financial accounting tools for business decision making 6e solution manual chapter 4

Moderate 40-50 11A Prepare and post adjusting entries; prepare adjusted trial balance and financial statements; assess financial performance.. 3B Prepare adjusting and subsequent entries

CHAPTER 4 Accrual Accounting Concepts

ASSIGNMENT CLASSIFICATION TABLE

Study Objectives Questions

Brief Exercises Exercises

A Problems

B Problems BYP

* 1 Explain when

revenue and

expenses are

recognized and how

this forms the basis of

accrual accounting

* 2 Describe the types of

adjusting entries and

2B, 4B, 5B, 6B, 7B, 8B, 11B

5, 6, 7, 8, 9 5, 6, 7, 8 3A, 4A, 5A,

6A, 7A, 8A, 11A

3B, 4B, 5B, 6B, 7B, 8B, 11B

3, 7

* 5 Prepare closing

entries and a

post-closing trial balance

1, 3

ASSIGNMENT CHARACTERISTICS TABLE

Time Allotted (min.)

3A Prepare adjusting and subsequent entries for

accruals

Simple 20-30

4A Prepare transaction and adjusting entries Simple 20-30

7A Prepare and post adjusting entries; prepare adjusted

trial balance

Moderate 30-40

8A Complete accounting cycle through to preparation of

financial statements

Moderate 70

9A Prepare and post closing entries; prepare

post-closing trial balance

Simple 25-35

10A Prepare adjusted trial balance, closing entries and

post-closing trial balance

Moderate 40-50

11A Prepare and post adjusting entries; prepare adjusted

trial balance and financial statements; assess

financial performance

Moderate 40-50

12A

Prepare and post closing entries; prepare

post-closing trial balance

Simple 25-35

1B Calculate profit on cash and accrual bases Moderate 25-35 2B

Prepare transaction and adjusting entries for

prepayments

Simple 20-30

ASSIGNMENT CHARACTERISTICS TABLE (Continued)

Time Allotted (min.)

3B Prepare adjusting and subsequent entries for

7B Prepare and post adjusting entries; prepare adjusted

9B Prepare and post closing entries; prepare

post-closing trial balance

Simple 25-35

10B Prepare adjusted trial balance, closing entries and

post-closing trial balance

Moderate 40-50

11B Prepare and post adjusting entries; prepare adjusted

trial balance and financial statements; assess

financial performance

Moderate 40-50

12B

Prepare and post closing entries; prepare

post-closing trial balance

Simple 25-35

ANSWERS TO QUESTIONS

1 Adjusting entries are made to adjust the accounts at the end of the period to ensure

revenues and expenses are recorded when they are earned or incurred

When revenues and expenses should be recognized in the accounting records is dictated by recognition criteria Revenue is recognized or recorded when, due to ordinary activities, an increase in future economic benefits arising from an increase in

an asset or a decrease in a liability has occurred In general, revenue recognition occurs when the sales or performance effort is substantially complete, the amount is determinable (measurable), and collection is reasonably assured In a service company, revenue is considered to be earned when the service is provided In a merchandising company, revenue is considered to be earned when the merchandise

is sold (normally at the point of sale)

Expenses are recognized in the income statement when, due to an ordinary activity, there is a decrease in future economic benefits related to a decrease in an asset or an increase in a liability and this change can be measured reliably

2 The law firm should recognize the revenue in April because that is when it was earned;

the work was performed during that month

3 Expenses of $4,500 should be deducted from the revenues in April because that is

when the expenses were incurred and the revenues earned

4 Under the cash basis of accounting, events are only recognized in the period that cash

is paid or received Under the accrual basis, revenue is recognized when the goods or services are delivered or performed and expenses are recognized when incurred Information presented on an accrual basis is more useful because it records events when they actually occurred and the timing of their recognition cannot be manipulated

by delaying or speeding up the time at which the related cash flow occurs Because of this, accrual basis information is better at predicting future performance

5 (a) Prepaid expenses are assets because they have a future benefit since they were

paid for before they are used or consumed

(b) As the benefit of the prepayment expires (often with the passage of time) the asset must be reduced and an expense recognized This requires an adjustment at the end of each accounting period, to expense the portion of the prepaid that has expired (been used up) during the period

Answers to Questions (Continued)

