Accounts

Accounting Principles: A Business Perspective, Financial Accounting (Chapters 1 – 8)
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())* -.ition Accounting: A Business Perspective (6r'in7(cgra'-#ill ,eries in Principles o) Accounting) 8#ar&cover9 :oger #0 #er$anson (Author), ;a$es <on %&'ar&s (Author), (ichael =0 (aher (Author) %ighth %&ition
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&re0ace 0rom t%e eig%t e.ition:
&%ilosop%y an. purpose
6$agine that "ou have gra&uate& )ro$ college 'ithout ta!ing an accounting course0 .ou are e$plo"e& " a co$pan" as a sales person, an& "ou eventuall" eco$e the sales $anager o) a territor"0 =hile atten&ing a sales $anagersJ $eeting, )inancial results are revie'e& " the Gice Presi&ent o) ,ales an& ter$s such as gross $argin percentage, cash )lo's )ro$ operating activities, an& A6FO inventor" $etho&s are eing &iscusse&0 The Gice Presi&ent eventuall" as!s "ou to &iscuss these topics as the" relate to "our territor"0 .ou tr" to &o so, ut it is o vious to ever"one in the $eeting that "ou &o not !no' 'hat "ou are tal!ing a out0 Accounting principles courses teach "ou the Klanguage o) usinessK so "ou un&erstan& ter$s an& concepts use& in usiness &ecisions0 6) "ou un&erstan& ho' accounting in)or$ation is prepare&, "ou 'ill e in an even stronger position 'hen )ace& 'ith a $anage$ent &ecision ase& on accounting in)or$ation0 The i$portance o) transactions anal"sis an& proper recor&ing o) transactions has clearl" &e$onstrate& in so$e o) the recent usiness )ailures that have een een reporte& in the press0 6) the

)inancial state$ents o) an enterprise are to properl" represent the results o) operations an& the )inancial con&ition o) the co$pan", the transactions $ust e anal"5e& an& recor&e& in the accounts )ollo'ing generall" accepte& accounting principles0 The &e its an& cre&its are i$portant not onl" to accounting $a3ors ut also to those entering or engage& in a usiness career to eco$e $anagers ecause the ulti$ate e))ects o) these 3ournal entries are re)lecte& in the )inancial state$ents0 6) expenses are reporte& as assets, lia ilities an& their relate& expenses are o$itte& )ro$ the )inancial state$ents, or reporte& revenues are recor&e& pre$aturel" or &o not reall" exist, the )inancial state$ents are $islea&ing0 The )inancial state$ents are onl" use)ul an& $eaning)ul i) the" are )air an& clearl" represent the usiness events o) the co$pan"0 =e 'rote this text to give "ou an un&erstan&ing o) ho' to use accounting in)or$ation to anal"5e usiness per)or$ance an& $a!e usiness &ecisions0 The text ta!es a usiness perspective0 =e use the annual reports o) real co$panies to illustrate $an" o) the accounting concepts0 .ou are )a$iliar 'ith $an" o) the co$panies 'e use, such as The Ai$ite&, The #o$e <epot, an& Coca-Cola Co$pan"0 2aining an un&erstan&ing o) accounting ter$inolog" an& concepts, ho'ever, is not enough to ensure "our success0 .ou also nee& to e a le to )in& in)or$ation on the 6nternet, anal"5e various

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usiness situations, 'or! e))ectivel" as a $e$ er o) a tea$, an& co$$unicate "our i&eas clearl"0 This text 'as &evelope& to help "ou &evelop these s!ills0

Curriculum concerns
,igni)icant changes have een reco$$en&e& )or accounting e&ucation0 ,o$e parties have expresse& concern that recent accounting gra&uates &o not possess the necessar" set o) s!ills to succee& in an accounting career0 The t"pical accounting gra&uate see$s una le to success)ull" &eal 'ith co$plex an& unstructure& Kreal 'orl&K accounting pro le$s an& generall" lac!s co$$unication an& interpersonal s!ills0 One reco$$en&ation is the greater use o) active learning techni4ues in a reenergi5e& classroo$ environ$ent0 The tra&itional lecture an& structure& pro le$ solving $etho& approach 'oul& e supple$ente& or replace& 'ith a $ore in)or$al classroo$ setting &ealing 'ith cases, si$ulations, an& group pro3ects0 Both insi&e an& outsi&e the classroo$, there 'oul& e t'o-'a" co$$unication et'een (1) pro)essor an& stu&ent an& (I) stu&ent an& stu&ent0 ,tu&" groups 'oul& e )or$e& so that stu&ents coul& tutor other stu&ents0 The purposes o) these reco$$en&ations inclu&e enhancing stu&entsJ critical thin!ing s!ills, 'ritten an& oral co$$unication s!ills, an& interpersonal s!ills0 One o) the $ost i$portant ene)its "ou can o tain )ro$ a college e&ucation is that "ou Klearn ho' to learnK0 The concept that "ou gain all o) "our learning in school an& then spen& the rest o) "our li)e appl"ing that !no'le&ge is not vali&0 Change is occurring at an increasingl" rapi& pace0 .ou 'ill pro a l" hol& $an" &i))erent 3o s &uring "our career, an& "ou 'ill pro a l" 'or! )or $an" &i))erent co$panies0 (uch o) the in)or$ation "ou learn in college 'ill e o solete in 3ust a )e' "ears0 There)ore, "ou 'ill e expecte& to engage in li)e-long learning0 (e$ori5ing is $uch less i$portant than learning ho' to thin! criticall"0 =ith this changing environ$ent in $in&, 'e have &evelope& a text that 'ill len& itsel) to &eveloping the s!ills that 'ill lea& to success in "our )uture career in usiness0 The section at the en& o) each chapter title&, KBe"on& the nu$ ersLCritical thin!ingK, provi&es the opportunit" )or "ou to a&&ress unstructure& case situations, the anal"sis o) real co$paniesJ )inancial situations, ethics cases, an& tea$ pro3ects0 %ach chapter also inclu&es one or t'o 1nternet pro2ects in the section title& KMsing the 6nternetLA vie' o) the real 'orl&K0 For $an" o) these ite$s, "ou 'ill use 'ritten an& oral co$$unication s!ills in presenting "our results0

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3b2ecti'es an. o'erall approac% o0 t%e eig%t% e.ition
The Accounting %&ucation Change Co$$ission (A%CC) $a&e speci)ic reco$$en&ations regar&ing teaching $aterials an& $etho&s use& in the )irst-"ear accounting course0 As a result, signi)icant changes have ta!en place in that course at $an" universities0 The A%CC states: T%e &irst course in accounting can signi&icantly bene&it t%ose '%o enter business, govern"ent, an un erstan ot%er organi(ations, '%ere ecision)"akers use accounting ecision)"aking by "anagers, in&or"ation. T%ese in ivi uals 'ill be better prepare &or t%eir responsibilities i& t%ey t%e role o& accounting in&or"ation in investors, govern"ent regulators, an ot%ers. All organi(ations %ave accountability

responsibilities to t%eir constituents, an accounting, properly use , is a po'er&ul tool in creating in&or"ation to i"prove t%e ecisions t%at a&&ect t%ose constituents. # One o) the purposes o) the )irst course shoul& e to recruit accounting $a3ors0 To help acco$plish this, the text has a section prece&ing each chapter entitle&, KCareers in accountingK0 =e retaine& a soli& coverage o) accounting that serves usiness stu&ents 'ell regar&less o) the $a3ors the" select0 Those 'ho choose not to $a3or in accounting, 'hich is a $a3orit" o) those ta!ing this course, 'ill eco$e etter users o) accounting in)or$ation ecause the" 'ill !no' so$ething a out the preparation o) that in)or$ation0

#pproac% an. organi4ation
Business emp%asis
=ithout actual usiness experience, usiness stu&ents so$eti$es lac! a )ra$e o) re)erence in atte$pting to appl" accounting concepts to usiness transactions0 =e see! to involve the usiness stu&ent $ore in real 'orl& usiness applications as 'e intro&uce an& explain the su 3ect $atter0
 5#n accounting perspecti'e: Business insig%t5

oxes throughout the text provi&e

exa$ples o) ho' co$panies )eature& in text exa$ples use accounting in)or$ation ever" &a", or the" provi&e other use)ul in)or$ation0

1 Accounting %&ucation Change Co$$ission, Position ,tate$ent /o0 T'o, FThe First Course in AccountH (Torrance, CA, ;une 1>>I), pp0 1-I0 p. D o) *++

 5#ccounting perspecti'e: 6ses o0 tec%nology5

oxes throughout the text &e$onstrate

ho' technolog" has a))ecte& the 'a" accounting in)or$ation is prepare&, $anipulate&, an& accesse&0
 ,o$e chapters contain 5# broa.er perspecti'e50 These situations, ta!en )ro$ annual reports

o) real co$panies an& )ro$ articles in current usiness perio&icals such as Accounting To ay, an& *anage"ent Accounting, relate to su 3ect $atter &iscusse& in that chapter or present other use)ul in)or$ation0 These real 'orl& exa$ples &e$onstrate the usiness relevance o) accounting0
 :eal 'orl& 4uestions an& real 'orl&

usiness &ecision cases are inclu&e& in al$ost ever"

chapter0
 The annual report appen&ix inclu&e& 'ith this text contains signi)icant portions o) the annual

report o) The Ai$ite&, 6nc0 (an" o) the real 'orl& 4uestions an& usiness &ecision cases are ase& on this annual report0
 /u$erous illustrations a&apte& )ro$ Accounting Tren s + Tec%niques sho' the )re4uenc" o)

use in usiness o) various accounting techni4ues0 Place& throughout the text, these illustrations give stu&ents real 'orl& &ata to consi&er 'hile learning a out &i))erent accounting techni4ues0
 Throughout the text 'e have inclu&e& nu$erous re)erences to the annual reports o) $an"

co$panies0
 Chapters 1-1D contain a section entitle&, KAnal"5ing an& using the )inancial resultsK0 This section

&iscusses an& illustrates a ratio or other anal"sis techni4ue that pertains to the content o) the chapter0 For instance, this section in Chapter * &iscusses the current ratio as it relates to a classi)ie& alance sheet0
 ,o$e o) the chapters contain en&-o)-chapter 4uestions, exercises, or usiness &ecision cases that

re4uire the stu&ent to re)er to the Annual report appen&ix an& ans'er certain 4uestions0 As state& earlier, this appen&ix is inclu&e& 'ith the text an& contains the signi)icant portions o) the annual report o) The Ai$ite&, 6nc0
 %ach chapter contains a section entitle&, KBe"on& the nu$ ersLCritical thin!ingK0 This section

contains usiness &ecision cases, annual report anal"sis pro le$s, 'riting assign$ents ase& on the %thical perspective an& Broa&er perspective oxes, group pro3ects, an& 6nternet pro3ects0

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&e.agogy
,tu&ents o)ten co$e into accounting principles courses )eeling anxious a out learning the su 3ect $atter0 :ecogni5ing this apprehension, 'e stu&ie& 'a"s to $a!e learning easier an& ca$e up 'ith so$e help)ul i&eas on ho' to $a!e this e&ition 'or! even etter )or stu&ents0
 6$prove$ents in the textJs content re)lect )ee& ac! )ro$ a&opters, suggestions

" revie'ers,

an& a serious stu&" o) the learning process itsel) " the authors an& e&itors0 /e' su 3ect $atter is intro&uce& onl" a)ter the stage has een set " transitional paragraphs et'een topic hea&ings0 These paragraphs provi&e stu&ents 'ith the reasons )or procee&ing to the ne' $aterial an& explain the progression o) topics 'ithin the chapter0
 The 6ntro&uction contains a section entitle& K#o' to stu&" the chapters in this textK, 'hich

shoul& e ver" help)ul to stu&ents0
 %ach chapter has an KMn&erstan&ing the learning o 3ectivesK section0 These Ksu$$ariesK ena le

the stu&ent to &eter$ine ho' 'ell the learning o 3ectives 'ere acco$plishe&0 =e 'ere the )irst authors (1>@*) to ever inclu&e Aearning o 3ectives in an accounting text0 These o 3ectives have een inclu&e& at the eginning o) the chapter, as $arginal notes 'ithin the chapter, at the en& o) the chapter, an& in supple$ents such as the Test an!, 6nstructorsJ resource gui&e, Co$puteri5e& test an!, an& ,tu&" gui&e0 The o 3ectives are also in&icate& )or each exercise an& pro le$0
 <e$onstration pro le$s an& solutions are inclu&e& )or each chapter, an& a &i))erent one

appears )or each chapter in the ,tu&" gui&e0 These &e$onstration pro le$s help stu&ents to assess their o'n progress " sho'ing the$ ho' pro le$s that )ocus on the topic(s) covere& in the chapter are 'or!e& e)ore stu&ents &o assigne& ho$e'or! pro le$s0
 Ne" ter$s are printe& )or e$phasis0 %n&-o)-chapter glossaries contain the &e)inition0  %ach chapter inclu&es a K,el)-testK consisting o) true-)alse an& $ultiple-choice 4uestions0 The

ans'ers an& explanations appear at the en& o) the chapter0 These sel)-tests are &esigne& to &eter$ine 'hether the stu&ent has learne& the essential in)or$ation in each chapter0
 6n the $argin

esi&e each exercise an& pro le$, 'e have inclu&e& a &escription o) the

re4uire$ents an& the relate& Aearning o 3ective(s)0 These &escriptions let stu&ents !no' 'hat the" are expecte& to &o in the pro le$0
 Throughout the text 'e use exa$ples ta!en )ro$ ever"&a" li)e to relate an accounting concept

eing intro&uce& or &iscusse& to stu&entsJ experiences0

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-t%ics
There is no etter ti$e to e$phasi5e high ethical stan&ar&s to stu&ents0 This text inclu&es $an" ite$s throughout the text entitle&, KAn ethical perspectiveK0 These ite$s present situations in 'hich stu&ents are li!el" to )in& the$selves throughout their careers0 The" range )ro$ resisting pressure " a superior or a client to &o the 'rong thing to &eci&ing et'een alternative corporate ehaviors that have environ$ental an& pro)it conse4uences0

-n.-o0-c%apter materials
<escri ing teaching $etho&s, the A%CC state&, KTeachers000shoul& place a priorit" on their interaction 'ith stu&ents an& on interaction a$ong stu&ents0 ,tu&entsJ involve$ent shoul& e pro$ote& " $etho&s such as cases, si$ulations, an& group pro3ects000K I A section entitle& KBe"on& the nu$ ersLCritical thin!ingK at the en& o) ever" chapter is &esigne& to i$ple$ent these reco$$en&ations0 Business &ecision cases re4uire critical thin!ing in co$plex situations o)ten ase& on real co$panies0 The Annual report anal"sis section re4uires anal"5ing annual reports an& interpreting the results in 'riting0 The %thics cases re4uire stu&ents to respon& in 'riting to situations the" are li!el" to encounter in their careers0 These cases &o not necessaril" have one right ans'er0 The 2roup pro3ects )or each chapter teach stu&ents ho' to 'or! e))ectivel" in tea$s, a s!ill that 'as stresse& " the A%CC an& is eco$ing increasingl" necessar" )or success in usiness0 The 6nternet pro3ects teach stu&ents ho' to retrieve use)ul in)or$ation )ro$ the 6nternet0 A tea$ approach can also e intro&uce& in the classroo$ using the regular exercises an& pro le$s in the text0 Tea$s can e assigne& the tas! o) presenting their solutions to exercises or pro le$s to the rest o) the class0 Msing this tea$ approach in class can help re-energi5e the classroo$ " creating an active, in)or$al environ$ent in 'hich stu&ents learn )ro$ each other0 (T'o a&&itional group pro3ects are &escri e& in the 6nstructorJs resource gui&e0 These pro3ects are &esigne& to e use& throughout the se$ester or 4uarter0) =e have inclu&e& a vast a$ount o) other resource $aterials )or each chapter 'ithin the text )ro$ 'hich the instructor $a" &ra': (1) one o) the largest selections o) en&-o)-chapter 4uestions, exercises, an& pro le$s availa le? (I) several co$prehensive revie' pro le$s that allo' stu&ents to revie' all $a3or concepts covere& to that point? an& (+) )ro$ one to three usiness &ecision cases per chapter0 Other !e" )eatures regar&ing en&-o)-chapter $aterial )ollo'0

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 A uni)or$ chart o) accounts appears in a separate )ile "ou can &o'nloa&0 This uni)or$ chart o)

accounts is use& consistentl" throughout the )irst 11 chapters0 =e elieve stu&ents 'ill ene)it )ro$ using the sa$e chart o) accounts )or all ho$e'or! pro le$s in those chapters0
 A co$prehensive revie' pro le$ at the en& o) Chapter * serves as a $ini practice set to test all

$aterial covere& to that point0 Another co$prehensive pro le$ at the en& o) Chapter 1> revie's the $aterial covere& in Chapters 18 an& 1>0 T'o co$prehensive u&geting pro le$s are also inclu&e& as usiness &ecision cases at the en& o) Chapter I+0
 ,o$e o) the en&-o)-chapter pro le$ $aterials (4uestions, exercises, pro le$s, usiness &ecision

cases, other KBe"on& the nu$ ersK ite$s, an& co$prehensive revie' pro le$s) have

een

up&ate&0 %ach exercise an& pro le$ is i&enti)ie& 'ith the learning o 3ective(s) to 'hich it relates0
 All en&-o)-chapter exercises an& pro le$s have een trace& ac! to the chapters to ensure that

nothing is as!e& o) a stu&ent that &oes not appear in the oo!0 This )eature 'as a strength o) previous e&itions, ensuring that instructors coul& con)i&entl" assign pro le$s 'ithout having to chec! )or applica ilit"0 Also, 'e too! notes 'hile teaching )ro$ the text an& clari)ie& pro le$ an& exercise instructions that see$e& con)using to our stu&ents0

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Table of Contents
1 The Accounting %nviron$ent00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001* 101 Aearning o 3ectives0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001* 10I Accounting <e)ine&000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001C 10+ %$plo"$ent opportunities in accounting00000000000000000000000000000000000000000000000000000000000000000000001@ 10* Financial accounting versus $anagerial accounting000000000000000000000000000000000000000000000000000000I1 10C <evelop$ent o) )inancial accounting stan&ar&s000000000000000000000000000000000000000000000000000000000000I+ 10D %thical ehavior o) accountants0000000000000000000000000000000000000000000000000000000000000000000000000000000000000IC 10@ Critical thin!ing an& co$$unication s!ills0000000000000000000000000000000000000000000000000000000000000000000ID 108 6nternet s!ills000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000I@ 10> #o' to stu&" the chapters in this text0000000000000000000000000000000000000000000000000000000000000000000000000000I@ I Accounting an& its use in usiness &ecisions0000000000000000000000000000000000000000000000000000000000000000000+B I01 Aearning o 3ectives00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+B I0I A career as an entrepreneur000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+B I0+ For$s o) usiness organi5ations000000000000000000000000000000000000000000000000000000000000000000000000000000000000+1 I0* T"pes o) activities per)or$e& " usiness organi5ations0000000000000000000000000000000000000000000000++ I0C Financial state$ents o) usiness organi5ations000000000000000000000000000000000000000000000000000000000000+* I0D The )inancial accounting process00000000000000000000000000000000000000000000000000000000000000000000000000000000000+> I0@ Mn&erl"ing assu$ptions or concepts 000000000000000000000000000000000000000000000000000000000000000000000000000*B I08 Transactions a))ecting onl" the alance sheet 00000000000000000000000000000000000000000000000000000000000000*1 I0> Transactions a))ecting the inco$e state$ent an&7or alance sheet 0000000000000000000000000000*C I01B ,u$$ar" o) alance sheet an& inco$e state$ent transactions000000000000000000000000000000000*8 I011 <ivi&en&s pai& to o'ners (stoc!hol&ers)000000000000000000000000000000000000000000000000000000000000000000000*> I01I Anal"5ing an& using the )inancial resultsLthe e4uit" ratio00000000000000000000000000000000000000000CI I01+ Mn&erstan&ing the learning o 3ectives000000000000000000000000000000000000000000000000000000000000000000000000C+ I01* Appen&ix: A co$parison o) corporate accounting 'ith accounting )or a sole proprietorship an& a partnership00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000C* I01C <e$onstration pro le$00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000CC I01D ,olution to &e$onstration pro le$00000000000000000000000000000000000000000000000000000000000000000000000000000C@ I01@ Ne" ter$s0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000C8 I018 ,el)-test000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000DB + :ecor&ing usiness transactions000000000000000000000000000000000000000000000000000000000000000000000000000000000000000@@ +01 Aearning o 3ectives000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000@@ +0I ,alar" potential o) accountants00000000000000000000000000000000000000000000000000000000000000000000000000000000000000@@ +0+ The account an& rules o) &e it an& cre&it0000000000000000000000000000000000000000000000000000000000000000000000@> +0* :ecor&ing changes in assets, lia ilities, an& stoc!hol&ersJ e4uit"00000000000000000000000000000000081
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+0C The accounting c"cle0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000008D +0D The 3ournal0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000008@ +0@ The le&ger0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000 >B +08 The accounting process in operation00000000000000000000000000000000000000000000000000000000000000000000000000000>1 +0> The use o) le&ger accounts00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001BC +01B Anal"5ing an& using the )inancial resultsL #ori5ontal an& vertical anal"ses0000000000011C +011 Ne" ter$s0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001I+ +01I ,el)-test000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001I* * A&3ust$ents )or )inancial reporting000000000000000000000000000000000000000000000000000000000000000000000000000000001** *01 Aearning o 3ectives00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001** *0I A career as a tax specialist000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001** *0+ Cash versus accrual asis accounting0000000000000000000000000000000000000000000000000000000000000000000000000001*C *0* The nee& )or a&3usting entries000000000000000000000000000000000000000000000000000000000000000000000000000000000000001*@ *0C Classes an& t"pes o) a&3usting entries000000000000000000000000000000000000000000000000000000000000000000000000001*> *0D A&3ust$ents )or &e)erre& ite$s0000000000000000000000000000000000000000000000000000000000000000000000000000000000001C1 *0@ A&3ust$ents )or accrue& ite$s00000000000000000000000000000000000000000000000000000000000000000000000000000000000001DI *08 %))ects o) )ailing to prepare a&3usting entries000000000000000000000000000000000000000000000000000000000000001DD *0> Anal"5ing an& using the )inancial resultsLtren& percentages0000000000000000000000000000000000001DD *01B Mn&erstan&ing the learning o 3ectives000000000000000000000000000000000000000000000000000000000000000000000001D@ C Co$pleting the accounting c"cle0000000000000000000000000000000000000000000000000000000000000000000000000000000000001>B C01 Aearning o 3ectives00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001>B C0I A career in in)or$ation s"ste$s00000000000000000000000000000000000000000000000000000000000000000000000000000000001>B C0+ The accounting c"cle su$$ari5e&000000000000000000000000000000000000000000000000000000000000000000000000000000001>1 C0* The 'or! sheet000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001>1 C0C Preparing )inancial state$ents )ro$ the 'or! sheet0000000000000000000000000000000000000000000000000001>> C0D ;ournali5ing a&3usting entries0000000000000000000000000000000000000000000000000000000000000000000000000000000000000IBB C0@ The closing process0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000IB1 C08 Accounting s"ste$s: Fro$ $anual to co$puteri5e&00000000000000000000000000000000000000000000000000I1B C0> A classi)ie& alance sheet000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000I1D C01B Anal"5ing an& using the )inancial results L the current ratio00000000000000000000000000000000000II+ C011 Mn&erstan&ing the learning o 3ectives00000000000000000000000000000000000000000000000000000000000000000000000II* D Accounting theor"00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000IC* D01 Aearning o 3ectives000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000IC* D0I A career as an accounting pro)essor0000000000000000000000000000000000000000000000000000000000000000000000000000IC* D0+ Tra&itional accounting theor"0000000000000000000000000000000000000000000000000000000000000000000000000000000000000ICC D0* Mn&erl"ing assu$ptions or concepts00000000000000000000000000000000000000000000000000000000000000000000000000ICD D0C Other asic concepts0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000IC8 D0D The $easure$ent process in accounting00000000000000000000000000000000000000000000000000000000000000000000IC> D0@ The $a3or principles0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000IDB D08 (o&i)"ing conventions (or constraints)0000000000000000000000000000000000000000000000000000000000000000000000ID8 D0> The )inancial accounting stan&ar&s oar&Js conceptual )ra$e'or! pro3ect000000000000000I@B
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D01B O 3ectives o) )inancial reporting00000000000000000000000000000000000000000000000000000000000000000000000000000000I@1 D011 Oualitative characteristics000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000I@+ D01I The asic ele$ents o) )inancial state$ents0000000000000000000000000000000000000000000000000000000000000000I@@ D01+ :ecognition an& $easure$ent in )inancial state$ents000000000000000000000000000000000000000000000I@> D01* ,u$$ar" o) signi)icant accounting policies00000000000000000000000000000000000000000000000000000000000000I@> D01C ,igni)icant accounting policies0000000000000000000000000000000000000000000000000000000000000000000000000000000000I8B D01D Mn&erstan&ing the learning o 3ectives0000000000000000000000000000000000000000000000000000000000000000000000I8+ @ 6ntro&uction to inventories an& the classi)ie& inco$e state$ent0000000000000000000000000000000000+B+ @01 Aearning o 3ective 0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+B+ @0I A career as a C%O000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+B+ @0+ T'o inco$e state$ents co$pare&L ,ervice co$pan" an& $erchan&ising co$pan" 00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000 +BC @0* ,ales revenues00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+BC @0C Cost o) goo&s sol&000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+1+ @0D Classi)ie& inco$e state$ent0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+I* @0@ Anal"5ing an& using the )inancial resultsL2ross $argin percentage0000000000000000000000000+I> @08 Mn&erstan&ing the learning o 3ectives000000000000000000000000000000000000000000000000000000000000000000000000+I> @0> Appen&ix: The 'or! sheet )or a $erchan&ising co$pan"0000000000000000000000000000000000000000000++1 @01B Ne" ter$s0000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000++8 @011 ,el)-test00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000 +*B 8 (easuring an& reporting inventories00000000000000000000000000000000000000000000000000000000000000000000000000000+C> 801 Aearning o 3ectives000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+C> 80I Choosing an accounting career000000000000000000000000000000000000000000000000000000000000000000000000000000000000+C> 80+ 6nventories an& cost o) goo&s sol&000000000000000000000000000000000000000000000000000000000000000000000000000000+DB 80* 6$portance o) proper inventor" valuation000000000000000000000000000000000000000000000000000000000000000000+D1 80C <eter$ining inventor" cost00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000+D+ 80D <epartures )ro$ cost asis o) inventor" $easure$ent0000000000000000000000000000000000000000000000+8@ 80@ Anal"5ing an& using )inancial resultsLinventor" turnover ratio00000000000000000000000000000000+>C 808 Mn&erstan&ing the learning o 3ectives000000000000000000000000000000000000000000000000000000000000000000000000+>C Alpha etical 6n&ex00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000*I@

p. 1+ o) *++

1 The Accounting Environment
1.1 Learning objectives
A)ter stu&"ing this intro&uction, "ou shoul& e a le to:
    

<e)ine accounting0 <escri e the )unctions per)or$e& " accountants0 <escri e e$plo"$ent opportunities in accounting0 <i))erentiate et'een )inancial an& $anagerial accounting0 6&enti)" several organi5ations that have a role in the &evelop$ent o) )inancial accounting

stan&ar&s0 .ou have e$ ar!e& on the challenging an& re'ar&ing stu&" o) accountingLan ol& an& ti$ehonore& &iscipline0 #istor" in&icates that all &evelope& societies re4uire certain accounting recor&s0 :ecor&-!eeping in an accounting sense is thought to have egun a out *BBB BC% The recor&-!eeping, control, an& veri)ication pro le$s o) the ancient 'orl& ha& $an" characteristics si$ilar to those 'e encounter to&a"0 For exa$ple, ancient govern$ents also !ept recor&s o) receipts an& &is urse$ents an& use& proce&ures to chec! on the honest" an& relia ilit" o) e$plo"ees0 A stu&" o) the evolution o) accounting suggests that accounting processes have &evelope& pri$aril" in response to usiness nee&s0 Also, econo$ic progress has a))ecte& the &evelop$ent o) accounting processes0 #istor" sho's that the higher the level o) civili5ation, the $ore ela orate the accounting $etho&s0 The e$ergence o) &ou le-entr" oo!!eeping 'as a crucial event in accounting histor"0 6n 1*>*, a Franciscan $on!, Auca Pacioli, &escri e& the &ou le-entr" (etho& o) Genice s"ste$ in his text calle& ,u""a e Arit%"etica, Geo"etric, Proportion et Proportionate (%ver"thing a out arith$etic, geo$etr", an& proportion)0 (an" consi&er PacioliJs ,u""a to e a re'or!e& version o) a $anuscript that circulate& a$ong teachers an& pupils o) the Genetian school o) co$$erce an& arith$etic0 ,ince PacioliJs &a"s, the roles o) accountants an& pro)essional accounting organi5ations have expan&e& in usiness an& societ"0 As pro)essionals, accountants have a responsi ilit" )or placing pu lic service a ove their co$$it$ent to personal econo$ic gain0 Co$ple$enting their o ligation to societ", accountants have anal"tical an& evaluative s!ills nee&e& in the solution o) ever-gro'ing 'orl&

p. 1* o) *++

pro le$s0 The special a ilities o) accountants, their in&epen&ence, an& their high ethical stan&ar&s per$it the$ to $a!e signi)icant an& uni4ue contri utions to usiness an& areas o) pu lic interest0 .ou pro a l" 'ill )in& that o) all the usiness !no'le&ge "ou have ac4uire& or 'ill learn, the stu&" o) accounting 'ill e the $ost use)ul0 .our )inancial an& econo$ic &ecisions as a stu&ent an& consu$er involve accounting in)or$ation0 =hen "ou )ile inco$e tax returns, accounting in)or$ation helps &eter$ine "our taxes pa"a le0 Mn&erstan&ing the &iscipline o) accounting also can in)luence $an" o) "our )uture pro)essional &ecisions0 .ou cannot escape the e))ects o) accounting in)or$ation on "our personal an& pro)essional li)e0 %ver" pro)it-see!ing usiness organi5ation that has econo$ic resources, such as $one", $achiner", an& uil&ings, uses accounting in)or$ation0 For this reason, accounting is calle& the language o) usiness0 Accounting also serves as the language provi&ing )inancial in)or$ation a out not-)or-pro)it organi5ations such as govern$ents, churches, charities, )raternities, an& hospitals0 #o'ever, this text concentrates on accounting )or usiness )ir$s0 The accounting s"ste$ o) a pro)it-see!ing usiness is an in)or$ation s"ste$ &esigne& to provi&e relevant )inancial in)or$ation on the resources o) a usiness an& the e))ects o) their use0 6n)or$ation is relevant i) it has so$e i$pact on a &ecision that $ust e $a&e0 Co$panies present this relevant in)or$ation in their )inancial state$ents0 6n preparing these state$ents, accountants consi&er the users o) the in)or$ation, such as o'ners an& cre&itors, an& &ecisions the" $a!e that re4uire )inancial in)or$ation0 As a ac!groun& )or stu&"ing accounting, this 6ntro&uction &e)ines accounting an& lists the et'een )inancial an& $anagerial accounting0 Because accounting in)or$ation $ust )unctions accountants per)or$0 6n a&&ition to surve"ing e$plo"$ent opportunities in accounting, it &i))erentiates con)or$ to certain stan&ar&s, 'e &iscuss several pro$inent organi5ations contri uting to these stan&ar&s0 As "ou continue "our stu&" o) accounting in this text, accountingLthe language o) usiness L'ill eco$e "our language also0 .ou 'ill reali5e that "ou are constantl" expose& to accounting in)or$ation in "our ever"&a" li)e0

1.2 Accounting Defined
The A$erican Accounting AssociationLone o) the accounting organi5ations &iscusse& later in this 6ntro&uctionL&e)ines accounting as Kthe process o) i&enti)"ing, $easuring, an& co$$unicating

p. 1C o) *++

econo$ic in)or$ation to per$it in)or$e& 3u&g$ents an& &ecisions " the users o) the in)or$ationK0 1 This in)or$ation is pri$aril" )inancialLstate& in $one" ter$s0 Accounting, then, is a $easure$ent an& co$$unication process use& to report on the activities o) pro)it-see!ing usiness organi5ations an& not-)or-pro)it organi5ations0 As a $easure$ent an& co$$unication process )or usiness, accounting supplies in)or$ation that per$its in)or$e& 3u&g$ents an& &ecisions " users o) the &ata0 The accounting process provi&es )inancial &ata )or a roa& range o) in&ivi&uals 'hose o 3ectives in stu&"ing the &ata var" 'i&el"0 Ban! o))icials, )or exa$ple, $a" stu&" a co$pan"Js )inancial state$ents to evaluate the co$pan"Js a ilit" to repa" a loan0 Prospective investors $a" co$pare accounting &ata )ro$ several co$panies to &eci&e 'hich co$pan" represents the est invest$ent0 Accounting also supplies $anage$ent 'ith signi)icant )inancial &ata use)ul )or &ecision $a!ing0 :elia le in)or$ation is necessar" e)ore &ecision $a!ers can $a!e a soun& &ecision involving the allocation o) scarce resources0 Accounting in)or$ation is valua le ecause &ecision $a!ers can use it to evaluate the )inancial conse4uences o) various alternatives0 Accountants eli$inate the nee& )or a cr"stal all to esti$ate the )uture0 The" can re&uce uncertaint" " using pro)essional 3u&g$ent to 4uanti)" the )uture )inancial i$pact o) ta!ing action or &ela"ing action0 Although accounting in)or$ation pla"s a signi)icant role in re&ucing uncertaint" 'ithin the organi5ation, it also provi&es )inancial &ata )or persons outsi&e the co$pan"0 This in)or$ation tells ho' $anage$ent has &ischarge& its responsi ilit" )or protecting an& $anaging the co$pan"Js resources0 ,toc!hol&ers have the right to !no' ho' a co$pan" is $anaging its invest$ents0 6n )ul)illing this o ligation, accountants prepare )inancial state$ents such as an inco$e state$ent, a state$ent o) retaine& earnings, a re4uire$ents0 Accounting is o)ten con)use& 'ith oo!!eeping0 Boo!!eeping is a $echanical process that recor&s the routine econo$ic activities o) a usiness0 Accounting inclu&es oo!!eeping ut goes 'ell e"on& it in scope0 Accountants anal"5e an& interpret )inancial in)or$ation, prepare )inancial state$ents, con&uct au&its, &esign accounting s"ste$s, prepare special )orecasts an& u&gets, an& provi&e tax services0 ,peci)icall" the accounting process consists o) the )ollo'ing groups o) )unctions (see %xhi it 1 elo'): 1 A$erican Accounting Association, A ,tate"ent o& Basic Accounting T%eory (%vanston, 6660, 1>DD), p0 10 p. 1D o) *++ usiness an& )inancial stu&ies, prepare alance sheet, an& a state$ent o) cash )lo's0 6n a&&ition, the" prepare tax returns )or )e&eral an& state govern$ents, as 'ell as )ul)ill other govern$ental )iling

 Accountants o serve $an" events (or activities) an& i&enti)" an& $easure in )inancial ter$s

(&ollars) those events consi&ere& evi&ence o) econo$ic activit"0 (O)ten, these three )unctions are collectivel" re)erre& to as anal"5e0) The purchase an& sale o) goo&s an& services are econo$ic events0
 /ext, the econo$ic events are recor&e&, classi)ie& into $eaning)ul groups, an& su$$ari5e&0  Accountants report on econo$ic events (or usiness activit") " preparing )inancial state$ents

an& special reports0 O)ten accountants interpret these state$ents an& reports )or various groups such as $anage$ent, investors, an& cre&itors0 6nterpretation $a" involve &eter$ining ho' the usiness is per)or$ing co$pare& to prior "ears an& other si$ilar usinesses0

1.3 Emplo ment opportunities in accounting
<uring the last hal)-centur", accounting has gaine& the sa$e pro)essional status as the $e&ical an& legal pro)essions0 To&a", the accountants in the Mnite& ,tates nu$ er 'ell over a $illion0 6n a&&ition, several $illion people hol& accounting-relate& positions0 T"picall", accountants provi&e services in various ranches o) accounting0 These inclu&e pu lic accounting, $anage$ent (in&ustrial) accounting, govern$ental or other not-)or-pro)it accounting, an& higher e&ucation0 The &e$an& )or accountants 'ill li!el" increase &ra$aticall" in the )uture0 This increase is greater than )or an" other pro)ession0 .ou $a" 'ant to consi&er accounting as a career0 &ublic accounting 0irms o))er pro)essional accounting an& relate& services )or a )ee to co$panies, other organi5ations, an& in&ivi&uals0 An accountant $a" #ccountant (CPA) " passing an exa$ination prepare& an& gra&e& eco$e a Certi0ie. &ublic " the A$erican 6nstitute o)

Certi)ie& Pu lic Accountants (A6CPA)0 The exa$ is a&$inistere& " co$puter0 6n a&&ition to passing the exa$, CPA can&i&ates $ust $eet other re4uire$ents, 'hich inclu&e o taining a state license0 These re4uire$ents var" " state0 A nu$ er o) states re4uire a CPA can&i&ate to have co$plete& speci)ic accounting courses an& earne& a certain nu$ er o) college cre&its ()ive "ears o) stu&" in $an" states)? 'or!e& a certain nu$ er o) "ears in pu lic accounting, in&ustr", or govern$ent? an& live& in that state a certain length o) ti$e e)ore ta!ing the CPA exa$ination0 As o) the "ear IBBB, )ive "ears o) course 'or! 'ere re4uire& to eco$e a $e$ er o) the A6CPA0 A)ter a can&i&ate passes the CPA exa$ination, so$e states (calle& one-tier states) insist that the can&i&ate $eet all re4uire$ents e)ore the state grants the CPA certi)icate an& license to practice0 Other states (calle& t'o-tier states) issue the CPA certi)icate i$$e&iatel" a)ter the can&i&ate passes the exa$0 #o'ever, these states issue the license to practice onl" a)ter all other re4uire$ents have een $et0 CPAs 'ho 'ant to rene' their licenses to practice $ust sta" current through continuing p. 1@ o) *++

pro)essional e&ucation progra$s an& $ust prove that the" have &one so0 /o one can clai$ to e a CPA an& o))er the services nor$all" provi&e& practice0 " a CPA unless that person hol&s an active license to

%xhi it 1: Functions per)or$e& " accountants

p. 18 o) *++

The pu lic accounting pro)ession in the Mnite& ,tates consists o) the Big-Four international CPA )ir$s, several national )ir$s, $an" regional )ir$s, an& nu$erous local )ir$s0 The Big-Four )ir$s inclu&e <eloitte P Touche, %rnst P .oung, NP(2, an& Price'aterhouse Coopers0 At all levels, these pu lic accounting )ir$s provi&e au&iting, tax, an&, )or nonau&it clients, $anage$ent a&visor" (or consulting) services0 #u.iting A usiness see!ing a loan or atte$pting to have its securities tra&e& on a stoc! exchange usuall" $ust provi&e )inancial state$ents to support its re4uest0 Msers o) a co$pan"Js )inancial state$ents are $ore con)i&ent that the co$pan" is presenting its state$ents )airl" 'hen a CPA has au&ite& the state$ents0 For this reason, co$panies hire CPA )ir$s to con&uct exa$inations (in.epen.ent au.its) o) their accounting an& relate& recor&s0 1n.epen.ent au.itors o) the CPA )ir$ chec! so$e o) the co$pan"Js recor&s " contacting external sources0 For exa$ple, the accountant $a" contact a an! to veri)" the cash alances o) the client0 A)ter co$pleting a co$pan" au&it, in&epen&ent au&itors give an in.epen.ent au.itor7s opinion or report 0 (For an exa$ple o) an au&itorJs opinion, see The Ai$ite&, 6nc0 annual report in the Annual report appen&ix at the en& o) the text0) This report states 'hether the co$pan"Js )inancial state$ents )airl" (e4uita l") report the econo$ic per)or$ance an& )inancial con&ition o) the usiness0 As "ou 'ill learn in the next section, au&itors 'ithin a usiness also con&uct au&its, 'hich are not in&epen&ent au&its0 Currentl" au&iting stan&ar&s are esta lishe& " the Pu lic Co$pan" Accounting Oversight Boar&0 6n IBBI The ,ar anes-Oxle" Act 'as passe&0 The Act 'as passe& as one result o) the large losses to the e$plo"ees an& investors )ro$ accounting )rau& situations involving co$panies such as %nron an& =orl&Co$0 The Act create& the Pu lic Co$pan" Accounting Oversight Boar&0 The Boar& consists o) )ive $e$ ers appointe& an& overseen " the ,ecurities an& %xchange Co$$ission0 The Boar& oversees an& investigates the au&its an& au&itors o) pu lic co$panies an& can sanction oth )ir$s an& in&ivi&uals )or violations o) la's, regulations, an& rules0 The Chie) %xecutive O))icer an& Chie) Financial O))icer o) a pu lic co$pan" $ust no' certi)" the co$pan"Js )inancial state$ents0 Corporate au&it co$$ittees, rather than the corporate $anage$ent, are no' responsi le )or hiring, co$pensating, an& overseeing the external au&itors0 $ax ser'ices CPAs o)ten provi&e expert a&vice on tax planning an& preparing )e&eral, state, an& local tax returns0 The o 3ective in preparing tax returns is to use legal $eans to $ini$i5e the taxes pai&0 Al$ost ever" $a3or usiness &ecision has a tax i$pact0 Tax planning helps clients !no' the tax e))ects o) each )inancial &ecision0 8anagement a.'isory (or consulting) ser'ices Be)ore ,ar anes-Oxle" $anage$ent a&visor" services 'ere the )astest gro'ing service area )or $ost large an& $an" s$aller CPA )ir$s0 (anage$ent p. 1> o) *++

)re4uentl" i&enti)ies pro3ects )or 'hich it &eci&es to retain the services o) a CPA0 #o'ever, the ,ar anes-Oxle" Act speci)icall" prohi its provi&ing certain t"pes o) consulting services to a pu licl"hel& co$pan" " its external au&itor0 These services inclu&e oo!!eeping, in)or$ation s"ste$s &esign an& i$ple$entation, appraisals or valuation services, actuarial services, internal au&its, $anage$ent an& hu$an resources services, ro!er7&ealer an& invest$ent services, an& legal or expert services relate& to au&it services0 Accounting )ir$s can per)or$ $an" o) these services )or pu licl" hel& co$panies the" &o not au&it0 Other services not speci)icall" anne& are allo'e& i) pre-approve& " the co$pan"Js au&it co$$ittee0 6n contrast to pu lic accountants, 'ho provi&e accounting services )or $an" clients, $anage$ent accountants provi&e accounting services )or a single usiness0 6n a co$pan" 'ith several $anage$ent accountants, the person in charge o) the accounting activit" is o)ten the controller or c%ie0 0inancial o00icer0 (anage$ent accountants $a" or $a" not e CPAs0 6) $anage$ent accountants pass an exa$ination prepare& an& gra&e& " the 6nstitute o) Certi)ie& (anage$ent Accountants (6C(A) an& $eet certain other re4uire$ents, the" eco$e Certi0ie. 8anagement #ccountants (C8#s)0 The 6C(A is an a))iliate o) the 6nstitute o) (anage$ent Accountants, an organi5ation pri$aril" consisting o) $anage$ent accountants e$plo"e& in private in&ustr"0 A career in $anage$ent accounting can e ver" challenging an& re'ar&ing0 (an" $anage$ent accountants speciali5e in one particular area o) accounting0 For exa$ple, so$e $a" speciali5e in $easuring an& controlling costs, others in u&geting (the &evelop$ent o) plans )or )uture operations), an& still others in )inancial accounting an& reporting0 (an" $anage$ent accountants eco$e specialists in the &esign an& installation o) co$puteri5e& accounting s"ste$s0 Other $anage$ent accountants are internal au.itors 'ho con&uct internal au.its0 The" ensure that the co$pan"Js &ivisions an& &epart$ents )ollo' the policies an& proce&ures o) $anage$ent0 This last group o) $anage$ent accountants $a" earn the &esignation o) Certi0ie. 1nternal #u.itor (C1#). The 6nstitute o) 6nternal Au&itors (66A) grants the C6A certi)icate to accountants a)ter the" have success)ull" co$plete& the 66A exa$ination an& $et certain other re4uire$ents0 (an" accountants, inclu&ing CPAs, 'or! in go'ernmental an. ot%er not-0or-pro0it accounting0 The" have essentiall" the sa$e e&ucational ac!groun& an& training as accountants in pu lic accounting an& $anage$ent accounting0 2overn$ental agencies at the )e&eral, state, an& local levels e$plo" govern$ental accountants0 O)ten the &uties o) these accountants relate to tax revenues an& expen&itures0 For exa$ple, 6nternal :evenue ,ervice e$plo"ees use their accounting ac!groun&s in revie'ing tax returns an& p. IB o) *++

investigating tax )rau&0 2overn$ent agencies that regulate usiness activit", such as a state pu lic service co$$ission that regulates pu lic utilities (e0g0 telephone co$pan", electric co$pan"), usuall" e$plo" govern$ental accountants0 These agencies o)ten e$plo" govern$ental accountants 'ho can revie' an& evaluate the utilitiesJ )inancial state$ents an& rate increase re4uests0 Also, FB6 agents traine& as accountants )in& their accounting ac!groun&s use)ul in investigating cri$inals involve& in illegal usiness activities, such as &rugs or ga$ ling0 /ot-)or-pro)it organi5ations, such as churches, charities, )raternities, an& universities, nee& accountants to recor& an& account )or )un&s receive& an& &is urse&0 %ven though these agencies &o not have a pro)it $otive, the" shoul& operate e))icientl" an& use resources e))ectivel"0 Approxi$atel" 1B,BBB accountants are e$plo"e& in higher e&ucation0 The activities o) these aca.emic accountants inclu&e teaching accounting courses, con&ucting scholarl" an& applie& research an& pu lishing the results, an& per)or$ing service )or the institution an& the co$$unit"0 Facult" positions exist in t'o-"ear colleges, )our-"ear colleges, an& universities 'ith gra&uate progra$s0 A signi)icant shortage o) accounting )acult" has &evelope& &ue to the retire$ent eginning in the late 1>>Bs o) $an" )acult" $e$ ers0 ,tarting salaries 'ill continue to rise signi)icantl" ecause o) the shortage0 .ou $a" 'ant to tal! 'ith so$e o) "our pro)essors a out the a&vantages an& &isa&vantages o) pursuing an accounting career in higher e&ucation0 A section prece&ing each chapter, entitle& KCareers in accountingK, &escri es various accounting careers0 .ou $ight )in& one that "ou 'oul& li!e to pursue0

1.! "inancial accounting versus managerial accounting
An accounting in)or$ation s"ste$ provi&es &ata to help &ecision $a!ers oth outsi&e an& insi&e the usiness0 <ecision $a!ers outsi&e the usiness are a))ecte& in so$e 'a" " the per)or$ance o) the usiness0 <ecision $a!ers insi&e the usiness are responsi le )or the per)or$ance o) the usiness0 For this reason, accounting is &ivi&e& into t'o categories: )inancial accounting )or those outsi&e an& $anagerial accounting )or those insi&e0 Financial accounting in)or$ation appears in )inancial state$ents that are inten&e& pri$aril" )or external use (although $anage$ent also uses the$ )or certain internal &ecisions)0 ,toc!hol&ers an& cre&itors are t'o o) the outsi&e parties 'ho nee& )inancial accounting in)or$ation0 These outsi&e parties &eci&e on $atters pertaining to the entire co$pan", such as 'hether to increase or &ecrease their invest$ent in a co$pan" or to exten& cre&it to a co$pan"0 Conse4uentl", )inancial accounting in)or$ation relates to the co$pan" as a 'hole, 'hile $anagerial accounting )ocuses on the parts or seg$ents o) the co$pan"0 p. I1 o) *++

(anage$ent accountants in a co$pan" prepare the )inancial state$ents0 Thus, $anage$ent accountants $ust e !no'le&gea le concerning )inancial accounting an& reporting0 The )inancial state$ents are the representations o) $anage$ent, not the CPA )ir$ that per)or$s the au&it0 The external users o) accounting in)or$ation )all into six groups? each has &i))erent interests in the co$pan" an& 'ants ans'ers to uni4ue 4uestions0 The groups an& so$e o) their possi le 4uestions are:
 3wners an. prospecti'e owners 0 #as the co$pan" earne& satis)actor" inco$e on its total

invest$entQ ,houl& an invest$ent e $a&e in this co$pan"Q ,houl& the present invest$ent e increase&, &ecrease&, or retaine& at the sa$e levelQ Can the co$pan" install costl" pollution control e4uip$ent an& still e pro)ita leQ
 Cre.itors an. len.ers. ,houl& a loan e grante& to the co$pan"Q =ill the co$pan" e a le

to pa" its &e ts as the" eco$e &ueQ
 -mployees an. t%eir unions. <oes the co$pan" have the a ilit" to pa" increase& 'agesQ 6s

the co$pan" )inanciall" a le to provi&e long-ter$ e$plo"$ent )or its 'or!)orceQ
 Customers. <oes the co$pan" o))er use)ul pro&ucts at )air pricesQ =ill the co$pan" survive

long enough to honor its pro&uct 'arrantiesQ
 9o'ernmental units. 6s the co$pan", such as a local pu lic utilit", charging a )air rate )or its

servicesQ
 9eneral public. 6s the co$pan" provi&ing use)ul pro&ucts an& gain)ul e$plo"$ent )or citi5ens

'ithout causing serious environ$ental pro le$sQ 2eneral-purpose )inancial state$ents provi&e $uch o) the in)or$ation nee&e& " external users o) )inancial accounting0 These 0inancial statements are )or$al reports provi&ing in)or$ation on a co$pan"Js )inancial position, cash in)lo's an& out)lo's, an& the results o) operations0 (an" co$panies pu lish these state$ents in annual reports0 (,ee The Ai$ite&, 6nc0, annual report in the Annual report appen&ix0) The annual report also contains the in&epen&ent au&itorJs opinion as to the )airness o) the )inancial state$ents, as 'ell as in)or$ation a out the co$pan"Js activities, pro&ucts, an& plans0 Financial accounting in)or$ation is historical in nature, reporting on 'hat has happene& in the past0 To )acilitate co$parisons et'een co$panies, this in)or$ation $ust con)or$ to certain usinesses or govern$ental organi5ations have " an authoritative organi5ation0 =e accounting stan&ar&s or principles calle& generally accepte. accounting principles (9##&)0 These generall" accepte& accounting principles )or &evelope& through accounting practice or een esta lishe&

&escri e several o) these authoritative organi5ations in the next $a3or section o) this 6ntro&uction0

p. II o) *++

(anagerial accounting in)or$ation is )or internal use an& provi&es special in)or$ation )or the $anagers o) a co$pan"0 The in)or$ation $anagers use $a" range )ro$ roa&, long-range planning &ata to &etaile& explanations o) 'h" actual costs varie& )ro$ cost esti$ates0 (anagerial accounting in)or$ation shoul&:
 :elate to the part o) the co$pan" )or 'hich the $anager is responsi le0 For exa$ple, a

pro&uction $anager 'ants in)or$ation on costs o) pro&uction ut not o) a&vertising0
 6nvolve planning )or the )uture0 For instance, a

u&get 'oul& sho' )inancial plans )or the

co$ing "ear0
 (eet t'o tests: the accounting in)or$ation $ust e use)ul (relevant) an& $ust not cost $ore to

gather an& process than it is 'orth0 (anagerial accounting generates in)or$ation that $anagers can use to $a!e soun& &ecisions0 The )our $a3or t"pes o) internal $anage$ent &ecisions are:
 Financial .ecisionsL&eci&ing 'hat a$ounts o) capital ()un&s) are nee&e& to run the usiness

an& 'hether to secure these )un&s )ro$ o'ners (stoc!hol&ers) or cre&itors0 6n this sense, capital $eans $one" use& " the co$pan" to purchase resources such as $achiner" an& uil&ings an& to pa" expenses o) con&ucting the usiness0
 :esource allocation .ecisionsL&eci&ing ho' the total capital o) a co$pan" is to

e

investe&, such as the a$ount to e investe& in $achiner"0
 &ro.uction .ecisionsL&eci&ing 'hat pro&ucts are to

e pro&uce&,

" 'hat $eans, an&

'hen0
 8arketing .ecisionsLsetting selling prices an& a&vertising u&gets? &eter$ining the location

o) a co$pan"Js $ar!ets an& ho' to reach the$0

1.# Development of financial accounting standards
,everal organi5ations are in)luential in the esta lish$ent o) generall" accepte& accounting principles (2AAP) )or usinesses or govern$ental organi5ations0 These are the A$erican 6nstitute o) Certi)ie& Pu lic Accountants, the Financial Accounting ,tan&ar&s Boar&, the 2overn$ental Accounting ,tan&ar&s Boar&, the ,ecurities an& %xchange Co$$ission, the A$erican Accounting Association, the Financial %xecutives 6nstitute, an& the 6nstitute o) (anage$ent Accountants0 %ach organi5ation has contri ute& in a &i))erent 'a" to the &evelop$ent o) 2AAP0 The A$erican 6nstitute o) Certi)ie& Pu lic Accountants (A6CPA) is a pro)essional organi5ation o) CPAs0 (an" o) these CPAs are in pu lic accounting practice0 Mntil recent "ears, the A6CPA 'as the &o$inant organi5ation in the &evelop$ent o) accounting stan&ar&s0 6n a IB-"ear perio& en&ing in p. I+ o) *++

1>C>, the A6CPA Co$$ittee on Accounting Proce&ure issue& C1 Accounting -esearc% Bulletins reco$$en&ing certain principles or practices0 Fro$ 1>C> through 1>@+, the co$$itteeJs successor, the #ccounting &rinciples Boar. (#&B) , issue& +1 nu$ ere& .pinions that CPAs generall" are re4uire& to )ollo'0 Through its $onthl" $aga5ine, the /ournal o& Accountancy , its research &ivision, an& its other &ivisions an& co$$ittees, the A6CPA continues to in)luence the &evelop$ent o) accounting stan&ar&s an& practices0 T'o o) its co$$itteesLthe Accounting ,tan&ar&s Co$$ittee an& the Au&iting ,tan&ar&s Co$$itteeLare particularl" in)luential in provi&ing input to the Financial Accounting ,tan&ar&s Boar& (the current rule-$a!ing Co$$ission an& other regulator" agencies0 6n 1>@+, an in&epen&ent, seven-$e$ er, )ull-ti$e Financial #ccounting "tan.ar.s Boar. (F#"B) replace& the Accounting Principles Boar&0 The FA,B has issue& nu$erous ,tate"ents o& Financial Accounting ,tan ar s0 The ol& Accounting -esearc% Bulletins an& Accounting Principles Boar .pinions are still e))ective unless speci)icall" superse&e& " a Financial Accounting ,tan&ar&s Boar& ,tate$ent0 The FA,B is the private sector organi5ation no' responsi le )or the &evelop$ent o) ne' )inancial accounting stan&ar&s0 The %$erging 6ssues Tas! Force o) the FA,B interprets o))icial pronounce$ents )or general application " accounting practitioners0 The conclusions o) this tas! )orce $ust also e )ollo'e& in )ilings 'ith the ,ecurities an& %xchange Co$$ission0 6n 1>8*, the 9o'ernmental #ccounting "tan.ar.s Boar. (9#"B) 'as esta lishe& 'ith a )ull-ti$e chairperson an& )our part-ti$e $e$ ers0 The 2A,B issues state$ents on accounting an& )inancial reporting in the govern$ental area0 This organi5ation is the private sector organi5ation no' responsi le )or the &evelop$ent o) ne' govern$ental accounting concepts an& stan&ar&s0 The 2A,B also has the authorit" to issue interpretations o) these stan&ar&s0 Create& un&er the ,ecurities an& %xchange Act o) 1>+*, the "ecurities an. -xc%ange Commission ("-C) is a govern$ent agenc" that a&$inisters i$portant acts &ealing 'ith the interstate sale o) securities (stoc!s an& on&s)0 The ,%C has the authorit" to prescri e accounting an& reporting practices )or co$panies un&er its 3uris&iction0 This inclu&es virtuall" ever" $a3or M, usiness corporation0 6nstea& o) exercising this po'er, the ,%C has a&opte& a polic" o) 'or!ing closel" 'ith the accounting pro)ession, especiall" the FA,B, in the &evelop$ent o) accounting stan&ar&s0 The ,%C in&icates to the FA,B the accounting topics it elieves the FA,B shoul& a&&ress0 Consisting largel" o) accounting e&ucators, the #merican #ccounting #ssociation (###) has sought to encourage research an& stu&" at a theoretical level into the concepts, stan&ar&s, an& principles o) accounting0 One o) its 4uarterl" $aga5ines, T%e Accounting -evie', carries $an" articles p. I* o) *++ o&") an& to the ,ecurities an& %xchange

reporting on scholarl" accounting research0 Another 4uarterl" 3ournal, Accounting 0ori(ons, reports on $ore practical $atters &irectl" relate& to accounting practice0 A thir& 3ournal, 1ssues in Accounting E ucation, contains articles relating to accounting e&ucation $atters0 ,tu&ents $a" 3oin the AAA as associate $e$ ers " contacting the A$erican Accounting Association, C@1@ Bessie <rive, ,arasota, Flori&a +*I++0 The Financial -xecuti'es 1nstitute is an organi5ation esta lishe& in 1>+1 'hose $e$ ers are pri$aril" )inancial polic"-$a!ing executives0 (an" o) its $e$ ers are chie) )inancial o))icers (CFOs) o) ver" large corporations0 The role o) the CFO has evolve& in recent "ears )ro$ nu$ er cruncher to strategic planner0 These CFOs pla"e& a $a3or role in restructuring A$erican usinesses in the earl" 1>>Bs0 ,lightl" $ore than 1*,BBB )inancial o))icers, representing approxi$atel" @,BBB co$panies in the Mnite& ,tates an& Cana&a, are $e$ ers o) the F%60 Through its Co$$ittee on Corporate :eporting (CC:) an& other $eans, the F%6 is ver" e))ective in representing the vie's o) the private )inancial sector to the FA,B an& to the ,ecurities an& %xchange Co$$ission an& other regulator" agencies0 The 1nstitute o0 8anagement #ccountants ()or$erl" the /ational Association o) Accountants) is an organi5ation 'ith approxi$atel" @B,BBB $e$ ers, consisting o) $anage$ent accountants in private in&ustr", CPAs, an& aca&e$ics0 The pri$ar" )ocus o) the organi5ation is on the use o) $anage$ent accounting in)or$ation )or internal &ecision $a!ing0 #o'ever, $anage$ent accountants prepare the )inancial state$ents )or external users0 Thus, through its (anage$ent Accounting Practices ((AP) Co$$ittee an& other $eans, the 6(A provi&es input on )inancial accounting stan&ar&s to the Financial Accounting ,tan&ar&s Boar& an& to the ,ecurities an& %xchange Co$$ission an& other regulator" agencies0 (an" other organi5ations such as the Financial Anal"sts Fe&eration (co$pose& o) invest$ent a&visers an& investors), the ,ecurities 6n&ustr" Associates (co$pose& o) invest$ent an!ers), an& CPA )ir$s have co$$ittees or tas! )orces that respon& to %xposure <ra)ts o) propose& FA,B ,tate$ents0 Their reactions are in the )or$ o) 'ritten state$ents sent to the FA,B an& testi$on" given at FA,B hearings0 (an" in&ivi&uals also $a!e their reactions !no'n to the FA,B0

1.$ Ethical behavior of accountants
,everal accounting organi5ations have co&es o) ethics governing the ehavior o) their $e$ ers0 For instance, oth the A$erican 6nstitute o) Certi)ie& Pu lic Accountants an& the 6nstitute o) (anage$ent Accountants have )or$ulate& such co&es0 (an" usiness )ir$s have also &evelope& co&es o) ethics )or their e$plo"ees to )ollo'0 p. IC o) *++

%thical ehavior involves $ore than $erel" $a!ing sure "ou are not violating a co&e o) ethics0 (ost o) us sense 'hat is right an& 'rong0 .et get-rich-4uic! opportunities can te$pt $an" o) us0 Al$ost an" &a", ne'spaper hea&lines reveal pu lic o))icials an& usiness lea&ers 'ho &i& not &o the right thing0 2ree& 'on out over their sense o) right an& 'rong0 These in&ivi&uals )ollo'e& slogans such as: K2et "ours 'hile the getting is goo&K? K<o unto others e)ore the" &o unto "ouK? an& K.ou have &one 'rong onl" i) "ou get caughtK0 (ore appropriate slogans $ight e: K6) it see$s too goo& to e true, it usuall" isK? KThere are no )ree lunchesK? an& the gol&en rule, K<o unto others as "ou 'oul& have the$ &o unto "ouK0 An accountantJs $ost valua le asset is an honest reputation0 Those 'ho ta!e the high roa& o) ethical ehavior receive praise an& honor? the" are sought out )or their a&vice an& services0 The" also li!e the$selves an& 'hat the" represent0 Occasionall", accountants &o ta!e the lo' roa& an& su))er the conse4uences0 The" so$eti$es )in& their na$es $entione& in T%e 2all ,treet /ournal an& ne's progra$s in an un)avora le light, an& )or$er )rien&s an& colleagues loo! &o'n on the$0 ,o$e o) these in&ivi&uals are re$ove& )ro$ the pro)ession0 Fortunatel", the accounting pro)ession has $an" lea&ers 'ho have ta!en the high roa&, gaine& the respect o) )rien&s an& colleagues, an& eco$e role $o&els )or all o) us to )ollo'0 (an" chapters in the text inclu&e an ethics case entitle&, KAn ethical perspectiveK0 =e !no' "ou 'ill ene)it )ro$ thin!ing a out the situational ethics in these cases0 O)ten "ou 'ill not have $uch &i))icult" in &eter$ining Kright an& 'rongK0 6nstea& o) $a!ing the cases Kclose callsK, 'e have atte$pte& to inclu&e situations usiness stu&ents $ight actuall" encounter in their careers0

1.% Critical thin&ing and communication s&ills
Accountants in practice an& usiness executives have generall" een &issatis)ie& 'ith accounting gra&uatesJ a ilit" to thin! criticall" an& to co$$unicate their i&eas e))ectivel"0 The Accounting %&ucation Change Co$$ission has reco$$en&e& that changes accountants to re$ove these co$plaints0 To a&&ress these concerns, 'e have inclu&e& a section at the en& o) each chapter entitle&, KBe"on& the nu$ ersLCritical thin!ingK0 6n that section, "ou are re4uire& to 'or! relativel" unstructure& usiness &ecision cases, anal"5e real-'orl& annual report &ata, 'rite a out situations involving ethics, an& participate in group pro3ects0 (ost o) the other en&-o)-chapter $aterials also involve anal"sis an& 'ritten co$$unication o) i&eas0 6n so$e o) the cases, (anal"sis, ethics situations, an& group pro3ects), "ou are as!e& to 'rite a $e$oran&u$ regar&ing the situation0 6n 'riting such a $e$oran&u$, i&enti)" "our role (au&itor, p. ID o) *++ e $a&e in the e&ucation o)

consultant), the au&ience ($anage$ent, stoc!hol&ers, an& cre&itors), an& the tas! (the speci)ic assign$ent)0 Present "our i&eas clearl" an& concisel"0 The purpose o) the group pro3ects is to assist "ou in learning to listen to an& 'or! 'ith others0 These s!ills are i$portant in succee&ing in the usiness 'orl&0 Tea$ pla"ers listen to the vie's o) others an& 'or! cohesivel" 'ith the$ to achieve group goals0

1.' (nternet s&ills
The 6nternet is a )act o) li)e0 6t is i$portant )or accountants an& stu&ents to e a le to use the 6nternet to )in& relevant in)or$ation0 Thus, each chapter contains approxi$atel" t'o 6nternet pro3ects relate& to accounting0 .our instructor $ight assign so$e o) these, or "ou coul& pursue the$ on "our o'n0

1.) *o+ to stud the chapters in this te,t
6n stu&"ing each chapter:
 Begin " rea&ing the learning o 3ectives at the eginning o) each chapter0  :ea& KMn&erstan&ing the learning o 3ectivesK at the en& o) the chapter )or a previe' o) the

chapter content0
 :ea& the chapter content0 %ach exercise at the en& o) the chapters i&enti)ies the learning

o 3ective(s) to 'hich it pertains0 6) "ou learn est " rea&ing a out a concept an& then 'or!ing a short exercise that illustrates that concept, 'or! the exercises as "ou rea& the chapter0
 :erea& KMn&erstan&ing the learning o 3ectivesK to &eter$ine i) "ou have achieve& each

o 3ective0
 ,tu&" the Ne" ter$s to see i) "ou un&erstan& each ter$0 6) "ou &o not un&erstan& a certain ter$,

re)er to the page in&icate& to rea& a out the ter$ in its original context0
 Ta!e the ,el)-test an& then chec! "our ans'ers 'ith those at the en& o) the chapter0  =or! the <e$onstration pro le$ to )urther rein)orce "our un&erstan&ing o) the chapter

content0 Then, co$pare "our solution to the correct solution that )ollo's i$$e&iatel"0
 Aoo! over the 4uestions at the en& o) the chapter an& thin! out an ans'er to each one0 6) "ou

cannot ans'er a particular 4uestion, re)er ac! into the chapter )or the nee&e& in)or$ation0
 =or! at least so$e o) the exercises at the en& o) the chapter0  =or! the Pro le$s assigne&

" "our instructor, using the )or$s availa le0 The" can

e

&o'nloa&e& )ro$ the pu lisherJs 'e site ('''0)reeloa&press0co$)0

p. I@ o) *++

 ,tu&" the ite$s in the KBe"on& the nu$ ersLCritical thin!ingK section an& the KMsing the

6nternetLA vie' o) the real 'orl&K section at the en& o) each chapter to relate 'hat "ou have learne& to real-'orl& situations0
 =or! the ,tu&" gui&e )or the chapter0 The ,tu&" gui&e is a supple$ent that contains ()or each

chapter) Aearning o 3ectives? <e$onstration pro le$ an& solution (&i))erent )ro$ the one in the text)? (atching, Co$pletion, True-)alse, an& (ultiple-choice 4uestions? an& ,olutions to all 4uestions an& exercises in the stu&" gui&e0 The ,tu&" gui&e can pu lisherJs 'e site ('''0)reeloa&press0co$)0 6) "ou per)or$ each o) these steps )or each chapter, "ou shoul& &o 'ell in the course0 :e$e$ er that a !no'le&ge o) accounting 'ill serve "ou 'ell regar&less o) the career "ou pursue0 e &o'nloa&e& )ro$ the

1nternational accounting stan.ar.s
6n recent "ears, there has een a $ove$ent to &evelop a single set o) glo al accounting stan&ar&s )or use aroun& the 'orl&0 Proponents o) this $ove$ent sa" that it 'ill oost cross- or&er invest$ent, &eepen international capital $ar!ets an& save $ultinational co$panies, 'ho $ust currentl" report un&er $ultiple s"ste$s, a lot o) ti$e an& $one"0 The 6nternational Accounting ,tan&ar&s Co$$ittee (6A,C) Foun&ation 'as esta lishe& as an in&epen&ent, not-)or pro)it, private sector organisation to 'or! to'ar&s this goal0 6t see!s to &evelop a glo all" accepte& set o) )inancial reporting stan&ar&s (6F:,s) un&er the &irection o) its stan&ar&s-setting o&", the 6nternational Accounting ,tan&ar&s Boar& (6A,B)0 The A6CPA (as 'ell as the other entities $entione& a ove) supports this e))ort an&, as o) earl" IB1B, states on its 'e site that: FThe gro'ing acceptance o) 6nternational Financial :eporting ,tan&ar&s (6F:,) as a asis )or M0,0 )inancial reporting represents a )un&a$ental change )or the M0,0 accounting pro)ession0 To&a" approxi$atel" 11+ countries re4uire or allo' the use o) 6F:, )or the preparation o) )inancial state$ents " pu licl" hel& co$panies0 6n the Mnite& ,tates, the ,ecurities an& %xchange Co$$ission (,%C) has een ta!ing steps to set a &ate to allo' M0,0 pu lic co$panies to use 6F:,, an& perhaps $a!e its a&option $an&ator"0 6n )act, on /ove$ er 1*, IBB8, the ,%C release& )or pu lic co$$ent a propose& roa&$ap 'ith a ti$eline an& !e" $ilestones )or a&opting 6F:, eginning in IB1*H0 Clearl", $an" ne' issues can e$erge et'een no' an& IB1*, ut the &irection see$s to e clear0 The A6CPA has a lin! on its 'e site to a page 'ith current

p. I8 o) *++

in)or$ation on the planne& $igration to 6F:,0 .ou $ight li!e to chec! it out )ro$ ti$e to ti$e at http:77'''0i)rs0co$7Bac!groun&erR2etR:ea&"0ht$l0 There is also a 'ealth o) in)or$ation on the 6F:, 'e site at http:77i)rs0org0

,tu&ents )ro$ countries other than the M, shoul& chec! the 'e site o) the pro)essional accounting organi5ation in "our countr" )or an up&ate on the current status0 For exa$ple, i) "ou go to the 'e site o) the 6nstitute o) Chartere& Accountants o) 6n&ia at http:77icai0org an& search on 6F:, "ou 'ill )in& a nu$ er o) lin!s to &ocu$ents covering the planne& $igration to 6F:, in 6n&ia0

p. I> o) *++

2 Accounting and its use in business decisions
2.1 Learning objectives
  

6&enti)" an& &escri e the three asic )or$s o) usiness organi5ations0 <istinguish a$ong the three t"pes o) activities per)or$e& " usiness organi5ations0 <escri e the content an& purposes o) the inco$e state$ent, state$ent o) retaine& earnings, alance sheet, an& state$ent o) cash )lo's0 ,tate the asic accounting e4uation an& &escri e its relationship to the alance sheet0 Msing the un&erl"ing assu$ptions or concepts, anal"5e usiness transactions an& &eter$ine Prepare an inco$e state$ent, a state$ent o) retaine& earnings, an& a alance sheet0 Anal"5e an& use the )inancial resultsLthe e4uit" ratio0

 

their e))ects on ite$s in the )inancial state$ents0
 

2.2 A career as an entrepreneur
=hen to&a"1s college stu&ents are polle& a out their long-ter$ career choice, a surprisingl" large nu$ er respon& that the" 'ish to so$e&a" o'n an& $anage their o'n usiness0 6n )act, the aspiration to start a usiness, to e an entrepreneur, is nearl" universal0 6t is 'i&el" ac!no'le&ge& that a &egree in accounting o))ers $an" a&vantages to a 'oul&- e entrepreneur0 6n )act, i) "ou as! o'ners o) s$all usinesses 'hich s!ill the" 'ish the" ha& $ore expertise in, the" 'ill ver" )re4uentl" repl" FaccountingH0 /o $atter 'hat the usiness $a" e, the o'ner an&7or $anager $ust e a le to un&erstan& the accounting an& )inancial conse4uences o) usiness &ecisions0 (ost success)ul entrepreneurs have learne& that it ta!es a lot $ore than a great $ar!eting i&ea or pro&uct innovation to $a!e a success)ul an!s or investors0 Once a usiness has usiness0 There are $an" steps involve& een launche&, the entrepreneur $ust e)ore an i&ea e a $anagerLa eco$es a success)ul an& re'ar&ing usiness0 %ntrepreneurs $ust e a le to raise capital, either )ro$ $anager o) people, inventor", )acilities, custo$er relationships, an& relationships 'ith the ver" an!s an& investors that provi&e& the capital0 Business o'ners 4uic!l" learn that in or&er to survive the" nee& to e 'ell-roun&e&, savv" in&ivi&uals 'ho can success)ull" $anage these &iverse relationships0 An accounting e&ucation is i&eal )or provi&ing this versatile ac!groun&0 6n a&&ition to provi&ing a goo& )oun&ation )or entrepreneurship in an" usiness, an accounting &egree o))ers other 'a"s o) uil&ing "our o'n usiness0 For exa$ple, a large percentage o) pu lic accountants 'or! as sole proprietorsL uil&ing an& $anaging their o'n pro)essional practice0 This can p. +B o) *++

e a ver" re'ar&ing career, 'or!ing closel" 'ith in&ivi&uals an& s$all usinesses0 One a&vantage o) this career is that "ou can esta lish "our practice in virtuall" an" location ranging )ro$ large cities to rural settings0 Finall", $an" accountants 'ho have gaine& speciali5e& expertise an& experience in a particular )iel& start their o'n practice as consultants0 %xpertise such as this, 'hich $a" e in a )iel& outsi&e o) tra&itional accounting practice, can generate illing rates 'ell in the excess o) M,< 1BB an hour0 The intro&uction to this text provi&e& a ac!groun& )or "our stu&" o) accounting0 /o' "ou are rea&" to learn a out the )or$s o) sho' the results o) &ecisions $a&e usiness organi5ations an& the t"pes o) usiness activities the" per)or$0 This chapter presents the )inancial state$ents use& " usinesses0 These )inancial state$ents " $anage$ent0 6nvestors, cre&itors, an& $anagers use these state$ents in evaluating $anage$ent1s past &ecisions an& as a asis )or $a!ing )uture &ecisions0 6n this chapter, "ou also stu&" the accounting process (or accounting c"cle) that accountants use to prepare those )inancial state$ents0 This accounting process uses )inancial &ata such as the recor&s o) sales $a&e to custo$ers an& purchases $a&e )ro$ suppliers0 6n a s"ste$atic $anner, accountants anal"5e, recor&, classi)", su$$ari5e, an& )inall" report these &ata in the )inancial state$ents o) usinesses0 As "ou stu&" this chapter, "ou 'ill egin to un&erstan& the uni4ue, s"ste$atic nature o) accountingLthe language o) usiness0

2.3 "orms of business organi-ations
Accountants )re4uentl" re)er to a usiness organi5ation as an accounting entity or a business entity0 A usiness entit" is an" usiness organi5ation, such as a har&'are store or grocer" store, that exists as an econo$ic unit0 For accounting purposes, each usiness organi5ation or entity has an existence separate )ro$ its o'ner(s), cre&itors, e$plo"ees, custo$ers, an& other usinesses0 This
1

separate existence o) the usiness organi5ation is !no'n as the business entity concept0 Thus, in the accounting recor&s o) the usiness entit", the activities o) each usiness shoul& e !ept separate )ro$ the activities o) other usinesses an& )ro$ the personal )inancial activities o) the o'ner(s)0 Assu$e, )or exa$ple, that "ou o'n t'o usinesses, a ph"sical )itness center an& a horse sta le0 Accor&ing to the usiness entit" concept, "ou 'oul& consi&er each usiness as an in&epen&ent usiness unit0 Thus, "ou 'oul& nor$all" !eep separate accounting recor&s )or each usiness0 /o'

1 =hen )irst stu&"ing an" &iscipline, stu&ents encounter ne' ter$s0 Msuall" these ter$s are set in ol&0 The ol&)ace color ter$s are also liste& an& &e)ine& at the en& o) each chapter (see Ne" ter$s)0 p. +1 o) *++

assu$e "our ph"sical )itness center is unpro)ita le ecause "ou are not charging enough )or the use o) "our exercise e4uip$ent0 .ou can &eter$ine this )act ecause "ou are treating "our ph"sical )itness center an& horse sta le as t'o separate usiness entities0 .ou $ust also !eep "our personal )inancial activities separate )ro$ "our t'o usinesses0 There)ore, "ou cannot inclu&e the car "ou &rive onl" )or personal use as a usiness activit" o) "our ph"sical )itness center or "our horse sta le0 #o'ever, the use o) "our truc! to pic! up )ee& )or "our horse sta le is a usiness activit" o) "our horse sta le0 As "ou 'ill see shortl", the usiness entit" concept applies to the three )or$s o) usinessesLsingle proprietorships, partnerships, an& corporations0 Thus, )or accounting purposes, all three usiness )or$s are separate )ro$ other usiness entities an& )ro$ their o'ner(s)0 ,ince $ost large usinesses are corporations, 'e use the corporate approach in this text an& inclu&e onl" a rie) &iscussion o) single proprietorships an& partnerships0 A single proprietors%ip is an unincorporate& usiness o'ne& " an in&ivi&ual an& o)ten $anage& " that sa$e person0 ,ingle proprietors inclu&e ph"sicians, la'"ers, electricians, an& other people in usiness )or the$selves0 (an" s$all service usinesses an& retail esta lish$ents are also single proprietorships0 /o legal )or$alities are necessar" to organi5e such usiness operations can egin 'ith onl" a li$ite& invest$ent0 6n a single proprietorship, the o'ner is solel" responsi le )or all &e ts o) the accounting purposes, ho'ever, the usiness0 For usiness is a separate entit" )ro$ the o'ner0 Thus, single usinesses, an& usuall"

proprietors $ust !eep the )inancial activities o) the usiness, such as the receipt o) )ees )ro$ selling services to the pu lic, separate )ro$ their personal )inancial activities0 For exa$ple, o'ners o) single proprietorships shoul& not enter the cost o) personal houses or car pa"$ents in the )inancial recor&s o) their usinesses0 A partners%ip is an unincorporate& usiness o'ne& " t'o or $ore persons associate& as partners0 O)ten the sa$e persons 'ho o'n the usiness also $anage the usiness0 (an" s$all retail esta lish$ents an& pro)essional practices, such as &entists, ph"sicians, attorne"s, an& $an" CPA )ir$s, are partnerships0 A partnership egins 'ith a ver al or 'ritten agree$ent0 A 'ritten agree$ent is pre)era le ecause it provi&es a per$anent recor& o) the ter$s o) the partnership0 These ter$s inclu&e the initial invest$ent o) each partner, the &uties o) each partner, the $eans o) &ivi&ing pro)its or losses et'een the partners each "ear, an& the settle$ent a)ter the &eath or 'ith&ra'al o) a partner0 %ach partner $a" e hel& lia le )or all the &e ts o) the partnership an& )or the actions o) each partner 'ithin the scope o) the usiness0 #o'ever, as 'ith the single proprietorship, )or accounting purposes, the partnership is a separate usiness entit"0 p. +I o) *++

A corporation is a incorporate&0

usiness incorporate& un&er the la's o) a state an& o'ne&

" a )e'

stoc!hol&ers or thousan&s o) stoc!hol&ers0 Al$ost all large usinesses an& $an" s$all usinesses are The corporation is uni4ue in that it is a separate legal usiness entit"0 The o'ners o) the corporation are stock%ol.ers, or s%are%ol.ers0 The" u" shares o) stoc!, 'hich are units o) o'nership, in the corporation0 ,houl& the corporation )ail, the o'ners 'oul& onl" lose the a$ount the" pai& )or their stoc!0 The corporate )or$ o) usiness protects the personal assets o) the o'ners )ro$ the cre&itors o) the corporation0
I

,toc!hol&ers &o not &irectl" $anage the corporation0 The" elect a oar& o) &irectors to represent their interests0 The oar& o) &irectors selects the o))icers o) the corporation, such as the presi&ent an& vice presi&ents, 'ho $anage the corporation )or the stoc!hol&ers0 Accounting is necessar" )or all three )or$s o) usiness organi5ations, an& each co$pan" $ust )ollo' generall" accepte& accounting principles (2AAP)0 ,ince corporations have such an i$portant i$pact on our econo$", 'e use the$ in this text to illustrate asic accounting principles an& concepts0

#n accounting perspecti'e: Business insig%t
Although corporations constitute a out 1@ per cent o) all usiness organi5ations, the" account )or al$ost >B per cent o) all sales volu$e0 ,ingle proprietorships constitute a out @C per cent o) all usiness organi5ations ut account )or less than 1B per cent o) sales volu$e0

2.! T pes of activities performed b business organi-ations
The )or$s o) usiness entities &iscusse& in the previous section are classi)ie& accor&ing to the t"pe o) o'nership o) the usiness entit"0 Business entities can also e groupe& " the t"pe o) usiness activities the" per)or$Lservice co$panies, $erchan&ising co$panies, an& $anu)acturing co$panies0 An" o) these activities can organi5ations0 e per)or$e& " co$panies using an" o) the three )or$s o) usiness

I =hen in&ivi&uals see! a an! loan to )inance the )or$ation o) a s$all corporation, the an! o)ten re4uires those in&ivi&uals to sign &ocu$ents $a!ing the$ personall" responsi le )or repa"ing the loan i) the corporation cannot pa"0 6n this instance, the in&ivi&uals can lose their original invest$ents plus the a$ount o) the loan the" are o ligate& to repa"0 p. ++ o) *++

 "er'ice companies per)or$ services )or a )ee0 This group inclu&es accounting )ir$s, la'

)ir$s, an& &r" cleaning esta lish$ents0 The earl" chapters o) this text &escri e accounting )or service co$panies0
 8erc%an.ising companies purchase goo&s that are rea&" )or sale an& then sell the$ to

custo$ers0 (erchan&ising co$panies inclu&e auto &ealerships, clothing stores, an& super$ar!ets0 =e egin the &escription o) accounting )or $erchan&ising co$panies in Chapter D0
 8anu0acturing companies u" $aterials, convert the$ into pro&ucts, an& then sell the

pro&ucts to other co$panies or to the )inal consu$ers0 (anu)acturing co$panies inclu&e steel $ills, auto $anu)acturers, an& clothing $anu)acturers0 All o) these co$panies pro&uce )inancial state$ents as the )inal en& pro&uct o) their accounting process0 These )inancial state$ents provi&e relevant )inancial in)or$ation oth to those insi&e the co$pan"L$anage$entLan& to those outsi&e the co$pan"Lcre&itors, stoc!hol&ers, an& other intereste& parties0 The next section intro&uces )our co$$on )inancial state$entsLthe inco$e state$ent, the state$ent o) retaine& earnings, the alance sheet, an& the state$ent o) cash )lo's0

2.# "inancial statements of business organi-ations
Business entities $a" have $an" o 3ectives an& goals0 For exa$ple, one o) "our o 3ectives in o'ning a ph"sical )itness center $a" e to i$prove your ph"sical )itness0 #o'ever, the t'o pri$ar" o 3ectives o) ever" usiness are pro)ita ilit" an& solvenc"0 &ro0itability is the a ilit" to generate inco$e0 "ol'ency is the a ilit" to pa" &e ts as the" eco$e &ue0 Mnless a usiness can pro&uce satis)actor" inco$e an& pa" its &e ts as the" eco$e &ue, the usiness cannot survive to reali5e its other o 3ectives0 There are )our asic )inancial state$ents0 Together the" present the pro)ita ilit" an& strength o) a co$pan"0 The )inancial state$ent that re)lects a co$pan"1s pro)ita ilit" is the income statement0 The statement o0 retaine. earnings sho's the change in retaine& earnings et'een the eginning an& en& o) a perio& (e0g0 a $onth or a "ear)0 The balance s%eet re)lects a co$pan"1s solvenc" an& )inancial position0 The statement o0 cas% 0lows sho's the cash in)lo's an& out)lo's )or a co$pan" over a perio& o) ti$e0 The hea&ings an& ele$ents o) each state$ent are si$ilar )ro$ co$pan" to co$pan"0 .ou can see this si$ilarit" in the )inancial state$ents o) actual co$panies in the appen&ix o) this text oo!0 The income statement, so$eti$es calle& an earnings state$ent, reports the pro)ita ilit" o) a usiness organi5ation )or a state perio o& ti"e. 6n accounting, 'e $easure pro)ita ilit" )or a perio&, p. +* o) *++

such as a $onth or "ear, " co$paring the revenues earne& 'ith the expenses incurre& to pro&uce these revenues0 :e'enues are the in)lo's o) assets (such as cash) resulting )ro$ the sale o) pro&ucts or the ren&ering o) services to custo$ers0 =e $easure revenues pro&uce revenues0 %xpenses are $easure& Thus, /et inco$e S :evenues – %xpenses /et inco$e is o)ten calle& the earnings o) the co$pan"0 =hen expenses excee& revenues, the usiness has a net loss, an& it has operate& unpro)ita l"0 6n %xhi it I, Part A sho's the inco$e state$ent o) (etro Courier, 6nc0, )or ;ul" IB1B0 This corporation per)or$s courier &eliver" services o) &ocu$ents an& pac!ages in ,an <iego in the state o) Cali)ornia, M,A0 (etro1s inco$e state$ent )or the $onth en&e& IB1B ;ul" +1, sho's that the revenues (or &eliver" )ees) generate& " serving custo$ers )or ;ul" totale& M,< C,@BB0 %xpenses )or the $onth a$ounte& to M,< +,DBB0 As a result o) these usiness activities, (etro1s net inco$e )or ;ul" 'as M,< I,1BB0 To &eter$ine its net inco$e, the co$pan" su tracts its expenses o) M,< +,DBB )ro$ its revenues o) M,< C,@BB0 %ven though corporations are taxa le entities, 'e ignore corporate inco$e taxes at this point0 One purpose o) the state"ent o& retaine earnings is to connect the inco$e state$ent an& the alance sheet0 The statement o0 retaine. earnings explains the changes in retaine& earnings et'een t'o alance sheet &ates0 These changes usuall" consist o) the a&&ition o) net inco$e (or &e&uction o) net loss) an& the &e&uction o) &ivi&en&s0 <ivi&en&s are the $eans " 'hich a corporation re'ar&s its stoc!hol&ers (o'ners) )or provi&ing it 'ith invest$ent )un&s0 A .i'i.en. is a pa"$ent (usuall" o) cash) to the o'ners o) the usiness? it is a &istri ution o) inco$e to o'ners rather than an expense o) &oing state$ent0 The e))ect o) a &ivi&en& is to re&uce cash an& retaine& earnings " the a$ount pai& out0 Then, the co$pan" no longer retains a portion o) the inco$e earne& ut passes it on to the stoc!hol&ers0 :eceiving &ivi&en&s is, o) course, one o) the pri$ar" reasons people invest in corporations0 The state$ent o) retaine& earnings )or (etro Courier, 6nc0, )or ;ul" IB1B is relativel" si$ple (see Part B o) %xhi it I)0 Organi5e& on ;une 1, (etro &i& not earn an" revenues or incur an" expenses &uring ;une0 ,o (etro1s eginning retaine& earnings alance on ;ul" 1 is 5ero0 (etro then a&&s its M,< p. +C o) *++ usiness0 Corporations are not re4uire& to pa" &ivi&en&s an&, ecause &ivi&en&s are not an expense, the" &o not appear on the inco$e " the prices agree& on in the exchanges in 'hich a usiness &elivers goo&s or ren&ers services0 -xpenses are the costs incurre& to " the assets surren&ere& or consu$e& in serving custo$ers0 6) the revenues o) a perio& excee& the expenses o) the sa$e perio&, net income results0

