ch 04 review and discussion problems solutions

Chapter 04 - Adjustments, Financial Statements, and the Quality of Earnings

4-1

Chapter 04 Adjustments, Financial Statements, and

the Quality of Earnings

ANSWERS TO MULTIPLE CHOICE

1. c 2. b 3. b 4. a 5. b 6. c 7. c 8. d 9. c 10. a

EXERCISES

E4–4. Req. 1 Prepaid Insurance is a deferred expense that needs to be adjusted each period for the amount used during the period.

The amount of expense is computed as follows: $3,600 x 3/24 = $450 used

Adjusting entry: Insurance expense (+E, SE) ..................................... 450 Prepaid insurance (A) .................................... 450 Req. 2 Shipping Supplies is a deferred expense that needs to be adjusted at the end of the period for the amount of supplies used during the period.

The amount is computed as follows: Beginning balance $11,000 Supplies purchased 60,000 Supplies on hand at end (20,000) Supplies used $51,000

Adjusting entry: Shipping supplies expense (+E, SE) ........................ 51,000 Shipping supplies (A) ..................................... 51,000


4-2

Req. 3 Prepaid Insurance Insurance Expense

10/1 3,600 AJE 450 AJE 450

End. 3,150 End. 450

Shipping Supplies Shipping Supplies Expense Beg. 11,000 Purch. 60,000 AJE 51,000 AJE 51,000 End. 20,000 End. 51,000

2011 Income statement: Insurance expense $ 450 Shipping supplies expense $51,000 Req. 4 2011 Balance sheet: Prepaid insurance $ 3,150 Shipping supplies $20,000 E4–5.

Balance Sheet Income Statement

Transaction

Assets

Liabilities Stockholders’

Equity

Revenues

Expenses Net

Income

E4–3 (a) NE +7,000 –7,000 NE +7,000 –7,000 E4–3 (b) +2,000 NE +2,000 +2,000 NE +2,000 E4–4 (a) –450 NE –450 NE +450 –450 E4–4 (b) –51,000 NE –51,000 NE +51,000 –51,000

E4–6. Req. 1

a. Accrued expense b. Deferred expense c. Accrued revenue d. Deferred expense e. Deferred expense f. Deferred revenue g. Accrued revenue

Req. 2 Computations

a. Wages expense (+E, SE) ........................... 2,700 Given Wages payable (+L) ........................... 2,700


4-3

b. Office supplies expense (+E, SE) ............... 675 $450 + $500 Office supplies (A) ............................ 675 - $275 = $675 used c. Rent receivable (+A) ..................................... 1,120 $560 x 2 months Rent revenue (+R, +SE) ..................... 1,120 = $1,120 earned d. Depreciation expense (+E, SE) .................. 12,100 Given Accumulated depreciation (+XA, A) 12,100 e. Insurance expense (+E, SE) ....................... 600 $2,400 x 6/24 = Prepaid insurance (A) ....................... 600 $600 used f. Unearned rent revenue (L) ......................... 3,200 $9,600 x 2/6 = Rent revenue (+R, +SE) ..................... 3,200 $3,200 earned g. Repair accounts receivable (+A) .................. 800 Given Repair shop revenue (+R, +SE) ......... 800 E4–10.

Debit Credit Independent Situations Code Amount Code Amount

a. Accrued wages, unrecorded and unpaid at year-end, $400 (example).

N 400 G 400

b. Service revenue earned but not yet collected at year-end, $600.

C 600 L 600

c. Dividends declared and paid during the year, $900.

K 900 A 900

d. Office Supplies on hand during the year, $400; supplies on hand at year-end, $160.

Q 240 B 240

e. Service revenue collected in advance, $800.

A 800 I 800

f. Depreciation expense for the year, $1,000. O 1,000 E 1,000

g. At year-end, interest on note payable not yet recorded or paid, $220.

P 220 H 220

h. Balance at year-end in Service Revenue account, $56,000. Give the closing entry at year-end.