6 (a) Unearned revenue arises when cash is received for goods or services to be

provided in the future It represents a liability because the cash has not yet been earned—the company has a future obligation to provide the goods or services (b) Unearned revenues must be adjusted at the end of an accounting period to reflect any revenues that have been earned

7 No Depreciation is the process of allocating the cost of a long-lived asset to expense

over its useful life Depreciation results in the presentation of the carrying amount (cost less accumulated depreciation) of the asset, not its fair value

8 (a) Depreciation expense is an expense account with a normal debit balance and is

reported on the income statement as part of the operating expenses This account shows the portion of the cost of a long-lived asset that has expired during the current accounting period

Accumulated depreciation is a contra asset account with a normal credit balance that is reported on the statement of financial position as a reduction of a depreciable asset (such as building and equipment) The balance in the accumulated depreciation account is the total depreciation that has been recognized from the date of acquisition to the statement of financial position date (b) Cost is the original cost of the asset when purchased

The carrying amount (also known as net book value) is the original cost of the asset less its related accumulated depreciation, and represents the portion of the asset that has not yet been depreciated

9 A contra asset account is an account with a credit balance that is deducted from the

related asset account on the statement of financial position Using a contra asset account discloses both the original cost of the asset and the total estimated cost which has expired or been used up to date This information is useful to the financial statement user

10 Yes, I agree A “simple” adjusting entry affects one statement of financial position

account and one income statement account An adjusting entry reallocates amounts between a statement of financial position account and an income statement account For example: to record the expiration of insurance the following entry would be recorded; a debit to Insurance Expense (an income statement account) and a credit to

Answers to Questions (Continued)

11 Disagree Adjusting entries never involve the Cash account In making adjusting

entries for prepayments, the cash has already been paid or received and recorded The adjusting journal entry is prepared to reflect the fact that a portion of the unearned revenue or prepaid expense arising in the past when the cash flow occurred is now earned or incurred, respectively In making adjusting entries for accruals, we record the fact that although the cash has not been paid or received, revenue has been earned or an expense has been incurred Again, there is no impact on the Cash account because cash has not yet been received or paid

12 To ensure that the adjusting entry is properly calculated and prepared, the preparer of

the adjusting entry must first properly understand the original cash payment transaction that lead to the recording of the prepayment On the other hand, in the case of an accrual, there is no cash payment to look up in the accounts Consequently

no original entry can be examined in the process of preparing an adjusting entry related to an accrual

13 Before the recording of adjusting entries to accrued revenues in the amount of $780

and accrued expenses in the amount of $510, the profit would be understated by the net of the amount of unrecorded revenue of $780, less unrecorded expense of $510 or

$270

14 Reactor should recognize the expense in the period that it was incurred—December—

and set up the corresponding liability to the utility company On December 31, Utility Expense should be debited and an accrued liability account such as Accounts Payable should be credited

15 Financial statements are prepared from an adjusted trial balance because the

balances of all accounts have been adjusted to show the effects of all financial events that have occurred during the accounting period An unadjusted trial balance is not up

to date for prepayments and accruals

Answers to Questions (Continued)

16 Adjusting entries are only recorded at the end of the accounting period, prior to the

preparation of the financial statements Transaction entries are made throughout the accounting period when transactions arise As well, adjusting entries never affect the Cash account and always result in an adjustment to a statement of financial position account and an income statement account Transaction entries often result in a debit

or credit to Cash and can affect any account on the statement of financial position or the income statement (or both)

Closing entries are required to reset the revenue and expense (income statement) and dividend accounts to zero and to update the balance in Retained Earnings to the closing balance per the statement of changes in equity Unlike adjusting entries, which are prepared before the financial statements and could be prepared more than once per year, closing entries are only prepared and posted after the year-end financial statements have been completed

17 The unadjusted, adjusted, and post-closing trial balances are similar in that they prove

the equality of the total debit and total credit balances Another similarity between the unadjusted and adjusted trial balances is that they are prepared at the end of an accounting period Where trial balances differ is that the unadjusted trial balance is prepared before any adjusting entries have been recorded or posted An adjusted trial balance is prepared after the adjusting entries have been posted to the accounts The financial statements are prepared from the adjusted trial balance After the financial statements have been prepared, closing entries are prepared and posted The post-closing trial balance is then prepared and used to form the basis of the opening balances for the next accounting period Unlike the adjusted trial balance which will list temporary (revenue, expense, dividend) account balances prior to recording the closing entries, a post-closing trial balance will not list temporary account balances as these have now been closed out to the Retained Earnings account Unadjusted and adjusted trial balances are prepared whenever financial statements are prepared but a post-closing trial balance is prepared only at the end of the year

