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Transaction #1: Cash contribution
Assets ... Equity
Contributed
Cash ...
Capital
Beginning Balances $0 $0
1) Cash Contribution +6,000 +6,000
Ending Balances 6,000 6,000

Transaction #2: Revenue recognition


Assets ... Equity
Accounts
... Retained Earnings
Receivable
Beginning Balances $0 $0
2) Revenue Recognition +2,000 +2,000
Ending Balances 2,000 2,000

Transaction #3: Cash collection


Assets ... Assets
Accounts
Cash ...
Receivable
Beginning Balances $6,000 $2,000
3) Cash Collection +1,500 -1,500
Ending Balances 7,500 500

Transaction #4: Rent payment


Assets ... Equity
Cash ... Retained Earnings
Beginning Balances $7,500 $2,000
4) Rent Payment -400 -400
Ending Balances 7,100 1,600

Transaction #5: Salaries payment


Assets ... Equity
Cash ... Retained Earnings
Beginning Balances $7,100 $1,600
5) Salaries Payment -300 -300
Ending Balances 6,800 1,300

Transaction #6: Purchase of certificate of deposit


Assets ... Assets
Certificate of
Cash ...
Deposit
Beginning Balances $6,800 $0
6) Purchase of CD -2,500 +2,500
Ending Balances 4,300 2,500

Transaction #7: Recognition of salaries payable


Liabilities ... Equity
Salaries Payable ... Retained Earnings
Beginning Balances $0 $1,300
7) Salaries Payable Accrual +1,200 -1,200
Ending Balances 1,200 100

Transaction #8: Recognition of interest receivable


Assets ... Equity
Interest ... Retained Earnings

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Receivable
Beginning Balances $0 $100
8) Interest Receivable Accrual +50 +50
Ending Balances 50 150

Note that Event No.5 and Event No.7 in 20X7 (salary expense) both decrease Retained Earnings. However, they
act differently as to their second corresponding accounts. When we pay cash for salary expenses (Event No.5),
assets (Cash) decrease, but when we record an accrual for salary expenses (Event No.7), liabilities (Salaries
Payable) increase.
For Event No.8 in 20X7 Fored Company recognized interest revenue on the certificate of deposit for 20X7, that is
for the 3 months (from October to December). The formula to calculate the interest accrual is as follows: $2,500
x 8% x (3 / 12) = $50.

At the end of accounting period 20X7, account balances were as follows:


Cash 4,300
Accounts Receivable 500
Interest Receivable 50
Certificate of Deposit 2,500
Land 0
Salaries Payable 1,200
Interest Payable 0
Note Payable 0
Contributed Capital 6,000
Retained Earnings 150

Analysis of transactions for period 20X8 is presented below.


Transaction #1: Recognition of salaries payable
Assets ... Liabilities
Cash ... Salaries Payable
Beginning Balances $4,300 $1,200
1) Salaries Payable Payment -1,200 -1,200
Ending Balances 3,100 0

Transaction #2: Revenue recognition


Assets ... Equity
Accounts
... Retained Earnings
Receivable
Beginning Balances $500 $150
2) Revenue Recognition +4,000 +4,000
Ending Balances 4,500 4,150

Transaction #3: Cash collection


Assets ... Assets
Accounts
Cash ...
Receivable
Beginning Balances $3,100 $4,500
3) Cash Collection +3,500 -3,500
Ending Balances 6,600 1,000

Transaction #4: Cash distribution


Assets ... Equity
Cash ... Retained Earnings
Beginning Balances $6,600 $4,150
4) Cash Distribution -1,500 -1,500
Ending Balances 5,100 2,650

Transaction #5: Land purchase


Assets ... Assets
Cash ... Land

! $!
Beginning Balances $5,100 $0
5) Land Purchase -5,000 +5,000
Ending Balances 100 5,000

Transaction #6: Borrowing from a bank


Assets ... Liabilities
Cash ... Note Payable
Beginning Balances $100 $0
6) Bank Loan +2,000 +2,000
Ending Balances 2,100 2,000

Transaction #7: Receipt of note receivable


Assets ... Equity
Interest Certificate of
Cash ... Retained Earnings
Receivable Deposit
Beginning Balances $2,100 $50 $2,500 $2,650
7.1) Interest Receivable
+150 +150
Accrual
7.2) Interest Collection +200 -200
7.3) Principal Collection +2,500 -2,500
Ending Balances 4,800 0 0 2,800

