ equity on the
balance sheet.

1-37
BYP 1-1 FINANCIAL REPORTING PROBLEM

(a) PepsiCo’s total assets at December 27, 2003 were $25,327 million
and at December 28, 2002 were $23,474 million.

(b) PepsiCo had $820 million of cash and cash equivalents at


December 27, 2003.

(c) PepsiCo had accounts payable (and other current liabilities) totaling
$5,213 million on December 27, 2003 and $4,998 million on December
28, 2002.

(d) PepsiCo reports net sales for three consecutive years as follows:

2001 $23,512 million


2002 $25,112 million
2003 $26,971 million
(e) From 2002 to 2003, PepsiCo’s net income increased $568 million
from $3,000 million to $3,568 million.
BYP 1-2 COMPARATIVE ANALYSIS PROBLEM

(a (in millions) PepsiCo Coca-Cola


)
1 Total assets $25,327 $27,342
.
2 Accounts receivable $ 2,830 $ 2,091
. (net)
3 Net sales $26,971 $21,044
.
4 Net income $ 3,568 $ 4,347
.

(b) PepsiCo’s total assets were approximately 7% less than Coca-


Cola’s total assets, and PepsiCo’s net sales were 28% greater than
Coca-Cola’s net sales. In addition, PepsiCo’s accounts receivable
were 35.3% greater than Coca-Cola’s and represent 10.5% of its net
sales. Coca-Cola’s accounts receivable amount to 9.9% of its net
sales. Both PepsiCo’s and Coca-Cola’s accounts receivable are at
satisfactory levels, being comparable to a 30-day collection period.

PepsiCo’s net income was 82% of Coca-Cola’s. It appears that


these two companies’ operations are comparable in some ways,
with Coca-Cola’s 2003 operations slightly more profitable.

1-39
BYP 1-3 RESEARCH CASE

(a) There is a concern that these payments “create the appearance—if


not the reality—that accounting firms will go easy on the audit to
hold on to the more lucrative consulting business.” Possible
solutions that have been proposed are that auditors should not do
anything other than audits for their clients. A more extreme
solution proposed is that auditors should not do anything other
than audits—period. That is, auditors shouldn’t do consulting
whether it is for audit clients or non-audit clients.

(b) At the time of this article the accounting profession policed itself.
That is, oversight and disciplinary actions were done by panels
that were created by accounting industry associations. The SEC
proposed creating a new oversight organization that would be
independent of the profession, and which would be comprised
largely of non-accountants.

(c) Some criticisms of the FASB that were cited in the article are that
(1) few people attend the FASB hearings (2) the board is comprised
primarily of accounting industry insiders (3) the rules that the
FASB issues are too complex (4) the FASB is too slow in issuing
new rules to deal with new issues, thus creating situations where
little guidance exists for important new problems.

(d) The article suggests that companies need to provide better and
more detailed disclosure about how they determine their financial
numbers, that auditors need to provide more detailed information
regarding how much they get paid for various services, and that
the SEC needs to provide better disclosure about its
correspondence with companies that it thinks are too aggressive in
their accounting practices.
BYP 1-4 INTERPRETING FINANCIAL STATEMENTS

(a) Creditors lend money to companies with the expectation that they
will be repaid at a specified point in time in the future. If a company
is generating cash from operations in excess of its investing
needs, it is more likely that it will be able to repay its creditors. Not
only did Xerox actually have negative cash from operations, but
most of the cash it received in order to meet its cash deficiency
was from issuing new debt. Both of these facts would be of
concern to the company’s creditors, since they would suggest
Xerox will be less likely to be able to repay its debts.

(b) As a stockholder you are interested in the long-term performance


of a company and how that translates into its stock price. Often
during the early years of a company’s life its cash provided by
operations is not sufficient to meet its investment needs, so that
company will have to get cash from outside sources. However, in
the case of Xerox, the company has operated for many years and
has a well established name brand. The negative cash from
operations might suggest operating deficiencies.

(c) The statement of cash flows reports information on a cash basis.