18 The retained earnings balance on the unadjusted and adjusted trial balances are often

the same since the account does not yet reflect the changes that arise from the recording of closing entries After the adjusted trial balance and financial statements are prepared, closing entries are recorded These will change the retained earnings balance by updating it for the effect of any profit or loss and dividends Consequently, the retained earnings balance on the post-closing trial balance will be different from the balance shown on the adjusted trial balance

19 Closing entries are prepared to transfer temporary account balances to retained

Answers to Questions (Continued)

20 The Dividends account is not closed with the expense accounts because it is not an

expense; it was not incurred for the purpose of generating revenue and does not appear on the income statement Dividends represent a distribution of retained earnings and are reported on the statement of changes in equity The Dividends account is also a temporary account and therefore requires a closing entry

21 (a) Profit:

(1) (Dr) Individual revenue accounts and (Cr) Income Summary

(2) (Dr) Income Summary and (Cr) Individual expense accounts

(3) (Dr) Income Summary and (Cr) Retained Earnings

(4) (Dr) Retained Earnings and (Cr) Dividends

(b) Loss:

(1) (Dr) Individual revenue accounts and (Cr) Income Summary

(2) (Dr) Income Summary and (Cr) Individual expense accounts

(3) (Dr) Retained Earnings and (Cr) Income Summary

(4) (Dr) Retained Earnings and (Cr) Dividends

Note that it is only step 3 that differs between the two situations

22 Steps in the accounting cycle that may be done on a daily basis include:

1) Analyzing business transactions

2) Journalizing the transactions

Steps in the accounting cycle that are done on a periodic basis include:

3) Posting to the general ledger accounts

4) Preparing a trial balance

5) Journalizing and posting adjusting entries (prepayments and accruals)

6) Preparing an adjusted trial balance

7) Preparing the financial statements – income statement, statement of changes in equity, statement of financial position, and statement of cash flows

Steps in the accounting cycle that are usually only done at the company’s year-end include:

8) Journalizing and posting closing entries

9) Preparing a post-closing trial balance

SOLUTIONS TO BRIEF EXERCISES

–5,000

0 +1,000

0 +500

0

0

$ 0 –75 +1,000

0

0 –1,000

0 –50

0 +200 –250

BRIEF EXERCISE 4-2

1 Collected $200 cash from customers for

2 Collected $500 cash from customers

3 Billed customers $600 for services

4 Provided $100 services to customers

5 Received $100 from customers in advance

for services to be provided in October 0 100

BRIEF EXERCISE 4-3

(a)

May 1 Supplies 4,800

Accounts Payable 4,800 (b)

Supplies Used = $1,500 + $4,800 – $2,300 = $4,000

(c)

Dec 31 Supplies Expense 4,000

Supplies 4,000 (d)

Open bal 1,500

Dec 31 Adj 4,000

Dec 31 Adj 4,000 Dec 31 Bal 2,300

BRIEF EXERCISE 4-4

(a) Jan 2 Vehicles 50,000

Cash 50,000 (b) The journal entry for the years 2015 and 2016 will be the same:

Dec 31 Depreciation Expense 10,000

Accumulated Depreciation—Vehicles 10,000 ($50,000 ÷ 5 = $10,000 per year)

(c)

CLAYMORE CORPORATION Statement of Financial Position (partial)

Dec 31 Unearned Revenue 3,500

Insurance Revenue 3,500 (d)

Marla Insurance Corp

Dec 31 Adj 3,500

Dec 31 Bal 2,500

BRIEF EXERCISE 4-6

(a) Nov 28 Salaries Expense 5,000

Cash 5,000 (b) Nov 30 Salaries Expense 3,000

Salaries Payable 3,000 (Accrual for 3 days of salary Nov 28 to Nov 30)

(c) Dec 5 Salaries Expense 2,000

Salaries Payable 3,000 Cash 5,000 (The expense pertains to salary for Dec.1 to 2)