I,1BB net inco$e )or ;ul"0 ,ince (etro pai& no &ivi&en&s in ;ul", the M,< I,1BB 'oul& e the en&ing alance o) retaine& earnings0 ,ee elo'0
A. Income Statement METRO COURIIER INC Income Statement For the Month Ended 2010 July 1 Revenues: Service $ 5,700 revenue Expenses: Salaries $ 2,600 expense Rent expense 400 Gas and oil 600 expense Total 3,600 expenses et inco!e $ 2,"00 #$% &' State!ent o( Retained Earnin)s *ETR+ ,+-R.ER , . ,' State!ent o( Retained Earnin)s /or t0e *ont0 Ended 20"0 1ul2 3" Retained earnin)s, 1ul2 " 303 $dd: et inco!e (or 1ul2 #$%2,"00 Retained earnin)s, 1ul2 3" $ 2,"00 #&% C. !alance Sheet METRO COURIER" INC. !alance Sheet 2010 July 1 A##et# ,as0 $ccount receiva5les Truc6s +((ice e7uip!ent $ $%a&%l%t%e# and Stoc'holder(# E)u%ty "5,500 4ia5ilities: 700 $ccounts pa2a5le 20,000 otes pa2a5le 2,500 Total lia5ilities Stoc60olders e7uit2: ,apital stoc6 Retained earnin)s Total stoc60olders8 e7uit2 Total assets $ 39,700 Total lia5ilities and stoc60olders8 e7uit2 $ $ $ $ $ 600 6,000 6,600 30,000 #&%2,"00 32,"00 39,700

%xhi it I: /ext, (etro carries this M,< I,1BB en&ing alance in retaine& earnings to the alance sheet (Part C)0 6) there ha& een a net loss, it 'oul& have &e&ucte& the loss )ro$ the eginning alance on the state$ent o) retaine& earnings0 For instance, i) &uring the next $onth (August) there is a net loss o)

p. +D o) *++

M,< CBB, the loss 'oul& e &e&ucte& )ro$ the eginning alance in retaine& earnings o) M,< I,1BB0 The retaine& earnings alance at the en& o) August 'oul& e M,< 1,DBB0 <ivi&en&s coul& also have a))ecte& the :etaine& %arnings alance0 To give a $ore realistic

illustration, assu$e that (1) (etro Courier, 6nc01s net inco$e )or August 'as actuall" M,< 1,CBB (revenues o) M,< C,DBB less expenses o) M,< *,1BB) an& (I) the co$pan" &eclare& an& pai& &ivi&en&s o) M,< 1,BBB0 Then, (etro1s state$ent o) retaine& earnings )or August 'oul& e:
METRO COURIER" INC. Statement o* Reta%ned Earn%n+# For the Month Ended 2010 Au+u#t 1 Retained earnin)s, $u)ust "'''''''''''''''''''''''''' $dd: et inco!e (or $u)ust''''''''''''''''''''' Total'''''''''''''''''''''''''''''''''''''''''' 4ess: :ividends''''''''''''''''''''''''''''''''''' Retained earnin)s, $u)ust 3"''''''''''''''''''''''''

$2,"00 ",500 $3,600 ",000 $2,600

The balance s%eet, so$eti$es calle& the state"ent o& &inancial position, lists the co$pan"1s assets, lia ilities, an& stoc!hol&ers1 e4uit" (inclu&ing &ollar a$ounts) as o) a speci)ic $o$ent in ti$e0 That speci)ic $o$ent is the close o) usiness on the &ate o) the alance sheet0 /otice ho' the hea&ing o) the alance sheet &i))ers )ro$ the hea&ings on the inco$e state$ent an& state$ent o) retaine& earnings0 A alance sheet is li!e a photograph? it captures the )inancial position o) a co$pan" at a particular point in ti$e0 The other t'o state$ents are )or a perio o) ti$e0 As "ou stu&" a out the assets, lia ilities, an& stoc!hol&ers1 e4uit" containe& in a alance sheet, "ou 'ill un&erstan& 'h" this )inancial state$ent provi&es in)or$ation a out the solvenc" o) the usiness0 #ssets are things o) value o'ne& " the usiness0 The" are also calle& the resources o) the usiness0 %xa$ples inclu&e cash, $achines, an& uil&ings0 Assets have value ecause a usiness can use or exchange the$ to pro&uce the services or pro&ucts o) the usiness0 6n Part C o) %xhi it I the assets o) (etro Courier, 6nc0, a$ount to M,< +8,@BB0 (etro1s assets consist o) cash, accounts recei'able (a$ounts &ue )ro$ custo$ers )or services previousl" ren&ere&), truc!s, an& o))ice e4uip$ent0 Liabilities are the &e ts o'e& " a usiness0 T"picall", a usiness $ust pa" its &e ts " certain &ates0 A usiness incurs $an" o) its lia ilities " purchasing ite$s on cre&it0 (etro1s lia ilities consist o) accounts payable (a$ounts o'e& to suppliers )or previous purchases) an& notes payable ('ritten pro$ises to pa" a speci)ic su$ o) $one") totaling M,< D,DBB0
+

+ (ost notes ear interest, ut in this chapter 'e assu$e that all notes ear no interest0 6nterest is an a$ount pai& " the orro'er to the len&er (in a&&ition to the a$ount o) the loan) )or use o) the $one" over ti$e0 p. +@ o) *++

(etro Courier, 6nc0, is a corporation0 The o'ners1 interest in a corporation is re)erre& to as stock%ol.ers; equity0 (etro1s stoc!hol&ers1 e4uit" consists o) (1) M,< +B,BBB pai& )or shares o) capital stoc! an& (I) retaine& earnings o) M,< I,1BB0 Capital stock sho's the a$ount o) the o'ners1 invest$ent in the corporation0 :etaine. earnings generall" consists o) the accu$ulate& net inco$e o) the corporation $inus &ivi&en&s &istri ute& to stoc!hol&ers0 =e &iscuss these ite$s later in the text0 At this point, si$pl" note that the alance sheet hea&ing inclu&es the na$e o) the organi5ation an& the title an& &ate o) the state$ent0 /otice also that the &ollar a$ount o) the total assets is e4ual to the clai$s on (or interest in) those assets0 The alance sheet sho's these clai$s un&er the hea&ing FAia ilities an& ,toc!hol&ers1 %4uit"H0 (anage$ent is intereste& in the cash in)lo's to the co$pan" an& the cash out)lo's )ro$ the co$pan" ecause these &eter$ine the co$pan"1s cash it has availa le to pa" its ills 'hen &ue0 The statement o0 cas% 0lows sho's the cash in)lo's an& cash out)lo's )ro$ operating, investing, an& )inancing activities0 .perating activities generall" inclu&e the cash e))ects o) transactions an& other events that enter into the &eter$ination o) net inco$e0 1nvesting activities generall" inclu&e usiness transactions involving the ac4uisition or &isposal o) long-ter$ assets such as lan&, uil&ings, an& e4uip$ent0 Financing acti'ities generall" inclu&e the cash e))ects o) transactions an& other events involving cre&itors an& o'ners (stoc!hol&ers)0 Chapter 1D &escri es the state$ent o) cash )lo's in &etail0 Our purpose here is to $erel" intro&uce this i$portant )inancial state$ent0 /or$all", a )ir$ prepares a state$ent o) cash )lo's )or the sa$e ti$e perio& as the inco$e state$ent0 The )ollo'ing state$ent, ho'ever, sho's the cash in)lo's an& out)lo's )or (etro Courier, 6nc0, since it 'as )or$e& on IB1B ;une 10 Thus, this cash )lo' state$ent is )or t'o $onths0
METRO COURIER" INC. Statement o* Ca#h Flo,# For the T,o-Month .er%od Ended 2010 July 1 ,as0 (lo;s (ro! operatin) activities: et inco!e'''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''' $2'"00 $d<ust!ents to reconcile net inco!e to net cas0 provided 52 operatin) activities: .ncrease in accounts receiva5le'''''''''''''''''''''''''''''''''''''' #700% .ncrease in accounts pa2a5le''''''''''''''''''''''''''''''''''''''''' et cas0 provided 52 operatin) activities''''''''''''''''' ,as0 (lo;s (ro! investin) activities: =urc0ase o( truc6s'''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''' =urc0ase o( o((ice e7uip!ent'''''''''''''''''''''''''''''''''''''''''''''''' et cas0 used 52 investin) activities''''''''''''''''''''''''''''''' ,as0 (lo;s (ro! (inancin) activities: =roceeds (ro! notes pa2a5le''''''''''''''''''''''''''''''''''''''''''''''''' =roceeds (ro! sale o( capital stoc6'''''''''''''''''''''''''''''''''''''''' $6,000 30,000 $#20,000% #2,500% #22,500% 600 $2,000

p. +8 o) *++

et cas0 provided 52 (inancin) activities''''''''''''''''''''''''' et increase in cas0'''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''''

36,000 $"5,500

At this point in the course, "ou nee& to un&erstan& 'hat a state$ent o) cash )lo's is rather than ho' to prepare it0 =e &o not as! "ou to prepare such a state$ent until "ou have stu&ie& Chapter 1D0 The inco$e state$ent, the state$ent o) retaine& earnings, the alance sheet, an& the state$ent o) cash )lo's o) (etro Courier, 6nc0, sho' the results o) $anage$ent1s past &ecisions0 The" are the en& pro&ucts o) the accounting process, 'hich 'e explain in the next section0 These )inancial state$ents give a picture o) the solvenc" an& pro)ita ilit" o) the co$pan"0 The accounting process &etails ho' this picture 'as $a&e0 (anage$ent an& other intereste& parties use these state$ents to $a!e )uture &ecisions0 (anage$ent is the )irst to !no' the )inancial results? then, it pu lishes the )inancial state$ents to in)or$ other users0 The $ost recent )inancial state$ents )or $ost co$panies can e )oun& on their 'e sites un&er F6nvestor :elationsH or so$e si$ilar hea&ing0

2.$ The financial accounting process
6n this section, 'e explain the accounting e4uationLthe )ra$e'or! )or the entire accounting process0 Then, 'e sho' "ou ho' to recogni5e a recor& usiness transactions0 6n the alance sheet presente& in %xhi it I (Part C), the total assets o) (etro Courier, 6nc0, 'ere e4ual to its total lia ilities an& stoc!hol&ers1 e4uit"0 This e4ualit" sho's that the assets o) a usiness are e4ual to its e4uities? that is, Assets S %4uities Assets 'ere &e)ine& earlier as the things o) value o'ne& " the usiness, or the econo$ic resources o) the usiness0 -quities are all clai$s to, or interests in, assets0 For exa$ple, assu$e that "ou " investing M,< 1B,BBB in "our o'n purchase& a ne' co$pan" auto$o ile )or M,< 1C,BBB usiness transaction an& &escri e un&erl"ing assu$ptions that accountants use to recor& usiness transactions0 /ext "ou learn ho' to anal"5e an&

corporation an& orro'ing M,< C,BBB in the na$e o) the corporation )ro$ a an!0 .our e4uit" in the auto$o ile is M,< 1B,BBB, an& the an!1s e4uit" is M,< C,BBB0 .ou can )urther &escri e the M,< C,BBB as a lia ilit" ecause "ou o'e the an! M,< C,BBB0 6) "ou are a corporation, "ou can &escri e "our M,< 1B,BBB e4uit" as stoc!hol&ers1 e4uit" or interest in the asset0 ,ince the o'ners in a corporation are stoc!hol&ers, the asic accounting equation eco$es: Assets A S Aia ilities A T ,toc!hol&ers1 %4uit" ,% Fro$ (etro1s alance sheet in %xhi it I (Part C), 'e can enter in the a$ount o) its assets, lia ilities, an& stoc!hol&ers1 e4uit":

p. +> o) *++

A S A T ,% M,< +8,@BB S M,< D,DBB T M,< +I,1BB :e$e$ er that so$eone $ust provi&e assets or resourcesLeither a cre&itor or a stoc!hol&er0 There)ore, this e4uation $ust al'a"s e in alance0 .ou can also loo! at the right si&e o) this e4uation in another $anner0 The lia ilities an& stoc!hol&ers1 e4uit" sho' the sources o) an existing group o) assets0 Thus, lia ilities are not onl" clai$s against assets ut also sources o) assets0 Together, cre&itors an& o'ners provi&e all the assets in a corporation0 The higher the proportion o) assets provi&e& " o'ners, the $ore solvent the co$pan"0 #o'ever, co$panies can so$eti$es i$prove their pro)ita ilit" " orro'ing )ro$ cre&itors an& using the )un&s e))ectivel"0 As a usiness engages in econo$ic activit", the &ollar a$ounts an& co$position o) its assets, lia ilities, an& stoc!hol&ers1 e4uit" change0 0o'ever, t%e equality o& t%e basic accounting equation al'ays %ol s. An accounting transaction is a usiness activit" or event that causes a $easura le change in the accounting e4uation, Assets S Aia ilities T ,toc!hol&ers1 e4uit"0 An exchange o) cash )or $erchan&ise is a transaction0 The exchange ta!es place at an agree& price that provi&es an o 3ective $easure o) econo$ic activit"0 For exa$ple, the o 3ective $easure o) the exchange $a" e M,< C,BBB0 These t'o )actorsLevi&ence an& $easure$entL$a!e possi le the recor&ing o) a transaction0 (erel" placing an or&er )or goo&s is not a recor&a le transaction ecause no exchange has ta!en place0 A source &ocu$ent usuall" supports the evi&ence o) the transaction0 A source .ocument is an" 'ritten or printe& evi&ence o) a receive&, usiness transaction that &escri es the essential )acts o) that ills receive& )ro$ suppliers )or ite$s transaction0 %xa$ples o) source &ocu$ents are receipts )or cash pai& or receive&, chec!s 'ritten or ills sent to custo$ers )or services per)or$e& or purchase&, cash register tapes, sales tic!ets, an& notes given or receive&0 =e han&le source &ocu$ents constantl" in our ever"&a" li)e0 %ach source &ocu$ent initiates the process o) recor&ing a transaction0

2.% .nderl ing assumptions or concepts
6n recor&ing usiness transactions, accountants rel" on certain un&erl"ing assu$ptions or concepts0 Both preparers an& users o) )inancial state$ents $ust un&erstan& these assu$ptions:
 Business entity concept (or accounting entity concept). <ata gathere& in an

accounting s"ste$ relates to a speci)ic usiness unit or entity0 The usiness entit" concept assu$es that each usiness has an existence separate )ro$ its o'ners, cre&itors, e$plo"ees, custo$ers, other intereste& parties, an& other usinesses0

p. *B o) *++

 8oney measurement concept. %cono$ic activit" is initiall" recor&e& an& reporte& in a

co$$on $onetar" unit o) $easureLthe &ollar in the Mnite& ,tates0 This )or$ o) $easure$ent is !no'n as "oney "easure"ent.
 -xc%ange-price (or cost) concept (principle). (ost o) the a$ounts in an accounting

s"ste$ are the o 3ective $one" prices &eter$ine& in the exchange process0 As a result, 'e recor& $ost assets at their ac4uisition cost0 Cost is the sacri)ice $a&e or the resources given up, $easure& in $one" ter$s, to ac4uire so$e &esire& thing, such as a ne' truc! (asset)0
 9oing-concern (continuity) concept. Mnless strong evi&ence exists to the contrar",

accountants assu$e that the usiness entit" 'ill continue operations into the in&e)inite )uture0 Accountants call this assu$ption the going)concern or continuity concept0 Assu$ing that the entit" 'ill continue in&e)initel" allo's accountants to value long-ter$ assets, such as lan&, at cost on the alance sheet since the" are to e use& rather than sol&0 (ar!et values o) these assets 'oul& e relevant onl" i) the" 'ere )or sale0 For instance, accountants 'oul& still recor& lan& purchase& in 1>88 at its cost o) M,< 1BB,BBB on the IB1B <ece$ er +1, alance sheet even though its $ar!et value has risen to M,< +BB,BBB0
 &erio.icity (time perio.s) concept. Accor&ing to the perio icity 3ti"e perio s4 concept

or assu$ption, an entit"1s li)e can e $eaning)ull" su &ivi&e& into ti$e perio&s (such as $onths or "ears) to report the results o) its econo$ic activities0 /o' that "ou un&erstan& usiness transactions an& the )ive asic accounting assu$ptions, "ou are rea&" to )ollo' so$e usiness transactions step " step0 To egin, 'e &ivi&e (etro1s transactions into t'o groups: (1) transactions a))ecting onl" the alance sheet in ;une, an& (I) transactions a))ecting the inco$e state$ent an&7or the alance sheet in ;ul"0 /ote that 'e coul& also classi)" these transactions as operating, investing, or )inancing activities, as sho'n in the state$ent o) cash )lo's0

2.' Transactions affecting onl the balance sheet
,ince each transaction a))ecting a usiness entit" $ust e recor&e& in the accounting recor&s, anal"5ing a transaction e)ore actuall" recor&ing it is an i$portant part o) )inancial accounting0 An error in transaction anal"sis results in incorrect )inancial state$ents0 To illustrate the anal"sis o) transactions an& their e))ects on the asic accounting e4uation, the activities o) (etro Courier, 6nc0, that le& to the state$ents in %xhi it I )ollo'0 The )irst set o) transactions ()or ;une), 1a, Ia, an& so on, are repeate& in the su$$ar" o) transactions, %xhi it + (Part A)0 The secon& set o) transactions ()or ;ul") (1 –D ) are repeate& in %xhi it * (Part A)0

p. *1 o) *++

2.'.1 1a. /+ners invested cash
=hen (etro Courier, 6nc0, 'as organi5e& as a corporation on IB1B ;une 1, the co$pan" issue& shares o) capital stoc! )or M,< +B,BBB cash to :on Chane", his 'i)e, an& their son0 This transaction increase& assets (cash) o) (etro " M,< +B,BBB an& increase& e4uities (the capital stoc! ele$ent o) stoc!hol&ers1 e4uit") accounting e4uation:
A##et# Tran#act%on E01lanat%on &e)innin) 5alances Stoc60older s invested cas0 &alance a(ter transaction Ca#h Account# Rece%2a&le $ 303 Truc'# O**%ce E)u%1ment $ 303 /$%a&%l%t%e# > Account# .aya&le Note# .aya&le 3 $ 303 Stoc'holder#( E)u%ty Ca1%tal Stoc' $ 303 30,000

" M,< +B,BBB0 Conse4uentl", the transaction "iel&s the )ollo'ing

asic

"a

$ 303 30,000

$ 303

/ $ 303

$ 30,000 .ncreased 52 $30,000

$ 30,000 .ncreased 52 $30,000

2.'.2 2a. 0orro+ed mone
The co$pan" orro'e& M,< D,BBB )ro$ Chane"1s )ather0 Chane" signe& the note )or the co$pan"0 The note ore no interest an& the co$pan" pro$ise& to repa" (recor&e& as a note payable) the a$ount orro'e& 'ithin one "ear0 A)ter inclu&ing the e))ects o) this transaction, the asic accounting e4uation is:
Tran#act%on E01lanat%on &alances 5e(ore transaction &orro;ed !one2 &alance a(ter transaction Ca#h $ 30,000 6,000 $ 36,000 .ncreased 52 $6,000 / A##et# Account# Truc'# Rece%2a&le $ 303 $ 303 O**%ce E)u%1ment $ 303 ? $%a&%l%t%e# 3 Account# Note# .aya&le .aya&le / $ 303 $ 303 6,000 $ 6,000 .ncreased 52 $6,000 3 $ 30,000 Stoc'holder(# E)u%ty Ca1%tal 3 Stoc' $ 30,000

2a

2.'.3 3a. 1urchased truc&s and office e2uipment for cash
(etro pai& M,< IB,BBB cash )or t'o use& &eliver" truc!s an& M,< 1,CBB )or o))ice e4uip$ent0 Truc!s an& o))ice e4uip$ent are assets ecause the co$pan" uses the$ to earn revenues in the )uture0 /ote that this transaction &oes not change the total a$ount o) assets in the asic e4uation ut onl" changes the co$position o) the assets0 This transaction &ecrease& cash an& increase& truc!s an& o))ice

p. *I o) *++

e4uip$ent (assets) " the total a$ount o) the cash &ecrease0 (etro receive& t'o assets an& gave up one asset o) e4ual value0 Total assets are still M,< +D,BBB0 The accounting e4uation no' is:
A##et# Ca#h $ 36,000 #2",500% $ "4,500 Account# Rece%2a&le $ 303 Truc'# $ 303 20,000 $ 20,000 O**%ce E)u%1ment $ 303 / ",500 $ ",500 / $ 6,000 3 $ 30,000 ? $%a&%l%t%e# 3 Note# .aya&le $ 6,000 Stoc'holder#( E)u%ty Ca1%tal 3 Stoc' 3 $ 30,000

Account# .aya&le $ 303

:ecreased 52 $2",500

.ncreased .ncreased 52 52 $",500 $20,000

2.'.! !a. 1urchased office e2uipment on account 3for credit4
(etro purchase& an a&&itional M,< 1,BBB o) o))ice e4uip$ent on account, agreeing to pa" 'ithin 1B &a"s a)ter receiving the ill0 (To purchase an ite$ on account $eans to u" it on cre&it0) This transaction increase& assets (o))ice e4uip$ent) an& lia ilities (accounts pa"a le) " M,< 1,BBB0 As state& earlier, accounts pa"a le are a$ounts o'e& to suppliers )or ite$s purchase& on cre&it0 /o' "ou can see the M,< 1,BBB increase in the assets an& lia ilities as )ollo's:
A##et# Ca#h $ $ "4,500 "4,500 Account# Rece%2a&le > Stoc'holder#( E)u%ty Note# Ca1%tal Truc'# O**%ce E)u%1ment Account# .aya&le .aya&le 3 Stoc' $ 20,000 $ ",500 / $ 6,000 $ 30,000 ",000 $ 20,000 $ 2,500 / .ncreased 52 $",000 $ ",000 ",000 $ 6,000 3 $ 30,000 .ncreased 52 $",000 / $%a&%l%t%e#

2.'.# #a. 1aid an account pa able
%ight &a"s a)ter receiving the ill, (etro pai& M,< 1,BBB )or the o))ice e4uip$ent purchase& on account (transaction *a)0 This transaction re&uce& cash " M,< 1,BBB an& re&uce& accounts pa"a le " M,< 1,BBB0 Thus, the assets an& lia ilities oth are re&uce& " M,< 1,BBB, an& the e4uation again alances as )ollo's:

p. *+ o) *++

Tran#act%on

5a

E01lanat%o n &alances 5e(ore transaction =aid an account pa2a5le &alance a(ter transaction

Ca#h $ "4,500 #",000% $ "3,500

A##et# Account# Truc'# Rece%2a&le $ 303 $ 20,000

O**%ce E)u%1ment $ 2,500 /

/ $%a&%l%t%e# 3 Account# Note# .aya&le .aya&le $ ",000 #",000% $ 6,000

Stoc'holder# e)u%ty 3 Ca1%tal Stoc' > $30,000

$ 303

$ 20,000

$ 2,500

$ 303

$ 6,000

>$30,000

:ecreased 52 $",000 A. Summary o* Tran#act%on#

:ecreased 52 $",000

METRO COURIER" INC. Summary o* Tran#act%on# Month o* June 2010 A##et# /$%a&%l%t%e# 3 O**%ce Account# Note# E)u%1ment .aya&le .aya&le $ 303 / $ 303 $ 303 Account# Truc'# Rece%2a&le $ 303 $ 303 Stoc'holder#( E)u%ty Ca1%tal 3 Stoc' $ 303 30,000 $ 30,000 / ? 20,000 $20,000 $20,000 ",500 $ ",500 ",000 $ 2,500 $ 2,500#,% ? $ ",000 $ / $ ",000 $ 6,000 6,000 6,000 3 $ 30,000 3 $ 30,000 3 $ 30,000 3 $ 30,000#E% 6,000 $6000 >$30,000

Tran#act%on "a 2a 3a 4a 5a

E01lanat%on &e)innin) 5alances Stoc60olders invested cas0

Ca#h $ 30 30,000 $ 30,000 6,000 $ 36,000 #2",500% $ "4,500

&orro;ed !one2 =urc0ased truc6s and o((ice e7uip!ent (or cas0 =urc0ased o((ice e7uip!ent on account

$ "4,500

=aid an account pa2a5le #",000% End3o(3!ont0 5alances $ "3,500#$% $ 303 $20,000#&% !. !alance Sheet METRO COURIER" INC. !alance Sheet 2010 June 0 A##et# $%a&%l%t%e# and Stoc'holder#( E)u%ty ,as0 Truc6s +((ice e7uip!ent #$% $ "3,500 4ia5ilities: #&% 20,000 #,%2,500 otes =a2a5le Total 4ia5ilities Stoc60olders8 e7uit2: ,apital stoc6 Total assets Total lia5ilities $ 36,000 and stoc60olders8 e7uit2 #:% $6,000 $ 6,000

#",000% / $ 303 $6,000#:%

#E% 30,000 $ 36,000

%xhi it +: Balance ,heet %xhi it +, Part A, is a su""ary o& transactions prepare& in accounting e4uation )or$ )or ;une0 A summary o0 transactions is a teaching tool use& to sho' the e))ects o) transactions on the accounting e4uation0 /ote that the stoc!hol&ers1 e4uit" has re$aine& at M,< +B,BBB0 This a$ount

p. ** o) *++

changes as the usiness egins to earn revenues or incur expenses0 .ou can see ho' the totals at the otto$ o) Part A o) %xhi it + tie into the alance sheet sho'n in Part B0 The &ate on the alance sheet is IB1B ;une +B0 These totals eco$e the eginning alances )or ;ul" IB1B0 Thus )ar, all transactions have consiste& o) exchanges or ac4uisitions o) assets either " orro'ing or " o'ner invest$ent0 =e use& this proce&ure to help "ou )ocus on the accounting e4uation as it relates to the alance sheet0 #o'ever, people &o not )or$ a usiness onl" to hol& existing assets0 The" )or$ usinesses so their assets can generate greater a$ounts o) assets0 Thus, a usiness increases its assets " provi&ing goo&s or services to custo$ers0 The results o) these activities appear in the inco$e state$ent0 The section that )ollo's sho's $ore o) (etro1s transactions as it egan earning revenues an& incurring expenses0

2.) Transactions affecting the income statement and5or balance sheet
To survive, a usiness $ust e pro)ita le0 This $eans that the revenues earne& " provi&ing goo&s an& services to custo$ers $ust excee& the expenses incurre&0 6n ;ul" IB1B, (etro Courier, 6nc0, egan selling services an& incurring expenses0 The explanations o) transactions that )ollo' allo' "ou to participate in this process an& learn the necessar" accounting proce&ures0

2.).1 1b. Earned service revenue and received cash
As its )irst transaction in ;ul", (etro per)or$e& &eliver" services )or custo$ers an& receive& M,< *,8BB cash0 This transaction increase& an asset (cash) " M,< *,8BB0 ,toc!hol&ers1 e4uit" (retaine& earnings) also increase& " M,< *,8BB, an& the accounting e4uation 'as in alance0 The M,< *,8BB is a revenue earne& " the usiness an&, as such, increases stoc!hol&ers1 e4uit" (in the )or$ o) retaine& earnings) ecause stoc!hol&ers prosper 'hen the usiness earns pro)its0 Ai!e'ise, i) the corporation sustains a loss, the loss 'oul& re&uce retaine& earnings0 :evenues increase the a$ount o) retaine& earnings 'hile expenses an& &ivi&en&s &ecrease the$0 (6n this )irst chapter, 'e sho' all o) these ite$s as i$$e&iatel" a))ecting retaine& earnings0 6n later chapters, the revenues, expenses, an& &ivi&en&s are accounte& )or separatel" )ro$ retaine& earnings &uring the accounting perio& an& are trans)erre& to retaine& earnings onl" at the en& o) the accounting perio& as part o) the closing process &escri e& in Chapter *0) The e))ects o) this M,< *,8BB transaction on the )inancial position o) (etro are:

p. *C o) *++

(etro 'oul& recor& the increase in stoc!hol&ers1 e4uit" rought a out " the revenue transaction as a separate account, retaine& earnings0 This &oes not increase capital stoc! ecause the Capital ,toc! account increases onl" 'hen the co$pan" issues shares o) stoc!0 The expectation is that revenue transactions 'ill excee& expenses an& "iel& net inco$e0 6) net inco$e is not &istri ute& to stoc!hol&ers, it is in )act retaine&0 Aater chapters sho' that ecause o) co$plexities in han&ling large nu$ ers o) transactions, revenues an& expenses a))ect retaine& earnings onl" at the en& o) an accounting perio&0 The prece&ing proce&ure is a shortcut use& to explain 'h" the accounting e4uation re$ains in alance0
Tran#ac t%on E01lanat%on &e)innin) 5alances #Ex0i5it 3% Earned service revenue and received cas0 &alances a(ter transaction $ Ca#h "3,500 4,900 $ "9,300 $ 20,000 $ 2,500 / $ 6,000 A##et# Account# Truc'# Rece%2a&le $ 303 $ 20,000 O**%ce E)u%1ment $ 2,500 / /$%a&%l%t%e# 3 Account# Note# .aya&le .aya&le $ 303 $ 6,000 Stoc'holder#( E)u%ty Ca1%tal 3 Reta%ned Stoc' Earn%n+# $ 30,000 $ 303 4,900 3 $ 30,000 $ 4,900 .ncreased 52 $4,900

"5

.ncreased 52 $4,900

2.).2 2b. 6ervice revenue earned on account 3for credit4
(etro per)or$e& courier &eliver" services )or a custo$er 'ho agree& to pa" M,< >BB at a later &ate0 The co$pan" grante& cre&it rather than re4uiring the custo$er to pa" cash i$$e&iatel"0 This is calle& earning revenue on account. The transaction consists o) exchanging services )or the custo$er1s pro$ise to pa" later0 This transaction is si$ilar to the prece&ing transaction in that stoc!hol&ers1 e4uit" (retaine& earnings) increases ecause the co$pan" has earne& revenues0 #o'ever, the transaction &i))ers ecause the co$pan" has not receive& cash0 6nstea&, the co$pan" has receive& another asset, an account receivable. As note& earlier, an account receiva le is the a$ount &ue )ro$ a custo$er )or goo&s or services alrea&" provi&e&0 The co$pan" has a legal right to collect )ro$ the custo$er in the )uture0 Accounting recogni5es such clai$s as assets0 The accounting e4uation, inclu&ing this M,< >BB ite$, is as )ollo's:
A##et# Tran#ac E01lanat%on t%on &alances 5e(ore transaction Earned service revenue on account &alances a(ter transaction Ca#h $ "9,300 $@00 $ "9,300 $@00 .ncreased 52 $@00 $ 20,000 $ 2,500 / $ 6,000 3$ 30,000 Account# Rece%2a&le Truc'# $%a&%l%t%e# O**%ce Account# E)u%1ment .aya&le Note# .aya&le Stoc'holder#( > E)u%ty Ca1%tal Reta%ned 3 Earn%n+# Stoc' $ 4,900 @00 $5,700 .ncreased 52 $@00

$ 20,000 $ 2,500 /

$ 6,000 $ 30,000

25

p. *D o) *++

2.).3 3b. Collected cash on accounts receivable
(etro collecte& M,< IBB on account )ro$ the custo$er in transaction I 0 The custo$er 'ill pa" the re$aining M,< @BB later0 This transaction a))ects onl" the alance sheet an& consists o) giving up a clai$ on a custo$er in exchange )or cash0 The transaction increases cash " M,< IBB an& &ecreases accounts receiva le " M,< IBB0 /ote that this transaction consists solel" o) a change in the co$position o) the assets0 =hen the co$pan" per)or$e& the services, it recor&e& the revenue0 There)ore, the co$pan" &oes not recor& the revenue again 'hen collecting the cash0
A##et# Tran#act E01lanat%on %on &alances 5e(ore transaction 35 ,ollected cas0 on account &alances a(ter transaction Ca#h Account# Rece%2a&le "9,300 200 "9,500 $ @00 $ #200% $700 20,000 $ 2,500 / $ 6,000 3 $ 30,000 Truc'# O**%ce E)u%1ment $ 2,500 / /$%a&%l%t%e# 3 Account# .aya&le Note# .aya&le Stoc'holder#( 3E)u%ty 3 Ca1%tal Stoc' $ 30,000

$ $ $

20,000

$ 6,000

.ncreased 52 $200

:ecreased 52 $200

2.).! !b. 1aid salaries
(etro pai& e$plo"ees M,< I,DBB in salaries0 This transaction is an exchange o) cash )or e$plo"ee services0 T"picall", co$panies pa" e$plo"ees )or their services a)ter the" per)or$ their 'or!0 ,alaries (or 'ages) are costs co$panies incur to pro&uce revenues, an& co$panies consi&er the$ an expense0 Thus, the accountant treats the transaction as a &ecrease in an asset (cash) an& a &ecrease in stoc!hol&ers1 e4uit" (retaine& earnings) ecause the co$pan" has incurre& an expense0 %xpense transactions re&uce net inco$e0 ,ince net inco$e eco$es a part o) the retaine& earnings alance, expense transactions also re&uce the retaine& earnings0
A##et# Ca#h $ "9,500 #2,600% $ "5,@00 Account# Rece%2a&le $ $ 700 700 Truc'# $ 20,000 $ 20,000 O**%ce E)u%1ment $ 2,500 / $ 2,500 / / $%a&%l%t%e# > Account# Note# .aya&le .aya&le 3 $6,000 $6,000 3 Stoc'holder#( E)u%ty Ca1%tal Stoc' $ 30,000 $ 30,000 Reta%ned Earn%n+# $ 5,700 #2,600% $ 3,"00

:ecreased 52 $2,600

:ecreased 52 $2,600

2.).# #b. 1aid rent
6n ;ul", (etro pai& M,< *BB cash )or o))ice space rental0 This transaction causes a &ecrease in cash o) M,< *BB an& a &ecrease in retaine& earnings o) M,< *BB ecause o) the incurrence o) rent expense0 Transaction C has the )ollo'ing e))ects on the a$ounts in the accounting e4uation: p. *@ o) *++

A##et# Ca#h $ "5,@00 #400% $ "5,500 :ecreased 52 $400 Account# Rece%2a&le $ $ 700 700

/ $%a&%l%t%e# 3 Stoc'holder#( E)u%ty O**%ce Account# Note# Reta%ned 3 Ca1%tal Stoc' E)u%1ment .aya&le .aya&le Earn%n+# $ 3,"00 $ 20,000 $ 2,500 / $ 6,000 $ 30,000 #400% $ 20,000 $ 2,500 / $ 6,000 3 $ 30,000 $ 2,700 :ecreased 52 $400 Truc'#

2.).$ $b. 7eceived bill for gas and oil used
At the en& o) the $onth, (etro receive& a M,< DBB ill )or gas an& oil consu$e& &uring the $onth0 This transaction involves an increase in accounts pa"a le (a lia ilit") ecause (etro has not "et pai& the ill an& a &ecrease in retaine& earnings ecause (etro has incurre& an expense0 (etro1s accounting e4uation no' rea&s:
A##et# Ca#h $ "5,500 $ "5,500 Account# Rece%2a&le $ $ 700 700 /$%a&%l%t%e# 3 Stoc'holder#( 3E)u%ty O**%ce Account# .aya&le Note# .aya&le Ca1%tal 3 Stoc' Reta%ned Earn%n+# E)u%1ment $ 20,000 $ 2,500 / $ 6,000 $ 30,000 $ 2,700 Truc'# 600 $ 20,000 $ 2,500 / $ 600 $ 6,000 3 $ 30,000 $ #600% 2,"00

.ncreased 52 $600

:ecreased 52 $600

2.18 6ummar of balance sheet and income statement transactions
Part A o) %xhi it * su$$ari5es the e))ects o) all the prece&ing transactions on the assets, lia ilities, an& stoc!hol&ers1 e4uit" o) (etro Courier, 6nc0, in ;ul"0 The eginning alances are the en&ing alances in Part A o) %xhi it +0 The su$$ar" sho's su totals a)ter each transaction? these su totals are optional an& $a" e o$itte&0 /ote ho' the accounting e4uation re$ains in alance a)ter each transaction an& at the en& o) the $onth0 The en&ing alances in each o) the colu$ns in Part A o) %xhi it * are the &ollar a$ounts in Part B an& those reporte& earlier in the alance sheet in Part C o) %xhi it I0 The ite$i5e& &ata in the :etaine& %arnings colu$n are the revenue an& expense ite$s in Part C o) %xhi it * an& those reporte& earlier in the inco$e state$ent in Part A o) %xhi it I0 The eginning alance in the :etaine& %arnings colu$n (M,< B) plus net inco$e )or the $onth (M,< I,1BB) is e4ual to the en&ing alance in retaine& earnings (M,< I,1BB) sho'n earlier in Part B o) %xhi it I0 :e$e$ er that the )inancial state$ents are not an en& in the$selves, ut are prepare& to assist users o) those state$ents to $a!e in)or$e& &ecisions0 Throughout the text 'e sho' ho' people use accounting in)or$ation in &ecision $a!ing0

p. *8 o) *++

2.11 Dividends paid to o+ners 3stoc&holders4
,toc!hol&ers1 e4uit" is (1) increase& " capital contri ute& " stoc!hol&ers an& " revenues earne& through operations an& (I) &ecrease& " expenses incurre& in pro&ucing revenues0 The pa"$ent o) cash or other assets to stoc!hol&ers in the )or$ o) &ivi&en&s also re&uces stoc!hol&ers1 e4uit"0 Thus, i) the o'ners receive a cash &ivi&en&, the e))ect 'oul& e to re&uce the retaine& earnings part o) stoc!hol&ers1 e4uit"? the a$ount o) &ivi&en&s is not an expense ut a &istri ution o) inco$e0

#n et%ical perspecti'e: "tate uni'ersity
;a$es ,tevens 'as ta!ing an accounting course at ,tate Mniversit"0 Also, he 'as helping co$panies )in& accounting s"ste$s that 'oul& )it their in)or$ation nee&s0 #e a&vise& one o) his clients to ac4uire a so)t'are co$puter pac!age that coul& recor& the usiness transactions an& prepare the )inancial state$ents0 The licensing agree$ent 'ith the so)t'are co$pan" speci)ie& that the asic charge )or one site 'as M,< *,BBB an& that M,< 1,BBB $ust e pai& )or each a&&itional site 'here the so)t'are 'as use&0 ;a$es 'as please& that his reco$$en&ation to ac4uire the so)t'are 'as )ollo'e&0 #o'ever, he 'as upset that $anage$ent 'ante& hi$ to install the so)t'are at eight other sites in the co$pan" an& &i& not inten& to pa" the extra M,< 8,BBB &ue the so)t'are co$pan"0 A $e$ er o) $anage$ent state&, FThe so)t'are co$pan" 'ill never !no' the &i))erence an&, esi&es, ever"one else see$s to e pirating so)t'are0 6) the" &o )in& out, 'e 'ill pa" the extra )ee at that ti$e0 Our expenses are high enough 'ithout pa"ing these unnecessar" costs0H ;a$es elieve& he $ight lose this client i) he &i& not &o as $anage$ent instructe&0

p. *> o) *++

#n accounting perspecti'e: 6ses o0 tec%nology
Accountants an& others can access the ho$e pages o) co$panies to )in& their annual reports an& other in)or$ation, ho$e pages o) CPA )ir$s to )in& e$plo"$ent opportunities an& services o))ere&, an& ho$e pages o) govern$ent agencies, universities, an& an" other agenc" that has esta lishe& a ho$e page0 B" $a!ing onscreen choices "ou can &iscover all !in&s o) interesting in)or$ation a out al$ost an"thing0 .ou can access li raries, even in )oreign countries, ne'spapers, such as The =all ,treet ;ournal, an& )in& a&&resses an& phone nu$ ers o) an"one in the nation0 =e have inclu&e& so$e 6nternet Pro3ects at the en& o) the chapters to give "ou so$e experience at Fsur)ing the netH )or accounting applications0

p. CB o) *++

A. Summary o* Tran#act%on# METRO COURIER" INC. Summary o* Tran#act%on# Month o* July 2010 A##et# Tran#act%on E01lanat%on &e)innin) 5alances #.llustration "'2% Earned service revenue and received cas0 Ca#h $ "3,500 4,900 $ "9,300 25 Earned service revenue on account $ "9,300 200 $ "9,500 #2,600% $ "5,@00 #400% $ "5,500 @00 $ @00 #200% $ 700 $ 20,000 $ 2,500 / $ 6,000 3 $ 30,000 $ 5,700 #2,600%#,% $ 700 $ 20,000 $ 2,500 / $ 6,000 3 $ 30,000 $ 3,"00 #400%#:% $ 700 $ 20,000 $ 2,500 / 600 $"5,500# $ $ 700#G% /% 20,000#A% $ 2,500 $ 6,000 3 $ 30,000 $ 2,700 #600%#E% $ 6,000 $ 20,000 $ 2,500 / $ 6,000 3 $ 30,000 $ 20,000 $ 2,500 / $ 6,000 3 $ 30,000 Account# Rece%2- Truc'# a&le $ 303 -$%a&%l%t%e# O**%ce Account# E)u%1ment .aya&le $ 303 3 Stoc'holder#( E)u%ty Reta%ned Earn%n+# $ 303 4,900#$% $ 4,900 @00#&% $ 5,700 Note# .aya&le Ca1%tal 3 Stoc' $ 6,000 3 $ 30,000

$ 20,000 $ 2,500 /

"5

35

,ollected cas0 on account

45

=aid salaries

55

=aid rent

65

Received 5ill (or )as and oil used End3o(3!ont0 5alances

/4I5

$

600#1%

3 465

$ 30,000#4%

$ 2,"00#*%

$39,700 !. !alance Sheet METRO COURIER" INC. !alance Sheet 2010 July 1 $%a&%l%t%e# and Stoc'holder#( #/%$"5,500 4ia5ilities: $ccounts pa2a5le otes pa2a5le #1%$600 #B%6,000 #A%20,000 #.%2,500

$6,600

$32,"00

A##et# ,as0 Truc6s +((ice e7uip!ent

$ccounts receiva5le #G%700

Total lia5ilities Stoc60olders8 e7uit2 $6,600 ,apital stoc6 Retained earnin)s Total stoc60olders8 e7uit2 Total lia5ilities and stoc60olders8 e7uit2 #4%$30,000 #*%2,"00 $32,"00 $39,700

Total assets

$39,700

C. Income Statement METRO COURIER" INC. Income Statement For the Month Ended 2010 July 1 Revenues: Service revenue Expenses: #$>&%$ 5,700

p. C1 o) *++

Salaries expense Rent expense Gas C oil expense Total expenses et inco!e

#,%$ 2,600 #:%400 #/%600 3,600 $ 2,"00

%xhi it *:

2.12 Anal -ing and using the financial results9the e2uit ratio
The t'o asic sources o) e4uit" in a co$pan" are stoc!hol&ers an& cre&itors? their co$ ine& interests are calle& total equities. To )in& the equity ratio, &ivi&e stoc!hol&ers1 e4uit" " total e4uities or total assets, since total e4uities e4uals total assets0 6n )or$ula )or$at:
%4uit" ratio= ,toc!hol&ers J e4uit" Total e4uities

The higher the proportion o) e4uities (or assets) supplie& " the o'ners, the $ore solvent the co$pan"0 #o'ever, a high portion o) &e t $a" in&icate higher pro)ita ilit" ecause 4uite o)ten the interest rate on &e t is lo'er than the rate o) earnings reali5e& )ro$ using the procee&s o) the &e t0 An exa$ple illustrates this concept: ,uppose that a co$pan" 'ith M,< 1BB,BBB in assets coul& have raise& the )un&s to ac4uire those assets in these t'o 'a"s:
Ca#e 1 $ssets''''''''''''''''$"00,000 4ia5ilities'''''''''''''''''''''''''$20,000 Stoc60olders8 e7uit2''''''''''''$90,000 Ca#e 2 $ssets''''''''''''''''$"00,000 4ia5ilities'''''''''''''''''''''''''$90,000 Stoc60olders8 e7uit2''''''''''''$20,000

=hen a co$pan" su))ers operating losses, its assets &ecrease0 6n Case 1, the assets 'oul& have to shrin! " 8B per cent e)ore the lia ilities 'oul& e4ual the assets0 6n Case I, the assets 'oul& have to shrin! onl" IB per cent e)ore the lia ilities 'oul& e4ual the assets0 =hen the lia ilities excee& the assets, the co$pan" is sai& to e insolvent0 There)ore, cre&itors are sa)er in Case 1 an& 'ill $ore rea&il" len& $one" to the co$pan"0 #o'ever, i) )un&s orro'e& at 1B per cent are use& to pro&uce earnings at a IB per cent rate, Case I is pre)era le in ter$s o) pro)ita ilit"0 There)ore, o'ners are etter o)) in Case I i) the orro'e& )un&s can earn $ore than the" cost0 /ext, 'e exa$ine the recent e4uit" ratios o) so$e actual co$panies:
Stoc'holder#( E)u%ty 47 m%ll%on#5 1o0nson C 1o0nson $ 23,734 3* ,orporation 6,"66 General Electric ,o!pan2 53,5@7 Name o* Com1any Total E)u%t%e# 47 m%ll%on#5 E)u%ty Rat%o $ 37,053 "5,205 460,0@7 64'"D 40'6 ""'6

p. CI o) *++

As "ou can see )ro$ the prece&ing &ata, the e4uit" ratios o) actual co$panies var" 'i&el"0 Co$panies such as ;ohnson P ;ohnson an& +( Corporation e$plo" a higher proportion o) stoc!hol&ers1 e4uit" (a lo'er proportion o) &e t) than 2% in an e))ort to have stronger alance sheets ($ore solvenc")0 2% e$plo"s a greater proportion o) &e t, possi l" in an atte$pt to increase pro)ita ilit"0 %ver" co$pan" $ust stri!e a alance et'een solvenc" an& pro)ita ilit" to ensure longrun survival0 The correct alance et'een proportions o) stoc!hol&er an& cre&itor e4uities &epen&s on the in&ustr", general usiness con&itions, an& $anage$ent philosoph"0 Chapter 1 has intro&uce& t'o i$portant co$ponents o) the accounting processLthe accounting e4uation an& the usiness transaction0 6n Chapter I, "ou learn a out &e its an& cre&its an& ho' accountants use the$ in recor&ing transactions0 Mn&erstan&ing ho' &ata are accu$ulate&, classi)ie&, an& reporte& in )inancial state$ents helps "ou un&erstan& ho' to use )inancial state$ent &ata in $a!ing &ecisions0

#n accounting perspecti'e: 6ses o0 tec%nology
=hen "ou appl" )or "our )irst 3o a)ter gra&uation, prospective e$plo"ers 'ill expect "ou to !no' ho' to use a PC to per)or$ $an" tas!s0 There)ore, e)ore "ou gra&uate "ou shoul& e a le to use 'or& processing, sprea&sheet, an& &ata ase so)t'are0 .ou shoul& e a le to use the 6nternet to )in& use)ul in)or$ation0 6n $an" universities, "ou can learn these s!ills in courses ta!en )or cre&it0 6) "our school &oes not o))er cre&it courses, ta!e noncre&it courses or atten& a training center0

2.13 .nderstanding the learning objectives
 A single proprietorship is an unincorporate&

usiness o'ne& " an in&ivi&ual an& o)ten

$anage& " that in&ivi&ual0
 A partnership is an unincorporate&  A corporation is a

usiness o'ne& " t'o or $ore persons associate& as

partners an& is o)ten $anage& " the$0 usiness incorporate& un&er the la's o) a state an& o'ne& " a )e' stoc!hol&ers or " thousan&s o) stoc!hol&ers0
 ,ervice co$panies per)or$ services )or a )ee0  (erchan&ising co$panies purchase goo&s that are rea&" )or sale an& then sell the$ to

custo$ers0

p. C+ o) *++

 (anu)acturing co$panies

u" $aterials, convert the$ into pro&ucts, an& then sell the

pro&ucts to other co$panies or to )inal custo$ers0
 The inco$e state$ent reports the revenues an& expenses o) a co$pan" an& sho's the

pro)ita ilit" o) that usiness organi5ation )or a state& perio& o) ti$e0
 The state$ent o) retaine& earnings sho's the change in retaine& earnings

et'een the

eginning o) the perio& (e0g0 a $onth) an& its en&0
 The

alance sheet lists the assets, lia ilities, an& stoc!hol&ers1 e4uit" (inclu&ing &ollar

a$ounts) o) a usiness organi5ation at a speci)ic $o$ent in ti$e0
 The state$ent o) cash )lo's sho's the cash in)lo's an& cash out)lo's )or a co$pan" )or a

state& perio& o) ti$e0
 The accounting e4uation is Assets S Aia ilities T ,toc!hol&ers1 e4uit"0  The le)t si&e o) the e4uation represents the le)t si&e o) the

alance sheet an& sho's things o) alance sheet an& sho's 'ho accounts

value o'ne& " the usiness0
 The right si&e o) the e4uation represents the right si&e o) the

provi&e& the )un&s to ac4uire the things o) value (assets)0
 ,o$e transactions a))ect onl" alance sheet ite$s: assets (such as cash,

receiva le, an& e4uip$ent), lia ilities (such as accounts pa"a le an&

notes pa"a le), an&

stoc!hol&ers1 e4uit" (capital stoc!)0 Other transactions a))ect oth alance sheet ite$s an& inco$e state$ent ite$s (revenues, expenses, an& eventuall" retaine& earnings)0
 %xhi it + (Part A) an& %xhi it * (Part A) sho' the e))ects o)

usiness transactions on the

accounting e4uation0
 The inco$e state$ent appears in %xhi it I (Part A) an& %xhi it * (Part C)0  The state$ent o) retaine& earnings appears in %xhi it I (Part B)0  The alance sheet appears in %xhi it I (Part C) an& %xhi it * (Part B)0  The e4uit" ratio is the stoc!hol&ers1 e4uit" &ivi&e& " total e4uities (or total assets)0  The e4uit" ratio sho's the percentage that assets 'oul& have to shrin! e)ore a co$pan" 'oul&

eco$e insolvent (lia ilities excee& assets)0

2.1! Appendi,: A comparison of corporate accounting +ith accounting for a sole proprietorship and a partnership
,o$e text oo! authors use a sole proprietorship an& a partnership )or$ o) usiness o'nership to illustrate accounting concepts an& practices0 6n a surve" o) users an& nonusers o) our text, 'e learne& that the $a3orit" pre)erre& the corporate approach ecause $ost stu&ents 'ill pro a l" 'or! )or or p. C* o) *++

invest in corporations0 Also, $an" s$all usinesses operate as corporations ecause o) the investors1 &esire )or li$ite& lia ilit"0 This appen&ix sheet0 As "ou learne& in this chapter, the stoc!hol&ers1 e4uit" section o) the alance sheet )or a corporation consists o) capital stoc! an& retaine& earnings0 The o'ner1s e4uit" section o) the alance sheet )or a sole proprietorship consists onl" o) the o'ner1s capital account0 The o'ner1s e4uit" section o) a partnership is si$ilar to that o) a single proprietorship except that it sho's a capital account an& its alance )or each partner0
Cor1orat%on Stoc60olders8 e7uit2: ,apital stoc6'''$"00,000 Retained earnin)s''''' 50,000 Total''''''''''''''''''$"50,000 $"50,000 Sole .ro1r%etor#h%1 +;ner8s e7uit2: 1o0n S!it0, ,apital''''$"50,000 .artner#h%1 =artners8 capital: 1o0n S!it0, ,apital'''''''''''' $75,000 Sa! 1ones, ,apital'''''''''''' 75,000 $"50,000

rie)l" &escri es the &i))erences in accounting )or these three )or$s o)

usiness

o'nership0 The $a3or &i))erence is in the stoc!hol&ers1 e4uit" or o'ner1s e4uit" section o) the alance

The stoc!hol&ers1 e4uit" section o) a corporate alance sheet can eco$e $ore co$plex as "ou 'ill see later in the text0 #o'ever, the ite$s in the o'ner1s e4uit" section o) the alance sheets o) a sole proprietorship an& a partnership al'a"s re$ain as 3ust sho'n0 6n a sole proprietorship, the o'ner1s capital alance consists o) the o'ner1s invest$ents in the usiness, plus cu$ulative net inco$e since the eginning o) the usiness, less an" a$ounts 'ith&ra'n " the o'ner0 Thus, all o) the a$ounts in the various stoc!hol&ers1 e4uit" accounts )or a corporation are in the o'ner1s capital account in a single proprietorship0 6n a partnership, each partner1s capital account eca$e a partner, less an" a$ounts 'ith&ra'n " that partner0 The <ivi&en&s account in a corporation is si$ilar to an o'ner1s &ra'ing account in a single proprietorship0 These accounts oth sho' a$ounts ta!en out o) the expense accounts si$ilarl" in all three )or$s o) organi5ation0 usiness " the o'ners0 6n a partnership, each partner has a &ra'ing account0 Accountants treat asset, lia ilit", revenue, an& alance consists o) that partner1s invest$ents in the usiness, plus that partner1s cu$ulative share o) net inco$e since that partner

2.1# Demonstration problem
On IB1B ;une 1, 2reen #ills :i&ing ,ta le, 6ncorporate&, 'as organi5e&0 The )ollo'ing transactions occurre& &uring ;une: ;une 1 ,hares o) capital stoc! 'ere issue& )or M,< 1B,BBB cash0

p. CC o) *++

* A horse sta le an& ri&ing e4uip$ent 'ere rente& (an& pai& )or) )or the $onth at a cost o) M,< 1,IBB0 8 #orse )ee& )or the $onth 'as purchase& on cre&it, M,< 8BB0 1C Boar&ing )ees o) M,< +,BBB )or ;une 'ere charge& to those o'ning horses oar&e& at the sta le0 (Fee is &ue on ;ul" 1B0) IB (iscellaneous expenses o) M,< DBB 'ere pai&0 I> Aan& 'as purchase& )ro$ a savings an& loan association " orro'ing M,< *B,BBB on a note )ro$ that association0 The loan is &ue to e repai& in )ive "ears0 6nterest pa"$ents are &ue at the en& o) each $onth eginning ;ul" +10 +B ,alaries o) M,< @BB )or the $onth 'ere pai&0 +B :i&ing an& lesson )ees 'ere ille& to custo$ers in the a$ount o) M,< I,8BB0 (Fees are &ue on ;ul" 1B0) Prepare a su$$ar" o) the prece&ing transactions0 Mse colu$ns hea&e& Cash, Accounts :eceiva le, Aan&, Accounts Pa"a le, /otes Pa"a le, Capital ,toc!, an& :etaine& %arnings0 <eter$ine alances a)ter each transaction to sho' that the asic accounting e4uation is in alance0 Prepare an inco$e state$ent )or ;une IB1B0 Prepare a state$ent o) retaine& earnings )or ;une IB1B0 Prepare a alance sheet as o) IB1B ;une +B0

p. CD o) *++

2.1$ 6olution to demonstration problem
a. A##et# :ate 1une " 4 9 "5 E01lanat%on ,apital stoc6 issued Rent expense /eed expense $ 9,900 &oardin) (ees $ 9,900 20 *iscellaneous expenses =urc0ased land 52 5orro;in) $ 9,200 30 Salaries paid Ridin) and lesson (ees 5illed $ 7,500 #700% $ 7,500 30 $ 3,000 $ 40,000 / $ 900 $ 40,000 3 $ "0,000 $ 3,000 #600% $ 9,200 2@ $ 3,000 / $ 40,000 $ 40,000 / $ 900 900 $ 40,000 $ 40,000 3 $ "0,000 $ $ 400 #300% 3 $ "0,000 $ $ 3,000 3,000 / $ 900 3 $ "0,000 / Ca#h $ "0,000 #",200% $ 9,900 / $ $ 900 900 3 $ "0,000 3 $ "0,000 8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: Summary o* Tran#act%on# Month o* June 2010 / $%a&%l%t%e# 3 Account# Account# $and Rece%2a&le .aya&le / Stoc'holder# E)u%ty Ca1%tal 3 Reta%ned Stoc' Earn%n+# $ "0,000 $ #",200% $ #",200% #900% $ #2,000% 3,000 $ ",000

Note# .aya&le

#600% $ 400

#700%

2,900 $ 5,900 $ 40,000 $ 900 $ 40,000 3 $ "0,000

2,900 $ 2,500

)
8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE Income Statement For the Month Ended 2010 June 0 Revenues: Aorse 5oardin) (ees revenue Ridin) and lesson (ee revenue Total revenues Expenses: Rent expense /eed expense Salaries expense *iscellaneous expense Total expenses et inco!e $ 900 700 600 3,300 $ 2,500 ",200 $ 3,000 $ 5,900 2,900

c)
8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: Statement o* Reta%ned Earn%n+# For the Month Ended 2010 June 0 Retained earnin)s, 1une " $ 303 $dd: et inco!e (or 1une 2,500 Total $ 2,500 4ess: :ividends 303 Retained earnin)s, 1une 30 $ 2,500

p. C@ o) *++

&)
8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE !alance Sheet 2010 June 0 A##et# $

,as0 4and

7,500 5,900 40,000

$ccounts receiva5le Total assets $%a&%l%t%e# and Stoc'holder#( E)u%ty 4ia5ilities: $ccounts pa2a5le oted pa2a5le Total lia5ilities Stoc60olders8 e7uit2: ,apital stoc6 Retained earnin)s Total stoc60olders8 e7uit2 Total lia5ilities and stoc60olders8 e7uit2 $ "0,000 2,500 $ $ $ $

53,300

900 40,000 40,900

"2,500

$53,300'00

2.1% ;e terms
#ccounting equation Assets S %4uities? or Assets S Aia ilities T ,toc!hol&ers1 e4uit"0 #ccounts payable A$ounts o'e& to suppliers )or goo&s or services purchase& on cre&it0 #ccounts recei'able A$ounts &ue )ro$ custo$ers )or services alrea&" provi&e&0 #ssets Things o) value o'ne& " the usiness0 %xa$ples inclu&e cash, $achines, an& uil&ings0 To their o'ners, assets possess service potential or utilit" that can e $easure& an& expresse& in $one" ter$s0 Balance s%eet Financial state$ent that lists a co$pan"1s assets, lia ilities, an& stoc!hol&ers1 e4uit" (inclu&ing &ollar a$ounts) as o) a speci)ic $o$ent in ti$e0 Also calle& a state"ent o& &inancial position. Business entity concept (or accounting entity concept) The separate existence o) the usiness organi5ation0 Capital stock The title given to an e4uit" account sho'ing the invest$ent in a usiness corporation " its stoc!hol&ers0 Continuity ,ee going)concern concept. Corporation Business incorporate& un&er the la's o) one o) the states an& o'ne& " a )e' stoc!hol&ers or " thousan&s o) stoc!hol&ers0 Cost ,acri)ice $a&e or the resources given up, $easure& in $one" ter$s, to ac4uire so$e &esire& thing, such as a ne' truc! (asset)0 <i'i.en. Pa"$ent (usuall" o) cash) to the o'ners o) a corporation? it is a &istri ution o) inco$e to o'ners rather than an expense o) &oing usiness0 -ntity A usiness unit that is &ee$e& to have an existence separate an& apart )ro$ its o'ners, cre&itors, e$plo"ees, custo$ers, other intereste& parties, an& other usinesses, an& )or 'hich accounting recor&s are $aintaine&0 p. C8 o) *++

-quities Broa&l" spea!ing, all clai$s to, or interests in, assets? inclu&es lia ilities an& stoc!hol&ers1 e4uit"0 -quity ratio A ratio )oun& " &ivi&ing stoc!hol&ers1 e4uit" " total e4uities (or total assets)0 -xc%ange-price (or cost) concept (principle) The o 3ective $one" prices &eter$ine& in the exchange process are use& to recor& $ost assets0 -xpenses Costs incurre& to pro&uce revenues, $easure& " the assets surren&ere& or consu$e& in serving custo$ers0 9oing-concern (continuity) concept The assu$ption " the accountant that unless strong evi&ence exists to the contrar", a usiness entit" 'ill continue operations into the in&e)inite )uture0 1ncome statement Financial state$ent that sho's the revenues an& expenses an& reports the pro)ita ilit" o) a usiness organi5ation )or a state& perio& o) ti$e0 ,o$eti$es calle& an earnings state"ent. Liabilities <e ts o'e& " a usinessLor cre&itors1 e4uit"0 %xa$ples: notes pa"a le, accounts pa"a le0 8anu0acturing companies Co$panies that u" $aterials, convert the$ into pro&ucts, an& then sell the pro&ucts to other co$panies or to )inal custo$ers0 8erc%an.ising companies Co$panies that purchase goo&s rea&" )or sale an& sell the$ to custo$ers0 8oney measurement concept :ecor&ing an& reporting econo$ic activit" in a co$$on $onetar" unit o) $easure such as the &ollar0 !et income A$ount " 'hich the revenues o) a perio& excee& the expenses o) the sa$e perio&0 !et loss A$ount " 'hich the expenses o) a perio& excee& the revenues o) the sa$e perio&0 !otes payable A$ounts o'e& to parties 'ho loan the co$pan" $one" a)ter the o'ner signs a 'ritten agree$ent (a note) )or the co$pan" to repa" each loan0 &artners%ip An unincorporate& usiness o'ne& " t'o or $ore persons associate& as partners0 &erio.icity (time perio.s) concept An assu$ption that an entit"1s li)e can e $eaning)ull" su &ivi&e& into ti$e perio&s (such as $onths or "ears) )or purposes o) reporting its econo$ic activities0 &ro0itability A ilit" to generate inco$e0 The inco$e state$ent re)lects a co$pan"1s pro)ita ilit"0 :etaine. earnings Accu$ulate& net inco$e less &ivi&en& &istri utions to stoc!hol&ers0 :e'enues 6n)lo's o) assets (such as cash) resulting )ro$ the sale o) pro&ucts or the ren&ering o) services to custo$ers0 "er'ice companies Co$panies (such as accounting )ir$s, la' )ir$s, or &r" cleaning esta lish$ents) that per)or$ services )or a )ee0 "ingle proprietors%ip An unincorporate& usiness o'ne& " an in&ivi&ual an& o)ten $anage& " that in&ivi&ual0 "ol'ency A ilit" to pa" &e ts as the" eco$e &ue0 The alance sheet re)lects a co$pan"1s solvenc"0 "ource .ocument An" 'ritten or printe& evi&ence o) a usiness transaction that &escri es the essential )acts o) that transaction, such as receipts )or cash pai& or receive&0

p. C> o) *++

"tatement o0 cas% 0lows Financial state$ent sho'ing cash in)lo's an& out)lo's )or a co$pan" over a perio& o) ti$e0 "tatement o0 retaine. earnings Financial state$ent use& to explain the changes in retaine& earnings that occurre& et'een t'o alance sheet &ates0 "tock%ol.ers; equity The o'ners1 interest in a corporation0 "tock%ol.ers or s%are%ol.ers O'ners o) a corporation? the" u" shares o) stoc!, 'hich are units o) o'nership, in the corporation0 "ummary o0 transactions Teaching tool use& in Chapter 1 to sho' the e))ects o) transactions on the accounting e4uation0 $ransaction A usiness activit" or event that causes a $easura le change in the ite$s in the accounting e4uation, Assets S Aia ilities T ,toc!hol&ers1 e4uit"0

2.1' 6elf<test
2.1'.1 True<"alse

6n&icate 'hether each o) the )ollo'ing state$ents is true or )alse0 The three )or$s o) usiness organi5ations are single proprietorship, partnership, an& trust0 The three t"pes o) usiness activit" are service, $erchan&ising, an& $anu)acturing0 The inco$e state$ent sho's the pro)ita ilit" o) the co$pan" an& is &ate& as o) a particular &ate, such as IB1B <ece$ er +10 The state$ent o) retaine& earnings sho's oth the net inco$e )or the perio& an& the eginning an& en&ing alances o) retaine& earnings0 The alance sheet contains the sa$e $a3or hea&ings as appear in the accounting e4uation0

2.1'.2

=ultiple<choice

,elect the est ans'er )or each o) the )ollo'ing 4uestions0 The en&ing alance in retaine& earnings is sho'n in the: a0 6nco$e state$ent0 0 ,tate$ent o) retaine& earnings0 c0 Balance sheet0 &0 Both ( ) an& (c)0 =hich o) the )ollo'ing is not a correct )or$ o) the accounting e4uationQ a0 Assets S %4uities0 0 Assets S Aia ilities T ,toc!hol&ers1 e4uit"0 c0 Assets – Aia ilities S ,toc!hol&ers1 e4uit"0 &0 Assets T ,toc!hol&ers1 e4uit" S Aia ilities0

p. DB o) *++

=hich o) the )ollo'ing is not one o) the )ive un&erl"ing assu$ptions or concepts $entione& in the chapterQ a0 %xchange-price concept0 0 6n)lation accounting concept0 c0 Business entit" concept0 &0 2oing-concern concept0 =hen the stoc!hol&ers invest cash in the usiness, 'hat is the e))ectQ a0 Aia ilities increase an& stoc!hol&ers1 e4uit" increases0 0 Both assets an& lia ilities increase0 c0 Both assets an& stoc!hol&ers1 e4uit" increase0 &0 /one o) the a ove0 =hen services are per)or$e& on account, 'hat is the e))ectQ a0 Both cash an& retaine& earnings &ecrease0 0 Both cash an& retaine& earnings increase0 c0 Both accounts receiva le an& retaine& earnings increase0 &0 Accounts pa"a le increases an& retaine& earnings &ecreases0 /o' turn to FAns'ers to sel)-testH at the en& o) "our chapter to chec! "our ans'ers0

2.1'.3


>uestions
Accounting has o)ten een calle& the language o) usiness0 6n 'hat respects 'oul& "ou agree 'ith this &escriptionQ #o' $ight "ou argue that this &escription is &e)icientQ <e)ine asset, lia ilit", an& stoc!hol&ers1 e4uit"0 #o' &o lia ilities an& stoc!hol&ers1 e4uit" &i))erQ #o' are the" si$ilarQ #o' &o accounts pa"a le an& notes pa"a le &i))erQ #o' are the" si$ilarQ <e)ine revenues0 #o' are revenues $easure&Q <e)ine expenses0 #o' are expenses $easure&Q =hat is a alance sheetQ On 'hat aspect o) a usiness &oes the alance sheet provi&e in)or$ationQ =hat is an inco$e state$entQ On 'hat aspect o) a usiness &oes this state$ent provi&e in)or$ationQ =hat in)or$ation &oes the state$ent o) retaine& earnings provi&eQ 6&enti)" the three t"pes o) activities sho'n in a state$ent o) cash )lo's0 =hat is a transactionQ =hat use &oes the accountant $a!e o) transactionsQ =h"Q p. D1 o) *++

     



  

 

=hat is the accounting e4uationQ =h" $ust it al'a"s alanceQ 2ive an exa$ple )ro$ "our personal li)e that illustrates "our use o) accounting in)or$ation in reaching a &ecision0 .ou have een electe& to the governing oar& o) "our church0 At the )irst $eeting "ou atten&, $ention is $a&e o) uil&ing a ne' church0 =hat accounting in)or$ation 'oul& the oar& nee& in &eci&ing 'hether or not to go ahea&Q





A co$pan" purchase& e4uip$ent )or M,< I,BBB cash0 The ven&or state& that the e4uip$ent 'as 'orth M,< I,*BB0 At 'hat a$ount shoul& the e4uip$ent e recor&e&Q =hat is $eant " $one" $easure$entQ O) 'hat signi)icance is the exchange-price (or cost) conceptQ #o' is the cost to ac4uire an asset &eter$ine&Q =hat e))ect &oes the going-concern (continuit") concept have on the a$ounts at 'hich long-ter$ assets are carrie& on the alance sheetQ O) 'hat i$portance is the perio&icit" (ti$e perio&s) concept to the preparation o) )inancial state$entsQ <escri e a transaction that 'oul&: 6ncrease oth an asset an& capital stoc!0 6ncrease oth an asset an& a lia ilit"0 6ncrease one asset an& &ecrease another asset0 <ecrease oth a lia ilit" an& an asset0 6ncrease oth an asset an& retaine& earnings0 <ecrease oth an asset an& retaine& earnings0 6ncrease a lia ilit" an& &ecrease retaine& earnings0 <ecrease oth an asset an& retaine& earnings0 6&enti)" the causes o) increases an& &ecreases in stoc!hol&ers1 e4uit" :eal worl. question: :e)er to the IBBB )inancial state$ents o) The Ai$ite& in the Annual :eport Appen&ix at the ac! o) the text0 =hat 'ere the net inco$e or loss a$ounts in the latest three "earsQ <iscuss the $eaning o) the changes a)ter rea&ing $anage$ent1s &iscussion an& anal"sis o) )inancial con&ition an& results o) operations0

 





          



:eal worl. question: :e)er to the )inancial state$ents o) The Ai$ite& in the Annual :eport Appen&ix0 #as the solvenc" o) the co$pan" i$prove& )ro$ one "ear to the nextQ <iscuss0

p. DI o) *++

2.1'.!

E,ercises

-xercise # (atch the &escriptions in Colu$n B 'ith the appropriate ter$s in Colu$n A0
Column A 1. 2. . ;. <. =. ,orporation' *erc0andisin) co!pan2' =artners0ip' *anu(acturin) co!pan2' Service co!pan2' Sin)le proprietors0ip' a. &. c. d. e. *. Column ! $n unincorporated 5usiness o;ned 52 an individual' T0e (or! o( or)aniEation used 52 !ost lar)e 5usinesses' &u2s ra; !aterials and converts t0e! into (inis0ed products' &u2s )oods in t0eir (inis0ed (or! and sells t0e! to custo!ers in t0at sa!e (or!' $n unincorporated 5usiness ;it0 !ore t0an one o;ner' =er(or!s services (or a (ee'

-xercise B Assu$e that retaine& earnings increase& " M,< +,DBB )ro$ IB1B ;une +B, to IB11 ;une +B0 A cash &ivi&en& o) M,< +BB 'as &eclare& an& pai& &uring the "ear0 a0 Co$pute the net inco$e )or the "ear0 0 Assu$e expenses )or the "ear 'ere M,< >,BBB0 Co$pute the revenue )or the "ear0 -xercise C On IB1B <ece$ er +1, Pere5 Co$pan" ha& assets o) M,< 1CB,BBB, lia ilities o) M,< >@,CBB, an& capital stoc! o) M,< +B,BBB0 <uring IB11, Pere5 earne& revenues o) M,< *C,BBB an& incurre& expenses o) M,< ++,@CB0 <ivi&en&s &eclare& an& pai& a$ounte& to M,< +,BBB0 a0 Co$pute the co$pan"1s retaine& earnings on IB1B <ece$ er +10 0 Co$pute the co$pan"1s retaine& earnings on IB11 <ece$ er +10 -xercise < At the start o) the "ear, a co$pan" ha& lia ilities o) M,< CB,BBB an& capital stoc! o) M,< 1CB,BBB0 At the en& o) the "ear, retaine& earnings a$ounte& to M,< 1+C,BBB0 /et inco$e )or the "ear 'as M,< *C,BBB, an& M,< 1C,BBB o) &ivi&en&s 'ere &eclare& an& pai&0 Co$pute retaine& earnings an& total assets at the eginning o) the "ear0 -xercise - For each o) the )ollo'ing events, &eter$ine i) it has an e))ect on the speci)ic ite$s (such as cash) in the accounting e4uation0 For the events that &o have an e))ect, present an anal"sis o) the transaction sho'ing its t'o si&es or &ual nature0 a0 Purchase& e4uip$ent )or cash, M,< 1I,BBB0 0 Purchase& a truc! )or M,< *B,BBB, signe& a note ('ith no interest) pro$ising pa"$ent in 1B &a"s0 c0 Pai& M,< 1,DBB )or the current $onth1s utilities0 &0 Pai& )or the truc! purchase& in ( )0 e0 %$plo"e& (ar" Chil&ers as a salesperson at M,< 1,IBB per $onth0 ,he is to start 'ee!0 'or! next

p. D+ o) *++

)0 ,igne& an agree$ent 'ith a an! in 'hich the an! agree& to len& the co$pan" up to M,< IBB,BBB an" ti$e 'ithin the next t'o "ears0 -xercise F Bra&le" Co$pan", engage& in a courier service selecte& transactions &uring ;ul" IB1B: a0 Purchase& o))ice e4uip$ent on account0 0 Pai& an account pa"a le0 c0 %arne& service revenue on account0 &0 Borro'e& $one" " signing a note at the an!0 e0 Pai& salaries )or $onth to e$plo"ees0 )0 :eceive& cash on account )ro$ a charge custo$er0 g0 :eceive& gas an& oil ill )or $onth0 h0 Purchase& &eliver" truc! )or cash0 i0 <eclare& an& pai& a cash &ivi&en&0 Msing a ta ular )or$ si$ilar to %xhi it * (Part A), in&icate the e))ect o) each transaction on the accounting e4uation using (T) )or increase an& (–) )or &ecrease0 /o &ollar a$ounts are nee&e&, an& "ou nee& not )ill in the %xplanation colu$n0 -xercise 9 6n&icate the a$ount o) change (i) an") in the stoc!hol&ers1 e4uit" alance ase& on each o) the )ollo'ing transactions: a0 The stoc!hol&ers investe& M,< 1BB,BBB cash in the usiness " purchasing capital stoc!0 0 Aan& costing M,< *B,BBB 'as purchase& " pa"ing cash0 c0 The co$pan" per)or$e& services )or a custo$er 'ho agree& to pa" M,< 18,BBB in one $onth0 &0 Pai& salaries )or the $onth, M,< 1I,BBB0 e0 Pai& M,< 1*,BBB on an account pa"a le0 -xercise = 2ive exa$ples o) transactions that 'oul& have the )ollo'ing e))ects on the ite$s in a )ir$1s )inancial state$ents: a0 6ncrease cash? &ecrease so$e other asset0 0 <ecrease cash? increase so$e other asset0 c0 6ncrease an asset? increase a lia ilit"0 &0 <ecrease retaine& earnings? &ecrease an asset0 e0 6ncrease an asset other than cash? increase retaine& earnings0 )0 <ecrease an asset? &ecrease a lia ilit"0 -xercise 1 =hich o) the )ollo'ing transactions results in a &ecrease in retaine& earningsQ =h"Q a0 %$plo"ees 'ere pai& M,< IB,BBB )or services receive& &uring the $onth0 p. D* o) *++ usiness, co$plete& the )ollo'ing

0 M,< 1@C,BBB 'as pai& to ac4uire lan&0 c0 Pai& an M,< 18,BBB note pa"a le0 /o interest 'as involve&0 &0 Pai& a M,< IBB account pa"a le0 -xercise > Assu$e that the )ollo'ing ite$s 'ere inclu&e& in the :etaine& %arnings colu$n in the su$$ar" o) transactions )or Cinc! Co$pan" )or ;ul" IB1B:
Salaries expense Service revenue Gas and oil expense Rent expense :ividends paid $"20,000 300,000 27,000 49,000 40,000

Prepare an inco$e state$ent )or ;ul" IB1B0 -xercise ? 2iven the )ollo'ing )acts, prepare a state$ent o) retaine& earnings )or Brin&le Co$pan", a tanning salon, )or August IB1B: Balance in retaine& earnings at en& o) ;ul", M,< 188,BBB0 <ivi&en&s pai& in August, M,< D+,DBB0 /et inco$e )or August, M,< @I,BBB0 The colu$n totals o) a su$$ar" o) transactions )or ,pee&" Printer :epair, 6nc0, as o) IB1B <ece$ er +1, 'ere as )ollo's:
$ccounts pa2a5le $ccounts receiva5le ,apital stoc6 ,as0 4and &uildin) E7uip!ent otes pa2a5le Retained earnin)s $60,000 @0,000 "00,000 40,000 90,000 50,000 30,000 20,000 F

Prepare a alance sheet0 =e have purposel" liste& the accounts out o) or&er0 -xercise 8 (erc! P Co0, 6nc0 is a 'orl& lea&er in the &iscover", &evelop$ent, $anu)acture an& $ar!eting o) a roa& range o) hu$an an& ani$al health pro&ucts0 The co$pan", 'hich has @B,BBB e$plo"ees, spen&s over M,< I illion ever" "ear on the research an& &evelop$ent o) ne' &rugs0 As o) the en& o) I, its I0I illion shares are value& in the stoc! $ar!et )or a total o) M,< 1+I illion0 2iven the )ollo'ing &ata )or (erc!, calculate the e4uit" ratios )or IBB+ an& IBBI0 Then co$$ent on the results0
2003 Stoc60olders8 e7uit2 Total e7uities -S: "4,932,400,000 -S: 3@,@"0,400,000 2002 -S: "3,24",600,000 -S: 35,634,@00,000

p. DC o) *++

2.1'.#

1roblems

&roblem # Aa!e'oo& Personal Finance Co$pan", 'hich provi&es )inancial a&visor" services, engage& in the )ollo'ing transactions &uring (a" IB1B: (a" 1:eceive& M,< +BB,BBB cash )or shares o) capital stoc! issue& 'hen co$pan" 'as organi5e&0 I The co$pan" orro'e& M,< *B,BBB )ro$ the an! on a note0 @ The co$pan" ought M,< 18I,*BB o) co$puter e4uip$ent )or cash0 11 Cash receive& )or services per)or$e& to &ate 'as M,< 1C,IBB0 1* ,ervices per)or$e& )or a custo$er 'ho agree& to pa" 'ithin a $onth 'ere M,< 1B,BBB0 1C %$plo"ee 'ages 'ere pai&, M,< 1+,IBB0 1> The co$pan" pai& M,< 1*,BBB on the note to the an!0 +1 6nterest pai& to the an! )or (a" 'as M,< 1*B0 (6nterest is an expense, 'hich re&uces retaine& earnings0) +1 The custo$er o) (a" 1* pai& M,< +,IBB o) the a$ount o'e& to the co$pan"0 +1 An or&er 'as receive& )ro$ a custo$er )or services to e ren&ere& next 'ee!, 'hich 'ill e ille& at M,< 1I,BBB0 Prepare a su$$ar" o) transactions (see Part A o) %xhi it *)0 Mse $one" colu$ns hea&e& Cash, Accounts :eceiva le, %4uip$ent, /otes Pa"a le, Capital ,toc!, an& :etaine& %arnings0 <eter$ine alances a)ter each transaction to sho' that the accounting e4uation alances0 &roblem B :elia le Aa'n Care ,ervice, 6nc0, a co$pan" that ta!es care o) la'ns an& shru personal resi&ences, engage& in the )ollo'ing transactions in April IB1B: Apr01 The co$pan" 'as organi5e& an& receive& M,< *BB,BBB cash )ro$ the o'ners in exchange )or capital stoc! issue&0 * The co$pan" ought e4uip$ent )or cash, M,< 1B1,@DB0 > The co$pan" ought a&&itional $o'ing e4uip$ent that cost M,< >,1IB an& agree& to pa" )or it in +B &a"s0 1C Cash receive& )or services per)or$e& to &ate 'as M,< +,8*B0 1D A$ount &ue )ro$ a custo$er )or services per)or$e& totale& M,< C,I8B0 +B O) the receiva le (see April 1D), M,< +,B@I 'as collecte& in cash0 +B (iscellaneous operating expenses o) M,< D,I*B 'ere pai& &uring the $onth0 +B An or&er 'as place& )or $iscellaneous e4uip$ent costing M,< I8,8BB0 a0 Prepare a su$$ar" o) transactions (see Part A o) %xhi it *)0 Mse $one" colu$ns hea&e& Cash, Accounts :eceiva le, %4uip$ent, Accounts Pa"a le, Capital ,toc!, an& :etaine& %arnings0 <eter$ine alances a)ter each transaction to sho' that the asic accounting e4uation alances0 p. DD o) *++ er" o)

0 Prepare a alance sheet as o) April +B0 &roblem C Anal"sis o) the transactions o) the (oonlight <rive-6n Theater )or ;une IB1B &isclose& the )ollo'ing:
Tic!et revenue M,< 18BBBB

%4uip$ent rent expense

CBBBB

Fil$ rent expense

C+*BB

Concession revenue

I>DBB

A&vertising expense

18DBB

,alaries expense

DBBBB

Mtilities expense

1*1BB

Cash &ivi&en&s &eclare& an& pai&

1IBBB

Balance sheet a$ounts at ;une +B inclu&e the )ollo'ing:
Cash M,< 1*B,BBB

Aan&

1*8BBB

Accounts pa"a le

8@DBB

Capital stoc!