An investor cannot get the complete story on the company’s
performance and financial position without looking at the income
statement and balance sheet. Also, investors would want to look at
more than one year’s worth of data. The current year might not be
representative of past or future years.

(d) Xerox is a well known company. It has a past record of paying


dividends. Its management probably decided to continue to pay a
dividend to demonstrate confidence in the company’s future. They
may have felt that by not paying the dividend for the year they
would send a negative message to investors. However, by
choosing to pay a cash dividend the company obviously weakened

1-41
its cash position, and decreased its ability to repay its debts.

BYP 1-5 A GLOBAL FOCUS

(a) Nestlé follows the standards issued by the International


Accounting Standards Committee. Tootsie Roll and Hershey Foods
are U.S. companies and therefore they follow the standards issued
by the Financial Accounting Standards Board. To the extent that
these standards differ, the comparison may be difficult.

(b) There are at least two issues here. First, Nestlé’s financial reports
are prepared under the historical cost convention. As noted in the
chapter, the cost principle underlies U.S. accounting standards.
Thus, this would assist comparison. The second issue relates to
the full disclosure principle discussed in the chapter. It is noted
that Nestlé provides disclosures as required by the “4 th and 7th
European Union company law directives.” To the extent that these
disclosure requirements differ from U.S. disclosure requirements,
comparison may be impeded.

(c) The primary concern here relates to the monetary unit assumption.
In the U.S., financial statements are prepared in terms of U.S.
dollars. Nestlé prepares its statements in terms of Swiss francs.
While conversion from francs to dollars is possible, it will not
necessarily capture the full economic situation.
BYP 1-6 EXPLORING THE WEB

(a) The field is normally divided into three broad areas: auditing,
financial/ tax, and management accounting.

(b) The skills required in these areas:

People skills, sales skills, communication skills, analytical skills,


ability to synthesize, creative ability, initiative, computer skills.

(c) The skills required in these areas differ as follows:

Financial Management
Auditing and Tax Accounting
People skills Medium Medium Medium
Sales skills Medium Medium Low
Communication skills Medium Medium High
Analytical skills High Very High High
Ability to synthesize Medium Low High
Creative ability Low Medium Medium
Initiative Medium Medium Medium
Computer skills High High Very High

(d) Some key job functions in accounting:

Auditing: Work in audit involves checking accounting ledgers and


financial statements within corporations and government. This work is
becoming increasingly computerized and can rely on sophisticated
random sampling methods. Audit is the bread and butter work of
accounting. This work can involve significant travel and allows you to
really understand how money is being made in the company that you
are analyzing. It’s great background!

Budget Analysis: Budget analysts are responsible for developing and

1-43
managing an organization’s financial plans. There are plentiful jobs in
this area in government and private industry. Besides quantitative
skills many budget analyst jobs require good people skills because of
negotiations involved in the work.
BYP 1-6 (Continued)

Financial: Financial accountants prepare financial statements


based on general ledgers and participate in important financial
decisions involving mergers and acquisitions, benefits/ERISA
planning, and long-term financial projections. This work can be
varied over time. One day you may be running spreadsheets. The
next day you may be visiting a customer or supplier to set up a new
account and discuss business. This work requires a good
understanding of both accounting and finance.

Management Accounting: Management accountants work in


companies and participate in decisions about capital budgeting
and line of business analysis. Major functions include cost
analysis, analysis of new contracts, and participation in efforts to
control expenses efficiently. This work often involves the analysis
of the structure of organizations. Is responsibility to spend money
in a company at the right level of our organization? Are goals and
objectives to control costs being communicated effectively?
Historically, many management accountants have been derided as
“bean counters.” This mentality has undergone major change as
management accountants now often work side by side with
marketing and finance to develop new business.

Tax: Tax accountants prepare corporate and personal income tax


statements and formulate tax strategies involving issues such as
financial choice, how to best treat a merger or acquisition, deferral
of taxes, when to expense items and the like. This work requires a
thorough understanding of economics and the tax code.
Increasingly, large corporations are looking for persons with both
an accounting and a legal background in tax. A person, for
example, with a JD and a CPA would be especially desirable to
many firms.