L 56,000 K 56,000

i. Balance at year-end in Interest Expense account, $460. Give the closing entry at

K 460 P 460


4-4

year-end. E4–11. Selected Balance Sheet Amounts at December 31, 2012

Assets: Equipment (recorded at cost per cost principle) $12,000Accumulated depreciation (for one year, as given) (1,200) Net book value of equipment (difference) 10,800 Office supplies (on hand, as given) 400 Prepaid insurance (remaining coverage, $600 x 18/24 months) 450

Selected Income Statement Amounts for the Year Ended December 31, 2012

Expenses: Depreciation expense (for one year, as given) $ 1,200Office supplies expense (used, $1,600 - $400 on hand) 1,200Insurance expense (for 6 months, $600 x 6/24 months) 150

E4–13. Req. 1 (a) Cash paid on accrued income taxes payable.

(b) Accrual of additional income tax expense.

(c) Cash paid on dividends payable.

(d) Amount of dividends declared for the period.

(e) Cash paid on accrued interest payable.

(f) Accrual of additional interest expense.

Req. 2 Computations: (a) Beg. Bal. + accrued income taxes - cash paid = End. bal.

$135 + 656 - ? = $79 ? = $712 paid

(c) Beg. Bal. + dividends declared - cash paid = End. bal.

$110 + 456 - ? = $118 ? = $448 paid

(f)

Beg. Bal. + accrued interest expense - cash paid = End. bal. $140 + ? - 1,127 = $150


4-5

? = $1,137 accrued


4-6

E4–15.

Items

Net Income

Total Assets

Total Liabilities

Stockholders’ Equity

Balances reported $60,000 $170,000 $80,000 $90,000 Additional adjustments: a. Wages (39,000)

39,000

(39,000)

b. Depreciation (17,000) (17,000) (17,000) c. Rent revenue 3,200 (3,200) 3,200 Adjusted balances 7,200 153,000 115,800 37,200 d. Income taxes (2,160) 2,160 (2,160) Correct balances $ 5,040 $153,000 $117,960 $35,040 Computations: a. Given, $39,000 accrued and unpaid. b. Given, $17,000 depreciation expense. c. $9,600 x 1/3 = $3,200 rent revenue earned. The remaining $6,400 in unearned

revenue is a liability for two months of occupancy "owed'' to the renter. d. $7,200 income before taxes x 30% = $2,160. E4–16. Req. 1 a. Rent receivable (+A) ................................... 2,500 Revenues (rent) (+R, +SE) .................. 2,500 b. Expenses (depreciation) (+E, SE) ............ 4,500 Accumulated depreciation (+XA, A) ... 4,500 c. Income tax expense (+E, SE) ................... 5,100 Income taxes payable (+L) .................. 5,100 Req. 2

As

Prepared

Effects of Adjusting

Entries

Corrected Amounts

Income statement: Revenues $97,000 a $2,500 $99,500 Expenses (73,000) b (4,500) (77,500) Income tax expense c (5,100) (5,100) Net income $24,000 (7,100) $16,900 Balance Sheet:


4-7

Assets Cash $20,000 $20,000 Accounts receivable 22,000 22,000 Rent receivable a 2,500 2,500 Equipment 50,000 50,000 Accumulated depreciation (10,000) b (4,500) (14,500) $82,000 (2,000) $80,000Liabilities Accounts payable $10,000 $10,000 Income taxes payable c 5,100 5,100

Stockholders' Equity Contributed capital 40,000 40,000 Retained earnings 32,000 (7,100) 24,900 $82,000 (2,000) $80,000

E4–20. Req. 1 The purposes of “closing the books” at the end of the accounting period are to:

Transfer the balance in the temporary accounts to a permanent account (Retained Earnings).

Create a zero balance in each of the temporary accounts for accumulation of activities in the next accounting period.

Req. 2 Revenues (R) ........................................................... 84 Expenses ($32 + $4 + $8 + $5 + $9) (E) ........ 58 Retained earnings (+SE) ................................. 26 PROBLEMS P4–2.