11*BBB

:etaine& earnings as o) IB1B ;une 1

8*>BB

a0 Prepare an inco$e state$ent )or ;une IB1B0 0 Prepare a state$ent o) retaine& earnings )or ;une IB1B0 c0 Prepare a alance sheet as o) IB1B ;une +B0 &0 #o' solvent &oes this co$pan" appear to eQ

p. D@ o) *++

&roblem < Aittle Fol!s Base all, 6nc0, 'as )or$e& " a group o) parents to $eet a nee& )or a place )or !i&s to pla" ase all0 At the eginning o) its secon& "ear o) operations, its alance sheet appeare& as )ollo's:
$ITT$E FO$6S !ASE!A$$ !alance Sheet 2010 A1r%l 0 A##et# ,as0 $ccounts Receiva5le 4and Total assets $%a&%l%t%e# and Stoc'holder#( E)u%ty 4ia5ilities: $ccounts pa2a5le Stoc60olders8 E7uit2: ,apital stoc6 Retained earnin)s Total lia5ilities and stoc60olders8 e7uit2 $ 400,000 272,000 672,000 $ 736,000 $ 64,000 $ 56,000 90,000 600,000 $ 736,000

The su$$ari5e& transactions )or (a" IB1B are as )ollo's: a0 6ssue& a&&itional capital stoc! )or cash, M,< IBB,BBB0 0 Collecte& M,< 8B,BBB on accounts receiva le0 c0 Pai& M,< D*,BBB on accounts pa"a le0 &0 :eceive& $e$ ership )ees )ro$ parents (nonre)un&a le): in cash, M,< IDB,BBB? an& on account, M,< 1IB,BBB0 e0 6ncurre& operating expenses: )or cash, M,< DB,BBB? an& on account, M,< 1DB,BBB0 )0 Pai& &ivi&en&s o) M,< 1D,BBB0 g0 Purchase& $ore lan& )or cash, M,< >D,BBB0 h0 Place& an or&er )or ne' e4uip$ent expecte& to cost M,< 1IB,BBB0 a0 Prepare a su$$ar" o) transactions (see Part A o) %xhi it *) using colu$n hea&ings as given in the alance sheet0 <eter$ine alances a)ter each transaction0 0 Prepare an inco$e state$ent )or (a" IB1B0 c0 Prepare a state$ent o) retaine& earnings )or (a" IB1B0 &0 Prepare a alance sheet as o) IB1B (a" +10 The alance sheets )or IB1B (a" +1, an& IB1B April +B, an& the inco$e state$ent )or (a" o) the Target-Aine 2ol) <riving :ange )ollo'0 (Co$$on practice is to sho' the $ost recent perio& )irst0)

p. D8 o) *++

TAR8ET-$INE 8O$F :RI>IN8 RAN8E Com1arat%2e !alance Sheet May 1" A1r%l 0" 2010 A##et# ,as0 4and Total assets $%a&%l%t%e# and Stoc'holder#( E)u%ty $ccounts pa2a5le ,apital stoc6 Retained earnin)s Total lia5ilities and stoc60olders8 e7uit2 TAR8ET-$INE 8O$F :RI>IN8 RAN8E Income Statement For the Month Ended 2010 May 1 Revenues: Service revenue Expenses: Salaries expense E7uip!ent rental expense et inco!e $"6,000 @,600 25,600 $39,400 $56,400 $46,900 "63,200 "44,000 $2"@,600 $"@0,900 $"9,000 $27,600 "44,000 "44,000 57,600 "@,200 $2"@,600 $"@0,900 2010

$64,000

All revenues earne& are on account0 ,tate the pro a le cause(s) o) the change in each o) the alance sheet accounts )ro$ April +B to IB1B (a" +10

2.1'.$

Alternate problems

#lternate problem # Preston Auto Paint Co$pan" ha& the te$porar" )ree use o) an ol& uil&ing an& co$plete& the )ollo'ing transactions in ,epte$ er IB1B: ,ept0 1 The co$pan" 'as organi5e& an& receive& M,< 1BB,BBB cash )ro$ the issuance o) capital stoc!0 C The co$pan" ought painting an& san&ing e4uip$ent )or cash at a cost o) M,< IC,BBB0 @ The co$pan" painte& the auto )leet o) a custo$er 'ho agree& to pa" M,< 8,BBB in one 'ee!0 The custo$er )urnishe& the special paint0 1* The co$pan" receive& the M,< 8,BBB )ro$ the transaction o) ,epte$ er @0 IB A&&itional san&ing e4uip$ent that cost M,< I,8BB 'as ac4uire& to&a"? pa"$ent 'as postpone& until ,epte$ er I80 I8 M,< I,*BB 'as pai& on the lia ilit" incurre& on ,epte$ er IB0 +B %$plo"ee salaries )or the $onth, M,< I,IBB, 'ere pai&0 +B Place& an or&er )or a&&itional painting e4uip$ent a&vertise& at M,< IB,BBB0 Prepare a su$$ar" o) transactions (see Part A o) %xhi it *) )or the co$pan" )or these transactions0 Mse $one" colu$ns hea&e& Cash, Accounts :eceiva le, %4uip$ent, Accounts Pa"a le, Capital ,toc!, p. D> o) *++

an& :etaine& %arnings0 <eter$ine alances a)ter each transaction to sho' that the asic accounting e4uation alances0 #lternate problem B Ouic!-,tart #o$e :epair Co$pan" co$plete& the )ollo'ing transactions in ;une IB1B: ;une 1 The co$pan" 'as organi5e& an& receive& M,< IBB,BBB cash )ro$ the issuance o) capital stoc!0 * The co$pan" pai& M,< *8,BBB cash )or a truc!0 @ The co$pan" orro'e& M,< 1B,BBB )ro$ its an! on a note0 > Cash receive& )or repair services per)or$e& 'as M,< *,CBB0 1I %xpenses o) operating the usiness so )ar this $onth 'ere pai& in cash, M,< +,*BB0 18 :epair services per)or$e& )or a custo$er 'ho agree& to pa" 'ithin a $onth a$ounte& to M,< C,*BB0 IC The co$pan" pai& M,< *,BDC on its loan )ro$ the an!, inclu&ing M,< *,BCB o) principal an& M,< 1C o) interest0 (The principal is the a$ount o) the loan0 6nterest is an expense, 'hich re&uces retaine& earnings0) +B (iscellaneous expenses incurre& in operating the usiness )ro$ ;une 1+ to &ate 'ere M,< +,8IC an& 'ere pai& in cash0 +B An or&er (contract) 'as receive& )ro$ a custo$er )or repair services to e per)or$e& to$orro', 'hich 'ill e ille& at M,< +,BBB0 a0 Prepare a su$$ar" o) transactions (see Part A o) %xhi it *)0 6nclu&e $one" colu$ns )or Cash, Accounts :eceiva le, Truc!s, /otes Pa"a le, Capital ,toc!, an& :etaine& %arnings0 <eter$ine alances a)ter each transaction to sho' that the asic accounting e4uation alances0 0 Prepare a alance sheet as o) IB1B ;une +B0 #lternate problem C Follo'ing are su$$ari5e& transaction &ata )or Auxur" Apart$ents, 6nc0, )or the "ear en&ing IB1B ;une +B0 The co$pan" o'ns an& operates an apart$ent uil&ing0

p. @B o) *++

:ent revenue )ro$ uil&ing o'ne& Buil&ing repairs Buil&ing cleaning, la or cost Propert" taxes on the uil&ing 6nsurance on the uil&ing Co$$issions pai& to rental agent Aegal an& accounting )ees ()or preparation o) tenant leases) Mtilities expense Cost o) ne' a'nings (installe& on ;une +B, 'ill last 1B "ears)

M,< 1CB,BBB I8@B +18C *BBB 1IIC CBBB 1IDB

8IIC CBBB

O) the M,< 1CB,BBB rent revenue, M,< C,BBB 'as not collecte& in cash until IB1B ;ul" C0 Prepare an inco$e state$ent )or the "ear en&e& IB1B ;une +B0 #lternate problem < The )ollo'ing &ata are )or Central <istrict Par!ing Corporation:
CENTRA$ :ISTRICT .AR6IN8 COR.ORATION !alance Sheet 2010 Octo&er 1 A##et# ,as0 $ccounts Receiva5le Total assets $%a&%l%t%e# and Stoc'holder#( E)u%ty $ccounts pa2a5le ,apital stoc6 Retained earnin)s Total lia5ilities and stoc60olders8 e7uit2 $ @4,000 232,00 0 36,000 $ 362,00 0 $ 344,00 0 "9,000 $ 362,00 0

The su$$ari5e& transactions )or Octo er IB1B are as )ollo's:

p. @1 o) *++

Oct01 The accounts pa"a le o'e& as o) ,epte$ er +B (M,< >*,BBB) 'ere pai&0 1 The co$pan" pai& rent )or the pre$ises )or Octo er, M,< 1>,IBB0 @ The co$pan" receive& cash o) M,< *,IBB )or par!ing " &ail" custo$ers &uring the 'ee!0 1B The co$pan" collecte& M,< 1*,*BB o) the accounts receiva le in the alance sheet at ,epte$ er +B0 1* Cash receipts )or the 'ee! )ro$ &ail" custo$ers 'ere M,< D,DBB0 1C Par!ing revenue earne& ut not "et collecte& )ro$ )leet custo$ers 'as M,< D,BBB0 1D The co$pan" pai& salaries o) M,< I,*BB )or the perio& Octo er 1–1C0 1> The co$pan" pai& a&vertising expenses o) M,< 1,IBB )or Octo er0 I1 Cash receipts )or the 'ee! )ro$ &ail" custo$ers 'ere M,< @,IBB0 I* The co$pan" incurre& $iscellaneous expenses o) M,< 8*B0 Pa"$ent 'ill e &ue /ove$ er 1B0 +1 Cash receipts )or the last 1B &a"s o) the $onth )ro$ &ail" custo$ers 'ere M,< 8,*BB0 +1 The co$pan" pai& salaries o) M,< +,BBB )or the perio& Octo er 1D–+10 +1 Billings to $onthl" custo$ers totale& M,< I1,DBB )or Octo er0 +1 Pai& cash &ivi&en&s o) M,< I*,BBB0 a0 Prepare a su$$ar" o) transactions (see Part A o) %xhi it *) using colu$n hea&ings as given in the prece&ing alance sheet0 <eter$ine alances a)ter each transaction0 0 Prepare an inco$e state$ent )or Octo er IB1B0 c0 Prepare a state$ent o) retaine& earnings )or Octo er IB1B0 &0 Prepare a alance sheet as o) IB1B Octo er +10 #lternate problem - The )ollo'ing alance sheets )or IB1B ;une +B, an& IB1B (a" +1, an& the inco$e state$ent )or ;une are )or Beach Ca$ping Trailer ,torage, 6nc0 (Co$$on practice is to sho' the $ost recent perio& )irst0)
!EAC9 CAM.IN8 TRAI$ER STOR A8E" INC Com1arat%2e !alance Sheet June 0" 2010 A##et# ,as0 $ $ccounts receiva5le 4and Total assets $ $%a&%l%t%e# and Stoc'holder#( $ccounts pa2a5le $ ,apital stoc6 Retained earnin)s Total lia5ilities and stoc60olders8 e7uit2 $ !EAC9 CAM.IN8 TRAI$ER STORA8E" INC. " Income Statement For the Month Ended 2010 June Revenues: 52,000 24,000 36,000 ""2,000 E)u%ty "9,000 60,000 34,000 ""2,000 $ $ $ $ 60,000 303 36,000 @6,000 24,000 60,000 "2,000 @6,000 May 1" 2010

p. @I o) *++

Service revenue Expenses: Salaries expense Supplies 5ou)0t and used et inco!e $ 49,000 24,000

$

"00,000

$

72,000 29,000

A cash &ivi&en& o) M,< D,BBB 'as &eclare& an& pai& in ;une0 ,tate the pro a le causes o) the changes in each o) the alance sheet accounts )ro$ (a" +1 to IB1B ;une +B0

2.1'.%

0e ond the numbers9critical thin&ing

Business .ecision case # Mpon gra&uation )ro$ high school, ;i$ Crane 'ent to 'or! )or a uil&er o) houses an& s$all apart$ent uil&ings0 <uring the next six "ears, Crane earne& a reputation as an excellent e$plo"eeLhar&'or!ing, &e&icate&, an& &epen&a leLin the light construction in&ustr"0 #e coul& han&le al$ost an" 3o re4uiring carpentr", electrical, or plu$ ing s!ills0 Crane then &eci&e& to go into usiness )or hi$sel) un&er the na$e ;i$1s Fix-6t ,hop, 6nc0 #e investe& cash, so$e po'er tools, an& a use& truc! in his usiness0 #e co$plete& $an" repair an& re$o&eling 3o s )or ho$eo'ners an& apart$ent o'ners0 The &e$an& )or his services 'as so large that he ha& $ore 'or! than he coul& han&le0 #e operate& out o) his garage, 'hich he ha& converte& into a shop, a&&ing several ne' pieces o) po'er 'oo&'or!ing e4uip$ent0 /o', t'o "ears a)ter going into usiness )or hi$sel), Crane $ust &eci&e 'hether to continue in his o'n usiness or to accept a position as construction supervisor )or a ho$e uil&er0 #e has een o))ere& an annual salar" o) M,< CB,BBB an& a pac!age o) )ringe ene)its ($e&ical an& hospitali5ation insurance, pension contri ution, vacation an& sic! pa", an& li)e insurance) 'orth approxi$atel" M,< 8,BBB per "ear0 The o))er is attractive to Crane0 But he &isli!es giving up his usiness since he has thoroughl" en3o"e& eing his o'n oss, even though it has le& to an average 'or!'ee! 'ell in excess o) the stan&ar& *B hours ,uppose Crane co$es to "ou )or assistance in gathering the in)or$ation nee&e& to help hi$ $a!e a &ecision0 #e rings along the accounting recor&s that have een $aintaine& )or his usiness " an experience& accountant0 Msing logic an& "our o'n li)e experiences, in&icate the nature o) the in)or$ation ;i$ nee&s i) he is to $a!e an in)or$e& &ecision0 Pa" particular attention to the in)or$ation li!el" to e )oun& in his usiness accounting recor&s0 <oes the accounting in)or$ation availa le enter &irectl" into the &ecisionQ =rite a $e$oran&u$ to ;i$ &escri ing the in)or$ation he 'ill nee& to $a!e an in)or$e& &ecision0 The $e$o1s hea&ings shoul& inclu&e <ate, To, Fro$, an& ,u 3ect0 (,ee the )or$at in 2roup Pro3ect % elo'0)

p. @+ o) *++

#nnual report analysis B :ecall that in this chapter 'e sho'e& that the e4uit" ratio is calculate& " &ivi&ing stoc!hol&ers1 e4uit" " total e4uities (or total assets)0 Another )or$at )or anal"5ing solvenc" is to &ivi&e total &e t " total e4uities0 This latter calculation tells the proportion o) assets )inance& " &e t rather than the proportion o) assets )inance& " stoc!hol&ers1 e4uit"0 These t'o ratios are co$ple$ents an& $ust a&& to 1BB per cent0 Thus, i) IC per cent o) assets 'ere )inance& " &e t, @C per cent 'ere )inance& " stoc!hol&ers1 e4uit"0 Msing the )ollo'ing historical &ata )ro$ 2ate'a", calculate the Ftotal-&e t-to total-capitalH ratio )or each "ear0 +,,@ Total lia ilities (BBBJs) Total stoc!hol&er s e4uit" ,tu&" these a$ounts an& co$$ent on the solvenc" o) the co$pan"0 6s there a tren& in the co$pan"1s solvenc" over ti$eQ 2ate'a" has experience& tre$en&ous gro'th in stoc!hol&ers1 e4uit" &uring the past six "ears, ut has also increase& lia ilities signi)icantl"0 Coul& 2ate'a" have gro'n this $uch 'ithout increasing lia ilitiesQ #nnual report analysis C Aoo! at The Ai$ite&, 6nc0, annual report in the Annual report appen&ix0 6n that report "ou 'ill )in& a letter outlining (anage$ent1s responsi ilities concerning the )inancial state$ents, as 'ell as the report o) the in&epen&ent au&itors0 =rite ans'ers to the )ollo'ing 4uestions: =ho is responsi le )or preparing the )inancial state$entsQ O) 'hat i$portance is the internal au&itQ =hat is the role o) the au&it co$$itteeQ =h" are no o))icers or e$plo"ees on the au&it co$$itteeQ =hat is the responsi ilit" o) the external in&epen&ent au&itorQ I+8B++> IB1@118 1+**+@C >+BB** 81CC*1 CCCC1> +@DB+C M,< 1,@@I,IBC +,,+ M,< 1,>+@,C@B +,,( M,< 1,C*D,BBC +,,, M,< 1,1B>,++@ ())) M,< 8C@,8@B ())* M,< CD8,*>I ())A M,< +>*,C*C

<oes the in&epen&ent au&itor have a solute assurance that the )inancial state$ents are )ree o) $aterial $isstate$entQ

p. @* o) *++

To 'hat extent &oes the in&epen&ent au&itor exa$ine evi&enceQ
-t%ics case- writing experience < :e)er to FAn ethical perspective: ,tate universit"H0 =rite a short essa" &iscussing the alternatives ;a$es ,tevens coul& pursue an& the li!el" outco$es o) those alternatives0 =hich o) the alternatives "ou have &iscusse& 'oul& "ou reco$$en&Q 9roup pro2ect - 6n tea$s o) t'o or three stu&ents, intervie' a usinessperson in "our co$$unit"0 As! ho' that person uses accounting in)or$ation in $a!ing usiness &ecisions an& o tain speci)ic exa$ples0 %ach tea$ shoul& 'rite a $e$oran&u$ to the instructor su$$ari5ing the results o) the intervie'0 6n)or$ation containe& in the $e$o shoul& inclu&e: <ate: To: Fro$: ,u 3ect: Content o) the $e$o $ust inclu&e the na$e an& title o) the person intervie'e&, na$e o) the co$pan", &ate o) the intervie', exa$ples o) the use o) accounting in)or$ation )or &ecision $a!ing, an& an" other pertinent in)or$ation0 9roup pro2ect F =ith a tea$ co$pose& o) one or t'o other stu&ents, conceive o) a usiness that "ou 'oul& li!e to )or$ a)ter gra&uation0 Then &escri e approxi$atel" 1C–IB transactions that the usiness $ight un&erta!e in its )irst $onth o) operations0 Prepare a su$$ar" o) transactions sho'ing ho' each transaction a))ects the accounting e4uation0 6&enti)" each asset, lia ilit", an& stoc!hol&ers1 e4uit" ite$ in "our su$$ar" o) transactions0 For instance, instea& o) grouping all assets in one nu$ er, sho' cash, accounts receiva le, an& so on in "our accounting e4uation0 9roup pro2ect 9 =ith a tea$ o) one or t'o other stu&ents an& using li rar" sources, 'rite a paper on the A$erican 6nstitute o) Certi)ie& Pu lic Accountants, their services to $e$ ers, an& their activities0 Be care)ul to cite sources )or "our in)or$ation0 <irect 4uotes shoul& e la ele& as such an& shoul& e single-space& an& in&ente& i) relativel" long or in 4uote $ar!s an& not in&ente& i) relativel" short0 To 4uote 'ithout giving the source is plagiaris$ an& shoul& e avoi&e& at all costs0

2.1'.'

.sing the (nternet9A vie+ of the real +orld

Gisit the )ollo'ing 'e site )or /o!ia: http:77'''0no!ia0co$ =rite a short paper &escri ing co$pan" in)or$ation, pro&ucts an& services, an& support availa le )or their pro&ucts0 Gisit the )ollo'ing 'e site )or For& (otor Co$pan": p. @C o) *++

http:77'''0)or&0co$ =hen the 'e page appears, search )or 6nvestor 6n)or$ation an& then locate the For& (otor Co$pan" Annual :eport0 Base& on "our investigation, 'rite a short paper &escri ing the general content o) the annual report0

2.1'.) 2.1'.).1

Ans+ers to self<test True<"alse

False. Corporation, not trust, is the thir& )or$0 $rue. The accounting )or all three o) these is covere& in this text0 False. The inco$e state$ent is &ate& using a perio& o) ti$e, such as FFor the .ear %n&e& IB1B <ece$ er +1H0 $rue. 6n a&&ition, the state$ent o) retaine& earnings sho's &ivi&en&s &eclare&0 $rue. Both sho' assets, lia ilities, an& stoc!hol&ers1 e4uit"0

2.1'.).2

=ultiple<choice

.. The en&ing alance in retaine& earnings is sho'n in oth the state$ent o) retaine& earnings an& in the alance sheet0 .. This )or$ o) the e4uation 'oul& not alance0 b. The in)lation accounting concept 'as not one o) the ones &iscusse&0 The other t'o 'ere the $one" $easure$ent concept an& the perio&icit" concept0 c. =hen the stoc!hol&ers invest cash, assets an& stoc!hol&ers1 e4uit" increase0 c. The per)or$ance o) services on account increases oth accounts receiva le an& retaine& earnings0

p. @D o) *++

3 7ecording business transactions
3.1 Learning objectives
A)ter stu&"ing this chapter, "ou shoul& e a le to:
 

Mse the account as the asic classi)"ing an& storage unit )or accounting in)or$ation0 %xpress the e))ects o) usiness transactions in ter$s o) &e its an& cre&its to &i))erent t"pes o) Aist the steps in the accounting c"cle0 :ecor& the e))ects o) usiness transactions in a 3ournal0 Post 3ournal entries to the accounts in the le&ger0 Prepare a trial alance to test the e4ualit" o) &e its an& cre&its in the 3ournali5ing an& Anal"5e an& use the )inancial resultsLhori5ontal an& vertical anal"ses0

accounts0
   

posting process0


3.2 6alar potential of accountants
,electing a $a3or represents $uch $ore than the choice o) courses a stu&ent ta!es in college0 To a signi)icant &egree, the stu&entJs $a3or, along 'ith aca&e$ic per)or$ance, 'ill &eter$ine the career paths availa le upon gra&uation0 Fe' pro)essionals 'oul& reco$$en& a speci)ic career choice ase& solel" on salaries0 #o'ever, as stu&ents select their $a3or an& $ap out their career path, it is i$portant that the" $a!e in)or$e& &ecisions 'ith respect to the potential )inancial re'ar&s o) the various options0 Outline& elo' is in)or$ation on selecte& salaries )or $an" accounting-relate& careers0 These salaries, current as o) IBB>, shoul& e vie'e& onl" as gui&elines0 ,alaries at all levels can var" signi)icantl" et'een locations0 Also, one shoul& a&& 1B to 1C per cent to the liste& salar" )or pro)essional certi)ications (such as the CPA) or )or a gra&uate &egree ((asters o) Accounting or (BA)0

p. @@ o) *++

Salar%e# *or .u&l%c Account%n+" Non-.artner#
.o#%t%on $ar+e C.A F%rm#? Startin) Salaries Salar2 5et;een "33 2ears *ana)erG:irector Small C.A F%rm#? Startin) Salaries Salar2 5et;een "33 2ears *ana)erG:irector Salary Ran+e $35,750 3 $42,500 $4",000 3 $5",250 $77,750 3 $""@,000 $2@,500 3 $36,250 $33,750 3 $42,500 $62,750 3 $94,500

Salar%e# *or Cor1orate Account%n+
.o#%t%on ,0ie( /inancial +((icerGTreasurer Hice =resident, /inance :irector o( /inance :irector o( $ccountin) ,ontroller $ssistant ,ontroller Tax :irector Tax *ana)er $udit :irector General $ccountin) 3 *ana)er General $ccountin) 3 "33 2ears experience General $ccountin) 3 startin) salar2

- $ar+e Cor1orat%on#
Salary Ran+e $244,500 3 $347,000 $"9@,000 3 $2@3,500 $"2",500 3 $"79,250 $""5,250 3 $"57,500 $"05,750 3 $"47,250 $9@,750 3 $""4,750 $""7,000 3 $20@,750 $79,000 3 $""3,750 $"27,750 3 $200,750 $6",250 3 $93,250 $37,500 3 $49,750 $3",750 3 $3@,750

,tu&ents intereste& in a career in accounting an& )inance can )in& &etaile& in)or$ation )or these an& $an" other accounting relate& careers at :o ert #al) ('''0ro erthal)0co$)0 Also, accounting pro)essors are generall" )a$iliar 'ith starting salaries an& 3o opportunities )or accounting gra&uates, so "ou $a" 'ant to a&&ress $ore speci)ic 4uestions a out potential careers an& salaries 'ith the$0 6n Chapter 1, 'e illustrate& the inco$e state$ent, state$ent o) retaine& earnings, alance sheet, an& state$ent o) cash )lo's0 These state$ents are the en& pro&ucts o) the )inancial accounting process, 'hich is ase& on the accounting e4uation0 The )inancial accounting process 4uanti)ies past $anage$ent &ecisions0 The results o) these &ecisions are co$$unicate& to usersL$anage$ent, cre&itors, an& investorsLan& serve as a asis )or $a!ing )uture &ecisions0 The ra' &ata o) accounting are the usiness transactions0 =e recor&e& the transactions in Chapter 1 as increases or &ecreases in the assets, lia ilities, an& stoc!hol&ersJ e4uit" ite$s o) the accounting e4uation0 This proce&ure sho'e& "ou ho' various transactions a))ecte& the accounting e4uation0 =hen 'or!ing through these sa$ple transactions, "ou pro a l" suspecte& that listing all transactions as increases or &ecreases in the transactions su$$ar" colu$ns 'oul& e too cu$ erso$e in practice0 (ost usinesses, even s$all ones, enter into $an" transactions ever" &a"0 Chapter I teaches "ou ho' to actuall" recor& usiness transactions in the accounting process0 To explain the &ual proce&ure o) recor&ing )ollo' a co$pan" through its various usiness transactions 'ith &e its an& cre&its, 'e intro&uce "ou to so$e ne' tools: the T-account, the 3ournal, an& the le&ger0 Msing these tools, "ou can usiness transactions0 Ai!e accountants, "ou can use a trial alance to chec! the e4ualit" o) "our recor&e& &e its an& cre&its0 This is the &ou le-entr" accounting p. @8 o) *++

s"ste$ that the Franciscan $on!, Auca Pacioli, &escri e& centuries ago0 Mn&erstan&ing this s"ste$ ena les "ou to etter un&erstan& the content o) )inancial state$ents so "ou can use the in)or$ation provi&e& to $a!e in)or$e& usiness &ecisions0

3.3 The account and rules of debit and credit
A usiness $a" engage in thousan&s o) transactions &uring a "ear0 An accountant classi)ies an& su$$ari5es the &ata in these transactions to create use)ul in)or$ation . "teps in recor.ing business transactions Aoo! at %xhi it C to see the steps in recor&ing an& posting the e))ects o) a usiness transaction0 /ote that source &ocu$ents provi&e the evi&ence that a usiness transaction occurre&0 These source &ocu$ents inclu&e such ite$s as ills receive& )ro$ suppliers )or goo&s or services receive&, ills sent to custo$ers )or goo&s sol& or services per)or$e&, an& cash register tapes0 The in)or$ation in the source &ocu$ent serves as the asis )or preparing a 3ournal entr"0 Then a )ir$ posts (trans)ers) that in)or$ation to accounts in the le&ger0 .ou can see )ro$ %xhi it C that a)ter "ou prepare the 3ournal entr", "ou post it to the accounts in the le&ger0 #o'ever, e)ore "ou can recor& the 3ournal entr", "ou $ust un&erstan& the rules o) &e it an& cre&it0 To teach "ou these rules, 'e egin " stu&"ing the nature o) an account0 Fortunatel", $ost usiness transactions are repetitive0 This $a!es the tas! o) accountants so$e'hat easier ecause the" can classi)" the transactions into groups having co$$on characteristics0 For exa$ple, a co$pan" $a" have thousan&s o) receipts or pa"$ents o) cash &uring a "ear0 As a result, a part o) ever" cash transaction can e recor&e& an& su$$ari5e& in a single place calle& an account0 An account is a part o) the accounting s"ste$ use& to classi)" an& su$$ari5e the increases, &ecreases, an& alances o) each asset, lia ilit", stoc!hol&ersJ e4uit" ite$, &ivi&en&, revenue, an& expense0 Fir$s set up accounts )or each &i))erent usiness ele$ent, such as cash, accounts receiva le, an& accounts pa"a le0 %ver" usiness has a Cash account in its accounting s"ste$ ecause !no'le&ge o) the a$ount o) cash on han& is use)ul in)or$ation0 Accountants $a" &i))er on the account title (or na$e) the" give the sa$e ite$0 For exa$ple, one accountant $ight na$e an account /otes Pa"a le an& another $ight call it Aoans Pa"a le0 Both account titles re)er to the a$ounts orro'e& " the co$pan"0 The account title shoul& e logical to help the accountant group si$ilar transactions into the sa$e account0 Once "ou give an account a title, "ou $ust use that sa$e title throughout the accounting recor&s0 The nu$ er o) accounts in a co$pan"Js accounting s"ste$ &epen&s on the in)or$ation nee&s o) those intereste& in the usiness0 The $ain re4uire$ent is that each account provi&es in)or$ation p. @> o) *++

use)ul in $a!ing &ecisions0 Thus, one account $a" e set up )or all cash rather than having a separate account )or each )or$ o) cash (coins on han&, currenc" on han&, an& &eposits in an!s)0 The a$ount o) cash is use)ul in)or$ation? the )or$ o) cash o)ten is not0 To illustrate recor&ing the increases an& &ecreases in an account, texts use the $-account, 'hich loo!s li!e a capital letter T0 The na$e o) the account, such as Cash, appears across the top o) the T0 =e recor& increases on one si&e o) the vertical line o) the T an& &ecreases on the other si&e0 A T-account appears as )ollo's:

#n accounting perspecti'e: Business insig%t
#ave "ou ever consi&ere& starting "our o'n un&erstan& accounting to success)ull" run "our usinessQ 6) so, "ou 'ill nee& to usiness0 To !no' ho' 'ell "our

usiness is &oing, "ou $ust un&erstan& an& anal"5e )inancial state$ents0 Accounting in)or$ation also tells "ou 'h" "ou are per)or$ing as reporte&0 6) "ou are in usiness to sell or &evelop a certain pro&uct or per)or$ a speci)ic service, "ou cannot operate pro)ita l" or consi&er expan&ing unless "ou accounting in)or$ation0 ase "our usiness &ecisions on

%xhi it C: The steps in recor&ing an& posting the e))ects o) a usiness transaction 6n Chapter 1, "ou sa' that each usiness transaction a))ects at least t'o ite$s0 For exa$ple, i) "ouL an o'nerLinvest cash in "our usiness, the co$pan"Js assets increase an& its stoc!hol&ersJ e4uit" increases0 This result 'as illustrate& in the su$$ar" o) transactions in %xhi it 10+0 6n the )ollo'ing

p. 8B o) *++

sections, 'e use &e its an& cre&its an& the &ou le-entr" proce&ure to recor& the increases an& &ecreases cause& " usiness transactions0 Accountants use the ter$ .ebit instea& o) sa"ing, KPlace an entr" on the le)t si&e o) the T-accountK0 The" use the ter$ cre.it )or KPlace an entr" on the right si&e o) the T-accountK0 <e it (a <r0) si$pl" $eans le)t si&e? cre&it (a
1

reviate&

reviate& Cr0) $eans right si&e0 Thus, )or all accounts a &e it

entr" is an entr" on the le)t si&e, 'hile a cre&it entr" is an entr" on the right si&e0
Any Account 4e(t, or de5it, side Ri)0t, or credit, side

A)ter recogni5ing a usiness event as a usiness transaction, 'e anal"5e it to &eter$ine its increase or &ecrease e))ects on the assets, lia ilities, stoc!hol&ersJ e4uit" ite$s, &ivi&en&s, revenues, or expenses o) the usiness0 Then 'e translate these increase or &ecrease e))ects into &e its an& cre&its0 6n each usiness transaction 'e recor&, the total &ollar a$ount o) &e its $ust e4ual the total &ollar a$ount o) cre&its0 =hen 'e &e it one account (or accounts) )or M,< 1BB, 'e $ust cre&it another account (or accounts) )or a total o) M,< 1BB0 The accounting re4uire$ent that each transaction e recor&e& " an entr" that has e4ual &e its an& cre&its is calle& .ouble-entry proce.ure, or &ualit"0 This &ou le-entr" proce&ure !eeps the accounting e4uation in alance0 The &ual recor&ing process pro&uces t'o sets o) accountsLthose 'ith &e it alances an& those 'ith cre&it alances0 The totals o) these t'o groups o) accounts $ust e e4ual0 Then, so$e assurance exists that the arith$etic part o) the transaction recor&ing process has een properl" carrie& out0 /o', let us actuall" recor& usiness transactions in T-accounts using &e its an& cre&its0

3.! 7ecording changes in assets? liabilities? and stoc&holders@ e2uit
=hile recor&ing usiness transactions, re$e$ er that the )oun&ation o) the accounting process is the )ollo'ing asic accounting e4uation:
Assets = Liabilities + Stockholders ' Equity

:ecor&ing transactions into the T-accounts is easier 'hen "ou )ocus on the e4ual sign in the accounting e4uation0 Assets, 'hich are on the le)t o) the e4ual sign, increase on the le)t si&e o) the Taccounts0 Aia ilities an& stoc!hol&ersJ e4uit", to the right o) the e4ual sign, increase on the right si&e o) the T-accounts0 .ou alrea&" !no' that the le)t si&e o) the T-account is the &e it si&e an& the right si&e

1The a

reviations F<r0H an& FCr0H are ase& on the Aatin 'or&s F e ereH an& Fcre&ereH0 A s"non"$

)or ebit an account is c%arge an account0 p. 81 o) *++

is the cre&it si&e0 ,o "ou shoul& e a le to )ill in the rest o) the rules o) increases an& &ecreases " &e&uction, such as:
A##et# :e5it (or increases / ,redit (or decreases $%a&%l%t%e# :e5it (or decreases ,redit (or increases 3 Stoc'holder#( E)u%ty :e5it (or ,redit (or decreases increases

To su$$ari5e:
 Assets increase " &e its (le)t si&e) to the T-account an& &ecrease " cre&its (right si&e) to the T-

account0
 Aia ilities an& stoc!hol&ersJ e4uit" &ecrease " &e its (le)t si&e) to the T-account an& increase

" cre&its (right si&e) to the T-account0 Appl"ing these t'o rules !eeps the accounting e4uation in alance0 /o' 'e appl" the &e it an& cre&it rules )or assets, lia ilities, an& stoc!hol&ersJ e4uit" to usiness transactions0 Assu$e a corporation issues shares o) its capital stoc! )or M,< 1B,BBB in transaction 10 (/ote the )igure in parentheses is the nu$ er o) the transaction an& ties the t'o si&es o) the transaction together0) The co$pan" recor&s the receipt o) M,< 1B,BBB as )ollo's:
#:r'% 415
Ca#h 10"000

#,r%

#:r'%

Ca1%tal Stoc' 415

#,r 10"000

This transaction increases the asset, cash, 'hich is recor&e& on the le)t si&e o) the Cash account0 Then, the transaction increases stoc!hol&ersJ e4uit", 'hich is recor&e& on the right si&e o) the Capital ,toc! account0 Assu$e the co$pan" orro'e& M,< C,BBB )ro$ a an! on a note (transaction I)0 A note is an uncon&itional 'ritten pro$ise to pa" to another part" (the transaction as )ollo's:
#:r'%
Ca#h

an!) the a$ount o'e& either 'hen

&e$an&e& or at a speci)ie& &ate, usuall" 'ith interest at a speci)ie& rate0 The )ir$ recor&s this
#,r% #:r'%
Note# .aya&le 425 <"000 425

#,r%

(1)

10,000
<"000

O serve that lia ilities, /otes Pa"a le, increase 'ith an entr" on the right (cre&it) si&e o) the account0 :ecor.ing c%anges in re'enues an. expenses 6n Chapter 1, 'e recor&e& the revenues an& expenses &irectl" in the :etaine& %arnings account0 #o'ever, this is not &one in practice ecause o) the volu$e o) revenue an& expense transactions0 6nstea&, usinesses treat the expense accounts as i) the" 'ere su classi)ications o) the &e it si&e o) the :etaine& %arnings account, an& the revenue accounts as i) the" 'ere su classi)ications o) the cre&it si&e0 ,ince )ir$s nee& the a$ounts o) revenues

p. 8I o) *++

an& expenses to prepare the inco$e state$ent, the" !eep a separate account )or each t"pe o) revenue an& expense0 The recor&ing rules )or revenues an& expenses are:
 :ecor& increases in revenues on the right (cre&it) si&e o) the T-account an& &ecreases on the

le)t (&e it) si&e0 The reasoning ehin& this rule is that revenues increase retaine& earnings, an& increases in retaine& earnings are recor&e& on the right si&e0
 :ecor& increases in expenses on the le)t (&e it) si&e o) the T-account an& &ecreases on the

right (cre&it) si&e0 The reasoning ehin& this rule is that expenses &ecrease retaine& earnings, an& &ecreases in retaine& earnings are recor&e& on the le)t si&e0 To illustrate these rules, assu$e the sa$e co$pan" receive& M,< 1,BBB cash )ro$ a custo$er )or services ren&ere& (transaction +)0 The Cash account, an asset, increases on the le)t (&e it) si&e o) the Taccount? an& the ,ervice :evenue account, an increase in retaine& earnings, increases on the right (cre&it) si&e0
(1) (2)
4 5

#:r'%

Ca#h

#,r%

#:r'%

10,000 5,000
1"000

Ser2%ce Re2enue 4 5

#,r% 1"000

/o' assu$e this co$pan" pai& M,< DBB in salaries to e$plo"ees (transaction *)0 The Cash account, an asset, &ecreases on the right (cre&it) si&e o) the T-account? an& the ,alaries %xpense account, a &ecrease in retaine& earnings, increases on the le)t (&e it) si&e0I
#:r%
Ca#h

(1) (2) (3)

10,000 5,000 1,000

4;5

#,r% =00

#:r'% 4;5

Salar%e# E01en#e =00

#,r%

Record%n+ chan+e# %n d%2%dend# Since dividends decrease retained earnin)s, increases appear on t0e le(t side o( t0e :ividends account and decreases on t0e ri)0t side' T0us, t0e (ir! records pa2!ent o( a -S: 2,000 cas0 dividend #transaction 5% as (ollo;s: #:r%
Ca#h

#,r%

(1) (2) (3)

10,000 5,000 1,000

(4)
4<5

600
2"000

#:r'% 4<5

:%2%dend# 2"000

#,r%

ICertain &e&uctions are nor$all" ta!en out o) e$plo"eesJ pa" )or social securit" taxes, )e&eral an& state 'ithhol&ing, an& so on0 Those &e&uctions are ignore& here0 p. 8+ o) *++

+

At the en& o) the accounting perio&, the accountant trans)ers an" alances in the expense, revenue, an& <ivi&en&s accounts to the :etaine& %arnings account0 This trans)er occurs onl" a)ter the in)or$ation in the expense an& revenue accounts has een use& to prepare the inco$e state$ent0 =e &iscuss an& illustrate this step in Chapter *0 To &eter$ine the alance o) an" T-account, total the &e its to the account, total the cre&its to the account, an& su tract the s$aller su$ )ro$ the larger0 6) the su$ o) the &e its excee&s the su$ o) the cre&its, the account has a .ebit balance0 For exa$ple, the )ollo'ing Cash account uses in)or$ation )ro$ the prece&ing transactions0 The account has a &e it alance o) M,< 1+,*BB, co$pute& as total &e its o) M,< 1D,BBB less total cre&its o) M,< I,DBB0
(Dr.) #"% #2% #3% Ca#h "0,000 5,000 ",000 "6,000 #4% #5% (Cr) 600 2,000 2,600

:r' 5al

"3,400

6), on the other han&, the su$ o) the cre&its excee&s the su$ o) the &e its, the account has a cre.it balance0 For instance, assu$e that a co$pan" has an Accounts Pa"a le account 'ith a total o) M,< 1B,BBB in &e its an& M,< 1+,BBB in cre&its0 The account has a cre&it alance o) M,< +,BBB, as sho'n in the )ollo'ing T-account:
(Dr.) "0,000 Account# .aya&le 7,000 6,000 "3,000 ,r' 5al 3,000 (Cr)

"0,000

!ormal balances ,ince &e its increase asset, expense, an& &ivi&en& accounts, the" nor$all" have &e it (or le)t-si&e) alances0 Conversel", ecause cre&its increase lia ilit", capital stoc!, retaine& earnings, an& revenue accounts, the" nor$all" have cre&it (or right-si&e) alances0 The )ollo'ing chart sho's the nor$al alances o) the seven accounts 'e have use&:
Normal Ty1e# o* Account# $ssets 4ia5ilities :e&%t I !alance# Cred%t I

+As 'e illustrate later in the text, so$e co$panies &e t &ivi&en&s &irectl" to the :etaine& %arnings account rather than to a <ivi&en&s account0 p. 8* o) *++

Stoc60olders8 E7uit2 ,apital Stoc6 Retained earnin)s :ividends Expenses Revenues I I I I I

At this point, "ou shoul& $e$ori5e the six rules o) &e it an& cre&it0 Aater, as "ou procee& in "our stu&" o) accounting, the rules 'ill eco$e auto$atic0 Then, "ou 'ill no longer as! "oursel), K6s this increase a &e it or cre&itQK Asset accounts increase on the &e it si&e, 'hile lia ilit" an& stoc!hol&ersJ e4uit" accounts increase on the cre&it si&e0 =hen the account alances are totale&, the" con)or$ to the )ollo'ing in&epen&ent e4uations: Assets S Aia ilities T ,toc!hol&ersJ %4uit" <e its S Cre&its The arrange$ent o) these t'o )or$ulas gives the )irst three rules o) &e it an& cre&it:
 6ncreases in asset accounts are &e its? &ecreases are cre&its0  <ecreases in lia ilit" accounts are &e its? increases are cre&its0  <ecreases in stoc!hol&ersJ e4uit" accounts are &e its? increases are cre&its0
A##et# A##et Account# :e5itJ ,redit > :e5it (or increase :e&%t# "' .ncrease assets' 2' :ecrease lia5ilities' 3' :ecrease stoc60olders8 e7uit2' 4' :ecrease revenues' 5' .ncrease expenses' 6' .ncrease dividends' 4' 5' 6' "' 2 3' 3 ,redit (or decrease / $%a&%l%t%e# $%a&%l%ty Account# :e5it ,reditJ 3 :e5it (or decrease Cred%t# :ecreases assets' .ncrease lia5ilities' .ncrease stoc60olders8 e7uit2' .ncrease revenues' :ecrease expenses' :ecrease dividends' > :e5it (or increase 3 ,redit (or decrease 3 :e5it (or decrease > ,redit (or increase > ,redit (or increase :e5it (or decrease E01en#e Account# and :%2%dend# Account :e5itJ ,redit Re2enue Account# :e5it ,reditJ 3 3 :e5it Stoc'holder(# E)u%ty 4Ca1%tal Stoc' and Reta%ned Earn%n+#5 ,reditJ > ,redit (or increase Stoc'holder#( E)u%ty Account4#5

%xhi it D: :ules o) &e it an& cre&it The &e it an& cre&it rules )or expense an& <ivi&en&s accounts an& )or revenue accounts )ollo' logicall" i) "ou re$e$ er that expenses an& &ivi&en&s are &ecreases in stoc!hol&ersJ e4uit" an& revenues are increases in stoc!hol&ersJ e4uit"0 ,ince stoc!hol&ersJ e4uit" accounts &ecrease on the p. 8C o) *++

&e it si&e, expense an& <ivi&en& accounts increase on the &e it si&e0 ,ince stoc!hol&ersJ e4uit" accounts increase on the cre&it si&e, revenue accounts increase on the cre&it si&e0 The last three &e it an& cre&it rules are:
 <ecreases in revenue accounts are &e its? increases are cre&its0  6ncreases in expense accounts are &e its? &ecreases are cre&its0  6ncreases in <ivi&en&s accounts are &e its? &ecreases are cre&its0

6n %xhi it D, 'e &epict these six rules o) &e it an& cre&it0 /ote )irst the treat$ent o) expense an& <ivi&en&s accounts as i) the" 'ere su classi)ications o) the &e it si&e o) the :etaine& %arnings account0 ,econ&, note the treat$ent o) the revenue accounts as i) the" 'ere su classi)ications o) the cre&it si&e o) the :etaine& %arnings account0 /ext, 'e &iscuss the accounting c"cle an& in&icate 'here steps in the accounting c"cle are &iscusse& in Chapters I through *0

3.# The accounting c cle
The accounting cycle is a series o) steps per)or$e& &uring the accounting perio& (so$e throughout the perio& an& so$e at the en&) to anal"5e, recor&, classi)", su$$ari5e, an& report use)ul )inancial in)or$ation )or the purpose o) preparing )inancial state$ents0 Be)ore "ou can visuali5e the eight steps in the accounting c"cle, "ou $ust e a le to recogni5e a usiness transaction0 Business transactions are $easura le events that a))ect the )inancial con&ition o) a usiness0 For exa$ple, assu$e that the o'ner o) a usiness spille& a pot o) co))ee in her o))ice or ro!e her leg 'hile s!iing0 These t'o events $a" rie)l" interrupt the operation o) the usiness0 #o'ever, the" are not $easura le in ter$s that a))ect the solvenc" an& pro)ita ilit" o) the usiness0 Business transactions can e the exchange o) goo&s )or cash et'een the usiness an& an external part", such as the sale o) a oo!, or the" can involve pa"ing salaries to e$plo"ees0 These events have one )un&a$ental criterion: The" $ust have cause& a $easura le change in the a$ounts in the accounting e4uation, Assets S Aia ilities T ,toc!hol&ersJ %4uit"0 The evi&ence that a usiness event has occurre& is a source &ocu$ent such as a sales tic!et, chec!, an& so on0 ,ource &ocu$ents are i$portant ecause the" are the ulti$ate proo) o) usiness transactions0 * A)ter "ou have &eter$ine& that an event is a $easura le usiness transaction an& have a&e4uate proo) o) this transaction, $entall" anal"5e the transactionJs e))ects on the accounting e4uation0 .ou

*(an" co$panies sen& an& receive source &ocu$ents electronicall", rather than on paper0 6n such an electronic co$puter environ$ent, source &ocu$ents $ight exist onl" in the co$puter &ata ases o) the t'o parties involve& in the transaction0 p. 8D o) *++

learne& ho' to &o this in Chapter 10 This chapter an& Chapters + an& * &escri e the other steps in the accounting c"cle0 The eight steps in the accounting c"cle an& the chapters that &iscuss the$ are:
 Anal"5e transactions " exa$ining source &ocu$ents (Chapters 1 an& I)0  ;ournali5e transactions in the 3ournal (Chapter I)0  Post 3ournal entries to the accounts in the le&ger (Chapter I)0  Prepare a trial

alance o) the accounts (Chapter I) an& co$plete the 'or! sheet (Chapter *)0

(This step inclu&es a&3usting entries )ro$ Chapter +0)
 Prepare )inancial state$ents (Chapter *)0  ;ournali5e an& post a&3usting entries (Chapters + an& *)0  ;ournali5e an& post closing entries (Chapter *)0  Prepare a post-closing trial alance (Chapter *)0

This listing serves as a previe' o) 'hat "ou 'ill stu&" in Chapters I-*0 /otice that )ir$s per)or$ the last )ive steps at the en& o) the accounting perio&0 ,tep C prece&es steps D an& @ ecause $anage$ent nee&s the )inancial state$ents at the earliest possi le &ate0 A)ter the state$ents have een &elivere& to $anage$ent, the a&3usting an& closing entries can e 3ournali5e& an& poste&0 6n %xhi it @, 'e &iagra$ the eight steps in the accounting c"cle0 .ou can per)or$ $an" o) these steps on a co$puter 'ith an accounting so)t'are pac!age0 #o'ever, "ou $ust un&erstan& a $anual accounting s"ste$ an& all o) the steps in the accounting c"cle to un&erstan& 'hat the co$puter is &oing0 This un&erstan&ing re$oves the $"ster" o) 'hat the co$puter is &oing 'hen it ta!es in ra' &ata an& pro&uces )inancial state$ents0

3.$ The journal
6n explaining the rules o) &e it an& cre&it, 'e recor&e& transactions &irectl" in the accounts0 %ach le&ger (general le&ger) account sho's onl" the increases an& &ecreases in that account0 Thus, all the e))ects o) a single usiness transaction 'oul& not appear in an" one account0 For exa$ple, the Cash account contains onl" &ata on changes in cash an& &oes not sho' ho' the cash 'as generate& or ho' it 'as spent0 To have a per$anent recor& o) an entire transaction, the accountant uses a oo! or recor& !no'n as a 3ournal0 A 2ournal is a chronological (arrange& in or&er o) ti$e) recor& o) usiness transactions0 A 2ournal entry is the recor&ing o) a usiness transaction in the 3ournal0 A 3ournal entr" sho's all the e))ects o) a usiness transaction as expresse& in &e it(s) an& cre&it(s) an& $a" inclu&e an explanation o) the transaction0 A transaction is entere& in a 3ournal e)ore it is entere& in le&ger accounts0 Because each

p. 8@ o) *++

transaction is initiall" recor&e& in a 3ournal rather than &irectl" in the le&ger, a 3ournal is calle& a oo! o) original entr"0 A usiness usuall" has $ore than one 3ournal0 Chapter * rie)l" &escri es several special 3ournals0 6n this chapter, 'e use the asic )or$ o) 3ournal, the general 3ournal0 As sho'n in %xhi it 8, a general 3ournal contains the )ollo'ing colu$ns:

%xhi it @: ,teps in the accounting c"cle

p. 88 o) *++

MICROTRAIN COM.AN@ 8eneral Journal :ate 20"0 ov' 29 $ccount Titles and Explanation ,as0 #>$% ,apital Stoc6 #>SE% Stoc60olders invested $50,000 cas0 in 5usiness' =ost' Re(' "00 300 :e5it 5 0 0 0 0 5 0 0 0 0 ,redit

E0h%&%t A? Journal entry

 <ate column0 The )irst colu$n on each 3ournal page is )or the &ate0 For the )irst 3ournal

entr" on a page, this colu$n contains the "ear, $onth, an& &a" (nu$ er)0 For all other 3ournal entries on a page, this colu$n contains onl" the &a" o) the $onth, until the $onth changes0
 #ccount titles an. explanation column0 The )irst line o) an entr" sho's the account

&e ite&0 The secon& line sho's the account cre&ite&0 /otice that 'e in&ent the cre&it account title to the right0 For instance, in %xhi it 8 'e sho' the &e it to the Cash account an& then the cre&it to the Capital ,toc! account0 An" necessar" explanation o) a transaction appears on the line(s) elo' the cre&it entr" an& is in&ente& hal)'a" et'een the accounts &e ite& an& cre&ite&0 A 3ournal entr" explanation shoul& e concise an& "et co$plete enough to &escri e )ull" the transaction an& prove the entr"Js accurac"0 =hen a 3ournal entr" is sel)-explanator", 'e o$it the explanation0
 &osting re0erence column0 This colu$n sho's the account nu$ er o) the &e ite& or

cre&ite& account0 For instance, in %xhi it 8, the nu$ er 1BB in the )irst entr" $eans that the Cash account nu$ er is 1BB0 /o nu$ er appears in this colu$n until the in)or$ation has een poste& to the appropriate le&ger account0 =e &iscuss posting later in the chapter0
 <ebit column0 6n the &e it colu$n, the a$ount o) the &e it is on the sa$e line as the title

o) the account &e ite&0
 Cre.it column0 6n the cre&it colu$n, the a$ount o) the cre&it is on the sa$e line as the

title o) the account cre&ite&0

#n account perspecti'e: 6ses o0 tec%nology
Preparing 3ournal entries in a co$puteri5e& s"ste$ is &i))erent than in a $anual s"ste$0 The co$puter nor$all" as!s )or the nu$ er o) the account to e &e ite&0 A)ter "ou t"pe the account nu$ er, the co$puter sho's the account title in its proper position0 The cursor then $oves to the &e it colu$n an& 'aits )or "ou to enter the

p. 8> o) *++

a$ount o) the &e it0 Then it as!s i) there are $ore &e its0 6) not, the co$puter pro$pts "ou )or the account nu$ er o) the cre&it0 A)ter "ou t"pe the account nu$ er, the co$puter supplies the account na$e o) the cre&it an& enters the sa$e a$ount &e ite& as the cre&it0 =hen there is $ore than one cre&it, "ou can overri&e the a$ount an& enter the correct a$ount0 Then "ou 'oul& enter the other cre&it in the sa$e 'a"0 6) "our &e its an& cre&its are not e4ual, the co$puter 'arns "ou an& $a!es "ou correct the error0 .ou can suppl" an explanation )or the entr" )ro$ a stan&ar& list or t"pe it in0 As "ou enter the 3ournal entries, the co$puter auto$aticall" posts the$ to the le&ger accounts0 At an" ti$e, "ou can have the co$puter print a trial alance0 A su$$ar" o) the )unctions an& a&vantages o) using a 3ournal )ollo's: The 3ournalL
 :ecor&s transactions in chronological or&er0  ,ho's the anal"sis o) each transaction in &e its an& cre&its0  ,upplies an explanation o) each transaction 'hen necessar"0  ,erves as a source )or )uture re)erence to accounting transactions0  %li$inates the nee& )or length" explanations )ro$ the accounts0  (a!es possi le posting to the le&ger at convenient ti$es0  Assists in $aintaining the le&ger in alance ecause the &e it(s) $ust al'a"s e4ual the cre&it(s)

in each 3ournal entr"0
 Ai&s in tracing errors 'hen the le&ger is not in alance0

3.% The ledger
A le.ger (general le&ger) is the co$plete collection o) all the accounts o) a co$pan"0 The le&ger $a" e in loose-lea) )or$, in a oun& volu$e, or in co$puter $e$or"0 Accounts )all into t'o general groups: (1) balance s%eet accounts (assets, lia ilities, an& stoc!hol&ersJ e4uit") an& (I) inco"e state"ent accounts (revenues an& expenses)0 The ter$s real accounts an& per$anent accounts also re)er to alance sheet accounts0 Balance sheet accounts are real accounts ecause the" are not su classi)ications or su &ivisions o) an" other account0 The" are permanent accounts ecause their alances are not trans)erre& (or close&) to an" other account at the en& o) the accounting perio&0 6nco$e state$ent accounts an& the <ivi&en&s account are nominal accounts ecause the" are $erel" su classi)ications o) the stoc!hol&ersJ e4uit" accounts0 /o$inal literall" $eans Kin na$e onl"K0 /o$inal accounts are also calle& temporary accounts ecause the" p. >B o) *++

te$poraril" contain revenue, expense, an& &ivi&en& in)or$ation that is trans)erre& (or close&) to the :etaine& %arnings account at the en& o) the accounting perio&0 The c%art o0 accounts is a co$plete listing o) the titles an& nu$ ers o) all the accounts in the le&ger0 The chart o) accounts can e co$pare& to a ta le o) contents0 The groups o) accounts usuall" appear in this or&er: assets, lia ilities, stoc!hol&ersJ e4uit", &ivi&en&s, revenues, an& expenses0 6n&ivi&ual accounts are in se4uence in the le&ger0 %ach account t"picall" has an i&enti)ication nu$ er an& a title to help locate accounts 'hen recor&ing &ata0 For exa$ple, a co$pan" $ight nu$ er asset accounts, 1BB-1>>? lia ilit" accounts, IBB-I>>? stoc!hol&ersJ e4uit" accounts an& <ivi&en&s account, +BB-+>>? revenue accounts, *BB-*>>? an& expense accounts, CBB-C>>0 =e use this nu$ ering s"ste$ in this text0 The uni)or$ chart o) accounts use& in the )irst 11 chapters appears in a separate )ile at the en& o) the text0 .ou shoul& print that )ile an& !eep it han&" )or 'or!ing certain pro le$s an& exercises0 Co$panies $a" use other nu$ ering s"ste$s0 For instance, so$eti$es a co$pan" nu$ ers its accounts in se4uence starting 'ith 1, I, an& so on0 The i$portant i&ea is that co$panies use so$e nu$ ering s"ste$0 /o' that "ou un&erstan& ho' to recor& &e its an& cre&its in an account an& ho' all accounts together )or$ a le&ger, "ou are rea&" to stu&" the accounting process in operation0

3.' The accounting process in operation
(icroTrain Co$pan" is a s$all corporation that provi&es on-site personal co$puter so)t'are training using the clientsJ e4uip$ent0 The co$pan" o))ers eginning through a&vance& training 'ith convenient sche&uling0 A s$all )leet o) truc!s transports personnel an& teaching supplies to the clientsJ sites0 The co$pan" rents a uil&ing an& is responsi le )or pa"ing the utilities0 =e illustrate the capital stoc! transaction that occurre& to )or$ the co$pan" (in /ove$ er) an& the )irst $onth o) operations (<ece$ er)0 The accounting process use& " this co$pan" is si$ilar to that o) an" s$all co$pan"0 The le&ger accounts use& " (icroTrain Co$pan" are:

p. >1 o) *++

Acct. Account T%tle No. "00 "03 "07 $ssets "09 ""2 "50 200 4ia5ilities Stoc60olders8 e7uit2 :ividends Revenues 2"6 300 3"0 320 400 505 506 Expenses =repaid .nsurance =repaid Rent Truc6s $ccounts =a2a5le -nearned Service /ees ,apital Stoc6 Retained Earnin)s :ividends Service Revenue $dvertisin) Expense Gas and +il Expense Salaries Expense -tilities Expense ,as0 $ccounts Receiva5le Supplies on Aand

:e#cr%1t%on &an6 deposits and cas0 on 0and' $!ounts o;ed to t0e co!pan2 52 custo!ers' .te!s suc0 as paper, envelopes, ;ritin) !aterials, and ot0er !aterials used in per(or!in) trainin) services (or custo!ers or in doin) ad!inistrative and clerical o((ice ;or6' .nsurance polic2 pre!iu!s paid in advance o( t0e periods (or ;0ic0 t0e insurance covera)e applies' Rent paid in advance o( t0e periods (or ;0ic0 t0e rent pa2!ent applies' Truc6s used to transport personnel and trainin) supplies to clients8 locations' $!ounts o;ed to creditors (or ite!s purc0ased (ro! t0e!' $!ounts received (ro! custo!ers 5e(ore t0e trainin) services 0ave 5een per(or!ed (or t0e!' T0e stoc60olders8 invest!ent in t0e 5usiness' T0e earnin)s retained in t0e 5usiness' T0e a!ount o( dividends declared to stoc60olders' $!ounts earned 52 per(or!in) trainin) services (or custo!ers' T0e cost o( advertisin) incurred in t0e current period' T0e cost o( )as and oil used in truc6s in t0e current period' T0e a!ount o( salaries incurred in t0e current period' T0e cost o( utilities incurred in t0e current period'

]

507 5""

/otice the gaps le)t et'een account nu$ ers (1BB, 1B+, 1B@, etc0)0 These gaps allo' the )ir$ to later a&& ne' accounts et'een the existing accounts0 To egin, a transaction $ust e 3ournali5e&0 >ournali4ing is the process o) entering the e))ects o) a transaction in a 3ournal0 Then, the in)or$ation is trans)erre&, or poste&, to the proper accounts in the le&ger0 &osting is the process o) recor&ing in the le&ger accounts the in)or$ation containe& in the 3ournal0 =e explain posting in $ore &etail later in the chapter0 6n the )ollo'ing exa$ple, notice that each usiness transaction a))ects t'o or $ore accounts in the le&ger0 Also note that the transaction &ate in oth the general 3ournal an& the general le&ger accounts is the sa$e0 6n the le&ger accounts, the &ate use& is the &ate that the transaction 'as recor&e& in the general 3ournal, even i) the entr" is not poste& until several &a"s later0 Our exa$ple sho's the 3ournal entries poste& to T-accounts0 6n practice, )ir$s post 3ournal entries to le&ger accounts, as 'e sho' later in the chapter0 Accountants use the accrual asis o) accounting0 Mn&er the accrual basis o0 accounting, the" recogni5e revenues 'hen the co$pan" $a!es a sale or per)or$s a service, regar&less o) 'hen the co$pan" receives the cash0 The" recogni5e expenses as incurre&, 'hether or not the co$pan" has pai& out cash0 Chapter + &iscusses the accrual asis o) accounting in $ore &etail0

p. >I o) *++

6n the )ollo'ing (icroTrain Co$pan" exa$ple, transaction 1 increases (&e its) Cash an& increases (cre&its) Capital ,toc! " M,< CB,BBB0 First, (icroTrain recor&s the transaction in the general 3ournal? secon&, it posts the entr" to the accounts in the general le&ger0
Tran#act%on 1?2010 No2. 2A Stoc'holder# %n2e#ted 7<0"000 and *ormed M%croTra%n Com1any. 8eneral Journal :ate $ccount Titles and Explanation =ost' :e5it Re(' 20"0 ov' 29 ,as0 #>$% "00 5 0 0 0 0 ,apital Stoc6 #>SE% Stoc60olders invested $50,000 cas0 in 5usiness' 8eneral $ed+er Ca#h (Dr.) 20"0 ov' 29 50,000 $cct' o' "00 (Cr.) (Dr.) Ca1%tal Stoc' $cct' o' 300 20"0 ov' 29 50,000 (Cr.) 300 ,redit

5 0 0 0 0

/o other transactions occurre& in /ove$ er0 The co$pan" prepares )inancial state$ents at the en& o) each $onth0 %xhi it > sho's the co$pan"Js alance sheet at IB1B /ove$ er +B0 The alance sheet re)lects le&ger account alances as o) the close o) usiness on IB1B /ove$ er +B0 These closing alances are the eginning alances on IB1B <ece$ er 10 The le&ger accounts sho' these closing alances as eginning alances (Beg0 al0)0 /o' assu$e that in <ece$ er IB1B, (icroTrain Co$pan" engage& in the )ollo'ing transactions0 =e sho' the proper recor&ing o) each transaction in the 3ournal an& then in the le&ger accounts (in Taccount )or$), an& &escri e the e))ects o) each transaction0
MICROTRAIN COM.AN@ !alance Sheet 2010 No2em&er 0 A##et# ,as0 $50,000 $%a&%l%t%e# and Stoc'holder#( E)u%ty Stoc60olders8 e7uit2: ,apital stoc6 Total $ssets $50,000 $50,000

Total lia5ilities and stoc60olders8 e7uit2 $50,000

%xhi it >: Balance sheet

p. >+ o) *++

Tran#act%on 2? :ec. 1 .a%d ca#h *or *our #mall truc'#" 7;0"000. 8eneral Journal :ate 20"0 :ec' " $ccount Titles and Explanation Truc6s #>$% ,as0 #3$% To record t0e purc0ase o( (our truc6s' 8eneral $ed+er Truc'# =ost' Re(' "50 "00 :e5it 4 0 0 0 0 (A) 4 0 0 0 0 #&% ,redit

#:r'%
20"0 :ec. 1

$cct' o' "50 4A5;0"000 Ca#h

#,r'%

#:r'%
20"0 :ec' " &e)' 5al'

$cct' o' "00 50,000 20"0 :ec. 1

#,r'%
4!5;0"0

00 Tran#act%on ? :ec. 1 .a%d ca#h *or %n#urance on the truc'# to co2er a one-year 1er%od *rom th%# date. 8eneral Journal :ate 20"0 :ec' " $ccount Titles and Explanation =repaid .nsurance #>$% ,as0 #3$% =urc0ased truc6 insurance to cover a one32ear period' 8eneral $ed+er .re1a%d In#urance =ost' Re(' "09 "00 :e5it 2 4 0 0 2 4 0 0 ,redit

#:r%
20"0 :ec. 1

$cct' o' "09 2";00 Ca#h

#,r%

#:r%
20"0 :ec' " &e)' &al

$cct' o' "00 50,000 20"0 :ec' " :ec. 1

#,r'%
40,000 2";0

-00ects o0 transaction An asset, prepai& insurance, increases (&e ite&)? an& an asset, cash, &ecreases (cre&ite&) " M,< I,*BB0 The &e it is to Prepai& 6nsurance rather than 6nsurance %xpense ecause the polic" covers $ore than the current accounting perio& o) <ece$ er (insurance policies are usuall" pai& one "ear in a&vance)0 As "ou 'ill see in Chapter +, prepai& ite$s are expense& as the" are use&0 6) this insurance

p. >* o) *++

polic" 'as onl" 'ritten )or <ece$ er, the entire M,< I,*BB &e it 'oul& have %xpense0
Tran#act%on ;? :ec. 1 Rented a &u%ld%n+ and 1a%d 71"200 to co2er a three-month 1er%od *rom th%# date. 8eneral Journal :ate 20"0 :ec' " $ccount Titles and Explanation =repaid Rent #>$% ,as0 #3$% =aid t0ree !ont0s8 rent on a 5uildin)' =ost' Re(' ""2 "00 :e5it " 2 0 0

een to 6nsurance

,redit

" 2 0 0

8eneral $ed+er .re1a%d Rent

#:r'% 20"0
:ec. 1

$cct' o' ""2

#,r%

1"200 Ca#h

#:r'% 20"0
:ec' " &e)' &al'

$cct' o' "00 20"0 50,000 :ec' " :ec' " :ec. 1

#,r'%

40,000 2,400 1"200

-00ects o0 transaction An asset, prepai& rent, increases (&e ite&)? an& another asset, cash, &ecreases (cre&ite&) " M,< 1,IBB0 The &e it is to Prepai& :ent rather than :ent %xpense ecause the pa"$ent covers $ore than the current $onth0 6) the pa"$ent ha& 3ust een )or <ece$ er, the &e it 'oul& have een to :ent %xpense0

p. >C o) *++

Tran#act%on <? :ec. ; .urcha#ed 71";00 o* tra%n%n+ #u11l%e# on account to &e u#ed o2er the ne0t #e2eral month#. 8eneral Journal :ate $ccount Titles and Explanation =ost' :e5it ,redit Re(' Supplies on Aand #>$% "07 " 4 0 0 20"0 :ec' 4 $ccounts =a2a5le #>4% To record t0e purc0ases o( trainin) supplies (or (uture use' 8eneral $ed+er Su11l%e# on 9and 200 " 4 0 0

#:r'%
20"0 :ec. ;

$cct' o' "07

#,r%

1";00 Account# .aya&le

#:r'%

$cct' o' 200 20"0 :ec. ;

#,r'%

1";00

-00ects o0 transaction An asset, supplies on han&, increases (&e ite&)? an& a lia ilit", accounts pa"a le, increases (cre&ite&) " M,< 1,*BB0 The &e it is to ,upplies on #an& rather than ,upplies %xpense ecause the supplies are to e use& over several accounting perio&s0 6n each o) the three prece&ing entries, 'e &e ite& an asset rather than an expense0 The reason is that the expen&iture applies to (or ene)its) $ore than 3ust the current accounting perio&0 =henever a co$pan" 'ill not )ull" use up an ite$ such as insurance, rent, or supplies in the perio& 'hen purchase&, it usuall" &e its an asset0 6n practice, ho'ever, so$eti$es the expense is initiall" &e ite& in these situations0 Co$panies so$eti$es u" ite$s that the" )ull" use up 'ithin the current accounting perio&0 For exa$ple, &uring the )irst part o) the $onth a co$pan" $a" u" supplies that it inten&s to consu$e )ull" &uring that $onth0 6) the co$pan" )ull" consu$es the supplies &uring the perio& o) purchase, the est practice is to &e it ,upplies %xpense at the ti$e o) purchase rather than ,upplies on #an&0 This sa$e a&vice applies to insurance an& rent0 6) a co$pan" purchases insurance that it )ull" consu$es &uring the current perio&, the co$pan" shoul& &e it 6nsurance %xpense at the ti$e o) purchase rather than Prepai& 6nsurance0 Also, i) a co$pan" pa"s rent that applies onl" to the current perio&, :ent %xpense shoul& e &e ite& at the ti$e o) purchase rather than Prepai& :ent0 As illustrate& in Chapter +, )ollo'ing this a&vice si$pli)ies the proce&ures at the en& o) the accounting perio&0

p. >D o) *++

Tran#act%on =? :ec. B Rece%2ed 7;"<00 *rom a cu#tomer %n 1ayment *or *uture tra%n%n+ #er2%ce#. 8eneral Journal :ate $ccount Titles and Explanation =ost' :e5it Re(' ,as0 #>$% "00 4 5 0 0 20"0 :ec' 7 -nearned Service /ees #>4% To record t0e receipt o( cas0 (ro! a custo!er in pa2!ent (or (uture trainin) services' 2"6

,redit

4 5 0 0

#:r'%
20"0 :ec' " :ec. B

8eneral $ed+er Ca#h $cct' o' "00 20"0 &e) &al 50,000 ;"<00 :ec' " :ec' " :ec' " Unearned Ser2%ce Fee#

#,r%
40,000 2,400 ",200

#:r'%

$cct' o' 2"6 20"0 :ec. B

#,r'%

;"<00

-00ects o0 transaction An asset, cash, increases (&e ite&)? an& a lia ilit", unearne& service revenue, increases (cre&ite&) " M,< *,CBB0 The cre&it is to Mnearne& ,ervice Fees rather than ,ervice :evenue ecause the M,< *,CBB applies to $ore than 3ust the current accounting perio&0 Mnearne& ,ervice Fees is a lia ilit" ecause, i) the services are never per)or$e&, the M,< *,CBB 'ill have to e re)un&e&0 6) the pa"$ent ha& een )or services to e provi&e& in <ece$ er, the cre&it 'oul& have een to ,ervice :evenue0

p. >@ o) *++

Tran#act%on B? :ec. 1< .er*ormed tra%n%n+ #er2%ce# *or a cu#tomer *or ca#h" 7<"000. 8eneral Journal :ate 20"0 :ec' "5 $ccount Titles and Explanation ,as0 #>$% Service Revenue #>SE% To record t0e receipt o( cas0 (or per(or!in) trainin) services (or a custo!er' =ost' Re(' "00 400 :e5it 5 0 0 0 5 0 0 0 ,redit

8eneral $ed+er Ca#h

#:r'%
20"0

$cct' o' "00 20"0 :ec' " :ec' " :ec' "

#,r%

:ec' " &e) &al' 50,000 :ec' 7 :ec. 1< 4,500 <"000

40,000 2,400 ",200

Ser2%ce Re2enue

#:r'%

$cct' o' 400 20"0 :ec. 1<

#,r'%
<"000

-00ects o0 transaction An asset, cash, increases (&e ite&)? an& a revenue, service revenue, increases (cre&ite&) " M,< C,BBB0
Tran#act%on A? :ec. 1B .a%d the 71";00 account 1aya&le re#ult%n+ *rom the tran#act%on o* :ecem&er ;. 8eneral Journal :ate $ccount Titles and Explanation =ost' :e5it Re(' 200 " 4 0 0 20"0 :ec' "7 $ccounts =a2a5le #34% ,as0 #3$% =aid t0e account pa2a5le arisin) (ro! t0e purc0ase o( Supplies on :ece!5er 4' 8eneral $ed+er Account# .aya&le "00

,redit

" 4 0 0

#:r'%

$cct' o' 200

#,r%

p. >8 o) *++

20"0 :ec. 1B 1";00 Ca#h

20"0 :ec' 4 ",400

#:r'%
20"0 :ec' :ec' :ec'

$cct' o' "00 20"0 " &e) &al' 50,000 7 "5 4,500 5,000 :ec' " :ec' " :ec' " :ec 1B

#,r'%
40,000 2,400 ",200 1";00

-00ects o0 transaction A lia ilit", accounts pa"a le, &ecreases (&e ite&)? an& an asset, cash, &ecreases (cre&ite&) " M,< 1,*BB0
Tran#act%on C? :ec. 20 !%lled a cu#tomer *or tra%n%n+ #er2%ce# 1er*ormed" 7<"B00. 8eneral Journal :ate 20"0 :ec' 20 $ccount Titles and Explanation $ccounts Receiva5le #>$% Service Revenue #>SE% To record t0e per(or!ance o( trainin) services on account (or ;0ic0 a custo!er ;as 5illed' =ost' Re(' "03 400 :e5it 5 7 0 0 5 7 0 0 ,redit

8eneral $ed+er Account# Rece%2a&le

#:r'%
20"0 :ec. 20

$cct' o' "03

#,r%

<"B00 Ser2%ce Re2enue $cct' o' 400 20"0 :ec' "5 :ec. 20 5,000 <"B00

#:r'%

#,r'%

-00ects o0 transaction

p. >> o) *++

An asset, accounts receiva le, increases (&e ite&)? an& a revenue, service revenue, increases (cre&ite&) " M,< C,@BB0
Tran#act%on 10? :ec. 2; Rece%2ed a &%ll *or ad2ert%#%n+ %n a local ne,#1a1er %n :ecem&er" 7<0. 8eneral Journal :ate 20"0 :ec' 24 $ccount Titles and Explanation $dvertisin) Expense #3SE% $ccounts =a2a5le #>4% Received a 5ill (or advertisin) (or t0e !ont0 o( :ece!5er' 8eneral $ed+er Ad2ert%#%n+ E01en#e =ost' Re(' 505 200 :e5it 5 0 5 0 ,redit

#:r'%
20"0 :ec. 2;

$cct' o' 505

#,r%

<0 Account# .aya&le $cct' o' 200 20"0

#:r'%
20"0 :ec' "7

#,r'%

",400

:ec'

4

",400 <0

:ec. 2;

-00ects o0 transaction An expense, a&vertising expense, increases (&e ite&)? an& a lia ilit", accounts pa"a le, increases (cre&ite&) " M,< CB0 The reason )or &e iting an expense rather than an asset is ecause all the cost pertains to the current accounting perio&, the $onth o) <ece$ er0 Other'ise, Prepai& A&vertising (an asset) 'oul& have een &e ite&0

p. 1BB o) *++

Tran#act%on 11? :ec. 2= Rece%2ed 7<00 on account# rece%2a&le *rom a cu#tomer. 8eneral Journal :ate 20"0 :ec' 26 $ccount Titles and Explanation ,as0 #>$% $ccounts Receiva5le #3$% Received $500 (ro! a custo!er on accounts receiva5le =ost' Re(' "00 "03 :e5it 5 0 0 5 0 0 ,redit

8eneral $ed+er Ca#h #:r'% $cct' o' "00 20"0 :ec' " &e) &al' 50,000 :ec' 7 :ec' "5 :ec. 2= Account# #:r'% 20"0 :ec' 20 5,700 4,500 5,000 <00 $cct' 20"0 :ec' " :ec' " :ec' "

#,r%
40,000 2,400 ",200 ",400

:ec' "7 Rece%2a&le o' "03 20"0 :ec. 2=

#,r'%
<00

-00ects o0 transaction One asset, cash, increases (&e ite&)? an& another asset, accounts receiva le, &ecreases (cre&ite&) " M,< CBB0
Tran#act%on 12? :ec. 2A .a%d #alar%e# o* 7 "=00 to tra%n%n+ 1er#onnel *or the *%r#t *our ,ee'# o* :ecem&er. 4.ayroll and other deduct%on# are to &e %+nored #%nce they ha2e not yet &een d%#cu##ed.5 8eneral Journal :ate 20"0 :ec' 29 $ccount Titles and Explanation Salaries Expense #3SE% ,as0 #3$% =aid trainin) personnel salaries (or t0e (irst (our ;ee6s o( :ece!5er' 8eneral $ed+er Salar%e# E01en#e =ost' Re(' 507 "00 :e5it 3 6 0 0 3 6 0 0 ,redit

#:r'%
20"0 :ec. 2A

$cct' o' 507 "=00 Ca#h

#,r%

#:r'%

$cct' o' "00

#,r'%

p. 1B1 o) *++

20"0 :ec' " :ec' 7 :ec' "5 :ec' 26 50,000 4,500 5,000 500

20"0 :ec' " :ec' " :ec' " :ec' "7 :ec. 2A 40,000 2,400 ",200 ",400 "=00

-00ects o0 transaction An expense, salaries expense, increases (&e ite&)? an& an asset, cash, &ecreases (cre&ite&) " M,< +,DBB0
Tran#act%on 1 ? :ec. 2C Rece%2ed and 1a%d the ut%l%t%e# &%ll *or :ecem&er" 71<0. 8eneral Journal :ate 20"0 :ec' 2@ $ccount Titles and Explanation -tilities Expense #3SE% ,as0 #>$% =aid t0e utilities 5ill (or :ece!5er' =ost' Re(' 5"" "00 :e5it " 5 0 " 5 0 ,redit

8eneral $ed+er Ut%l%t%e# E01en#e

#:r'%
20"0 :ec. 2C

$cct' o' 5"" 1<0 Ca#h

#,r%

#:r'%
20"0 :ec' " :ec' 7 :ec' "5 :ec' 26

$cct' o' "00 20"0 50,000 4,500 5,000 500 :ec' " :ec' " :ec' " :ec' "7 :ec' 29 :ec. 2C

#,r'%
40,000 2,400 ",200 ",400 3,600 1<0

-00ects o0 transaction An expense, utilities expense, increases (&e ite&)? an& an asset, cash, &ecreases (cre&ite&) " M,< 1CB0

p. 1BI o) *++

Tran#act%on 1;? :ec. 0 Rece%2ed a &%ll *or +a# and o%l u#ed %n the truc'# *or :ecem&er" 7=A0. 8eneral Journal :ate 20"0 :ec' 30 $ccount Titles and Explanation Gas and +il Expense #3SE% $ccounts =a2a5le #>4% Received a 5ill (or )as and oil used in t0e truc6s (or :ece!5er' =ost' Re(' 506 200 :e5it 6 9 0 6 9 0 ,redit

8eneral $ed+er 8a# and O%l E01en#e

#:r'%
20"0 :ec. 0

$cct' o' 506

#,r%

=A0 Account# .aya&le

#:r'%
20"0 :ec' "7

$cct' o' 200 20"0 ",400 :ec' 4 :ec'24

#,r'%

",400 50

p. 1B+ o) *++

:ec. 0

=A0

-00ects o0 transaction An expense, gas an& oil expense, increases (&e ite&)? an& a lia ilit", accounts pa"a le, increases (cre&ite&) " M,< D8B0
Tran#act%on 1<? :ec. 1 A d%2%dend o* 7 "000 ,a# 1a%d to #toc'holder#. 8eneral Journal :ate 20"0 :ec' 3" $ccount Titles and Explanation :ividends #3SE% ,as0 #3$% :ividends ;ere paid to stoc60olders' =ost' Re(' 320 "00 :e5it 3 0 0 0 3 0 0 0 ,redit

8eneral $ed+er :%2%dend#

#:r'%
20"0 :ec. 1

$cct' o' 320 "000 Ca#h $cct' o' "00 20"0 50,000 4,500 5,000 500 :ec' " :ec' " :ec' " :ec' "7 :ec' 29 :ec' 2@ :ec. 1

#,r%

#:r'%
20"0 :ec' " &e) &al' :ec' 7 :ec' "5 :ec' 26

#,r'%
40,000 2,400 ",200 ",400 3,600 "50 "000

-00ects o0 transaction The <ivi&en&s account increases (&e ite&)? an& an asset, cash, &ecreases (cre&ite&) " M,< +,BBB0 Transaction 1C conclu&es the anal"sis o) the (icroTrain Co$pan" transactions0 The next section &iscusses an& illustrates posting to le&ger accounts an& cross-in&exing0

#n accounting perspecti'e: 6ses o0 tec%nology

p. 1B* o) *++

The concept o) the 6nternet &ates to the 1>DBs 'hen the $ilitar" tie& together several co$puters )or$ing a Knet'or!K that allo'e& users to co$$unicate 'ith each other instantaneousl" on their co$puters over $an" $iles0 Then universities an& scienti)ic institutions connecte& to the net'or! to $eet their research an& co$$unication nee&s0 (ore an& $ore organi5ations hoo!e& up to the net'or! over ti$e0 To&a" $an" co$panies see! custo$ers an& e$plo"ees over the 6nternet0 ,tu&ents an& )acult" use the 6nternet to per)or$ research, co$$unicate 'ith their colleagues (using e-$ail), an& search &istant li raries0 Accountants in practice are heav" users o) the 6nternet to locate co$pan" &ata, tax regulations, an& al$ost an" other in)or$ation the" nee&0 .ou 'ill )in& that learning to use the 6nternet e))ectivel" is essential to "our )uture success0

3.) The use of ledger accounts
A 3ournal entr" is li!e a set o) instructions0 The carr"ing out o) these instructions is !no'n as posting. As state& earlier, posting is recor&ing in the le&ger accounts the in)or$ation containe& in the 3ournal0 A 3ournal entr" &irects the entr" o) a certain &ollar a$ount as a &e it in a speci)ic le&ger account an& &irects the entr" o) a certain &ollar a$ount as a cre&it in a speci)ic le&ger account0 %arlier, 'e poste& the 3ournal entries )or (icroTrain Co$pan" to T-accounts0 6n practice, ho'ever, co$panies post these 3ournal entries to le&ger accounts0 Msing a ne' exa$ple, ;en!s Co$pan", 'e illustrate posting to le&ger accounts0 Aater, 'e sho' "ou ho' to post the (icroTrain Co$pan" 3ournal entries to le&ger accounts0 6n %xhi it 1B, the )irst 3ournal entr" )or the ;en!s Co$pan" &irects that M,< 1B,BBB e poste& in the le&ger as a &e it to the Cash account an& as a cre&it to the Capital ,toc! account0 =e post the &e it in the general le&ger Cash account " using the )ollo'ing proce&ure: %nter in the Cash account the &ate, a short explanation, the 3ournal &esignation (K2K )or general 3ournal) an& the 3ournal page nu$ er )ro$ 'hich the &e it is poste&, an& the M,< 1B,BBB in the <e it colu$n0 Then, enter the nu$ er o) the account to 'hich the &e it is poste& in the Posting :e)erence colu$n o) the general 3ournal0 Post the cre&it in a si$ilar $anner ut as a cre&it to Account /o0 +BB0 The arro's in %xhi it 1B sho' ho' these a$ounts 'ere poste& to the correct accounts0 %xhi it 1B sho's the le&ger account0 6n contrast to the t'o-si&e& T-account )or$at sho'n so )ar, the three-colu$n )or$at has colu$ns )or &e it, cre&it, an& alance0 The three-colu$n )or$ has the

p. 1BC o) *++

a&vantage o) sho'ing the alance o) the account a)ter each ite$ has een poste&0 6n a&&ition, in this chapter, 'e in&icate 'hether each alance is a &e it or a cre&it0 6n later chapters an& in practice, the nature o) the alance is usuall" not in&icate& since it is un&erstoo&0 Also, notice that 'e give an explanation )or each ite$ in the le&ger accounts0 O)ten accountants o$it these explanations ecause each ite$ can e trace& ac! to the general 3ournal )or the explanation0 Posting is al'a"s )ro$ the 3ournal to the le&ger accounts0 Postings can e $a&e (1) at the ti$e the transaction is 3ournali5e&? (I) at the en& o) the &a", 'ee!, or $onth? or (+) as each 3ournal page is )ille&0 The choice is a $atter o) personal taste0 =hen posting the general 3ournal, the &ate use& in the le&ger accounts is the &ate the transaction 'as recor&e& in the 3ournal, not the &ate the 3ournal entr" 'as poste& to the le&ger accounts0 Fre4uentl", accountants $ust chec! an& trace the origin o) their transactions, so the" provi&e crossin&exing0 Cross-in.exing is the placing o) (1) the account nu$ er o) the le&ger account in the general 3ournal an& (I) the general 3ournal page nu$ er in the le&ger account0 As sho'n in %xhi it 1B, the account nu$ er o) the le&ger account to 'hich the posting 'as $a&e is in the Posting :e)erence colu$n o) the general 3ournal0 /ote the arro' )ro$ Account /o0 1BB in the le&ger to the 1BB in the Posting :e)erence colu$n esi&e the )irst &e it in the general 3ournal0 Accountants place the nu$ er o) the general 3ournal page )ro$ 'hich the entr" 'as poste& in the Posting :e)erence colu$n o) the le&ger account0 /ote the arro' )ro$ page 1 in %xhi it 1B the general 3ournal to 21 in the Posting :e)erence colu$n o) the Cash account in the general le&ger0 The notation K21K $eans general 3ournal, page 10 The &ate o) the transaction also appears in the general le&ger0 /ote the arro's )ro$ the &ate in the general 3ournal to the &ates in the general le&ger0
=a)e " JEN6S COM.AN@ 8eneral Journal :ate 20"0 1an' $ccount Titles and Explanation "#&% ,as0 #>$% ,apital Stoc6 #>SE% Stoc60olders invested $"0,000 cas0 in t0e 5usiness' 5 ,as0 #>$% otes =a2a5le #>4% &orro;ed $5,000 (ro! t0e 5an6 on a note' ?8eneral $ed+er Ca#h Explanation 20"0 31an' #&%" Stoc60olders invest!ent 5 &an6 loan =ost Re(' G" G" :e5t #$% " 0 0 0 0 5 0 0 0 ,redit "00 20" 5 0 0 0 5 0 0 0 =ost' :e5it Re(' #,%"00 " 0 0 0 0 #$% 300 ,redit

" 0 0 0 0 #:%

$ccount o "00#,%
&alance " 0 0 0 0 :r " 5 0 0 0 :r

p. 1BD o) *++

Note# .aya&le :ate 20"0 1an' 5 Explanation &orro;ed cas0 =ost Re(' G" :e5t ,redit 5 0 0 0

$ccount o' 20"
&alance 5 0 0 0 ,r

Ca1%tal Stoc' Explanation 20"0 K 1an' #&%" ,as0 (ro! stoc60olders =ost Re(' G" :e5t ,redit # " 0 0 0 0 : %

$ccount o' 300 &alance
" 0 0 0 0 ,r

%xhi it 1B: 2eneral 3ournal an& general le&ger? posting an& cross-in&exing Cross-in&exing ai&s the tracing o) an" recor&e& transaction, either )ro$ general 3ournal to general le&ger or )ro$ general le&ger to general 3ournal0 /or$all", the" place cross-re)erence nu$ ers in the Posting :e)erence colu$n o) the general 3ournal 'hen the entr" is poste&0 6) this practice is )ollo'e&, the cross-re)erence nu$ ers in&icate that the entr" has een poste&0

p. 1B@ o) *++

MICROTRAIN COM.AN@ 8eneral Journal

=a)e" =ost' :e5it Re('
"00J 300 5 0 0 0 0 5 0 0 0 0

:ate
20"0 ov' 29

$ccount Titles and Explanation
,as0 #>$% ,apital Stoc6 #>SE% Stoc60olders invested $50,000 cas0 in t0e 5usiness'

,redit

:ec

"

Truc6 #>$% ,as0 #3$% To record t0e purc0ase o( (our truc6s'

"50 "00

4 0 0 0 0 4 0 0 0 0

"

=repaid .nsurance #>$% ,as0 #3$% =urc0ased truc6 insurance to cover a one32ear period'

"09 "00

2 4 0 0 2 4 0 0

"

=repaid Rent #>$% ,as0 #3$% =aid t0ree !ont0s8 rent on a 5uildin)'

""2 "00

" 2 0 0 " 2 0 0

4

Supplies on Aand #>$% $ccounts =a2a5le #>4% To record t0e purc0ase o( trainin) supplies (or (uture use'

"07 200

" 4 0 0 " 4 0 0

7

,as0 #>$% -nearned Service /ees #>4% To record t0e receipt o( cas0 (ro! a custo!er in pa2!ent (or (uture trainin) services'

"00 2"6

4 5 0 0 4 5 0 0

"5

,as0 #>$% Service Revenue #>SE% To record t0e receipt o( cas0 (or per(or!in) trainin) services (or a custo!er'

"00 400

5 0 0 0 5 0 0 0

"7

$ccounts =a2a5le #34% ,as0 #3$% =aid t0e account pa2a5le arisin) (ro! t0e purc0ase o( supplies on :ece!5er 4' 8eneral Journal

200 "00

" 4 0 0 " 4 0 0

=a)e 2

:ate
20"0 :ec' 20

$ccount Titles and Explanation
$ccounts Receiva5le #>$%

=ost' :e5it
Re(' "03 5 7 0 0

,redit

p. 1B8 o) *++

Service Revenue #>SE% To record t0e per(or!ance o( trainin) services on account (or ;0ic0 a custo!er ;as 5illed' 24 $dvertisin) Expense #3SE% $ccounts =a2a5le #>4% Received a 5ill (or advertisin) (or t0e !ont0 o( :ece!5er' 26 ,as0 #>$% $ccounts Receiva5le #3$% Received $500 (ro! a custo!er on accounts receiva5le' 29 Salaries Expense #3SE% ,as0 #3$% =aid trainin) personnel salaries (or t0e (irst (our ;ee6s o( :ece!5er' 2@ -tilities Expense #3SE% ,as0 #3$% =aid t0e utilities 5ill (or :ece!5er' 30 Gas and +il Expense #3SE% $ccounts =a2a5le #3$% Received a 5ill (or )as and oil used in t0e truc6s (or :ece!5er' 3" :ividends #3SE% ,as0 #3$% :ividends ;ere paid to stoc60olders'

400

5 7 0 0

505 200

5 0 5 0

"00 "03

5 0 0 5 0 0

507 "00

3 6 0 0 3 6 0 0

5"" "00

" 5 0 " 5 0

506 200

6 9 0 6 9 0

320 "00

3 0 0 0 3 0 0 0

%xhi it 11: 2eneral 3ournal (a)ter posting) To un&erstan& the posting an& cross-in&exing process, trace the entries )ro$ the general 3ournal to the general le&ger0 The le&ger accounts nee& not contain explanations o) all the entries, since an" nee&e& explanations can e o taine& )ro$ the general 3ournal0 Aoo! at %xhi it 11 to see ho' all the /ove$ er an& <ece$ er transactions o) (icroTrain Co$pan" 'oul& e 3ournali5e&0 As sho'n in %xhi it 11, "ou s!ip a line et'een 3ournal entries to sho' 'here one 3ournal entr" en&s an& another egins0 This proce&ure is stan&ar& practice a$ong accountants0 /ote that no &ollar signs appear in 3ournals or le&gers0 =hen a$ounts are in even &ollar a$ounts, accountants leave the cents colu$n lan! or use 5eros or a &ash0 =hen the" use line& accounting 'or!

p. 1B> o) *++

papers, co$$as or &eci$al points are not nee&e& to recor& an a$ount0 =hen the" use unline& paper, the" a&& oth co$$as an& &eci$al points0 /ext, o serve %xhi it 1I, the three-colu$n general le&ger accounts o) (icroTrain Co$pan" a)ter the 3ournal entries have een poste&0 %ach le&ger account 'oul& appear on a separate page in the le&ger0 Trace the postings )ro$ the general 3ournal to the general le&ger to $a!e sure "ou !no' ho' to post 3ournal entries0 All the 3ournal entries illustrate& so )ar have involve& one &e it an& one cre&it? these 3ournal entries are calle& simple 2ournal entries0 (an" usiness transactions, ho'ever, a))ect $ore than t'o accounts0 The 3ournal entr" )or these transactions involves $ore than one &e it an&7or cre&it0 ,uch 3ournal entries are calle& compoun. 2ournal entries. As an illustration o) a co$poun& 3ournal entr", assu$e that on IB11 ;anuar" I, (icroTrain Co$pan" purchase& M,< 8,BBB o) training e4uip$ent )ro$ =ilson Co$pan"0 ,ee elo'0
MICROTRAIN COM.AN@ 8eneral $ed+er Ca#h