(e) Junior Staff Accountant $36-63,000

1-45
BYP 1-7 GROUP DECISION CASE

(a) The estimate of the $4,900 loss was based on the difference
between the $20,000 invested in the driving range and the bank
balance of $15,100 at March 31. This is not a valid basis for
determining income because it only shows the change in cash
between two points in time.

(b) The balance sheet at March 31 is as follows:

CHIP-SHOT DRIVING RANGE


Balance Sheet
March 31, 2005

Assets
Cash............................................................................................ 15,100
Caddy shack.............................................................................. 6,000
Equipment.................................................................................. 800
Total assets........................................................................ $21,900

Liabilities and Stockholders’ Equity


Liabilities
Accounts payable ($150 + $100)...................................... $ 250
Stockholders’ equity
Common stock...................................................... $20,000
Retained earnings................................................ 1,650
Total stockholders’ equity.......................... $21,650
Total liabilities and stockholders’ equity. . $21,900

As shown in the balance sheet, the stockholders’ equity at March


31 is $21,650. The estimate of $1,650 of net income is the
difference between the initial investment of $20,000 and $21,650.
This was not a valid basis for determining net income because
changes in stockholders’ equity between two points in time may
have been caused by factors unrelated to net income. For
example, there may be dividends and/or additional capital
investments by the stockholders.
BYP 1-7 (Continued)

(c) Actual net income for March can be determined by adding dividends
to the change in stockholders’ equity during the month as shown
below:

Stockholders’ equity, March 31, per balance sheet............... $21,650


Stockholders’ equity, March 1................................................. 20,000
Increase in stockholders’ equity............................................. 1,650
Add: Dividends........................................................................ 800
Net income................................................................................. $ 2,450

Alternatively, net income can be found by determining the revenues


earned [described in (d) below] and subtracting expenses.

(d) Revenues earned can be determined by adding expenses incurred


during the month to net income. March expenses were Rent, $1,000;
Wages, $400; Advertising, $750; and Utilities, $100 for a total of
$2,250. Revenues earned, therefore, were $4,700 ($2,250 + $2,450).
Alternatively, since all revenues are received in cash, revenues earned
can be computed from an analysis of the changes in cash as follows:

Beginning cash balance......................................... $20,000


Less: Cash payments
Caddy shack........................................... $6,000
Golf balls and clubs............................... 800
Rent......................................................... 1,000
Advertising ($750 – $150)...................... 600
Wages..................................................... 400
Dividends................................................ 800 9,600
Cash balance before revenues.............................. 10,400
Cash balance, March 31.......................................... 15,100
Revenues earned..................................................... $ 4,700

1-47
BYP 1-8 COMMUNICATION ACTIVITY

To: Erin Danielle

From: Student

I have received the balance sheet of Bloomington Company as of


December 31, 2006. A number of items in this balance sheet are not
properly reported. They are:

1. The balance sheet should be dated as of a specific date, not for a


period of time. Therefore, it should be dated “December 31, 2006.”

2. Equipment should be shown as an asset but reported below Supplies


on the balance sheet.

3. Accounts receivable should be shown as an asset and reported


between Cash and Supplies on the balance sheet.

4. Accounts payable should be shown as a liability, not an asset. The


note payable is also a liability and should be reported in the liability
section.

5. Liabilities and stockholders’ equity should be shown on the balance


sheet. Common stock and dividends are not liabilities.

6. Common stock, retained earnings, and dividends are part of


stockholders’ equity. The Dividends account is not reported on the
balance sheet but is subtracted from beginning retained earnings to
arrive at retained earnings at the end of the period.
BYP 1-8 (Continued)

A correct balance sheet is as follows:

BLOOMINGTON COMPANY
Balance Sheet
December 31, 2006

Assets
Cash.................................................................................................... $ 9,000
Accounts receivable......................................................................... 6,000
Supplies............................................................................................. 2,000
Equipment.......................................................................................... 22,500
$39,500
Liabilities and Stockholders’ Equity
Liabilities
Notes payable............................................................................ $10,500
Accounts payable...................................................................... 8,000
Total liabilities.................................................................... 18,500
Stockholders’ equity
Common stock............................................................ $23,000
Retained earnings....................................................... (2,000) 21,000
Total liabilities and stockholders’ equity......... $39,500

1-49
BYP 1-9 ETHICS CASE

(a) The students should identify all of the stakeholders in the case; that
is, all the parties that are affected, either beneficially or negatively, by
the action or decision described in the case. The list of stakeholders
in this case are:

„ Jeff Hunter, interviewee.