Req. 1

a. Deferred revenue e. Deferred expense

b. Accrued expense f. Accrued revenue

c. Deferred expense g. Accrued expense

d. Deferred revenue h. Accrued expense


4-8

Req. 2 a. Unearned rent revenue (L) ......................................... 5,600 Rent revenue (+R, +SE) ..................................... 5,600 ($8,400 ÷ 6 months = $1,400 per month x 4 months) b. Interest expense (+E, SE) .......................................... 540 Interest payable (+L) ............................................ 540 ($18,000 x .12 x 3/12) c. Depreciation expense (+E, SE) .................................. 2,500 Accumulated depreciation (+XA, A) .................. 2,500 d. Unearned service revenue (L) .................................... 500 Service revenue (+R, +SE) ................................. 500 ($3,000 x 2/12) e. Insurance expense (+E, SE) ...................................... 1,500 Prepaid insurance (A) ..................................... 1,500 ($9,000 ÷ 12 months = $750 per month x 2 months of coverage) f. Accounts receivable (+A) ............................................. 4,000 Service revenue (+R, +SE) ................................ 4,000 g. Wage expense (+E, SE) ............................................. 14,000 Wages payable (+L) ........................................... 14,000 h. Property tax expense (+E, SE) ................................... 500 Property tax payable (+L) ..................................... 500


4-9

P4–3. Req. 1

a. Deferred expense e. Accrued revenue

b. Deferred expense f. Deferred expense

c. Accrued expense g. Accrued expense

d. Accrued expense h. Accrued expense Req. 2 a. Depreciation expense (+E, SE) .................................. 4,000 Accumulated depreciation (+XA, A) .................. 4,000 b. Supplies expense (+E, SE) ........................................ 1,150 Supplies (A) ...................................................... 1,150 (Beg. Inventory of $400 + Purchases $1,000 – Ending Inventory $250) c. Repairs expense (+E, SE) .......................................... 1,200 Accounts payable (+L) ....................................... 1,200 d. Property tax expense (+E, SE) ................................... 1,500 Property tax payable (+L) ..................................... 1,500 e. Accounts receivable (+A) ............................................. 6,000 Service revenue (+R, +SE) ................................ 6,000 f. Insurance expense (+E, SE) ...................................... 200 Prepaid insurance (A) ..................................... 200 ($1,200 ÷ 36 months x 6 months of coverage) g. Interest expense (+E, SE) .......................................... 385 Interest payable (+L) ............................................ 385 ($11,000 x .14 x 3/12) h. Income tax expense (+E, SE) .................................... 8,270 Income tax payable (+L)....................................... 8,270 To accrue income tax expense incurred but not paid:

Income before adjustments (given) $30,000 Effect of adjustments (a) through (g) (2,435) (–$4,000–$1,150–$1,200 Income before income taxes 27,565 –$1,500+$6,000–$200–$385) Income tax rate x 30% Income tax expense $ 8,270 (rounded)


4-10

P4–7. Req. 1

December 31, 2011, Adjusting Entries: (a) Supplies expense (+E, SE) ...................................... 400 Supplies (A) .................................................. 400 (b) Insurance expense (+E, SE) .................................... 400 Prepaid insurance (A) ................................... 400 (c) Depreciation expense (+E, SE) ............................... 4,200 Accumulated depreciation (+XA, A) .............. 4,200 (d) Wages expense (+E, SE) ......................................... 720 Wages payable (+L) ........................................ 720 (e) Income tax expense (+E, SE) .................................. 5,880 Income taxes payable (+L) ............................. 5,880 Req. 2

ELLIS, INC. Income Statement

For the Year Ended December 31, 2011

Operating Revenue: Service revenue $61,600

Operating Expenses: Supplies expense ($640 - $240) 400 Insurance expense 400 Depreciation expense 4,200 Wages expense 720 Remaining expenses (not detailed) 33,360 Total expenses 39,080 Operating Income 22,520 Income tax expense 5,880 Net Income $16,640 Earnings per share ($16,640 ÷ 5,000 shares) $3.33


4-11

P4–7. (continued) Req. 2 (continued)

ELLIS, INC. Balance Sheet

At December 31, 2011

Assets Liabilities and Stockholders’ Equity Current Assets: Current Liabilities:

Cash $46,000 Accounts payable $ 2,400 Accounts receivable 10,400 Wages payable 720 Supplies 240 Income taxes payable 5,880 Prepaid insurance 400 Total current liabilities 9,000

Total current assets 57,040 Note payable, long term 16,000 Service trucks 16,000 Total liabilities 25,000 Accumulated depreciation (13,800) Stockholders' Equity Other assets (not detailed) 8,960 Contributed capital 20,560 Retained earnings* 22,640 Total stockholders' equity 43,200 Total assets $68,200