Transaction #8: Recognition of interest payable


Liabilities ... Equity
Interest
... Retained Earnings
Payable
Beginning Balances $0 $2,00
8) Interest Payable Accrual 133 -133
Ending Balances 133 2,667
Event No.5 in 20X8 records the historical value of land. Even though by December 31, 20X8 the land value rose,
we do not adjust it in books, but leave it as it was when purchased.
Event No.7 in 20X8 is actually composed of three parts: 7.1 - recognizing the remaining part of interest on the
certificate of deposit ($2,500 x 8% x [9 / 12] = $150); 7.2 - collecting cash for Interest Receivable; and 7.3 -
getting the principal amount from the bank.
Event No.8 in 20X8 acts to record the accrual for interest payable on the note that the company bought on May
1, 20X8. The note has a 12-month term, so we need to recognize an interest expense only from the moment of
acquiring the note till the end of the accounting period, December 31. The calculation is as follows: $2,000 x
10% x (8 / 12) = $133.

At the end of accounting period 20X8, account balances were as follows:


Cash 4,800
Accounts Receivable 1,000
Interest Receivable 0
Certificate of Deposit 0
Land 5,000
Salaries Payable 0
Interest Payable 133
Note Payable 2,000
Contributed Capital 6,000
Retained Earnings 2,667
Let's prepare financial statements for 20X7 and 20X8. The two accounting periods will be included in the same
tables so that we can compare account balances.
Remember the vertical financial statements model described in Lesson No. 1. We will use it now in our exercise.

Fored Services
Income Statement

! %!
For the Period Ended For the Period Ended
20X7 20X8
Services Revenue $2,000 $4,000
Interest Revenue 50 150
Total Revenue $2,050 $4,150
Salary Expense (1,500) $0
Rent Expense (400) 0
Interest Expense 0 (133)
Total Expenses (1,900) (133)
Net Income $150 $4,017

Fored Services
Balance Sheet
For the Period Ended For the Period Ended
20X7 20X8
Assets
Cash $4,300 $4,800
Accounts receivable 500 1,000
Interest Receivable 50 0
Certificate of Deposit 2,500 0
Land 0 5,000
Total Assets $7,350 $10,800

Liabilities
Salaries Payable $1,200 $0
Interest Payable 0 133
Note payable 0 2,000
Total Liabilities $1,200 $2,133

Equity
Contributed Capital $6,000 $6,000
Retained Earnings 150 2,667
Total Equity $6,150 $8,667

Total Liability and Equity $7,350 $10,800


Fored Services
Statement of Changes in Equity
For the Period Ended For the Period Ended
20X7 20X8
Beginning Contrib. Capital $0 $6,000
Plus: Capital Acquisition 6,000 0
Ending Contributed Capital $6,000 $6,000

Beginning Retained Earnings $0 $150


Plus: Net Income 150 4,017
Less: Distribution 0 (1,500)
Ending Retained Earnings $150 $2,667

Total Equity $6,150 $8,667

Fored Services
Statement of Cash Flows

! &!
For the Period Ended For the Period Ended
20X7 20X8

Cash Flows from Operating Activities


Cash Receipts from Revenue $1,500 $3,700
Cash Payments for Expenses (700) (1,200)

Net Cash Flow from Operat. Activities $800 $2,500

Cash Flows from Investment Activities


Cash Receipts from Redeemed CD $0 $2,500
Cash Payment to Purchase CD (2,500) 0
Cash Payment to Purchase Land 0 (5,000)

Net Cash Flow from Invest. Activities (2,500) (2,500)

Cash Flows from Financing Activities


Cash Receipts from Cap. Cont. $6,000 $0
Cash Receipts from Borrowed Funds 0 2,000
Cash Payment for Distribution 0 (1,500)
Net Cash Flow from Financing Activities $6,000 $500

Net Change in Cash $4,300 500


Plus: Beginning Cash Balance 0 4,300
Ending Cash Balance $4,300 $4,800
Cash receipts from revenue for 20X8 include both services revenue ($3,500) and interest revenue ($200).

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