$ccount o' "00
,redit &alance 5 0 0 0 0 :r

:ate 20"0 :ec' " " " " 7 "5 "7 26 29 2@ 3"

Explanation &e)innin) 5alanceJ Truc6s =repaid insurance =repaid rent -nearned service (ees Service revenue =aid account pa2a5le ,ollected account receiva5le Salaries -tilities :ividends Account# Rece%2a&le

=ost Re(' G" G" G" G" G" G" G2 G2 G2 G2

:e5it

4 0 0 0 0 2 4 0 0 " 2 0 0 4 5 0 0 5 0 0 0 " 4 0 0 5 0 0 3 6 0 0 " 5 0 3 0 0 0

" 0 0 0 0 :r 7 6 0 0 :r 6 4 0 0 :r " 0 @ 0 0 :r " 5 @ 0 0 :r " 4 5 0 0 :r " 5 0 0 0 :r " " 4 0 0 :r " " 2 5 0 :r 9 2 5 0 :r

$ccount o' "03
=ost Re(' G2 G2 :e5it 5 7 0 0 5 0 0 ,redit &alance 5 7 0 0 :r 5 2 0 0 :r

:ate 20"0 :ec' 20 26

Explanation Service revenue ,ollections Su11l%e# on 9and

$ccount o' "07
=ost Re(' G" :e5it " 4 0 0 ,redit &alance " 4 0 0 :r

:ate 20"0 :ec' 4

Explanation =urc0ased on account

p. 11B o) *++

.re1a%d In#urance :ate 20"0 :ec' " Explanation +ne32ear polic2 on truc6s 8eneral $ed+er .re1a%d Rent :ate 20"0 :ec' " Explanation T0ree3!ont0 pa2!ent Truc'# :ate 20"0 :ec' " Explanation =aid cas0 Account# .aya&le :ate 20"0 :ec' 4 "7 24 30 Explanation Supplies =aid (or supplies $dvertisin) Gas and oil Unearned Ser2%ce Fee# :ate 20"0 :ec' 7 Explanation Received cas0 Ca1%tal Stoc' :ate 20"0 :ec' " Explanation &e)innin) 5alance 8eneral $ed+er :%2%dend# :ate 20"0 :ec' 3" Explanation ,as0 Ser2%ce Re2enue :ate 20"0 :ec' "5 Explanation ,as0 =ost Re(' G" :e5t =ost Re(' G2 :e5t 3 =ost Re(' :e5it =ost Re(' G" :e5it =ost Re(' G" G" G2 G2 :e5it =ost Re(' G" :e5it 4 0 =ost Re(' G" :e5it " =ost Re(' G" :e5it

$ccount o' "09
,redit 2 4 0 0 =a)e " $ccount o' ""2 ,redit 2 0 0 &alance 2 4 0 0 :r

&alance " 2 0 0 :r

$ccount o' "50
,redit 0 0 0 &alance 4 0 0 0 0 :r

$ccount o' 200
,redit " 4 " 4 0 0 5 0 6 9 % 0 0 &alance " 4 0 0 ,r 3 0 3 5 0 ,r 7 3 0 ,r

$ccount o' 2"6
,redit 4 5 0 0 &alance 4 5 0 0 ,r

$ccount o' 300
,redit &alance 5 0 0 0 0 ,r =a)e 3 $ccount o' 320 ,redit 0 0 0

&alance 3 0 0 0 :r

$ccount o' 400
,redit 5 0 0 0 &alance 5 0 0 0 ,r

p. 111 o) *++

20

+n account Ad2ert%#%n+ E01en#e

G2

5 7

0 0

" 0 7 0 0 ,r

$ccount o' 505
=ost Re(' G2 :e5t 5 0 ,redit &alance 5 0 :r

:ate 20"0 :ec' 24

Explanation +n account 8a# and O%l E01en#e

$ccount o' 506
=ost Re(' G2 :e5t 6 9 0 ,redit &alance 6 9 0 :r

:ate 20"0 :ec' 30

Explanation +n account Salar%e# E01en#e

$ccount o' 507
=ost Re(' G2 :e5t 3 6 0 0 ,redit &alance 3 6 0 0 :r

:ate 20"0 :ec' 29

Explanation ,as0 paid Ut%l%t%e# E01en#e

$ccount o' 5""
=ost Re(' G2 :e5t " 5 0 ,redit &alance " 5 0 :r

:ate 20"0 :ec' 2@

Explanation ,as0 paid

%xhi it 1I: 2eneral le&ger - %xten&e& illustration
MICROTRAIN COM.AN@ Tr%al !alance :ecem&er 1" 2010 Account T%tle ,as0 $ccounts Receiva5le Supplies on Aand =repaid .nsurance =repaid Rent Truc6s $ccounts =a2a5le -nearned Service /ees ,apital Stoc6 :ividends Service Revenue $dvertisin) Expense Gas and +il Expense Salaries Expense -tilities Expense 50 690 3,600 "50 3,000 "0,700 :e&%t# $ 9,250 5,200 ",400 2,400 ",200 40,000 $ 730 4,500 50,000 Cred%t#

Acct. No. "00 "03 "07 "09 ""2 "50 200 2"6 300 320 400 505 506 507 5""

%xhi it 1+: Trail alance

p. 11I o) *++

(icroTrain pai& M,< I,BBB cash 'ith the alance &ue on IB11 (arch +0 The general 3ournal entr" )or (icroTrain Co$pan" is:
:e&%t 20"" 1an' 2 E7uip!ent #>$% ,as0 #3$% $ccounts =a2a5le #>4% Trainin) e7uip!ent purc0ased (ro! Lilson ,o!pan2' 9,000 2,000 6,000 Cred%t

/ote that the )ir$ cre&its t'o accounts, Cash an& Accounts Pa"a le, in this one entr"0 #o'ever, the &ollar totals o) the &e its an& cre&its are e4ual0 Perio&icall", accountants use a trial alance to test the e4ualit" o) their &e its an& cre&its0 A trial balance is a listing o) the le&ger accounts an& their &e it or cre&it alances to &eter$ine that &e its e4ual cre&its in the recor&ing process0 The accounts appear in this or&er: assets, lia ilities, stoc!hol&ersJ e4uit", &ivi&en&s, revenues, an& expenses0 =ithin the assets categor", the $ost li4ui& (closest to eco$ing cash) asset appears )irst an& the least li4ui& appears last0 =ithin the lia ilities, those lia ilities 'ith the shortest $aturities appear )irst0 ,tu&" %xhi it 1+, the trial colu$n )or &e it alances, the colu$n )or cre&it alances, an& the e4ualit" o) the t'o totals0 =hen the trial alance &oes not alance, tr" re-totaling the t'o colu$ns0 6) this step &oes not locate the error, &ivi&e the &i))erence in the totals " I an& then " >0 6) the &i))erence is &ivisi le " I, "ou $a" have trans)erre& a &e it- alance& account to the trial alance as a cre&it, or a cre&it- alance& account as a &e it0 =hen the &i))erence is &ivisi le " I, loo! )or an a$ount in the trial alance that is e4ual to one-hal) o) the &i))erence0 Thus, i) the &i))erence is M,< 8BB, loo! )or an account 'ith a alance o) M,< *BB an& see i) it is in the 'rong colu$n0 6) the &i))erence is &ivisi le " >, "ou $a" have $a&e a transposition error in trans)erring a alance to the trial alance or a sli&e error0 A transposition error occurs 'hen t'o &igits are reverse& in an a$ount (e0g0 'riting @C+ as C@+ or 11B as 1B1)0 A sli&e error occurs 'hen "ou place a &eci$al point incorrectl" (e0g0 M,< 1,CBB recor&e& as M,< 1C0BB)0 Thus, 'hen a &i))erence is &ivisi le " >, co$pare the trial alance a$ounts 'ith the general le&ger account alances to see i) "ou $a&e a transposition or sli&e error in trans)erring the a$ounts0 alance )or (icroTrain Co$pan"0 /ote the listing o) the account nu$ ers an& account titles on the le)t, the

p. 11+ o) *++

#n et%ical perspecti'e: Financial <eals, 1nc.
Aarr" Fisher 'as captain o) the )oot all tea$ at Prestige Mniversit"0 Aater, he earne& a $asterJs &egree in usiness a&$inistration 'ith a concentration in accounting0 Mpon gra&uation, Aarr" accepte& a position 'ith Financial <eals, 6nc0, in the accounting an& )inance &ivision0 At )irst, things 'ere going s$oothl"0 #e 'as tall, goo& loo!ing, an& ha& an outgoing personalit"0 The presi&ent o) the co$pan" too! a li!ing to hi$0 #o'ever, Aarr" 'as so$e'hat othere& 'hen the presi&ent starte& as!ing hi$ to &o so$e things that 'ere slightl" unethical0 =hen he proteste& $il&l", the presi&ent sai&: KCo$e on, son, this is the 'a" the usiness 'orl& 'or!s0 .ou have great potential i) "ou &onJt let things li!e this get in "our 'a"0K As ti$e 'ent on, Aarr" 'as as!e& to &o things that 'ere $ore unethical, an& )inall" he 'as per)or$ing illegal acts0 =hen he resiste&, the presi&ent appeale& to his lo"alt" an& as!e& hi$ to e a tea$ pla"er0 The presi&ent also pro$ise& Aarr" great 'ealth so$eti$e in the )uture0 Finall", 'hen he 'as tol& to )alsi)" so$e )inancial state$ents " $a!ing i$proper entries an& to sign so$e &ocu$ents containing $aterial errors, the presi&ent supporte& his re4uest " stating: K.ou are in too &eep no' to re)use to cooperate0 6) 6 go &o'n, "ou are going 'ith $e0K Through various co$pan" sche$es, Aarr" ha& convince& so$e )rien&s an& relatives to invest a out M,< 1B $illion0 (ost o) this 'oul& e lost i) the various co$pan" sche$es 'ere reveale&0 Aarr" coul& not sleep at night an& egan each &a" 'ith a pain in his sto$ach an& " eco$ing ph"sicall" ill0 #e 'as un&er great strain an& elieve& that he coul& lose his $in&0 #e also hear& that the presi&ent ha& a sha&" past an& coul& eco$e violent in retaliating against his ene$ies0 6) Aarr" lo's the 'histle, he elieves he 'ill go to prison )or his part in the sche$es0 (/ote: This scenario is ase& on an actual situation 'ith so$e )acts change& to protect the guilt"0)

6) "ou still cannot )in& the error, it $a" e &ue to one o) the )ollo'ing causes:
 Failing to post part o) a 3ournal entr"0  Posting a &e it as a cre&it, or vice versa0  6ncorrectl" &eter$ining the alance o) an account0  :ecor&ing the alance o) an account incorrectl" in the trial alance0  O$itting an account )ro$ the trial alance0

p. 11* o) *++

 (a!ing a transposition or sli&e error in the accounts or the 3ournal0

Msuall", "ou shoul& 'or! ac!'ar& through the steps ta!en to prepare the trial alance0 Assu$ing "ou have alrea&" re-totale& the colu$ns an& trace& the a$ounts appearing in the trial alance ac! to the general le&ger account alances, use the )ollo'ing steps: Geri)" the alance o) each general le&ger account, veri)" postings to the general le&ger, veri)" general 3ournal entries, an& then revie' the transactions an& possi l" the source &ocu$ents0 The e4ualit" o) the t'o totals in the trial alance &oes not necessaril" $ean that the accounting process has een error-)ree0 ,erious errors $a" have een $a&e, such as )ailure to recor& a transaction, or posting a &e it or cre&it to the 'rong account0 For instance, i) a transaction involving pa"$ent o) a M,< 1BB account pa"a le is never recor&e&, the trial alance totals still alance, ut at an a$ount that is M,< 1BB too high0 Both cash an& accounts pa"a le 'oul& e overstate& " M,< 1BB0 .ou can prepare a trial alance at an" ti$eLat the en& o) a &a", a 'ee!, a $onth, a 4uarter, or a "ear0 T"picall", "ou 'oul& prepare a trial alance e)ore preparing the )inancial state$ents0

#n accounting perspecti'e: 6ses o0 tec%nology
The co$puters o) persons in a given &epart$ent or uil&ing are )re4uentl" connecte& in a Aocal Area /et'or! (AA/)0 These persons can then access si$ultaneousl" the progra$s an& &ata ases store& in the AA/ an& can co$$unicate 'ith all other persons in the AA/ through e$ail0 A $ore a&vance& t"pe o) co$puter net'or! is calle& Client7,erver Co$puting0 Mn&er this structure, an" co$puter in the net'or! can e use& to up&ate the in)or$ation store& else'here in the net'or!0 For exa$ple, accounting in)or$ation store& in one co$puter coul& e up&ate& " authori5e& persons )ro$ a nu$ er o) other co$puters in the s"ste$0 The use o) net'or!s is &esigne& to i$prove e))icienc" an& to re&uce so)t'are an& har&'are costs0

3.18 Anal -ing and using the financial results9 *ori-ontal and vertical anal ses
The calculation o) &ollar an&7or percentage changes )ro$ one "ear to the next in an ite$ on )inancial state$ents is %ori4ontal analysis0 For instance, in the )ollo'ing &ata ta!en )ro$ the IBBB annual report o) #e'lett-Pac!ar& Co$pan", the a$ount o) inventor" increase& " M,< 8+D $illion )ro$ 1>>> Octo er +1, to IBBB Octo er +10 This a$ount represente& a 1@ per cent increase0 To )in& the

p. 11C o) *++

a$ount o) the increase or &ecrease, su tract the 1>>> a$ount )ro$ the IBBB a$ount0 To )in& the percentage change, &ivi&e the increase or &ecrease " the 1>>> a$ount0 Nno'ing the &ollar a$ount an& percentage o) change in an a$ount is $uch $ore $eaning)ul than $erel" !no'ing the a$ount at one point in ti$e0 B" anal"5ing the &ata, 'e can see that cash an& cash e4uivalents &ecline& in IBBB0 Their &ecline at least partiall" explains the increases in so$e o) the other current assets0 =e can also see that the co$pan" investe& in propert", plant an& e4uip$ent0 An" ter$s in #e'lett-Pac!ar&Js list o) assets that "ou &o not un&erstan& are explaine& in later chapters0 At this point, all 'e 'ant "ou to un&erstan& is the nature o) hori5ontal an& vertical anal"ses0 Bertical analysis sho's the percentage that each ite$ in a )inancial state$ent is o) so$e signi)icant total such as total assets or sales0 For instance, in the #e'lett-Pac!ar& &ata 'e can see that cash an& cash e4uivalents 'ere 1C0+ per cent o) total assets as o) 1>>> Octo er +1, an& ha& &ecline& to 1B0B per cent o) total assets " IBBB Octo er +10 Total current assets (cash plus other a$ounts that 'ill eco$e cash or e use& up 'ithin one "ear) increase& )ro$ D10+ per cent o) total assets to D80+ per cent &uring IBBB0 Aong-ter$ invest$ents an& other non-current assets accounte& )or 180* per cent o) total assets as o) IBBB Octo er +10
Increa#e or 4:ecrea#e5 2000 o2er 1CCC 2000 A##et# 4%n m%ll%on#5 Current a##et#? ,as0 and cas0 e7uivalents S0ort3ter! invest!ents $ccounts receiva5le /inancin) receiva5les .nventor2 +t0er current assets Total current assets .ro1erty" 1lant and e)u%1ment? =ropert2, plant and e7uip!ent, net $on+-term %n2e#tment# and other non-current a##et# Total assets $ 3,4"5 5@2 6,3@4 2,"74 5,6@@ 4,@70 $ 23,244 4,500 6,265 $ 34,00@ $ 5,4"" "7@ 5,@59 ",99@ 4,963 3,342 $ 2",642 4,333 @,322 $ 35,2@7 $ #",@@6% 4"3 436 295 936 ",629 $ ",602 "67 #3,057% $ #",299% 337D 23"D 7D "5D "7D 4@D 7D 4D 333D 34D "0'0D "'7D "9'9D 6'4D "6'9D "4'6D 69'3D "3'2D "9'4D "00'0D "5'3D 0'5D "6'@D 5'4D "3'9D @'5D 6"'3D "2'3D 26'4D "00'0D 1CCC :ollar# .ercent .ercent o* Total A##et# Octo&er 1 2000 1CCC

(anage$ent per)or$s hori5ontal an& vertical anal"ses along 'ith other )or$s o) anal"sis to help evaluate the 'is&o$ o) its past &ecisions an& to plan )or the )uture0 Other &ata 'oul& have to e exa$ine& e)ore &ecisions coul& e $a&e regar&ing the assets sho'n0 For instance, i) "ou &iscovere& the lia ilities that 'oul& have to e pai& 'ithin a short ti$e " #e'lett-Pac!ar& 'ere $ore than M,< +B illion, "ou $ight conclu&e that the co$pan" is short o) cash even though current assets increase&

p. 11D o) *++

su stantiall" &uring IBBB0 =e illustrate hori5ontal an& vertical anal"ses to a $uch greater extent later in the text0

#n accounting perspecti'e: Business insig%t
(an" co$panies have een restructuring their organi5ations an& re&ucing the nu$ er o) e$plo"ees to cut expenses0 2eneral (otors, ATPT, 6B(, an& nu$erous other co$panies have ta!en this action0 One coul& 4uestion 'hether co$panies place as $uch value on their e$plo"ees as in the past0 6n previous "ears it 'as co$$on to see the )ollo'ing state$ent in the annual reports o) co$panies: KOur e$plo"ees are our $ost valua le assetK0 Co$panies are not per$itte& to sho' e$plo"ees as assets on their alance sheets0 <o "ou thin! the" shoul& e allo'e& to &o soQ

=hat "ou have learne& in this chapter is asic to "our stu&" o) accounting0 The entire process o) accounting is ase& on the &ou le-entr" concept0 Chapter + explains that a&3ust$ents ring the accounts to their proper alances e)ore accurate )inancial state$ents are prepare&0

3.18.1

.nderstanding the learning objectives

 An account is a storage unit use& to classi)" an& su$$ari5e $one" $easure$ents o) usiness

activities o) a si$ilar nature0
 A )ir$ sets up an account 'henever it nee&s to provi&e use)ul in)or$ation a out a particular

usiness ite$ to so$e part" having a vali& interest in the usiness0
 A T-account rese$ les the letter T0  <e its are entries on the le)t si&e o) a T-account0  Cre&its are entries on the right si&e o) a T-account0  <e its increase asset, expense, an& <ivi&en&s accounts0  Cre&its increase lia ilit", stoc!hol&ersJ e4uit", an& revenue accounts0  Anal"5e transactions " exa$ining source &ocu$ents0  ;ournali5e transactions in the 3ournal0  Post 3ournal entries to the accounts in the le&ger0  Prepare a trial alance o) the accounts an& co$plete the 'or! sheet0  Prepare )inancial state$ents0

p. 11@ o) *++

 ;ournali5e an& post a&3usting entries0  ;ournali5e an& post closing entries0 Prepare a post-closing trial alance0  A 3ournal contains a chronological recor& o) the transactions o) a usiness0 An exa$ple o) a

general 3ournal is sho'n in %xhi it 110 ;ournali5ing is the process o) entering a transaction in a 3ournal0
 Posting is the process o) trans)erring in)or$ation recor&e& in the 3ournal to the proper places

in the le&ger0
 Cross-in&exing is the placing o) (1) the account nu$ er o) the le&ger account in the general

3ournal an& (I) the general 3ournal page nu$ er in the le&ger account0
 An exa$ple o) cross-in&exing appears in %xhi it 1B0  A trial alance is a listing o) the le&ger accounts an& their &e it or cre&it alances0  6) the trial alance &oes not alance, an accountant 'or!s ac!'ar& to &iscover the error0  A trial alance is sho'n in %xhi it 1+0  #ori5ontal anal"sis involves calculating the &ollar an&7or percentage changes in an ite$ )ro$

one "ear to the next0
 Gertical anal"sis sho's the percentage that each ite$ in a )inancial state$ent is o) so$e

signi)icant total0

3.18.2

Demonstration problem
8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: !alance Sheet 2010 June 0 A##et# ,as0 $ccounts receiva5le 4and Total assets $%a&%l%t%e# and Stoc'holder#( E)u%ty 4ia5ilities: $ccounts pa2a5le otes pa2a5le Total lia5ilities Stoc60olders8 e7uit2: ,apital stoc6 Retained earnin)s Total stoc60olders8 e7uit2 Total lia5ilities and stoc60olders8 e7uit2 $ "0,000 2,"00 "2,"00 $52,@00 $ 900 40,000 $ 40,900 $ 7,500 5,400 40,000 $ 52,@00

2reen #ills :i&ing ,ta le, 6ncorporate&, ha& the )ollo'ing alance sheet on IB1B ;une +B:

p. 118 o) *++

a0 Prepare the 3ournal entries to recor& the transactions )or ;ul" IB1B0 0 Post the 3ournal entries to the le&ger accounts a)ter entering the eginning alances in those accounts0 6nsert cross-in&exing re)erences in the 3ournal an& le&ger0 Mse the )ollo'ing chart o) accounts:
"00 "03 "30 "40 200 20" 300 3"0 ,as0 $ccounts Receiva5le 4and &uildin)s $ccounts =a2a5le otes =a2a5le ,apital Stoc6 Retained Earnin)s 320 402 404 507 5"3 540 569 :ividends Aorse &oardin) /ees Revenue Ridin) and 4esson /ees Revenue Salaries Expense /eed Expense .nterest Expense *iscellaneous Expense

c0 Prepare a trial alance0

3.18.3
a0

6olution to demonstration problem
8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: 8eneral Journal

=a)e" ,redit
2 5 0 0 0 2 5 0 0 0

:ate
20"0 1ul2 "

$ccount Titles and Explanation
,as0 #>$% ,apital Stoc6 #>SE% $dditional capital stoc6 issued' " &uildin)s #>$% ,as0 #3$% =aid (or 5uildin)' 9 $ccount =a2a5le #34% ,as0 #3$% =aid accounts pa2a5le' "0 ,as0 #>$% $ccounts Receiva5le #3$% ,ollected accounts receiva5le' "2 /eed Expense #3SE% $ccounts =a2a5le #>4% =urc0ased (eed on account "5 $ccounts Receiva5le #>$% Aorse &oardin) /ee Revenue #>SE% &illed 5oardin) (ees (or 1ul2'

=ost' :e5it Re('
"00 300

"40 "00

2 4 0 0 0 2 4 0 0 0

200 "00

9 0 0 9 0 0

"00 "03

5 4 0 0 5 4 0 0

5"3 200

" " 0 0 " " 0 0

"03 402

4 5 0 0 4 5 0 0

p. 11> o) *++

24

*iscellaneous Expense #3SE% ,as0 #3$% =aid !iscellaneous expenses (or 1ul2'

569 "00

9 0 0 9 0 0

3"

.nterest Expense #3SE% ,as0 #3$% =aid interest

540 "00

2 0 0 2 0 0

3"

Salaries Expense #3SE% ,as0 #3$% =aid salaries (or 1ul2'

507 "00

" 4 0 0 " 4 0 0

3"

$ccounts Receiva5le #>$% Ridin) and 4esson /ee Revenue #>SE% &illed ridin) and lesson (ees (or 1ul2'

"03 404

3 6 0 0 3 6 0 0

3"

:ividends #3SE% ,as0 #3$% =aid a dividend to stoc60olders'

320 "00

" 0 0 0 " 0 0 0

b.
$and :ate 20"0 1une 30 1ul2 " " 9 "0 24 3" 3" 3" Explanation &alance Stoc60olders8 invest!ent &uildin)s $ccounts pa2a5le $ccounts receiva5le *iscellaneous expense .nterest expense Salaries expense :ividends

8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: 8eneral $ed+er $ccount o' "00 =ost Re(' G" G" G" G" G" G" G" G" 5 4 0 0 9 0 0 2 0 0 " 4 0 0 " 0 0 0 :e5t ,redit &alance 7 5 0 0 0 :r 2 5 0 0 0 2 4 0 0 0 9 0 0 3 2 5 0 0 :r 9 5 0 0 :r 7 7 0 0 :r " 3 " 0 0 :r " 2 3 0 0 :r " 2 " 0 0 :r " 0 7 0 0 :r @ 7 0 0 :r

Account# Rece%2a&le :ate 20"0 1une 30 1ul2 "0 "5 3" Explanation &alance ,as0 Aorse 5oardin) (ees Ridin) and lessons (ees G" G" G" =ost Re(' :e5t

$ccount o' "03
,redit &alance 5 4 0 0 :r 5 4 0 0 4 5 0 0 3 6 0 0 3 0 3 4 5 0 0 :r 9 " 0 0 :r

p. 1IB o) *++

$and :ate 20"0 1une 30 Explanation &alance !u%ld%n+# :ate 20"0 1ul2 " Explanation ,as0 Account# .aya&le :ate 20"0 1une 30 1ul2 9 "2 Explanation &alance ,as0 /eed expense G" G" =ost Re(' :e5t =ost Re(' G" :e5t =ost Re(' :e5t

$ccount o' "30
,redit &alance 4 0 0 0 0 :r

$ccount o' "40
,redit &alance 2 4 0 0 0 :r

2 4 0 0 0

$ccount o' 200
,redit &alance 9 0 0 ,r 9 0 0 " " 0 0 3 0 3 " " 0 0 ,r

Note# .aya&le :ate 20"0 1une 30 Explanation &alance Ca1%tal Stoc' :ate 20"0 1une 30 1ul2 " Explanation &alance ,as0

8eneral $ed+er #continued% =ost Re(' :e5t

$ccount o' 20" ,redit

&alance 4 0 0 0 0 ,r

$ccount o' 300
=ost Re(' G" :e5t ,redit &alance " 0 0 0 0 ,r 2 5 0 0 0 3 5 0 0 0 ,r

Reta%ned Earn%n+# :ate 20"0 1une 30 Explanation &alance :%2%dend# :ate 20"0 1ul2 3" Explanation ,as0 9or#e !oard%n+ Fee Re2enue :ate 20"0 1ul2 "5 Explanation $ccounts receiva5le R%d%n+ and $e##on Fee Re2enue =ost Re(' G" :e5t =ost Re(' G" :e5t =ost Re(' :e5t

$ccount o' 3"0
,redit &alance 2 " 0 0 ,r

$ccount o' 320
,redit " 0 0 0 &alance " 0 0 0 :r

$ccount o' 402
,redit 4 5 0 0 &alance 4 5 0 0 ,r

$ccount o' 404

p. 1I1 o) *++

:ate 20"0 1ul2 3"

Explanation $ccounts receiva5le

=ost Re(' G"

:e5t

,redit 3 6 0 0

&alance 3 6 0 0 ,r

8eneral $ed+er #concluded% Salar%e# E01en#e :ate 20"0 1ul2 3" Explanation ,as0 Feed E01en#e :ate 20"0 1ul2 "2 Explanation $ccounts pa2a5le Intere#t E01en#e :ate 20"0 1ul2 3" Explanation ,as0 M%#cellaneou# E01en#e :ate 20"0 1ul2 24 Explanation ,as0 =ost Re(' G" :e5t =ost Re(' G" :e5t =ost Re(' G" :e5t =ost Re(' G" :e5t

$ccount o' 507 ,redit

&alance " 4 0 0 :r

" 4 0 0

$ccount o' 5"3
,redit " " 0 0 &alance " " 0 0 :r

$ccount o' 540
,redit 2 0 0 &alance 2 0 0 :r

$ccount o' 569
,redit 9 0 0 &alance 9 0 0 :r

c.

8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: Tr%al !alance 2010 July 1

Acct. No. "00 "03 "30 "40 200 20" 300 3"0 320 402 404 507 5"3 540 569 Account T%tle ,as0 $ccounts Receiva5le 4and &uildin)s $ccounts =a2a5le otes =a2a5le ,apital Stoc6 Retained Earnin)s :ividends Aorse &oardin) /ee Revenue Ridin) and 4esson /ee Revenue Salaries Expense /eed Expense .nterest Expense *iscellaneous Expense ",400 ","00 200 900 $96,300 $96,300 ",000 4,500 3,600 :e&%t# $ @,700 9,"00 40,000 24,000 $ ","00 40,000 35,000 2,"00 Cred%t#

p. 1II o) *++

3.11 ;e terms
#ccount A part o) the accounting s"ste$ use& to classi)" an& su$$ari5e the increases, &ecreases, an& alances o) each asset, lia ilit", stoc!hol&ersJ e4uit" ite$, &ivi&en&, revenue, an& expense0 The three-colu$n account is nor$all" use&0 6t contains colu$ns )or &e it, cre&it, an& alance0 #ccounting cycle A series o) steps per)or$e& &uring the accounting perio& (so$e throughout the perio& an& so$e at the en&) to anal"5e, recor&, classi)", su$$ari5e, an& report use)ul )inancial in)or$ation )or the purpose o) preparing )inancial state$ents0 #ccrual basis o0 accounting :ecogni5es revenues 'hen sales are $a&e or services are per)or$e&, regar&less o) 'hen cash is receive&0 :ecogni5es expenses as incurre&, 'hether or not cash has een pai& out0 Business transactions (easura le events that a))ect the )inancial con&ition o) a usiness0 C%art o0 accounts The co$plete listing o) the account titles an& account nu$ ers o) all o) the accounts in the le&ger? so$e'hat co$para le to a ta le o) contents0 Compoun. 2ournal entry A 3ournal entr" 'ith $ore than one &e it an&7or cre&it0 Cre.it The right si&e o) an" account? 'hen use& as a ver , to enter a &ollar a$ount on the right si&e o) an account? cre&its increase lia ilit", stoc!hol&ersJ e4uit", an& revenue accounts an& &ecrease asset, expense, an& <ivi&en&s accounts0 Cre.it balance The alance in an account 'hen the su$ o) the cre&its to the account excee&s the su$ o) the &e its to that account0 Cross-in.exing The placing o) (1) the account nu$ er o) the le&ger account in the general 3ournal an& (I) the general 3ournal page nu$ er in the le&ger account0 <ebit The le)t si&e o) an" account? 'hen use& as a ver , to enter a &ollar a$ount on the le)t si&e o) an account? &e its increase asset, expense, an& <ivi&en&s accounts an& &ecrease lia ilit", stoc!hol&ersJ e4uit", an& revenue accounts0 <ebit balance The alance in an account 'hen the su$ o) the &e its to the account excee&s the su$ o) the cre&its to that account0 <ouble-entry proce.ure The accounting re4uire$ent that each transaction $ust e recor&e& " an entr" that has e4ual &e its an& cre&its0 =ori4ontal analysis The calculation o) &ollar an&7or percentage changes in an ite$ on the )inancial state$ents )ro$ one "ear to the next0 >ournal A chronological (arrange& in or&er o) ti$e) recor& o) usiness transactions? the si$plest )or$ o) 3ournal is the t'o-colu$n general 3ournal0 >ournal entry ,ho's all o) the e))ects o) a usiness transaction as expresse& in &e it(s) an& cre&it(s) an& $a" inclu&e an explanation o) the transaction0 >ournali4ing A step in the accounting recor&ing process that consists o) entering the e))ects o) a transaction in a 3ournal0 Le.ger The co$plete collection o) all o) the accounts o) a co$pan"? o)ten re)erre& to as the general le&ger0 !ominal accounts ,ee te$porar" accounts0 !ote An uncon&itional 'ritten pro$ise to pa" to another part" the a$ount o'e& either 'hen &e$an&e& or at a certain speci)ie& &ate0

p. 1I+ o) *++

&ermanent accounts (real accounts) Balance sheet accounts? their alances are not trans)erre& (or close&) to an" other account at the en& o) the accounting perio&0 &osting :ecor&ing in the le&ger accounts the in)or$ation containe& in the 3ournal0 :eal accounts ,ee per$anent accounts0 "imple 2ournal entry An entr" 'ith one &e it an& one cre&it0 $-account An account rese$ ling the letter T, 'hich is use& )or illustrative purposes onl"0 <e its are entere& on the le)t si&e o) the account, an& cre&its are entere& on the right si&e o) the account0 $emporary accounts (nominal accounts) The" te$poraril" contain the revenue, expense, an& &ivi&en& in)or$ation that is trans)erre& (or close&) to a stoc!hol&ersJ e4uit" account (:etaine& %arnings) at the en& o) the accounting perio&0 $rial balance A listing o) the le&ger accounts an& their &e it or cre&it alances to &eter$ine that &e its e4ual cre&its in the recor&ing process0 Bertical analysis ,ho's the percentage that each ite$ in a )inancial state$ent is o) so$e signi)icant total such as total assets or sales0

3.12 6elf<test
3.12.1 True<false

6n&icate 'hether each o) the )ollo'ing state$ents is true or )alse0 All o) the steps in the accounting c"cle are per)or$e& onl" at the en& o) the accounting perio&0 A transaction $ust e 3ournali5e& in the 3ournal e)ore it can e poste& to the le&ger accounts0 The le)t si&e o) an" account is the cre&it si&e0 :evenues, lia ilities, an& capital stoc! accounts are increase& " &e its0 The &ivi&en&s account is increase& " &e its0 6) the trial alance has e4ual &e it an& cre&it totals, it cannot contain an" errors0

3.12.2

=ultiple<choice

,elect the est ans'er )or each o) the )ollo'ing 4uestions0 =hen the stoc!hol&ers invest cash in the usiness: a0 Capital ,toc! is &e ite& an& Cash is cre&ite&0 0 Cash is &e ite& an& <ivi&en&s is cre&ite&0 c0 Cash is &e ite& an& Capital ,toc! is cre&ite&0 &0 /one o) the a ove0 Assu$e that cash is pai& )or insurance to cover a three-"ear perio&0 The reco$$en&e& &e it an& cre&it are: a0 <e it 6nsurance %xpense, cre&it Cash0

p. 1I* o) *++

0 <e it Prepai& 6nsurance, cre&it Cash0 c0 <e it Cash, cre&it 6nsurance %xpense0 &0 <e it Cash, cre&it Prepai& 6nsurance0 A co$pan" receive& cash )ro$ a custo$er in pa"$ent )or )uture &eliver" services0 The correct &e it an& cre&it are: a0 <e it Cash, cre&it Mnearne& <eliver" Fees0 0 <e it Cash, cre&it <eliver" Fee :evenue0 c0 <e it Accounts :eceiva le, cre&it <eliver" Fee :evenue0 &0 /one o) the a ove0 A co$pan" per)or$e& &eliver" services )or a custo$er )or cash0 The correct &e it an& cre&it are: a0 <e it Cash, cre&it Mnearne& <eliver" Fees0 0 <e it Cash, cre&it <eliver" Fee :evenue0 c0 <e it Accounts :eceiva le, cre&it <eliver" Fee :evenue0 &0 /one o) the a ove0 A cash &ivi&en& o) M,< CBB 'as &eclare& an& pai& to stoc!hol&ers0 The correct 3ournal entr" is:
a' ,apital stoc6 ,as0 5' ,as0 :ividends c' :ividends ,as0 d' ,as0 ,apital stoc6 500 500 500 500 500 500 500 500

/o' turn to FAns'ers to sel)-testH at the en& o) the chapter to chec! "our ans'ers0

3.12.3
  

>uestions
<escri e the steps in recor&ing an& posting the e))ects o) a usiness transaction0 2ive so$e exa$ples o) source &ocu$ents0 <e)ine an account0 =hat are the t'o asic )or$s (st"les) o) accounts illustrate& in the chapterQ =hat is $eant " the ter$ &ou le-entr" proce&ure, or &ualit"Q <escri e ho' "ou 'oul& &eter$ine the alance o) a T-account0 <e)ine &e it an& cre&it0 /a$e the t"pes o) accounts that are:
 

  

6ncrease& " a &e it0 <ecrease& " a &e it0

p. 1IC o) *++

  

6ncrease& " a cre&it0 <ecrease& " a cre&it0

<o "ou thin! this s"ste$ $a!es senseQ Can "ou conceive o) other possi le $etho&s )or recor&ing changes in accountsQ =hich o) the steps in the accounting c"cle are per)or$e& throughout the accounting perio&Q =hich o) the steps in the accounting c"cle are per)or$e& onl" at the en& o) the accounting perio&Q =h" are expense an& revenue accounts use& 'hen all revenues an& expenses coul& e sho'n &irectl" in the :etaine& %arnings accountQ =hat is the purpose o) the <ivi&en&s account an& ho' is it increase&Q Are the )ollo'ing possi ilities conceiva le in an entr" involving onl" one &e it an& one cre&itQ =h"Q
      







 

6ncrease a lia ilit" an& increase an expense0 6ncrease an asset an& &ecrease a lia ilit"0 6ncrease a revenue an& &ecrease an expense0 <ecrease an asset an& increase another asset0 <ecrease an asset an& increase a lia ilit"0 <ecrease a revenue an& &ecrease an asset0 <ecrease a lia ilit" an& increase a revenue0



<escri e the nature an& purposes o) the general 3ournal0 =hat &oes 3ournali5ing $eanQ 2ive an exa$ple o) a co$poun& entr" in the general 3ournal0 <escri e a le&ger an& a chart o) accounts0 #o' &o these t'o co$pare 'ith a oo! an& its ta le o) contentsQ <escri e the act o) posting0 =hat &i))iculties coul& arise i) no cross-in&exing existe& et'een the general 3ournal an& the le&ger accountsQ =hich o) the )ollo'ing cash pa"$ents 'oul& involve the i$$e&iate recor&ing o) an expenseQ =h"Q
   







Pai& ven&ors )or o))ice supplies previousl" purchase& on account0 Pai& an auto$o ile &ealer )or a ne' co$pan" auto0 Pai& the current $onthJs rent0 Pai& salaries )or the last hal) o) the current $onth0

p. 1ID o) *++



=hat t"pes o) accounts appear in the una&3uste& trial alanceQ =hat are the purposes o) this trial alanceQ .ou have )oun& that the total o) the <e its colu$n o) the trial alance o) Burns Co$pan" is M,< IBB,BBB, 'hile the total o) the Cre&its colu$n is M,< 18B,BBB0 =hat are so$e possi le causes o) this &i))erenceQ 6) the &i))erence et'een the colu$ns is &ivisi le " >, 'hat t"pes o) errors are possi leQ





,tore e4uip$ent 'as purchase& )or M,< I,BBB0 6nstea& o) &e iting the ,tore %4uip$ent account, the &e it 'as $a&e to <eliver" %4uip$ent0 O) 'hat help 'ill the trial alance e in locating this errorQ =h"Q



A stu&ent re$e$ ere& that the si&e to'ar& the 'in&o' in the classroo$ 'as the &e it si&e o) an account0 The stu&ent too! an exa$ination in a roo$ 'here the 'in&o's 'ere on the other si&e o) the roo$ an& eca$e con)use& an& consistentl" reverse& &e its an& cre&its0 =oul& the stu&entJs trial alance have e4ual &e it an& cre&it totalsQ 6) there 'ere no existing alances in an" o) the accounts to egin 'ith, 'oul& the error prevent the stu&ent )ro$ preparing correct )inancial state$entsQ =h"Q

3.12.!

E,ercises

-xercise # A &iagra$ o) the various t"pes o) accounts )ollo's0 ,ho' 'here pluses (T) or $inuses (-) shoul& e inserte& to in&icate the e))ect &e its an& cre&its have on each account0
A##et :e5it Account# / $%a&%l%ty Account# 3 Stoc'holder#( E)u%ty Account# ,redit :e5it ,redit :e5it ,redit E01en#e and :%2%dend# Re2enue Account# Account :e5itJ ,redit :e5it

Account# ,reditJ

-xercise B Prepare the 3ournal entr" re4uire& )or each o) the )ollo'ing transactions: a0 Cash 'as receive& )or services per)or$e& )or custo$ers, M,< 1,IBB0 0 ,ervices 'ere per)or$e& )or custo$ers on account, M,< *,IBB0 -xercise C Prepare the 3ournal entr" re4uire& )or each o) the )ollo'ing transactions: a0 Capital stoc! 'as issue& )or M,< 1BB,BBB0 0 Purchase& $achiner" )or cash, M,< +B,BBB0

p. 1I@ o) *++

-xercise < Prepare the 3ournal entr" re4uire& )or each o) the )ollo'ing transactions: a0 Capital stoc! 'as issue& )or M,< IBB,BBB cash0 0 A M,< +B,BBB loan 'as arrange& 'ith a an!0 The an! increase& the co$pan"Js chec!ing account " M,< +B,BBB a)ter $anage$ent o) the co$pan" signe& a 'ritten pro$ise to return the M,< +B,BBB in +B &a"s0 c0 Cash 'as receive& )or services per)or$e& )or custo$ers, M,< @BB0 &0 ,ervices 'ere per)or$e& )or custo$ers on account, M,< 1,IBB0 -xercise - For each o) the )ollo'ing unrelate& transactions, give the 3ournal entr" to recor& the transaction0 Then sho' ho' the 3ournal entr" 'oul& e poste& to T-accounts0 .ou nee& not inclu&e explanations or account nu$ ers0 a0 Capital stoc! 'as issue& )or M,< 1BB,BBB cash0 0 ,alaries )or a perio& 'ere pai& to e$plo"ees, M,< I*,BBB0 c0 ,ervices 'ere per)or$e& )or custo$ers on account, M,< *B,BBB0 -xercise F %xplain each o) the sets o) &e its an& cre&its in these accounts )or Tuxe&os, 6nc0, a co$pan" that rents 'e&&ing clothing an& accessories0 There are 1B transactions to e explaine&0 %ach set is &esignate& " the s$all letters to the le)t o) the a$ount0 For exa$ple, the )irst transaction is the issuance o) capital stoc! )or cash an& is &enote& " the letter (a)0

p. 1I8 o) *++

Ca#h

:%2%dend#

#a% #d%

200,000 ",900

#5% #e% #(% #)% #i%

"50,000 ",000 600 2,000 30,000

#e%

",000

&al'

8

"9,200 Ser2%ce Re2enue ",900

Account# Rece%2a&le

#c% #1%
&al'

",900 "2,000 "2,000 Su11l%e#

#d%

#c% #1%
&al'

",900 "2,000 "3,90,

on 9and

Rent E01en#e

#5% #i%
&al'

"50,000 30,000 "90,000 Account# .aya&le

#(%

600

:el%2ery 900 200,000

E01en#e

#0%
Ca1%tal Stoc'

#0% #)%

900 Salar%e# E01en#e 2,000

#a%

-xercise 9 Assu$e the le&ger accounts given in the previous pro le$ are those o) Tuxe&os, 6nc0, as the" appear at IB1B <ece$ er +10 Prepare the trial alance as o) that &ate0 -xercise = Prepare 3ournal entries to recor& each o) the )ollo'ing transactions )or ,anche5 Co$pan"0 Mse the letter o) the transaction in place o) the &ate0 6nclu&e an explanation )or each entr"0 a0 Capital stoc! 'as issue& )or cash, M,< +BB,BBB0 0 Purchase& truc!s " signing a note earing no interest, M,< I1B,BBB0 c0 %arne& service revenue on account, M,< *,8BB0 &0 Collecte& the account receiva le resulting )ro$ transaction (c), M,< *,8BB0 e0 Pai& the note pa"a le )or the truc!s purchase&, M,< I1B,BBB0 )0 Pai& utilities )or the $onth in the a$ount o) M,< 1,8BB0 g0 Pai& salaries )or the $onth in the a$ount o) M,< @,CBB0 h0 6ncurre& supplies expenses on account in the a$ount o) M,< 1,>IB0 i0 Purchase& another truc! )or cash, M,< *8,BBB0 p. 1I> o) *++

30 Per)or$e& &eliver" services on account, M,< I*,BBB0 -xercise 1 Msing the &ata in the previous pro le$, post the entries to T-accounts0 =rite the letter o) the transaction in the account e)ore the &ollar a$ount0 <eter$ine a alance )or each account0 -xercise > Msing "our ans'er )or the previous exercise, prepare a trial alance0 Assu$e the &ate o) the trial alance is IB1B (arch +10 -xercise ? ;ohn A&a$s o'ns an& $anages a o'ling center calle& ,tri!e Aanes0 #e also

$aintains his o'n accounting recor&s an& 'as a out to prepare )inancial state$ents )or the "ear IB1B0 =hen he prepare& the trial alance )ro$ the le&ger accounts, the total o) the &e its colu$n 'as M,< *+C,BBB, an& the total o) the cre&its colu$n 'as M,< *IC,BBB0 =hat are the possi le reasons 'h" the totals o) the &e its an& cre&its are out o) alanceQ #o' 'oul& "ou nor$all" procee& to )in& an error i) the t'o trial alance colu$ns &o not agreeQ -xercise L :e)er to the Consoli&ate& Balance ,heets o) The Ai$ite& in the Annual :eport Appen&ix locate& in the ac! o) this text0 Per)or$ oth hori5ontal an& vertical anal"sis on each o) The Ai$ite&Js asset accounts, treating total assets as a signi)icant total )or vertical anal"sis0 co$$ent on the results0 /ote: =hile "ou can certainl" &o this exercise 'ith a calculator, co$puter sprea&sheets such as %xcel are i&eal )or this t"pe o) anal"sis0

3.12.#

1roblems

&roblem # The transactions o) Aightning Pac!age <eliver" Co$pan" )or (arch IB1B )ollo': (ar0 1 The co$pan" 'as organi5e& an& issue& capital stoc! )or M,< +BB,BBB cash0 I Pai& M,< D,BBB as the rent )or (arch on a co$pletel" )urnishe& uil&ing0 C Pai& cash )or &eliver" truc!s, M,< 18B,BBB0 D Pai& M,< *,BBB as the rent )or (arch on t'o )or!li)t truc!s0 > Pai& M,< I,IBB )or supplies receive& an& use& in (arch0 1I Per)or$e& &eliver" services )or custo$ers 'ho pro$ise& to pa" M,< I@,BBB at a later &ate0 IB Collecte& cash o) M,< *,CBB )ro$ custo$ers on account (see (arch 1I entr")0 I1 :eceive& a ill )or M,< 1,IBB )or a&vertising in the local ne'spaper in (arch0 p. 1+B o) *++

I@ Pai& cash )or gas an& oil consu$e& in (arch, M,< *CB0 +1 Pai& M,< I,*BB salaries to e$plo"ees )or (arch0 +1 :eceive& an or&er )or services at M,< 1I,BBB0 The services 'ill e per)or$e& in April0 +1 Pai& cash &ivi&en&, M,< 1,BBB0 Prepare the 3ournal entries re4uire& to recor& these transactions in the general 3ournal o) the co$pan"0 &roblem B %cono$" Aaun&r" Co$pan" ha& the )ollo'ing transactions in August IB1B: Aug0 1 6ssue& capital stoc! )or cash, M,< 1CB,BBB0 + Borro'e& M,< *B,BBB )ro$ the an! on a note0 * Purchase& cleaning e4uip$ent )or M,< IC,BBB cash0 D Per)or$e& services )or custo$ers 'ho pro$ise& to pa" later, M,< 1D,BBB0 @ Pai& this $onthJs rent on a uil&ing, M,< I,8BB0 1B Collections 'ere $a&e )or the services per)or$e& on August D, M,< +,IBB0 1* ,upplies 'ere purchase& on account )or use this $onth, M,< +,BBB0 1@ A ill )or M,< *BB 'as receive& )or utilities )or this $onth0 IC Aaun&r" services 'ere per)or$e& )or custo$ers 'ho pai& i$$e&iatel", M,< II,BBB0 +1 Pai& e$plo"ee salaries, M,< D,BBB0 +1 Pai& cash &ivi&en&, M,< I,BBB0 a0 Prepare 3ournal entries )or these transactions0 0 Post the 3ournal entries to T-accounts0 %nter the account nu$ er in the Posting :e)erence colu$n o) the 3ournal as "ou post each a$ount0 Mse the )ollo'ing account nu$ ers:
Acct. No. "00 "03 "70 200 20" 300 320 400 507 5"" 5"5 5"9 Account T%tle ,as0 $ccounts receiva5le E7uip!ent $ccounts pa2a5le otes pa2a5le ,apital stoc6 :ividends Service revenue Salaries expense -tilities expense Rent expense Supplies expense

c0 Prepare a trial alance as o) IB1B August +10

p. 1+1 o) *++

&roblem C Clean-,'eep ;anitorial, 6nc0, a co$pan" provi&ing 3anitorial services, 'as organi5e& IB1B ;ul" 10 The )ollo'ing account nu$ ers an& titles constitute the chart o) accounts )or the co$pan":
Acct. No. "00 "03 "50 "60 "70 200 20" 300 3"0 320 400 506 507 5"" 5"2 5"5 5"9 Account T%tle ,as0 $ccounts receiva5le Truc6s +((ice e7uip!ent E7uip!ent $ccounts pa2a5le otes pa2a5le ,apital stoc6 Retained earnin)s :ividends Service revenue Gas and oil expense Salaries expense -tilities expense .nsurance expense Rent expense Supplies expense

;ul" 1 The co$pan" issue& M,< DBB,BBB o) capital stoc! )or cash0 C O))ice space 'as rente& )or ;ul", an& M,< C,BBB 'as pai& )or the rental0 8 <es!s an& chairs 'ere purchase& )or the o))ice on account, M,< I8,8BB0 1B %4uip$ent 'as purchase& )or M,< CB,BBB? a note 'as given, to e pai& in +B &a"s0 1C Purchase& truc!s )or M,< 1CB,BBB, pa"ing M,< 1IB,BBB cash an& giving a DB-&a" note to the &ealer )or M,< +B,BBB0 ;ul" 18 Pai& )or supplies receive& an& alrea&" use&, M,< I,88B0 I+ :eceive& M,< 1@,I8B cash as service revenue0 I@ 6nsurance expense )or ;ul" 'as pai&, M,< *,CBB0 +B Pai& )or gasoline an& oil use& " the truc! in ;ul", M,< C@D0 +1 Bille& custo$ers )or 3anitorial services ren&ere&, M,< *B,+IB0 +1 Pai& salaries )or ;ul", M,< C1,8*B0 +1 Pai& utilities ills )or ;ul", M,< C,I8B0 +1 Pai& cash &ivi&en&s, M,< >,DBB0 a0 Prepare general le&ger accounts )or all o) these accounts except :etaine& %arnings0 The :etaine& %arnings account has a eginning alance o) 5ero an& $aintains this alance throughout the perio&0 0 ;ournali5e the transactions given )or ;ul" IB1B in the general 3ournal0 c0 Post the 3ournal entries to le&ger accounts0 p. 1+I o) *++

&0 Prepare a trial alance as o) IB1B ;ul" +10 &roblem < Tri$ Aa'n, 6nc0, is a la'n care co$pan"0 Thus, the co$pan" earns its revenue )ro$ sen&ing its truc!s to custo$ersJ resi&ences an& certain co$$ercial esta lish$ents to care )or la'ns an& shru er"0 Tri$ Aa'nJs trial alance at the en& o) the )irst 11 $onths o) the "ear )ollo's:
TRIM $ADN" INC. Tr%al !alance 2010 No2em&er 0 Acct. No. "00 "03 "50 "60 200 300 3"0 400 505 506 507 5"" 5"5 5"9 53" Account T%tle ,as0 $ccounts Receiva5le Truc6s +((ice /urniture $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " Service Revenue $dvertisin) Expense Gas an d +il Expense Salaries Expense -tilities Expense Rent Expense Supplies Expense Entertain!ent Expense "9,300 2",@00 65,950 2,3"0 "5,000 75,600 2,550 $465,"50 $465,"50 :e&%t# $ 63,740 99,600 "02,@00 9,400 $ 33,600 30,000 30,540 37",0"0 Cred%t#

<ec0 I Pai& rent )or <ece$ er, M,< +,BBB0 C Pai& the accounts pa"a le o) M,< ++,DBB0 8 Pai& a&vertising )or <ece$ er, M,< 1,CBB0 1B Purchase& a ne' o))ice &es! on account, M,< 1,BCB0 1+ Purchase& M,< I*B o) supplies on account )or use in <ece$ er0 1C Collecte& cash )ro$ custo$ers on account, M,< @C,BBB0 IB Pai& )or custo$er entertain$ent, M,< *CB0 I* Collecte& an a&&itional M,< D,BBB )ro$ custo$ers on account0 ID Pai& )or gasoline use& in the truc!s in <ece$ er, M,< I@B0 I8 Bille& custo$ers )or services ren&ere&, M,< @>,CBB0 +B Pai& )or $ore <ece$ er supplies, M,< 1I,BBB0 +1 Pai& <ece$ er salaries, M,< 1C,+BB0

p. 1++ o) *++

+1 Pai& a M,< *,BBB cash &ivi&en&0 (The <ivi&en&s account is /o0 +IB0) a0 Open three-colu$n general le&ger accounts )or each o) the accounts in the trial alance un&er the &ate o) IB1B <ece$ er 10 Place the 'or& Balance in the explanation space o) each account0 Also open an account )or <ivi&en&s, /o0 +IB0 0 Prepare entries in the general 3ournal )or the prece&ing transactions )or <ece$ er IB1B0 c0 Post the 3ournal entries to three-colu$n general le&ger accounts0 &0 Prepare a trial alance as o) IB1B <ece$ er +10 &roblem - (arc (iller prepare& the )ollo'ing trial alance )ro$ the le&ger o) the Ouic!-Fix TG :epair Co$pan"0 The trial alance &i& not alance0
EUIC6-FIF RE.AIR COM.AN@ Tr%al !alance 2010 :ecem&er 1 Acct. No. "00 "03 "60 "72 200 300 3"0 320 400 507 5"5 569 Account T%tle ,as0 $ccounts Receiva5le +((ice /urniture +((ice E7uip!ent $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s :ividends Service Revenue Salaries Expense Rent Expense *iscellaneous Expense 290,000 40,000 7,200 $654,000 $652,400 29,900 360,000 :e&%t# $ 6@,200 60,900 "20,000 49,000 $ 32,400 "90,000 90,000 Cred%t#

The &i))erence in totals in the trial errors ha& een $a&e:

alance cause& (iller to care)ull" exa$ine the co$pan"Js

accounting recor&s0 6n searching ac! through the accounting recor&s, (iller )oun& that the )ollo'ing
 One entire entr" that inclu&e& a M,< 1B,BBB &e it to Cash an& a M,< 1B,BBB cre&it to

Accounts :eceiva le 'as never poste&0
 6n co$puting the alance o) the Accounts Pa"a le account, a cre&it o) M,< +,IBB 'as

o$itte& )ro$ the co$putation0
 6n preparing the trial alance, the :etaine& %arnings account alance 'as sho'n as M,<

8B,BBB0 The le&ger account has the alance at its correct a$ount o) M,< 8+,IBB0
 One &e it o) M,< I,*BB to the <ivi&en&s account 'as poste& as a cre&it to that account0

p. 1+* o) *++

 O))ice e4uip$ent o) M,< 1I,BBB 'as &e ite& to O))ice Furniture 'hen purchase&0

Prepare a correcte& trial alance )or the Ouic!-Fix TG :epair Co$pan" as o) IB1B <ece$ er +10 Also, 'rite a &escription o) the e))ect(s) o) each error0

3.12.$
August IB1B:

Alternate problems

#lternate problem # ,pee&" Aaun&r" Co$pan", 6nc0, entere& into the )ollo'ing transactions in Aug0 1 :eceive& cash )or capital stoc! issue& to o'ners, M,< *BB,BBB0 + Pai& rent )or August on a uil&ing an& laun&r" e4uip$ent rente&, M,< +,BBB0 D Per)or$e& laun&r" services )or M,< I,BBB cash0 8 ,ecure& an or&er )ro$ a custo$er )or laun&r" services o) M,< @,BBB0 The services are to e per)or$e& next $onth0 1+ Per)or$e& laun&r" services )or M,< D,+BB on account )or various custo$ers0 1C :eceive& an& pai& a ill )or M,< *+B )or supplies use& in operations0 I+ Cash collecte& )ro$ custo$ers on account, M,< I,DBB0 +1 Pai& M,< I,*BB salaries to e$plo"ees )or August0 +1 :eceive& the electric an& gas ill )or August, M,< +8C, ut &i& not pa" it at this ti$e0 +1 Pai& cash &ivi&en&, M,< 1,BBB0 Prepare 3ournal entries )or these transactions in the general 3ournal0 #lternate problem B The transactions liste& elo' are those o) :elia le Co$puter :epair, 6nc0, )or April IB1B: Apr0 1 Cash o) M,< CBB,BBB 'as receive& )or capital stoc! issue& to the o'ners0 + :ent 'as pai& )or April, M,< +,CBB0 D Truc!s 'ere purchase& )or M,< CD,BBB cash0 @ O))ice e4uip$ent 'as purchase& on account )ro$ =agner Co$pan" )or M,< @D,8BB0 1* ,alaries )or )irst t'o 'ee!s 'ere pai&, M,< 1I,BBB0 1C M,< I8,BBB 'as receive& )or services per)or$e&0 18 An invoice 'as receive& )ro$ :ogerJs 2as ,tation )or M,< *BB )or gas an& oil use& &uring April0 I+ A note 'as arrange& 'ith the an! )or M,< 8B,BBB0 The cash 'as receive&, an& a note pro$ising to return the M,< 8B,BBB on IB1B (a" +B, 'as signe&0 I> Purchase& truc!s )or M,< @+,DBB " signing a note0 +B ,alaries )or the re$ain&er o) April 'ere pai&, M,< 1*,*BB0 p. 1+C o) *++

a0 Prepare 3ournal entries )or these transactions0 0 Post the 3ournal entries to T-accounts0 %nter the account nu$ er in the Posting :e)erence colu$n o) the 3ournal as "ou post each a$ount0 Mse the )ollo'ing account nu$ ers:
Acct. No. "00 "50 "72 200 20" 300 400 506 507 5"5 Account T%tle ,as0 Truc6s +((ice e7uip!ent $ccounts pa2a5le otes pa2a5le ,apital stoc6 Service revenue Gas and oil expense Salaries expense Rent expense

c0 Prepare a trial alance as o) IB1B April +B0 #lternate problem C :api& Pic! Mp P <eliver", 6nc0, 'as organi5e& IB1B ;anuar" 10 6ts chart o) accounts is as )ollo's:
Acct. No. "00 "03 "50 "60 "72 200 20" 300 3"0 400 506 507 5"" 5"2 5"5 530 Account t%tle ,as0 $ccounts receiva5le Truc6s +((ice (urniture +((ice e7uip!ent $ccounts pa2a5le otes pa2a5le ,apital stoc6 Retained earnin)s Service revenue Gas and oil expense Salaries expense -tilities expense .nsurance expense Rent expense Repairs expense

;an0 1 The co$pan" receive& M,< CDB,BBB cash an& M,< I*B,BBB o) o))ice )urniture in exchange )or M,< 8BB,BBB o) capital stoc!0 I Pai& garage rent )or ;anuar", M,< D,BBB0 * Purchase& co$puters on account, M,< 1+,IBB0 D Purchase& &eliver" truc!s )or M,< I8B,BBB? pa"$ent 'as $a&e " giving cash o) M,< 1CB,BBB an& a +B-&a" note )or the re$ain&er0 ;an 1I Purchase& insurance )or ;anuar" on the &eliver" truc!s0 The cost o) the polic", M,< 8BB, 'as pai& in cash0 p. 1+D o) *++

1C :eceive& an& pai& ;anuar" utilities ills, M,< >DB0 1C Pai& salaries )or )irst hal) o) ;anuar", M,< +,DBB0 1@ Cash receive& )or &eliver" services to &ate a$ounte& to M,< 1,8BB0 IB :eceive& ill )or gasoline purchase& an& use& in ;anuar", M,< 18B0 I+ Purchase& &eliver" truc!s )or cash, M,< 1B8,BBB0 IC Cash sales o) &eliver" services 'ere M,< I,88B0 I@ Purchase& a cop" $achine on account, M,< +,DBB0 +1 Pai& salaries )or last hal) o) ;anuar", M,< *,8BB0 +1 ,ales o) &eliver" services on account a$ounte& to M,< 11,*BB0 +1 Pai& )or repairs to a &eliver" truc!, M,< 1,1IB0 a0 Prepare general le&ger accounts )or all these accounts except :etaine& %arnings0 The :etaine& %arnings account has a eginning alance o) 5ero an& $aintains this alance throughout the perio&0 0 ;ournali5e the transactions given )or IB1B ;anuar" in the general 3ournal0 c0 Post the 3ournal entries to le&ger accounts0 &0 Prepare a trial alance as o) IB1B ;anuar" +10 #lternate problem C The trial alance o) Cali)ornia Tennis Center, 6nc0, at the en& o) the )irst 11 $onths o) its )iscal "ear )ollo's:

p. 1+@ o) *++

CA$IFORNIA TENNIS CENTER" INC. Tr%al !alance 2010 No2em&er 0 Acct. No. "00 "03 "30 200 20" 300 3"0 4"3 505 507 5"" 5"5 5"9 530 53" 540 Account T%tle ,as0 $ccounts Receiva5le 4and $ccounts =a2a5le otes =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " *e!5ers0ip and 4esson Revenue $dvertisin) Expense Salaries Expense -tilities Expense Rent Expense Supplies Expense Repairs Expense Entertain!ent Expense .nterest Expense 2",000 66,000 2,"00 33,000 2,250 ",500 970 300 $33@,@50 $33@,@50 :e&%t# $7","90 9",750 60,000 $"9,750 "5,000 50,000 53,700 202,500 Cred%t#

<ec0 1 Pai& uil&ing rent )or <ece$ er, M,< *,BBB0 I Pai& ven&ors on account, M,< 18,BBB0 C Purchase& lan& )or cash, M,< 1B,BBB0 @ ,ol& $e$ erships on account )or <ece$ er, M,< I@,BBB0 1B Pai& the note pa"a le o) M,< 1C,BBB, plus interest o) M,< 1CB0 1+ Cash collections )ro$ custo$ers on account, M,< +D,BBB0 1> :eceive& a ill )or repairs, M,< IIC0 I* Pai& the <ece$ er utilities ill, M,< 18B0 I8 :eceive& a ill )or <ece$ er a&vertising, M,< 1,DCB0 I> Pai& the e4uip$ent repair ill receive& on the 1>th, M,< IIC0 +B 2ave tennis lessons )or cash, M,< *,CBB0 +B Pai& salaries, M,< D,BBB0 +B ,ales o) $e$ erships on account since <ece$ er @, M,< 18,BBB ()or the $onth o) <ece$ er)0 +B Costs pai& in entertaining custo$ers in <ece$ er, M,< +CB0 +B Pai& &ivi&en&s o) M,< 1,CBB0 (The <ivi&en&s account is /o0 +IB0)

p. 1+8 o) *++

a0 Open three-colu$n general le&ger accounts )or each o) the accounts in the trial alance0 Place the 'or& Balance in the explanation space an& enter the &ate IB1B <ece$ er 1, on this sa$e line0 Also open an account )or <ivi&en&s, /o0 +IB0 0 Prepare entries in the general 3ournal )or the transactions &uring <ece$ er IB1B0 c0 Post the 3ournal entries to le&ger accounts0 &0 Prepare a trial alance as o) IB1B <ece$ er +10 #lternate problem - Bill Baxter prepare& a trial alance he prepare& 'as as )ollo's:
S.ECIA$ .ART@ RENTA$S" INC. Tr%al !alance 2010 :ecem&er 1 Acct. No.
"00 "03 "70 200 300 3"0 320 400 505 507 5"" 5"5 ,as0 $ccounts Receiva5le E7uip!ent $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s :ividends Service Revenue $dvertisin) Expense Salaries Expense -tilities Expense Rent Expense ",200 "76,000 44,900 64,000 $ 596,900 $ 640,000 "6,000 432,000

alance )or ,pecial Part" :entals, 6nc0, a

co$pan" that rents ta les, chairs, an& other part" supplies0 The trial alance &i& not alance0 The trial

Account T%tle

:e&%t#
$ 74,000 50,900 "60,000

Cred%t#

$ 34,000 "30,000 44,000

6n tr"ing to ) in& out 'h" the trial alance &i& not alance, Baxter &iscovere& the )ollo'ing errors: %4uip$ent 'as un&erstate& (too lo') " M,< 1I,BBB ecause o) an error in a&&ition in &eter$ining the alance o) that account in the le&ger0 A cre&it o) M,< *,8BB to Accounts :eceiva le in the 3ournal 'as not poste& to the le&ger account at all0 A &e it o) M,< 1D,BBB )or a se$iannual &ivi&en& 'as poste& as a cre&it to the Capital ,toc! account0 The alance o) M,< 1I,BBB in the A&vertising %xpense account 'as entere& as M,< 1,IBB in the trial alance0

p. 1+> o) *++

(iscellaneous %xpense (Account /o0 CD8), 'ith a alance o) M,< +,IBB, 'as o$itte& )ro$ the trial alance0 Prepare a correcte& trial alance as o) IB1B <ece$ er +10 Also, 'rite a &escription o) the e))ect(s) o) each error0

3.12.%

0e ond the numbers9Critical thin&ing

Business .ecision case # ;ohn ;aco s lost his 3o as a carpenter 'ith a contractor 'hen a recession hit the construction in&ustr"0 ;aco s ha& een $a!ing M,< CB,BBB per "ear0 #e &eci&e& to )or$ his o'n co$pan", ;aco s Corporation, an& &o ho$e repairs0 The )ollo'ing is a su$$ar" o) the transactions o) the usiness &uring the )irst three $onths o) operations in IB1B: ;an0 1C ,toc!hol&ers investe& M,< *B,BBB in the usiness0 Fe 0 IC :eceive& pa"$ent o) M,< *,*BB )or re$o&eling a ase$ent into a recreation roo$0 The ho$eo'ner purchase& all o) the uil&ing $aterials0 (ar0 C Pai& cash )or an a&vertise$ent that appeare& in the local ne'spaper, M,< 1CB0 Apr0 1B :eceive& M,< @,BBB )or converting a roo$ over a garage into an o))ice )or a college pro)essor0 The pro)essor purchase& all o) the $aterials )or the 3o 0 11 Pai& gas an& oil expenses )or auto$o ile, M,< >BB0 1I (iscellaneous usiness expenses 'ere pai&, M,< *CB0 1C Pai& &ivi&en&s o) M,< I,BBB0 a0 Prepare 3ournal entries )or these transactions0 0 Post the 3ournal entries to T-accounts0 c0 #o' pro)ita le is this ne' ventureQ ,houl& ;aco s sta" in this usinessQ #nnual report analysis B :e)er to the Annual :eport o) The Ai$ite&, 6nc0 in the Annual :eport Appen&ix0 Per)or$ hori5ontal an& vertical anal"ses o) the lia ilities an& stoc!hol&erJs e4uit" sections o) the alance sheets )or the t'o $ost recent "ears sho'n0 #ori5ontal anal"sis involves sho'ing the &ollar a$ount an& percentage increase or &ecrease o) the latest "ear over the prece&ing "ear a$ounts0 Gertical anal"sis involves sho'ing the percentage o) total lia ilities an& stoc!hol&erJs e4uit" that each account represents as o) the alance sheet &ates0 =rite co$$ents on an" i$portant changes et'een the t'o "ears that are evi&ence o) &ecisions $a&e " $anage$ent0

p. 1*B o) *++

#nnual report analysis C 6n The #o$e <epotJs recent Annual :eport, the )ollo'ing passages appear:

The pri$ar" !e" to our success is our +>,BBB e$plo"ees 'ho 'ear those orange aprons "ou see in our stores0 Fe' great achieve$entsLin usiness or in an" aspect o) li)eLare reache& an& sustaine& 'ithout the support an& involve$ent o) large nu$ ers o) people co$$itte& to share& values an& goals the" &ee$ 'orth"0 6n&ee&, one nee& loo! no )urther than the usiness section o) the $orning ne'spaper to rea& o) ho' "et another K lue chipK A$erican usiness, entrenche& in an& isolate& " its o'n ureaucrac", has lost the support o) its e$plo"ees an& custo$ers000 Fran!l", the iggest &i))erence et'een The #o$e <epot an& our co$petitors is not the pro&ucts on our shelves, it is our people an& their a ilit" to )orge strong on&s o) lo"alt" an& trust 'ith our custo$ers000 000Contrar" to conventional $anage$ent 'is&o$, those at the top o) organi5ation charts are not the source o) all 'is&o$0 (an" o) our opinions000 000=e 'ant our people to e the$selves an& to e ol& enough to appl" their talents as in&ivi&uals0 Certainl", people can o)ten perceive great ris! acting this 'a"0 Thus, 'e go to great lengths to e$po'er our e$plo"ees to e $averic!s, to express &i))erences o) opinion 'ithout )ear o) eing )ire& or &e$ote&000=e &o ever"thing 'e can to $a!e people )eel challenge& an& inspire& at 'or! instea& o) eing threatene& an& $a&e to )eel insecure0 An organi5ation can, a)ter all, acco$plish $ore 'hen people 'or! together instea& o) against each other0 =rite ans'ers to the )ollo'ing 4uestions: a0 <o "ou thin! The #o$e <epot $anage$ent regar&s its e$plo"ees $ore as expenses or assetsQ %xplain0 0 =hat &oes The #o$e <epot regar& as its $ost valua le assetQ %xplain "our ans'er0 c0 6s The #o$e <epot per$itte& to list its hu$an resources as assets on its alance sheetQ =h" or 'h" notQ &0 Coul& its philosoph" regar&ing its e$plo"ees e the $a3or )actor in its outstan&ing )inancial per)or$anceQ %xplain0 -t%ics case D Eriting experience < :e)er to KAn ethical perspective: Financial &eals, 6nc0K0 =rite out the ans'ers to the )ollo'ing 4uestions: a0 =hat $otivate& Aarr" to go along 'ith unethical an& illegal actionsQ %xplain0 est i&eas co$e )ro$ the people 'ho 'or! on the sales )loor0 =e encourage our e$plo"ees to challenge senior $anage$ent &irectives i) the" )eel strongl" enough a out their &issenting

p. 1*1 o) *++

0 =hat are Aarr"Js options no'Q Aist each possi ilit"0 c0 =hat 'oul& "ou &o i) "ou 'ere Aarr"Q <escri e in &etail0 &0 =hat &o "ou thin! the real Aarr" &i&Q <escri e in &etail0 9roup pro2ect - 6n tea$s o) t'o or three stu&ents, intervie' in person or " spea!erphone a ne' sta)) $e$ er 'ho has 'or!e& )or a CPA )ir$ )or onl" one or t'o "ears0 ,ee! in)or$ation on the a&vantages an& &isa&vantages o) 'or!ing )or a CPA )ir$0 Also, in4uire a out the nature o) the 'or! an& the training progra$s o))ere& " the )ir$ )or ne' e$plo"ees0 As a tea$, 'rite a $e$oran&u$ to the instructor su$$ari5ing the results o) the intervie'0 The hea&ing o) the $e$oran&u$ shoul& contain the &ate, to 'ho$ it is 'ritten, )ro$ 'ho$, an& the su 3ect $atter0 9roup pro2ect F =ith one or t'o other stu&ents an& using li rar" resources, 'rite a report on the li)e o) Auca Pacioli, so$eti$es re)erre& to as the )ather o) accounting0 Pacioli 'as a Franciscan $on! 'ho 'rote a oo! on &ou le-entr" accounting in 1*>*0 Be care)ul to cite sources an& treat &irect 4uotes properl"0 (6) "ou &o not !no' ho' to &o this, as! "our instructor0)

3.12.'

.sing the (nternet9A vie+ of the real +orld

Gisit the )ollo'ing 'e site: http:77'''0ro erthal)0co$ Clic! on ;o ,ee!ers0 :ea& the in)or$ation an& 'rite a $e$o to "our instructor a out "our search an& 'hat "ou learne& a out certain 3o s in accounting0 Gisit the )ollo'ing 'e site: http:77'''0sec0gov 6nvestigate this site )or an"thing o) interest0 =rite a $e$o to "our instructor a out "our search0

3.12.) 3.12.).1

Ans+ers to self<test True<false

False. Onl" the last )ive steps are per)or$e& at the en& o) the perio&0 The )irst three steps are per)or$e& throughout the accounting perio&0 $rue. The 3ournal is the oo! o) original entr"0 An" a$ounts appearing in a le&ger account $ust have een poste& )ro$ the 3ournal0 p. 1*I o) *++

False. The le)t si&e o) an" account is the &e it si&e0 False. These accounts are all increase& " cre&its0 $rue. ,ince &ivi&en&s re&uce stoc!hol&ersJ e4uit", the <ivi&en&s account is increase& " &e its0 False. An entire 3ournal entr" $a" not have een poste&, or a &e it or cre&it $ight have een poste& to the 'rong account0

3.12.).2

=ultiple<choice

c. An asset, Cash, is increase& " a &e it, an& the Capital ,toc! account is increase& " a cre&it0 b. ,ince the insurance covers $ore than the current accounting perio&, an asset is &e ite& instea& o) an expense0 The cre&it is to Cash0 a0 The receipt o) cash e)ore services are per)or$e& creates a lia ilit", Mnearne& <eliver" Fees0 To increase a lia ilit", it is cre&ite&0 Cash is &e ite& to increase its alance0 b0 Cash is increase& " the &e it, an& <eliver" ,ervice :evenue is increase& " the cre&it0

c. <ivi&en&s is increase& " the &e it, an& Cash is &ecrease& " the cre&it0

p. 1*+ o) *++

! Adjustments for financial reporting
!.1 Learning objectives
     

<escri e the asic characteristics o) the cash asis an& the accrual asis o) accounting0 6&enti)" the reasons 'h" a&3usting entries $ust e $a&e0 6&enti)" the classes an& t"pes o) a&3usting entries0 Prepare a&3usting entries0 <eter$ine the e))ects o) )ailing to prepare a&3usting entries0 Anal"5e an& use the )inancial results an& tren& percentages0

!.2 A career as a ta, specialist
=hile $ost stu&ents are a'are that accountants )re4uentl" assist their clients 'ith tax returns an& other tax issues, )e' are a'are o) the large nu$ er o) &iverse an& challenging careers availa le in the )iel& o) taxation0 /earl" all pu lic accounting )ir$s, ranging )ro$ the FBig *H international )ir$s to the sole practitioner, generate a signi)icant portion o) their )ees through tax co$pliance, planning an& consulting0 =ith over 1CC $illion in&ivi&ual tax returns )ile& in the M, ever" "ear, it is not surprising that $an" in&ivi&uals an& $ost usinesses nee& assistance in &ealing 'ith the incre&i l" co$plex M, an& international tax la's0 This co$plexit" also provi&es tre$en&ous tax planning opportunities0 As a tax specialist, "ou 'ill sho' in&ivi&ual clients ho' to re&uce their taxes 'hile si$ultaneousl" helping the$ $a!e &ecisions a out investing, u"ing a house, )un&ing their chil&ren1s e&ucation, an& planning their retire$ent0 For "our usiness clients, care)ul planning an& structuring o) usiness invest$ents an& transactions can save $illions o) &ollars in taxes0 6n )act, it is sa)e to sa" that ver" )e' signi)icant usiness transactions ta!e place 'ithout the care)ul gui&ance o) a tax specialist0 A career in taxation is " no $eans li$ite& to pu lic accounting0 Because there are so $an" t"pes o) taxes i$pacting so $an" aspects o) our lives, tax specialists act as consultants in a large nu$ er o) )iel&s0 For exa$ple, $an" co$panies o))er &e)erre& co$pensation or stoc! e$plo"ees, as 'ell as health care ene)its0 ,igni)icant tax savings can onus plans to their oth the executives0 /earl" all co$panies provi&e so$e sort o) pension or other retire$ent plan )or their e generate& )or co$pan" an& their e$plo"ees i) these ene)its are structure& correctl"0 6n response to the a$a5ing co$plexit" o) our tax la's, $an" schools o))er $asters &egrees speciali5ing in tax0 ,uch a &egree is not re4uire& to speciali5e in tax, ut &oes o))er stu&ents a signi)icant a&vantage i) the" 'ant to pursue a career in taxation0 6n a recent surve" o) 1,*BB chie) )inancial o))icers, the top t'o responses to the p. 1** o) *++

4uestion F'hich one o) the )ollo'ing areas o) speciali5ation 'oul& "ou reco$$en& to so$eone 3ust eginning his or her career in accountingQH 'ere personal )inancial planning an& tax accounting0 These responses re)lect the in&isputa le )act that as the M, &e$ographic inclu&es $ore 'ealth", an& ol&er, A$ericans than ever e)ore, pro)essional tax gui&ance 'ill e in ever-increasing &e$an&0 The career paths outline& a ove &o not nearl" cover all o) the $an" pro)essional options availa le to tax specialists0 For exa$ple, are "ou concerne& that a tra&itional tax accounting 3o $a" e too ta$e )or "ouQ ,pecial agents o) the 6:, routinel" participate in cri$inal investigations an& arrests, 'or!ing closel" 'ith other )e&eral la' en)orce$ent agencies0 Are "ou intereste& in la'Q Accounting o))ers an i&eal un&ergra&uate &egree )or aspiring usiness an& tax attorne"s0 6) "ou thin! "ou $a" e intereste& in a career as a tax specialist, e sure to consult 'ith one o) "our school1s tax pro)essors a out the $an" 3o opportunities this )iel& provi&es0 Chapters 1 an& I intro&uce& the accounting process o) anal"5ing, classi)"ing, an& su$$ari5ing usiness transactions into accounts0 .ou learne& ho' these transactions are entere& into the 3ournal an& poste& to the le&ger accounts0 .ou also !no' ho' to use the trial alance to test the e4ualit" o) &e its an& cre&its in the 3ournali5ing an& posting process0 The purpose o) the accounting process is to pro&uce accurate )inancial state$ents so the" $a" e use& )or $a!ing soun& usiness &ecisions0 At this point in "our stu&" o) accounting, "ou are concentrating on three )inancial state$entsLthe inco$e state$ent, the state$ent o) retaine& earnings, an& the state$ent o) cash )lo's appears in Chapter 1D0 =hen "ou egan to anal"5e usiness transactions in Chapter 1, "ou sa' that the evi&ence o) the transaction is usuall" a source &ocu$ent0 6t is an" 'ritten or printe& evi&ence that &escri es the essential )acts o) a usiness transaction0 %xa$ples are receipts )or cash pai& or receive&, chec!s 'ritten or receive&, ills sent to custo$ers, or ills receive& )ro$ suppliers0 The giving, receiving, or creating o) source &ocu$ents triggere& the 3ournal entries $a&e in Chapter I0 The 3ournal entries 'e &iscuss in this chapter are a 5usting entries. The arrival o) the en& o) the accounting perio& triggers a&3usting entries0 Accountants use a&3usting entries to ring accounts to their proper alances e)ore preparing )inancial state$ents0 6n this chapter, "ou learn the &i))erence et'een the cash asis an& accrual asis o) accounting0 Then "ou learn a out the classes an& t"pes o) a&3usting entries an& ho' to prepare the$0 alance sheet0 <etaile& coverage o) the

!.3 Cash versus accrual basis accounting
Pro)essionals such as ph"sicians an& la'"ers an& so$e relativel" s$all usinesses $a" account )or their revenues an& expenses on a cash asis0 The cas% basis o0 accounting recogni5es revenues p. 1*C o) *++

'hen cash is receive& an& recogni5es expenses 'hen cash is pai& out0 For exa$ple, un&er the cash asis, a co$pan" 'oul& treat services ren&ere& to clients in IB1B )or 'hich the co$pan" collecte& cash in IB11 as IB11 revenues0 ,i$ilarl", un&er the cash asis, a co$pan" 'oul& treat expenses incurre& in IB1B )or 'hich the co$pan" &is urse& cash in IB11 as IB11 expenses0 Mn&er the FpureH cash asis, even the purchase o) a uil&ing 'oul& e &e ite& to an expense0 #o'ever, un&er the F$o&i)ie&H cash asis, the purchase o) long-live& assets (such as a uil&ing) 'oul& e &e ite& to an asset an& &epreciate& (gra&uall" charge& to expense) over its use)ul li)e0 /or$all" the F$o&i)ie&H cash asis is use& " those )e' in&ivi&uals an& s$all usinesses that use the cash asis0

Ca#h !a#%# Revenues are reco)niEed $s cas0 is received

Accrual !a#%# $s earned #)oods are delivered or services are per(or!ed% $s incurred to produce revenues

Expenses are reco)niEed

$s cas0 is paid

%xhi it 1*: Cash asis an& accrual asis o) accounting co$pare& Because the cash asis o) accounting &oes not $atch expenses incurre& an& revenues earne&, it is generall" consi&ere& theoreticall" unaccepta le0 The cash asis is accepta le in practice onl" un&er those circu$stances 'hen it approxi$ates the results that a co$pan" coul& o tain un&er the accrual asis o) accounting0 Co$panies using the cash asis &o not have to prepare an" a&3usting entries unless the" &iscover the" have $a&e a $ista!e in preparing an entr" &uring the accounting perio&0 Mn&er certain circu$stances, co$panies $a" use the cash asis )or inco$e tax purposes0 Throughout the text 'e use the accrual asis o) accounting, 'hich $atches expenses incurre& an& revenues earne&, ecause $ost co$panies use the accrual asis0 The accrual basis o0 accounting recogni5es revenues 'hen sales are $a&e or services are per)or$e&, regar&less o) 'hen cash is receive&0 %xpenses are recogni5e& as incurre&, 'hether or not cash has een pai& out0 For instance, assu$e a co$pan" per)or$s services )or a custo$er on account0 Although the co$pan" has receive& no cash, the revenue is recor&e& at the ti$e the co$pan" per)or$s the service0 Aater, 'hen the co$pan" receives the cash, no revenue is recor&e& ecause the co$pan" has alrea&" recor&e& the revenue0 Mn&er the accrual asis, a&3usting entries are nee&e& to ring the accounts up to &ate )or unrecor&e& econo$ic activit" that has ta!en place0 6n %xhi it 1*, sho'n elo', 'e sho' 'hen revenues an& expenses are recogni5e& un&er the cash asis an& un&er the accrual asis0

p. 1*D o) *++

!.! The need for adjusting entries
The inco$e state$ent o) a usiness reports all revenues earne& an& all expenses incurre& to generate those revenues &uring a given perio&0 An inco$e state$ent that &oes not report all revenues an& expenses is inco$plete, inaccurate, an& possi l" $islea&ing0 ,i$ilarl", a alance sheet that &oes not report all o) an entit"1s assets, lia ilities, an& stoc!hol&ers1 e4uit" at a speci)ic ti$e $a" e $islea&ing0 %ach a&3usting entr" has a &ual purpose: (1) to $a!e the inco$e state$ent report the proper revenue or expense an& (I) to $a!e the alance sheet report the proper asset or lia ilit"0 Thus, ever" a&3usting entr" a))ects at least one inco$e state$ent account an& one alance sheet account0
1anuar2 /e5ruar2 *arc0 $pril *a2 1une 1ul2 $u)ust Septe!5er +cto5er ove!5er Su&total :ece!5er Total Com1an%e#
Source' American Institute of Certified Public Accountants

30 @ "6 9 "9 4@ 9 "4 42 "7 "3 22; 376 =00
Accounting Trends & Techniques (Ne !ork' AICPA" #$$%& '()

%xhi it 1C: ,u$$ar"-)iscal "ear en&ing " $onth ,ince those intereste& in the activities o) a usiness nee& ti$el" in)or$ation, co$panies $ust

prepare )inancial state$ents perio&icall"0 To prepare such state$ents, the accountant &ivi&es an entit"1s li)e into ti$e perio&s0 These ti$e perio&s are usuall" e4ual in length an& are calle& accounting perio s. An accounting perio. $a" e one $onth, one 4uarter, or one "ear0 An accounting year, or )iscal "ear, is an accounting perio& o) one "ear0 A 0iscal year is an" 1I consecutive $onths0 The )iscal "ear $a" or $a" not coinci&e 'ith the calen.ar year, 'hich en&s on <ece$ er +10 As 'e sho' in %xhi it 1C, D+ per cent o) the co$panies surve"e& in IBB* ha& )iscal "ears that coinci&e 'ith the calen&ar "ear0 6n IBB8, the co$para le )igure )or pu licl"-tra&e& co$panies in the M, 'as DC per cent0 Co$panies in certain in&ustries o)ten have a )iscal "ear that &i))ers )ro$ the calen&ar "ear0 For instance $an" retail stores en& their )iscal "ear on ;anuar" +1 to avoi& closing their oo!s &uring their pea! sales perio&0 Other co$panies select a )iscal "ear en&ing at a ti$e 'hen inventories an& usiness activit" are lo'est0 Perio&ic reporting an& the $atching principle necessitate the preparation o) a 5usting entries. #.2usting entries are 3ournal entries $a&e at the en& o) an accounting perio& or at an" ti$e

p. 1*@ o) *++

)inancial state$ents are to e prepare& to ring a out a proper "atc%ing o) revenues an& expenses0 The matc%ing principle re4uires that expenses incurre& in pro&ucing revenues e &e&ucte& )ro$ the revenues the" generate& &uring the accounting perio&0 The $atching principle is one o) the un&erl"ing principles o) accounting0 This $atching o) expenses an& revenues is necessar" )or the inco$e state$ent to present an accurate picture o) the pro)ita ilit" o) a usiness0 A&3usting entries re)lect unrecor&e& econo$ic activit" that has ta!en place ut has not "et een recor&e&0 =h" has the co$pan" not recor&e& this activit" " the en& o) the perio&Q One reason is that it is $ore convenient an& econo$ical to 'ait until the en& o) the perio& to recor& the activit"0 A secon& reason is that no source &ocu$ent concerning that activit" has "et co$e to the accountant1s attention0 A&3usting entries ring the a$ounts in the general le&ger accounts to their proper alances e)ore the co$pan" prepares its )inancial state$ents0 That is, a&3usting entries convert the a$ounts that are actuall" in the general le&ger accounts to the a$ounts that shoul& e in the general le&ger accounts )or proper )inancial reporting0 To $a!e this conversion, the accountants anal"5e the accounts to &eter$ine 'hich nee& a&3ust$ent0 For exa$ple, assu$e a co$pan" purchase& a three-"ear insurance polic" costing M,< DBB at the eginning o) the "ear an& &e ite& M,< DBB to Prepai& 6nsurance0 At "ear-en&, the co$pan" shoul& re$ove M,< IBB o) the cost )ro$ the asset an& recor& it as an expense0 Failure to &o so $isstates assets an& net inco$e on the )inancial state$ents0