Total liabilities and stockholders' equity

$68,200

*Unadjusted balance, $6,000 + Net income, $16,640 = Ending balance, $22,640. Req. 3 December 31, 2011, Closing Entry: Service revenue (R) .................................................. 61,600 Retained earnings (+SE) ................................ 16,640 Supplies expense (E) .................................... 400 Insurance expense (E) .................................. 400 Depreciation expense (E) ............................. 4,200 Wages expense (E) ...................................... 720 Remaining expenses (not detailed) (E) .......... 33,360 Income tax expense (E) ................................ 5,880


4-12

COMPREHENSIVE PROBLEMS COMP4–1.

Req. 1, 2, 3, and 5 T-accounts (in thousands)

Cash Accounts Receivable Supplies Bal. 4 b 12 Bal. 7 Bal. 16 a 12 e 91 c 52 f 34 i 23 l 21 c 156 g 13 d 4 h 19 f 34 k 22 Bal. 53 Bal. 25 Bal. 18

Land

Equipment

Accumulated Depreciation

Bal. 0 Bal. 78 Bal. 8 b 12 m 8 Bal. 12 Bal. 78 Bal. 16

Other Assets Accounts Payable Income Tax Payable Bal. 5 Bal. 0 Bal. 0 g 13 h 19 e 20 p 10

i 23 Bal. 18 Bal. 24 Bal. 10

Wages Payable Interest Payable LT Notes Payable Bal. 0 Bal. 0 Bal. 0 o 16 n 1 a 12 Bal. 16 Bal. 1 Bal. 12

Contributed Capital

Retained Earnings

Service Revenue

Bal. 85 Bal. 17 Bal. 0 d 4 k 22 c 208 CE 41 CE 208 Bal. 89 Bal. 36 Bal. 0

Depreciation Expense

Income Tax Expense

Interest Expense

Bal. 0 Bal. 0 Bal. 0 m 8 CE 8 p 10 CE 10 n 1 CE 1

Bal. 0 Bal. 0 Bal. 0


4-13

Supplies Expense

Wages Expense

Remaining Expenses

Bal. 0 Bal. 0 Bal. 0 l 21 CE 21 o 16 CE 16 e 111 CE 111

Bal. 0 Bal. 0 Bal. 0 Req. 2

a. Cash (+A) .......................................................... 12,000 Notes payable (+L) .................................. 12,000 b. Land (+A) ........................................................... 12,000 Cash (A) ................................................ 12,000 c. Cash (+A) .......................................................... 156,000 Accounts receivable (+A) ................................... 52,000 Service revenue (+R, +SE) ...................... 208,000 d. Cash (+A) .......................................................... 4,000 Contributed capital (+SE) ........................ 4,000 e. Remaining expenses (+E, SE)......................... 111,000 Accounts payable (+L) ............................. 20,000 Cash (A) ................................................ 91,000 f. Cash (+A) .......................................................... 34,000 Accounts receivable (A) ......................... 34,000 g. Other assets (+A) .............................................. 13,000 Cash (A) ................................................ 13,000 h. Accounts payable (L) ....................................... 19,000 Cash (A) ................................................ 19,000 i. Supplies (+A) ..................................................... 23,000 Accounts payable (+L) ............................. 23,000 j. No entry required; no revenue earned in 2012. k. Retained earnings (SE) ................................... 22,000 Cash (A) ................................................ 22,000


4-14

COMP4–1. (continued) Req. 3

l. Supplies expense (+E, SE) .............................. 21,000 Supplies (A) ............................................ 21,000 ($39,000 in account – $18,000 at year end) m. Depreciation expense (+E, SE) ....................... 8,000 Accumulated depreciation (+XA, A) ........ 8,000 n. Interest expense (+E, SE) ............................... 1,000 Interest payable (+L) ................................ 1,000 ($12,000 x .10 x 10/12) o. Wages expense (+E, SE) ................................ 16,000 Wages payable (+L) ................................. 16,000 p. Income tax expense (+E, SE) .......................... 10,000 Income taxes payable (+L) ....................... 10,000