Interest Payable 900 (c) 2016

Jan 1 Bank Loan Payable 30,000

Interest Payable 900 Cash 30,900

BRIEF EXERCISE 4-9

(a) $400 = $2,600 – $2,200

(b) $3,500 = $400 (2013 payable balance) + $3,600 – $500 Notice how the change in the

payable each year indicates the difference between the expense and the cash paid In

other words, in this year, the company had to pay off last year’s tax of $400 but did not

pay off $500 of this year’s tax Since this year’s tax was $3,600, only $3,100 of this

was paid off This $3,100 along with the $400 relating to last year totals $3,500

(c) $4,400 = $4,200 – $500 (2014 payable balance) + $700 (2015 payable balance) The

$4,200 that was paid would have included $500 relating to the prior year so the

remainder of $3,700 would have related to the current year Since $700 of the current

year’s tax is unpaid, the total tax expense for this year must have been $3,700 + $700

BRIEF EXERCISE 4-10

OROMOCTO CORPORATION Adjusted Trial Balance February 28, 2015

Debit Credit

Cash

Accounts receivable

Supplies

Prepaid insurance

Equipment

Accumulated depreciation—equipment

Accounts payable

Salaries payable

Income tax payable

Common shares

Retained earnings

Dividends

Fees earned

Salaries expense

Rent expense

Depreciation expense

Supplies expense

Insurance expense

Utilities expense

Income tax expense

Totals

$ 8,000 28,000

1,000 2,500 23,450 2,000 16,400 6,000 4,400 4,000 3,500 2,400 0 300

$101,950 $ 5,400 13,000 3,000 50 20,000 21,000 39,500 0000 000

$101,950

BRIEF EXERCISE 4-11

(a)

OROMOCTO CORPORATION

Income Statement Year Ended February 28, 2015

(b)

OROMOCTO CORPORATION Statement of Changes in Equity Year Ended February 28, 2015

Common Retained Total Shares Earnings Equity

Balance, March 1, 2014 $15,000 $21,000 $36,000 Issued common shares 5,000 5,000 Profit 2,500 2,500 Dividends 000000 (2,000) (2,000) Balance, February 28, 2015 $20,000 $21,500 $41,500

BRIEF EXERCISE 4-11 (Continued)

(c)

OROMOCTO CORPORATION Statement of Financial Position February 28, 2015

Assets Current Assets

Cash $ 8,000 Accounts receivable 28,000 Supplies 1,000 Prepaid insurance 2,500 Total current assets 39,500 Property, plant, and equipment

Common shares $20,000

Retained earnings 21,500

Total shareholders’ equity 41,500 Total liabilities and shareholders’ equity $57,550

BRIEF EXERCISE 4-13

(a) Service revenue $126,000

Expenses

Salaries expense $90,000

Repairs and maintenance expense 15,000

Income tax expense 4,200 109,200

Repairs and Maintenance Expense 15,000

Income Tax Expense 4,200

30 Income Summary 16,800

Retained Earnings 16,800

30 Retained Earnings 5,000

Dividends 5,000

BRIEF EXERCISE 4-13 (Continued)

(c) CE means closing entry

Service Revenue Nov 30 CE1 126,000

Nov 30 Bal 126,000 Nov 30 Bal 0

Salaries Expense Nov 30 Bal 90,000

Nov 30 CE2 90,000 Nov 30 Bal 0

Repairs and Maintenance Expense

Nov 30 Bal 15,000

Nov 30 CE2 15,000 Nov 30 Bal 0

Income Tax Expense

Nov 30 Bal 4,200

Nov 30 CE2 4,200 Nov 30 Bal 0

Dividends Nov 30 Bal 5,000

Nov 30 CE4 5,000 Nov 30 Bal 0 Income Summary

Nov 30 CE2 109,200 Nov 30 CE3 16,800

Nov 30 CE1 126,000 Nov 30 Bal 0 Retained Earnings

Nov 30 CE4 5,000

Nov 30 CE3 16,800 Nov 30 Bal 61,800

SOLUTIONS TO EXERCISES

EXERCISE 4-1

(a) Since the performance by WestJet is not complete until the flight actually occurs,

revenue should not be recognized until December WestJet should recognize the revenue in December when the customer has been provided with the flight

(b) Revenue should be recognized as each magazine is delivered

(c) Revenue should be recognized on a per game basis over the season from April to