%xhi it 1D: T'o classes an& )our t"pes o) a&3usting entries

p. 1*8 o) *++

Co$panies continuousl" receive ene)its )ro$ $an" assets such as prepai& expenses (e0g0 prepai& insurance an& prepai& rent)0 Thus, an entr" coul& e $a&e &ail" to recor& the expense incurre&0 T"picall", )ir$s &o not $a!e the entr" until )inancial state$ents are to e prepare&0 There)ore, i) $onthl" )inancial state$ents are prepare&, $onthl" a&3usting entries are re4uire&0 B" custo$, an& in so$e instances " la', usinesses report to their o'ners at least annuall"0 Accor&ingl", a&3usting entries are re4uire& at least once a "ear0 :e$e$ er, ho'ever, that the entr" trans)erring an a$ount )ro$ an asset account to an expense account shoul& trans)er onl" the asset cost that has expire&0

#n accounting perspecti'e: 6ses o0 tec%nology
%ventuall", co$puters 'ill pro a l" enter a&3usting entries continuousl" on a realti$e asis so that up-to-&ate )inancial state$ents can e printe& at an" ti$e 'ithout prior notice0 Co$puters 'ill e )e& the )acts concerning activities that 'oul& nor$all" result in a&3usting entries an& instructe& to see! an" necessar" in)or$ation )ro$ their o'n &ata ases or those o) other co$puters to continuall" a&3ust the accounts0

!.# Classes and t pes of adjusting entries
A&3usting entries )all into t'o roa& classes: &e)erre& ($eaning to postpone or &ela") ite$s an& accrue& ($eaning to gro' or accu$ulate) ite$s0 <e0erre. items consist o) a&3usting entries involving &ata previousl" recor&e& in accounts0 These entries involve the trans)er o) &ata alrea&" recor&e& in asset an& lia ilit" accounts to expense an& revenue accounts, respectivel"0 #ccrue. items consist o) a&3usting entries relating to activit" on 'hich no &ata have een previousl" recor&e& in the accounts0 These entries involve the initial, or )irst, recor&ing o) assets an& lia ilities an& the relate& revenues an& expenses (see %xhi it 1D)0 <e)erre& ite$s consist o) t'o t"pes o) a&3usting entries: asset7expense a&3ust$ents an& lia ilit"7revenue a&3ust$ents0 For exa$ple, prepai& insurance an& prepai& rent are assets until the" are use& up? then the" eco$e expenses0 Also, unearne& revenue is a lia ilit" until the co$pan" ren&ers the service? then the unearne& revenue eco$es earne& revenue0 Accrue& ite$s consist o) t'o t"pes o) a&3usting entries: asset7revenue a&3ust$ents an& lia ilit"7expense a&3ust$ents0 For exa$ple, assu$e a co$pan" per)or$s a service )or a custo$er ut has not "et ille& the custo$er0 The accountant recor&s this transaction as an asset in the )or$ o) a receiva le an& as revenue ecause the co$pan" has earne& a revenue0 Also, assu$e a co$pan" o'es

p. 1*> o) *++

its e$plo"ees salaries not "et pai&0 The accountant recor&s this transaction as a lia ilit" an& an expense ecause the co$pan" has incurre& an expense0
MICROTRAIN COM.AN@ Tr%al !alance 2010 :ecem&er 1 Acct. No. "00 "03 "07 "09 ""2 "50 200 2"6 300 320 400 505 506 507 5"" Account T%tle ,as0 $ccounts Receiva5le Supplies on Aand =repaid .nsurance =repaid Rent Truc6s $ccounts =a2a5le -nearned Service /ees ,apital Stoc6 :ividends Service Revenue $dvertisin) Expense Gas and +il Expense Salaries Expense -tilities Expense 50 690 3,600 "50 $65,@30 $65,@30 3,000 "0,700 :e&%t# $ 9,250 5,200 ",400 2,400 ",200 40,000 $ 730 4,500 50,000 Cred%t#

%xhi it 1@: Trial alance 6n this chapter, 'e illustrate each o) the )our t"pes o) a&3usting entries: asset7expense, lia ilit"7revenue, asset7revenue, an& lia ilit"7expense0 Aoo! at %xhi it 1@, the trial alance o) the (icroTrain Co$pan" at IB1B <ece$ er +10 As "ou can see, (icroTrain $ust a&3ust several accounts e)ore it can prepare accurate )inancial state$ents0 The a&3ust$ents )or these accounts involve &ata alrea&" recor&e& in the co$pan"1s accounts0 6n $a!ing a&3ust$ents )or (icroTrain Co$pan", 'e $ust a&& several accounts to the co$pan"1s chart o) accounts sho'n in Chapter I0 These ne' accounts are:
Ty1e o* Account $sset ,ontra assetJ 4ia5ilit2 Revenue Expenses Acct. No. "2" "5" 206 4"9 5"2 5"5 5"9 52" Account T%tle .nterest Receiva5le $ccu!ulated :eprecationMTruc6s Salaries =a2a5le .nterest Revenue .nsurance Expense Rent Expense Supplies Expense :epreciation ExpenseM :e#cr%1t%on T0e a!ount o( interest earned 5ut not 2et received' T0e total depreciation expense ta6en on truc6s since t0e ac7uisition date' T0e 5alance o( t0is account is deducted (ro! t0at o( Truc6s on t0e 5alance s0eet' T0e a!ount o( salaries earned 52 e!plo2ees 5ut not 2et paid 52 t0e co!pan2'

p. 1CB o) *++

Truc6s

T0e a!ount o( interest earned in t0e current period' T0e cost o( insurance incurred in t0e current period' T0e cost o( rent incurred in t0e current period' T0e cost o( supplies used in t0e current period' T0e portion o( t0e cost o( t0e truc6s assi)ned to expense durin) t0e current period'
asset account on t0e 5alance s0eet' Le explain t0e

J$ccountants deduct t0e 5alance o( a contra asset (ro! t0e 5alance o( t0e related reasons (or usin) a contra asset account later in t0e c0apter'

/o' "ou are rea&" to )ollo' as (icroTrain Co$pan" $a!es its a&3ust$ents )or &e)erre& ite$s0 6) "ou )in& the process con)using, revie' the eginning o) this chapter so "ou clearl" un&erstan& the purpose o) a&3usting entries0

#n accounting perspecti'e: 6ses o0 tec%nology
6t is &i))icult to na$e a pu licl" o'ne& co$pan" that &oes not provi&e an extensive 'e site0 6n )act, 'e sites have eco$e an i$portant lin! et'een co$panies an& their investors0 (ost 'e sites 'ill have a lin! title& investor relations or $erel" co$pan" in)or$ation 'hich provi&es a 'ealth o) )inancial in)or$ation ranging )ro$ au&ite& )inancial state$ents to charts o) the co$pan"Js stoc! prices0 As an exa$ple, chec! out the 2ap, 6ncs 'e site at: http:77'''0gapinc0co$ Bro'se the 2ap site an& see )or "oursel) the co$prehensiveness o) the )inancial in)or$ation availa le there0

!.$ Adjustments for deferred items
This section &iscusses the t'o t"pes o) a&3ust$ents )or &e)erre& ite$s: asset7expense a&3ust$ents an& lia ilit"7revenue a&3ust$ents0 6n the asset7expense group, "ou learn ho' to prepare a&3usting entries )or prepai& expenses an& &epreciation0 6n the lia ilit"7revenue group, "ou learn ho' to prepare a&3usting entries )or unearne& revenues0 (icroTrain Co$pan" $ust $a!e several asset7expense a&3ust$ents )or prepai& expenses0 A prepai. expense is an asset a'aiting assign$ent to expense, such as prepai& insurance, prepai& rent, an& supplies on han&0 /ote that the nature o) these three a&3ust$ents is the sa$e0 &repai. insurance =hen a co$pan" pa"s an insurance polic" pre$iu$ in a&vance, the purchase creates the asset, prepai insurance. This a&vance pa"$ent is an asset ecause the co$pan" 'ill p. 1C1 o) *++

receive insurance coverage in the )uture0 =ith the passage o) ti$e, ho'ever, the asset gra&uall" expires0 The portion that has expire& eco$es an expense0 To illustrate this point, recall that in Chapter I, (icroTrain Co$pan" purchase& )or cash an insurance polic" on its truc!s )or the perio& IB1B <ece$ er 1, to IB11 /ove$ er +B0 The 3ournal entr" $a&e on IB1B <ece$ er 1, to recor& the purchase o) the polic" 'as:
20"0 :ec' " =repaid .nsurance ,as0 =urc0ased truc6 insurance to cover a one32ear period' 2,400 2400

The t'o accounts relating to insurance are Prepai& 6nsurance (an asset) an& 6nsurance %xpense (an expense)0 A)ter posting this entr", the Prepai& 6nsurance account has a M,< I,*BB &e it alance on IB1B <ece$ er 10 The 6nsurance %xpense account has a 5ero alance on IB1B <ece$ er 1, ecause no ti$e has elapse& to use an" o) the polic"1s ene)its0
#:r'% 20"0
:ec' " &al' 2,400 .re1a%d In#urance

#,r%

#:r'% 20"0
:ec' " &al'

In#urance E01en#e

#,r%

303

B" IB1B <ece$ er +1, one $onth o) the "ear covere& " the polic" has expire&0 There)ore, part o) the ser'ice potential (or ene)it o taine& )ro$ the asset) has expire&0 The asset no' provi&es less )uture services or ene)its than 'hen the co$pan" ac4uire& it0 =e recogni5e this re&uction " treating the cost o) the services receive& )ro$ the asset as an expense0 For the (icroTrain Co$pan" exa$ple, the service receive& 'as one $onth o) insurance coverage0 ,ince the polic" provi&es the sa$e services )or ever" $onth o) its one-"ear li)e, 'e assign an e4ual a$ount (M,< IBB) o) cost to each $onth0 Thus, (icroTrain charges 171I o) the annual pre$iu$ to 6nsurance %xpense on IB1B <ece$ er +10 The a&3usting 3ournal entr" is:
20"0 :ec' 3" .nsurance Expense =repaid .nsurance 200 200 $d<ust!ent "M.nsurance

p. 1CI o) *++

To record insurance expense (or :ece!5er'

A)ter posting these t'o 3ournal entries, the accounts in T-account )or$at appear as )ollo's:
#:r'%
.re1a%d In#urance

#,r%

20"0 :ec' " =urc0ased on account 2,400 &al' $(ter ad<ust!ent #:r'% In#urance E01en#e .ncreased 52 $200 20"0 3" $d<ust!ent " 200 2,200

20"0 :ec' 3" $d<ust!ent "

200 :ecreased 52 $200

#,r'%

6n practice, accountants &o not use T-accounts0 6nstea&, the" use three-colu$n le&ger accounts that have the a&vantage o) sho'ing a alance a)ter each transaction0 A)ter posting the prece&ing t'o entries, the three-colu$n le&ger accounts appear as )ollo's:
.re1a%d In#urance :ate :ec' 20"0 " Explanation =urc0ased on $ccount =ost Re(' G" :e5it 2400 ,redit &alance 2400 :r'

3" In#urance E01en#e :ate :ec' 20"0 3"

$d<ust!ent Explanation $d<ust!ent

G3J =ost Re(' G3J :e5it 200

200 ,redit

2200 :r' &alance 200 :r'

J$ssu!ed pa)e nu!5er

Be)ore this a&3usting entr" 'as $a&e, the entire M,< I,*BB insurance pa"$ent $a&e on IB1B <ece$ er 1, 'as a prepai& expense )or 1I $onths o) protection0 ,o on IB1B <ece$ er +1, one $onth o) protection ha& passe&, an& an a&3usting entr" trans)erre& M,< IBB o) the M,< I,*BB (M,< I,*BB71I S M,< IBB) to 6nsurance %xpense0 On the inco$e state$ent )or the "ear en&e& IB1B <ece$ er +1, (icroTrain reports one $onth o) insurance expense, M,< IBB, as one o) the expenses it incurre& in generating that "ear1s revenues0 6t reports the re$aining a$ount o) the prepai& expense, M,< I,IBB, as an asset on the alance sheet0 The M,< I,IBB prepai& expense represents 11 $onths o) insurance protection that re$ains as a )uture ene)it0 &repai. rent Prepai& rent is another exa$ple o) the gra&ual consu$ption o) a previousl" recor&e& asset0 Assu$e a co$pan" pa"s rent in a&vance to cover $ore than one accounting perio&0 On

p. 1C+ o) *++

the &ate it pa"s the rent, the co$pan" &e its the prepa"$ent to the Prepai& :ent account (an asset account)0 The co$pan" has not "et receive& expen&iture creates an asset0 =e $easure rent expense si$ilarl" to insurance expense0 2enerall", the rental contract speci)ies the a$ount o) rent per unit o) ti$e0 6) the prepa"$ent covers a three-$onth rental, 'e charge one-thir& o) this rental to each $onth0 /otice that the a$ount charge& is the sa$e each $onth even though so$e $onths have $ore &a"s than other $onths0 For exa$ple, (icroTrain Co$pan" pai& M,< 1,IBB rent in a&vance on IB1B <ece$ er I8, to cover a three-$onth perio& eginning on that &ate0 The 3ournal entr" 'oul& e:
20"0 :ec' " =repaid Rent ,as0 =aid t0ree !ont0s8 rent on a 5uildin)' ",200 ",200

ene)its resulting )ro$ this expen&iture0 Thus, the

The t'o accounts relating to rent are Prepai& :ent (an asset) an& :ent %xpense0 A)ter this entr" is poste&, the Prepai& :ent account has a M,< 1,IBB alance an& the :ent %xpense account has a 5ero alance ecause no part o) the rent perio& has "et elapse&0
#:r'% 20"0
:ec' " &al' ,as0 =aid ",200 .re1a%d Rent

#,r%

#:r'% 20"0
:ec' " &al'

Rent E01en#e

#,r%

303

On IB1B <ece$ er +1, (icroTrain $ust prepare an a&3usting entr"0 ,ince one thir& o) the perio& covere& " the prepai& rent has elapse&, it charges one-thir& o) the M,< 1,IBB o) prepai& rent to expense0 The re4uire& a&3usting entr" is:
20"0 :ec' $d<ust!ent 2MRent 3" Rent Expense =repaid Rent To record rent expense (or :ece!5er 400 400

p. 1C* o) *++

A)ter posting this a&3usting entr", the T-accounts appear as )ollo's:
#:r'%
.re1a%d Rent ",200 900 Rent E01en#e 400 20"0 :ec' 3" $d<ust!ent 2 400 20"0 :ec' " ,as0 =aid &al' a(ter ad<ust!ent

#,r%
:ecreased 52 $400

#:r'%
.ncreased 52 $400 20"0 :ec' 3" $d<ust!ent 2

#,r%

The M,< *BB rent expense appears in the inco$e state$ent )or the "ear en&e& IB1B <ece$ er +10 (icroTrain reports the re$aining M,< 8BB o) prepai& rent as an asset in the alance sheet on IB1B <ece$ er +10 Thus, the a&3usting entries have acco$plishe& their purpose o) $aintaining the accurac" o) the )inancial state$ents0 "upplies on %an. Al$ost ever" usiness uses supplies in its operations0 6t $a" classi)" supplies si$pl" as supplies (to inclu&e all t"pes o) supplies), or $ore speci)icall" as o))ice supplies (paper, stationer", )lopp" &is!ettes, pencils), selling supplies (gu$$e& tape, string, paper ags, cartons, 'rapping paper), or training supplies (transparencies, training $anuals)0 Fre4uentl", co$panies u" supplies in ul!0 These supplies are an asset until the co$pan" uses the$0 This asset $a" e calle& supplies on %an or supplies inventory. %ven though these ter$s in&icate a prepai& expense, the )ir$ &oes not use prepai in the asset1s title0 On IB1B <ece$ er *, (icroTrain Co$pan" purchase& supplies )or M,< 1,*BB an& recor&e& the transaction as )ollo's:
20"0 :ec'

4

Supplies on Aand ,as0 To record t0e purc0ase o( supplies (or (uture use'

",400

",400

(icroTrain1s t'o accounts relating to supplies are ,upplies on #an& (an asset) an& ,upplies %xpense0 A)ter this entr" is poste&, the ,upplies on #an& account sho's a &e it alance o) M,< 1,*BB an& the ,upplies %xpense account has a 5ero alance as sho'n in the )ollo'ing T-accounts:
#:r'% 20"0 :ec' 4 &al' ,as0 =aid Su11l%e# On 9and #,r'% #:r'% 20"0 :ec' 4 &al' Su11l%e# E01en#e #,r'%

",400

303

An actual ph"sical inventor" (a count o) the supplies on han&) at the en& o) the $onth sho'e& onl" M,< >BB o) supplies on han&0 Thus, the co$pan" $ust have use& M,< CBB o) supplies in <ece$ er0

p. 1CC o) *++

An a&3usting 3ournal entr" rings the t'o accounts pertaining to supplies to their proper alances0 The a&3usting entr" recogni5es the re&uction in the asset (,upplies on #an&) an& the recor&ing o) an expense (,upplies %xpense) " trans)erring M,< CBB )ro$ the asset to the expense0 Accor&ing to the ph"sical inventor", the asset alance shoul& e M,< >BB an& the expense alance, M,< CBB0 ,o (icroTrain $a!es the )ollo'ing a&3usting entr":
20"0 :ec' 3" Supplies Expense Supplies on Aand To record supplies used durin) :ece!5er' 500 500 $d<ust!ent 3MSupplies

A)ter posting this a&3usting entr", the T-accounts appear as )ollo's:
#:r'%
Su11l%e# on 9and

#,r%
20"0 :ec' 3" $d<ust!ent 3 :ecreased 52 $500 500

20"0 :ec' 4 ,as0 =aid ",400 &al' a(ter @00 ad<ust!ent

#:r'%
.ncreased 52 $500

Su11l%e# E01en#e

#,r'%
500

20"0 :ec 3" $d<ust!ent 3

The entr" to recor& the use o) supplies coul& costl" a proce&ure0

e $a&e 'hen the supplies are issue& )ro$ the

storeroo$0 #o'ever, such care)ul accounting )or s$all ite$s each ti$e the" are issue& is usuall" too Accountants $a!e a&3usting entries )or supplies on han&, li!e )or an" other prepai& expense, e)ore preparing )inancial state$ents0 ,upplies expense appears in the inco$e state$ent0 ,upplies on han& is an asset in the alance sheet0 ,o$eti$es co$panies u" assets relating to insurance, rent, an& supplies !no'ing that the" 'ill use the$ up e)ore the en& o) the current accounting perio& (usuall" one $onth or one "ear)0 6) so, an expense account is usuall" &e ite& at the ti$e o) purchase rather than &e iting an asset account0 This proce&ure avoi&s having to $a!e an a&3usting entr" at the en& o) the accounting perio&0 ,o$eti$es, too, a co$pan" &e its an expense even though the asset 'ill ene)it $ore than the current perio&0 Then, at the en& o) the accounting perio&, the )ir$1s a&3usting entr" trans)ers so$e o) the cost )ro$ the expense to the asset0 For instance, assu$e that on ;anuar" 1, a co$pan" pai& M,< 1,IBB rent to cover a three-"ear perio& an& &e ite& the M,< 1,IBB to :ent %xpense0 At the en& o) the "ear, it trans)ers M,< 8BB )ro$ :ent %xpense to Prepai& :ent0 To si$pli)" our approach, 'e 'ill consistentl" &e it the asset 'hen the asset 'ill ene)it $ore than the current accounting perio&0 p. 1CD o) *++

<epreciation ;ust as prepai& insurance an& prepai& rent in&icate a gra&ual using up o) a previousl" recor&e& asset, so &oes &epreciation0 #o'ever, the overall ti$e involve& in using up a &eprecia le asset (such as a uil&ing) is $uch longer an& less &e)inite than )or prepai& expenses0 Also, a prepai& expense generall" involves a )airl" s$all a$ount o) $one"0 <eprecia le assets, ho'ever, usuall" involve larger su$s o) $one"0 A .epreciable asset is a $anu)acture& asset such as a uil&ing, $achine, vehicle, or piece o) e4uip$ent that provi&es service to a usiness0 6n ti$e, these assets lose their utilit" ecause o) (1) 'ear an& tear )ro$ use or (I) o solescence &ue to technological change0 ,ince co$panies gra&uall" use up these assets over ti$e, the" recor& &epreciation expense on the$0 <epreciation expense is the a$ount o) asset cost assigne& as an expense to a particular perio&0 The process o) recor&ing &epreciation expense is calle& .epreciation accounting. The three )actors involve& in co$puting &epreciation expense are:
 #sset cost0 The asset cost is the a$ount that a co$pan" pai& to purchase the &eprecia le asset0  -stimate. resi.ual 'alue. The estimate. resi.ual 'alue (scrap 'alue) is the a$ount

that the co$pan" can pro a l" sell the asset )or at the en& o) its esti$ate& use)ul li)e0
 -stimate. use0ul li0e. The estimate. use0ul li0e o) an asset is the esti$ate& ti$e that a

co$pan" can use the asset0 Mse)ul li)e is an esti$ate, not an exact $easure$ent, that a co$pan" $ust $a!e in a&vance0 #o'ever, so$eti$es the use)ul li)e is &eter$ine& " co$pan" polic" (e0g0 !eep a )leet o) auto$o iles )or three "ears)0 Accountants use &i))erent $etho&s )or recor&ing &epreciation0 The $etho& illustrate& here is the straig%t)line "et%o . =e &iscuss other &epreciation $etho&s in Chapter 1B0 ,traight-line &epreciation assigns the sa$e a$ount o) &epreciation expense to each accounting perio& over the li)e o) the asset0 The .epreciation 0ormula (straig%t-line) to co$pute straight-line &epreciation )or a one-"ear perio& is:
Annual de'recation = Asset cost * Estimated residual +alue Estimated years of useful life

To illustrate the use o) this )or$ula, recall that on <ece$ er 1, (icroTrain Co$pan" purchase& )our s$all truc!s at a cost o) M,< *B,BBB0 The 3ournal entr" 'as:
20"0 :ec' " Truc6s ,as0 To record t0e purc0ase o( (our truc6s' 40,000 40,000

p. 1C@ o) *++

The esti$ate& resi&ual value )or each truc! 'as M,< 1,BBB, so (icroTrain esti$ate& the total resi&ual value )or all )our truc!s at M,< *,BBB0 The co$pan" esti$ate& the use)ul li)e o) each truc! to e )our "ears0 Msing the straight-line &epreciation )or$ula, (icroTrain calculate& the annual &epreciation on the truc!s as )ollo's: Annual &eprecation S
,S- %$"$$$ * ,S- %"$$$ = ,S- )"$$$ % years

The a$ount o) &epreciation expense )or one $onth 'oul& e 171I o) the annual a$ount0 Thus, &epreciation expense )or <ece$ er is M,< >,BBB U 1I S M,< @CB0 The &i))erence et'een an asset1s cost an& its esti$ate& resi&ual value is an asset1s .epreciable amount. To satis)" the $atching principle, the )ir$ $ust allocate the &eprecia le a$ount as an expense to the various perio&s in the asset1s use)ul li)e0 6t &oes this " &e iting the a$ount o) &epreciation )or a perio& to a &epreciation expense account an& cre&iting the a$ount to an accu$ulate& &epreciation account0 (icroTrain1s &epreciation on its &eliver" truc!s )or <ece$ er is M,< @CB0 The co$pan" recor&s the &epreciation as )ollo's:
20"0 :ec' 3" :epreciation Expense N Truc6s $ccu!ulated :epreciation 3 Truc6s To record depreciation expense (or :ece!5er' 750 750 $d<usted 43 :epreciation

A)ter posting the a&3usting entr", the T-accounts appear as )ollo':
#:r'%
:e1rec%at%on E01en#eGTruc'# 20"0 :ec 3" $d<ust!ent 4 750

#,r%

.ncreased 52 $750

#:r'%

Accumulated :e1rec%at%onGTruc'# #,r'% 20"0 :ec' 3" $d<ust!ent 4 750

.ncreased 52 $750 #5oo6 value o( asset decreased%

(icroTrain reports &epreciation expense in its inco$e state$ent0 An& it reports accu$ulate& &epreciation in the alance sheet as a &e&uction )ro$ the relate& asset0

p. 1C8 o) *++

The accumulate. .epreciation account is a contra asset account that sho's the total o) all &epreciation recor&e& on the asset &ro" t%e ate o& acquisition up t%roug% t%e balance s%eet ate. A contra asset account is a &e&uction )ro$ the asset to 'hich it relates in the un&epreciate& cost or oo! value0 The accu"ulate alance sheet0 The purpose o) a contra asset account is to re&uce the original cost o) the asset &o'n to its re$aining epreciation account &oes not represent cash that is eing set asi&e to replace the 'orn out asset0 The un epreciate cost o& t%e asset is the &e it alance in the asset account (original cost) $inus the cre&it alance in the accu$ulate& &epreciation contra account0 Accountants also re)er to an asset1s cost less accu$ulate& &epreciation as the book 'alue (or net oo! value) o) the asset0 Thus, oo! value is the cost not "et allocate& to an expense0 6n the previous exa$ple, the oo! value o) the e4uip$ent a)ter the )irst $onth is:
,ost 4ess: $ccu!ulated depreciation &oo6 value #or cost not 2et allocated to as an expense% -S: 40,000 750 3@,250

(icroTrain cre&its the &epreciation a$ount to an accu$ulate& &epreciation account, 'hich is a contra asset, rather than &irectl" to the asset account0 Co$panies use contra accounts 'hen the" 'ant to sho' state$ent rea&ers the original a$ount o) the account to 'hich the contra account relates0 For instance, )or the asset Truc!s, it is use)ul to !no' oth the original cost o) the asset an& the total accu$ulate& &epreciation a$ount recor&e& on the asset0 There)ore, the asset account sho's the original cost0 The contra account, Accu$ulate& <epreciationLTruc!s, sho's the total a$ount o) recor&e& &epreciation )ro$ the &ate o) ac4uisition0 B" having oth original cost an& the accu$ulate& &epreciation a$ounts, a user can esti$ate the approxi$ate percentage o) the ene)its e$ o&ie& in the asset that the co$pan" has consu$e&0 For instance, assu$e the accu$ulate& &epreciation a$ount is a out three-)ourths the cost o) the asset0 Then, the ene)its 'oul& e approxi$atel" three-)ourths consu$e&, an& the co$pan" $a" have to replace the asset soon0 Thus, to provi&e $ore co$plete alance sheet in)or$ation to users o) )inancial state$ents, co$panies sho' oth the original ac4uisition cost an& accu$ulate& &epreciation0 6n the prece&ing exa$ple )or a&3ust$ent *, the alance sheet at IB1B <ece$ er +1, 'oul& sho' the asset an& contra asset as )ollo's:
A##et#

Truc6s 4ess: $ccu!ulated deprecation

-S: 40,000 750 -S: 3@,250

p. 1C> o) *++

As "ou $a" expect, the accu$ulate& &epreciation account alance increases each perio& " the a$ount o) &epreciation expense recor&e& until the re$aining esti$ate& resi&ual value0 A lia ilit"7revenue a&3ust$ent involving unearne& revenues covers situations in 'hich a custo$er has trans)erre& assets, usuall" cash, to the selling co$pan" e)ore the receipt o) $erchan&ise or services0 :eceiving assets e)ore the" are earne& creates a lia ilit" calle& unearne. re'enue. The )ir$ &e its such receipts to the asset account Cash an& cre&its a lia ilit" account0 The lia ilit" account cre&ite& $a" e Mnearne& Fees, :evenue :eceive& in A&vance, A&vances " Custo$ers, or so$e si$ilar title0 The seller $ust either provi&e the services or return the custo$er1s $one"0 B" per)or$ing the services, the co$pan" earns revenue an& cancels the lia ilit"0 Co$panies receive a&vance pa"$ents )or $an" ite$s, such as training services, &eliver" services, tic!ets, an& $aga5ine or ne'spaper su scriptions0 Although 'e illustrate an& &iscuss onl" a&vance& receipt o) training )ees, )ir$s treat the other ite$s si$ilarl"0 6nearne. ser'ice 0ees On <ece$ er @, (icroTrain Co$pan" receive& M,< *,CBB )ro$ a custo$er in pa"$ent )or )uture training services0 The )ir$ recor&e& the )ollo'ing 3ournal entr":
20"0 :ec' 7 ,as0 -nearned Service /ees To record t0e receipt o( cas0 (ro! a custo!er in pa2!ent (or (uture trainin) services' 4,500 4,500

oo! value o) the asset e4uals the

The t'o T-accounts relating to training )ees are Mnearne& ,ervice Fees (a lia ilit") an& ,ervice :evenue0 These accounts appear as )ollo's on IB1B <ece$ er +1 ( e)ore a&3ust$ent):
#:r'%
Unearned Ser2%ce Fee# #,r'% 20"0 :ec' 7 ,as0 received in advance 4,500

#:r'%
JT0e $"0,700 5alance ca!e

Ser2%ce Re2enue #,r'% 20"0 &al' 5e(ore ad<ust!ent "0,700J (ro! transactions discussed in ,0apter 2'

The alance in the Mnearne& ,ervice Fees lia ilit" account esta lishe& 'hen (icroTrain receive& the cash 'ill e converte& into revenue as the co$pan" per)or$s the training services0 Be)ore (icroTrain prepares its )inancial state$ents, it $ust $a!e an a&3usting entr" to trans)er the a$ount o) the services per)or$e& " the co$pan" )ro$ a lia ilit" account to a revenue account0 6) 'e assu$e that

p. 1DB o) *++

(icroTrain earne& one-thir& o) the M,< *,CBB in the Mnearne& ,ervice Fees account " <ece$ er +1, then the co$pan" trans)ers M,< 1,CBB to the ,ervice :evenue account as )ollo's:
20"0 :ec' $d<ust!ent 5M Revenue earned 3" -nearned Service /ees Service Revenue To trans(er a portion o( trainin) (ees (ro! t0e lia5ilit2 account to t0e revenue account' ",500 ",500

A)ter posting the a&3usting entr", the T-accounts 'oul& appear as )ollo's:
:ecreased 52 $",500

#:r'%
20"0 20"0 :ec' 3"

Unearned Ser2%ce Fee# 20"0 $d<ust!ent 5 ",500 :ec' 7 ,as0 received in advance &al' a(ter ad<ust!ent

#,r'%

4,500 3,000

#:r'%

Ser2%ce Re2enue 20"0 &al' 5e(ore ad<ust!ent :ec' 3" $d<ust!ent 5 &al' a(ter ad<ust!ent

#,r'%
"0,700 ",500 "2,200 .ncreased M 52 $",500

(icroTrain reports the service revenue in its inco$e state$ent )or IB1B0 The co$pan" reports the M,< +,BBB alance in the Mnearne& ,ervice Fees account as a lia ilit" in the alance sheet0 6n IB11, the co$pan" 'ill li!el" earn the M,< +,BBB an& trans)er it to a revenue account0 6) (icroTrain &oes not per)or$ the training services, the co$pan" 'oul& have to re)un& the $one" to the training service custo$ers0 For instance, assu$e that (icroTrain coul& not per)or$ the re$aining M,< +,BBB o) training services an& 'oul& have to re)un& the $one"0 Then, the co$pan" 'oul& $a!e the )ollo'ing entr":
-nearned Service /ees ,as0 To record t0e re(und o( unearned trainin) (ees' 3,000 3,000

Thus, the co$pan" $ust either per)or$ the training services or re)un& the )ees0 This )act shoul& strengthen "our un&erstan&ing that unearne& service )ees an& si$ilar ite$s are lia ilities0 p. 1D1 o) *++

Accountants $a!e the a&3usting entries )or &e)erre& ite$s )or &ata alrea&" recor&e& in a co$pan"1s asset an& lia ilit" accounts0 The" also $a!e a&3usting entries )or accrue& ite$s, 'hich 'e &iscuss in the next section, )or usiness &ata not "et recor&e& in the accounting recor&s0

#n accounting perspecti'e: Business insig%t
Accor&ing to the /ational Association o) Colleges an& %$plo"ers, the average o))er to an accounting $a3or in IBB> 'as M,< *8,++* an& ten&s to increase each "ear0 Accor&ing to recent surve"s, the $ar!et )or accounting gra&uates re$ains ris!0 O)ten, one o) the chie) pro le$s )or gra&uates is ho' to han&le $ultiple 3o o))ers0 As a result o) the lo' une$plo"$ent rate, e$plo"ersLespeciall" s$all accounting )ir$s 'ith li$ite& recruiting can&i&ates0 u&getsLare &oing 'hatever the" can to gra 4uali)ie&

!.% Adjustments for accrued items
Accrue& ite$s re4uire t'o t"pes o) a&3usting entries: asset7revenue a&3ust$ents an& lia ilit"7expense a&3ust$ents0 The )irst groupLasset7revenue a&3ust$entsLinvolves accrue& assets? the secon& groupLlia ilit"7expense a&3ust$entsLinvolves accrue& lia ilities0 #ccrue. assets are assets, such as interest receiva le or accounts receiva le, that have not een recor&e& " the en& o) an accounting perio&0 These assets represent rights to receive )uture pa"$ents that are not &ue at the alance sheet &ate0 To present an accurate picture o) the a))airs o) the usiness on the alance sheet, )ir$s recogni5e these rights at the en& o) an accounting perio& " preparing an a&3usting entr" to correct the account alances0 To in&icate the &ual nature o) these a&3ust$ents, the" recor& a relate& revenue in a&&ition to the asset0 =e also call these a&3ust$ents accrue. re'enues ecause the revenues $ust e recor&e&0 1nterest re'enue ,avings accounts literall" earn interest $o$ent " $o$ent0 :arel" is pa"$ent o) the interest $a&e on the last &a" o) the accounting perio&0 Thus, the accounting recor&s nor$all" &o not sho' the interest revenue earne& ( ut not "et receive&), 'hich a))ects the total assets o'ne& " the investor, unless the co$pan" $a!es an a&3usting entr"0 The a&3usting entr" at the en& o) the accounting perio& &e its a receiva le account (an asset) an& cre&its a revenue account to recor& the interest earne& an& the asset o'ne&0 For exa$ple, assu$e (icroTrain Co$pan" has so$e $one" in a savings account0 On IB1B <ece$ er +1, the $one" on &eposit has earne& one $onth1s interest o) M,< DBB, althoug h the p. 1DI o) *++

co$pan" has not receive& the interest0 An entr" $ust sho' the a$ount o) interest earne& " IB1B <ece$ er +1, as 'ell as the a$ount o) the asset, interest receiva le (the right to receive this interest)0 The entr" to recor& the accrual o) revenue is:
20"0 $d<ust!ent 6M.nterest revenue accrued :ec' 3" .nterest Receiva5le .nterest Revenue To record one !ont08s interest revenue' 600 600

The T-accounts relating to interest 'oul& appear as )ollo's:
#:r'%
.ncreased 52 $600 20"0 :ec 3" Intere#t Rece%2a&le $d<ust!ent 6 600

#,r'%

#:r'%

Intere#t

Re2enue

#,r'%
.ncreased 52 $600

20"0 :ec' 3" $d<ust!ent 6 600'

(icroTrain reports the M,< DBB &e it

alance in 6nterest :eceiva le as an asset in the IB1B

<ece$ er +1, alance sheet0 This asset accu$ulates gra&uall" 'ith the passage o) ti$e0 The M,< DBB cre&it alance in 6nterest :evenue is the interest earne& &uring the $onth0 :ecall that in recor&ing revenue un&er accrual asis accounting, it &oes not $atter 'hether the co$pan" collects the actual cash &uring the "ear or not0 6t reports the interest revenue earne& &uring the accounting perio& in the inco$e state$ent0 6nbille. training 0ees A co$pan" $a" per)or$ services )or custo$ers in one accounting perio& 'hile it ills )or the services in a &i))erent accounting perio&0 (icroTrain Co$pan" per)or$e& M,< 1,BBB o) training services on account )or a client at the en& o) <ece$ er0 ,ince it ta!es ti$e to &o the paper 'or!, (icroTrain 'ill ill the client )or the services in ;anuar"0 The necessar" a&3usting 3ournal entr" at IB1B <ece$ er +1, is:
$d<ust!ent 7M-n5illed 20"0 :ec' 3" $ccounts Receiva5le #or Service /ees Receiva5le% Service Revenue To record un5illed trainin) services per(or!ed in :ece!5er' ",000 ",000

p. 1D+ o) *++

A)ter posting the a&3usting entr", the T-accounts appear as )ollo's:
#:r'% 20"0
=revious 5al' &al' a(ter ad<ust!ent Account# Rece%2a&le 5,200J 6,200

#,r'%

:ec' 3" $d<ust!ent 7 ",000JO JT0is previous 5alance ca!e (ro! transactions discussed in ,0apter 2' #:r'% Ser2%ce Re2enue 20"0 &al' 5e(ore ad<ust!ent :ec' 3" $d<ust!ent 5Mpreviousl2 unearned revenue' :ec' 3" $d<ust!ent 7 &al' a(ter 5ot0 ad<ust!ents ",500 ",000 "3200

#,r'%
"0,700

The service revenue appears in the inco$e state$ent? the asset, accounts receiva le, appears in the alance sheet0 #ccrue. liabilities are lia ilities not "et recor&e& at the en& o) an accounting perio&0 The" represent o ligations to $a!e pa"$ents not legall" &ue at the alance sheet &ate, such as e$plo"ee salaries0 At the en& o) the accounting perio&, the co$pan" recogni5es these o ligations " preparing an a&3usting entr" inclu&ing oth a lia ilit" an& an expense0 For this reason, 'e also call these o ligations accrue. expenses0 "alaries The recor&ing o) the pa"$ent o) e$plo"ee salaries usuall" involves a &e it to an expense account an& a cre&it to Cash0 Mnless a co$pan" pa"s salaries on the last &a" o) the accounting perio& )or a pa" perio& en&ing on that &ate, it $ust $a!e an a&3usting entr" to recor& an" salaries incurre& ut not "et pai&0 (icroTrain Co$pan" pai& M,< +,DBB o) salaries on Fri&a", IB1B <ece$ er I8, to cover the )irst )our 'ee!s o) <ece$ er0 The entr" $a&e at that ti$e 'as:
20"0 :ec' 29 Salaries Expense ,as0 =aid trainin) e!plo2ee salaries (or t0e (irst (our ;ee6s o( :ece!5er' 3,600 3,600

p. 1D* o) *++

Assu$ing that the last &a" o) <ece$ er IB1B )alls on a (on&a", this expense account &oes not sho' salaries earne& " e$plo"ees )or the last &a" o) the $onth0 /or &oes an" account sho' the e$plo"er1s o ligation to pa" these salaries0 The T-accounts pertaining to salaries appear as )ollo's e)ore a&3ust$ent:
#:r'% 20"0 :ec' 29
Salar%e# E01en#e 3,600

#,r%

#:r'%

Salar%e# .aya&le 20"0 :ec' 29 &al'

#,r% 303

6) salaries are M,< +,DBB )or )our 'ee!s, the" are M,< >BB per 'ee!0 For a )ive-&a" 'or!'ee!, &ail" salaries are M,< 18B0 (icroTrain $a!es the )ollo'ing a&3usting entr" on <ece$ er +1 to accrue salaries )or one &a":
20"0 :ec' 3" Salaries Expense Salaries =a2a5le To accrue one da28s salaries t0at ;ere earned 5ut not paid' "90 "90

A)ter a&3ust$ent, the t'o T-accounts involve& appear as )ollo's:
#:r'%
Salar%e# E01en#e 3,600 "90 3,790

#,r%

20"0 :ec' 29 &al' :ec' 3" $d<ust!ent 9 &al' a(ter ad<ust!ent

#:r'%

Salar%e# .aya&le 20"0 :ec' 3" $d<ust!ent 9 Fa%lure to Reco+n%He

#,r'%
"90 E**ect on Net Income +verstates net inco!e -nderstates net inco!e -nderstates net inco!e +verstates net inco!e .ncreased 52 $"90 E**ect on !alance Sheet Item# +verstates assets +verstates retained earnin)s +verstates lia5ilities -nderstates retained earnin)s -nderstates assets -nderstates retained earnin)s -nderstates lia5ilities +verstates retained earnin)s

"' 2' 3' 4'

,onsu!ption o( t0e 5ene(its o( an asset #prepaid expense% Earnin) o( previousl2 unearned revenues $ccrual o( assets $ccrual o( lia5ilities

%xhi it 18: %))ects o) )ailure to recogni5e a&3ust$ents
The &e it in the a&3usting 3ournal entr" rings the $onth1s salaries expense up to its correct M,< +,@8B a$ount )or inco$e state$ent purposes0 The cre&it to ,alaries Pa"a le recor&s the M,< 18B salar" lia ilit" to e$plo"ees0 The alance sheet sho's salaries pa"a le as a lia ilit"0

p. 1DC o) *++

Another exa$ple o) a lia ilit"7expense a&3ust$ent is 'hen a co$pan" incurs interest on a note pa"a le0 The &e it 'oul& e to 6nterest %xpense, an& the cre&it 'oul& e to 6nterest Pa"a le0 =e &iscuss this a&3ust$ent in Chapter >0

!.' Effects of failing to prepare adjusting entries
Failure to prepare proper a&3usting entries causes net inco$e an& the alance sheet to e in error0 .ou can see the e))ect o) )ailing to recor& each o) the $a3or t"pes o) a&3usting entries on net inco$e an& alance sheet ite$s in %xhi it 180 Msing (icroTrain Co$pan" as an exa$ple, this chapter has &iscusse& an& illustrate& $an" o) the t"pical entries that co$panies $ust $a!e at the en& o) an accounting perio&0 Aater chapters explain other exa$ples o) a&3usting entries0

!.) Anal -ing and using the financial results9trend percentages
6t is so$eti$es $ore in)or$ative to express all the &ollar a$ounts as a percentage o) one o) the a$ounts in the ase "ear rather than to loo! onl" at the &ollar a$ount o) the ite$ in the )inancial state$ents0 .ou can calculate tren. percentages " &ivi&ing the a$ount )or each "ear )or an ite$, such as net inco$e or net sales, " the a$ount o) that ite$ )or the ase "ear: Current year amount .rend 'ercenta/e = 0ase year amount To illustrate, assu$e that ,hopaAot, a large retailer, an& its su si&iaries reporte& the )ollo'ing net inco$e )or the "ears en&e& IBB1 ;anuar" +1, through IB1B0 The last colu$n expresses these &ollar a$ounts as a percentage o) the IBB1 a$ount0 For instance, 'e 'oul& calculate the 1IC per cent )or IBBI as: 8(M,< 1,DB>,BBB7M,< 1,I>1,BBB)C 1BB9
:ollar Amount o* Net Income 4m%ll%on#5 "@@" "@@2 "@@3 "@@4 "@@5 "@@6 "@@7 "@@9 "@@@ 2000 200" $",2@" "'60@ ",@@5 2,333 2,69" 2,740 3,056 3,526 4,430 5,377 6,2@5 .ercenta+e o* 1CC1 Net Income "00 D "25 "55 "9" 209 2"2 237 273 343 4"6 499

p. 1DD o) *++

%xa$ining the tren& percentages, 'e can see that ,hopaAotJs s net inco$e has increase& stea&il" over the 1B-"ear perio&0 The IB1B net inco$e is over * ti$es as $uch as the IBB1 a$ount0 This is the !in& o) per)or$ance that $anage$ent an& stoc!hol&ers see!, ut &o not al'a"s get0 6n the )irst three chapters o) this text, "ou have learne& $ost o) the steps o) the accounting process0 Chapter * sho's the )inal steps in the accounting c"cle0

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.ou $ight 'ant to visit these sites to learn $ore a out a possi le career in accounting0

!.18 .nderstanding the learning objectives


The cash asis o) accounting recogni5es revenues 'hen cash is receive& an& recogni5es The accrual asis o) accounting recogni5es revenues 'hen sales are $a&e or services are

expenses 'hen cash is pai& out0


per)or$e&, regar&less o) 'hen cash is receive&? expenses are recogni5e& as incurre&, 'hether or not cash has een pai& out0


The accrual asis is $ore generall" accepte& than the cash asis ecause it provi&es a etter A&3usting entries convert the a$ounts that are actuall" in the accounts to the a$ounts that A&3usting entries re)lect unrecor&e& econo$ic activit" that has ta!en place ut has not "et een recor&e&0 <e)erre& ite$s consist o) a&3usting entries involving &ata previousl" recor&e& in accounts0

$atching o) revenues an& expenses0


shoul& e in the accounts )or proper perio&ic )inancial reporting0




A&3usting entries in this class nor$all" involve $oving &ata )ro$ asset an& lia ilit" accounts to expense an& revenue accounts0 The t'o t"pes o) a&3ust$ents 'ithin this &e)erre& ite$s class are asset7expense a&3ust$ents an& lia ilit"7revenue a&3ust$ents0


Accrue& ite$s consist o) a&3usting entries relating to activit" on 'hich no &ata have een

previousl" recor&e& in the accounts0 These entries involve the initial recor&ing o) assets an& p. 1D@ o) *++

lia ilities an& the relate& revenues an& expenses0 The t'o t"pes o) a&3ust$ents 'ithin this accrue& ite$s class are asset7revenue a&3ust$ents an& lia ilit"7expense a&3ust$ents0
  

This chapter illustrates entries )or &e)erre& ite$s an& accrue& ite$s0 Failure to prepare a&3usting entries causes net inco$e an& the alance sheet to e in error0 For a particular ite$ such as sales or net inco$e, select a ase "ear an& express all &ollar

a$ounts in other "ears as a percentage o) the ase "ear &ollar a$ount0

!.18.1

Demonstration problem

A$ong other ite$s, the trial alance o) Nor$an Co$pan" )or IB1B <ece$ er +1, inclu&es the )ollo'ing account alances:
:e&%t# Supplies on Aand =repaid Rent &uildin)s $ccu!ulated :epreciationM&uildin)s Salaries Expense -nearned :eliver2 /ees "24,000 4,000 $ 6,000 25,200 200,000 $33,250 Cred%t#

,o$e o) the supplies represente& " the M,< D,BBB alance o) the ,upplies on #an& account have een consu$e&0 An inventor" count o) the supplies actuall" on han& at <ece$ er +1 totale& M,< I,*BB0 On (a" 1 o) the current "ear, a rental pa"$ent o) M,< IC,IBB 'as $a&e )or 1I $onths1 rent? it 'as &e ite& to Prepai& :ent0 The annual &epreciation )or the uil&ings is ase& on the cost sho'n in the Buil&ings account less an esti$ate& resi&ual value o) M,< 1B,BBB0 The esti$ate& use)ul lives o) the uil&ings are *B "ears each0 The salaries expense o) M,< 1I*,BBB &oes not inclu&e M,< D,BBB o) unpai& salaries earne& since the last pa"&a"0 The co$pan" has earne& one-)ourth o) the unearne& &eliver" )ees " <ece$ er +10 <eliver" services o) M,< DBB 'ere per)or$e& )or a custo$er, ut a ill has not "et een sent0 a0 Prepare the a&3usting 3ournal entries )or <ece$ er +1, assu$ing a&3usting entries are prepare& onl" at "ear-en&0 0 Base& on the a&3uste& alance sho'n in the Accu$ulate& <epreciationLBuil&ings account, ho' $an" "ears has Nor$an Co$pan" o'ne& the uil&ingQ

p. 1D8 o) *++

!.18.2
20"0 :ec' 3"

6olution to demonstration problems
=ost' Re(' :e5it 3 6 0 0 3 6 0 0 ,redit

6ORMAN COM.AN@ 8eneral Journal :ate $ccount Titles and Explanation Supplies Expense Supplies on Aand To record supplies expense #$6,000 3 $2,400%' 3" Rent Expense =repaid Rent To record rent expense #$25,200 I 9G"2%' 3" :epreciation ExpenseM&uildin)s $ccu!ulated :eprecationM&uildin)s To record depreciation #$200,000 3 $"0,000 G 40 2ears%' 3" Salaries Expense Salaries =a2a5le To record accrued salaries' 3" -nearned :eliver2 /ees Service Revenue To record deliver2 (ees earned' 3" $ccounts Receiva5le Service Revenue To record deliver2 (ees earned'

" 6 9 0 0 " 6 9 0 0

4 7 5 0 4 7 5 0

6 0 0 0 6 0 0 0

" 0 0 0 " 0 0 0

6 0 0 6 0 0

%ight "ears? co$pute& as: .otal accumulated de'recation ,S- (("#2$+ ,S- %"32$ S Annual de'recation e1'ense ,S- %"32$

!.18.3

;e Terms

#ccounting perio. A ti$e perio& nor$all" o) one $onth, one 4uarter, or one "ear into 'hich an entit"1s li)e is ar itraril" &ivi&e& )or )inancial reporting purposes0 #ccounting year An accounting perio& o) one "ear0 The accounting "ear $a" or $a" not coinci&e 'ith the calen&ar "ear0 #ccrual basis o0 accounting :ecogni5es revenues 'hen sales are $a&e or services are per)or$e&, regar&less o) 'hen cash is receive&0 :ecogni5es expenses as incurre&, 'hether or not cash has een pai& out0

p. 1D> o) *++

#ccrue. assets an. liabilities Assets an& lia ilities that exist at the en& o) an accounting perio& ut have not "et een recor&e&? the" represent rights to receive, or o ligations to $a!e, pa"$ents that are not legall" &ue at the alance sheet &ate0 %xa$ples are accrue& )ees receiva le an& salaries pa"a le0 #ccrue. items A&3usting entries relating to activit" on 'hich no &ata have een previousl" recor&e& in the accounts0 Also, see accrue assets an liabilities. #ccrue. re'enues an. expenses Other na$es )or accrue& assets an& lia ilities0 #ccumulate. .epreciation account A contra asset account that sho's the total o) all &epreciation recor&e& on the asset up through the alance sheet &ate0 #.2usting entries ;ournal entries $a&e at the en& o) an accounting perio& to ring a out a proper $atching o) revenues an& expenses? the" re)lect econo$ic activit" that has ta!en place ut has not "et een recor&e&0 A&3usting entries are $a&e to ring the accounts to their proper alances e)ore )inancial state$ents are prepare&0 Book 'alue For &eprecia le assets, oo! value e4uals cost less accu$ulate& &epreciation0 Calen.ar year The nor$al "ear, 'hich en&s on <ece$ er +10 Cas% basis o0 accounting :ecogni5es revenues 'hen cash is receive& an& recogni5es expenses 'hen cash is pai& out0 Contra asset account An account sho'n as a &e&uction )ro$ the asset to 'hich it relates in the alance sheet? use& to re&uce the original cost o) the asset &o'n to its re$aining un&epreciate& cost or oo! value0 <e0erre. items A&3usting entries involving &ata previousl" recor&e& in the accounts0 <ata are trans)erre& )ro$ asset an& lia ilit" accounts to expense an& revenue accounts0 %xa$ples are prepai& expenses, &epreciation, an& unearne& revenues0 <epreciable amount The &i))erence et'een an asset1s cost an& its esti$ate& resi&ual value0 <epreciable asset A $anu)acture& asset such as a uil&ing, $achine, vehicle, or e4uip$ent on 'hich &epreciation expense is recor&e&0 <epreciation accounting The process o) recor&ing &epreciation expense0 <epreciation expense The a$ount o) asset cost assigne& as an expense to a particular ti$e perio&0 <epreciation 0ormula (straig%t-line): -stimate. resi.ual 'alue (scrap 'alue) The a$ount that the co$pan" can pro a l" sell the asset )or at the en& o) its esti$ate& use)ul li)e0 -stimate. use0ul li0e The esti$ate& ti$e perio&s that a co$pan" can $a!e use o) the asset0 Fiscal year An accounting "ear o) an" 1I consecutive $onths that $a" or $a" not coinci&e 'ith the calen&ar "ear0 For exa$ple, a co$pan" $a" have an accounting, or )iscal, "ear that runs )ro$ April 1 o) one "ear to (arch +1 o) the next0 8atc%ing principle An accounting principle re4uiring that expenses incurre& in pro&ucing revenues e &e&ucte& )ro$ the revenues the" generate& &uring the accounting perio&0 &repai. expense An asset a'aiting assign$ent to expense0 An exa$ple is prepai& insurance0 Assets such as cash an& accounts receiva le are not prepai& expenses0 "er'ice potential The ene)its that can e o taine& )ro$ assets0 The )uture services that assets can ren&er $a!e assets Fthings o) valueH to a usiness0 $ren. percentages Calculate& " &ivi&ing the a$ount o) an ite$ )or each "ear " the a$ount o) that ite$ )or the ase "ear0 p. 1@B o) *++

6nearne. re'enue Assets receive& )ro$ custo$ers e)ore services are per)or$e& )or the$0 ,ince the revenue has not een earne&, it is a lia ilit", o)ten calle& revenue receive in a vance or a vances by custo"ers.

!.18.! !.18.!.1

6elf<test True<false

6n&icate 'hether each o) the )ollo'ing state$ents is true or )alse: %ver" a&3usting entr" a))ects at least one inco$e state$ent account an& one alance sheet account0 All calen&ar "ears are also )iscal "ears, ut not all )iscal "ears are calen&ar "ears0 The accu$ulate& &epreciation account is an asset account that sho's the a$ount o) &epreciation )or the current "ear onl"0 The Mnearne& <eliver" Fees account is a revenue account0 6) all o) the a&3usting entries are not $a&e, the )inancial state$ents are incorrect0

!.18.#

=ultiple<choice

,elect the est ans'er )or each o) the )ollo'ing 4uestions0 An insurance polic" pre$iu$ o) M,< 1,IBB 'as pai& on IB1B ,epte$ er 1, to cover a one-"ear perio& )ro$ that &ate0 An asset 'as &e ite& on that &ate0 A&3usting entries are prepare& once a "ear, at "ear-en&0 The necessar" a&3usting entr" at the co$pan"1s "ear-en&, IB1B <ece$ er +1, is:
a' =repaid insurance .nsurance expense 5' .nsurance expense =repaid insurance c' =repaid insurance .nsurance expense d' .nsurance expense =repaid insurance 400 900 900 400

400 900 900 400

The ,upplies on #an& account has a

alance o) M,< 1,CBB at "ear-en&0 The actual a$ount o)

supplies on han& at the en& o) the perio& 'as M,< *BB0 The necessar" a&3usting entr" is:
a' Supplies expense Supplies on 0and 5' Supplies expense Supplies on 0and c' Supplies on 0and Supplies expense d' Supplies on 0and Supplies expense ","00 400 ","00 400

","00 400 ","00 400

p. 1@1 o) *++

A co$pan" purchase& a truc! )or M,< IB,BBB on IB1B ;anuar" 10 The truc! has an esti$ate& resi&ual value o) M,< C,BBB an& is expecte& to last )ive "ears0 A&3usting entries are prepare& onl" at "ear-en&0 The necessar" a&3usting entr" at IB1B <ece$ er +1, the co$pan"1s "ear-en&, is:
a' :eprecation expense N Truc6s $ccu!ulated 5' :eprecation expense N Truc6s Truc6s c' :eprecation expense N Truc6s $ccu!ulated deprecation N Truc6s d' $ccu!ulated deprecation truc6s :eprecation expense N Truc6s 4,000 3,000 3,000 3,000 4,000 3,000 3,000 3,000

A co$pan" receive& cash o) M,< I*,BBB on IB1B Octo er 1, as su scriptions )or a one-"ear perio& )ro$ that &ate0 A lia ilit" account 'as cre&ite& 'hen the cash 'as receive&0 The $aga5ine is to e pu lishe& " the co$pan" an& &elivere& to su scri ers each $onth0 The co$pan" prepares a&3usting entries at the en& o) each $onth ecause it prepares )inancial state$ents each $onth0 The a&3usting entr" the co$pan" 'oul& $a!e at the en& o) each o) the next 1I $onths 'oul& e:
a' -nearned su5scription (ees Su5scription (ee revenue 5' -nearned su5scription (ees Su5scription (ee revenue c' -nearned su5scription (eeds Su5scription (ee revenue d' Su5scription (ee revenue -nearned su5scription (ees 2,000 2,000 2,000 2,000 "9,000 "9,000 6,000 6,000

=hen a co$pan" earns interest on a note receiva le or on a an! account, the &e it an& cre&it are as )ollo's:
:e&%t $ccounts receiva5le .nterest receiva5le .nterest revenue .nterest revenue Cred%t .nterest revenue .nterest revenue $ccounts receiva5le .nterest receiva5le

a' 5' c' d'

p. 1@I o) *++

6) M,< +,BBB has een earne& " a co$pan"1s 'or!ers since the last pa"&a" in an accounting perio&, the necessar" a&3usting entr" 'oul& e: a0 <e it an expense an& cre&it a lia ilit"0 0 <e it an expense an& cre&it an asset0 c0 <e it a lia ilit" an& cre&it an asset0 &0 <e it a lia ilit" an& cre&it an expense0 /o' turn to FAns'ers to sel) testH at the ac! o) the oo! to chec! "our ans'ers0

!.18.$


>uestions
=hich events &uring an accounting perio& trigger the recor&ing o) nor$al 3ournal entriesQ =hich event triggers the $a!ing o) a&3usting entriesQ <escri e the &i))erence et'een the cash asis an& accrual asis o) accounting0 =h" are a&3usting entries necessar"Q =h" not treat ever" cash &is urse$ent as an expense an& ever" cash receipt as a revenue 'hen the cash changes han&sQ FA&3usting entries 'oul& not e necessar" i) the Vpure1 cash asis o) accounting 'ere )ollo'e& (assu$ing no $ista!es 'ere $a&e in recor&ing cash transactions as the" occurre&)0 Mn&er the cash asis, receipts that are o) a revenue nature are consi&ere& revenue 'hen receive&, an& expen&itures that are o) an expense nature are consi&ere& expenses 'hen pai&0 6t is the use o) the accrual asis o) accounting, 'here an e))ort is $a&e to $atch expenses incurre& against the revenues the" create, that $a!es a&3usting entries necessar"0H <o "ou agree 'ith this state$entQ =h"Q

 





=h" &o accountants not !eep all the accounts at their proper alances continuousl" throughout the perio& so that a&3usting entries 'oul& not have to e $a&e e)ore )inancial state$ents are prepare&Q

 

=hat is the )un&a$ental &i))erence et'een &e)erre& ite$s an& accrue& ite$sQ 6&enti)" the t"pes o) a&3usting entries inclu&e& in each o) the t'o $a3or classes o) a&3usting entries0 2ive an exa$ple o) a 3ournal entr" )or each o) the )ollo'ing:
   



%4ual gro'th o) an expense an& a lia ilit"0 %arning o) revenue that 'as previousl" recor&e& as unearne& revenue0 %4ual gro'th o) an asset an& a revenue0 6ncrease in an expense an& &ecrease in an asset0

p. 1@+ o) *++



A )ello' stu&ent $a!es the )ollo'ing state$ent: F.ou can easil" tell 'hether a co$pan" is using the cash or accrual asis o) accounting0 =hen an a$ount is pai& )or )uture rent or insurance services, a )ir$ that is using the cash asis &e its an expense account 'hile a )ir$ that is using the accrual asis &e its an asset account0H 6s the stu&ent correctQ



.ou notice that the ,upplies on #an& account has a &e it alance o) M,< I,@BB at the en& o) the accounting perio&0 #o' 'oul& "ou &eter$ine the extent to 'hich this account nee&s a&3ust$entQ



,o$e assets are converte& into expenses as the" expire an& so$e lia ilities eco$e revenues as the" are earne&0 2ive exa$ples o) asset an& lia ilit" accounts )or 'hich this state$ent is true0 2ive exa$ples o) asset an& lia ilit" accounts to 'hich the state$ent &oes not appl"0



2ive the &epreciation )or$ula to co$pute straight-line &epreciation )or a one-"ear perio&0 =hat &oes the ter$ accrue& lia ilit" $eanQ =hat is $eant " the ter$ service potentialQ =hen assets are receive& e)ore the" are earne&, 'hat t"pe o) an account is cre&ite&Q As the a$ounts are earne&, 'hat t"pe o) account is cre&ite&Q =hat &oes the 'or& accrue& $eanQ 6s there a conceptual &i))erence et'een interest pa"a le an& accrue& interest pa"a leQ (atching expenses incurre& 'ith revenues earne& is $ore &i))icult than $atching expenses pai& 'ith revenues receive&0 <o "ou thin! the e))ort is 'orth'hileQ :eal worl. question :e)er to the )inancial state$ents o) The Ai$ite&, 6nc0, in the Annual report appen&ix0 Approxi$atel" 'hat percentage o) the &eprecia le assets un&er propert", plant, an& e4uip$ent has een &epreciate& as o) the en& o) the $ost recent "ear sho'nQ

  







!.18.%

E,ercises

-xercise # ,elect the correct response )or each o) the )ollo'ing $ultiple-choice 4uestions: The cash asis o) accounting: (a) :ecogni5es revenues 'hen sales are $a&e or services are ren&ere&0 ( ) :ecogni5es expenses as incurre&0 (c) 6s t"picall" use& " so$e relativel" s$all usinesses an& pro)essional persons0 (&) :ecogni5es revenues 'hen cash is receive& an& recogni5es expenses 'hen incurre&0 p. 1@* o) *++

The accrual asis o) accounting: (a) :ecogni5es revenues onl" 'hen cash is receive&0 ( ) 6s use& " al$ost all co$panies0 (c) :ecogni5es expenses onl" 'hen cash is pai& out0 (&) :ecogni5es revenues 'hen sales are $a&e or services are per)or$e& an& recogni5es expenses onl" 'hen cash is pai& out0 -xercise B ,elect the correct response )or each o) the )ollo'ing $ultiple-choice 4uestions: The least co$$on accounting perio& a$ong the )ollo'ing is: (a) One $onth0 ( ) T'o $onths0 (c) Three $onths0 (&) T'elve $onths0 The nee& )or a&3usting entries is ase& on: (a) The $atching principle0 ( ) ,ource &ocu$ents0 (c) The cash asis o) accounting0 (&) Activit" that has alrea&" een recor&e& in the proper accounts0 -xercise C ,elect the correct response )or each o) the )ollo'ing $ultiple-choice 4uestions: =hich o) the )ollo'ing t"pes o) a&3ust$ents elongs to the &e)erre& ite$s classQ (a) Asset7revenue a&3ust$ents0 ( ) Aia ilit"7expense a&3ust$ents0 (c) Asset7expense a&3ust$ents0 (&) Asset7lia ilit" a&3ust$ents0 =hich o) the )ollo'ing t"pes o) a&3ust$ents elongs to the accrue& ite$s classQ (a) Asset7expense a&3ust$ents0 ( ) Aia ilit"7revenue a&3ust$ents0 (c) Asset7lia ilit" a&3ust$ents0 (&) Aia ilit"7expense a&3ust$ents0

p. 1@C o) *++

-xercise < A one-"ear insurance polic" 'as purchase& on August 1 )or M,< I,*BB, an& the )ollo'ing entr" 'as $a&e at that ti$e:
=repaid .nsurance ,as0 2,400 2,400

=hat a&3usting entr" is necessar" at <ece$ er +1, the en& o) the accounting "earQ ,ho' ho' the T-accounts )or Prepai& 6nsurance an& 6nsurance %xpense 'oul& appear a)ter the entries are poste&0 -xercise - Assu$e that rent o) M,< 1I,BBB 'as pai& on IB1B ,epte$ er 1, to cover a one-"ear perio& )ro$ that &ate0 Prepai& :ent 'as &e ite&0 6) )inancial state$ents are prepare& onl" on <ece$ er +1 o) each "ear, 'hat a&3usting entr" is necessar" on IB1B <ece$ er +1, to accounts involve& to their proper alancesQ -xercise F At IB1B <ece$ er +1, an a&3usting entr" 'as $a&e as )ollo's:
Rent Expense =repaid Rent ",500 ",500

ring the

.ou !no' that the gross a$ount o) rent pai& 'as M,< *,CBB, 'hich 'as to cover a one-"ear perio&0 <eter$ine: a0 The opening &ate o) the "ear to 'hich the M,< *,CBB o) rent applies0 0 The entr" that 'as $a&e on the &ate the rent 'as pai&0 -xercise 9 ,upplies 'ere purchase& )or cash on IB1B (a" I, )or M,< 8,BBB0 ,ho' ho' this purchase 'oul& e recor&e&0 Then sho' the a&3usting entr" that 'oul& e necessar", assu$ing that M,< I,CBB o) the supplies re$aine& at the en& o) the "ear0 -xercise = Assu$e that a co$pan" ac4uire& a uil&ing on IB1B ;anuar" 1, at a cost o) M,< 1,BBB,BBB0 The uil&ing has an esti$ate& use)ul li)e o) *B "ears an& an esti$ate& resi&ual value o) M,< IBB,BBB0 =hat a&3usting entr" is nee&e& on IB1B <ece$ er +1, to recor& the &epreciation )or the entire "ear IB1BQ

p. 1@D o) *++

-xercise 1 On IB1B ,epte$ er 1, Pro)essional 2ol)er ;ournal, 6nc0, receive& a total o) M,< 1IB,BBB as pa"$ent in a&vance )or one-"ear su scriptions to a $onthl" $aga5ine0 A lia ilit" account 'as cre&ite& to recor& this cash receipt0 B" the en& o) the "ear, one-thir& o) the $aga5ines pai& )or in a&vance ha& een &elivere&0 2ive the entries to recor& the receipt o) the su scription )ees an& to a&3ust the accounts at <ece$ er +1, assu$ing annual )inancial state$ents are prepare& at "ear-en&0 -xercise > On IB1B April 1C, :ialto Theater sol& M,< >B,BBB in tic!ets )or the su$$er $usicals to e per)or$e& (one per $onth) &uring ;une, ;ul", an& August0 On IB1B ;ul" 1C, :ialto Theater &iscovere& that the group that 'as to per)or$ the ;ul" an& August $usicals coul& not &o so0 6t 'as too late to )in& another group 4uali)ie& to per)or$ the $usicals0 A &ecision 'as $a&e to re)un& the re$aining unearne& tic!et revenue to its tic!et hol&ers, an& this 'as &one on ;ul" IB0 ,ho' the appropriate 3ournal entries to e $a&e on April 1C, ;une +B, an& ;ul" IB0 :ialto has a ;une +Bth "earen&0 -xercise ? 2uilt" P 6nnocent, a la' )ir$, per)or$e& legal services in late <ece$ er IB1B )or clients0 The M,< +B,BBB o) services 'oul& e ille& to the clients in ;anuar" IB110 2ive the a&3usting entr" that is necessar" on IB1B <ece$ er +1, i) )inancial state$ents are prepare& at the en& o) each $onth0 -xercise L A )ir$ orro'e& M,< +B,BBB on /ove$ er 10 B" <ece$ er +1, M,< +BB o) interest ha& een incurre&0 Prepare the a&3usting entr" re4uire& on <ece$ er +10 -xercise 8 Convenient (ailing ,ervices, 6nc0, incurs salaries at the rate o) M,< +,BBB per &a"0 The last pa"&a" in ;anuar" is Fri&a", ;anuar" I@0 ,alaries )or (on&a" an& Tues&a" o) the next 'ee! have not een recor&e& or pai& as o) ;anuar" +10 Financial state$ents are prepare& $onthl"0 2ive the necessar" a&3usting entr" on ;anuar" +10 -xercise ! ,tate the e))ect that each o) the )ollo'ing in&epen&ent situations 'oul& have on the a$ount o) annual net inco$e reporte& )or IB1B an& IB110 a, /o a&3ust$ent 'as $a&e )or accrue& salaries o) M,< 8,BBB as o) IB1B <ece$ er +10 0 The collection o) M,< C,BBB )or services "et unper)or$e& as o) IB1B <ece$ er +1, 'as cre&ite& to a revenue account an& not a&3uste&0 The services are per)or$e& in IB110

p. 1@@ o) *++

-xercise 3 6n the )ollo'ing ta le, in&icate the e))ects o) )ailing to recogni5e each o) the in&icate& a&3ust$ents " 'riting FOH )or overstate& an& FMH )or un&erstate&0
E**ect on !alance Sheet Item# E**ect on Fa%lure to Reco+n%He "' 2' 3' 4' 5' :epreciation on a 5uildin) ,onsu!ption o( supplies on 0and T0e earnin) o( tic6et revenue received in advance T0e earnin) o( interest on a 5an6 account Salaries incurred 52 unpaid Net Income Stoc'holder#( A##et# $%a&%l%t%e# E)u%ty

-xercise & The )ollo'ing &ata regar&ing net inco$e (loss) are )or Per!ins Parts, a $e&iu$-si5e& auto$otive supplier, )or the perio& IBB*–IBB>0
Net Income 4Earn%n+#5 47 m%ll%on#5 "@9@ "@@0 "@@" "@@2 "@@3 "@@4 '''''' '''''' '''''' '''''' '''''' '''''' ''''''''''' ''''''''''' ''''''''''' ''''''''''' ''''''''''' ''''''''''' $ 960 3,935 #2,259% #7,395% 2,52@ 5,309 "@@5 "@@6 "@@7 "@@9 "@@@ 2000 '''''''' '''''''' '''''''' '''''''' '''''''' '''''''' Net Income 4Earn%n+#5 47 m%ll%on#5 '''''''''''''' '''''''''''''' '''''''''''''' '''''''''''''' '''''''''''''' '''''''''''''' $ 4,"3@ 4,446 6,@20 22,07" 7,237 3,467

Msing 1>8> as the ase "ear, calculate the tren& percentages, an& co$$ent on the results0

!.18.'

1roblems

&roblem # A$ong other ite$s, the trial alance o) Fil$ laster, 6nc0, a $ovie rental co$pan", at <ece$ er +1 o) the current "ear inclu&es the )ollo'ing account alances:
:e&%t# =repaid .nsurance =repaid Rent Supplies on Aand -S: "0,000 -S: "4,400 -S: 2,900

%xa$ination o) the recor&s sho's that a&3ust$ents shoul& e $a&e )or the )ollo'ing ite$s: a0 O) the prepai& insurance in the trial alance, M,< *,BBB is )or coverage &uring the $onths a)ter <ece$ er +1 o) the current "ear0 0 The alance in the Prepai& :ent account is )or a 1I-$onth perio& that starte& Octo er 1 o) the current "ear0 c0 M,< +BB o) interest has een earne& ut not receive&0 p. 1@8 o) *++

&0 ,upplies use& &uring the "ear a$ount to M,< 1,8BB0 Prepare the annual "ear-en& a&3usting 3ournal entries at <ece$ er +10 &roblem B (arathon (aga5ine, 6nc0, has the )ollo'ing account alances, a$ong others, in its trial alance at <ece$ er +1 o) the current "ear:
:e&%t# Supplies on Aand'''''''''''''''''' =repaid Rent ''''''''''''''''''''''''' -nearned Su5scription /ees ''' Su5scriptions Revenue''''''''''' Salaries Expense ''''''''''''''''''' "23,000 $3,720 7,200 $"5,000 26",000 Cred%t#

 The inventor" o) supplies on han& at <ece$ er +1 a$ounts to M,< @IB0  The

alance in the Prepai& :ent account is )or a one-"ear perio& starting Octo er 1 o) the

current "ear0
 One-thir& o) the M,< 1C,BBB alance in Mnearne& ,u scription Fees has een earne&0  ,ince the last pa"&a", the e$plo"ees o) the co$pan" have earne& a&&itional salaries in the

a$ount o) M,< C,*+B0 a0 Prepare the "ear-en& a&3usting 3ournal entries at <ece$ er +10 0 Open le&ger accounts )or each o) the accounts involve&, enter the alances as sho'n in the trial alance, post the a&3usting 3ournal entries, an& calculate "ear-en& alances0 &roblem C #illsi&e Apart$ents, 6nc0, a&3usts an& closes its oo!s each <ece$ er +10 Assu$e the accounts )or all prior "ears have een properl" a&3uste& an& close&0 Follo'ing are so$e o) the co$pan"1s account alances prior to a&3ust$ent on IB1B <ece$ er +1: =1LL"1<- #&#:$8-!$", 1!C. &artial $rial Balance +,(, <ecember @(
:e&%t# $ 7,500 7,000 255,000 6@,000 Cred%t#

=repaid insurance Supplies on 0and &uildin)s $ccu!ulated deprecation N &uildin)s -nearned rent Salaries expense Rent revenue

$ @6,000 2,700 277,500

p. 1@> o) *++

The Prepai& 6nsurance account

alance represents the re$aining cost o) a )our-"ear insurance

polic" &ate& IB11 ;une +B, having a total pre$iu$ o) M,< 1I,BBB0 The ph"sical inventor" o) the o))ice suppl" stoc!roo$ in&icates that the supplies on han& cost M,< +,BBB0 The uil&ing 'as originall" ac4uire& on 1>>* ;anuar" 1, at 'hich ti$e $anage$ent esti$ate& that the uil&ing 'oul& last *B "ears an& have a resi&ual value o) M,< 1C,BBB0 ,alaries earne& since the last pa"&a" ut unpai& at <ece$ er +1 a$ount to M,< C,BBB0 6nterest earne& ut not collecte& on a savings account &uring the "ear a$ounts to M,< *BB0 The Mnearne& :ent account arose through the prepa"$ent o) rent " a tenant in the uil&ing )or 1I $onths eginning IB1B Octo er 10 Prepare the annual "ear-en& a&3usting entries in&icate& " the a&&itional &ata0 &roblem < The reporte& net inco$e a$ounts )or 2ul) Coast (aga5ine, 6nc0, )or calen&ar "ears IB1B an& IB11 'ere M,< IBB,BBB an& M,< III,BBB, respectivel"0 /o annual a&3usting entries 'ere $a&e at either "ear-en& )or an" o) the )ollo'ing transactions: A )ire insurance polic" to cover a three-"ear perio& )ro$ the &ate o) pa"$ent 'as purchase& on IB1B (arch 1 )or M,< +,DBB0 The Prepai& 6nsurance account 'as &e ite& at the &ate o) purchase0 ,u scriptions )or $aga5ines in the a$ount o) M,< @I,BBB to cover an 18-$onth perio& )ro$ IB1B (a" 1, 'ere receive& on IB1B April 1C0 The Mnearne& ,u scription Fees account 'as cre&ite& 'hen the pa"$ents 'ere receive&0 A uil&ing costing M,< 18B,BBB an& having an esti$ate& use)ul li)e o) CB "ears an& a resi&ual value o) M,< +B,BBB 'as purchase& an& put into service on IB1B ;anuar" 10 On IB11 ;anuar" 1I, salaries o) M,< >,DBB 'ere pai& to e$plo"ees0 The account &e ite& 'as ,alaries %xpense0 One-thir& o) the a$ount pai& 'as earne& " e$plo"ees in <ece$ er o) IB1B0 Calculate the correct net inco$e )or IB1B an& IB110 6n "our ans'er, start 'ith the reporte& net inco$e0 Then sho' the e))ects o) each correction (a&3ust$ent), using a plus or a $inus to in&icate 'hether reporte& inco$e shoul& e increase& or &ecrease& as a result o) the correction0 =hen the corrections are a&&e& to or &e&ucte& )ro$ the reporte& net inco$e a$ounts, the result shoul& e the correct net inco$e a$ounts0 The ans'er )or$at shoul& appear as )ollo's:
E01lanat%on o* correct%on# Reported net inco!e To correct error in accountin) (or: /ire insurance polic2 pre!iu!: ,orrect expense in 20"0 2010 $200,000 3",000 2011 $222,000

p. 18B o) *++

,orrect expense in 20""

3",200

&roblem - ;upiter Pu lishing Co$pan" egan operations on IB1B <ece$ er 10 The co$pan"1s oo!!eeper inten&e& to use the cash asis o) accounting0 Conse4uentl", the oo!!eeper recor&e& all cash receipts an& &is urse$ents )or ite$s relating to operations in revenue an& expense accounts0 /o a&3usting entries 'ere $a&e prior to preparing the )inancial state$ents )or <ece$ er0 <ec0 1 6ssue& capital stoc! )or M,< +BB,BBB cash0 + :eceive& M,< 1**,BBB )or $aga5ine su scriptions to run )or t'o "ears )ro$ this &ate0 The $aga5ine is pu lishe& $onthl" on the I+r&0 * Pai& )or a&vertising to e run in a national perio&ical )or six $onths (starting this $onth)0 The cost 'as M,< +D,BBB0 @ Purchase& )or cash an insurance polic" to cover a t'o-"ear perio& eginning <ece$ er M,< I*,BBB0 1I Pai& the annual rent on the uil&ing, M,< +D,BBB, e))ective through IB11 /ove$ er +B0 1C :eceive& M,< I1D,BBB cash )or t'o-"ear su scriptions starting 'ith the <ece$ er issue0 1C ,alaries )or the perio& <ece$ er 1–1C a$ounte& to M,< *8,BBB0 Beginning as o) this &ate, salaries 'ill e pai& on the Cth an& IBth o) each $onth )or the prece&ing t'o-'ee! perio&0 IB ,alaries )or the perio& <ece$ er 1–1C 'ere pai&0 I+ ,upplies purchase& )or cash, M,< I1,DBB0 (Onl" M,< 1,8BB o) these 'ere su se4uentl" use& in IB1B0) I@ Printing costs applica le e4uall" to the next six issues eginning 'ith the <ece$ er issue 'ere pai& in cash, M,< 1**,BBB0 +1 Cash sales o) the <ece$ er issue, M,< 8*,BBB0 +1 Mnpai& salaries )or the perio& <ece$ er 1D–+1 a$ounte& to M,< II,BBB0 +1 ,ales on account o) <ece$ er issue, M,< 1*,BBB0 a0 Prepare 3ournal entries )or the transactions as the oo!!eeper prepare& the$0 0 Prepare 3ournal entries as the" 'oul& have een prepare& un&er the accrual asis0 =here the entr" is the sa$e as un&er the cash asis, $erel" in&icate Fsa$eH0 =here possi le, recor& the original transaction so that no a&3usting entr" 'oul& e necessar" explanations. at the en& o) the $onth0 6gnore 1C,

p. 181 o) *++

!.18.)