Req. 4

H & H TOOL, INC. Income Statement


Operating Revenues: Service revenue $208,000 Operating Expenses: Depreciation expense 8,000

Supplies expense 21,000 Wages expenses 16,000

Remaining expenses 111,000 Total operating expenses 156,000 Operating Income 52,000 Other Item: Interest expense 1,000 Pretax income 51,000 Income tax expense 10,000 Net Income $41,000 Earnings per share [$41,000 ÷ 89,000 shares all year]

$0.46


4-15

COMP4–1. (continued)

H & H TOOL, INC. Statement of Stockholders' Equity


Contributed

Capital

Retained Earnings

Total Stockholders'

Equity Balance, January 1, 2012 $85,000 $ 17,000 $102,000 Additional stock issuance 4,000 4,000 Net income 41,000 41,000 Dividends declared (22,000) (22,000) Balance, December 31, 2012 $89,000 $36,000 $125,000

H & H TOOL, INC. Balance Sheet

At December 31, 2012

Assets Liabilities and Stockholders’ Equity Current Assets: Current Liabilities:

Cash $ 53,000 Accounts payable $ 24,000 Accounts receivable 25,000 Interest payable 1,000 Supplies 18,000 Wages payable 16,000

Total current assets 96,000 Income taxes payable 10,000 Land 12,000 Total current liabilities 51,000 Equipment 78,000 Notes payable 12,000 Less: Accumulated deprec. (16,000) Total liabilities 63,000 Other assets 18,000 Stockholders' Equity: Contributed capital 89,000 Retained earnings 36,000 Total stockholders'

equity

125,000 Total assets $188,000

Total liabilities and stockholders' equity

$188,000


4-16

COMP4–1. (continued)

H & H TOOL, INC. Statement of Cash Flows


Cash from Operating Activities: Cash collected from customers (c + f) $190,000 Cash paid to suppliers and employees (e +h) (110,000) Cash provided by operations 80,000 Cash from Investing Activities: Purchase of land (b) (12,000) Purchase of other assets (g) (13,000) Cash used for investing activities (25,000) Cash from Financing Activities: Borrowing from bank (a) 12,000 Issuance of stock (d) 4,000 Payment of dividends (k) (22,000) Cash used for financing activities (6,000) Change in cash 49,000 Beginning cash balance, January 1, 2012 4,000 Ending cash balance, December 31, 2012 $ 53,000

Req. 5

December 31, 2012, Closing Entry Service revenue (R) ......................................... 208,000 Retained earnings (+SE) ......................... 41,000 Depreciation expense (E) ...................... 8,000 Interest expense (E) .............................. 1,000 Supplies expense (E) ............................. 21,000 Wages expense (E) ............................... 16,000 Remaining expenses (E) ....................... 111,000 Income tax expense (E) ......................... 10,000


4-17

COMP4–1. (continued) Req. 6 (a) Current ratio = Current assets Current liabilities = $96,000 $51,000 = 1.88

This suggests that H & H Tool, Inc., has sufficient current assets to pay current liabilities.

(b) Total asset turnover = Sales Average total assets = $208,000 [($102,000 + $188,000) 2] = $208,000 $145,000 = 1.43

This suggests that H & H Tool, Inc., generated $1.43 for every dollar of assets. (c) Net profit margin = Net income Sales = $41,000 $208,000 = 0.197 or 19.7%

This suggests that H & H Tool, Inc., earns $0.197 for every dollar in sales that it generates. For all of the ratios, a comparison across time and a comparison against an industry average or competitors will need to be analyzed to determine how liquid (current ratio) the company is and how efficient (total asset turnover) and how effective (net profit margin) H & H Tool’s management is.

CASES AND PROJECTS

CP4–6. Transaction (a): 1. This transaction will affect Carey’s financial statements for 14 years (from 2011 to

2024) in conformity with the matching principle. [$14,000 ÷ $1,000 per year = 14 years]

2. Income statement: Depreciation expense, as given $1,000 each year 3. Balance sheet at December 31, 2013: Assets:


4-18

Office equipment $14,000Less: Accumulated depreciation* 3,000 Net book (carrying) value $11,000

*$1,000 x 3 years = $3,000. 4. An adjusting entry each year over the life of the asset would be recorded to reflect the allocation of the cost of the asset when used to generate revenues:

Depreciation expense (+E, SE) . . . . . . . . 1,000 Accumulated depreciation (+XA, A) . 1,000

Transaction (b): 1. This transaction will affect Carey’s financial statements for 2 years--2013 and 2014-

-because four month’s rent revenue was earned in 2013, and two months' rent revenue will be earned in 2014.