October, since that is when the products (games) are provided to the fans

(d) Interest revenue should be accrued and recognized by RBC Financial Group evenly

over the term of the loan

(e) Revenue should be recognized when the sweater is shipped to the customer in

September, provided there is reasonable assurance of collectability

EXERCISE 4-2

(a) Accrual Basis

(b) Cash Basis Service revenue

Expenses

Operating expenses

Insurance expense

Profit before income tax

Income tax expense

Profit

$52,000 31,000 1,000 32,000

20,000 3,000

$17,000

$44,000 27,500 2,000 29,500 14,500

-

$ 14,500

(c) The accrual basis of accounting provides more useful information for decision makers because it recognizes revenue when earned and expenses when incurred This provides a better measurement of performance because it records what has happened regardless of the movement of cash This also enhances the predictive ability of the income statement

EXERCISE 4-3

(a) 2015

June 1 Prepaid Insurance 1,800

Cash 1,800 Aug 31 Prepaid Rent 6,500

Cash 6,500 Sept 4 Cash 3,600

Unearned Revenue 3,600 Nov 30 Prepaid Cleaning 2,000

Cash 2,000 Dec 5 Cash 1,500

Unearned Revenue 1,500

(b) 2015

Dec 31 Insurance Expense 1,050

Prepaid Insurance 1,050 ($1,800 × 7/12 months = $1,050)

31 Rent Expense 5,200 Prepaid Rent 5,200 ($6,500 × 4/5 months = $5,200)

31 Unearned Revenue 1,600

Sponsorship Revenue 1,600 ($3,600 × 4/9 games = $1,600)

31 Repairs and Maintenance Expense 1,000

Prepaid Cleaning 1,000

31 Unearned Revenue 1,025

Sponsorship Revenue 1,025 ($1,500 – $475 not played = $1,025 played)

Dec 31 Adj 1,600 Dec 31 Adj 1,025

Nov 30 2,000 Dec 31 Adj 1,000 Dec 31 Adj 1,000

Dec 31 Bal 1,000

Note: The Cash account has not been included in this solution, as per the instructions

EXERCISE 4-4

(a) 2015

Dec 31 Depreciation Expense 4,000

Accumulated Depreciation—Vehicles 4,000 ($28,000 ÷ 7 = $4,000 per year)

31 Depreciation Expense 4,000

Accumulated Depreciation—Equipment 4,000 ($12,000 ÷ 3 = $4,000 per year)

31 Depreciation Expense 2,000

Accumulated Depreciation—Furniture 2,000 ($10,000 ÷ 5 = $2,000 per year)

31 Interest Expense 188 Interest Payable 188 ($45,000 × 5% × 1/12 months = $188 (rounded))

1 Interest Payable 188 Cash 188

4 Cash 300

Accounts Receivable 300

2 Cash 6,000

Accounts Receivable 6,000

EXERCISE 4-6

(a) July 2 Prepaid Rent 1,500

Cash 1,500

7 Supplies 200 Accounts Payable 200

14 Cash 3,275 Accounts Receivable 3,275 ($6,550 ÷ 2)

15 Cash 1,000 Bank Loan Payable 1,000

21 Cash 1,000 Unearned Revenue 1,000

28 Accounts Receivable 1,500 Service Revenue 1,500 (b) July 31 Accounts Receivable 800

Service Revenue 800

31 Rent Expense 750 Prepaid Rent 750 ($1,500 ÷ 2 = $750)

31 Supplies Expense 900 Supplies 900 ($1,200 + $200 − $500 = $900)

31 Depreciation Expense 125 Accumulated Depreciation—Equipment 125 ($15,000 ÷ 10 x 1/12)

31 Interest Expense 4

Interest Payable 4 ($1,000 × 5% × 1/12 months)

31 Salaries Expense 2,500

EXERCISE 4-7

1 Mar 031 Depreciation Expense 1,350

Accumulated Depreciation—Equipment 1,350 ($21,600 ÷ 4 × 3/12 months)

2 31 Unearned Revenue 6,400

Rent Revenue ($9,600 × 2/3) 6,400

3 31 Interest Expense 100

Interest Payable 100 ($20,000 × 6% × 1/12 months)

4 31 Supplies Expense 1,950

Supplies ($2,800 – $850) 1,950

5 31 Insurance Expense 3,600

Prepaid Insurance 3,600 ($14,400 × 3/12)

6 31 Income Tax Expense 3,200

Income Tax Payable 3,200

EXERCISE 4-8

Unearned Revenue 1,600 January entry: Unearned Revenue 1,600

Service Revenue 1,600

Unearned Revenue

Jan 1 Bal 2,350 Jan 31 Bal 750 The balance in Unearned Revenue on January 1, 2015 was $2,350 ($750 + $1,600)