„ Both Baltimore firms.
„ Great Northern College.

(b) The students should identify the ethical issues, dilemmas, or other
considerations pertinent to the situation described in the case. In this
case the ethical issues are:

„ Is it proper that Jeff charged both firms for the total travel costs
rather than split the actual amount of $282 between the two firms?

„ Is collecting $564 as reimbursement for total costs of $282 ethical


behavior?

„ Did Jeff deceive both firms or neither firm?

(c) Each student must answer the question for himself/herself. Would you
want to start your first job having deceived your employer before your
first day of work? Would you be embarrassed if either firm found out
that you double-charged? Would your school be embarrassed if your
act was uncovered? Would you be proud to tell your professor that
you collected your expenses twice?
BYP 1-10 CONTINUING COOKIE CHRONICLE

(a) Natalie has a choice between a sole proprietorship and a corporation.


A partnership is not an option since she is the sole owner of the
business.

A proprietorship is easier to create and operate because there are no


formal procedures involved in creating the proprietorship. However, if
she operates the business as a proprietorship she will personally
have unlimited liability for the debts of the business. Operating the
business as a corporation would limit her liability to her investment in
the business. Natalie will in all likelihood require the services of a
lawyer to incorporate. Costs to incorporate as well as additional
ongoing costs to administrate and operate the business as a
corporation may be costly.

My recommendation is that Natalie choose the proprietorship form of


business organization. This is a very small business where the cost of
incorporating outweighs the benefits of incorporating at this point in
time. Furthermore, it will be easier to stop operating the business if
Natalie decides not to continue with it once she has finished college.

(b) Yes, Natalie will need accounting information to help her operate her
business. She will need information on her cash balance on a daily or
weekly basis to help her determine if she can pay her bills. She will
need to know the cost of her services so she can establish her prices.
She will need to know revenue and expenses so she can report her
net income for personal income tax purposes, on an annual basis. If
she borrows money, she will need financial statements so lenders can
assess the liquidity, solvency, and profitability of the business. Natalie
would also find financial statements useful to better understand her
business and identify any financial issues as early as possible.
Monthly financial statements would be best because they are more
timely, but they are also more work to prepare.

1-51
BYP 1-10 (Continued)

(c) Assets: Cash, Accounts Receivable, Supplies, Equipment, Prepaid


Insurance
Liabilities: Accounts Payable, Unearned Revenue, Notes Payable
Owner’s Equity: Natalie Koebel, Capital, Natalie Koebel, Drawings
Revenue: Teaching Revenue
Expenses: Advertising Expense, Supplies Expense, Travel Expense,
Telephone Expense, Insurance Expense

(d) Natalie should have a separate bank account. This will make it easier
to prepare financial statements for her business. The business is a
separate entity from Natalie and must be accounted for separately.

(e) I recommend that Natalie keep the car as a personal asset and pay
for all costs personally. She should keep track of how many miles
she drives for business purposes versus personal use and
determine the percentage of business use versus personal use.
She should keep track of all costs of owning and operating her car
including such things as fuel, insurance, registration, and repairs
and maintenance. Then she can multiply the percentage of
business use by the total cost of owning and operating her car to
calculate the amount of expense the business can record for travel.
The business will record this as an expense. Natalie can either
reimburse herself for these business expenses by taking cash out
of the business to pay for these costs or she can treat it as an
investment in the business.
[Note to instructors: This last question is fairly complex and there
are income tax considerations. This suggested solution does not
cover all of the issues that should be considered. The intent is just
to ensure students begin to think about how to deal with a fairly
common issue for self-employed people.]