2. The 2013 income statement should report rent revenue earned of $20,000 ($30,000

x 4/6). Occupancy was provided for only 4 months in 2013. This is in conformity with the revenue principle.

3. This transaction created a $10,000 liability ($30,000 - $20,000 = $10,000) as of

December 31, 2013, because at that date Carey "owes'' the renter two more months' occupancy for which it has already collected the cash.

4. Yes, an adjusting entry must be made to (a) increase the Rent Revenue account by

$10,000 for two months’ rent earned in 2014 and (b) to decrease the liability to $0 representing no future occupancy owed (in conformity with the revenue principle).

December 31, 2014--Adjusting entry: Unearned Rent Revenue (L) ......................... 10,000 Rent Revenue (+R, +SE) ....................... 10,000


4-19

CP4–6. (continued) Transaction (c): 1. This transaction will directly affect Carey’s financial statements for two years, with

the expense incurred in 2013 and the cash payment in 2014. 2. The $7,500 should be reported as wage expense in the 2013 income statement and

as a liability on the 2013 balance sheet. On January 5, 2014, the liability will be paid. Therefore, the 2014 balance sheet will reflect a reduced cash balance and reduced liability balance. The transaction will not directly affect the 2014 income statement (unless the adjusting entry was not made).

3. Yes, an adjusting entry must be made to (a) record the $7,500 as an expense in

2013 (matching principle) and (b) to record the liability which will be paid in 2014. December 31, 2013--Adjusting entry:

Wage expense (+E, SE) ............................... 7,500 Wages payable (+L) .............................. 7,500 Note: On January 5, 2014, the liability, Wages Payable, of $7,500 will be paid. Wage

expense for 2014 will not include this $7,500. The 2014 related entry will debit (decrease) Wages Payable, and credit (decrease) Cash, $7,500.

Transaction (d): 1. Yes, service revenue of $45,000 (i.e., $60,000 x 3/4) should be recorded as earned

by Carey in conformity with the revenue principle. Service revenue is recognized as the service is performed.

2. Recognition of revenue earned but not collected by the end of 2013 requires an

adjusting entry. This adjusting entry is necessary to (a) record the revenue earned (to be reported on the 2013 income statement) and (b) record the related account receivable (an asset to be reported on the 2013 balance sheet). The adjusting entry on December 31, 2013 is:

Accounts receivable (+A) ............................................ 45,000 Service revenue (+R, +SE) .............................. 45,000 ($60,000 total price x 3/4 completed) 3. February 15, 2014--Completion of the last phase of the service contract and cash

collected in full: Cash (+A) .................................................................. 60,000 Accounts receivable (A) ................................. 45,000 Service revenue (+R, +SE) .............................. 15,000


4-20

CP4–7. Req. 1 Adjusting entries: (a) Expenses (insurance) (+E, SE) ....................................... 1 Prepaid insurance (A) ........................................... 1 To adjust for expired insurance. (b) Rent receivable (+A) ......................................................... 2 Revenues (rent) (+R, +SE) ...................................... 2 To adjust for rent revenue earned but not yet collected. (c) Expenses (depreciation) (+E, SE) ................................... 11 Accumulated depreciation (+XA, A) ....................... 11 To adjust for annual depreciation. (d) Expenses (wages) (+E, SE) ............................................ 3 Wages payable (+L) ................................................ 3 To adjust for wages earned but not recorded or paid. (e) Income tax expense (+E, SE) ......................................... 5 Income taxes payable (+L) ...................................... 5 To adjust for income tax expense. (f) Unearned rent revenue (L) ............................................... 3 Revenues (rent) (+R, +SE) ...................................... 3 To adjust for rent revenue collected but unearned. Req. 2

Closing entry (from the adjusted trial balance): Revenues (R) ................................................................... 103 Retained earnings (+SE) .............................................. 15 Expenses (E) ............................................................... 83 Income tax expense (E) .............................................. 5 To close the temporary accounts to Retained Earnings for

2011.