(b) Journal entry to record depreciation: Depreciation Expense

1 month = $60; Annual depreciation = $720 ($60 × 12)

Number of months depreciated = accumulated depreciation ($3,660) ÷ monthly depreciation ($60) = 61 months or 5 years, 1 month

Therefore the equipment is 5 years, 1 month old It would have been purchased on January 1, 2010

(c) Journal entry to adjust insurance: Insurance Expense

Since the prepaid insurance is $1,600, we can assume that 4 months ($1,600 ÷ $400

= 4) of the policy remain Consequently, if it expires at $400 per month, then the policy

is $3,200 ÷ $400 = 8 months old and it was purchased on June 1, 2014

Prepaid Insurance June 1, 2014 4,800 June 30 to

Dec 31 Adj 2,800 Dec 31, 2014 Bal 2,000

Jan 31 Adj 400 Jan 31, 2015 Bal 1,600

Derive the balance by working backward up through the T account Therefore, the balance in Supplies on January 1 was $900 ($700 + $950 – $750)

(e) Journal entry to record income tax payable: Income Tax Expense

Income Tax Payable

Jan 1 Bal 150

Derive the balance by working backward up through the T account The balance in Income Tax Payable on January 1 was $$150 ($150 − $100 + $100) It is assumed that income tax instalments are paid monthly and that the balance owing at December 31 (January 1) was the adjustment required at year-end after the income tax return was prepared This balance owing must be paid within three months of the company’s year-end

EXERCISE 4-9

FRASER VALLEY SERVICES LTD

Adjusted Trial Balance August 31, 2015

Debit Credit Cash $ 11,430

Service revenue 54,275 Salaries expense 19,200

EXERCISE 4-10

(a)

FRASER VALLEY SERVICES LTD

Income Statement Year Ended August 31, 2015

FRASER VALLEY SERVICES LTD

Statement of Changes in Equity Year Ended August 31, 2015

Shares Earnings Equity Balance, September 1, 2014 $4,000 $ 5,400 $ 9,400 Issued common shares 1,000 1,000 Profit 11,450 11,450 Dividends 00000 (600) (600) Balance, August 31, 2015 $5,000 $16,250 $21,250

EXERCISE 4-10 (Continued)

(c)

FRASER VALLEY SERVICES LTD

Statement of Financial Position

August 31, 2015

Assets Current assets

Cash $11,430 Accounts receivable 18,225 Supplies 3,400 Prepaid insurance 3,450 Total current assets 36,505 Property, plant, and equipment

Non-current liabilities

Bank loan payable 25,000 Total liabilities 34,950 Shareholders’ equity

Common shares 5,000 Retained earnings 16,250 Total shareholders’ equity 21,250 Total liabilities and shareholders’ equity $56,200

031 Income Summary 11,450

Retained Earnings 11,450

31 Retained Earnings 600

Dividends 600 (b)

FRASER VALLEY SERVICES LTD

Post-Closing Trial Balance August 31, 2015

700 25,000 5,000 16,250

$62,105

• Under the CASH BASIS, expenses are recorded when the cash is paid out; and

• Under the ACCRUAL BASIS of accounting, expenses are recorded when they are incurred which is when their cost has “expired”, “used up” (lost its future benefit), which is not always in the same time period as when the cash is paid out

(a) Cash basis profit

$187,800 Cash collected from customers

109,400 Cash paid for operating costs

$ 78,400 Cash basis profit

PROBLEM 4-1A

PROBLEM 4-1A (Continued)

(b) Accrual basis profit

$78,400 (a) Cash basis profit

–3,000 Accounts payable owing at the end of the year should be accrued; the

related expense was incurred in year and thus, reduces profit

+8,400 Accounts receivable arise from sales that have been made during the

year, and thus, revenue must be recognized and recorded in the year –24,600 Depreciation expense is a non-cash expense which reduces profit for the

year

–15,800 Income tax owing at the end of the year should be accrued; the expense

related to the current year

+3,000 Prepaid insurance at the end of the year is an asset rather than an

expense Amount has been deducted from cash and must be added back for accrual basis profit

–2,800 Unearned revenue that was received in cash during the current year has

not been earned and thus, must reduce the cash basis profit

00 0000

$43,600 Accrual basis profit

Notice how the difference between a cash basis and an accrual basis revenue or expense is always the change in the related balance sheet account For example, if accounts receivable goes up during the year, that change is the difference between cash and accrual revenue