Alternate problems
ean Gacation Tours, 6nc0, at <ece$ er +1 o) the

#lternate problem # The trial alance o) Cari

current "ear inclu&es, a$ong other ite$s, the )ollo'ing account alances:

:e&%t# =repaid .nsurance '''''''''''''''''''''''''''''''''''''''' =repaid Rent '''''''''''''''''''''''''''''''''''''''''''''''' &uildin)s'''''''''''''''''''''''''''''''''''''''''''''''''''''' $ccu!ulated :epreciationM&uildin)s''''''''''''' Salaries Expense '''''''''''''''''''''''''''''''''''''''''' 200,000 $24,000 24,000 "99,000

Cred%t#

$3",600

The alance in the Prepai& 6nsurance account is the a&vance pre$iu$ )or one "ear )ro$ ,epte$ er 1 o) the current "ear0 The uil&ings are expecte& to last IC "ears, 'ith an expecte& resi&ual value o) M,< +B,BBB0 ,alaries incurre& ut not pai& as o) <ece$ er +1 a$ount to M,< 8,*BB0 The alance in Prepai& :ent is )or a one-"ear perio& that starte& (arch 1 o) the current "ear0 Prepare the annual "ear-en& a&3usting 3ournal entries at <ece$ er +10 #lternate problem B A$ong the account alances sho'n in the trial alance o) <un'oo&" (ail ,tation, 6nc0, at <ece$ er +1 o) the current "ear are the )ollo'ing:
:e&%t# $"0,000 6,000 "69,000 Cred%t#

Supplies on 0and =repaid insurance &uildin)s $ccu!ulated deprecation and 5uildin)s

$ 3@,000

The inventor" o) supplies on han& at <ece$ er +1 a$ounts to M,< +,BBB0 The alance in the Prepai& 6nsurance account is )or a t'o-"ear polic" ta!en out ;une 1 o) the current "ear0 <epreciation )or the uil&ings is ase& on the cost sho'n in the Buil&ings account, less resi&ual value esti$ate& at M,<18,BBB0 =hen ac4uire&, the lives o) the uil&ings 'ere esti$ate& at CB "ears each0 a0 Prepare the "ear-en& a&3usting 3ournal entries at <ece$ er +10 0 Open le&ger accounts )or each o) the accounts involve&, enter the alances as sho'n in the trial alance, post the a&3usting 3ournal entries, an& calculate "ear-en& alances0 p. 18I o) *++

#lternate problem C /eva&a Ca$ping %4uip$ent :ental Co$pan" occupies rente& 4uarters on the $ain street o) Aas Gegas0 To get this location, the co$pan" rente& a store larger than nee&e& an& su lease& (rente&) a portion o) the area to (ax1s :estaurant0 The partial trial Ca$ping %4uip$ent :ental Co$pan" as o) IB1B <ece$ er +1, is as )ollo's:
NE>E:A CAM.IN8 EEUI.MENT RENTA$ COM.AN@ Tr%al !alance 2010 :ecem&er 1 :e&%t# ,as0 =repaid .nsurance Supplies on Aand ,a!pin) E7uip!ent $ccu!ulated :epreciationM,a!pin) E7uip!ent otes =a2a5le E7uip!ent Rental Revenue Su5lease Rental Revenue &uildin) Rent Expense Salaries Expense "4,400 "@6,000 $"00,000 "",400 20,000 "76,000 $ "@,200 40,000 ",500,000 9,900 Cred%t#

alance o) /eva&a

a0 ,alaries o) e$plo"ees a$ount to M,< +BB per &a" an& 'ere last pai& through =e&nes&a", <ece$ er I@0 <ece$ er +1 is a ,un&a"0 The store is close& ,un&a"s0 0 An anal"sis o) the Ca$ping %4uip$ent account &isclose&:
&alance, 20"0 1anuar2 " $ddition, 20"0 1ul2 " &alance, 20"0 :ece!5er 3", per trial 5alance $"29,000 49,000 $"76,000

The co$pan" esti$ates that all e4uip$ent 'ill last IB "ears )ro$ the &ate the" 'ere ac4uire& an& that the resi&ual value 'ill e 5ero0 c0 The store carries one co$ ine& insurance polic", 'hich is ta!en out once a "ear e))ective August 10 The pre$iu$ on the polic" no' in )orce a$ounts to M,< @,IBB per "ear0 &0 Mnuse& supplies on han& at IB1B <ece$ er +1, have a cost o) M,< >,IBB0 e0 <ece$ er1s rent )ro$ (ax1s :estaurant has not "et een receive&, M,< 8BB0 )0 6nterest accrue& on the note pa"a le is M,< @BB0 Prepare the annual "ear-en& entries re4uire& " the prece&ing state$ent o) )acts0

p. 18+ o) *++

#lternate problem < The reporte& net inco$e a$ounts )or ,a)et" =aste Control Co$pan" 'ere IB1B, M,< IBB,BBB? an& IB11, M,< I+B,BBB0 6o annual a&3usting entries 'ere $a&e at either "earen& )or an" o) these transactions: a0 A uil&ing 'as rente& on IB1B April 10 Cash o) M,< 1*,*BB 'as pai& on that &ate to cover a t'o"ear perio&0 Prepai& :ent 'as &e ite&0 0 The alance in the O))ice ,upplies on #an& account on IB1B <ece$ er +1, 'as M,< D,BBB0 An inventor" o) the supplies on IB1B <ece$ er +1, reveale& that onl" M,< +,CBB 'ere actuall" on han& at that &ate0 /o ne' supplies 'ere purchase& &uring IB110 At IB11 <ece$ er +1, an inventor" o) the supplies reveale& that M,< 8BB 'ere on han&0 c0 A uil&ing costing M,< 1,IBB,BBB an& having an esti$ate& use)ul li)e o) *B "ears an& a resi&ual value o) M,< I*B,BBB 'as put into service on IB1B ;anuar" 10 &0 ,ervices 'ere per)or$e& )or custo$ers in <ece$ er IB1B0 The M,< I*,BBB ill )or these services 'as not sent until ;anuar" IB110 The onl" transaction that 'as recor&e& 'as a &e it to Cash an& a cre&it to ,ervice :evenue 'hen pa"$ent 'as receive& in ;anuar"0 Calculate the correct net inco$e )or IB1B an& IB110 6n "our ans'er, start 'ith the reporte& net inco$e a$ounts0 Then sho' the e))ects o) each correction (a&3ust$ent) using a plus or a $inus to in&icate 'hether reporte& inco$e shoul& e increase& or &ecrease& as a result o) the correction0 =hen the corrections are a&&e& to or &e&ucte& )ro$ the reporte& net inco$e a$ounts, the result shoul& e the correct net inco$e a$ounts0 The ans'er )or$at shoul& e as )ollo's: E01lanat%on o* Correct%on#
Reported net inco!e To correct error in accountin) (or: =repaid rent: ,orrect expense in 20"0 ,orrect expense in 20"" 35,400 37,200 2010 $200,000 2011 $230,000

#lternate problem - On IB1B ;une 1, :ichar& Cross opene& a s'i$$ing pool cleaning an& $aintenance service, Cross Pool Co$pan"0 #e vaguel" recalle& the process o) $a!ing 3ournal entries an& esta lishing le&ger accounts )ro$ a high school oo!!eeping course he ha& ta!en so$e "ears ago0 At the en& o) ;une, he prepare& an inco$e state$ent )or the $onth o) ;une, ut he ha& the )eeling that he ha& not procee&e& correctl"0 #e contacte& his rother, ;ohn, a recent college gra&uate 'ith a $a3or in accounting, )or assistance0 ;ohn i$$e&iatel" note& that his rother ha& !ept his recor&s on a cash asis0

p. 18* o) *++

;une 1 :eceive& cash o) M,< I8,BBB )ro$ various custo$ers in exchange )or service agree$ents to clean an& $aintain their pools )or ;une, ;ul", August, an& ,epte$ er0 C Pai& rent )or auto$otive an& cleaning e4uip$ent to e use& &uring the perio& ;une through ,epte$ er, M,< 8,BBB0 The pa"$ent covere& the entire perio&0 8 Purchase& a t'o-"ear lia ilit" insurance polic" e))ective ;une 1 )or M,< 1I,BBB cash0 1B :eceive& an a&vance o) M,< >,BBB )ro$ a Flori&a 1D Pai& salaries )or the )irst hal) o) ;une, M,< 8,*BB0 1@ Pai& M,< >BB )or a&vertising to e run in a local ne'spaper )or t'o 'ee!s in ;une an& )our 'ee!s in ;ul"0 1> Pai& the rent o) M,< I*,BBB un&er a )our-$onth lease on a uil&ing rente& an& occupie& on ;une 10 ID Purchase& M,< C,*BB o) supplies )or cash0 (Onl" M,< >BB o) these supplies 'ere use& in ;une0) I> Bille& various custo$ers )or services ren&ere&, M,< 1D,BBB0 +B Mnpai& e$plo"ee services receive& in the last hal) o) ;une a$ounte& to M,< 1I,DBB0 +B :eceive& a ill )or M,< DBB )or gas an& oil use& in ;une0 a0 Prepare the entries )or the transactions as :ichar& $ust have recor&e& the$ un&er the cash asis o) accounting0 0 Prepare 3ournal entries as the" 'oul& have een prepare& un&er the accrual asis0 =here the entr" is the sa$e as un&er the cash asis, $erel" in&icate Fsa$eH0 =here possi le, recor& the original transaction so that no a&3usting entr" 'oul& e necessar" at the explanations0 en& o) the $onth0 6gnore uil&ing contractor in exchange )or an agree$ent to help service pools in his housing &evelop$ent &uring Octo er through (a"0

!.18.18 0e ond the numbers9Critical thin&ing
Business .ecision case # .ou have 3ust een hire& " Top %xecutive %$plo"$ent Agenc", 6nc0, to help prepare a&3usting entries at the en& o) an accounting perio&0 6t eco$es o vious to "ou that $anage$ent &oes not see$ to have $uch o) an un&erstan&ing a out the necessit" or a&3usting entries or 'hich accounts $ight possi l" nee& a&3ust$ent0 The )irst step "ou ta!e is to prepare the )ollo'ing una&3uste& trial alance )ro$ the general le&ger0 Onl" those le&ger accounts that ha& en&-o)-"ear alances are inclu&e& in the trial alance0

p. 18C o) *++

:e&%t# ,as0 $ccounts Receiva5le Supplies on Aand =repaid .nsurance +((ice E7uip!ent $ccu!ulated :epreciationM+((ice E7uip!ent &uildin)s $ccu!ulated :epreciationM&uildin)s $ccounts =a2a5le 4oan =a2a5le #&an6% -nearned ,o!!ission /ees ,apital Stoc6 Retained Earnin)s ,o!!issions Revenue $dvertisin) Expense Salaries Expense -tilities Expense *iscellaneous Expense 6,000 ""2,500 7,500 3,600 $723,300 360,000 $ 90,000 29,000 3,000 2,700 "20,000

Cred%t#

$ 45,000 "05,000 @,000 "5,000 30,000 "60,000 9@,300 270,000

$723,300

a0 %xplain to $anage$ent 'h" a&3usting entries in general are $a&e0 0 %xplain to $anage$ent 'h" so$e o) the speci)ic accounts appearing in the trial alance $a" nee& a&3ust$ent an& 'hat the nature o) each a&3ust$ent $ight e (&o not 'orr" a out speci)ic &ollar a$ounts)0 Business .ecision case B A )rien& o) "ours, ;ac! An&re's, is 4uite excite& over the opportunit" he has to purchase the lan& an& several $iscellaneous assets o) <ra!e Bo'ling Aanes Co$pan" )or M,< *BB,BBB0 An&re's tells "ou that (r an& (rs <ra!e (the sole stoc!hol&ers in the co$pan") are $oving &ue to (r <ra!e1s ill health0 The annual rent on the uil&ing an& e4uip$ent is M,< C*,BBB0 <ra!e reports that the usiness earne& a pro)it o) M,< 1BB,BBB in IB1B (last "ear)0 An&re's elieves an annual pro)it o) M,< 1BB,BBB on an invest$ent o) M,< *BB,BBB is a reall" goo& &eal0 But, e)ore co$pleting the &eal, he as!s "ou to loo! it over0 .ou agree an& &iscover the )ollo'ing: <ra!e has co$pute& his annual pro)it )or IB1B as the su$ o) his cash &ivi&en&s plus the increase in the Cash account: <ivi&en&s o) M,< DB,BBB T 6ncrease in Cash account o) M,< *B,BBB S M,< 1BB,BBB pro)it0 As u"er o) the usiness, An&re's 'ill ta!e over responsi ilit" )or repa"$ent o) a M,< +BB,BBB loan (plus interest) on the lan&0 The lan& 'as ac4uire& at a cost o) M,< DI*,BBB seven "ears ago0 An anal"sis o) the Cash account sho's the )ollo'ing )or IB1B: p. 18D o) *++

Rental revenues received ,as0 paid out in 20"0 (orM Salaries paid to e!plo2ees -tilities paid $dvertisin) expenses paid Supplies purc0ased and used .nterest paid on loan 4oan principal paid ,as0 dividends .n crease in cas0 5alance (or t0e 2ear $260,000 "9,000 "5,000 24,000 "9,000 30,000 60,000

$465,000

425,000 $ 40,000

.ou also )in& that the annual rent o) M,< C*,BBB, a <ece$ er utilit" ill o) M,< *,BBB, an& an a&vertising ill o) M,< D,BBB have not een pai&0 a0 Prepare a 'ritten report )or An&re's giving "our appraisal o) <ra!e Bo'ling Aanes Co$pan" as an invest$ent0 Co$$ent on <ra!e1s $etho& o) co$puting the annual pro)it o) the usiness0 0 6nclu&e in "our report an approxi$ate inco$e state$ent )or IB1B0 9roup pro2ect C 6n tea$s o) t'o or three stu&ents, go to the li rar" to locate one co$pan"1s annual report )or the $ost recent "ear0 6&enti)" the na$e o) the co$pan" an& the $a3or pro&ucts or services o))ere&, as 'ell as gross revenues, $a3or expenses, an& the tren& o) pro)its over the last three "ears0 Calculate tren& percentages )or revenues, expenses, an& pro)its using the ol&est "ear as the ase "ear0 %ach tea$ shoul& 'rite a $e$oran&u$ to $anage$ent su$$ari5ing the &ata an& co$$enting on the tren& percentages0 The hea&ing o) the $e$oran&u$ shoul& contain the &ate, to 'ho$ it is 'ritten, )ro$ 'ho$, an& the su 3ect $atter0 9roup pro2ect < =ith one or t'o other stu&ents an& using li rar" an& internet sources, 'rite a paper on ,tate"ent o& Accounting ,tan ar s 6o. #78, FAccounting )or Postretire$ent Bene)its Other Than PensionsH0 This stan&ar& resulte& in so$e o) the largest a&3usting entries ever $a&e0 Co$panies ha& to recor& an expense an& a lia ilit" to account )or these costs on an accrual asis0 6n the past the" t"picall" ha& recor&e& this expense on a cash asis, recogni5ing the expense onl" 'hen cash 'as pai& to retirees0 Be sure to cite "our sources an& treat &irect 4uotes properl"0 9roup pro2ect - =ith one or t'o other stu&ents an& using li rar" sources, 'rite a paper on hu$an resource accounting0 2enerall" accepte& accounting principles &o not allo' Fhu$an assetsH to

p. 18@ o) *++

e inclu&e& a$ong assets on the alance sheet0 =h" is thisQ Be sure to cite "our sources an& to treat &irect 4uotes properl"0

!.18.11 .sing the (nternet9A vie+ of the real +orld
Gisit the 'e site: http:77'''0p'cglo al0co$ Clic! on the ,ar anes-Oxle" Act0 =rite a rie) report to "our instructor su$$ari5ing "our )in&ings0

!.18.12 Ans+ers to self<test !.18.12.1 True<false
$rue. %ver" a&3usting entr" involves either $oving previousl" recor&e& &ata )ro$ an asset account to an expense account or )ro$ a lia ilit" account to a revenue account (or in the opposite &irection) or si$ultaneousl" entering ne' &ata in an asset account an& a revenue account or in a lia ilit" account an& an expense account0 $rue. A )iscal "ear is an" 1I consecutive $onths, so all calen&ar "ears are also )iscal "ears0 A calen&ar "ear, ho'ever, $ust en& on <ece$ er +1, so it &oes not inclu&e )iscal "ears that en& on an" &ate other than <ece$ er +1 (such as ;une +B)0 False. The accu$ulate& &epreciation account is a contra asset that sho's the total o) all &epreciation recor&e& on an asset )ro$ its ac4uisition &ate up through the alance sheet &ate0 False. The Mnearne& <eliver" Fees account is a lia ilit"0 As the )ees are earne&, the a$ount in that account is trans)erre& to a revenue account0 $rue. 6) an a&3usting entr" is overloo!e& an& not $a&e, at least one inco$e state$ent account an& one alance sheet account 'ill e incorrect0

!.18.12.2 =ultiple<choice
.. One-thir& o) the ene)its have expire&0 There)ore, M,< *BB $ust e $ove& )ro$ the asset (cre&it) to an expense (&e it)0 a. M,< 1,1BB o) the supplies have een use&, so that a$ount $ust e $ove& )ro$ the asset (cre&it) to an expense (&e it)0 c. The a$ount o) annual &epreciation is &eter$ine& as (M,< IB,BBB – M,< C,BBB) &ivi&e& " C S M,< +,BBB0 The &e it is to <epreciation %xpenseLTruc!s, an& the cre&it is to Accu$ulate& <epreciationLTruc!s, a contra asset account0

p. 188 o) *++

b. %ach $onth M,< I,BBB 'oul& e trans)erre& )ro$ the ,u scription Fees, to a revenue account (cre&it)0

lia ilit"

account

(&e it),

Mnearne&

b. An asset, 6nterest :eceiva le, is &e ite&, an& 6nterest :evenue is cre&ite&0 a. The &e it 'oul& e to ,alaries %xpense, an& the cre&it 'oul& e to ,alaries Pa"a le0

p. 18> o) *++

# Completing the accounting c cle
#.1 Learning objectives
A)ter stu&"ing this chapter, "ou shoul& e a le to:
  

,u$$ari5e the steps in the accounting c"cle0 Prepare a 'or! sheet )or a service co$pan"0 Prepare an inco$e state$ent, state$ent o) retaine& earnings, an& alance sheet using Prepare a&3usting an& closing entries using in)or$ation containe& in the 'or! sheet0 Prepare a post-closing trial alance0 <escri e the evolution o) accounting s"ste$s0 Prepare a classi)ie& alance sheet0 Anal"5e an& use the )inancial resultsLthe current ratio0

in)or$ation containe& in the 'or! sheet0
    

#.2 A career in information s stems
#ave "ou ever hear& the sa"ings K!no'le&ge is po'erK or Kin)or$ation is $one"KQ =hen people tal! a out accounting, 'hat the" are reall" tal!ing a out is in)or$ation0 The in)or$ation use& " usinesses, as 'ell as the technolog" that supports that in)or$ation, represents so$e o) the $ost valua le assets )or organi5ations aroun& the 'orl&0 Ger" o)ten, the success o) a usiness &epen&s on e))ective creation, $anage$ent, an& use o) in)or$ation0 As co$panies eco$e ever $ore reliant on technolog", the nee& )or 'ell-e&ucate& (anage$ent 6n)or$ation ,"ste$s ((6,) au&itors an& control pro)essionals increases0 6$prove& technolog" has the potential to &ra$aticall" i$prove usiness organi5ations an& practices, re&uce costs an& exploit ne' usiness an& invest$ent opportunities0 At the sa$e ti$e, co$panies )ace constant challenges in selecting an& i$ple$enting these ne' technologies0 Because o) their high value an& inherent co$plexit", the &evelop$ent, support, an& au&iting o) in)or$ation s"ste$s has eco$e one o) the )astest gro'ing specialties in accounting0 2ra&uates 'ith special interests an& s!ills in co$puting an& technolog" have expansive opportunities0 6n a&&ition to tra&itional accounting an& au&iting )unctions, (6, pro)essionals per)or$ evaluations o) technologies an& co$$unications protocols involving electronic &ata interchange, client servers, local an& 'i&e area net'or!s, &ata co$$unications, teleco$$unications, an& integrate& voice7&ata7vi&eo s"ste$s0 6n pu lic accounting, technolog" has i$pacte& the au&iting pro)ession " p. 1>B o) *++

exten&ing the !no'le&ge re4uire& to &ra' conclusions an& the s!ills re4uire& to au&it a&vance& accounting an& in)or$ation s"ste$s0 =ith $anage$ent consulting practices gro'ing an& in)or$ation s"ste$s eco$ing a larger percentage o) pu lic accounting revenue, (6, pro)essionals are in high &e$an&0 6) "ou are consi&ering a &egree in co$puter or in)or$ation s"ste$s, "ou shoul& consi&er the a&vantages that an accounting $a3or or $inor can give "ou in 'or!ing closel" 'ith usinesses an& consulting )ir$s0 A &ual $a3or in accounting an& (6, is one o) the $ost &esira le un&ergra&uate &egree co$ inations in the 'or!)orce0 This chapter explains t'o ne' steps in the accounting cycleLthe preparation o) the 'or! sheet an& closing entries0 6n a&&ition, 'e rie)l" &iscuss the evolution o) accounting s"ste$s an& present a classi)ie& alance sheet0 This alance sheet )or$at $ore closel" rese$ les actual co$pan" alance sheets0 A)ter co$pleting this chapter, "ou 'ill un&erstan& ho' accounting sho' the solvenc" an& pro)ita ilit" o) the entit"0 egins 'ith source &ocu$ents that are evi&ence o) a usiness entit"Js transactions an& en&s 'ith )inancial state$ents that

#.3 The accounting c cle summari-ed
6n Chapter 1, "ou learne& that 'hen an event is a $easura le usiness transaction, "ou nee& a&e4uate proo) o) this transaction0 Then, "ou anal"5e the transactionJs e))ects on the accounting e4uation, Assets S Aia ilities T ,toc!hol&ersJ e4uit"0 6n Chapters I an& +, "ou per)or$e& other steps in the accounting c"cle0 Chapter I presente& the eight steps in the accounting c"cle as a previe' o) the content o) Chapters I through *0 As a revie', stu&" the &iagra$ o) the eight steps in the accounting c"cle in %xhi it 1>0 :e$e$ er that the )irst three steps occur &uring the accounting perio& an& the last )ive occur at the en&0 The next section explains ho' to use the 'or! sheet to )acilitate the co$pletion o) the accounting c"cle0

#.! The +or& sheet
The work s%eet is a colu$nar sheet o) paper or a co$puter sprea&sheet on 'hich accountants su$$ari5e in)or$ation nee&e& to $a!e the a&3usting an& closing entries an& to prepare the )inancial state$ents0 Msuall", the" save these 'or! sheets to &ocu$ent the en&-o)-perio& entries0 A 'or! sheet is onl" an accounting tool an& not part o) the )or$al accounting recor&s0 There)ore, 'or! sheets $a" var" in )or$at? so$e are prepare& in pencil so that errors can e correcte& easil"0 Other 'or! sheets are prepare& on personal co$puters 'ith sprea&sheet so)t'are0 Accountants prepare 'or! sheets each ti$e )inancial state$ents are nee&e&L$onthl", 4uarterl", or at the en& o) the accounting "ear0

p. 1>1 o) *++

This chapter illustrates a 1I-colu$n 'or! sheet that inclu&es sets o) colu$ns )or an una&3uste& trial alance, a&3ust$ents, a&3uste& trial alance, inco$e state$ent, state$ent o) retaine& earnings, an& alance sheet0 %ach set has a &e it an& a cre&it colu$n0 (,ee %xhi it IB0) Accountants use these initial steps in preparing the 'or! sheet0 The )ollo'ing sections &escri e the &etaile& steps )or co$pleting the 'or! sheet0
 %nter the titles an& alances o) le&ger accounts in the Trial Balance colu$ns0  %nter a&3ust$ents in the A&3ust$ents colu$ns0  %nter a&3uste& account alances in the A&3uste& Trial Balance colu$ns0  %xten& a&3uste& alances o) revenue an& expense accounts )ro$ the A&3uste& Trial Balance

colu$ns to the 6nco$e ,tate$ent colu$ns0
 %xten& an" alances in the :etaine& %arnings an& <ivi&en&s accounts to the ,tate$ent o)

:etaine& %arnings colu$ns0
 %xten& a&3uste& alances o) asset, lia ilit", an& capital stoc! accounts )ro$ the A&3uste&

Trial Balance colu$ns to the Balance ,heet colu$ns0 6nstea& o) preparing a separate trial alance as 'e &i& in Chapter I, accountants use the Trial Balance colu$ns on a 'or! sheet0 Aoo! at %xhi it IB an& note that the nu$ ers an& titles o) the le&ger accounts o) (icroTrain Co$pan" are on the le)t portion o) the 'or! sheet0 Msuall", onl" those accounts 'ith alances as o) the en& o) the accounting perio& are liste&0 (,o$e accountants &o list the entire chart o) accounts, even those 'ith 5ero alances0) Assu$e "ou are (icroTrainJs accountant0 .ou list the :etaine& %arnings account in the trial alance even though it has a 5ero alance to (1) sho' its relative position a$ong the accounts an& (I) in&icate that <ece$ er IB1B is the )irst $onth o) operations )or this co$pan"0 /ext, "ou enter the alances o) the le&ger accounts in the Trial Balance colu$ns0 The accounts are in the or&er in 'hich the" appear in the general le&ger: assets, lia ilities, stoc!hol&ersJ e4uit", &ivi&en&s, revenues, an& expenses0 Then, total the colu$ns0 6) the &e it an& cre&it colu$n totals are not e4ual, an error exists that $ust e correcte& e)ore "ou procee& 'ith the 'or! sheet0 As "ou learne& in Chapter +, a&3ust$ents ring the accounts to their proper alances e)ore accountants prepare the inco$e state$ent, state$ent o) retaine& earnings, an& alance sheet0 .ou enter these a&3ust$ents in the A&3ust$ents colu$ns o) the 'or! sheet0 Also, "ou cross-re)erence the &e its an& cre&its o) the entries " placing a !e" nu$ er or letter to the le)t o) the a$ounts0 This !e" nu$ er )acilitates the actual 3ournali5ing o) the a&3usting entries later ecause "ou &o not have to rethin! the a&3ust$ents to recor& the$0 For exa$ple, the nu$ er (1) i&enti)ies the a&3ust$ent &e iting 6nsurance %xpense an& cre&iting Prepai& 6nsurance0 /ote in the Account Titles colu$n that p. 1>I o) *++

the 6nsurance %xpense account title is elo' the trial alance totals ecause the 6nsurance %xpense account &i& not have a alance0 =or! sheet preparers o)ten provi&e rie) explanations at the otto$ )or the !e"e& entries as in %xhi it IB0 Although these explanations are optional, the" provi&e valua le in)or$ation )or those 'ho revie' the 'or! sheet later0 The a&3ust$ents ('hich 'ere &iscusse& an& illustrate& in Chapter +) )or (icroTrain Co$pan" are: alance e)ore the a&3ust$ent an&, there)ore, &i& not appear in the trial

%xhi it 1>: ,teps in the accounting c"cle
 %ntr" (1) recor&s the expiration o) M,< IBB o) prepai& insurance in <ece$ er0  %ntr" (I) recor&s the expiration o) M,< *BB o) prepai& rent in <ece$ er0  %ntr" (+) recor&s the using up o) M,< CBB o) supplies &uring the $onth0  %ntr" (*) recor&s M,< @CB &epreciation expense on the truc!s )or the $onth0 (icroTrain

ac4uire& the truc!s at the eginning o) <ece$ er0

p. 1>+ o) *++

(icroTrain ac4uire& the truc!s at the eginning o) <ece$ er
 %ntr" (C) recor&s the earning o) M,< 1,CBB o) the M,< *,CBB in the Mnearne& ,ervice Fees

account0
 %ntr" (D) recor&s M,< DBB o) interest earne& in <ece$ er0  %ntr" (@) recor&s M,< 1,BBB o) un ille& training services per)or$e& in <ece$ er0  %ntr" (8) recor&s the M,< 18B accrual o) salaries expense at the en& o) the $onth0

O)ten it is &i))icult to &iscover all the a&3usting entries that shoul& e $a&e0 The )ollo'ing steps are help)ul:
 %xa$ine a&3usting entries $a&e at the en& o) the prece&ing accounting perio&0 The sa$e

t"pes o) entries o)ten are necessar" perio& a)ter perio&0
 %xa$ine the account titles in the trial alance0 For exa$ple, i) the co$pan" has an account

title& Truc!s, an entr" $ust e $a&e )or &epreciation0
 %xa$ine various usiness &ocu$ents (such as ills )or services receive& or ren&ere&) to

&iscover other assets, lia ilities, revenues, an& expenses that have not "et een recor&e&0
 As! the $anager or other personnel speci)ic 4uestions regar&ing a&3ust$ents that $a"

e

necessar"0 For exa$ple: K=ere an" services per)or$e& &uring the $onth that have not "et een ille&QK

p. 1>* o) *++

MICROTRAIN COM.AN@ Dor' Sheet For the Month Ended 2010 :ecem&er 1 Acct Account T%tle# . Tr%al !alance AdIu#tment# AdIu#ted Tra%l !alance Income Statement

Statement o* Reta%ned Earn%n+#

!alance Sheet

No. 100 Cash 103 Accounts Receivable 107 Supplies on Hand 108 !"epaid #nsu"ance 112 !"epaid Rent 150 $"uc%s

:e&%t 8,250 5,200 1,400 2,400 1,200 40,0 0 0

Cred%t

:e&%t

Cred%t

:e&%t Cred%t 8,250 6,200

:e&%t Cred%t :e&%t Cred%t

:e&%t 8,250 6,200 00 2,200 800 40,000

(7) 1,000

(3) 500 00 n) 200 2,200 (2) 400 &++ 40,00 0 730 4,500 50,000 -0. 3,000 10,700 (5) 1,500 (7) 1,000 S0 660 (3) 130 65, 30 (1) 200 (Z) 400 (3) 500 (t) 750 (t) 750 m 600 5,130 600 600 (6) 500 #S0 (S) 180 5,130 53,40 6S,410 0 100 6,510 13,80 0 7,2 0 7,2 0 13,80 13,80 3,000 7,2 C 0 0 4,2 0 7,2 0 7,2 C 200 400 500 750 750 200 400 500 750 3,7S0 #S0 13,200 50 680 3,780 150 13,20 0 (5) 1,500 730 3,000 50,000 -03,000 .0.

200 Accounts !a&able 216 'nea"ned Se"vice (ees 300 Capital Stoc% 310 Retained )a"nin*s 2010 +ece,be" 31 320 +ividends 3,000 400 Se"vice Revenue 505 Adve"tisin* )/pense 506 1as and 0il )/pense 507 Sala"ies )/pense 511 'tilities )/pense 512 SIS <1A 521 151 121 418 206 #nsu"ance )/pense Rent )/pense Supplies )/pense +ep"eciation )/pense. $"uc%s Accu,ulated +ep"eciation. $"uc%s #nte"est Receivable #nte"est Revenue Sala"ies !a&able Net #nco,e Retained )a"nin*s, 2010 +ece,be" 31 50 6 0 3,600 150 65, 30

600

53, 50

%xhi it IB: Co$plete& 'or!sheet

p. 1>C o) *++

(1) To recor& insurance expenses )or <ece$ er0 (I) To recor& rent expenses )or <ece$ er0 (+) To recor& supplies expenses )or <ece$ er0 (*) To recor& &epreciation expenses )or <ece$ er0 (C) To trans)er )ees )or service provi&e& in <ece$ er )ro$ the lia ilit" account to the revenue account0 (D) To recor& one $onthJs interest revenue0 (@) To recor& un ille& training services per)or$e& in <ece$ er0 (8) To accrue one &a"Js salaries that 'ere earne& ut are unpai&0 A)ter all the a&3usting entries are entere& in the A&3ust$ents colu$ns, total the t'o colu$ns0 The totals o) these t'o colu$ns shoul& e e4ual 'hen all &e its an& cre&its are entere& properl"0 A)ter (icroTrainJs a&3ust$ents, co$pute the a&3uste& alance o) each account an& enter these in the A&3uste& Trial Balance colu$ns0 For exa$ple, ,upplies on #an& (Account /o0 1B@) ha& an una&3uste& alance o) M,< 1,*BB0 A&3usting entr" (+) cre&ite& the account )or M,< CBB, leaving a &e it alance o) M,< >BB0 This a$ount is a &e it in the A&3uste& Trial Balance colu$ns0 /ext, exten& all accounts having alances to the A&3uste& Trial Balance colu$ns0 /ote care)ull" ho' the rules o) &e it an& cre&it appl" in &eter$ining 'hether an a&3ust$ent increases or &ecreases the account alance0 For exa$ple, ,alaries %xpense (Account /o0 CB@) has a M,< +,DBB &e it alance in the Trial Balance colu$ns0 A M,< 18B &e it a&3ust$ent increases this account, 'hich has a M,< +,@8B &e it alance in the A&3uste& Trial Balance colu$ns0 ,o$e account alances re$ain the sa$e ecause no a&3ust$ents have a))ecte& the$0 For exa$ple, the alance in Accounts Pa"a le (Account /o0 IBB) &oes not change an& is si$pl" exten&e& to the A&3uste& Trial Balance colu$ns0 /o', total the A&3uste& Trial Balance &e it an& cre&it colu$ns0 The totals $ust e e4ual e)ore ta!ing the next step in co$pleting the 'or! sheet0 =hen the Trial Balance an& A&3ust$ents colu$ns oth alance ut the A&3uste& Trial Balance colu$ns &o not, the $ost pro a le cause is a $ath error or an error in extension0 The A&3uste& Trial Balance colu$ns $a!e the next step o) sorting the a$ounts to the 6nco$e ,tate$ent, the ,tate$ent o) :etaine& %arnings, an& the Balance ,heet colu$ns $uch easier0 Begin " exten&ing all o) (icroTrainJs revenue an& expense account alances in the A&3uste& Trial Balance colu$ns to the 6nco$e ,tate$ent colu$ns0 ,ince revenues carr" cre&it alances, exten& the$ to the cre&it colu$n0 A)ter exten&ing expenses to the &e it colu$n, su total each colu$n0 (icroTrainJs total expenses are M,< D,C1B an& total revenues are M,< 1+,8BB0 Thus, net inco$e )or the perio& is p. 1>D o) *++

M,< @,I>B (M,< 1+,8BBLM,< D,C1B)0 %nter this M,< @,I>B inco$e in the &e it colu$n to $a!e the t'o colu$n totals alance0 .ou 'oul& recor& a net loss in the opposite $anner? expenses (&e its) 'oul& have een larger than revenues (cre&its) so a net loss 'oul& e entere& in the cre&it colu$n to $a!e the colu$ns alance0 /ext, co$plete the ,tate$ent o) :etaine& %arnings colu$ns0 %nter the M,< @,I>B net inco$e a$ount )or <ece$ er in the cre&it ,tate$ent o) :etaine& %arnings colu$n0 Thus, this net inco$e a$ount is the alancing )igure )or the 6nco$e ,tate$ent colu$ns an& is also in the cre&it ,tate$ent o) :etaine& %arnings colu$n0 /et inco$e appears in the ,tate$ent o) :etaine& %arnings cre&it colu$n ecause it causes an increase in retaine& earnings0 A&& the M,< @,I>B net inco$e to the eginning retaine& earnings alance o) M,< B, an& &e&uct the &ivi&en&s o) M,< +,BBB0 As a result, the en&ing alance o) the :etaine& %arnings account is M,< *,I>B0 /o' exten& the assets, lia ilities, an& capital stoc! accounts in the A&3uste& Trial Balance colu$ns to the Balance ,heet colu$ns0 %xten& asset a$ounts as &e its an& lia ilit" an& capital stoc! a$ounts as cre&its0 /ote that the en&ing retaine& earnings a$ount &eter$ine& in the ,tate$ent o) :etaine& %arnings colu$ns appears again as a cre&it in the Balance ,heet colu$ns0 The en&ing retaine& earnings a$ount is a &e it in the ,tate$ent o) :etaine& %arnings colu$ns to alance the ,tate$ent o) :etaine& %arnings colu$ns0 The en&ing retaine& earnings is a cre&it in the Balance ,heet colu$ns ecause it increases stoc!hol&ersJ e4uit", an& increases in stoc!hol&ersJ e4uit" are cre&its0 (:etaine& earnings 'oul& have a &e it en&ing alance0 =hen the Balance ,heet colu$n totals &o not agree on the )irst atte$pt, 'or! ac!'ar& through the process use& in preparing the 'or! sheet0 ,peci)icall", ta!e the )ollo'ing steps until "ou &iscover the error: alance onl" i) cu$ulative losses an& &ivi&en&s excee& cu$ulative earnings0) =ith the inclusion o) the en&ing retaine& earnings a$ount, the Balance ,heet colu$ns

p. 1>@ o) *++

MICROTRAIN COM.AN@ Income Statement For the Month Ended 2010 :ecem&er 1

Revenues: Service Revenue .nterest Revenue Total Revenue Expenses: $dvertisin) Expense Gas and +il Expense Salaries Expense -tilities Expense .nsurance Expense Rent Expense Supplies Expense :epreciation ExpenseMTruc6s Total Expense et .nco!e $ 50 690 3,790 "50 200 400 500 750 6,5"0 $ 7,2@0 $"3,200 600 $"3,900

%xhi it I1: 6nco$e state$ent
 :e-total the t'o Balance ,heet colu$ns to see i) "ou $a&e an error in a&&ition0 6) the colu$n

totals &o not agree, chec! to see i) "ou &i& not exten& a alance sheet ite$ or i) "ou $a&e an incorrect extension )ro$ the A&3uste& Trial Balance colu$ns0
 :e-total the ,tate$ent o) :etaine& %arnings colu$ns an& &eter$ine 'hether "ou entere& the

correct a$ount o) retaine& earnings in the appropriate ,tate$ent o) :etaine& %arnings an& Balance ,heet colu$ns0
 :e-total the 6nco$e ,tate$ent colu$ns an& &eter$ine 'hether "ou entere& the correct

a$ount o) net inco$e or net loss )or the perio& in the appropriate 6nco$e ,tate$ent an& ,tate$ent o) :etaine& %arnings colu$ns0

#n accounting perspecti'e: 6ses o0 tec%nology
%lectronic sprea&sheets have nu$erous applications in accounting0 An electronic sprea&sheet is si$pl" a large lan! page that contains ro's an& colu$ns on the co$puter screen0 The loc!s create& " the intersection o) the ro's an& colu$ns are cells? each cell can hol& one or $ore 'or&s, a nu$ er, or the pro&uct o) a $athe$atical )or$ula0 ,prea&sheets are i&eal )or creating large 'or! sheets, trial alances, an& other sche&ules, an& )or per)or$ing large volu$es o) calculations such as &epreciation calculations0 The $ost popular sprea&sheet progra$ is (icroso)t

p. 1>8 o) *++

%xcelW0 Free sprea&sheet progra$s are also availa le )ro$ co$panies such as 2oogle an& Xoho0

#.# 1reparing financial statements from the +or& sheet
=hen the 'or! sheet is co$plete&, all the necessar" in)or$ation to prepare the inco$e state$ent, state$ent o) retaine& earnings, an& alance sheet is rea&il" availa le0 /o', "ou nee& onl" recast the in)or$ation into the appropriate )inancial state$ent )or$at0 The in)or$ation "ou nee& to prepare the inco$e state$ent in %xhi it I1 is in the 'or! sheetJs 6nco$e ,tate$ent colu$ns in %xhi it IB0 The in)or$ation "ou nee& to prepare the state$ent o) retaine& earnings is ta!en )ro$ the ,tate$ent o) :etaine& %arnings colu$ns in the 'or! sheet0 Aoo! at %xhi it II, (icroTrain Co$pan"Js state$ent o) retaine& earnings )or the $onth en&e& IB1B <ece$ er +10 To prepare this state$ent, use the eginning :etaine& %arnings account alance (Account /o0 +1B), a&& the net inco$e (or &e&uct the net loss), an& then su tract the <ivi&en&s (Account /o0 +IB)0 Carr" the en&ing :etaine& %arnings alance )or'ar& to the alance sheet0 :e$e$ er that the state$ent o) retaine& earnings helps to relate inco$e state$ent in)or$ation to alance sheet in)or$ation0 6t &oes this " in&icating ho' net inco$e on the inco$e state$ent relates to retaine& earnings on the alance sheet0
MICROTRAIN COM.AN@ Statement o* Reta%ned Earn%n+# For the Month Ended 2010 :ecem&er 1"

Retained earnin)s, 20"0 :ece!5er " et inco!e (or t0e :ece!5er Total 4ess: :ividends Retained earnin)s, 20"0 :ece!5er 3"

$ $ $

M0M 7,2@0 7,2@0 3,000 4,2@0

%xhi it II: ,tate$ent o) retaine& earnings

p. 1>> o) *++

MICROTRAIN COM.AN@ !alance Sheet 2010 :ecem&er 1 A##et#

,as0 $ccounts receiva5le Supplies on 0and =repaid insurance =repaid rent .nterest receiva5le Truc6s 4ess: $ccu!ulated depredation 750 Total assets $%a&%l%t%e# and Stoc'holder#( E)u%ty 4ia5ilities: $ccounts pa2a5le -nearned service (ees Salaries pa2a5le Total lia5ilities Stoc60olders8 e7uit2: ,apital stoc6 Retained earnin)s 4,2@0 Total stoc60olders8 e7uit2 Total lia5ilities and stoc60olders8 e7uit2

$ 40,000

$ 9,250 6,200 @00 2,200 900 600 3@,250 $ 59,200

$ 730 3,000 "90 $ 3,@"0 $ 50,000 54,2@0 $ 59,200

%xhi it I+: Balance sheet The in)or$ation nee&e& to prepare a alance sheet co$es )ro$ the Balance ,heet colu$ns o) alance sheet )or (icroTrainJs 'or! sheet (%xhi it IB)0 As state& earlier, the correct a$ount )or the en&ing retaine& earnings appears on the state$ent o) retaine& earnings0 ,ee the co$plete& (icroTrain in %xhi it I+0

#.$ Aournali-ing adjusting entries
A)ter co$pleting (icroTrainJs )inancial state$ents )ro$ the 'or! sheet, "ou shoul& enter the a&3usting entries in the general 3ournal an& post the$ to the appropriate le&ger accounts0 .ou 'oul& prepare these a&3usting entries as "ou learne& in Chapter +, except that the 'or! sheet is no' "our source )or $a!ing the entries0 The preparation o) a 'or! sheet &oes not eli$inate the nee& to prepare an& post a&3usting entries ecause the 'or! sheet is onl" an in)or$al accounting tool an& is not part o) the )or$al accounting recor&s0 The nu$erical notations in the A&3ust$ents colu$ns an& the a&3ust$ents explanations at the otto$ o) the 'or! sheet i&enti)" each a&3usting entr"0 The A&3ust$ents colu$ns sho' each entr" 'ith its appropriate &e it an& cre&it0 (icroTrainJs a&3usting entries as the" 'oul& appear in the general 3ournal a)ter posting are:

p. IBB o) *++

MICROTRAIN COM.AN@ 8eneral Journal :ate Account T%tle# and E01lanat%on AdIu#t%n+ Entr%e# .o#t. :e&%t Re*.

1a+e Cred%t

20"0 :ec' 3"

.nsurance Expense #3SE% =repaid .nsurance #3$% To record insurance expense (or :ece!5er'

5"2 "09

2 0 0 2 0 0

3"

Rent Expense #3SE% =repaid Rent #3$% To record rent expense (or :ece!5er'

5"5 ""2

4 0 0 4 0 0

3"

Supplies Expense #3SE% Supplies on Aand #3$% To record supplies used durin) :ece!5er'

5"9 "07

5 0 0 5 0 0

3"

:epreciation ExpenseMTruc6s #3SE% $ccu!ulated :epredationMTruc6s #3$% To record depreciation expense (or :ece!5er'

52" "5"

7 5 0 7 5 0

3"

-nearned Service /ees #34% Service Revenue #>SE% To trans(er a potion o( trainin) (ees (ro! t0e lia5ilit2 account to t0e revenue account'

2"6 400

" 5 0 0 " 5 0 0

3"

.nterest Receiva5le #>$% .nterest Revenue #>SE% To record one !ont08s interest revenue'

"2" 4"9

6 0 0 6 0 0

3"

$ccounts Receiva5le #>$% Service Revenue #>SE% To record un5illed trainin) services per(or!ed in :ece!5er'

"03 400

" 0 0 0 " 0 0 0

3"

Salaries Expense #3SE% Salaries =a2a5le #>4% To accrue one da28s salaries t0at ;ere earned 52 are unpaid'

507 206

" 9 0 " 9 0

#.% The closing process
6n Chapter I, "ou learne& that revenue, expense, an& &ivi&en&s accounts are no$inal (te$porar") accounts that are $erel" su classi)ications o) a real (per$anent) account, :etaine& %arnings0 .ou also learne& that 'e prepare )inancial state$ents )or certain accounting perio&s0 The closing process trans)ers (1) the alances in the revenue an& expense accounts to a clearing account calle& 6nco$e p. IB1 o) *++

,u$$ar" an& then to :etaine& %arnings an& (I) the alance in the <ivi&en&s account to the :etaine& %arnings account0 The closing process re&uces revenue, expense, an& <ivi&en&s account alances to 5ero so the" are rea&" to receive &ata )or the next accounting perio&0 Accountants $a" per)or$ the closing process $onthl" or annuall"0 The 1ncome "ummary account is a clearing account use& onl" at the en& o) an accounting perio& to su$$ari5e revenues an& expenses )or the perio&0 A)ter trans)erring all revenue an& expense account alances to 6nco$e ,u$$ar", the alance in the 6nco$e ,u$$ar" account represents the net inco$e or net loss )or the perio&0 Closing or trans)erring the alance in the 6nco$e ,u$$ar" account to the :etaine& %arnings account results in a 5ero alance in 6nco$e ,u$$ar"0 Also close& at the en& o) the accounting perio& is the <ivi&en&s account containing the &ivi&en&s &eclare& " the oar& o) &irectors to the stoc!hol&ers0 =e close the <ivi&en&s account &irectl" to the :etaine& %arnings account an& not to 6nco$e ,u$$ar" ecause &ivi&en&s have no e))ect on inco$e or loss )or the perio&0 6n accounting, 'e o)ten re)er to the process o) closing as closing the oo!s0 :e$e$ er that onl" revenue, expense, an& <ivi&en& accounts are close&Lnot asset, lia ilit", Capital ,toc!, or :etaine& %arnings accounts0 The )our asic steps in the closing process are:
 Closing t%e re'enue accountsLtrans)erring the

alances in the revenue accounts to a alances in the expense accounts to a

clearing account calle& 6nco$e ,u$$ar"0
 Closing t%e expense accountsLtrans)erring the

clearing account calle& 6nco$e ,u$$ar"0
 Closing t%e 1ncome "ummary accountLtrans)erring the alance o) the 6nco$e ,u$$ar"

account to the :etaine& %arnings account0
 Closing t%e <i'i.en.s account Ltrans)erring the

alance o) the <ivi&en&s account to the

:etaine& %arnings account0 :evenues appear in the 6nco$e ,tate$ent cre&it colu$n o) the 'or! sheet0 The t'o revenue accounts in the 6nco$e ,tate$ent cre&it colu$n )or (icroTrain Co$pan" are service revenue o) M,< 1+,IBB an& interest revenue o) M,< DBB (%xhi it IB)0 Because revenue accounts have cre&it alances, "ou $ust &e it the$ )or an a$ount e4ual to their alance to ring the$ to a 5ero alance0 =hen "ou &e it ,ervice :evenue an& 6nterest :evenue, cre&it 6nco$e ,u$$ar" (Account /o0 DBB)0 %nter the account nu$ ers in the Posting :e)erence colu$n 'hen the 3ournal entr" has een poste& to the le&ger0 <o this )or all other closing 3ournal entries0

p. IBI o) *++

:ate

Account T%tle# and E01lanat%on Clo#%n+ Entr%e#

MICROTRAIN COM.AN@ 8eneral Journal

20"0 :ec' 3"

.o#t. :e&%t Re*.

.a+e ;

Cred%t

Service Revenue .nterest Revenue .nco!e Su!!ar2 To close t0e revenue accounts in t0e .nco!e State!ent credit colu!n to .nco!e Su!!ar2'

400 4"9 600

" 3 2 0 0 6 0 0 " 3 9 0 0

A)ter the closing entries have een poste&, the ,ervice :evenue an& 6nterest :evenue accounts (in T-account )or$at) o) (icroTrain appear as )ollo's0 /ote that the accounts no' have 5ero alances0 Ser2%ce Re2enue $ccount o' 400 &al' 5e(ore closin) To close to .nco!e Su!!ar2"3,20 0 &al' a(ter closin) Intere#t Re2enue $ccount o' 4"9 &al' 5e(ore closin) To close to .nco!e Su!!ar2 600 &al' a(ter closin)

#:r% 20"0

#,r'% "3,200

:ecreased 52 $"3,200

:ec' 3"

M0M
#,r'% 600

20"0 :ec' 3" :ecreased 52 $600

M0M

As a result o) the previous entr", "ou 'oul& cre&it the 6nco$e ,u$$ar" account )or M,< 1+,8BB0 =e sho' the 6nco$e ,u$$ar" account in ,tep +0 %xpenses appear in the 6nco$e ,tate$ent &e it colu$n o) the 'or! sheet0 (icroTrain Co$pan" has eight expenses in the 6nco$e ,tate$ent &e it colu$n0 As sho'n " the colu$n su total, these expenses a&& up to M,< D,C1B0 ,ince expense accounts have &e it alances, cre&it each account to ring it to a 5ero alance0 Then, $a!e the &e it in the closing entr" to the 6nco$e ,u$$ar" account )or M,< D,C1B0 Thus, to close the expense accounts, (icroTrain $a!es the )ollo'ing entr":

p. IB+ o) *++

MICROTRAIN COM.AN@ 8eneral Journal :ate Account T%tle# and E01lanat%on .o#t. Re*. 600 :e&%t

Page ;
Cred%t

20"0 :ec'

3" .nco!e Su!!ar2 $dvertisin) Expense Gas and +il Expense Salaries Expense -tilities Expense .nsurance Expense Rent Expense Supplies Expense :epreciation ExpenseMTruc6s To close t0e expense accounts appearin) in t0e .nco!e

6 5 " 0 5 0 6 9 0 3 7 9 0 " 5 0 2 0 0 4 0 0 5 0 0 7 5 0

505 506 507 5"" 5"2 5"5 5"9 52"

The &e it o) M,< D,C1B to the 6nco$e ,u$$ar" account agrees 'ith the 6nco$e ,tate$ent &e it colu$n su total in the 'or! sheet0 This co$parison 'ith the 'or! sheet serves as a chec! that all revenue an& expense ite$s have een liste& an& close&0 6) the &e it in the prece&ing entr" 'as $a&e )or a &i))erent a$ount than the colu$n su total, the co$pan" 'oul& have an error in the closing entr" )or expenses0 A)ter the" have een close&, (icroTrainJs expense accounts appear as )ollo's0 /ote that each account has a 5ero alance a)ter closing0

p. IB* o) *++

#:r%

Ad2ert%#%n+ E01en#e $ccount o' 505

#,r'%

Bal. befo e clo!"#$

% 50

2010 % % &ec. 31 'o clo!e to I#co(e &ec ea!e) b+ ,50

S*((a + Bal. afte clo!"#$
#:r'%

50

-08a# and O%l E01en#e $ccount o' 506

#,r'%

Bal. befo e clo!"#$

680

2010 &ec. 31 'o clo!e to I#co(e S*((a + 680 &ec ea!e) b+ ,680

Bal. afte clo!"#$
#:r'%

-0Salar%e# E01en#e $ccount o' 507

#,r'%

Bal. befo e clo!"#$

3,780

2010 &ec. 31 'o clo!e to I#co(e &ec ea!e) b+ ,3,780

S*((a + Bal. afte clo!"#$
#:r'%

3,780

-0Ut%l%t%e# E01en#e $ccount o' 5""

#,r'%

Bal. befo e clo!"#$

150

2010 &ec. 31 'o clo!e to I#co(e S*((a + 150 &ec ea!e) b+ ,150

Bal. afte clo!"#$
#:r'%

-0In#urance E01en#e $ccount o' 5"2

#,r'%

Bal. befo e clo!"#$

200

2010 &ec. 31 'o clo!e to I#co(e S*((a + 200 &ec ea!e) b+ ,200

p. IBC o) *++

Bal. afte clo!"#$
#:r'%

-0Rent E01en#e $ccount o' 5"5

#,r'%

Bal. befo e clo!"#$

400

2010 &ec. 31 'o clo!e to I#co(e S*((a + 400 &ec ea!e) b+ ,400

Bal. afte clo!"#$
#:r'%

-0Su11l%e# E01en#e $ccount o' 5"9

#,r'%

Bal. befo e clo!"#$

500

2010 &ec. 31 'o clo!e to I#co(e S*((a + 500 &ec ea!e) b+ ,500

Bal. afte clo!"#$ Bal. befo e clo!"#$

-0#,r'%

:e1rec%at%on E01en#e-Truc'# #:r'% $ccount o' 52"

% 750.

2010 / &ec. 31 'o clo!e to I#co(e S*((a + 750 &ec ea!e) b+ ,750

Bal. afte clo!"#$

-0-

The expense accounts coul& e close& e)ore the revenue accounts? the en& result is the sa$e0 As the result o) closing the revenues an& expenses o) (icroTrain, the total revenues an& expenses have een trans)erre& to the 6nco$e ,u$$ar" account0
Income Summary Total e01en#e# Total re2enue# ;

.( total expenses exceed total revenues, t0e account 0as a de5it 5alance, ;0ic0 is t0e net loss (or t0e period

.( total revenues exceed total expenses, t0e account 0as a credit 5alance, ;0ic0 is t0e net inco!e (or t0e period'

(icroTrainJs 6nco$e ,u$$ar" account no' has a cre&it alance o) M,< @,I>B, the co$pan"Js net inco$e )or <ece$ er0

p. IBD o) *++

Income Summary 20"0 /ro! closin) 6,5"0 :ec' 3" t0e expense accounts
(-r&

(Cr.&

20"0 :ec' 3" /ro! closin) t0e revenue accounts &al' 5e(ore closin) t0is account #net inco!e%

"3,900

7,2@0

/ext, close (icroTrainJs 6nco$e ,u$$ar" account to its :etaine& %arnings account0 The 3ournal entr" to &o this is:
MICROTRAIN COM.AN@ 8eneral Journal

=a)e 4 ,redit 7 2 @ 0

:ate 20"0 :ec'

$ccount Titles and Explanation 3" .nco!e Su!!ar2 Retained Earnin)s To close t0e .nco!e Su!!ar2 account to t0e Retained Earnin)s account'

=ost' Re(' :e5t 600 7 2 @ 0 3"0

A)ter its 6nco$e ,u$$ar" account is close&, the co$pan"Js 6nco$e ,u$$ar" an& :etaine& %arnings accounts appear as )ollo's:
Income Summary
(-r.& Account No. 4$$

20"0 :ec' 3" /ro! closin) t0e expense accounts 6,5"0 :ec' 3" To close t0is account to Retain ed Earnin)s

K20"0 :ec' 3" /ro! closin) T0e revenue accounts &al' 5e(ore closin) t0is account #net inco!e%

(Cr.&

"3,900 7,2@0

7,2@0

&al' a(ter closin)

M0M

Reta%ned Earn%n+#
(-r& Account No. (5$ (Cr.&

&al' 5e(ore closin) =rocess 20"0 :ec' 3" /ro! .nco!e Su!!ar2

303

7,2@0

:ecreased 52 $7,2@0

The last closing entr" closes (icroTrainJs <ivi&en&s account0 This account has a &e it

alance

e)ore closing0 To close the account, cre&it the <ivi&en&s account an& &e it the :etaine& %arnings account0 The <ivi&en&s account is not close& to the 6nco$e ,u$$ar" ecause it is not an expense an&

p. IB@ o) *++

&oes not enter into inco$e &eter$ination0 The 3ournal entr" to close (icroTrainJs <ivi&en&s account is:
MICROTRAIN COM.AN@ 8eneral Journal

=a)e 4 ,redit 3 0 0 0

:ate 20"0 :ec'

$ccount Titles and Explanation 3" Retained Earnin)s #3SE% :ividends #>SE% To close t0e :ividends account to t0e Retained Earnin)s account'

=ost' Re(' :e5it 3"0 3 0 0 0 320

A)ter this closing entr" is poste&, the co$pan"Js <ivi&en&s an& :etaine& %arnings accounts appear as )ollo's:
:%2%dend#
(-r.&

&al' 5e(ore closin) 3,000

Account No. (#$ (Cr.&

20"0 :ec' 3" To close to Retained Earnin)

3000

:ecreased 52 $3,000 &al' a(ter closin)
(-r.&

-0Reta%ned Earn%n+#

20"0

Account No. (5$ (Cr.&

&al' 5e(ore closin) process -020"0 :ec' 3" /ro! .nco!e Su!!ar2 7,2@0 &al' a(ter closin) process is co!plete 4,2@0

:ec' 3" /ro! dividends 3,000

A)ter "ou have co$plete& the closing process, the onl" accounts in the general le&ger that have not een close& are the per$anent alance sheet accounts0 Because these accounts contain the opening alances )or the co$ing accounting perio&, &e it alance totals $ust e4ual cre&it alance totals0 The preparation o) a post-closing trial alance serves as a chec! on the accurac" o) the closing process an& ensures that the oo!s are in alance at the start o) the ne' accounting perio&0 The post-closing trial alance &i))ers )ro$ the a&3uste& trial its proper en&ing alance0 alance in onl" t'o i$portant respects: (1) it exclu&es all te$porar" accounts since the" have een close&? an& (I) it up&ates the :etaine& %arnings account to

p. IB8 o) *++

A post-closing trial balance is a trial alance ta!en a)ter the closing entries have een poste&0 The onl" accounts that shoul& e open are assets, lia ilities, capital stoc!, an& :etaine& %arnings accounts0 Aist all the account alances in the &e it an& cre&it colu$ns an& total the$ to $a!e sure &e its an& cre&its are e4ual0 Aoo! at %xhi it I*, a post-closing trial alance )or (icroTrain Co$pan" as o) IB1B <ece$ er +10 The a$ounts in the post-closing trial alance are )ro$ the le&ger a)ter the closing entries have een poste&0 The next section rie)l" &escri es the evolution o) accounting s"ste$s )ro$ the one-3ournal, onele&ger $anual s"ste$ "ou have een stu&"ing to co$puteri5e& s"ste$s0 Then, 'e &iscuss the role o) an accounting s"ste$0

#n accounting perspecti'e: 6ses o0 tec%nology
6) "ou are stu&"ing in the M,, "ou $a" 'ant to visit the A$erican 6nstitute o) Certi)ie& Pu lic Accountants 'e site at: http:77'''0aicpa0org .ou 'ill )in& in)or$ation a out the CPA exa$, a out eco$ing a CPA, hot accounting topics, an& various other topics, such as the M, states that have passe& a 1CB-hour re4uire$ent to sit )or the CPA exa$0 .ou can also learn such things as the states that have approve& li$ite& lia ilit" co$panies (AACs) an& li$ite& lia ilit" partnerships (AAPs)0 These )or$s o) organi5ation serve to place li$its on accountantsJ lia ilit"0 .ou can also )in& the phone nu$ ers an& $ailing a&&resses o) ,tate Boar&s o) accountanc" an& ,tate ,ocieties o) CPAs0 Bro'se aroun& this site to investigate an"thing else that is o) interest0 ,i$ilar sites are availa le in other countries as 'ell0

#.' Accounting s stems: "rom manual to computeri-ed
The $anual accounting s"ste$ 'ith onl" one general 3ournal an& one general le&ger has een in use )or hun&re&s o) "ears an& is still use& " so$e ver" s$all co$panies0 2ra&uall", so$e $anual s"ste$s evolve& to inclu&e $ultiple 3ournals an& le&gers )or increase& e))icienc"0 For instance, a $anual s"ste$ 'ith $ultiple 3ournals an& le&gers o)ten inclu&es: a sales 3ournal to recor& all cre&it sales, a purchases 3ournal to recor& all cre&it purchases, a cash receipts 3ournal to recor& all cash receipts, an& a cash &is urse$ents 3ournal to recor& all cash pa"$ents0 ,till recor&e& in the general 3ournal are a&3usting an& closing entries an& an" other entries that &o not )it in one o) the special 3ournals0 Besi&es the general le&ger, such a s"ste$ nor$all" has su si&iar" le&gers )or accounts receiva le an& accounts p. IB> o) *++

pa"a le sho'ing ho' $uch each custo$er o'es an& ho' $uch is o'e& to each supplier0 The general le&ger sho's the total a$ount o) accounts receiva le an& accounts pa"a le, ut the &etails in the su si&iar" le&gers allo' co$panies to sen& ills to custo$ers an& pa" ills to suppliers0 Another innovation in $anual s"ste$s 'as the Kone 'riteK or peg oar& s"ste$0 B" creating one &ocu$ent an& aligning other recor&s un&er it on a peg oar&, co$panies coul& recor& transactions $ore e))icientl"0 These s"ste$s per$it the 'riting o) a chec! an& the si$ultaneous recor&ing o) the chec! in the cash &is urse$ents 3ournal0 %ven though so$e o) these s"ste$s are still in use to&a", co$puters $a!e the$ o solete0 <uring the 1>CBs, co$panies also use& oo!!eeping $achines to supple$ent $anual s"ste$s0 These $achines recor&e& recurring transactions such as sales on account0 The" poste& transactions to the general le&ger an& su si&iar" le&ger accounts an& co$pute& ne' alances0 =ith the &evelop$ent o) co$puters, oo!!eeping $achines eca$e o solete0 The" 'ere 4uite expensive, an& co$puters egan using $ain)ra$e co$puters0 easil" outper)or$e& the$0 6n the $i&-1>CBs, large co$panies

%arl" accounting applications 'ere in pa"roll, accounts receiva le, accounts pa"a le, an& inventor"0 =ithin a )e' "ears, progra$s existe& )or all phases o) accounting, inclu&ing $anu)acturing operations an& the total integration o) other accounting progra$s 'ith the general le&ger0 Mntil the 1>8Bs, s$all an& $e&iu$-si5e& co$panies either continue& 'ith a $anual s"ste$, rente& ti$e on another co$pan"Js co$puter, or hire& a service ureau to per)or$ at least so$e accounting )unctions0
MICROTRAIN COM.AN@ Tr%al !alance 2010 :ecem&er 1 Acct. No. "00 Account T%tle ,as0 :e&%t# $ 9,250 Cred%t#

"03 "07 "09 ""2 "2" "50 "5" 200 206 2"6 300 3"0

$ccounts Receiva5le Supplies on Aand =repaid .nsurance =repaid Rent .nterest Receiva5le Truc6s $ccu!ulated :epreciationMTruc6s $ccounts =a2a5le Salaries =a2a5le -nearned Service /ees ,apital Stoc6 Retained Earnin)s

6,200 @00 2,200 900 600 40,000 $ 750 730 "90 3,000 50,000 4,2@0 $ 59,@50 $ 59,@50

p. I1B o) *++

%xhi it I*: Post closing trial alance

#n accounting perspecti'e: Business insig%t
6$agine a co$pan" 'ith an Accounts :eceiva le account an& an Accounts Pa"a le account in its general le&ger an& no Accounts :eceiva le ,u si&iar" Ae&ger or Accounts Pa"a le ,u si&iar" Ae&ger0 #o' 'oul& this co$pan" !no' to 'ho$ to sen& ills an& in 'hat a$ountsQ Also, ho' 'oul& e$plo"ees !no' )or 'hich suppliers to 'rite chec!s an& in 'hat a$ountsQ ,uch su si&iar" recor&s are necessar" either on paper or in a co$puter )ile0 #ere is ho' the general le&ger an& su si&iar" le&gers $ight loo!:
Su5sidiar2 $ccounts Receiva5le 4ed)er 1+A 1+ ES 200 5 SP4H.$ S*.TA 300 General 4ed)er Su5sidiar2 $ccounts =a2a5le 4ed)er &E44 ,+R=+R$T.+ "00 GR$ GER ,+R=+R$T.+ $,,+- TS =$P$&4E ",000 1$*ES LE44S 400 L+ G ,+R=+R$T.+ 300 600

$,,+- TS RE,E.H$&4E @00

5

5

=hen a sale on account is $a&e to ;ohn ;ones, the &e it is poste& to oth the control account, Accounts :eceiva le, in the 2eneral Ae&ger an& the su si&iar" account, ;ohn ;ones, in the ,u si&iar" Accounts :eceiva le Ae&ger0 Ai!e'ise, 'hen a purchase on account is $a&e )ro$ Bell Corporation, the cre&it is poste& to oth the control account, Accounts Pa"a le, in the 2eneral Ae&ger an& to the su si&iar" account, Bell Corporation, in the ,u si&iar" Accounts Pa"a le Ae&ger0 At the en& o) the accounting perio&, the alances in each o) the control accounts in the 2eneral Ae&ger $ust agree 'ith the totals o) the accounts in their respective su si&iar" le&gers as sho'n a ove0 A given co$pan" coul& have hun&re&s or even thousan&s o) accounts in their su si&iar" le&gers that sho' the &etail not supplie& " the totals in the control accounts0

# broa.er perspecti'e: "kills 0or t%e long %aul

p. I11 o) *++

The &ecision has een $a&e: .ou 8Trac"9 have opte& to start "our career " 3oining an international accounting )ir$0 But "ou can not help 'on&ering i) "ou have the right s!ills oth )or short an& long-ter$ success in pu lic accounting0 (ost stu&ents un&erstan& that accounting !no'le&ge, organi5ational a ilit" an& interpersonal s!ills are critical to success in pu lic accounting0 But it is i$portant )or the eginner to reali5e that &i))erent s!ills are e$phasi5e& at &i))erent points in a pu lic accountantJs career0 Aet us exa$ine the &uties an& s!ills nee&e& at each levelL,ta)) Accountant ("ears 1-I), ,enior Accountant ("ears +-*), (anager7 ,enior (anager ("ears C-11) an& Partner ("ears 11T)0 "ta00 accountantF-nt%usiastic learner Aet us travel 'ith Trac" as she egins her career at the sta)) level0 At the outset, she 'or!s &irectl" un&er a senior accountant on each o) her au&its an& is responsi le )or co$pleting au&its an& a&$inistrative tas!s assigne& to her0 #er &uties inclu&e &ocu$enting 'or! papers, interacting 'ith client accounting sta)), clerical tas!s an& &iscussing 4uestions that arise 'ith her senior0 Trac" 'ill 'or! on &i))erent au&it engage$ents &uring her )irst "ear an& learn the )ir$Js au&it approach0 ,he 'ill e intro&uce& to various in&ustries an& accounting s"ste$s0 The t'o $ost i$portant traits to e &e$onstrate& at the sta)) level are (1) a positive attitu&e an& (I) the a ilit" to learn 4uic!l" 'hile a&apting to un)a$iliar situations0 "enior accountantF3rgani4er an. teac%er As a senior accountant, Trac" 'ill e responsi le )or the &a"-to-&a" $anage$ent o) several au&it engage$ents &uring the "ear0 ,he 'ill plan the au&its, oversee the per)or$ance o) interi$ au&it testing an& &irect "ear-en& )iel& 'or!0 ,he 'ill also per)or$ $uch o) the )inal 'rap-up 'or!, such as preparing chec!lists, 'riting the $anage$ent letter an& revie'ing or &ra)ting the )inancial state$ents0 Throughout this process, Trac" 'ill spen& a su stantial a$ount o) ti$e instructing an& supervising sta)) accountants0 The t'o $ost critical s!ills nee&e& at the senior level are (1) the a ilit" to organi5e an& control an au&it an& (I) the a ilit" to teach sta)) accountants ho' to au&it0 8anager/senior managerF9eneral manager an. salesperson

p. I1I o) *++

Mpon pro$otion to $anager, Trac" 'ill

egin the trans)or$ation )ro$ au&itor to

executive0 ,he 'ill $anage several au&its at one ti$e an& eco$e active in illing clients as 'ell as negotiating au&it )ees0 ,he 'ill han&le $an" i$portant client $eetings an& closing con)erences0 Trac" 'ill also eco$e $ore involve& in the )ir$Js a&$inistrative tas!s0 Finall", outsi&e o) her client service an& a&$inistrative &uties, Trac" 'ill e evaluate& to a large extent on her co$$unit" involve$ent an& a ilit" to assist the partners in generating ne' usiness )or the )ir$0 The t'o s!ills $ost e$phasi5e& at the $anager level are (1) general $anage$ent a ilit" an& (I) sales an& co$$unication s!ills0 &artnerFLea.er an. expert As a partner in the )ir$, Trac" 'ill have $an" roa& responsi ilities0 ,he 'ill engage in high-level client service activities, usiness &evelop$ent, recruiting, strategic planning, o))ice a&$inistration an& counseling0 Besi&es serving as the engage$ent partner on several au&its, she 'ill have ulti$ate responsi ilit" )or the 4ualit" o) service provi&e& to each o) her clients0 Although a certain in&ustr" or a&$inistrative )unction 'ill eco$e her specialt", she 'ill o)ten e calle& upon to per)or$ a 'i&e variet" o) au&it an& a&$inistrative &uties 'hen other partners have sche&uling con)licts0 ,he 'ill e expecte& to serve as a positive exa$ple to those 'ho 'or! )or her an& 'ill train others in her areas o) expertise0 At the partnership level, 'hat is loo!e& )or is lea&ership a ilit" plus the a ilit" to eco$e an expert in a speci)ic in&ustr" or a&$inistrative )unction0 1n t%e meantime Those planning on a pu lic accounting career shoul& &o $ore than 3ust learn accounting0 To &evelop the nee&e& s!ills, a roa& e&ucation ac!groun& in usiness an& non usiness courses is re4uire& plus participation in extracurricular activities that pro$ote lea&ership an& co$$unication s!ills0 6t is never too earl" to start uil&ing the s!ills )or long-ter$ success0 ,ource: <ana :0 #er$anson an& #eather (0 #er$anson, /e' Accountant, ;anuar" 1>>B, pp0 I*-ID, Y 1>>B, /e' <uBois Corporation0

The &evelop$ent o) the personal co$puter (PC) in 1>@D an& its 'i&esprea& use a &eca&e later &rasticall" change& the accounting s"ste$s o) s$all an& $e&iu$-si5e& usinesses0 The nu$ er an& p. I1+ o) *++

4ualit" o) accounting so)t'are pac!ages )or PCs an& the po'er o) PCs 4uic!l" increase&0 ,oon s$all an& $e&iu$-si5e& usinesses coul& $aintain all accounting )unctions on a PC0 B" the 1>>Bs, the cost o) PCs an& accounting so)t'are pac!ages ha& &ecrease& signi)icantl", accounting so)t'are pac!ages ha& eco$e $ore user-)rien&l", an& co$puter literac" ha& increase& so $uch that $an" ver" s$all usinesses converte& )ro$ $anual to co$puteri5e& s"ste$s0 #o'ever, so$e s$all usiness o'ners still use $anual s"ste$s ecause the" are )a$iliar an& $eet their nee&s, an& the persons !eeping the recor&s $a" not e co$puter literate0 .our !no'le&ge o) the ena les "ou to asic $anual accounting s"ste$ &escri e& in these )irst )our chapters etter un&erstan& a co$puteri5e& accounting s"ste$0 The co$puter auto$aticall"

per)or$s so$e o) the steps in the accounting c"cle, such as posting 3ournal entries to the le&ger accounts, closing the oo!s, an& preparing the )inancial state$ents0 #o'ever, i) "ou un&erstan& all o) the steps in the accounting c"cle, "ou 'ill etter un&erstan& ho' to use the resulting &ata in &ecision $a!ing0

#n accounting perspecti'e: $%e impact o0 tec%nology
:esults )ro$ a recent surve" o) 1,*BB chie) )inancial o))icers (CFOs) in&icate that to$orro'Js accounting pro)essionals 'ill e calle& upon to ri&ge the gap et'een technolog" an& usiness0 =ith the rise o) integrate& accounting an& in)or$ation s"ste$s, technical expertise 'ill go han& in han& 'ith general usiness !no'le&ge0

As 'e sho' in %xhi it IC, an accounting system is a set o) recor&s an& the proce&ures an& e4uip$ent use& to per)or$ the accounting )unctions0 (anual s"ste$s consist o) 3ournals an& le&gers on paper0 Co$puteri5e& accounting s"ste$s consist o) accounting so)t'are, co$puter )iles, co$puters, an& relate& peripheral e4uip$ent such as printers0 :egar&less o) the s"ste$, the )unctions o) accountants inclu&e: (1) o serving, i&enti)"ing, an& $easuring econo$ic events? (I) recor&ing, classi)"ing, an& su$$ari5ing $easure$ents? an& (+) reporting econo$ic events an& interpreting )inancial state$ents0 Both internal an& external users tell accountants their in)or$ation nee&s0 The accounting s"ste$ ena les a co$pan"Js accounting sta)) to suppl" relevant accounting in)or$ation to $eet those nee&s0 As internal an& external users $a!e &ecisions that egins again0 eco$e econo$ic events, the c"cle o) in)or$ation, &ecisions, an& econo$ic events

p. I1* o) *++

The pri$ar" )ocus o) the )irst )our chapters has een on ho' "ou can use an accounting s"ste$ to prepare )inancial state$ents0 #o'ever, 'e also &iscusse& ho' to use that in)or$ation in $a!ing &ecisions0 Aater chapters also sho' ho' to prepare in)or$ation an& ho' that in)or$ation helps users to $a!e in)or$e& &ecisions0 =e have not eli$inate& the preparation aspects ecause 'e elieve that the $ost in)or$e& users are ones 'ho also un&erstan& ho' the in)or$ation 'as prepare&0 These users un&erstan& not onl" the li$itations o) the in)or$ation ut also its relevance )or &ecision $a!ing0 The next section &iscusses an& illustrates the classi)ie& alance sheet, 'hich ai&s in the anal"sis o) the )inancial position o) co$panies0 One exa$ple o) this anal"sis is the current ratio an& its use in anal"5ing the short-ter$ &e t-pa"ing a ilit" o) a co$pan"0

%xhi it IC: The role o) an accounting s"ste$

#n accounting perspecti'e: 6ses o0 tec%nology
Accounting so)t'are pac!ages are t"picall" $enu &riven an& organi5e& into $o&ules such as general le&ger, accounts pa"a le, accounts receiva le, invoicing, inventor", pa"roll, )ixe& assets, 3o cost, an& purchase or&er0 For instance, general 3ournal entries are $a&e in the general le&ger $o&ule, an& this $o&ule contains all o) the co$pan"Js accounts0 The accounts pa"a le $o&ule recor&s all transactions involving cre&it

p. I1C o) *++

purchases )ro$ suppliers an& pa"$ents $a&e to those suppliers0 The accounts receiva le $o&ule recor&s all sales on cre&it to various custo$ers an& a$ounts receive& )ro$ custo$ers0

#.) A classified balance sheet
The alance sheets 'e presente& so )ar have een unclassi)ie& alance sheets0 As sho'n in %xhi it I+, an unclassi0ie. balance s%eet has three $a3or categories: assets, lia ilities, an& stoc!hol&ersJ e4uit"0 A classi0ie. balance s%eet contains the sa$e three $a3or categories an& su &ivi&es the$ to provi&e use)ul in)or$ation )or interpretation an& anal"sis " users o) )inancial state$ents0 %xhi it ID, sho's a slightl" revise& classi)ie& su si&iaries0 /ote that The #o$e <epot classi)ie&
1

alance sheet )or The #o$e <epot, 6nc0, an& alance sheet is in a vertical )or$at (assets

appearing a ove lia ilities an& stoc!hol&ersJ e4uit") rather than the hori5ontal )or$at (assets on the le)t an& lia ilities an& stoc!hol&ersJ e4uit" on the right)0 The t'o )or$ats are e4uall" accepta le0 The #o$e <epot classi)ie& alance sheet su &ivi&es t'o o) its three $a3or categories0 The #o$e <epot su &ivi&es its assets into current assets, propert" an& e4uip$ent, long-ter$ invest$ents, longter$ notes receiva le, intangi le assets (cost in excess o) the )air value o) net assets ac4uire&), an& other assets0 The co$pan" su &ivi&es its lia ilities into current lia ilities an& long-ter$ lia ilities (inclu&ing &e)erre& inco$e taxes)0 A later chapter &escri es $inorit" interest0 ,toc!hol&ersJ e4uit" is the sa$e in a classi)ie& alance sheet as in an unclassi)ie& alance sheet0 Aater chapters &escri e )urther su &ivisions o) the stoc!hol&ersJ e4uit" section0 =e &iscuss the in&ivi&ual ite$s in the classi)ie& alance sheet later in the text0 Our onl" purpose here is to rie)l" &escri e the ite$s that can e liste& un&er each categor"0 ,o$e o) these ite$s are not in The #o$e <epotJs alance sheet0

1Foun&e& in 1>@8, The #o$e <epot is A$ericaJs largest ho$e i$prove$ent retailer an& ran!s a$ong the nationJs +B largest retailers0 The co$pan" has $ore than 1,BBB )ull-service 'arehouse stores0 Their pri$ar" custo$ers are &o-it-"oursel)ers0 p. I1D o) *++

T9E 9OME :E.OT" INC. AN: SU!SI:IARIES Con#ol%dated !alance Sheet 2001 January 2A 4amount# %n m%ll%on#" e0ce1t #hare data5

1anuar2 29, 200" $ssets ,urrent $ssets: ,as0 and ,as0 E7uivalents S0ort3Ter! .nvest!ents, includin) current !aturities o( lon)3ter! invest!ents Receiva5les, net *erc0andise .nventories +t0er ,urrent $ssets Total ,urrent $ssets =ropert2 and E7uip!ent, at cost: 4and &uildin)s /urniture, /ixtures and E7uip!ent 4ease0old .!prove!ents ,onstruction in =ro)ress ,apital 4eases $ 4ess: $ccu!ulated :epreciation and $!ortiEation et =ropert2 and E7uip!ent 4on)3Ter! .nvest!ents otes Receiva5le ,ost in Excess o( /air Halue o( et $ssets $c7uired, net o( accu!ulated a!ortiEation o( $4" at 1anuar2 25, 200" and $33 at 1anuar2 30, 2000 +t0er Total assets 4ia5ilities and Stoc60olders8 E7uit2 ,urrent 4ia5ilities: $ccounts =a2a5le $ccrued Salaries and Related Expenses Sales Taxes =a2a5le +t0er $ccrued Expenses .nco!e Taxes =a2a5le ,urrent .nstall!ents o( 4on)3Ter! :e5t Total ,urrent 4ia5ilities 4on)3Ter! :e5t, excludin) current install!ents +t0er 4on)3Ter! 4ia5ilities :e(erred .nco!e Taxes *inorit2 .nterest Stoc60olders8 e7uit2: $ ",545 245 "@5 ",@95 "" $ ",@76 627 2@9 ",402 79 4 $4,395 3"4 "34 $ "3,609 2",395 $ $ 4,230 6,"67 2,977 665 ",032 26" "5,232 2,"64 "3,069 "5 77 $ "67 "0 935 6,556 20@ $ 7,777

p. I1@ o) *++

,o!!on Stoc6, par value $0'05' $ut0oriEed: "0,000,000,000 s0aresQ issued and outstandin)3 2,323,747,000 s0ares at 200" 1anuar2 29 and 2,304,3"7,000 s0ares at 2000 1anuar2 30 =aid3.n ,apital Retained Earnin)s $ccu!ulated +t0er ,o!pre0ensive .nco!e 4ess: S0ares =urc0ased (or ,o!pensation =lans Total Stoc60olders8 E7uit2 Total 4ia5ilities and Stoc60olders8 E7uit2 $ ""6 4,9"0 "0,"5" #67% "5,0"0 6 "5,004 2",395

%xhi it ID: A classi)ie& alance sheet Current assets are cash an& other assets that a usiness can convert to cash or uses up in a relativel" short perio&Lone "ear or one operating c"cle, 'hichever is longer0 An operating cycle is the ti$e it ta!es to start 'ith cash, u" necessar" ite$s to pro&uce revenues (such as $aterials, " collecting the supplies, la or, an&7or )inishe& goo&s), sell services or goo&s, an& receive cash

resulting receiva les0 Co$panies in service in&ustries an& $erchan&ising in&ustries generall" have operating c"cles shorter than one "ear0 Co$panies in so$e $anu)acturing in&ustries, such as &istilling an& lu$ er, have operating c"cles longer than one "ear0 #o'ever, since $ost operating c"cles are shorter than one "ear, the one-"ear perio& is usuall" use& in i&enti)"ing current assets an& current lia ilities0 Co$$on current assets in a service usiness inclu&e cash, $ar!eta le securities, accounts receiva le, notes receiva le, interest receiva le, an& prepai& expenses0 /ote that on a alance sheet, current assets are in or&er o) ho' easil" the" are converti le to cash, )ro$ $ost li4ui& to least li4ui&0 Cas% inclu&es &eposits in an!s availa le )or current operations at the alance sheet &ate plus cash on han& consisting o) currenc", un&eposite& chec!s, &ra)ts, an& $one" or&ers0 Cash is the )irst current asset to appear on a alance sheet0 The ter$ cash nor$all" inclu&es cash e4uivalents0 Cas% equi'alents are highl" li4ui&, short-ter$ invest$ents ac4uire& 'ith te$poraril" i&le cash an& easil" converti le into a !no'n cash a$ount0 %xa$ples are Treasur" $aturing 'ithin >B &a"s, certi)icates o) &eposit, an& $one" $ar!et )un&s0 8arketable securities are te$porar" invest$ents such as short-ter$ o'nership o) stoc!s an& on&s o) other co$panies0 ,uch invest$ents &o not 4uali)" as cash e4uivalents0 These invest$ents earn a&&itional $one" on cash that the usiness &oes not nee& at present ut 'ill pro a l" nee& 'ithin one "ear0 #ccounts recei'able (also calle& tra&e accounts receiva le) are a$ounts o'e& to a usiness " custo$ers0 An account receiva le arises 'hen a co$pan" per)or$s a service or sells $erchan&ise on cre&it0 Custo$ers nor$all" provi&e no 'ritten evi&ence o) in&e te&ness on sales invoices or &eliver" ills, short-ter$ notes

p. I18 o) *++

tic!ets except their signatures0 /otice the ter$ net in the alance sheet o) The #o$e <epot (%xhi it ID)0 This ter$ in&icates the possi ilit" that the co$pan" $a" not collect so$e o) its accounts receiva le0 6n the alance sheet, the accounts receiva le a$ount is the su$ o) the in&ivi&ual accounts receiva le )ro$ custo$ers sho'n in a su si&iar" le&ger or )ile0 8erc%an.ise in'entories are goo&s hel& )or sale0 Chapter D $erchan&ise inventories0 A note is an uncon&itional 'ritten pro$ise to pa" another part" the a$ount o'e& either 'hen &e$an&e& or at a certain speci)ie& &ate, usuall" 'ith interest (a charge $a&e )or use o) the $one") at a speci)ie& rate0 A note receiva le appears on the alance sheet o) the co$pan" to 'hich the note is given0 A note receiva le arises (1) 'hen a co$pan" $a!es a sale an& receives a note )ro$ the custo$er, (I) 'hen a custo$er gives a note )or an a$ount &ue on an account receiva le, or (+) 'hen a co$pan" loans $one" an& receives a note in return0 Chapter > &iscusses notes at length0 Other current assets $ight inclu&e interest receiva le an& prepai& expenses0 1nterest recei'able arises 'hen a co$pan" has earne& ut not collecte& interest " the alance sheet &ate0 Msuall", the a$ount is not &ue until later0 &repai. expenses inclu&e rent, insurance, an& supplies that have een pai& )or ut all the ene)its have not "et een reali5e& (or consu$e&) )ro$ these expenses0 6) prepai& expenses ha& not een pai& )or in a&vance, the" 'oul& re4uire the )uture &is urse$ent o) cash0 usiness has on han& or uses )or a relativel" long ti$e0 Further$ore, prepai& expenses are consi&ere& assets ecause the" have service potential0 Long-term assets are assets that a %xa$ples inclu&e propert", plant, an& e4uip$ent? long-ter$ invest$ents? an& intangi le assets0 &roperty, plant, an. equipment are assets 'ith use)ul lives o) $ore than one "ear? a co$pan" ac4uires the$ )or use in the usiness rather than )or resale0 (These assets are calle& propert" an& e4uip$ent in The #o$e <epotJs alance sheet0) The ter$s plant assets or )ixe& assets are also use& )or propert", plant, an& e4uip$ent0 To agree 'ith the or&er in the hea&ing, alance sheets generall" list propert" )irst, plant next, an& e4uip$ent last0 These ite$s are )ixe& assets ecause the co$pan" uses the$ )or long-ter$ purposes0 =e &escri e several t"pes o) propert", plant, an& e4uip$ent next0 Lan. is groun& the co$pan" uses )or usiness operations? this inclu&es groun& on 'hich the co$pan" locates its usiness uil&ings an& that is use& )or outsi&e storage space or par!ing0 Aan& o'ne& )or invest$ent is not a plant asset ecause it is a long-ter$ invest$ent0 Buil.ings are structures the co$pan" uses to carr" on its usiness0 Again, the uil&ings that a co$pan" o'ns as invest$ents are not plant assets0 300ice 0urniture inclu&es )ile ca inets, &es!s, chairs, an& shelves0 300ice equipment inclu&es co$puters, copiers, FAZ $achines, an& phone ans'ering $achines0 p. I1> o) *++ egins our &iscussion o)

Lease%ol. impro'ements are an" ph"sical alterations $a&e " the lessee to the lease& propert" 'hen these ene)its are expecte& to last e"on& the current accounting perio&0 An exa$ple is 'hen the lessee uil&s roo$ partitions in a lease& uil&ing0 (The lessee is the one o taining the rights to possess an& use the propert"0) Construction in progress represents the partiall" co$plete& stores or other uil&ings that a co$pan" such as The #o$e <epot plans to occup" 'hen co$plete&0 #ccumulate. .epreciation is a contra asset account to &eprecia le assets such as uil&ings, $achiner", an& e4uip$ent0 This account sho's the total &epreciation ta!en )or the &eprecia le assets0 On the alance sheet, co$panies &e&uct the accu$ulate& &epreciation (as a contra asset) )ro$ its relate& asset0 Long-term in'estments A long-term in'estment usuall" consists o) securities o) another co$pan" hel& 'ith the intention o) (1) o taining control o) another co$pan", (I) securing a per$anent source o) inco$e )or the investor, or (+) esta lishing )rien&l" ter$ purposes0 For $ost usiness relations0 The long-ter$ e stoc!s or on&s o) other invest$ent classi)ication in the alance sheet &oes not inclu&e those securities purchase& )or shortusinesses, long-ter$ invest$ents $a" corporations0 Occasionall", long-ter$ invest$ents inclu&e )un&s accu$ulate& )or speci)ic purposes, rental properties, an& plant sites )or )uture use0 1ntangible assets 1ntangible assets consist o) the noncurrent, non$onetar", nonph"sical assets o) a usiness0 Co$panies $ust charge the costs o) intangi le assets to expense over the perio& ene)ite&0 A$ong the intangi le assets are rights grante& " govern$ental o&ies, such as patents an& cop"rights0 Other intangi le assets inclu&e leasehol&s an& goo&'ill0 A patent is a right grante& " the )e&eral govern$ent? it gives the o'ner o) an invention the authorit" to $anu)acture a pro&uct or to use a process )or a speci)ie& ti$e0 A copyrig%t grante& " the )e&eral govern$ent gives the o'ner the exclusive privilege o) pu lishing 'ritten $aterial )or a speci)ie& ti$e0 Lease%ol.s are rights to use rente& properties, usuall" )or several "ears0 9oo.will is an intangi le value attache& to a usiness, evi&ence& " the a ilit" to earn larger net inco$e per &ollar o) invest$ent than that earne& " co$petitors in the sa$e in&ustr"0 The a ilit" to pro&uce superior pro)its is a valua le resource o) a usiness0 /or$all", co$panies recor& goo&'ill onl" at the ti$e o) purchase an& then onl" at the price pai& )or it0 The #o$e <epot has la ele& its goo&'ill Kcost in excess o) the )air value o) net assets ac4uire&K0 #ccumulate. amorti4ation is a contra asset account to intangi le assets0 This account sho's the total a$orti5ation ta!en on the intangi le assets0 p. IIB o) *++

Current liabilities are &e ts &ue 'ithin one "ear or one operating c"cle, 'hichever is longer0 The pa"$ent o) current lia ilities nor$all" re4uires the use o) current assets0 Balance sheets list current lia ilities in the or&er the" $ust e pai&? the sooner a lia ilit" $ust e pai&, the earlier it is liste&0 %xa$ples o) current lia ilities )ollo'0 #ccounts payable are a$ounts o'e& to suppliers )or goo&s or services purchase& on cre&it0 Accounts pa"a le are generall" &ue in +B or DB &a"s an& &o not ear interest0 6n the alance sheet, the accounts pa"a le a$ount is the su$ o) the in&ivi&ual accounts pa"a le to suppliers sho'n in a su si&iar" le&ger or )ile0 !otes payable are uncon&itional 'ritten pro$ises " the co$pan" to pa" a speci)ic su$ o) $one" at a certain )uture &ate0 The notes $a" arise )ro$ orro'ing $one" )ro$ a an!, )ro$ the purchase o) assets, or )ro$ the giving o) a note in settle$ent o) an account pa"a le0 2enerall", onl" notes pa"a le &ue in one "ear or less are inclu&e& as current lia ilities0 "alaries payable are a$ounts o'e& to e$plo"ees )or services ren&ere&0 The co$pan" has not pai& these salaries " the alance sheet &ate ecause the" are not &ue until later0 "ales taxes payable are the taxes a co$pan" has collecte& )ro$ custo$ers ut not "et re$itte& to the taxing authorit", usuall" the state0 Other accrue& expenses $ight inclu&e taxes 'ithhel& )ro$ e$plo"ees, inco$e taxes pa"a le, an& interest pa"a le0 $axes wit%%el. 0rom employees inclu&e )e&eral inco$e taxes, state inco$e taxes, an& social securit" taxes 'ithhel& )ro$ e$plo"eesJ pa"chec!s0 The co$pan" plans to pa" these a$ounts to the proper govern$ental agencies 'ithin a short perio&0 1ncome taxes payable are the taxes pai& to the state an& )e&eral govern$ents " a corporation on its inco$e0 1nterest payable is interest that the co$pan" has accu$ulate& on notes or on&s ut has not pai& " the alance sheet &ate ecause it is not &ue until later0 <i'i.en.s payable, or a$ounts the co$pan" has &eclare& pa"a le to stoc!hol&ers, represent a &istri ution o) inco$e0 ,ince the corporation has not pai& these &eclare& &ivi&en&s " the sheet &ate, the" are a lia ilit"0 6nearne. re'enues (revenues receive& in a&vance) result 'hen a co$pan" receives pa"$ent )or goo&s or services e)ore earning the revenue, such as pa"$ents )or su scriptions to a $aga5ine0 These unearne& revenues represent a lia ilit" to per)or$ the agree& services or other contractual re4uire$ents or to return the assets receive&0 Co$panies report an" current install$ent on long-ter$ &e t &ue 'ithin one "ear un&er current lia ilities0 The re$aining portion continues to e reporte& as a long-ter$ lia ilit"0 alance

p. II1 o) *++

Long-term liabilities are &e ts such as a $ortgage pa"a le an& on&s pa"a le that are not &ue )or $ore than one "ear0 Co$panies shoul& sho' $aturit" &ates in the alance sheet )or all long-ter$ lia ilities0 /or$all", the lia ilities 'ith the earliest &ue &ates are liste& )irst0 !otes payable 'ith $aturit" &ates at least one "ear e"on& the alance sheet &ate are long-ter$ lia ilities0 Bon.s payable are long-ter$ lia ilities an& are evi&ence& the alance sheet )or all $a3or long-ter$ lia ilities0 The &e)erre& inco$e taxes on The #o$e <epotJs alance sheet result )ro$ a &i))erence et'een inco$e tax expense in the accounting recor&s an& the inco$e tax pa"a le on the co$pan"Js tax return0 "tock%ol.ers7 equity sho's the o'nersJ interest in the usiness0 This interest is e4ual to the a$ount contri ute& plus the inco$e le)t in the usiness0 The ite$s un&er stoc!hol&ersJ e4uit" in The #o$e <epotJs alance sheet are pai&-in capital (inclu&ing co$$on stoc!) an& retaine& earnings0 &ai.-in capital sho's the capital pai& into the co$pan" as the o'nersJ invest$ent0 :etaine. earnings sho's the cu$ulative inco$e o) the co$pan" less the a$ounts &istri ute& to the o'ners in the )or$ o) &ivi&en&s0 Cu$ulative translation a&3ust$ents result )ro$ translating )oreign currencies into M, &ollars (a topic &iscusse& in a&vance& accounting courses)0 The unreali5e& loss on invest$ents is &iscusse& in Chapter 1*0 The next section sho's ho' t'o categories on the classi)ie& alance sheet relate to each other0 Together the" help reveal a co$pan"Js short-ter$ &e t-pa"ing a ilit"0 " )or$al printe& certi)icates so$eti$es secure& " liens (clai$s) on propert", such as $ortgages0 (aturit" &ates shoul& appear on

#.18 Anal -ing and using the financial results 9 the current ratio
The current ratio in&icates the short-ter$ &e t-pa"ing a ilit" o) a co$pan"0 To )in& the current ratio, 'e &ivi&e current assets " current lia ilities0 For instance, %xhi it ID sho's that The #o$e <epotJs current assets as o) IBB1 ;anuar" I8, 'ere M,< @,@@@,BBB,BBB an& its current lia ilities 'ere Current assets Current ratio = M,< *,+8C,BBB,BBB0 Thus, its current ratio 'as: Current liabilities ,S- 3"333"$$$"$$$ = 5.33 75 ,S- %"(62"$$$"$$$ The current ratio o) 10@@:1 )or The #o$e <epot $eans that it has al$ost t'ice as $an" current assets as current lia ilities0 Because current lia ilities are nor$all" pai& 'ith current assets, the co$pan" appears to e a le to pa" its short-ter$ o ligations easil"0 6n evaluating a co$pan"Js short-ter$ &e t-pa"ing a ilit", "ou shoul& also exa$ine the 4ualit" o) the current assets0 6) the" inclu&e large a$ounts o) uncollecta le accounts receiva le an&7or o solete

p. III o) *++

an& unsala le inventor", even a I:1 current ratio $a" e ina&e4uate to allo' the co$pan" to pa" its current lia ilities0 The #o$e <epot un&ou te&l" &oes not have such a pro le$0 The current assets, current lia ilities, an& current ratios o) so$e other co$panies as o) the thir& 4uarter o) IBB1 'ere:
Current Com1any Lal3*art Stores, .nc' Ae;lett3=ac6ard ,o!pan2 3* ,orporation General Electric ,o!pan2 1o0nson C 1o0nson Current A##et# $ 32,620,000,000 "5,792,000,000 6,556,000,000 3"3,050,000,000 "@,07@,000,000 Current $%a&%l%t%e# $ 32,96@,000,000 "3,@50,000,000 5,006,000,000 "69,799,000,000 7,504,000,000 Rat%o '@@:" "'"3:" "'3":" "'95:" 2'54:"

=e &escri e& each o) these co$panies earlier in the text0

As "ou can see )ro$ these co$parisons, the current ratios var" a great &eal0 An ol& rule o) thu$ is that the current ratio shoul& e at least I:10 #o'ever, 'hat constitutes an a&e4uate current ratio &epen&s on availa le lines o) cre&it, the cash-generating a ilit" o) the co$pan", an& the nature o) the in&ustr" in 'hich the co$pan" operates0 For instance, co$panies in the airline in&ustr" are a le to generate huge a$ounts o) cash on a &ail" asis an& $a" e a le to pa" their current lia ilities even i) their current ratio is less than 1:10 Co$paring a co$pan"Js current ratio 'ith other co$panies in the sa$e in&ustr" $a!es sense ecause all o) these co$panies )ace a out the sa$e econo$ic con&itions0 A co$pan" 'ith the lo'est current ratio in its in&ustr" $a" e una le to pa" its short-ter$ o ligations on a ti$el" asis, unless it can orro' )un&s )ro$ a an! on a line o) cre&it0 A co$pan" 'ith the highest current ratio in its in&ustr" $a" have on han& too $an" current assets, such as cash an& $ar!eta le securities, 'hich coul& e investe& in $ore pro&uctive assets0 The next chapter &escri es the assu$ptions, concepts, an& principles that constitute the accounting theor" un&erl"ing )inancial accounting0 Thus, accounting theor" &ictates the stan&ar&s an& proce&ures applie& to the reporting o) )inancial in)or$ation in the )inancial state$ents0

#.11 .nderstanding the learning objectives
 Anal"5e transactions " exa$ining source &ocu$ents0  ;ournali5e transactions in the 3ournal0  Post 3ournal entries to the accounts in the le&ger0  Prepare a trial alance o) the accounts an& co$plete the 'or! sheet0  Prepare )inancial state$ents0  ;ournali5e an& post a&3usting entries0  ;ournali5e an& post closing entries0  Prepare a post-closing trial alance0

p. II+ o) *++

 The 'or! sheet is a colu$nar sheet o) paper on 'hich accountants su$$ari5e in)or$ation

nee&e& to $a!e the a&3usting an& closing entries an& to prepare the )inancial state$ents0
 =or! sheets $a" var" in )or$at0 The 'or! sheet illustrate& in the chapter has 1I colu$nsL

t'o each )or trial alance, a&3ust$ents, a&3uste& trial alance, inco$e state$ent, state$ent o) retaine& earnings, an& alance sheet0
 The in)or$ation nee&e& to prepare the inco$e state$ent is in the 6nco$e ,tate$ent

colu$ns o) the 'or! sheet0 /et inco$e )or the perio& is the a$ount nee&e& to alance the t'o 6nco$e ,tate$ent colu$ns in the 'or! sheet0
 The in)or$ation nee&e& to prepare the state$ent o) retaine& earnings is in the ,tate$ent o)

:etaine& %arnings colu$ns o) the 'or! sheet0 The en&ing :etaine& %arnings alance is carrie& )or'ar& to the alance sheet0
 The in)or$ation nee&e& to prepare the alance sheet is in the Balance ,heet colu$ns o) the

'or! sheet0
 As explaine& in Chapter +, a&3usting entries are necessar" to ring the accounts to their

proper alances e)ore preparing the )inancial state$ents0 Closing entries are necessar" to re&uce the alances o) revenue, expense, an& <ivi&en&s accounts to 5ero so the" are rea&" to receive &ata )or the next accounting perio&0
 :evenue accounts are close& " &e iting the$ an& cre&iting the 6nco$e ,u$$ar" account0  %xpense accounts are close& " cre&iting the$ an& &e iting the 6nco$e ,u$$ar" account0  The alance in the 6nco$e ,u$$ar" account represents the net inco$e or net loss )or the

perio&0
 To close the 6nco$e ,u$$ar" account, the alance is trans)erre& to the :etaine& %arnings

account0
 To close the <ivi&en&s account, the alance is trans)erre& to the :etaine& %arnings account0  Onl" the alance sheet accounts have alances an& appear on the post-closing trial alance0  All revenue, expense, an& <ivi&en&s accounts have 5ero alances an& are not inclu&e& in the

post-closing trial alance0
 (anual s"ste$s an& co$puteri5e& s"ste$s per)or$ the sa$e accounting )unctions0  The ease o) accounting 'ith a PC has encourage& even s$all co$panies to convert to

co$puteri5e& s"ste$s0
 A classi)ie& alance sheet su &ivi&es the $a3or categories on the alance sheet0 For instance,

a classi)ie& alance sheet su &ivi&es assets into current assets? long-ter$ invest$ents? propert", plant, an& e4uip$ent? an& intangi le assets0 6t su &ivi&es lia ilities into current p. II* o) *++

lia ilities an& long-ter$ lia ilities0 Aater chapters sho' $ore accounts in the stoc!hol&ersJ e4uit" section, ut the su &ivisions re$ain asicall" the sa$e0
 The current ratio gives so$e in&ication o) the short-ter$ &e t-pa"ing a ilit" o) a co$pan"0  To )in& the current ratio, &ivi&e current assets " current lia ilities0

#.11.1

Demonstration problem
alance )or 2reen #ills

This pro le$ involves using a 'or! sheet )or 2reen #ills :i&ing ,ta le, 6ncorporate&, )or the $onth en&e& IB1B ;ul" +1, an& per)or$ing the closing process0 The trial :i&ing ,ta le, 6ncorporate&, as o) IB1B ;ul" +1, 'as as )ollo's:
8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: Tr%al !alance 2010 July 1 Account T%tle ,as0 :e&%t# $ "0,700 Cred%t#

Acct. No. "00

"03 "30 "40 200 20" 300 3"0 320 402 404 507 5"3 540 569

$ccounts Receiva5le 4and &uildin)s $ccounts =a2a5le otes =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1ul2 " :ividends Aorse &oardin) /ees Revenue Ridin) 4esson /ees Revenue Salaries Expense /eed Expense .nterest Expense *iscellaneous Expense

9,"00 40,000 24,000 $ ","00 40,000 35,000 3,"00 ",000 4,500 3,600 ",400 ","00 200 900 $ 97,300
E97,300

<epreciation expense )or the $onth is M,< IBB0 Accrue& salaries on ;ul" +1 are M,< +BB0 a0 Prepare a 1I-colu$n 'or! sheet )or the $onth en&e& IB1B ;ul" +10 0 ;ournali5e the a&3usting entries0 c0 ;ournali5e the closing entries0

#.11.2

6olution to demonstration problem

a0 ,ee the 'or! sheet elo'0

p. IIC o) *++

8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE Dor' Sheet For the Month Ended 2010 July 31 Acct. Account T%tle# No. 100 103 130 140 200 201 300 310 320 402 404 507 513 540 563 520 141 Cash Accounts Receivable 2and 3uildin*s Accounts !a&able 4otes !a&able Capital Stoc% Retained )a"nin*s 20"0 5ul& 1 +ividends Ho"se 3oa"din* (ees Revenue Ridin* and 2esson (ees Revenue Sala"ies )/pense (eed )/pense #nte"est )/pense 6iscellaneous )/pense +ep"eciation )/pense -3uildin*s Accu,ulated +ep"eciation. 3uildin*s Sala"ies !a&able )00 4et #nco,e Retained )a"nin*s, 2010 5ul& 31 Ad7ust,ents8 4%5 To record depreciation o( 5uildin) *or 1ul2' 425 To record accrued salaries o( $300' Tr%al !alance :e&%t 10,700 S,100 40,000 24,000 Cred%t AdIu#tment# :e&%t Cred%t AdIu#ted !alance :e&%t 10,700 3,100 40,000 24,000 Cred%t Income Statement :e&%t Cred%t Statement o* Reta%ned Earn%n+# :e&%t Cred%t !alance Sheet :e&%t 10,700 8,100 40,000 24,000 Cred%t

1,100 40,000 35,000 3,100 4,500 3,500

1,100 40,0 0 0 35,000 3,100 1,000 4,500 3,600 4,500 3,600 1,700 1,100 200 S00 200

1,100 40,000 35,000

3,100

1,000

1,000

1,400 1,100 200 300 87,300 37,300

(2) 300

1,700 1,100 200 S00 200

(1) 200 (1) 200 (2) 300 5oo

200 300 87,500 37,300 4,000 4,100 8,100 8,100 8,100 1,000 6,200 7,200 4,100 7,200 7,200

200 300

206

82,300 76,600 6,200 S2,S00 32,800

0

p. IID o) *++

8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: 8eneral Journal

.a+e
.o#t. Re*. :e&t Cred%t

;
:ate 201 0 July Account T%tle# and E01lanat%on
AdIu#t%n+ Entr%e#

:e1redat%on E01en#eG <20 1 !u%ld%n+# 4-SE5 Accumulated :e1rec%at%onG 1;1 !u%ld%n+# 4-A5 To record de1rec%at%on e01en#e. Salar%e# E01en#e 4-SE5 Salar%e# .aya&le 43$5 To record accrued #alar%e#. <0B 20=

2 0 0 2 0 0

1

0 0 0 0

c0
8REEN 9I$$S RI:IN8 STA!$E" INCOR.ORATE: 8eneral Journal :ate Account T%tle# and E01lanat%on Clo#%n+ Entr%e# .o#t. :e&t .a+e ; Cred%t

Re*. ;02 ;0; =00

2010 July

1 9or#e !oard%n+ Fee# Re2enue R%d%n+ $e##on Fee# Re2enue Income Summary To clo#e re2enue account#. 1 Income Summary Salar%e# E01en#e Feed E01en#e Intere#t E01en#e M%#cellaneou# E01en#e :e1rec%at%on E01en#eG!u%ld%n+# To clo#e e01en#e account#. 1 Income Summary Reta%ned Earn%n+# To clo#e Income Summary account. 1 Reta%ned Earn%n+# :%2%dend# To clo#e d%2%dend# account.