4-21

CP4–7. (continued) Req. 3 (a) Shares outstanding: 1,000 shares (given) – no change all year. (b) Interest expense: $20 thousand x .10 = $2 thousand. (c) Ending balance in retained earnings: Unadjusted balance, $(3,000) + Net income, $15,000 = $12,000. (d) Average income tax rate: $5,000 income tax expense ÷ ($103,000 revenues - $83,000 total expenses) = 25%. (e) Rent Receivable -- report on the balance sheet as an asset (probably current). Unearned Rent Revenue -- report on the balance sheet as a liability probably

(current) for future occupancy "owed''. (f) Net income of $15,000 was computed on the basis of accrual accounting concepts.

Revenue is recognized when earned and expenses recorded when incurred regardless of the timing of the respective cash flows. Cash inflows, in addition to certain revenues, were from numerous sources such as the issuance of capital stock, borrowing, and revenue collected in advance. Similarly, cash outflows were, in addition to certain expenses, due to numerous transactions such as the purchase of operational and other assets, prepaid insurance, and dividends to stockholders.

(g) EPS: $15,000 ÷ 1,000 shares (per (a) above) =$15.00 per share. (h) Selling price per share: $30,000 contributed capital ÷ 1,000 shares = $30 per

share. (i) The prepaid insurance account reflected a $2,000 balance before the adjustment

(decrease) of $1,000. Therefore, it appears that the policy premium was paid on January 1, 2011, and it was prepaid for two years (2011 and 2012). Other possibilities might be (a) a 12-month policy purchased on July 1, 2011, or (b) a 2-month policy purchased on December 1, 2011. In any case, one-half of the premium has expired.

(j) Net profit margin: $15,000 net income ÷ $103,000 revenues = 0.146 (14.6%).


4-22

CP4–8. Req. 1

CRYSTAL’S DAY SPA AND SALON, INC. Income Statement


Items

Cash Basis Per Crystal’s

Statement

Explanation of Changes

Corrected Basis

Revenues: Spa fees $1,215,000 See * below. $1,102,000Expenses: Office rent 130,000 Exclude rent for Jan. 2013 ($130,000 ÷ 13) (g) 120,000 Utilities 43,600 No change 43,600 Telephone 12,200 See ** below. 11,800 Salaries 562,000 Add December 2012 salary ($18,000 ÷ 12) (e) 563,500 Supplies 31,900 See *** below. 29,825 Miscellaneous 12,400 No change 12,400 Depreciation 0 Given for 2012 (c) 20,500 Total expenses 792,100 801,625Net income $ 422,900 $ 300,375

* Cash collected for spa fees $1,215,000 Fees earned in prior years (a) -142,000 Fees earned in 2012 but not yet collected (b) + 29,000 Fees earned in 2012 $1,102,000

** $12,200 telephone paid + $1,400 December 2012 telephone bill - $1,800 December 2011 bill paid in 2012 = $11,800

*** Supplies (d) Beg. 3,125 Purchases 31,900 29,825 UsedEnd. 5,200


4-23

CP4–8. (continued) Req. 2

Memo to Crystal Mullinex should include the following:

(1) Net income was overstated by $122,525 because of inappropriate recognition of revenue (overstated by $113,000) and expenses (understated by $9,525). Revenue should be recognized when earned, not when the cash is collected. Similarly, expenses should be matched against revenue in the period when the services or materials were used (including depreciation expense).

(2) Some other items the parties should consider in the pricing decision: (a) A correct balance sheet at December 31, 2012. (b) Collectability of any receivables (if they are to be sold with the business). (c) Any liabilities of the spa to be assumed by the purchaser. (d) Current employees -- how will they be affected? (e) Adequacy of the rented space -- is there a long-term noncancellable lease? (f) Characteristics of Crystal’s spa practices.

(g) Expected future cash flows of the business. What is the present value of those expectations?

ch 04 review and discussion problems solutions

Documents

net profit margin

property tax payable

property tax expense

income tax expense

income taxes payable

unearned rent revenue

net income

interest payable