An alternate calculation:

Less: Increase in unearned revenue (2,800)

Add: Increase in accounts receivable 8,400

Add: Increase in accumulated depreciation 24,600

Deduct: Increase in prepaid insurance (3,000)

Total expenses – accrual method $149,800

Therefore, on an accrual basis the profit is:

PROBLEM 4-1A (Continued)

(c) I recommend that Southlake use the accrual basis of accounting The cash basis does

not correctly show when the revenue was earned or when the expenses were incurred and therefore does not measure performance effectively Because of this, the accrual basis is a better indicator of future performance The cash basis of accounting is not in accordance with generally accepted accounting principles for these reasons

1 (a) Jan 2 Supplies 4,100

Cash 4,100 (b) Dec 31 Supplies Expense ($4,100 – $700) 3,400

Supplies 3,400

2 (a) Apr 1 Vehicles 45,000

Cash 5,000 Bank Loan Payable 40,000 (b) Dec 31 Depreciation Expense 6,750

Accumulated Depreciation—Vehicles 6,750 ($45,000 ÷ 5 years × 9/12 months)

3 (a) Aug 1 Prepaid Insurance 3,600

Cash 3,600 (b) Dec 31 Insurance Expense ($3,600 × 5/12 months) 1,500

Prepaid Insurance 1,500

4 (a) Nov 9 Cash 1,600

Unearned Revenue 1,600 (b) Dec 31 Unearned Revenue ($1,600 × ½) 800

Service Revenue 800

5 (a) Dec 1 Prepaid Rent 2,400

Cash 2,400 (b) Dec 31 Rent Expense 1,200

Prepaid Rent 1,200

PROBLEM 4-2A

1 (a) Mar 31 Interest Expense 80

Interest Payable 80 ($12,000 × 8% × 1/12 months)

(b) Apr 1 Interest Payable 80

3 (a) Mar 31 Salaries Expense 2,000

Salaries Payable (5 × $200 × 2 days) 2,000

(b) Apr 3 Salaries Payable 2,000

Cash 750

5 (a) Mar 31 Accounts Receivable 3,000

Service Revenue 3,000 (b) Apr 4 No entry required

Apr 30 Cash 2,000

Accounts Receivable 2,000

PROBLEM 4-3A

1 (a) June 1, 2014 Vehicles 80,000

Cash 80,000 (b) Nov 30, 2015 Depreciation Expense 8,000

2 (a) Oct 1, 2015 Cash (400 × $320) 128,000

Unearned Revenue 128,000

(b) Nov 30, 2015 Unearned Revenue 32,000

3 (a) Feb 17, 2015 Supplies 2,100

Cash 2,100 (b) Nov 30, 2015 Supplies Expense ($1,000 + $2,100 – $500) 2,600

Supplies 2,600

4 (a) June 1, 2015 Cash 100,000

Bank Loan Payable 100,000 (b) Nov 30, 2015 Interest Expense 500

Rent Revenue 200

(c) Dec 4, 2015 Cash 600

Accounts Receivable 200 Rent Revenue 400

PROBLEM 4-4A

PROBLEM 4-4A (Continued)

6 (b) Nov 30, 2015 Salaries Expense 2,000

and Monday] 2,000 (c) Dec 7, 2015 Salaries Payable (Sunday and Monday) 2,000

Salaries Expense (Tuesday through Saturday) 5,000

Cash 7,000

7 (b) Nov 30, 2015 Income Tax Expense 1,250

Income Tax Payable 1,250

(c) Dec 29, 2015 Income Tax Payable 1,250

Cash 1,250

1, 2013, when the company made adjusting entries at the end of the prior fiscal year on July

31, 2014 insurance expense for the period December 1, 2013 to July 31, 2014 which covers

8 months would have been recorded for $450 × 8 = $3,600 This would have reduced the prepaid insurance relating to this policy to $7,200 ($10,800 – $3,600) During this past fiscal year ending July 31, 2015, this balance would have remained unchanged

Policy A2958 cost $4,500 and was purchased during the current fiscal year When purchased, the Prepaid Insurance account would have been debited for this amount The total amount of prepaid insurance on the unadjusted trial balance would therefore be $7,200 relating to the first policy plus $4,500 for a total of $11,700

Cost per Subscription

Unearned Revenue