; < 0 0 = 0 0 A 1 0 0

=00 <0B <1 <;0 <=A <20

; 0 0 0 1 B 0 0 1 1 0 0 2 0 0 A 0 0 2 0 0

=00 10

; 1 0 0 ; 1 0 0

10 20

1 0 0 0 1 0 0 0

p. II@ o) *++

#.11.3

;e termsJ

#ccounting cycle ,eries o) steps per)or$e& &uring the accounting perio& to anal"5e, recor&, classi)", su$$ari5e, an& report use)ul )inancial in)or$ation )or the purpose o) preparing )inancial state$ents0 The steps inclu&e anal"5ing transactions, 3ournali5ing transactions, posting 3ournal entries, ta!ing a trial alance an& co$pleting the 'or! sheet, preparing )inancial state$ents, 3ournali5ing an& posting a&3usting entries, 3ournali5ing an& posting closing entries, an& ta!ing a post-closing trial alance0 #ccounting system A set o) recor&s an& the proce&ures an& e4uip$ent use& to per)or$ accounting )unctions0 #ccounts payable A$ounts o'e& to suppliers )or goo&s or services purchase& on cre&it0 #ccounts recei'able A$ounts &ue )ro$ custo$ers )or services per)or$e& or $erchan&ise sol& on cre&it0 #ccumulate. amorti4ation A contra account to intangi le assets0 #ccumulate. .epreciation A contra account to &eprecia le assets such as uil&ings, $achiner", an& e4uip$ent0 Bon.s payable =ritten pro$ises to pa" a &e)inite su$ at a certain &ate as evi&ence& " )or$al printe& certi)icates that are so$eti$es secure& " liens on propert", such as $ortgages0 Buil.ings ,tructures use& to carr" on the usiness0 Cas% 6nclu&es &eposits in an!s availa le )or current operations at the alance sheet &ate plus cash on han& consisting o) currenc", un&eposite& chec!s, &ra)ts, an& $one" or&ers0 Cas% equi'alents #ighl" li4ui&, short-ter$ invest$ents ac4uire& 'ith te$poraril" i&le cash0 Classi0ie. balance s%eet ,u &ivi&es the three $a3or alance sheet categories (assets, lia ilities, an& stoc!hol&ersJ e4uit") to provi&e $ore in)or$ation )or users o) )inancial state$ents0 Assets $a" e &ivi&e& into current assets? long-ter$ invest$ents? propert", plant, an& e4uip$ent? an& intangi le assets0 Aia ilities $a" e &ivi&e& into current lia ilities an& longter$ lia ilities0 Closing process The act o) trans)erring the alances in the revenue an& expense accounts to a clearing account calle& 6nco$e ,u$$ar" an& then to the :etaine& %arnings account0 The alance in the <ivi&en&s account is also trans)erre& to the :etaine& %arnings account0 Construction in progress :epresents the partiall" co$plete& stores or other uil&ings that a co$pan" plans to occup" 'hen co$plete&0 Copyrig%t 2rants the o'ner the exclusive privilege o) pu lication o) 'ritten $aterial )or a speci)ic ti$e0 Current assets Cash an& other assets that a usiness can convert into cash or use up in one "ear or one operating c"cle, 'hichever is longer0 Current liabilities <e ts &ue 'ithin one "ear or one operating c"cle, 'hichever is longer0 The pa"$ent o) current lia ilities nor$all" re4uires the use o) current assets0 Current ratio Calculate& " &ivi&ing current assets " current lia ilities0 <i'i.en.s payable A$ounts &eclare& pa"a le to stoc!hol&ers an& that represent a &istri ution o) inco$e0 9oo.will An intangi le value attache& to a usiness, evi&ence& " the a ilit" to earn larger net inco$e per &ollar o) invest$ent than that earne& " co$petitors in the sa$e in&ustr"0 1ncome "ummary account A clearing account use& onl" at the en& o) an accounting perio& to su$$ari5e revenues an& expenses )or the perio&0 p. II8 o) *++

1ncome taxes payable Are the taxes pa"a le to the state an& )e&eral govern$ents " a corporation ase& on its inco$e0 1ntangible assets /oncurrent, non$onetar", nonph"sical assets o) a usiness0 1nterest payable 6nterest that has accu$ulate& on &e ts, such as notes or on&s0 This accrue& interest has not een pai& at the alance sheet &ate ecause it is not &ue until later0 1nterest recei'able Arises 'hen interest has een earne& ut not collecte& at the alance sheet &ate0 Lan. 2roun& the co$pan" uses )or usiness operations0 Aan& coul& inclu&e groun& on 'hich the co$pan" locates its usiness uil&ings an& that use& )or outsi&e storage space or a par!ing lot0 Lease%ol. impro'ements Are an" ph"sical alterations $a&e " the lessee to the lease& propert" 'hen these ene)its are expecte& to last e"on& the current accounting perio&0 Lease%ol.s :ights to use rente& properties0 Long-term assets Assets that are on han& or use& " a usiness )or a relativel" long ti$e0 %xa$ples inclu&e long-ter$ invest$ents? propert", plant, an& e4uip$ent? an& intangi le assets0 Long-term in'estment Msuall" securities o) another co$pan" hel& 'ith the intention o) (1) o taining control o) another co$pan", (I) securing a per$anent source o) inco$e )or the investor, or (+) esta lishing )rien&l" usiness relations0 Long-term liabilities <e ts such as a $ortgage pa"a le an& on&s pa"a le that are not &ue )or $ore than one "ear0 8arketable securities Te$porar" invest$ents that a co$pan" $a!es to earn a return on i&le cash0 8erc%an.ise in'entory 2oo&s hel& )or sale0 !ote An uncon&itional 'ritten pro$ise to pa" to another part" the a$ount o'e& either 'hen &e$an&e& or at a certain &ate0 !otes payable Mncon&itional 'ritten pro$ises " a co$pan" to pa" a speci)ic su$ o) $one" at a certain )uture &ate0 300ice equipment 6nclu&es co$puters, copiers, FAZ $achines, an& phone ans'ering $achines0 300ice 0urniture 6nclu&es )ile ca inets, &es!s, chairs, an& shelves0 3perating cycle The ti$e it ta!es to start 'ith cash, u" necessar" ite$s to pro&uce revenues (such as $aterials, supplies, la or, an&7or inventories), sell services or goo&s, an& receive cash " collecting the resulting receiva les0 &ai.-in capital ,ho's the capital pai& into the co$pan" as the o'nersJ invest$ent0 &atent A right grante& " the )e&eral govern$ent authori5ing the o'ner o) an invention to $anu)acture a pro&uct or to use a process )or a speci)ic ti$e0 &ost-closing trial balance A trial alance ta!en a)ter the closing entries have een poste&0 &repai. expenses Assets a'aiting assign$ent to expense0 6te$s such as rent, insurance, an& supplies that have een pai& )or ut )ro$ 'hich all o) the ene)its have not "et een reali5e& (or consu$e&)0 Prepai& expenses are classi)ie& as current assets0 &roperty, plant, an. equipment Assets 'ith use)ul lives o) $ore than one "ear that a co$pan" ac4uire& )or use in a usiness rather than )or resale? also calle& plant assets or )ixe& assets0

p. II> o) *++

:etaine. earnings ,ho's the cu$ulative inco$e o) the co$pan" less the a$ounts &istri ute& to the o'ners in the )or$ o) &ivi&en&s0 "alaries payable A$ounts o'e& to e$plo"ees )or services ren&ere&0 "ales taxes payable Are taxes a co$pan" has collecte& )ro$ custo$ers ut has not re$itte& to the taxing authorit", usuall" the state0 "tock%ol.ers7 equity ,ho's the o'nersJ interest (e4uit") in the usiness0 $axes wit%%el. 0rom employees 6te$s such as )e&eral inco$e taxes, state inco$e taxes, an& social securit" taxes 'ithhel& )ro$ e$plo"eesJ pa"chec!s0 6nclassi0ie. balance s%eet A alance sheet sho'ing onl" three $a3or categories: assets, lia ilities, an& stoc!hol&ersJ e4uit"0 6nearne. re'enues (re'enues recei'e. in a.'ance) :esult 'hen pa"$ent is receive& )or goo&s or services e)ore revenue has een earne&0 Eork s%eet A colu$nar sheet o) paper on 'hich accountants have su$$ari5e& in)or$ation nee&e& to $a!e the a&3usting an& closing entries an& to prepare the )inancial state$ents0 G,o$e o) these ter$s have een &e)ine& in earlier chapters ut are inclu&e& here )or "our convenience0

#.11.! #.11.!.1
• • • • • •

6elf<test True<false

6n&icate 'hether each o) the )ollo'ing state$ents is true or )alse0 At the en& o) the accounting perio&, three trial alances are prepare&0 The a$ounts in the A&3ust$ents colu$ns are al'a"s a&&e& to the a$ounts in the Trial Balance colu$ns to &eter$ine the a$ounts in the A&3uste& Trial Balance colu$ns0 6) a net loss occurs, it appears in the 6nco$e ,tate$ent cre&it colu$n an& ,tate$ent o) :etaine& %arnings &e it colu$n0 A)ter the closing process is co$plete, no <ivi&en&s, or 6nco$e ,u$$ar" account0 The post-closing trial alance $a" contain revenue an& expense accounts0 All accounting s"ste$s currentl" in use are co$puteri5e&0 alance can exist in an" revenue, expense,

#.11.!.2
•

=ultiple<choice

,elect the est ans'er )or each o) the )ollo'ing 4uestions0 =hich o) the )ollo'ing accounts is least li!el" to e a&3uste& on the 'or! sheetQ o o o ,upplies on #an&0 Aan&0 Prepai& :ent0

p. I+B o) *++

o • o o o o • o o o o • o o o o • o o o o

Mnearne& <eliver" Fees0 2eneral 3ournal0 2eneral le&ger0 Aast six colu$ns o) the 'or! sheet0 First six colu$ns o) the 'or! sheet0 6nco$e ,tate$ent &e it colu$n o) the 'or! sheet0 ,tate$ent o) :etaine& %arnings cre&it colu$n o) the 'or! sheet0 ,tate$ent o) retaine& earnings0 Balance sheet0 The <ivi&en&s account is close& to 6nco$e ,u$$ar"0 The closing o) expense accounts results in a &e it to 6nco$e ,u$$ar"0 The closing o) revenues results in a cre&it to 6nco$e ,u$$ar"0 The 6nco$e ,u$$ar" account is close& to the :etaine& %arnings account0 Current assets inclu&e cash, accounts receiva le, an& e4uip$ent0 Plant, propert", an& e4uip$ent is one categor" o) long-ter$ assets0 Current lia ilities inclu&e accounts pa"a le, salaries pa"a le, an& notes receiva le0 ,toc!hol&ersJ e4uit" is su &ivi&e& into current an& long-ter$ categories0

6) the Balance ,heet colu$ns &o not alance, the error is $ost li!el" to exist in the:

/et inco$e )or a perio& appears in all ut 'hich one o) the )ollo'ingQ

=hich o) the )ollo'ing state$ents is )alse regar&ing the closing processQ

=hich o) the )ollo'ing state$ents is true regar&ing the classi)ie& alance sheetQ

/o' turn to FAns'ers to sel)-testH at the en& o) the chapter to chec! "our ans'ers0

#.11.!.3
 

>uestions

At 'hich stage o) the accounting c"cle is a 'or! sheet usuall" prepare&Q =h" are the )inancial state$ents prepare& e)ore the a&3usting an& closing entries are 3ournali5e& an& poste&Q <escri e the purposes )or 'hich the 'or! sheet is prepare&0 .ou have ta!en over a set o) accounting oo!s )or a s$all usiness as a part-ti$e 3o 0 At the en& o) the )irst accounting perio&, "ou have partiall" co$plete& the 'or! sheet " entering the proper le&ger accounts an& alances in the Trial Balance colu$ns0 .ou turn to the $anager an& as!, K=here is the list o) a&&itional in)or$ation 6 can use in entering p. I+1 o) *++

 

the a&3usting entriesQK The $anager in&icates there is no such list0 (6n all the text pro le$s "ou have &one, "ou have al'a"s een given this in)or$ation0) #o' 'oul& "ou o tain the in)or$ation )or this real-li)e situationQ =hat are the conse4uences o) not $a!ing all o) the re4uire& a&3ust$ents at the en& o) the accounting perio&Q


#o' are the a$ounts in the A&3uste& Trial Balance colu$ns o) a 'or! sheet &eter$ine&Q The 'or! sheet )or Bri&ges Co$pan" sho's net inco$e o) M,< *B,BBB0 The )ollo'ing )our a&3ust$ents 'ere ignore&:
   



,u scriptions Fees earne&, M,< 1,IBB0 <epreciation o) e4uip$ent, M,< *,BBB0 <epreciation o) uil&ing, M,< 1B,BBB0 ,alaries accrue&, M,< +,BBB0 =hat is the correct net inco$eQ



A)ter the A&3uste& Trial Balance colu$ns o) a 'or! sheet have een totale&, 'hich account alances are exten&e& to the 6nco$e ,tate$ent colu$ns, 'hich account alances are exten&e& to the ,tate$ent o) :etaine& %arnings colu$ns, an& 'hich account alances are exten&e& to the Balance ,heet colu$nsQ

 

#o' is the state$ent o) retaine& earnings prepare&Q =hat is the purpose o) closing entriesQ =hat accounts are not a))ecte& " closing entriesQ A co$pan" has net inco$e o) M,< CB,BBB )or the "ear0 6n 'hich colu$ns o) the 'or! sheet 'oul& net inco$e appearQ 6s it possi le to prepare $onthl" )inancial state$ents 'ithout 3ournali5ing an& posting a&3usting an& closing entriesQ #o'Q =hat is the purpose o) a post-closing trial alanceQ <escri e so$e o) the 'a"s in 'hich the $anual accounting s"ste$ has evolve&0 =hen &i& co$puteri5e& accounting s"ste$s co$e into useQ <e)ine an accounting s"ste$0 #o' is a classi)ie& alance sheet &i))erent than an unclassi)ie& alance sheetQ :eal worl. question :e)er to KA roa&er perspective: ,!ills )or the long haulK to ans'er the )ollo'ing true-)alse 4uestions:
 





     

The sa$e s!ills are nee&e& at each level in a CPA )ir$0 The t'o $ost i$portant traits at the sta)) accountant level are a positive attitu&e an& the a ilit" to learn 4uic!l" 'hile a&apting to un)a$iliar situations0 p. I+I o) *++

 

The senior accountant nee&s $anage$ent s!ills in a&&ition to technical s!ills0 Partners eco$e increasingl" involve& in technical $atters an& have less an& less interaction 'ith people0



:eal worl. question :e)erring to the Annual report appen&ix in "our text, i&enti)" the classi)ications (or categories) o) assets use& " The Ai$ite& in its alance sheet0 :eal worl. question :e)erring to the Annual report appen&ix in "our text, i&enti)" the classi)ications (or categories) o) lia ilities use& " The Ai$ite& in its alance sheet0



#.11.!.!

E,ercises

-xercise # Aist the steps in the accounting c"cle0 =oul& the s"ste$ still 'or! i) an" o) the steps 'ere per)or$e& out o) or&erQ -xercise B Three o) the $a3or colu$n hea&ings on a 'or! sheet are Trial Balance, 6nco$e ,tate$ent, an& Balance ,heet0 <eter$ine un&er 'hich $a3or colu$n hea&ings each o) the )ollo'ing ite$s 'oul& appear an& 'hether it 'oul& e a &e it or cre&it0 (For exa$ple, Cash 'oul& appear on the &e it si&e o) the Trial Balance an& Balance ,heet colu$ns0)
Statement o* Reta%ned Earn%n+# :e&%t Cred%t

a. &. c. d. e. *. +. h.

Account T%tle# Accounts Receivable Accounts !a&able #nte"est Revenue Adve"tisin* )/pense Capital Stoc% Retained )a"nin*s 93e*:; 4et inco,e <o" the ,onth Retained )a"nin*s 9)nd;

Tr%al !alance :e&%t

Cred%t

Income Statement :e&%t Cred%t

!alance Sheet :e&%t

Cred%t

-xercise C Assu$e a eginning alance in :etaine& %arnings o) M,< 8*,BBB an& net inco$e )or the "ear o) M,< +D,BBB0 6llustrate ho' these 'oul& appear in the ,tate$ent o) :etaine& %arnings colu$ns an& Balance ,heet colu$ns in the 'or! sheet0 -xercise < 6n the previous exercise, i) there 'as a &e it alance o) M,< I1D,BBB in the :etaine& %arnings account as o) the eginning o) the "ear an& a net loss o) M,< 1>I,BBB )or the "ear, sho' ho' these 'oul& e treate& in the 'or! sheet0

p. I++ o) *++

-xercise - <a$on <avis 'as preparing the 'or! sheet )or <rano Plu$ ing Co$pan"0 #e calculate& the net inco$e to e M,< CB,BBB0 =hen he totale& the Balance ,heet colu$ns, the colu$n totals 'ere &e it, M,< *BB,BBB? an& cre&it, M,< +BB,BBB0 =hat 'as the pro a le cause o) this &i))erenceQ 6) this 'as not the cause, 'hat shoul& he &o to )in& the errorQ -xercise F The Trial Balance o) the Printer :epair Co$pan" at IB1B <ece$ er +1, contains the )ollo'ing account alances liste& in alpha etical or&er to increase "our s!ill in sorting a$ounts to the proper 'or! sheet colu$ns0
.r%nter Re1a%r Com1any
Tr%al !alance Account !alance# 2010 :ecem&er 1

$ccounts =a2a5le $ccounts Receiva5le $ccu!ulated :epreciationM&uildin)s $ccu!ulated :epreciationME7uip!ent &uildin)s ,apital Stoc6 ,as0 E7uip!ent =repaid .nsurance Retained Earnin)s, 20"0 1anuar2 " Salaries Expense Service Revenue Supplies on Aand -tilities Expense

$ 4",000 @2,000 25,000 @,000 "40,000 65,000 60,000 36,000 3,600 4,900 @6,000 2@0,000 4,000 3,200

Msing these account alances an& the )ollo'ing a&&itional in)or$ation, prepare a 'or! sheet )or Printer :epair Co$pan"0 Arrange the accounts in their approxi$ate usual or&er0
 ,upplies on han& at IB1B <ece$ er +1, have a cost o) M,< I,*BB0  The alance in the Prepai& 6nsurance account represents the cost o) a t'o-"ear insurance

polic" covering the perio& )ro$ IB1B ;anuar" 1, through IB11 <ece$ er +10
 The esti$ate& lives o) &eprecia le assets are uil&ings, *B "ears, an& e4uip$ent, IB "ears0

/o salvage values are anticipate&0 -xercise 9 Tex an Corporation ha& a IB1B ;anuar" 1, alance in its :etaine& %arnings account o) M,< >B,BBB0 For the "ear IB1B, net inco$e 'as M,< CB,BBB an& &ivi&en&s &eclare& an& pai& 'ere M,< I*,BBB0 Prepare a state$ent o) retaine& earnings )or the "ear en&e& IB1B <ece$ er +10 -xercise = :u ino Co$pan" reporte& net inco$e o) M,< 1BB,BBB )or the current "ear0 %xa$ination o) the 'or! sheet an& supporting &ata in&icates that the )ollo'ing ite$s 'ere ignore&: p. I+* o) *++

 Accrue& salaries 'ere M,< D,BBB at <ece$ er +10  <epreciation on e4uip$ent ac4uire& on ;ul" 1 a$ounte& to M,< *,BBB0

Base& on this in)or$ation, (a) 'hat a&3usting 3ournal entries shoul& have een $a&e at <ece$ er +1, an& ( ) 'hat is the correct net inco$eQ -xercise 1 :e)er to the 'or! sheet prepare& in the Printer :epair Co$pan" exercise0 Prepare the a&3usting an& closing 3ournal entries0 -xercise > The 6nco$e ,tate$ent colu$n totals on a 'or! sheet prepare& at IB1B <ece$ er +1, are &e it, M,< CBB,BBB? an& cre&it, M,< >BB,BBB0 6n T-account )or$at, sho' ho' the postings to the 6nco$e ,u$$ar" account 'oul& appear as a result o) the closing process0 6&enti)" 'hat each posting represents0 -xercise ? A)ter a&3ust$ent, these selecte& account alances o) Col& ,trea$ Ca$pgroun& are:
:e&%t# Retained earnin)s Rental revenue Salaries expense :epreciated expense N &uildin)s -tilities expense :ividends $336,000'00 64000 209000 32000 Cred%t# $540,000'00 @60000

6n T-account )or$at, sho' ho' 3ournal entries to close the oo!s )or the perio& 'oul& e poste&0 (.ou &o not nee& to sho' the closing 3ournal entries0) %nter these alances in the accounts e)ore &oing so0 Ne" the postings )ro$ the )irst closing entr" 'ith the nu$ er (1), the secon& 'ith the nu$ er (I), an& so on0

p. I+C o) *++

-xercise L The )ollo'ing account alances appeare& in the 6nco$e ,tate$ent colu$ns o) the 'or! sheet entries prepare& )or Aiu Co$pan" )or the "ear en&e& IB1B <ece$ er +1:
Account T%tle# Income Statement :e&%t Cred%t

Service Revenue $dvertisin) Expense Salaries Expense -tilities Expense .nsurance Expense Rent Expense Supplies Expense :epreciation ExpenseME7uip!ent .nterest Expense .nterest Revenue "49,552 et .nco!e "92,553 33","25 ",350 "30,000 2,250 @00 6,750 2,250 4,500 562

330,000

","25 33","25 33","25

Prepare the closing 3ournal entries0 -xercise 8 =hich o) the )ollo'ing accounts are li!el" to appear in the post-closing trial alance )or the Bla!e Co$pan"Q
 Accounts :eceiva le  Cash  ,ervice :evenue  Buil&ings  ,alaries %xpense  Capital ,toc!  <ivi&en&s  Accounts Pa"a le  6nco$e ,u$$ar"  Mnearne& ,u scription Fees

p. I+D o) *++

-xercise ! Msing the legen& at the right, &eter$ine the categor" (nu$ er) into 'hich "ou 'oul& place each o) these ite$s0
Item $e+end

a' 5' c' d' e' (' )' 0' i' <'

4and' *ar6eta5le securities' otes pa2a5le, due in t0ree 2ears' Taxes ;it00eld (ro! e!plo2ees' =atents' Retained earnin)s' -nearned su5scription (ees' &onds o( anot0er corporation #a 2032ear invest!ent%' otes pa2a5le, due in six !ont0s' $ccu!ulated depreciation'

"' 2' 3' 4' 5' 6' 7'

,urrent assets' 4on)3ter! invest!ents' =ropert2, plant, and e7uip!ent' .ntan)i5le assets' ,urrent lia5ilities' 4on)3ter! lia5ilities' Stoc60olders8 e7uit2'

-xercise 3 The )ollo'ing &ata are )ro$ the IBB1 annual report o) The Procter P 2a$ le Co$pan" an& its su si&iaries0 This co$pan" $ar!ets a roa& range o) laun&r", cleaning, paper, eaut" care, health care, )oo&, an& everage pro&ucts in $ore than 1*B countries aroun& the 'orl&0 Aea&ing ran&s inclu&e Ariel, Crest, Pa$pers, Pantene, Crisco, Gic!s, an& (ax Factor0 The &ollar a$ounts are in $illions0
June 0 2001 2000

,urrent assets ,urrent lia5ilities

$"0,99@ @,946

$"0,"46 "0,"4"

Calculate the current rations )or the t'o "ears0 Co$$ent on 'hether the tren& is )avora le or un)avora le0

p. I+@ o) *++

#.11.!.#

1roblems

&roblem # The )ollo'ing a&3uste& trial alance is )or ;asper Appliance :epair Co$pan":
JAS.ER A..$IANCE RE.AIR COM.AN@ AdIu#ted Tr%al !alance 2010 June 0 :e&%t# Cred%t#

,as0 $ccounts Receiva5le Truc6s $ccu!ulated :epreciationMTruc6s $ccounts =a2a5le otes =a2a5le ,apital Stoc6 Retained Earnin)s, 200@ 1ul2 " :ividends Service Revenue Rent Expense $dvertisin) Expense Salaries Expense Supplies Expense .nsurance Expense :epreciation ExpenseMTruc6s .nterest Expense *iscellaneous Expense

$ 63,000 42,000 ""0,000 $ 30,000 "0,900 20,000 50,000 5,500 "0,000 230,000 "2,000 5,000 @0,000 ",500 ",200 "0,000 ",000 600 $346,300 $346,300

Prepare the closing 3ournal entries at the en& o) the )iscal "ear, IB1B ;une +B0

p. I+8 o) *++

&roblem B The a&3uste& trial alance )or <enver Architects , 6nc0, )ollo's:
:EN>ER ARC9ITECTS" INC. AdIu#ted Tr%al !alance 2010 :ecem&er 1 :e&%t# Cred%t#

,as0 $ccounts Receiva5le .nterest Receiva5le otes Receiva5le =repaid .nsurance =repaid Rent Supplies on Aand E7uip!ent $ccu!ulated :epreciationME7uip!ent &uildin)s $ccu!ulated :epreciationM&uildin)s 4and $ccounts =a2a5le otes =a2a5le .nterest =a2a5le Salaries =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " :ividends Service Revenue .nsurance Expense Rent Expense $dvertisin) Expense :epreciation ExpenseME7uip!ent :epreciation ExpenseM&uildin)s Supplies Expense Salaries Expense .nterest Expense .nterest Revenue

$ @0,000 20,000 200 4,000 @60 2,400 600 60,000 $ "2,500 "40,000 "5,000 56,240 60,000 "0,000 750 7,000 "00,000 20,200 40,000 360,000 ",@20 @,600 ",200 2,500 3,000 2,290 "50,000 750 200 $ 595,650 $ 595,650

a0 Prepare an inco$e state$ent0 0 Prepare a state$ent o) retaine& earnings0 c0 Prepare a classi)ie& alance sheet0 &0 Prepare the closing 3ournal entries0 e0 ,ho' the post-closing trial alance assu$ing "ou ha& poste& the closing entries to the general le&ger0

p. I+> o) *++

&roblem C The )ollo'ing trial alance an& a&&itional &ata are )or ,ure ,ale :ealit" Co$pan"
SURE SA$E REA$T@ COM.AN@ Tr%al !alance 2010 :ecem&er 1 :e&%t# Cred%t#

,as0 $ccounts Receiva5le =repaid Rent E7uip!ent $ccu!ulated :epreciationME7uip!ent $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " :ividends ,o!!issions Revenue Salaries Expense Travel Expense *iscellaneous Expense

$ 62,900 ""7,"20 46,090 "73,760 $ 2","20 62,400 @6,000 4@,@20 46,090 653,200 32",600 @6,490 "9,720 $ 992,640 $ 992,640

The prepai& rent is )or the perio& IB1B ;ul" 1, to IB11 ;une +B0 The e4uip$ent has an expecte& li)e o) 1B "ears 'ith no salvage value0 Accrue& salaries are M,< 11,CIB0 Travel expenses accrue& ut unrei$ urse& to sales sta)) at <ece$ er +1 'ere M,< 1@,I8B a0 Prepare a 1I-colu$n 'or! sheet )or the "ear en&e& IB1B <ece$ er +10 .ou nee& not inclu&e account nu$ ers or explanations o) a&3ust$ents0 0 Prepare a&3usting 3ournal entries0 c0 Prepare closing 3ournal entries0

p. I*B o) *++

&roblem < The )ollo'ing trial alance an& a&&itional &ata are )or ,outh ,ea Tours, 6nc0:
SOUT9 SEA TOURS" INC. Tr%al !alance 2010 :ecem&er 1 :e&%t# Cred%t#

,as0 $ccounts Receiva5le =repaid .nsurance =repaid $dvertisin) otes Receiva5le 4and &uildin)s $ccu!ulated :epreciationM&uildin)s +((ice E7uip!ent $ccu!ulated :epreciationM+((ice E7uip!ent $ccounts =a2a5le otes =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " :ividends Service Revenue Salaries Expense Travel Expense .nterest Revenue .nterest Expense

$ "0@,050 "33,750 4,350 "9,000 "",250 @0,000 "65,000 $ 4@,500 93,400 "6,690 56,950 75,000 240,000 47,920 30,000 369,350 @6,000 """,000 600 3,000 $ 954,900 $ 954,900

The co$pan" consistentl" )ollo'e& the polic" o) initiall" &e iting all prepai& ite$s to asset accounts0 The uil&ings have an expecte& li)e o) CB "ears 'ith no salvage value0 The o))ice e4uip$ent has an expecte& li)e o) 1B "ears 'ith no salvage value0 Accrue& interest on notes receiva le is M,< *CB0 Accrue& interest on the notes pa"a le is M,< 1,BBB0 Accrue& salaries are M,< I,1BB0 %xpire& prepai& insurance is M,< +,@CB0 %xpire& prepai& a&vertising is M,< 1D,CBB0

p. I*1 o) *++

a0 Prepare a 1I-colu$n 'or! sheet )or the "ear en&e& IB1B <ece$ er +10 .ou nee& not inclu&e account nu$ ers0 Brie)l" explain the entries in the A&3ust$ents colu$ns at the otto$ o) the 'or! sheet, as 'as &one in %xhi it IB0 0 Prepare the re4uire& closing entries0 &roblem - The )ollo'ing trial alance an& a&&itional &ata are )or Flori&a Ti$e-,hare Propert" (anage$ent Co$pan":
F$ORI:A TIME-S9ARE .RO.ERT@ MANA8EMENT COM.AN@ Tr%al !alance 2010 :ecem&er 1 :e&%t# Cred%t#

,as0 =repaid Rent =repaid .nsurance Supplies on Aand +((ice E7uip!ent $ccu!ulated :epreciationM+((ice E7uip!ent $uto!o5iles $ccu!ulated :epreciationM$uto!o5iles $ccounts =a2a5le -nearned *ana)e!ent /ees ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " :ividends ,o!!issions Revenue *ana)e!ent /ee Revenue Salaries Expense $dvertisin) Expense Gas and +il Expense *iscellaneous Expense

$ 424,000 29,900 7,690 2,400 24,000 $ 5,760 64,000 "6,000 2,990 "2,490 360,000 "20,640 29,000 260,000 "@,200 "@@,940 2,400 "4,240 ",600 $ 7@6,@60 $ 7@6,@60

6nsurance expense )or the "ear, M,< +,8*B0 :ent expense )or the "ear, M,< 1>,IBB0 <epreciation expense: o))ice e4uip$ent, M,< I,88B? an& auto$o iles, M,< 1I,8BB0 ,alaries earne& ut unpai& at <ece$ er +1, M,< ID,D*B0 ,upplies on han& at <ece$ er +1, M,< 1,BBB0 The unearne& $anage$ent )ees 'ere receive& an& recor&e& on IB1B /ove$ er 10 The a&vance pa"$ent covere& six $onthsJ $anage$ent o) an apart$ent uil&ing0

p. I*I o) *++

a0 Prepare a 1I-colu$n 'or! sheet )or the "ear en&e& IB1B <ece$ er +10 .ou nee& not inclu&e account nu$ ers or explanations o) a&3ust$ents0 0 Prepare an inco$e state$ent0 c0 Prepare a state$ent o) retaine& earnings0 &0 Prepare a classi)ie& alance sheet0 e0 Prepare a&3usting an& closing entries0

#.11.!.$

Alternate problems
:REAM 9OME REA$T@ COM.AN@ AdIu#ted Tr%al !alance 2010 June 0 :e&%t# Cred%t#

#lternate problem # The )ollo'ing a&3uste& trial alance is )or <rea$ #o$e :ealt" Co$pan":

,as0 $ccounts Receiva5le +((ice E7uip!ent $ccu!ulated :epreciationM+((ice E7uip!ent $uto!o5iles $ccu!ulated :epreciationM$uto!o5iles $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s, 200@ 1ul2 " :ividends ,o!!issions Revenue Salaries Expense ,o!!issions Expense Gas and +il Expense Rent Expense Supplies Expense -tilities Expense :epreciation ExpenseM+((ice E7uip!ent :epreciation ExpenseM$uto!o5iles $

$ @9,000 40,000 35,000 $ "4,000 40,000 20,000 63,000 75,000 54,700 5,000 "70,000 25,000 "20,000 4,000 "4,900 ",400 2,000 3,500 9,000 3@6,700 $ 3@6,700

Prepare the closing 3ournal entries at the en& o) the )iscal "ear, IB1B ;une +B0

p. I*+ o) *++

#lternate problem B The a&3uste& trial alance )or Penro& 6nsurance Consultants, 6nc0, )ollo's:
.enrod In#urance Con#ultant#" Inc. AdIu#ted Tr%al !alance 2010 :ecem&er 1

:e&%t#

Cred%t#

,as0 $ccounts Receiva5le .nterest Receiva5le otes Receiva5le =repaid .nsurance Supplies on Aand 4and &uildin)s $ccu!ulated :epreciationM&uildin)s +((ice E7uip!ent $ccu!ulated :epreciationM+((ice E7uip!ent $ccounts =a2a5le Salaries =a2a5le .nterest =a2a5le otes =a2a5le #due 20""% ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " :ividends ,o!!issions Revenue $dvertisin) Expense ,o!!issions Expense Travel Expense :epreciation ExpenseM&uildin)s Salaries Expense :epreciation ExpenseM+((ice E7uip!ent Supplies Expense .nsurance Expense Repairs Expense -tilities Expense .nterest Expense .nterest Revenue

$ "07,200 69,000 400 20,000 2,400 ",900 32,000 "@0,000 $ 40,000 29,000 9,000 49,000 9,500 @00 64,000 "20,000 42,900 40,000 3@2,520 24,000 75,440 "2,990 9,500 @9,400 2,900 3,900 3,600 ",@00 3,400 ",900 ",600 $ 726,320 $ 726,320

a0 Prepare an inco$e state$ent )or the "ear en&e& IB1B <ece$ er +10 0 Prepare a state$ent o) retaine& earnings0 c0 Prepare a classi)ie& alance sheet0

p. I** o) *++

&0 Prepare the closing 3ournal entries0 e0 ,ho' the post-closing trial alance assu$ing "ou ha& poste& the closing entries to the general le&ger0 #lternate problem C The )ollo'ing trial Processing Co$pan":
RAMON :ATA .ROCESSIN8 COM.AN@ Tr%al !alance 2010 :ecem&er 1 :e&%t# Cred%t#

alance an& a&&itional &ata are )or :a$on <ata

,as0 $ccounts Receiva5le =repaid Rent =repaid .nsurance E7uip!ent $ccu!ulated :epreciationME7uip!ent $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " :ividends Service Revenue ,o!!issions Expense Travel Expense *iscellaneous Expense

$ 76,000 @9,000 7,200 2,400 90,000 $ 40,000 30,000 "00,000 65,600 24,000 370,000 270,000 36,000 "2,000 $ 605,600 $ 605,600

The prepai& rent is )or the perio& IB1B ;anuar" 1, to IB11 <ece$ er +10 The e4uip$ent is expecte& to last 1B "ears 'ith no salvage value0 The prepai& insurance 'as )or the perio& IB1B April 1, to IB11 (arch +10 Accrue& co$$issions pa"a le total M,< +,BBB at <ece$ er +10 a0 Prepare a 1I-colu$n 'or! sheet )or the "ear en&e& IB1B <ece$ er +10 .ou nee& not inclu&e account nu$ ers or explanations o) a&3ust$ents0 0 Prepare the a&3usting 3ournal entries0 c0 Prepare the closing 3ournal entries0

p. I*C o) *++

#lternate problem < The )ollo'ing trial alance an& a&&itional &ata are )or Best-Frien& Pet #ospital, 6nc0
!EST-FRIEN: .ET 9OS.ITA$" INC. Tr%al !alance 2010 :ecem&er 1 :e&%t# Cred%t#

,as0 $ccounts Receiva5le Supplies on Aand =repaid /ire .nsurance =repaid Rent E7uip!ent $ccu!ulated :epreciation ME7uip!ent $ccounts =a2a5le otes =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " Service Revenue .nterest Expense Salaries Expense $dvertisin) Expense Supplies Expense *iscellaneous Expense 4e)al and $ccountin) Expense -tilities Expense

$

"6,4@0 54,3@0 @00 ",900 2",600 "25,000 $ 25,000 2@,550 @,000 "50,000 20,695 "7@,0"0 225 "42,200 2@,250 2,"35 3,705 "3,750 ",900

$

4"3,245

$ 4"3,245

The co$pan" consistentl" )ollo'e& the polic" o) initiall" &e iting all prepai& ite$s to asset accounts0 Prepai& )ire insurance is M,< DBB as o) the en& o) the "ear0 ,upplies on han& are M,< D+8 as o) the en& o) the "ear0 Prepai& rent is M,< I,DIC as o) the en& o) the "ear0 The e4uip$ent is expecte& to last 1B "ears 'ith no salvage value0 Accrue& salaries are M,< I,DIC0 a0 Prepare a 1I-colu$n 'or! sheet )or the "ear en&e& IB1B <ece$ er +10 .ou nee& not inclu&e account nu$ ers0 Brie)l" explain the entries in the A&3ust$ents colu$ns at the otto$ o) the 'or! sheet, as 'as &one in %xhi it IB0 0 Prepare the IB1B <ece$ er +1, closing entries0

p. I*D o) *++

#lternate problem - The )ollo'ing trial alance an& a&&itional &ata are )or :os'ell 6nterior <ecorators, 6nc0:
ROSDE$$ INTERIOR :ECORATORS" INC Tr%al !alance 2010 :ecem&er 1 :e&%t# Cred%t#

,as0 $ccounts Receiva5le Supplies on Aand =repaid Rent =repaid $dvertisin) =repaid .nsurance +((ice E7uip!ent $ccu!ulated :epreciationM+((ice E7uip!ent +((ice /urniture $ccu!ulated :epreciationM+((ice /urniture $ccounts =a2a5le otes =a2a5le #due 20""% ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " :ividends Service Revenue Salaries Expense -tilities Expense *iscellaneous Expense

$ 95,400 9",600 4,000 "2,240 2,990 4,400 7,600 $ 2,760 2@,200 9,290 25,200 4,000 "00,000 22,400 45,520 250,000 @9,900 20,000 24,000 $ 4"2,640 $ 4"2,640

,upplies on han& at IB1B <ece$ er +1, are M,< 1,BBB0 :ent expense )or IB1B is M,< 1B,BBB0 A&vertising expense )or IB1B is M,< I,+B*0 6nsurance expense )or IB1B is M,< I,*BB0 <epreciation expense is o))ice e4uip$ent, M,< >1I, an& o))ice )urniture, M,< +,BBB0 Accrue& interest on notes pa"a le is M,< 1CB0 Accrue& salaries are M,< *,IBB0 a0 Prepare a 1I-colu$n 'or! sheet )or the "ear en&e& IB1B <ece$ er +10 .ou nee& not inclu&e account nu$ ers or explanations o) a&3ust$ents0 0 Prepare an inco$e state$ent0 c0 Prepare a state$ent o) retaine& earnings0 &0 Prepare a classi)ie& alance sheet0 p. I*@ o) *++

e0 Prepare a&3usting an& closing entries0

#.11.!.%

0e ond the numbers9Critical thin&ing

Business .ecision case # #eather an& <an #olt $et 'hile oth 'ere e$plo"e& in the interior tri$ an& upholster" &epart$ent o) an auto $anu)acturer0 A)ter their $arriage, the" &eci&e& to earn so$e extra inco$e " &oing s$all 3o s involving canvas, vin"l, an& upholstere& pro&ucts0 Their 'or! 'as consi&ere& excellent, an& at the urging o) their custo$ers, the" &eci&e& to go into usiness )or the$selves, operating out o) the ase$ent o) the house the" o'ne&0 To &o this, the" investe& M,< 1IB,BBB cash in their usiness0 The" spent M,< 1B,CBB )or a se'ing $achine (expecte& li)e, 1B "ears) an& M,< 1I,BBB )or other $iscellaneous tools an& e4uip$ent (expecte& li)e, C "ears)0 The" un&ertoo! onl" custo$ 'or!, 'ith the custo$ers purchasing the re4uire& $aterials, to avoi& stoc!ing an" inventor" other than supplies0 2enerall", the" re4uire& an a&vance &eposit on all 3o s0 The usiness see$e& success)ul )ro$ the start, as the #olts receive& or&ers )ro$ $an" custo$ers0 But the" )elt so$ething 'as 'rong0 The" 'or!e& har& an& charge& co$petitive prices0 .et there see$e& to e arel" enough cash availa le )ro$ the usiness to cover i$$e&iate personal nee&s0 ,u$$ari5e&, the chec! oo! o) the usiness )or IB1B, their secon& "ear o) operations, sho'e&:
&alance, 20"0 1anuar2 " ,as0 received (ro! custo!ers: /or ;or6 done in 200@ /or ;or6 done in 20"0 /or ;or6 to 5e done in 20"" ,as0 paid out: T;o32ear insurance polic2 dated 20"0 1anuar2 " -tilities Supplies +t0er Expenses Taxes, includin) sales taxes :ividends &alance, 20"0 :ece!5er 3" $ "@,200 49,000 "04,000 72,000 26,400 40,000 $ 30@,600 73,600 $ 36,000 200,000 49,000 $ 294,000 393,200 $ @@,200

Consi&ering ho' $uch the" 'or!e&, the #olts 'ere concerne& that the cash alance &ecrease& " M,< IC,DBB even though the" onl" receive& &ivi&en&s o) M,< *B,BBB0 Their co$ ine& inco$e )ro$ the auto $anu)acturer ha& een M,< *C,BBB0 The" 'ere seriousl" consi&ering giving up their usiness an& going ac! to 'or! )or the auto $anu)acturer0 The" turne& to "ou )or a&vice0 .ou &iscovere& the )ollo'ing: p. I*8 o) *++

O) the supplies purchase& in IB1B, M,< I*,BBB 'ere use& on 3o s ille& to custo$ers in IB1B? no supplies 'ere use& )or an" other 'or!0 =or! co$plete& in IB1B an& ille& to custo$ers )or 'hich cash ha& not "et een receive& " "earen& a$ounte& to M,< *B,BBB0 Prepare a 'ritten report )or the #olts, respon&ing to their elie) that their usiness is not su))icientl" pro)ita le0 (#int: Prepare an inco$e state$ent )or IB1B an& inclu&e it in "our report0) #nnual report analysis B Msing the Annual report appen&ix, calculate the current ratios )or the t'o "ears sho'n )or The Ai$ite&, 6nc0 =rite a su$$ar" o) the results o) "our calculations0 Also, loo! at so$e o) the other &ata provi&e& " the co$pan" in preparing "our co$$ents0 For instance, loo! at the net inco$e )or the last three "ears0 Broa.er perspecti'e D Eriting experience C :ea& the KA roa&er perspective: ,!ills )or the long haulK0 =rite a &escription o) a career in pu lic accounting roa&er perspective at each level 'ithin the )ir$0 <iscuss the s!ills nee&e& an& ho' "ou coul& &evelop these s!ills0 9roup pro2ect < 6n tea$s o) t'o or three stu&ents, intervie' a $anage$ent accountant0 (anage$ent accountants $a" have the title o) chie) )inancial o))icer (CFO), controller, or so$e other accounting title 'ithin a co$pan"0 ,ee! in)or$ation on the a&vantages an& &isa&vantages o) 'or!ing as a $anage$ent accountant0 Also in4uire a out the nature o) the 'or! an& an" training progra$s o))ere& " the co$pan"0 As a tea$, 'rite a $e$oran&u$ to the instructor su$$ari5ing the results o) the intervie'0 The hea&ing o) the $e$oran&u$ shoul& contain the &ate, to 'ho$ it is 'ritten, )ro$ 'ho$, an& the su 3ect $atter0 9roup pro2ect - =ith a s$all group o) stu&ents, o tain an annual report o) a co$pan" in 'hich "ou have so$e interest0 .ou $a" o tain the annual report )ro$ "our instructor, the li rar", the 6nternet, or the co$pan"0 <escri e the nature o) each ite$ on the classi)ie& alance sheet0 .ou $a" have to &o li rar" research on so$e o) the ite$s0 Also, calculate the current ratio )or the $ost recent t'o "ears an& co$$ent0 =rite a report to "our instructor su$$ari5ing the results o) the pro3ect0 9roup pro2ect F =ith a s$all group o) stu&ents an& using li rar" sources, 'rite a paper co$paring the )eatures o) three &i))erent accounting so)t'are pac!ages (such as Peachtree Co$plete, Oui! oo!s Pro, <ac%as", (.OB Business %ssentials, /et,uite ,$all Businee an& Cougar (ountain )0 2ive the strengths an& 'ea!nesses o) each0 Cite sources )or the in)or$ation an& treat &irect 4uotes properl"0

#.11.!.'

.sing the (nternet9A vie+ of the real +orld

Gisit the )ollo'ing 6nternet site: p. I*> o) *++

http:77'''0$erc!0co$ Pursue choices "ou are o))ere& on the screen un&er 6nvestor :elations until "ou locate the $ost recent consoli&ate& alance sheet0 6n a short report to "our instructor, &escri e ho' "ou got to the alance sheet an& i&enti)" the $a3or hea&ings use& in the alance sheet0 For instance, the )irst such hea&ing is Assets0 Also, calculate the current ratio0 Gisit the )ollo'ing 6nternet site: http:77'''0!o&a!0co$ T"pe in KAnnual reportK in the search ox to locate the $ost recent annual report an& then )in& the consoli&ate& state$ent o) )inancial position0 6&enti)" the $a3or hea&ings 'ithin the alance sheet an& calculate the current ratio )or the $ost recent "ear0 =rite a $e$o to "our instructor su$$ari5ing "our )in&ings0

#.11.!.)
$rue-0alse

Ans+ers to self<test

$rue0 The three trial alances are the una&3uste& trial alance, the a&3uste& trial alance, an& the post-closing trial alance0 The )irst t'o trial alances appear on the 'or! sheet0 False0 6) a &e it- alance account (such as Prepai& :ent) is cre&ite& in the a&3ust$ent, the a$ount in the A&3ust$ents colu$ns is &e&ucte& )ro$ the a$ount in the Trial Balance colu$ns to &eter$ine the a$ount )or that ite$ in the A&3uste& Trial Balance colu$ns0 $rue0 The net loss appears in the 6nco$e ,tate$ent cre&it colu$n to ecause it re&uces :etaine& %arnings0 $rue0 All o) these accounts are close&, or re&uce& to 5ero process0 False0 All revenue an& expense accounts have 5ero alances a)ter closing0 False0 ,o$e $anual accounting s"ste$s are still in use0 8ultiple-c%oice b. The other accounts are ver" li!el" to e a&3uste&0 The Aan& account 'oul& e a&3uste& onl" i) an error has een $a&e involving that account0 c. The A&3uste& Trial Balance colu$ns shoul& alance e)ore ite$s are sprea& to the 6nco$e ,tate$ent, ,tate$ent o) :etaine& %arnings, an& Balance ,heet colu$ns0 There)ore, i) the Balance ,heet colu$ns &o not alance, the error is li!el" to exist in the last six colu$ns o) the 'or! sheet0 alances, as a result o) the closing alance the 6nco$e ,tate$ent colu$ns0 Then the loss appears in the ,tate$ent o) :etaine& %arnings &e it colu$n

p. ICB o) *++

.. The net inco$e )or the perio& &oes not appear in the alance sheet0 6t &oes appear in all o) the other places liste&0 a. The <ivi&en&s account is close& to the :etaine& %arnings account rather than to the 6nco$e ,u$$ar" account0 0 Plant, propert", an& e4uip$ent is one o) the long-ter$ asset categories0 :esponse (a) shoul& not inclu&e e4uip$ent0 :esponse (c) shoul& not inclu&e notes receiva le0 ,toc!hol&ersJ e4uit" is not su &ivi&e& into current an& long-ter$ categories0

#.11.!.18 Comprehensive revie+ problem
Aope5 <eliver" ,ervice Co$pan" has the )ollo'ing chart o) accounts:
Acct. No. "00 "03 "07 "09 ""2 "40 "4" "50 "5" 200 206 300 Account T%tle ,as0 $ccounts Receiva5le Supplies on Aand =repaid .nsurance =repaid Rent &uildin)s $ccu!ulated :epreciationM&uildin)s Truc6s $ccu!ulated :epreciationMTruc6s $ccounts =a2a5le Salaries =a2a5le ,apital Stoc6 Acct. No. 3"0 320 400 507 5"" 5"2 5"5 5"9 520 52" 569 600 Account T%tle Retained Earnin)s :ividends Service Revenue Salaries Expense -tilities Expense .nsurance Expense Rent Expense Supplies Expense :epreciation ExpenseM&uildin)s :epreciation ExpenseMTruc6s *iscellaneous Expense .nco!e Su!!ar2

The post-closing trial alance as o) IB1B (a" +1, 'as as )ollo's:
$O.EK :E$I>ER@ SER>ICE COM.AN@ .o#t-Clo#%n+ Tr%al !alance 2010 May 1 Acct. No. "00 Account T%tle ,as0 :e&%t# $ 90,000 Cred%t#

"03 "07 "09 ""2 "40 "4" "50 "5" 200 300 3"0

$ccounts Receiva5le Supplies on Aand =repaid .nsurance =repaid Rent &uildin)s $ccu!ulated :epreciation M&uildin)s Truc6s $ccu!ulated :epreciationMTruc6s $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s

30,000 "4,000 4,900 "2,000 320,000 $ 36,000 90,000 30,000 24,000 300,000 "50,900 $ 540,900 $ 540,900

p. IC1 o) *++

The transactions )or ;une IB1B 'ere as )ollo's: ;une 1 Per)or$e& &eliver" services )or custo$ers on account, M,< DB,BBB0 + Pai& &ivi&en&s, M,< 1B,BBB0 * Purchase& a M,< IB,BBB truc! on account0 @ Collecte& M,< II,BBB o) the accounts receiva le0 8 Pai& M,< 1D,BBB o) the accounts pa"a le0 11 Purchase& M,< *,BBB o) supplies on account0 The asset account )or supplies 'as &e ite&0 1@ Per)or$e& &eliver" services )or cash, M,< +I,BBB0 IB Pai& the utilities ills )or ;une, M,< 1,IBB0 I+ Pai& $iscellaneous expenses )or ;une, M,< DBB0 I8 Pai& salaries o) M,< I8,BBB )or ;une0
 <epreciation expense on the uil&ings )or ;une is M,< 8BB0  <epreciation expense on the truc!s )or ;une is M,< *BB0  Accrue& salaries at ;une +B are M,< *,BBB0  A ph"sical count sho'e& M,< 1I,BBB o) supplies on han& on ;une +B0  The prepai& insurance alance o) M,< *,8BB applies to a t'o-"ear perio& eginning IB1B ;une

10
 The prepai& rent o) M,< 1I,BBB applies to a one-"ear perio& eginning IB1B ;une 10  Per)or$e& M,< 1I,BBB o) &eliver" services )or custo$ers as o) ;une +B that 'ill not e ille& to

those custo$ers until ;ul"0 a0 Open three-colu$n le&ger accounts )or the accounts liste& in the chart o) accounts0 0 %nter the IB1B (a" +1, account alances in the accounts0 c0 ;ournali5e the transactions )or ;une IB1B0 &0 Post the ;une 3ournal entries an& inclu&e cross-re)erences (assu$e all 3ournal entries appear on page 1B o) the 3ournal)0 e0 Prepare a 1I-colu$n 'or! sheet as o) IB1B ;une +B0 )0 Prepare an inco$e state$ent, a state$ent o) retaine& earnings, an& a classi)ie& alance sheet0 g0 Prepare an& post the a&3usting entries (assu$e the" appear on page 11 o) the general 3ournal)0 h0 Prepare an& post the closing entries (assu$e the" appear on page 1I o) the general 3ournal)0

i0 Prepare a post-closing trial alance0

p. ICI o) *++

$ Accounting theor
$.1 Learning objectives
A)ter stu&"ing this chapter, "ou shoul& e a le to:
    

6&enti)" an& &iscuss the un&erl"ing assu$ptions or concepts o) accounting0 6&enti)" an& &iscuss the $a3or principles o) accounting0 6&enti)" an& &iscuss the $o&i)"ing conventions (or constraints) o) accounting0 <escri e the conceptual )ra$e'or! pro3ect o) the Financial Accounting ,tan&ar&s Boar&0 <iscuss the nature an& content o) a co$pan"Js su$$ar" o) signi)icant accounting policies in

its annual report0

$.2 A career as an accounting professor
<o "ou en3o" college li)eQ <o "ou en3o" teaching othersQ 6) so, "ou $ight 'ant to consi&er a career as a college pro)essor0 Although a position as a college pro)essor $a" pa" less than so$e other career alternatives, the intangi le ene)its are e"on& $easure0 A college pro)essor can $a!e a real &i))erence in the lives o) hun&re&s, even thousan&s, o) stu&ents over a career0 ,tu&ents co$e to college 'ith great potential, ut are in nee& o) so$e a&&itional training an& gui&ance0 The 'or! o) a college pro)essor is a valua le invest$ent in our nationJs $ost valua le resourceLpeople0 College )acult" generall" teach )e'er hours each 'ee! than ele$entar" an& secon&ar" school teachers0 This is ecause $ost college )acult" have at least t'o a&&itional i$portant responsi ilities: research an& service0 The research co$ponent represents )ar $ore than 3ust su$$ari5ing 'hat others have alrea&" learne&0 6t represents arriving at ne' !no'le&ge " &iscovering things that previousl" 'ere un!no'n0 For instance, accounting research has &e$onstrate& the 'a"s in 'hich accounting nu$ ers such as earnings an& stoc!hol&erJs e4uit" are relate& to stoc! prices0 This illustrates the i$portance o) accounting nu$ ers an& has resulte& in a large strea$ o) &iscover" calle& Capital (ar!ets research0 Besi&es teaching an& research, $ost )acult" have signi)icant service responsi ilities as 'ell0 Accounting )acult" are involve& in service to the universit", the accounting pro)ession, an& to the general pu lic0 (an" college )acult" &e&icate 1B-IB hours or $ore each 'ee! to the service co$ponent o) their 3o s0 The &e$an& )or college pro)essors varies greatl" " &iscipline0 6n )iel&s such as %nglish, Fine Arts, Philosoph", an& Ps"cholog" there is a large suppl" o) can&i&ates 'ith a&vance& &egrees an&, thus, the co$petition )or positions as college pro)essors in these areas is intense0 #o'ever, in applie& )iel&s such p. IC+ o) *++

as accounting an& engineering, there is a shortage o) can&i&ates 'ith a&vance& &egrees0 The opportunities )or pro)essors in these applie& )iel&s are excellent, an& the chance to $a!e a real &i))erence in the lives o) others is exciting0 Chapter 1 rie)l" intro&uce& the o&" o) theor" un&erl"ing accounting proce&ures0 6n this chapter, 'e &iscuss accounting theor" in greater &epth0 /o' that "ou have learne& so$e accounting proce&ures, "ou are etter a le to relate these theoretical concepts to accounting practice0 #ccounting t%eory is Ka set o) asic concepts an& assu$ptions an& relate& principles that explain an& gui&e the accountantJs actions in i&enti)"ing, $easuring, an& co$$unicating econo$ic in)or$ationK0 1 To so$e people, the 'or& theor" i$plies so$ething a stract an& out o) reach0 Mn&erstan&ing the theor" ehin& the accounting process, ho'ever, helps one $a!e &ecisions in &iverse accounting situations0 Accounting theor" provi&es a logical )ra$e'or! )or accounting practice0 The )irst part o) the chapter &escri es un&erl"ing accounting assu$ptions or concepts, the $easure$ent process, the $a3or principles, an& $o&i)"ing conventions or constraints0 Accounting theor" has &evelope& over the "ears an& is containe& in authoritative accounting literature an& text oo!s0 The next part o) the chapter &escri es the &evelop$ent o) the Financial Accounting ,tan&ar&s Boar&Js (FA,B) conceptual )ra$e'or! )or accounting0 This )ra$e'or! uil&s on accounting theor" &evelope& over ti$e an& serves as a asis )or )or$ulating accounting stan&ar&s in the )uture0 Presenting the tra&itional o&" o) theor" )irst an& the conceptual )ra$e'or! secon& gives "ou a sense o) the historical &evelop$ent o) accounting theor"0 <espite so$e overlap et'een the t'o parts o) the chapter, re$e$ er that FA,BJs conceptual )ra$e'or! uil&s on tra&itional theor" rather than replaces it0 The )inal part o) the chapter &iscusses signi)icant accounting policies containe& in annual reports issue& " co$panies an& illustrates the$ 'ith an actual exa$ple )ro$ an annual report o) the =alt <isne" Co$pan"0

$.3 Traditional accounting theor
Tra&itional accounting theor" consists o) un&erl"ing assu$ptions, rules o) $easure$ent, $a3or principles, an& $o&i)"ing conventions (or constraints)0 The )ollo'ing sections &escri e these aspects o) accounting theor" that greatl" in)luence accounting practice0

1A$erican Accounting Association, A ,tate"ent o& Basic Accounting T%eory (,arasota, Fla0, 1>DD), pp0 1-I0 p. IC* o) *++

$.! .nderl ing assumptions or concepts
The $a3or un&erl"ing assu$ptions or concepts o) accounting are (1) &iscusses the e))ects o) these assu$ptions on the accounting process0 <ata gathere& in an accounting s"ste$ $ust relate to a speci)ic usiness unit or entit"0 The business entity concept assu$es that each usiness has an existence separate )ro$ its o'ners, cre&itors, e$plo"ees, custo$ers, intereste& parties, an& other usinesses0 For each usiness (such as a horse sta le or a )itness center), the usiness, not the usiness o'ner, is the accounting entit"0 There)ore, )inancial state$ents are i&enti)ie& as elonging to a particular usiness entit"0 The content o) these )inancial state$ents reports onl" on the activities, resources, an& o ligations o) that entit"0 A usiness entit" $a" e $a&e up o) several &i))erent legal entities0 For instance, a large usiness (such as 2eneral (otors Corporation) $a" consist o) several separate corporations, each o) 'hich is a separate legal entit"0 For reporting purposes, ho'ever, the corporations $a" e consi&ere& as one usiness entit" ecause the" have a co$$on o'nership0 Chapter 1* illustrates this concept0 =hen accountants recor& usiness transactions )or an entit", the" assu$e it is a going concern0 The going-concern (continuity) assumption states that an entit" 'ill continue to operate in&e)initel" unless strong evi&ence exists that the entit" 'ill ter$inate0 The ter$ination o) an entit" occurs 'hen a co$pan" ceases usiness operations an& sells its assets0 The process o) ter$ination is calle& liqui.ation0 6) li4ui&ation appears li!el", the going-concern assu$ption is no longer vali&0 Accountants o)ten cite the going-concern assu$ption to 3usti)" using historical costs rather than $ar!et values in $easuring assets0 (ar!et values are o) less signi)icance to an entit" using its assets rather than selling the$0 On the other han&, i) an entit" is li4ui&ating, it shoul& use li4ui&ation values to report assets0 The econo$ic activit" o) a usiness is nor$all" recor&e& an& reporte& in $one" ter$s0 8oney measurement is the use o) a $onetar" unit such as the &ollar instea& o) ph"sical or other units o) $easure$ent0 Msing a particular $onetar" unit provi&es accountants 'ith a co$$on unit o) $easure$ent to report econo$ic activit"0 =ithout a $onetar" unit, it 'oul& e i$possi le to a&& such ite$s as uil&ings, e4uip$ent, an& inventor" on a alance sheet0 Financial state$ents i&enti)" their unit o) $easure (such as the &ollar in the Mnite& ,tates) so the state$ent user can $a!e vali& co$parisons o) a$ounts0 For exa$ple, it 'oul& e &i))icult to co$pare relative asset a$ounts or pro)ita ilit" o) a co$pan" reporting in M, &ollars 'ith a co$pan" reporting in ;apanese "en0 usiness entit", (I) going concern (continuit"), (+) $one" $easure$ent, (*) sta le &ollar, an& (C) perio&icit"0 This section

p. ICC o) *++

6n the Mnite& ,tates, accountants $a!e another assu$ption regar&ing $one" $easure$entLthe sta le &ollar assu$ption0 Mn&er the stable .ollar assumption, the &ollar is accepte& as a reasona l" sta le unit o) $easure$ent0 Thus, accountants $a!e no a&3ust$ents )or the changing value o) the &ollar in the pri$ar" )inancial state$ents0 Msing the sta le &ollar assu$ption creates a &i))icult" in &epreciation accounting0 Assu$e, )or exa$ple, that a co$pan" ac4uire& a uil&ing in 1>@C an& co$pute& the +B-"ear straight-line &epreciation on the uil&ing 'ithout a&3usting )or an" changes in the value o) the &ollar0 Thus, the &epreciation &e&ucte& in IBB8 is the sa$e as the &epreciation &e&ucte& in 1>@C0 The co$pan" $a!es no a&3ust$ents )or the &i))erence et'een the values o) the 1>@C &ollar an& the IBB8 &ollar0 Both &ollars are treate& as e4ual $onetar" units o) $easure$ent &espite su stantial price in)lation over the +B-"ear perio&0 Accountants an& usiness executives have expresse& concern over this in)lation pro le$, especiall" &uring perio&s o) high in)lation0 Accor&ing to the perio.icity (time perio.s) assumption, accountants &ivi&e an entit"Js li)e into $onths or "ears to report its econo$ic activities0 Then, accountants atte$pt to prepare accurate reports on the entit"Js activities )or these perio&s0 Although these ti$e-perio& reports provi&e use)ul an& ti$el" )inancial in)or$ation )or investors an& cre&itors, the" $a" e inaccurate )or so$e o) these ti$e perio&s entries0 Accounting reports cover relativel" short perio&s0 These ti$e perio&s are usuall" o) e4ual length so that state$ent users can $a!e vali& co$parisons o) a co$pan"Js per)or$ance )ro$ perio& to perio&0 The length o) the accounting perio& $ust e state& in the )inancial state$ents0 For instance, so )ar, the inco$e state$ents in this text 'ere )or either one $onth or one "ear0 Co$panies that pu lish their )inancial state$ents, such as pu licl" hel& corporations, generall" prepare $onthl" state$ents )or internal $anage$ent an& pu lish )inancial state$ents 4uarterl" an& annuall" )or external state$ent users0 #ccrual basis an. perio.icity Chapter + &e$onstrate& that )inancial state$ents $ore accuratel" re)lect the )inancial status an& operations o) a co$pan" 'hen prepare& un&er the accrual asis rather than the cash asis o) accounting0 Mn&er the cash asis, 'e recor& revenues 'hen cash is receive& an& expenses 'hen cash is pai&0 Mn&er the accrual asis, ho'ever, 'e recor& revenues 'hen services are ren&ere& or pro&ucts are sol& an& expenses 'hen incurre&0 The perio&icit" assu$ption re4uires preparing a&3usting entries un&er the accrual asis0 =ithout the perio&icit" assu$ption, a usiness 'oul& have onl" one ti$e perio& running )ro$ its inception to its ter$ination0 Then, the concepts o) cash asis an& accrual asis accounting 'oul& e irrelevant p. ICD o) *++ ecause accountants $ust esti$ate &epreciation expense an& certain other a&3usting

ecause all revenues an& all expenses 'oul& e recor&e& in that one ti$e perio& an& 'oul& not have to e assigne& to arti)iciall" short perio&s o) one "ear or less0 #pproximation an. 2u.gment because o0 perio.icity To provi&e perio&ic )inancial in)or$ation, accountants $ust o)ten esti$ate expecte& uncollecti le accounts (see Chapter >) an& the use)ul lives o) &eprecia le assets0 Mncertaint" a out )uture events prevents precise $easure$ent an& $a!es esti$ates necessar" in accounting0 Fortunatel", these esti$ates are o)ten reasona l" accurate0

$.# /ther basic concepts
Other asic accounting concepts that a))ect accounting )or entities are (1) general-purpose )inancial state$ents, (I) su stance over )or$, (+) consistenc", (*) &ou le entr", an& (C) articulation0 =e &iscuss these asic accounting concepts next0 Accountants prepare general-purpose 0inancial statements at regular intervals to $eet $an" o) the in)or$ation nee&s o) external parties an& top-level internal $anagers0 6n contrast, accountants can gather special-purpose )inancial in)or$ation )or a speci)ic &ecision, usuall" on a one-ti$e asis0 For exa$ple, $anage$ent $a" nee& speci)ic in)or$ation to &eci&e 'hether to purchase a ne' co$puter s"ste$0 ,ince special-purpose )inancial in)or$ation $ust e speci)ic, this in)or$ation is est o taine& )ro$ the &etaile& accounting recor&s rather than )ro$ the )inancial state$ents0 6n so$e usiness transactions, the econo$ic su stance o) the transaction con)licts 'ith its legal )or$0 For exa$ple, a contract that is legall" a lease $a", in )act, e e4uivalent to a purchase0 A co$pan" $a" have a three-"ear contract to lease (rent) an auto$o ile at a state& $onthl" rental )ee0 At the en& o) the lease perio&, the co$pan" receives title to the auto a)ter pa"ing a no$inal su$ (sa", M,< 1)0 The econo$ic su stance o) this transaction is a purchase rather than a lease o) the auto0 Thus, un&er the su stance-over-)or$ concept, the auto is an asset on the alance sheet an& is &epreciate& instea& o) sho'ing rent expense on the inco$e state$ent0 Accountants recor& a transactionJs econo$ic su stance rather than its legal )or$0 Consistency generall" re4uires that a co$pan" use the sa$e accounting principles an& reporting practices through ti$e0 This concept prohi its in&iscri$inate s'itching o) accounting principles or $etho&s, such as changing inventor" $etho&s ever" "ear0 #o'ever, consistenc" &oes not prohi it a change in accounting principles i) the in)or$ation nee&s o) )inancial state$ent users are etter serve& " the change0 =hen a co$pan" $a!es a change in accounting principles, it $ust $a!e the )ollo'ing &isclosures in the )inancial state$ents: (1) nature o) the change? (I) reasons )or the change? (+) e))ect o) the change on current net inco$e, i) signi)icant? an& (*) cu$ulative e))ect o) the change on past inco$e0 p. IC@ o) *++

Chapter I intro&uce& the

asic accounting concept o) the &ou le-entr" $etho& o) recor&ing

transactions0 Mn&er the &ou le-entr" approach, ever" transaction has a t'o-si&e& e))ect on each part" engaging in the transaction0 Thus, to recor& a transaction, each part" &e its at least one account an& cre&its at least one account0 The total &e its e4ual the total cre&its in each 3ournal entr"0 =hen learning ho' to prepare 'or! sheets in Chapter *, "ou learne& that )inancial state$ents are )un&a$entall" relate& an& articulate (interact) 'ith each other0 For exa$ple, 'e carr" the a$ount o) net inco$e )ro$ the inco$e state$ent to the state$ent o) retaine& earnings0 Then 'e carr" the en&ing alance on the state$ent o) retaine& earnings to the e4uities into alance0 6n %xhi it I@ 'e su$$ari5e the un&erl"ing assu$ptions or concepts0 The next section &iscusses the $easure$ent process use& in accounting0 alance sheet to ring total assets an& total

$.$ The measurement process in accounting
%arlier, 'e &e)ine& accounting as Kthe process o) i&enti)"ing, $easuring, an& co$$unicating econo$ic in)or$ation to per$it in)or$e& 3u&g$ents an& &ecisions " the users o) the in)or$ationK0 I 6n this section, 'e )ocus on the $easure$ent process o) accounting0 Accountants $easure a usiness entit"Js assets, lia ilities, an& stoc!hol&ersJ e4uit" an& an" changes that occur in the$0 B" assigning the e))ects o) these changes to particular ti$e perio&s (perio&icit"), the" can )in& the net inco$e or net loss o) the accounting entit" )or those perio&s0 Accountants $easure the various assets o) a usiness in &i))erent 'a"s0 The" $easure cash at its speci)ie& a$ount0 Chapter > explains ho' the" $easure clai$s to cash, such as accounts receiva le, at their expecte& cash in)lo's, ta!ing into consi&eration possi le uncollecti les0 The" $easure inventories, prepai& expenses, plant assets, an& intangi les at their historical costs (actual a$ounts pai&)0 A)ter the ac4uisition &ate, the" carr" so$e ite$s, such as inventor", at the lo'er-o)-cost-or$ar!et value0 A)ter the ac4uisition &ate, the" carr" plant assets an& intangi les at original cost less accu$ulate& &epreciation or a$orti5ation0 The" $easure lia ilities at the a$ount o) cash that 'ill e pai& or the value o) services that 'ill e per)or$e& to satis)" the lia ilities0 Accountants can easil" $easure so$e changes in assets an& lia ilities, such as the ac4uisition o) an asset on cre&it an& the pa"$ent o) a lia ilit"0 Other changes in assets an& lia ilities, such as those recor&e& in a&3usting entries, are $ore &i))icult to $easure ecause the" o)ten involve esti$ates an&7or calculations0 The accountant $ust &eter$ine 'hen a change has ta!en place an& the a$ount o)

I6 i&0, p0 10 p. IC8 o) *++

the change0 These &ecisions involve $atching revenues an& expenses an& are gui&e& " the principles &iscusse& next0
Assu,ption o" Concept &usiness entit2 +esc"iption Each business has an e1istence se'arate from its o ners" creditors" em'loyees" customers" other interested 'arties" and other businesses. Goin) concern #continuit2% An entity ill continue to o'erate indefinitely unless stron/ e+idence e1ists that the entity ill terminate. Each business uses a monetary unit of *one2 !easure!ent measurement" such as the dollar" instead of 'hysical or other units of measurement. Sta5le dollar .he dollar is acce'ted as a reasonably stable unit of measure. #,po"tance -efines the sco'e of the business such as a horse stable or 'hysical fitness center. Identifies hich transactions should be recorded on the com'any's books. Allo s a com'any to continue carryin/ 'lant assets at their historical costs in s'ite of a chan/e in their market +alues. Pro+ides accountants ith a common unit of measure to re'ort economic acti+ity. .his conce't 'ermits us to add an d subtract items on the financial statements. Permits us to make no ad8ustments in the financial statements for the chan/in/ +alue of the dollar. .his assum'tion orks fairly ell in the ,nited States because of our relati+ely lo rate of inflation. Permits us to 're'are financial statements that co+er 'eriods shorter than the entire life of a business. .hus" e kno ho ell a business is 'erformin/ before it terminates its o'erations. .he need for ad8ustin/ entries arises because of this conce't and the use of accrual accountin/. Allo s com'anies to 're'are only one set of financial statements instead of a se'arate set for each 'otential ty'e of user of those statements. .he financial statements should be free of bias so they do not fa+or the interests of any one ty'e of user. Encoura/es the accountant to record the true nature of a transaction rather than its a''arent nature. .his a''roach is the accountin/ equi+alent of :tell it like it is.: An a''arent lease transaction that has all the characteristics of a 'urchase should be recorded as a 'urchase. Pre+ents a com'any from chan/in/ accountin/ methods hene+er it likes to 'resent a better 'icture or to mani'ulate income. .he in+entory and de'reciation cha'ters (Cha'ters 3 and 5$& both mention the im'ortance of this conce't. ,ses a system of checks and balances to hel' identify hether or not errors ha+e been made in recordin/ transactions. =hen the debits do not equal the credits" this inequality immediately si/nals us to sto' and find the error. Chan/es in account balances durin/ an accountin/ 'eriod are reflected in financial statements that are related to one another. >or instance" earnin/ re+enue increases net income on the income statement" retained earnin/s on the statement of retained earnin/s" and assets and retained earnin/s on the balance sheet. .he statement of retained earnin/s ties the income statement and balance sheet to/ether.

=eriodicit2 #ti!e periods%

An entity's life can be subdi+ided into months or years to re'ort its economic acti+ities.

General3purpose (inancial state!ents

9ne set of financial statements ser+es the needs of all users.

Su5stance over (or!

Accountants should record the economic substance of a transaction rather than its le/al form.

,onsistenc2

;enerally requires that a com'any use the same accountin/ 'rinci'les and re'ortin/ 'ractices e+ery accountin/ 'eriod. E+ery transaction has a t o<sided effect on each com'any or 'arty en/a/in/ in the transaction. >inancial statements are fundamentally related and articulate (interact& ith each other.

:ou5le entr2

$rticulation

%xhi it I@: The un&erl"ing assu$ptions or concepts

$.% The major principles
2enerall" accepte& accounting principles (2AAP) set )orth stan&ar&s or $etho&s )or presenting )inancial accounting in)or$ation0 A stan&ar&i5e& presentation )or$at ena les users to co$pare the p. IC> o) *++

)inancial in)or$ation o) &i))erent co$panies $ore easil"0 2enerall" accepte& accounting principles have een either &evelope& through accounting practice or esta lishe& " authoritative organi5ations0 Organi5ations that have contri ute& to the &evelop$ent o) the principles are the A$erican 6nstitute o) Certi)ie& Pu lic Accountants (A6CPA), the Financial Accounting ,tan&ar&s Boar& (FA,B), the ,ecurities an& %xchange Co$$ission (,%C), the A$erican Accounting Association (AAA), the Financial %xecutives 6nstitute (F%6), an& the 6nstitute o) (anage$ent Accounting (6(A)0 This section explains the )ollo'ing $a3or principles:
 %xchange-price (or cost) principle0  :evenue recognition principle0  (atching principle0  2ain an& loss recognition principle0  Full &isclosure principle0

=henever resources are trans)erre& et'een t'o parties, such as u"ing $erchan&ise on account, the accountant $ust )ollo' the exchange-price (or cost) principle in presenting that in)or$ation0 The exc%ange-price (or cost) principle re4uires an accountant to recor& trans)ers o) resources at prices agree& on " the parties to the exchange at the ti$e o) exchange0 This principle sets )orth (1) 'hat goes into the accounting s"ste$Ltransaction &ata? (I) 'hen it is recor&e&Lat the ti$e o) exchange? an& (+) the a$ountsLexchange pricesLat 'hich assets, lia ilities, stoc!hol&ersJ e4uit", revenues, an& expenses are recor&e&0 As applie& to $ost assets, this principle is o)ten calle& the cost principle0 6t &ictates that purchase& or sel)-constructe& assets are initiall" recor&e& at historical cost0 =istorical cost is the a$ount pai&, or the )air $ar!et value o) the lia ilit" incurre& or other resources surren&ere&, to ac4uire an asset an& place it in a con&ition an& position )or its inten&e& use0 For instance, 'hen the cost o) a plant asset (such as a $achine) is recor&e&, its cost inclu&es the net purchase price plus an" costs o) recon&itioning, testing, transporting, an& placing the asset in the location )or its inten&e& use0 Accountants pre)er the ter$ exchange-price principle to cost principle ecause it see$s inappropriate to re)er to lia ilities, stoc!hol&ersJ e4uit", an& such assets as cash an& accounts receiva le as eing $easure& in ter$s o) cost0 (ore recentl", the FA,B in ,FA, 1C@ has $ove& &e)initivel" to'ar&s )air $ar!et value accounting, or F$ar!-to-$ar!etH, 'hich recor&s the value o) an asset or lia ilit" at its current $ar!et value (also !no'n as a F)air valueH) rather than its oo! value0 ,FA, 1C@ &e)ines F)air valueH as Fthe price that 'oul& e receive& to sell an asset or pai& to trans)er a lia ilit" in an or&erl" transaction et'een $ar!et participants at the $easure$ent &ateH0 p. IDB o) *++

6t is also &e)ine& as Fan exit price )ro$ the perspective o) a $ar!et participant that hol&s the asset or o'es the lia ilit"H, 'hether or not the usiness plans to hol& the asset7lia ilit" )or invest$ent, or sell it0 FThe )air value accounting stan&ar& ,FA, 1C@ applies to )inancial assets o) all pu licl"-tra&e& co$panies in the M, as o) IBB@ /ov0 1C0 6t also applies to non-)inancial assets an& lia ilities that are recogni5e&, or &isclose&, at )air value on a recurring asis0 Beginning in IBB>, the stan&ar& 'ill appl" to other non-)inancial assets0 ,FA, 1C@ applies to ite$s )or 'hich other accounting pronounce$ents re4uire or per$it )air value $easure$ents except share- ase& pa"$ent transactions, such as stoc! option co$pensation0 F,FA, 1C@ provi&es a hierarch" o) three levels o) input &ata )or &eter$ining the )air value o) an asset or lia ilit"0 This hierarch" ran!s the 4ualit" an& relia ilit" o) in)or$ation use& to &eter$ine )air values, 'ith level 1 inputs eing the $ost relia le an& level + inputs eing the least relia le0
 Aevel 1 is 4uote& prices )or i&entical ite$s in active, li4ui& an& visi le $ar!ets such as stoc!

exchanges0
 Aevel I is o serva le in)or$ation )or si$ilar ite$s in active or inactive $ar!ets, such as t'o

si$ilarl" situate& uil&ings in a &o'nto'n real estate $ar!et0
 Aevel + are uno serva le inputs to

e use& in situations 'here $ar!ets &o not exist or are eco$es highl"

illi4ui& such as the present cre&it crisis0 At this point )air $ar!et valuation su 3ective0H

Fair value accounting has een a contentious topic since it 'as intro&uce&, For exa$ple, F an!s an& invest$ent an!s have ha& to re&uce the value o) the $ortgages an& $ortgage- ac!e& securities to re)lect current pricesH0 Those prices &ecline& severel" 'ith the collapse o) cre&it $ar!ets as $ortgage &e)aults escalate& in the )inancial crisis o) IBB8-IBB>0 <espite &e ate over the proper i$ple$entation o) )air $ar!et value accounting, 6nternational Financial :eporting ,tan&ar&s utili5e this approach $uch $ore than the 2enerall" Accepte& Accounting Principles o) the Mnite& ,tates0 To learn $ore a out )air $ar!et value accounting, visit the A6CPA site, (http:77'''0aicpa0org7(e&iaCenter7)vaR)a40ht$), the source use& )or the explanation o) this topic0

#n accounting perspecti'e: Business insig%t
6n so$e %uropean countries, the )inancial state$ents contain secret reserves0 These secret reserves arise )ro$ a co$pan" not reporting all o) its pro)its 'hen it has a ver" goo& "ear0 The 3usti)ication is that the stoc!hol&ers vote on the a$ount o) &ivi&en&s the" receive each

p. ID1 o) *++

"ear? i) all pro)its 'ere reporte&, the stoc!hol&ers $ight vote to pa" the entire a$ount out as &ivi&en&s0 B" hol&ing ac! so$e pro)its, not onl" are the cre&itors $ore protecte& ut the co$pan" is also $ore solvent an& has $ore resources to invest in pro&uctive assets0

:evenue is not &i))icult to &e)ine or $easure? it is the in)lo' o) assets )ro$ the sale o) goo&s an& services to custo$ers, $easure& " the cash expecte& to e receive& )ro$ custo$ers0 #o'ever, the crucial 4uestion )or the accountant is 'hen to recor& a revenue0 Mn&er the re'enue recognition principle, revenues shoul& e earne& an& reali5e& e)ore the" are recogni5e& (recor&e&)0 -arning o0 re'enue All econo$ic activities un&erta!en " a co$pan" to create revenues are part o) the earning process0 (an" activities $a" have prece&e& the actual receipt o) cash )ro$ a custo$er, inclu&ing (1) placing a&vertise$ents, (I) calling on the custo$er several ti$es, (+) su $itting sa$ples, (*) ac4uiring or $anu)acturing goo&s, an& (C) selling an& &elivering goo&s0 For these activities, the co$pan" incurs costs0 Although revenue 'as actuall" eing earne& " these activities, accountants &o not recogni5e revenue until the ti$e o) sale ecause o) the re4uire$ent that revenue e su stantiall" earne& e)ore it is recogni5e& (recor&e&)0 This re4uire$ent is the earning principle. :eali4ation o0 re'enue Mn&er the reali4ation principle, the accountant &oes not recogni5e (recor&) revenue until the seller ac4uires the right to receive pa"$ent )ro$ the u"er0 The seller ac4uires this right )ro$ the u"er at the ti$e o) sale )or $erchan&ise transactions or 'hen services have een per)or$e& in service transactions0 Aegall", a sale o) $erchan&ise occurs 'hen title to the goo&s passes to the u"er0 The ti$e at 'hich title passes nor$all" &epen&s on the shipping ter$sL FOB shipping point or FOB &estination (as 'e &iscuss in Chapter D)0 As a practical $atter, accountants generall" recor& revenue 'hen goo&s are &elivere&0 The a&vantages o) recogni5ing revenue at the ti$e o) sale are (1) the actual transactionL&eliver" o) goo&sLis an o serva le event? (I) revenue is easil" $easure&? (+) ris! o) loss &ue to price &ecline or &estruction o) the goo&s has passe& to the u"er? (*) revenue has een earne&, or su stantiall" so? an& (C) ecause the revenue has een earne&, expenses an& net inco$e can e &eter$ine&0 As &iscusse& later, the &isa&vantage o) recogni5ing revenue at the ti$e o) sale is that the revenue $ight not e recor&e& in the perio& &uring 'hich $ost o) the activit" creating it occurre&0 -xceptions to t%e reali4ation principle The )ollo'ing exa$ples are instances 'hen practical consi&erations $a" cause accountants to var" the point o) revenue recognition )ro$ the ti$e o) sale0 These exa$ples illustrate the e))ect that the accounting principles an& stan&ar&s0 p. IDI o) *++ usiness environ$ent has on the &evelop$ent o)

Cas% collection as point o0 re'enue recognition ,o$e s$all co$panies recor& revenues an& expenses at the ti$e o) cash collection an& pa"$ent, 'hich $a" not occur at the ti$e o) sale0 This proce&ure is the cash asis o) accounting0 The cash asis is accepta le pri$aril" in service enterprises that &o not have su stantial cre&it transactions or inventories, such as usiness entities o) &octors or &entists0 1nstallment basis o0 re'enue recognition =hen collecting the selling price o) goo&s sol& in $onthl" or annual install$ents an& consi&era le &ou t exists as to collecti ilit", the co$pan" $a" use the install$ent asis o) accounting0 Co$panies $a!e these sales in spite o) the &ou t)ul collecti ilit" o) the account ecause their $argin o) pro)it is high an& the goo&s can e repossesse& i) the pa"$ents are not receive&0 Mn&er the installment basis, the percentage o) total gross $argin (selling price o) a goo& $inus its cost) recogni5e& in a perio& is e4ual to the percentage o) total cash )ro$ a sale that is receive& in that perio&0 Thus, the gross $argin recogni5e& in a perio& is e4ual to the cash receive& ti$es the gross $argin percentage (gross $argin &ivi&e& " selling price)0 The )or$ula to recogni5e gross pro)it on cash collections $a&e on install$ent sales o) a certain "ear is: Cash collections 1 ;ross mar/in 'ercenta/e =;ross mar/in reco/ni?ed To e $ore precise, 'e expan& the &escriptions in the )or$ula as )ollo's:
,as0 collections t0is 2ear resultin) I (ro! install!ent sales !ade in a certain 2ear Gross !ar)in percenta)e ? Gross !ar)in reco)niEed t0is (or t0e 2ear o( sale 2ear on cas0 collections t0is 2ear (ro! install!ent sales !ade in a certain 2ear

To illustrate, assu$e a co$pan" sol& a stereo set0 The )acts o) the sale are:
:ate o* #ale 20"0 +ct' " Sell%n+ 1r%ce -S: 500 Co#t -S: 300 8ro## mar+%n 4Sell%n+ 1r%ce L Co#t5 #5003300% N 200 8ro## mar+%n 1ercenta+e 48ro## mar+%nMSell%n+ 1r%ce5 #200G500% ? 40 per cent

The u"er $a!es 1B e4ual $onthl" install$ent pa"$ents o) M,< CB to pa" )or the set (1B Z M,< CB S M,< CBB)0 6) the co$pan" receives three $onthl" pa"$ents in IB1B, the total a$ount o) cash receive& in IB1B is M,< 1CB (+ Z M,< CB)0 The gross $argin to recogni5e in IB1B is:
20"0 cas0 collections (ro! 20"0 install!ent sales US: 1<0 I Gross !ar)in percenta)e ? 20"0 )ross !ar)in on 20"0 install!ent sales reco)niEed on 20"0 cas0 collections (ro! 20"0 install!ent sales ;0 1er cent / US: =0

I

p. ID+ o) *++

The co$pan" collects the other install$ents 'hen &ue so it receives a total o) M,< +CB in IB11 )ro$ IB1B install$ent sales0 The gross $argin to recogni5e in IB11 on these cash collections is as )ollo's:
20"" cas0 collections (ro! 20"0 install!ent sales US: <0 I F Gross !ar)in percenta)e on 20"0 ? 20"" )ross !ar)in reco)niEed on install!ent sales 20"" cas0 collections (ro! 20"0 install!ent sales ;0 1er cent / US: 1;0
Total Amount o* @ear Ca#h Reco+n%Hed 8ro## Mar+%n Reco+n%Hed

6n su$$ar", the total receipts an& gross $argin recogni5e& in the t'o "ears are as )ollo's:
20"0 20"" $"50 30D ''''' 350 70D $500 "00D $ 60 30D "40 70D $200 "00D

Because the install$ent install$ents.

asis &ela"s so$e revenue recognition

e"on& the ti$e o) sale, it is

accepta le )or accounting purposes onl" 'hen consi&era le &ou t exists as to collecti ilit" o) the :e'enue recognition on long-term construction pro2ects Co$panies recogni5e revenue )ro$ a long-ter$ construction pro3ect un&er t'o &i))erent $etho&s: (1) the co$plete&-contract $etho& or (I) the percentage-o)-co$pletion $etho&0 The complete.-contract met%o. &oes not recogni5e an" revenue until the pro3ect is co$plete&0 6n that perio&, the" recogni5e all revenue even though the contract $a" have re4uire& three "ears to co$plete0 Thus, the co$plete&-contract $etho& recogni5es revenues at the ti$e o) sale, as is true )or $ost sales transactions0 Co$panies carr" costs incurre& on the pro3ect )or'ar& in an inventor" account (Construction in Process) an& charge the$ to expense in the perio& in 'hich the revenue is recogni5e&0 ,o$e accountants argue that 'aiting so long to recogni5e an" revenue is unreasona le0 The" elieve that ecause revenue-pro&ucing activities have een per)or$e& &uring each "ear o) construction, revenue shoul& e recogni5e& in each "ear o) construction even i) esti$ates are nee&e&0 The

percentage-o0-completion met%o. recogni5es revenue ase& on the esti$ate& stage o) co$pletion o) a long-ter$ pro3ect0 To $easure the stage o) co$pletion, )ir$s co$pare actual costs incurre& in a perio& 'ith the total esti$ate& costs to e incurre& on the pro3ect0 To illustrate, assu$e that a co$pan" has a contract to uil& a &a$ )or M,< ** $illion0 The esti$ate& construction cost is M,< *B $illion0 .ou calculate the esti$ate& gross $argin as )ollo's:
Sale# 1r%ce o* dam -S: 44 !illion E#t%mated co#t# o* con#truct dam -S: 40 !illion E#t%mated +ro## mar+%n 4#ale# 1r%ce L e#t%mated co#t#5 #44 !illion N 40 !illion% N 4 !illion

p. ID* o) *++

The )ir$ recogni5es the M,< * $illion gross $argin in the )inancial state$ents " recor&ing the assigne& revenue )or the "ear an& then &e&ucting actual costs incurre& that "ear0 The )or$ula to recogni5e revenue is: Actualconstruction costs incurred durin/ the 'eriod 1 .otal sales 'rice = @e+enue reco/ni?ed for 'eriod .otal estimated construction costs for the entire 'ro8ect ,uppose that " the en& o) the )irst "ear (IB1B), the co$pan" ha& incurre& actual construction costs o) M,< +B $illion0 These costs are @C per cent o) the total esti$ate& construction costs (M,< +B $illion7M,< *B $illion S @C per cent)0 Mn&er the percentage-o)-co$pletion $etho&, the )ir$ 'oul& use the @C per cent )igure to assign revenue to the )irst "ear0 6n IB11, it incurs another M,< D $illion o) construction costs0 6n IB1I, it incurs the )inal M,< * $illion o) construction costs0 The a$ount o) revenue to assign to each "ear is as )ollo's:
Year Ratio of Actual Construction Costs to Total Estimated Construction Costs
47 0 m%ll%on 3 7;0 m%ll%on / B<N5 B<N 2011 47= m%ll%on 3 7;0 m%ll%on / 1<N5 1<N 2012 47; m%ll%on 3 7;0 m%ll%on / 10N5 10N F 7;; m%ll%on / 7;.; m%ll%on 7;; m%ll%on F 7;; m%ll%on / 7=.= m%ll%on F 7;; m%ll%on /

X

Agreed Price of !am

2010

Amount of Re"enue to Recogni#e (Assign)
7 m%ll%on

The a$ount o) gross $argin to recogni5e in each "ear is as )ollo's:
Pear
20"0 20"" 20"2

$ssi)ned Revenues
$33'0 !illion 6'6 4'4 $44'0 !illion

$ctual 3 ,onstruction ,osts
3 $30'0 !illion 3 6'0 3 4'0 $40'0 !illion

Reco)niEed ? Gross *ar)in
? $3'0 !illion ? 0'6 ? 0'4 $4'0 !illion

Num&er o* Com1an%e# 200 =ercenta)e o( co!pletion 79 -nits o( deliver2 32 ,o!pleted contract @ 2002 2001 2000 92 26 5 90 7" 2" "@ 35

Source: $!erican .nstitute o( ,erti(ied =u5lic $ccountants, Account%n+ Trend# O Techn%)ue# 4Ne, Por6: $.,=$, 2004%, p' 432

%xhi it I8: (etho&s o) accounting )or long-ter$ contracts This co$pan" 'oul& &e&uct other costs incurre& in the accounting perio&, such as general an& a&$inistrative expenses, )ro$ gross $argin to &eter$ine net inco$e0 For instance, assu$ing general an& a&$inistrative expenses 'ere M,< 1BB,BBB in IB1B, net inco$e 'oul& e (M,< +,BBB,BBB - M,< 1BB,BBB) S M,< I,>BB,BBB0

p. IDC o) *++

%xpense recognition is closel" relate& to, an& so$eti$es &iscusse& as part o), the revenue recognition principle0 The matc%ing principle states that expenses shoul& e recogni5e& (recor&e&) as the" are incurre& to pro&uce revenues0 An expense is the out)lo' or using up o) assets in the generation o) revenue0 Fir$s voluntaril" incur expense to pro&uce revenue0 For instance, a television set &elivere& " a &ealer to a custo$er in exchange )or cash is an asset consu$e& to pro&uce revenue? its cost eco$es an expense0 ,i$ilarl", the cost o) services such as la or are voluntaril" incurre& to pro&uce revenue0 $%e measurement o0 expense Accountants $easure $ost assets use& in operating a usiness " their historical costs0 There)ore, the" $easure a &epreciation expense resulting )ro$ the consu$ption o) those assets " the historical costs o) those assets0 The" $easure other expenses, such as 'ages that are pai& )or currentl", at their current costs0 $%e timing o0 expense recognition The $atching principle i$plies that a relationship exists et'een expenses an& revenues0 For certain expenses, such as costs o) ac4uiring or pro&ucing the pro&ucts sol&, "ou can easil" see this relationship0 #o'ever, 'hen a &irect relationship cannot e seen, 'e charge the costs o) assets 'ith li$ite& lives to expense in the perio&s ene)ite& on a s"ste$atic an& rational allocation asis0 <epreciation o) plant assets is an exa$ple0 &ro.uct costs are costs incurre& in the ac4uisition or $anu)acture o) goo&s0 As "ou 'ill see in the next chapter, inclu&e& as pro&uct costs )or purchase& goo&s are invoice, )reight, an& insurance-intransit costs0 For $anu)acturing co$panies, pro&uct costs inclu&e all costs o) $aterials, la or, an& )actor" operations necessar" to pro&uce the goo&s0 Pro&uct costs attach to the goo&s purchase& or pro&uce& an& re$ain in inventor" accounts as long as the goo&s are on han&0 =e charge pro&uct costs to expense 'hen the goo&s are sol&0 The result is a precise $atching o) cost o) goo&s sol& expense to its relate& revenue0 &erio. costs are costs not tracea le to speci)ic pro&ucts an& expense& in the perio& incurre&0 ,elling an& a&$inistrative costs are perio& costs0 The gain an. loss recognition principle states that 'e recor& gains onl" 'hen reali5e&, ut losses 'hen the" )irst eco$e evi&ent0 Thus, 'e recogni5e losses at an earlier point than gains0 This principle is relate& to the conservatis$ concept0 9ains t"picall" result )ro$ the sale o) long-ter$ assets )or $ore than their gains e)ore the" are actuall" reali5e& is not allo'e&0 Losses consu$e assets, as &o expenses0 #o'ever, unli!e expenses, the" &o not pro&uce revenues0 Aosses are usuall" involuntar", such as the loss su))ere& )ro$ &estruction " )ire on an uninsure& p. IDD o) *++ oo! value0 Fir$s shoul& not recogni5e gains until the" are reali5e& through sale or exchange0 :ecogni5ing potential

uil&ing0 A loss on the sale o) a uil&ing $a" e voluntar" 'hen $anage$ent &eci&es to sell the uil&ing even though incurring a loss0 The 0ull .isclosure principle states that in)or$ation i$portant enough to in)luence the &ecisions o) an in)or$e& user o) the )inancial state$ents shoul& e &isclose&0 <epen&ing on its nature, co$panies shoul& &isclose this in)or$ation either in the )inancial state$ents, in notes to the )inancial state$ents, or in supple$ental state$ents0 6n 3u&ging 'hether or not to &isclose in)or$ation, it is etter to err on the si&e o) too $uch &isclosure rather than too little0 (an" la'suits against CPAs an& their clients have resulte& )ro$ ina&e4uate or $islea&ing &isclosure o) the un&erl"ing )acts0 =e su$$ari5e the $a3or principles an& &escri e the i$portance o) each in %xhi it I>0

#n accounting perspecti'e: Business insig%t
The accounting $o&el involves reporting revenues earne& an& expenses incurre& " the co$pan"0 ,o$e have argue& that social ene)its an& social costs create& " the co$pan" shoul& also e reporte&0 ,uppose, )or instance, that a co$pan" is &u$ping toxic 'aste into a river an& this action causes cancer a$ong the citi5ens &o'nstrea$0 ,houl& this cost e reporte& 'hen preparing )inancial state$ents sho'ing the per)or$ance o) the co$pan"Q =hat &o "ou thin!A

$.' =odif ing conventions 3or constraints4
6n certain instances, co$panies &o not strictl" appl" accounting principles ecause o) $o&i)"ing conventions (or constraints)0 8o.i0ying con'entions are custo$s e$erging )ro$ accounting practice that alter the results o taine& )ro$ a strict application o) accounting principles0 Three $o&i)"ing conventions are cost- ene)it, $aterialit", an& conservatis$0 Cost-bene0it The cost- ene)it consi&eration involves &eci&ing 'hether the ene)its o) inclu&ing optional in)or$ation in )inancial state$ents excee& the costs o) provi&ing the in)or$ation0 Msers ten& to thin! in)or$ation is cost )ree since the" incur none o) the costs o) provi&ing the in)or$ation0 Preparers reali5e that provi&ing in)or$ation is costl"0 The ene)its o) using in)or$ation shoul& excee& the costs o) provi&ing it0 The $easure$ent o) ene)its is inexact, 'hich $a!es application o) this $o&i)"ing convention &i))icult in practice0 8ateriality (aterialit" is a $o&i)"ing convention that allo's accountants to &eal 'ith i$$aterial (uni$portant) ite$s in an expe&ient ut theoreticall" incorrect $anner0 The )un&a$ental 4uestion accountants $ust as! in 3u&ging the $aterialit" o) an ite$ is 'hether a !no'le&gea le userJs &ecisions 'oul& e &i))erent i) the in)or$ation 'ere presente& in the theoreticall" correct $anner0 6) not, the p. ID@ o) *++

ite$ is i$$aterial an& $a"

e reporte& in a theoreticall" incorrect

ut expe&ient $anner0 For

instance, ecause inexpensive ite$s such as calculators o)ten &o not $a!e a &i))erence in a state$ent userJs &ecision to invest in the co$pan", the" are i$$aterial (uni$portant) an& $a" e expense& 'hen purchase&0 #o'ever, ecause expensive ite$s such as $ain)ra$e co$puters usuall" &o $a!e a &i))erence in such a &ecision, the" are $aterial (i$portant) an& shoul& e recor&e& as assets an& &epreciate&0 Accountants shoul& recor& all $aterial ite$s in a theoreticall" correct $anner0 The" $a" recor& i$$aterial ite$s in a theoreticall" incorrect $anner si$pl" ecause it is $ore convenient an& less expensive to &o so0 For exa$ple, the" $a" &e it the cost o) a 'aste as!et to an expense account rather than an asset account even though the 'aste as!et has an expecte& use)ul li)e o) +B "ears0 6t si$pl" is not 'orth the cost o) recor&ing &epreciation expense on such a s$all ite$ over its li)e0 The FA,B &e)ines $aterialit" as Kthe $agnitu&e o) an o$ission or $isstate$ent o) accounting in)or$ation that, in the light o) surroun&ing circu$stances, $a!es it pro a le that the 3u&g$ent o) a reasona le person rel"ing on the in)or$ation 'oul& have een change& or in)luence& " the o$ission or $isstate$entK0+ The ter$ $agnitu&e in this &e)inition suggests that the $aterialit" o) an ite$ $a" e assesse& e $aterial0 (aterialit" involves $ore than the relative &ollar a$ounts0 O)ten the nature o) the ite$ $a!es it $aterial0 For exa$ple, it $a" e 4uite signi)icant to !no' that a co$pan" is pa"ing ri es or $a!ing illegal political contri utions, even i) the &ollar a$ounts o) such ite$s are relativel" s$all0 Conser'atism Conservatis$ $eans eing cautious or pru&ent an& $a!ing sure that assets an& net inco$e are not overstate&0 ,uch overstate$ents can $islea& potential investors in the co$pan" an& cre&itors $a!ing loans to the co$pan"0 =e appl" conservatis$ 'hen the lo'er-o)-cost-or-$ar!et rule is use& )or inventor" (see Chapter @)0 Accountants $ust reali5e a )ine line exists conservative an& incorrect accounting0 ,ee %xhi it +B )or a su$$ar" o) the $o&i)"ing conventions an& their i$portance0 The next section o) this chapter &iscusses the conceptual )ra$e'or! pro3ect o) the Financial Accounting ,tan&ar&s Boar&0 The FA,B &esigne& the conceptual )ra$e'or! pro3ect to resolve so$e +FA,B, ,tate"ent o& Financial Accounting 9oncepts 6o. :, KOualitative Characteristics o) Accounting 6n)or$ationK (,ta$)or&, Conn0, 1>8B), p0 xv0 Cop"right Y " the Financial Accounting ,tan&ar&s Boar&, #igh :i&ge Par!, ,ta$)or&, Connecticut BD>BC, M0,0A0 Ouote& (or excerpte&) 'ith per$ission0 Copies o) the co$plete &ocu$ents are availa le )ro$ the FA,B0 p. ID8 o) *++ et'een " loo!ing at its relative si5e0 A M,< 1B,BBB error in an expense in a co$pan" 'ith earnings o) M,< +B,BBB is $aterial0 The sa$e error in a co$pan" earning M,< +B,BBB,BBB $a" not

&isagree$ents a out the proper theoretical )oun&ation )or accounting0 =e present onl" the portions o) the pro3ect relevant to this text0
!"inciple Exc0an)e3price #or cost% +esc"iption @equires transfers of resources to be recorded at 'rices a/reed on by the 'arties to the e1chan/e at the time of the e1chan/e. Revenue reco)nition @e+enues should be earned and reali?ed before they are reco/ni?ed (recorded&. #,po"tance .ells the accountant to record a transfer of resources at an ob8ecti+ely determinable amount at the time of the e1chan/e. Also" self<constructed assets are recorded at their actual cost rather than at some estimate of hat they ould ha+e cost if they had been 'urchased. Informs accountant that re+enues /enerally should be reco/ni?ed hen ser+ices are 'erformed or /oods are sold. E1ce'tions are made for items such as installment sales and lon/<term construction 'ro8ects. Indicates that e1'enses are to be recorded as soon as they are incurred rather than aitin/ until some future time. .ells the accountant to be conser+ati+e hen reco/ni?in/ /ains and losses. ;ains can only be reco/ni?ed hen they ha+e been reali?ed throu/h sale or e1chan/e. Losses should be reco/ni?ed as soon as they become e+ident. .hus" 'otential losses can be recorded" but only /ains that ha+e actually been reali?ed can be recorded. @equires the accountant to disclose e+erythin/ that is im'ortant. A /ood rule to follo isBif in doubt" disclose. Another /ood rule isBif you are not consistent" disclose all the facts and the effect on income.

*atc0in) Gain and loss reco)nition

E1'enses should be reco/ni?ed (recorded& as they are incurred to 'roduce re+enues. ;ains may be recorded only hen reali?ed" but losses should be recorded hen they first become e+ident.

/ull disclosure

Information im'ortant enou/h to influence the decisions of an informed user of the financial statements should be disclosed.

%xhi it I>: The $a3or principles
6odi<&in* Convention ,ost35ene(it +esc"iption 9'tional information should be included financial statements only if the benefits 'ro+idin/ it e1ceed its costs. #,po"tance

*aterialit2

,onservatis!

Lets the accountant kno that information that is not required should be made a+ailable only if its benefits e1ceed its costs. An e1am'le may be com'anies /oin/ to the e1'ense of 'ro+idin/ information on the effects of inflation hen the inflation rate is lo andCor users do not seem to benefit si/nificantly from the information. 9nly items that ould affect a Allo accountants to treat immaterial (relati+ely small dollar amount& information kno led/eable user's decision are in a theoretically incorrect but e1'edient manner. >or instance" a astebasket can be material (im'ortant& and must be e1'ensed rather than ca'itali?ed and de'reciated e+en thou/h it may last for ($ re'orted in a theoretically correct ay. years. .ransactions should be recorded so =arns accountants that assets and net income are not to be o+erstated. :Antici'ate that assets and net income are not (and record& all 'ossible losses and do not antici'ate (or record& any 'ossible /ains: o+erstated. is common ad+ice under this constraint. Also" conser+ati+e a''lication of the matchin/ 'rinci'le in+ol+es makin/ sure that ad8ustments for e1'enses for such items as uncollectible accounts" arranties" and de'reciation are adequate.

%xhi it +B: (o&i)"ing conventions

$.) The financial accounting standards board@s conceptual frame+or& project
%xperts have &e ate& the exact nature o) the asic concepts an& relate& principles co$posing accounting theor" )or "ears0 The &e ate continues to&a" &espite nu$erous re)erences to generall"

p. ID> o) *++

accepte& accounting principles (2AAP)0 To &ate, all atte$pts to present a concise state$ent o) 2AAP have receive& onl" li$ite& acceptance0 <ue to this li$ite& success, $an" accountants suggest that the starting point in reaching a concise state$ent o) 2AAP is to see! agree$ent on the o 3ectives o) )inancial accounting an& reporting0 The elie) is that i) a person (1) care)ull" stu&ies the environ$ent, (I) !no's 'hat o 3ectives are sought, (+) can i&enti)" certain 4ualitative traits o) accounting in)or$ation, an& (*) can &e)ine the asic ele$ents o) )inancial state$ents, that person can &iscover the principles an& stan&ar&s lea&ing to the state& o 3ectives0 The FA,B co$plete& the )irst three goals " pu lishing KO 3ectives o) Financial :eporting " Business %nterprisesK an& KOualitative Characteristics o) Accounting 6n)or$ationK0* A&&ressing the )ourth goal are concepts state$ents entitle& K%le$ents o) Financial ,tate$ents o) Business %nterprisesK an& K%le$ents o) Financial ,tate$entsK0C

$.18 /bjectives of financial reporting
Financial reporting ob2ecti'es are the roa& overri&ing goals sought " accountants engaging in )inancial reporting0 Accor&ing to the FA,B, the )irst o 3ective o) )inancial reporting is to: provi e in&or"ation t%at is use&ul to present an potential investors an cre itors an ot%er users in "aking rational invest"ent, cre it, an business an econo"ic activities an
8

si"ilar

ecisions. T%e

in&or"ation s%oul be co"pre%ensible to t%ose '%o %ave a reasonable un erstan ing o& are 'illing to stu y t%e in&or"ation 'it% reasonable iligence.

*FA,B, ,tate"ent o& Financial Accounting 9oncepts 6o. #, KO 3ectives o) Financial :eporting " Business %nterprisesK (,ta$)or&, Conn0, 1>@8)? an& ,tate"ent o& Financial Accounting 9oncepts 6o. :, KOualitative Characteristics o) Accounting 6n)or$ationK (,ta$)or&, Conn0, 1>8B)0 Cop"right Y " the Financial Accounting ,tan&ar&s Boar&, #igh :i&ge Par!, ,ta$)or&, Connecticut BD>BC, M0,0A0 Ouote& (or excerpte&) 'ith per$ission0 Copies o) the co$plete &ocu$ents are availa le )ro$ the FA,B0 CFA,B, ,tate"ent o& Financial Accounting 9oncepts 6o. ;, K%le$ents o) Financial ,tate$ents o) Business %nterprisesK (,ta$)or&, Conn0, 1>8B)? an& ,tate"ent o& Financial Accounting 9oncepts 6o. 8, K%le$ents o) Financial ,tate$entsK (,ta$)or&, Conn0, 1>8C)0 Cop"right Y " the Financial Accounting ,tan&ar&s Boar&, #igh :i&ge Par!, ,ta$)or&, Connecticut BD>BC, M0,0A0 Ouote& (or excerpte&) 'ith per$ission0 Copies o) the co$plete &ocu$ents are availa le )ro$ the FA,B0 DFA,B, ,tate"ent o& Financial Accounting 9oncepts 6o. #, p0 viii0 p. I@B o) *++

6nterprete& properl"0

roa&l", the ter$ other users inclu&es e$plo"ees, securit" anal"sts,

ro!ers, an&

la'"ers0 Financial reporting shoul& provi&e in)or$ation to all 'ho are 'illing to learn to use it The secon& o 3ective o) )inancial reporting is to: provi e in&or"ation to %elp present an &ro" potential investors an cre itors an ot%er users in assessing t%e a"ounts, ti"ing, an uncertainty o& prospective cas% receipts t%e procee s &ro" t%e sale,

ivi en s <o'ner 'it% ra'als= or interest an

re e"ption, or "aturity o& securities or loans. ,ince investors> an cre itors> cas% &lo's are relate to enterprise cas% &lo's, &inancial reporting s%oul provi e in&or"ation to %elp investors, cre itors, an ot%ers assess t%e a"ounts, ti"ing, an uncertainty o& prospective net cas% in&lo's to t%e relate enterprise. ? This o 3ective ties the cash )lo's o) investors (o'ners) an& cre&itors to the cash )lo's o) the enterprise, a tie-in that appears entirel" logical0 %nterprise cash in)lo's are the source o) cash )or &ivi&en&s, interest, an& the re&e$ption o) $aturing &e t0 Thir&, )inancial reporting shoul&: provi e in&or"ation about t%e econo"ic resources o& an enterprise, t%e clai"s to t%ose resources 3obligations o& t%e enterprise to trans&er resources to ot%er entities an o'ners> equity4, an t%e e&&ects o& transactions, events, an circu"stances t%at c%ange its resources an clai"s to t%ose resources.@ =e can &ra' so$e conclusions )ro$ these three o 3ectives an& )ro$ a stu&" o) the environ$ent in 'hich )inancial reporting is carrie& out0 For exa$ple, )inancial reporting shoul&:
 Provi&e in)or$ation a out an enterpriseJs past per)or$ance ecause such in)or$ation is a asis

)or pre&icting )uture enterprise per)or$ance0
 Focus on earnings an& its co$ponents, &espite the e$phasis in the o 3ectives on cash )lo's0

(%arnings co$pute& un&er the accrual

asis generall" provi&e a

etter in&icator o) a ilit" to

generate )avora le cash )lo's than &o state$ents prepare& un&er the cash asis0) On the other han&, )inancial reporting &oes not see! to:
 (easure the value o) an enterprise ut to provi&e in)or$ation use)ul in &eter$ining its value0  %valuate $anage$entJs per)or$ance, pre&ict earnings, assess ris!, or esti$ate earning po'er

ut to provi&e in)or$ation to persons 'ho 'ish to $a!e these evaluations0 @6 i&0 86 i&0 p. I@1 o) *++

These conclusions are so$e o) those reache& in ,tate"ent o& Financial Accounting 9oncepts 6o. #0 As the Boar& state&, these state$ents Kare inten&e& to esta lish the o 3ectives an& concepts that the Financial Accounting ,tan&ar&s Boar& 'ill use in &eveloping stan&ar&s o) )inancial accounting an& reportingK0> #o' success)ul the Boar& 'ill e in the approach a&opte& re$ains to e seen0

$.11 >ualitative characteristics
Accounting in)or$ation shoul& possess qualitati'e c%aracteristics to e use)ul in &ecision $a!ing0 This criterion is &i))icult to appl"0 The use)ulness o) accounting in)or$ation in a given instance &epen&s not onl" on in)or$ation characteristics ut also on the capa ilities o) the &ecision $a!ers an& their pro)essional a&visers0 Accountants cannot speci)" 'ho the &ecision $a!ers are, their characteristics, the &ecisions to e $a&e, or the $etho&s chosen to $a!e the &ecisions0 There)ore, the" &irect their attention to the characteristics o) accounting in)or$ation0 /ote the FA,BJs graphic su$$ari5ation o) the 4ualities accountants consi&er in %xhi it +1 1B To have rele'ance, in)or$ation $ust e pertinent to or a))ect a &ecision0 The in)or$ation $ust $a!e a &i))erence to so$eone 'ho &oes not alrea&" have it0 :elevant in)or$ation $a!es a &i))erence in a &ecision either " a))ecting usersJ pre&ictions o) outco$es o) past, present, or )uture events or " con)ir$ing or correcting expectations0 /ote that in)or$ation nee& not e a pre&iction to e use)ul in &eveloping, con)ir$ing, or altering expectations0 %xpectations are co$$onl" ase& on the present or past0 For exa$ple, an" atte$pt to pre&ict )uture earnings o) a co$pan" 'oul& 4uite li!el" start 'ith a revie' o) present an& past earnings0 Although in)or$ation that $erel" con)ir$s prior expectations $a" e less use)ul, it is still relevant ecause it re&uces uncertaint"0 Critics have allege& that certain t"pes o) accounting in)or$ation lac! relevance0 For exa$ple, so$e argue that a cost o) M,< 1 $illion pai& )or a tract o) lan& *B "ears ago an& reporte& in the current alance sheet at that a$ount is irrelevant (except )or possi le tax i$plications) to users )or &ecision $a!ing to&a"0 ,uch criticis$ has encourage& research into the t"pes o) in)or$ation relevant to users0 ,o$e suggest using a &i))erent valuation asis, such as current cost, in reporting such assets0 &re.icti'e 'alue an. 0ee.back 'alue ,ince actions ta!en no' can a))ect onl" )uture events, in)or$ation is o viousl" relevant 'hen it possesses pre.icti'e 'alue, or i$proves usersJ a ilities to pre&ict outco$es o) events0 6n)or$ation that reveals the relative success o) users in pre&icting outco$es possesses 0ee.back 'alue0 Fee& ac! reports on past activities an& can $a!e a &i))erence in

>6 i&0, p0 i0 1BFA,B, ,tate"ent o& Financial Accounting 9oncepts 6o. :, p0 1C0 p. I@I o) *++

&ecision $a!ing

" (1) re&ucing uncertaint" in a situation, (I) re)uting or con)ir$ing prior asis )or )urther pre&ictions0 For exa$ple, a report on the )irst

expectations, an& (+) provi&ing a

4uarterJs earnings o) a co$pan" re&uces the uncertaint" surroun&ing the a$ount o) such earnings, con)ir$s or re)utes the pre&icte& a$ount o) such earnings, an& provi&es a possi le asis on 'hich to pre&ict earnings )or the )ull "ear0 :e$e$ er that although accounting in)or$ation $a" possess pre&ictive value, it &oes not consist o) pre&ictions0 (a!ing pre&ictions is a )unction per)or$e& " the &ecision $a!er0 $imeliness $imeliness re4uires accountants to provi&e accounting in)or$ation at a ti$e 'hen it $a" e consi&ere& in reaching a &ecision0 Mtilit" o) in)or$ation &ecreases 'ith age0 To !no' 'hat the net inco$e )or IB1B 'as in earl" IB11 is $uch $ore use)ul than receiving this in)or$ation a "ear later0 6) in)or$ation is to e o) an" value in &ecision $a!ing, it $ust e availa le e)ore the &ecision is $a&e0 6) not, the in)or$ation is o) little value0 6n &eter$ining 'hat constitutes ti$el" in)or$ation, accountants consi&er the other 4ualitative characteristics an& the cost o) gathering in)or$ation0 For exa$ple, a ti$el" esti$ate )or uncollecti le accounts $a" e $ore valua le than a later, veri)ie& actual a$ount0 Ti$eliness alone cannot $a!e in)or$ation relevant, ut potentiall" relevant in)or$ation can e ren&ere& irrelevant " a lac! o) ti$eliness0

%xhi it +1: A hierarch" o) accounting 4ualities
p. I@+ o) *++

6n a&&ition to eing relevant, in)or$ation $ust e relia le to e use)ul0 6n)or$ation has reliability 'hen it )aith)ull" &epicts )or users 'hat it purports to represent0 Thus, accounting in)or$ation is relia le i) users can &epen& on it to re)lect the un&erl"ing econo$ic activities o) the organi5ation0 The relia ilit" o) in)or$ation &epen&s on its representational )aith)ulness, veri)ia ilit", an& neutralit"0 The in)or$ation $ust also e co$plete an& )ree o) ias0 :epresentational 0ait%0ulness To gain insight into this 4ualit", consi&er a $ap0 =hen it sho's roa&s an& ri&ges 'here roa&s an& ri&ges actuall" exist, a $ap possesses representational 0ait%0ulness0 A correspon&ence exists et'een 'hat is on the $ap an& 'hat is present ph"sicall"0 ,i$ilarl", representational )aith)ulness exists 'hen accounting state$ents on econo$ic activit" correspon& to the actual un&erl"ing activit"0 =here there is no correspon&ence, the cause $a" e (1) ias or (I) lac! o) co$pleteness0
 -00ects o0 bias0 Accounting $easure$ents contain bias i) the" are consistentl" too high or too

lo'0 Accountants create ias in accounting $easure$ents " choosing the 'rong $easure$ent $etho& or intro&ucing ias either &eli eratel" or through lac! o) s!ill0
 Completeness0 To e )ree )ro$ ias, in)or$ation $ust e su))icientl" co$plete to ensure that

it vali&l" represents un&erl"ing events an& con&itions0 Completeness $eans &isclosing all signi)icant in)or$ation in a 'a" that ai&s un&erstan&ing an& &oes not $islea&0 Fir$s can re&uce the relevance o) in)or$ation " o$itting in)or$ation that 'oul& $a!e a &i))erence to users0 alance sheet, an inco$e state$ent, a Currentl", )ull &isclosure re4uires presentation o) a

state$ent o) cash )lo's, an& necessar" notes to the )inancial state$ents an& supporting sche&ules0 Also re4uire& in annual reports o) corporations are state$ents o) changes in stoc!hol&ersJ e4uit" 'hich contain in)or$ation inclu&e& in a state$ent o) retaine& earnings0 ,uch state$ents $ust e co$plete, 'ith ite$s properl" classi)ie& an& segregate& (such as reporting sales revenue separatel" )ro$ other revenues)0 :e4uire& &isclosures $a" e $a&e in (1) the o&" o) the )inancial state$ents, (I) the notes to such state$ents, (+) special co$$unications, an&7or (*) the presi&entJs letter or other $anage$ent reports in the annual report0 Another aspect o) co$pleteness is )ull" &isclosing all changes in accounting principles an& their e))ects011 <isclosure shoul& inclu&e unusual activities (loans to o))icers), changes in expectations (losses on inventor"), &epreciation expense )or the perio&, long-ter$ o ligations entere& into that are not recor&e& " the accountant (a IB-"ear lease on a uil&ing), ne' arrange$ents 'ith certain groups (pension an& pro)it-sharing plans )or e$plo"ees), an& signi)icant events that occur a)ter the &ate o) the 11APB, APB Opinion /o0 IB, KAccounting ChangesK (/e' .or!: A6CPA, ;ul" 1>@1)0 p. I@* o) *++

state$ents (loss o) a $a3or custo$er)0 Fir$s $ust also &isclose accounting policies ($a3or principles an& their $anner o) application) )ollo'e& in preparing the )inancial state$ents01I Because o) its e$phasis on &isclosure, 'e o)ten call this aspect o) relia ilit" the )ull &isclosure principle0 Beri0iability Financial in)or$ation has 'eri0iability 'hen in&epen&ent $easurers can su stantiall" &uplicate it " using the sa$e $easure$ent $etho&s0 Geri)ia ilit" eli$inates $easurer ias0 The re4uire$ent that )inancial in)or$ation e ase& on o 3ective evi&ence arises )ro$ the &e$onstrate& nee&s o) users )or relia le, un iase& )inancial in)or$ation0 Mn iase& in)or$ation is especiall" necessar" 'hen parties 'ith opposing interests (cre&it see!ers an& cre&it grantors) rel" on the sa$e in)or$ation0 6) the in)or$ation is veri)ia le, this enhances the relia ilit" o) in)or$ation0 Financial in)or$ation is never co$pletel" )ree o) su 3ective opinion an& 3u&g$ent? it al'a"s possesses var"ing &egrees o) veri)ia ilit"0 Cancele& chec!s an& invoices support so$e $easure$ents0 Accountants can never veri)" other $easure$ents, such as perio&ic &epreciation charges, ecause o) their ver" nature0 Thus, )inancial in)or$ation in $an" instances is veri)ia le onl" in that it represents a consensus o) 'hat other accountants 'oul& report i) the" )ollo'e& the sa$e proce&ures0 !eutrality !eutrality $eans that the accounting in)or$ation shoul& e )ree o) $easure$ent $etho& ias0 The pri$ar" concern shoul& e relevance an& relia ilit" o) the in)or$ation that results )ro$ application o) the principle, not the e))ect that the principle $a" have on a particular interest0 /on-neutral accounting in)or$ation )avors one set o) intereste& parties over others0 For exa$ple, a particular )or$ o) $easure$ent $ight )avor stoc!hol&ers over cre&itors, or vice versa0 KTo e neutral, accounting in)or$ation $ust report econo$ic activit" as )aith)ull" as possi le, 'ithout coloring the i$age it co$$unicates )or the purpose o) in)luencing activit"0 Geri)ia ilit" see!s to eli$inate $easurer $etho& ias0 =hen comparability exists, reporte& &i))erences an& si$ilarities in )inancial in)or$ation are real an& not the result o) &i))ering accounting treat$ents0 Co$para le in)or$ation reveals relative strengths an& 'ea!nesses in a single co$pan" through ti$e an& et'een t'o or $ore co$panies at the sa$e ti$e0 Consistency re4uires that a co$pan" use the sa$e accounting principles an& reporting practices through ti$e0 Consistenc" lea&s to co$para ilit" o) )inancial in)or$ation )or a single co$pan" 1IAPB, APB Opinion /o0 II, K<isclosure o) Accounting PoliciesK (/e' .or!: A6CPA, April 1>@I)0 1+FA,B, ,tate"ent o& Financial Accounting 9oncepts 6o. :, par0 1BB0 p. I@C o) *++ ehavior in so$e particular &irection0K 1+ Accounting stan&ar&s are not li!e tax regulations that &eli eratel" )oster or restrain certain t"pes o) ias? neutralit" see!s to eli$inate $easure$ent

through ti$e0 Co$para ilit" et'een co$panies is $ore &i))icult ecause the" $a" account )or the sa$e activities in &i))erent 'a"s0 For exa$ple, Co$pan" B $a" use one $etho& o) &epreciation, 'hile Co$pan" C accounts )or an i&entical asset in si$ilar circu$stances using another $etho&0 A high &egree o) inter-co$pan" co$para ilit" in accounting in)or$ation &oes not exist unless accountants are re4uire& to account )or the sa$e activities in the sa$e $anner across co$panies an& through ti$e0 As 'e sho' in %xhi it +1, accountants $ust consi&er one pervasive constraint an& one threshol& )or recognition in provi&ing use)ul in)or$ation0 First, the ene)its secure& )ro$ the in)or$ation $ust e greater than the costs o) provi&ing that in)or$ation0 ,econ&, onl" $aterial ite$s nee& e &isclose& an& accounte& )or strictl" in accor&ance 'ith generall" accepte& accounting principles (2AAP)0 =e &iscusse& cost- ene)it an& $aterialit" earlier in the chapter0

#n accounting perspecti'e: 6se o0 tec%nology
.ou $a" 'ant to visit the ho$e page o) the Financial Accounting ,tan&ar&s Boar& at: http:77'''0)as 0org .ou can chec! out the latest &evelop$ents at the FA,B to see ho' the rules o) accounting $ight e changing0 .ou can investigate )acts a out the FA,B, press releases, exposure &ra)ts, pu lications, e$erging issues, oar& actions, )orthco$ing $eetings, an& $an" other topics0

$.12 The basic elements of financial statements
Thus )ar 'e have &iscusse& o 3ectives o) )inancial reporting an& 4ualitative characteristics o) accounting in)or$ation0 A thir& i$portant tas! in &eveloping a conceptual )ra$e'or! )or an" &iscipline is i&enti)"ing an& &e)ining its asic ele$ents0 The FA,B i&enti)ie& an& &e)ine& the asic ele$ents o) )inancial state$ents in 9oncepts ,tate"ent 6o. ;. Aater, 9oncepts ,tate"ent 6o. 8 revise& so$e o) the &e)initions0 =e &e)ine& $ost o) the ter$s earlier in this text in a less technical 'a"? the $ore technical &e)initions )ollo'0 (These ite$s are not repeate& in this chapterJs Ne" ter$s0) #ssets are pro a le )uture econo$ic ene)its o taine& or controlle& " a particular entit" as a result o) past transactions or events0 Liabilities are pro a le )uture sacri)ices o) econo$ic ene)its arising )ro$ present o ligations o) a particular entit" to trans)er assets or provi&e services to other entities in the )uture as a result o) past transactions or events0 -quity or net assets is the resi&ual interest in the assets o) an entit" that re$ains a)ter &e&ucting its lia ilities0 6n a usiness enterprise, the e4uit" is the o'nership interest0 6n a not-)or-pro)it p. I@D o) *++

organi5ation, 'hich has no o'nership interest in the sa$e sense as a usiness enterprise, net assets is &ivi&e& into three classes ase& on the presence or a sence o) &onor-i$pose& restrictionsL per$anentl" restricte&, te$poraril" restricte&, an& unrestricte& net assets0 Compre%ensi'e income is the change in e4uit" o) a usiness enterprise &uring a perio& )ro$ transactions an& other events an& circu$stances )ro$ non-o'ner sources0 6t inclu&es all changes in e4uit" &uring a perio& except those resulting )ro$ invest$ents " o'ners an& &istri utions to o'ners0 :e'enues are in)lo's or other enhance$ents o) assets o) an" entit" or settle$ents o) its lia ilities (or a co$ ination o) oth) )ro$ &elivering or pro&ucing goo&s, ren&ering services, or other activities that constitute the entit"Js ongoing $a3or or central operations0 -xpenses are out)lo's or other using up o) assets or incurrences o) lia ilities (or a co$ ination o) oth) )ro$ &elivering or pro&ucing goo&s, ren&ering services, or carr"ing out other activities that constitute the entit"Js ongoing $a3or or central operations0 9ains are increases in e4uit" (net assets) )ro$ peripheral or inci&ental transactions o) an entit" an& )ro$ all other transactions an& other events an& circu$stances a))ecting the entit" except those that result )ro$ revenues or invest$ents " o'ners0 Losses are &ecreases in e4uit" (net assets) )ro$ peripheral or inci&ental transactions o) an entit" an& )ro$ all other transactions an& other events an& circu$stances a))ecting the entit" except those that result )ro$ expenses or &istri utions to o'ners0 1n'estments by owners are increases in e4uit" o) a particular usiness enterprise resulting )ro$ trans)ers to it )ro$ other entities o) so$ething valua le to o tain or increase o'nership interests (or e4uit") in it0 Assets are $ost co$$onl" receive& as invest$ents " o'ners, ut that 'hich is receive& $a" also inclu&e services or satis)action or conversion o) lia ilities o) the enterprise0 <istributions to owners are &ecreases in e4uit" o) a particular usiness enterprise resulting )ro$ trans)erring assets, ren&ering services, or incurring lia ilities " the enterprise to o'ners0 <istri utions to o'ners &ecrease o'nership interest (or e4uit") in an enterprise0 1*

1*FA,B, ,tate"ent o& Financial Accounting 9oncepts 6o. 80 p. I@@ o) *++

#n accounting perspecti'e: Business insig%t
Accountants recor& expen&itures on ph"sical resources such as lan&, uil&ings, an& e4uip$ent that ene)it )uture perio&s as assets0 #o'ever, the" expense expen&itures on hu$an resources )or hiring an& training that ene)it )uture perio&s0 Also, 'hen a co$puter is &roppe& an& &estro"e&, accountants recor& a loss0 #o'ever, 'hen the presi&ent o) the co$pan" &ies, the" recor& no loss0 ,houl& the accounting $o&el e change& regar&ing the accounting )or hu$an resourcesQ

$.13 7ecognition and measurement in financial statements
6n <ece$ er 1>8*, the FA,B issue& ,tate"ent o& Financial Accounting 9oncepts 6o. A, K:ecognition an& (easure$ent in Financial ,tate$ents o) Business %nterprisesK, &escri ing recognition criteria an& provi&ing gui&ance )or the ti$ing an& nature o) in)or$ation inclu&e& in )inancial state$ents01C The recognition criteria esta lishe& in the ,tate$ent are )airl" consistent 'ith those use& in current practice0 The ,tate$ent in&icates, ho'ever, that 'hen in)or$ation $ore use)ul than currentl" reporte& in)or$ation is availa le at a reasona le cost, it shoul& e inclu&e& in )inancial state$ents0

$.1! 6ummar of significant accounting policies
As part o) their annual reports, co$panies inclu&e su$$aries o) signi)icant accounting policies0 These policies assist users in interpreting the )inancial state$ents0 To a large extent, accounting theor" &eter$ines the nature o) these policies0 Co$panies $ust )ollo' generall" accepte& accounting principles in preparing their )inancial state$ents0 The accounting policies o) The =alt <isne" Co$pan", one o) the 'orl&Js lea&ing entertain$ent co$panies, as containe& in a recent annual report )ollo'0 A)ter each, the chapter o) this text 'here 'e &iscuss that particular polic" is in parentheses0 =hile a )e' o) the ite$s have alrea&" een covere&, the re$ain&er o))er a previe' o) the concepts explaine& in later chapters0 1CFA,B, ,tate"ent o& Financial Accounting 9oncepts 6o. A, K:ecognition an& (easure$ent in Financial ,tate$ents o) Business %nterprisesK (,ta$)or&, Conn0, 1>8*)0 Cop"right Y " the Financial Accounting ,tan&ar&s Boar&, #igh :i&ge Par!, ,ta$)or&, Connecticut BD>BC, M0,0A0 Copies o) the co$plete &ocu$ent are availa le )ro$ the FA,B0 (6n case "ou are 'on&ering 'h" 'e &o not $ention ,tate"ent o& Financial Accounting 9oncepts 6o. B , it pertains to accounting )or not-)or-pro)it organi5ations an& is, there)ore, not relevant to this text0) p. I@8 o) *++

#n et%ical perspecti'e: 8aple%urst company
(aplehurst Co$pan" $anu)actures large spinning $achines )or the textile in&ustr"0 The co$pan" ha& purchase& M,< 1BB,BBB o) s$all han& tools to use in its usiness0 The co$pan"Js accountant recor&e& the tools in an asset account an& 'as going to 'rite the$ o)) over IB "ears0 (anage$ent 'ante& to 'rite these tools o)) as an expense o) this "ear ecause revenues this "ear ha& een a nor$all" high an& 'ere expecte& to e lo'er in the )uture0 (anage$entJs goal 'as to s$ooth out inco$e rather than sho'ing sharp increases an& &ecreases0 =hen tol& 1BB,BBB 'as a $aterial ite$ that $ust " the accountant that M,< e accounte& )or in a theoreticall" correct

$anner, $anage$ent &eci&e& to consi&er the tools as consisting o) 1B groups, each having a cost o) M,< 1B,BBB0 ,ince a$ounts un&er M,< IB,BBB are consi&ere& i$$aterial )or this co$pan", all o) the tools coul& then e charge& to expense this "ear0 The accountant is concerne& a out this treat$ent0 ,he &ou ts that she coul& success)ull" &e)en& $anage$entJs position i) the au&itors challenge the expensing o) these ite$s0

$.1# 6ignificant accounting policies
$.1#.1 1rinciples of consolidation

The consoli&ate& )inancial state$ents o) the Co$pan" inclu&e the accounts o) The =alt <isne" Co$pan" an& its su si&iaries a)ter eli$ination o) inter-co$pan" accounts an& transactions0 6nvest$ents in a))iliate& co$panies are accounte& )or using the e4uit" $etho&0 (Chapter 1*)

$.1#.2

Accounting changes

The Co$pan" change& its $etho& o) accounting )or pre-opening costs (see /ote 1I)0 These changes ha& no cash i$pact0 The pro )or$a a$ounts presente& in the consoli&ate& state$ent o) inco$e re)lect the e))ect o) retroactive application o) expensing pre-opening costs0 (Chapters 1+ an& 1*)

$.1#.3

7evenue recognition

:evenues )ro$ the theatrical &istri ution o) $otion pictures are recogni5e& 'hen $otion pictures are exhi ite&0 Television licensing revenues are recor&e& 'hen the progra$ $aterial is availa le )or p. I@> o) *++

telecasting " the licensee an& 'hen certain other con&itions are $et0 :evenues )ro$ vi&eo sales are recogni5e& on the &ate that vi&eo units are $a&e 'i&el" availa le )or sale " retailers0 :evenues )ro$ participants an& sponsors at the the$e par!s are generall" recor&e& over the perio& o) the applica le agree$ents co$$encing 'ith the opening o) the relate& attraction0 (Chapter C)

$.1#.!

Cash? cash e2uivalents and investments

Cash an& cash e4uivalents consist o) cash on han& an& $ar!eta le securities 'ith original $aturities o) three $onths or less0 (Chapter 8) ,FA, ##A re4uires that certain invest$ents in &e t an& e4uit" securities e classi)ie& into one o) three categories0 <e t securities that the Co$pan" has the positive intent an& a ilit" to hol& to $aturit" are classi)ie& as Khel&-to-$aturit"K an& reporte& at a$orti5e& cost0 <e t securities not classi)ie& as hel&-to-$aturit" an& $ar!eta le e4uit" securities are classi)ie& as either Ktra&ingK or Kavaila le-)or-saleK, an& are recor&e& at )air value 'ith unreali5e& gains an& losses inclu&e& in earnings or stoc!hol&ersJ e4uit", respectivel"0 (Chapter 1*)

$.1#.#

=erchandise inventories

Carr"ing a$ounts o) $erchan&ise, $aterials an& supplies inventories are generall" &eter$ine& on a $oving average cost asis an& are state& at the lo'er o) cost or $ar!et0 (Chapter @)

$.1#.$

"ilm and television costs
ase& on the ratio o) the

Fil$ an& television pro&uction an& participation costs are expense& pro&uction

current perio&Js gross revenues to esti$ate& total gross revenues )ro$ all sources on an in&ivi&ual asis0 %sti$ates o) total gross revenues are revie'e& perio&icall" an& a$orti5ation is a&3uste& accor&ingl"0 Television roa&cast rights are a$orti5e& principall" on an accelerate& asis over the esti$ate& use)ul lives o) the progra$s0 (Chapter 11)

$.1#.%

Theme par&s? resorts and other propert

The$e par!s, resorts an& other propert" are carrie& at cost0 <epreciation is co$pute& on the straight-line $etho& ase& upon esti$ate& use)ul lives ranging )ro$ three to )i)t" "ears0 (Chapter +)

$.1#.'

/ther assets

:ights to the na$e, li!eness an& portrait o) =alt <isne", goo&'ill an& other intangi le assets are a$orti5e& over perio&s ranging )ro$ t'o to )ort" "ears0 (Chapter 11)

p. I8B o) *++

$.1#.)

7is& management contracts

6n the nor$al course o) usiness, the Co$pan" e$plo"s a variet" o) o))- alance-sheet )inancial instru$ents to $anage its exposure to )luctuations in interest an& )oreign currenc" exchange rates, inclu&ing interest rate an& cross-currenc" s'ap agree$ents, )or'ar& an& option contracts, an& interest rate exchange-tra&e& )utures0 The co$pan" &esignates interest rate an& cross-currenc" s'aps as he&ges o) invest$ents an& &e t, an& accrues the &i))erential to e pai& or receive& un&er the agree$ents as interest rates change over the lives o) the contracts0 <i))erences pai& or receive& on s'ap agree$ents are recogni5e& as a&3ust$ents to interest inco$e or expense over the li)e o) the s'aps, there " a&3usting the e))ective interest rate on the un&erl"ing invest$ent or o ligation0 2ains an& losses on the ter$ination o) s'ap agree$ents, prior to the original $aturit", are &e)erre& an& a$orti5e& to interest inco$e or expense over the original ter$ o) the s'aps0 2ains an& losses arising )ro$ interest rate )utures, )or'ar&s an& option contracts, an& )oreign currenc" )or'ar& an& option contracts are recogni5e& in inco$e or expense as o))sets o) gains an& losses resulting )ro$ the un&erl"ing he&ge& transactions0 (Chapter 1*) Cash )lo's )ro$ interest rate an& )oreign exchange ris! $anage$ent activities are classi)ie& in the sa$e categor" as the cash )lo's )ro$ the relate& invest$ent, orro'ing or )oreign exchange activit"0 (Chapter 1D) The Co$pan" classi)ies its &erivative )inancial instru$ents as hel& or issue& )or purposes other than tra&ing0 (Chapter 1*)

$.1#.18 Earnings per share
%arnings per share a$ounts are ase& upon the 'eighte& average nu$ er o) co$$on an& co$$on e4uivalent shares outstan&ing &uring the "ear0 Co$$on e4uivalent shares are exclu&e& )ro$ the co$putation in perio&s in 'hich the" have an anti&ilutive e))ect0 (Chapter 1+) As "ou procee& through the re$aining chapters, "ou can see the accounting theories intro&uce& in this chapter eing applie&0 6n Chapter D, )or instance, 'e &iscuss 'h" sales revenue is recogni5e& an& recor&e& onl" a)ter goo&s have een &elivere& to the custo$er0 ,o )ar, 'e have use& service co$panies to illustrate accounting techni4ues0 Chapter D intro&uces $erchan&ising operations0 (erchan&ising co$panies, such as clothing stores, u" goo&s in their )inishe& )or$ an& sell the$ to custo$ers0

p. I81 o) *++

$.1$ .nderstanding the learning objectives
 The $a3or un&erl"ing assu$ptions or concepts o) accounting are (1)

usiness entit", (I) going

concern (continuit"), (+) $one" $easure$ent, (*) sta le &ollar, (C) perio&icit", an& (D) accrual asis an& perio&icit"0
 Other

asic accounting concepts that a))ect the accounting )or entities are (1) general-purpose

)inancial state$ents, (I) su stance over )or$, (+) consistenc", (*) &ou le entr", an& (C) articulation0
 The $a3or principles inclu&e exchange-price (or cost), revenue recognition, $atching, gain an&

loss recognition, an& )ull &isclosure0 (a3or exceptions to the reali5ation principle inclu&e cash collection as point o) revenue recognition, install$ent asis o) revenue recognition, an& the percentage-o)-co$pletion $etho& o) recogni5ing revenue on long-ter$ construction pro3ects0
 (o&i)"ing conventions inclu&e cost- ene)it, $aterialit", an& conservatis$0  The FA,B has &e)ine& the o 3ectives o) )inancial reporting, 4ualitative characteristics o)

accounting in)or$ation, an& ele$ents o) )inancial state$ents0
 Financial reporting o 3ectives are the roa& overri&ing goals sought " accountants engaging in

)inancial reporting0
 Oualitative characteristics are those that accounting in)or$ation shoul& possess to e use)ul in

&ecision $a!ing0 The t'o pri$ar" 4ualitative characteristics are relevance an& relia ilit"0 Another 4ualitative characteristic is co$para ilit"0
 Pervasive constraints inclu&e cost- ene)it anal"sis an& $aterialit"0  The FA,B has i&enti)ie& an& &e)ine& the asic ele$ents o) )inancial state$ents0  The FA,B has also &escri e& revenue recognition criteria an& provi&e& gui&ance as to the ti$ing

an& nature o) in)or$ation to e inclu&e& in )inancial state$ents0
 The su$$ar" o) signi)icant accounting policies ai& users in interpreting the )inancial

state$ents0
 To a large extent, accounting theor" &eter$ines the nature o) those policies0

$.1$.1

Demonstration problem

For each o) the )ollo'ing transactions or circu$stances an& the entries $a&e, state 'hich, i) an", o) the assu$ptions, concepts, principles, or $o&i)"ing conventions o) accounting have een violate&0 For each violation, give the entr" to correct the i$proper accounting assu$ing the oo!s have not een close&0 <uring the "ear, <orse" Co$pan" &i& the )ollo'ing: p. I8I o) *++

 #a& its uil&ings appraise&0 The" 'ere )oun& to have a $ar!et value o) M,< *1B,BBB, although

their oo! value 'as onl" M,< +8B,BBB0 The accountant &e ite& the Buil&ings an& Accu$ulate& <epreciationLBuil&ings accounts )or M,< 1C,BBB each an& cre&ite& Pai&-in CapitalLFro$ Appreciation0 /o separate $ention 'as $a&e o) this action in the )inancial state$ents0
 Purchase& ne' electric pencil sharpeners )or its o))ices at a total cost o) M,< DB0 These pencil

sharpeners 'ere recor&e& as assets an& are eing &epreciate& over )ive "ears0

$.1$.1.1

6olution to demonstration problem

 The cost principle an& the $o&i)"ing convention o) conservatis$ $a" have een violate&0 ,uch

'rite-ups si$pl" are not loo!e& on 'ith )avor in accounting0 To correct the situation, the entr" $a&e nee&s to e reverse&:
.a%d-%n Ca1%tal !u%ld%n+ Accumulated :e1rec%at%onG!u%ld%n+ 0"000 1<"000 1<"000

 Theoreticall", no violations occurre&, ut the cost o) co$piling insigni)icant in)or$ation coul&

e consi&ere& a violation o) accepta le accounting practice0 As a practical $atter, the M,< DB coul& have een expense& on $aterialit" groun&s.

$.1$.2

;e terms

#ccounting t%eory KA set o) asic concepts an& assu$ptions an& relate& principles that explain an& gui&e the accountantJs actions in i&enti)"ing, $easuring, an& co$$unicating econo$ic in)or$ationK0 Bias %xists 'hen accounting $easure$ents are consistentl" too high or too lo'0 Business entity concept The speci)ic unit )or 'hich accounting in)or$ation is gathere&0 Business entities have a separate existence )ro$ o'ners, cre&itors, e$plo"ees, custo$ers, other intereste& parties, an& other usinesses0 Comparability A 4ualitative characteristic o) accounting in)or$ation? 'hen in)or$ation is co$para le, it reveals &i))erences an& si$ilarities that are real an& are not the result o) &i))ering accounting treat$ents0 Complete.-contract met%o. A $etho& o) recogni5ing revenue on long-ter$ pro3ects un&er 'hich no revenue is recogni5e& until the perio& in 'hich the pro3ect is co$plete&? si$ilar to recogni5ing revenue upon the co$pletion o) a sale0 Completeness A 4ualitative characteristic o) accounting in)or$ation? re4uires &isclosure o) all signi)icant in)or$ation in a 'a" that ai&s un&erstan&ing an& &oes not $islea&? so$eti$es calle& the )ull &isclosure principle0 Conser'atism Being cautious or pru&ent an& $a!ing sure that net assets an& net inco$e are not overstate&0 Consistency :e4uires a co$pan" to use the sa$e accounting principles an& reporting practices through ti$e0

p. I8+ o) *++

Cost-bene0it consi.eration <eter$ining 'hether ene)its o) inclu&ing in)or$ation in )inancial state$ents excee& costs0 Cost principle ,ee %xchange-price principle0 -arning principle The re4uire$ent that revenue e su stantiall" earne& e)ore it is recogni5e& (recor&e&)0 -xc%ange-price (or cost) principle Trans)ers o) resources are recor&e& at prices agree& on " the parties at the ti$e o) the exchange0 Fee.back 'alue A 4ualitative characteristic that in)or$ation has 'hen it reveals the relative success o) users in pre&icting outco$es0 Financial reporting ob2ecti'es The roa& overri&ing goals sought " accountants engaging in )inancial reporting0 Full .isclosure principle 6n)or$ation i$portant enough to in)luence the &ecisions o) an in)or$e& user o) the )inancial state$ents shoul& e &isclose&0 9ain an. loss recognition principle 2ains $a" e recor&e& onl" 'hen reali5e&, ut losses shoul& e recor&e& 'hen the" )irst eco$e evi&ent0 9ains T"picall" result )ro$ the sale o) long-ter$ assets )or $ore than their oo! value0 9oing-concern (continuity) assumption The assu$ption that an entit" 'ill continue to operate in&e)initel" unless strong evi&ence exists that the entit" 'ill ter$inate0 =istorical cost The a$ount pai&, or the )air $ar!et value o) a lia ilit" incurre& or other resources surren&ere&, to ac4uire an asset an& place it in a con&ition an& position )or its inten&e& use0 1nstallment basis A revenue recognition proce&ure in 'hich the percentage o) total gross $argin recogni5e& in a perio& on an install$ent sale is e4ual to the percentage o) total cash )ro$ the sale that is receive& in that perio&0 Liqui.ation Ter$inating a usiness " ceasing usiness operations an& selling o)) its assets0 Losses Asset expirations that are usuall" involuntar" an& &o not create revenues0 8atc%ing principle %xpenses shoul& e recogni5e& as the" are incurre& to pro&uce revenues0 8ateriality A $o&i)"ing convention that allo's the accountant to &eal 'ith i$$aterial (uni$portant) ite$s in an expe&ient ut theoreticall" incorrect $anner? also a 4ualitative characteristic speci)"ing that )inancial accounting report onl" in)or$ation signi)icant enough to in)luence &ecisions or evaluations0 8o.i0ying con'entions Custo$s e$erging )ro$ accounting practice that alter the results o taine& )ro$ a strict application o) accounting principles? conservatis$ is an exa$ple0 8oney measurement Mse o) a $onetar" unit o) $easure$ent, such as the &ollar, instea& o) ph"sical or other units o) $easure$entL)eet, inches, gra$s, an& so on0 !eutrality A 4ualitative characteristic that re4uires accounting in)or$ation to e )ree o) $easure$ent $etho& ias0 &ercentage-o0-completion met%o. A $etho& o) recogni5ing revenue ase& on the esti$ate& stage o) co$pletion o) a long-ter$ pro3ect0 The stage o) co$pletion is $easure& " co$paring actual costs incurre& in a perio& 'ith total esti$ate& costs to e incurre& in all perio&s0 &erio. costs Costs that cannot e trace& to speci)ic pro&ucts an& are expense& in the perio& incurre&0

p. I8* o) *++

&erio.icity (time perio.s) assumption An assu$ption o) the accountant that an entit"Js li)e can e &ivi&e& into ti$e perio&s )or reporting its econo$ic activities0 &re.icti'e 'alue A 4ualitative characteristic that in)or$ation has 'hen it i$proves usersJ a ilities to pre&ict outco$es o) events0 &ro.uct costs Costs incurre& in the ac4uisition or $anu)acture o) goo&s0 Pro&uct costs are accounte& )or as i) the" 'ere attache& to the goo&s, 'ith the result that the" are charge& to expense 'hen the goo&s are sol&0 Hualitati'e c%aracteristics Characteristics that accounting in)or$ation shoul& possess to e use)ul in &ecision $a!ing0 :eali4ation principle A principle that &irects that revenue is recogni5e& onl" a)ter the seller ac4uires the right to receive pa"$ent )ro$ the u"er0 :ele'ance A 4ualitative characteristic re4uiring that in)or$ation e pertinent to or a))ect a &ecision0 :eliability A 4ualitative characteristic re4uiring that in)or$ation )aith)ull" &epict )or users 'hat it purports to represent0 :epresentational 0ait%0ulness A 4ualitative characteristic re4uiring that accounting state$ents on econo$ic activit" correspon& to the actual un&erl"ing activit"0 :e'enue recognition principle The principle that revenues shoul& e earne& an& reali5e& e)ore the" are recogni5e& (recor&e&)0 "table .ollar assumption An assu$ption that the &ollar is a reasona l" sta le unit o) $easure$ent0 $imeliness A 4ualitative characteristic re4uiring that accounting in)or$ation e provi&e& at a ti$e 'hen it $a" e consi&ere& e)ore $a!ing a &ecision0 Beri0iability A 4ualitative characteristic o) accounting in)or$ation? in)or$ation is veri)ia le 'hen it can e su stantiall" &uplicate& " in&epen&ent $easurers using the sa$e $easure$ent $etho&s0

$.1$.3
$rue-0alse

6elf<test

6n&icate 'hether each o) the )ollo'ing state$ents is true or )alse0 o o o o o o The usiness entit" concept assu$es that each usiness has an existence separate )ro$ all parties except its o'ners0 =hen the su stance o) a transaction &i))ers )ro$ its legal )or$, the accountant shoul& recor& the econo$ic su stance0 The $atching principle is )un&a$ental to the accrual asis o) accounting0 %xceptions to the reali5ation principle inclu&e the install$ent asis o) revenue recognition )or sales revenue an& the co$plete&-contract $etho& )or long-ter$ construction pro3ects0 6$$aterial ite$s &o not have to e recor&e& at all0 The conceptual )ra$e'or! pro3ect resulte& in i&enti)"ing t'o pri$ar" 4ualitative characteristics that accounting in)or$ation shoul& possessLrelevance an& relia ilit"0 p. I8C o) *++

8ultiple-c%oice ,elect the est ans'er )or each o) the )ollo'ing 4uestions0 The un&erl"ing assu$ptions o) accounting inclu&es all the )ollo'ing except: a0 Business entit"0 0 2oing concern0 c0 (atching0 &0 (one" $easure$ent an& perio&icit"0 The concept that re4uires co$panies to use the sa$e accounting practices an& reporting practices through ti$e is: a0 ,u stance over )or$0 0 Consistenc"0 c0 Articulation0 &0 /one o) the a ove0 =hich o) the )ollo'ing state$ents is )alse regar&ing the revenue recognition principleQ a0 :evenue $ust e su stantiall" earne& e)ore it is recogni5e&0 0 The accountant usuall" recogni5es revenue pa"$ent )ro$ the u"er0 c0 ,o$e s$all co$panies use the cash asis o) accounting0 &0 Mn&er the install$ent asis, the gross $argin recogni5e& in a perio& is e4ual to the a$ount o) cash receive& )ro$ install$ent sales ti$es the gross $argin percentage )or the "ear o) sale0 Assu$e the )ollo'ing )acts regar&ing the construction o) a ri&ge: Construction costs this perio&000000 M,< +,BBB,BBB Total esti$ate& construction costs0001B,BBB,BBB Total sales price000000000000000 1C,BBB,BBB The revenue that shoul& e recogni5e& this perio& is: a0 M,< +,BBB,BBB0 0 M,< *,CBB,BBB0 c0 M,< C,BBB,BBB0 p. I8D o) *++ e)ore the seller ac4uires the right to receive

&0 M,< D,CBB,BBB0 (o&i)"ing conventions inclu&e all o) the )ollo'ing except: a0 Perio&icit"0 0 Cost- ene)it0 c0 (aterialit"0 &0 Conservatis$0 =hich o) the )ollo'ing is not part o) the conceptual )ra$e'or! pro3ectQ a0 O 3ectives o) )inancial reporting0 0 Ouantitative characteristics0 c0 Oualitative characteristics0 &0 Basic ele$ents o) )inancial state$ents0 /o' turn to FAns'ers to sel)-testH at the en& o) the chapter to chec! "our ans'ers .

$.1$.!


>uestions
/a$e the assu$ptions un&erl"ing generall" accepte& accounting principles0 Co$$ent on the vali&it" o) the sta le unit o) $easure$ent assu$ption &uring perio&s o) high in)lation0

    

=h" &oes the accountant use the usiness entit" conceptQ =hen is the going-concern assu$ption not to e use&Q =hat is $eant " the ter$ accrual asis o) accountingQ =hat is its alternativeQ =hat &oes it $ean to sa" that accountants recor& su stance rather than )or$Q 6) a co$pan" changes an accounting principle ecause the change etter $eets the in)or$ation nee&s o) users, 'hat &isclosures $ust e $a&eQ =hat is the exchange-price (or cost) principleQ =hat is the signi)icance o) a&hering to this principleQ =hat t'o re4uire$ents generall" $ust e $et e)ore recogni5ing revenue in a perio&Q Mn&er 'hat circu$stances, i) an", is the receipt o) cash an accepta le ti$e to recogni5e revenueQ =hat t'o $etho&s $a" e use& in recogni5ing revenues on long-ter$ construction contractsQ <e)ine expense0 =hat principles gui&e the recognition o) expenseQ p. I8@ o) *++

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 





   

#o' &oes an expense &i))er )ro$ a lossQ =hat is the )ull &isclosure principleQ =hat role &oes cost- ene)it pla" in )inancial reportingQ =hat is $eant " the accounting ter$ conservatis$Q #o' &oes it a))ect the a$ounts reporte& in the )inancial state$entsQ <oes $aterialit" relate onl" to the relative si5e o) &ollar a$ountsQ 6&enti)" the three $a3or parts o) the conceptual )ra$e'or! pro3ect0 =hat are the t'o pri$ar" 4ualitative characteristicsQ :eal worl. question A recent annual report o) the A$erican ,hip Buil&ing Co$pan" state&:

   

-evenues, costs, an pro&its applicable to construction an conversion contracts are inclu e in t%e consoli ate state"ents o& operations using t%e... percentage)o&) co"pletion accounting "et%o .... T%e co"plete contract "et%o 'as use &or inco"e tax reporting in t%e years t%is "et%o 'as allo'e . =h" $ight the $anage$ent o) a co$pan" 'ant to use t'o &i))erent $etho&s )or accounting an& tax purposesQ


:eal worl. question A recent annual report o) Chevron Corporation state&:

Environ"ental expen itures t%at relate to current or &uture revenues are expense or capitali(e as appropriate. Expen itures t%at relate to an existing con ition cause by past operations, an


o not contribute to current or &uture revenue generation, are expense .

=hich principle o) accounting is eing )ollo'e& " this polic"Q =hat is the purpose o) inclu&ing a K,u$$ar" o) signi)icant accounting policiesK in the co$pan"Js annual reportQ

p. I88 o) *++

$.1$.#

E,ercises
Column # Column B a0 An assu$ption relie& on in the preparation o) the pri$ar" )inancial state$ents that 'oul& e unreasona le 'hen the in)lation rate is high0 Consistenc"0 <isclosure0 Perio&icit"0 0 Concerne& 'ith relative &ollar a$ounts0 c0 The usual asis )or the recor&ing o) assets0 &0 :e4uire& i) the accounting treat$ent &i))ers )ro$ that previousl" use& )or a particular ite$0 Conservatis$0 e0 An assu$ption that 'oul& e unreasona le to use in reporting on a )ir$ that ha& eco$e insolvent0 ,ta le &ollar0 (atching0 )0 /one o) these0 g0 :e4uires a co$pan" to use the sa$e accounting proce&ures an& practices through ti$e0 (aterialit"0 h0 An assu$ption that the li)e o) an entit" can e su &ivi&e& into ti$e perio&s )or reporting purposes0 %xchange-price (cost)0 i0 <iscourages un&ue opti$is$ in $easuring an& reporting net assets an& net inco$e0 Business entit"0 30 :e4uires separation o) personal )ro$ usiness activities in the recor&ing an& reporting processes0

-xercise # (atch the ite$s in Colu$n A 'ith the proper &escriptions in Colu$n B0

2oing concern (continuit")0

p. I8> o) *++

-xercise B Par!er Clothing Co$pan" sells its pro&ucts on an install$ent sales asis0 <ata )or IB1B an& IB11 )ollo':
Installment sales......................... Cost of goods sold on installment sales ..... Other expenses.......................... Cash olle ted from 2010 sales.............. Cash olle ted from 2011 sales.............. 2010 $800,000 560,000 120,000 !80,000 2011 $960,000 720,000 160,000 2!0,000 6!0,000

a0 Co$pute the net inco$e )or IB11, assu$ing use o) the accrual (sales) recognition0

asis o) revenue

0 Co$pute the net inco$e )or IB11, assu$ing use o) the install$ent asis o) recogni5ing gross $argin0 -xercise C A co$pan" has a contract to uil& a ship at a price o) M,< CBB $illion an& an

esti$ate& cost o) M,< *BB $illion0 Costs o) M,< 1BB $illion 'ere incurre&0 Mn&er the percentage-o)co$pletion $etho&, ho' $uch revenue 'oul& e recogni5e&Q -xercise < A co$pan" )ollo's a practice o) expensing the pre$iu$ on its )ire insurance polic" 'hen the polic" is pai&0 6n IB1B, the co$pan" charge& to expense the M,< D,BBB pre$iu$ pai& on a three-"ear polic" covering the perio& IB1B ;ul" 1, to IB1B ;une +B0 6n IB1B, a pre$iu$ o) M,< C,*BB 'as charge& to expense on the sa$e polic" )or the perio& IB1B ;ul" 1, to IB1B ;ul" +B0 a0 ,tate the principle o) accounting that 'as violate& " this practice0 0 Co$pute the e))ects o) this violation on the )inancial state$ents )or the calen&ar "ear IB1B0 c0 ,tate the asis on 'hich the co$pan"Js practice $ight e 3usti)ie&0

p. I>B o) *++

-xercise - (atch the &escriptions in Colu$n B 'ith the accounting 4ualities in Colu$n A0 Mse so$e &escriptions $ore than once0 Column #: Accounting qualities :elevance0 Fee& ac! value0 <ecision $a!ers0 :epresentational )aith)ulness0 :elia ilit"0 Co$para ilit"0 Bene)its excee& costs0 Pre&ictive value0 Ti$eliness0 <ecision use)ulness0 Geri)ia ilit"0 Mn&erstan&a ilit"0 /eutralit"0 (aterialit"0 Column B: <escriptions a0 Msers o) accounting in)or$ation0 0 Pervasive constraint0 c 0 Mser-speci)ic 4ualities0 &0 Pri$ar" &ecision-speci)ic 4ualities0 e0 6ngre&ients o) pri$ar" 4ualities0 )0 ,econ&ar" an& interactive 4ualities0 g0 Threshol& )or recognition0

$.1$.$

1roblems

&roblem # ,elect the est ans'er to each o) the )ollo'ing 4uestions: The assu$ption that each usiness has an existence separate )ro$ its o'ners, cre&itors, e$plo"ees, custo$ers, other intereste& parties, an& other usinesses is the: p. I>1 o) *++

a0 2oing-concern assu$ption0 0 Business entit" concept0 c0 ,eparate entit" concept0 &0 Corporation concept0 Co$panies shoul& use li4ui&ation values to report assets i) 'hich o) the )ollo'ing con&itions existsQ a0 There are changes in the value o) the &ollar0 0 The perio&icit" assu$ption is applie&0 c0 The co$pan" is not a going concern an& 'ill e &issolve&0 &0 The accrual asis o) accounting is not use&0 Assu$e that a co$pan" has pai& )or a&vertising an& that the a& has alrea&" appeare&0 The co$pan" chose to report the ite$ as prepai& a&vertising an& inclu&es it a$ong the assets on the alance sheet0 Previousl", the co$pan" ha& al'a"s expense& expen&itures such as this0 This practice is a violation o): a0 2enerall" accepte& accounting principles0 0 The $atching concept0 c0 The consistenc" concept0 &0 All o) the a ove0 :ecor&ing revenue onl" a)ter the seller has o taine& the right to receive pa"$ent )ro$ the u"er )or $erchan&ise sol& or services per)or$e& is calle& the: a0 %arning principle0 0 6nstall$ent asis0 c0 :eali5ation principle0 &0 Co$plete&-contract $etho&0 &roblem B :a$ire5 Gi&eo, 6nc0, sells vi&eo recor&ers un&er ter$s calling )or a s$all &o'n pa"$ent an& $onthl" pa"$ents sprea& over three "ears0 Follo'ing are &ata )or the )irst three "ears o) the co$pan"Js operations:
2008 ;ross mar/in rate ($D Cash collected in #$5$7 >rom sales in............................E#54"$$$ >rom sales in.............................................. >rom sales in............................................ 200 %$D E#66"$$$ E%6$"$$$ 2010 2$D

Total sales )or IB1B 'ere M,< 1,DBB,BBB, 'hile general an& selling expenses a$ounte& to M,< *BB,BBB0 a0 Co$pute net inco$e )or IB1B, assu$ing revenues are recogni5e& at the ti$e o) sale0

p. I>I o) *++

0 Co$pute net inco$e )or IB1B, using the install$ent $etho& o) accounting )or sales an& gross $argin0 &roblem C The )ollo'ing &ata relate to (erit Construction Co$pan"Js long-ter$ construction pro3ects )or the "ear IB1B:
Contract 'rice.................................... Costs incurred 'rior to #$5$ ............... Costs incurred in #$5$........................ Estimated costs to be incurred in future years................................ Co,pleted !"o7ects E#$"$$$"$$$ ..... ("3$$"$$$ ..... 55"5$$"$$$ < $< #nco,plete !"o7ects E5$$"$$$"$$$ 54"$$$"$$$ (#"$$$"$$$ (#"$$$"$$$

2eneral an& a&$inistrative expenses incurre& in IB1B a$ounte& to M,< I $illion, none o) 'hich is to e consi&ere& a construction cost0 a0 Co$pute net inco$e )or IB1B un&er the co$plete&-contract $etho&0 0 Co$pute net inco$e )or IB1B un&er the percentage-o)-co$pletion $etho&0 &roblem < For each o) the )ollo'ing nu$ ere& ite$s, state the letter or letters o) the principle(s), assu$ption(s), or concept(s) use& to 3usti)" the accounting proce&ure )ollo'e&0 The accounting proce&ures are all correct0 a0 Business entit"0 0 Conservatis$0 c0 %arning principle o) revenue recognition0 &0 2oing concern (continuit")0 e0 %xchange-price (cost) principle0 )0 (atching principle0 g0 Perio& cost (or principle o) i$$e&iate recognition o) expense)0 h0 :eali5ation principle0 i0 ,ta le &ollar assu$ption0 6nventor" is recor&e& at the lo'er o) cost or $ar!et value0 A truc! purchase& in ;anuar" 'as reporte& at 8B per cent o) its cost even though its $ar!et value at "ear-en& 'as onl" @B per cent o) its cost0 The collection o) M,< *B,BBB o) cash )or services to e per)or$e& next "ear 'as reporte& as a current lia ilit"0 The presi&entJs salar" 'as treate& as an expense o) the "ear even though he spent $ost o) his ti$e planning the next t'o "earsJ activities0 /o entr" 'as $a&e to recor& the co$pan"Js receipt o) an o))er o) M,< 8BB,BBB )or lan& carrie& in its accounts at M,< *+C,BBB0

p. I>+ o) *++

A suppl" o) printe& stationer", chec!s, an& invoices 'ith a cost o) M,< 8,CBB 'as treate& as a current asset at "ear-en& even though it ha& no value to others0 A tract o) lan& ac4uire& )or M,< 18B,BBB 'as recor&e& at that price even though it 'as appraise& at M,< I+B,BBB, an& the co$pan" 'oul& have een 'illing to pa" that a$ount0 The co$pan" pai& an& charge& to expense the M,< *,IBB pai& to Craig /elson )or rent o) a truc! o'ne& " hi$0 Craig /elson is the sole stoc!hol&er o) the co$pan"0 &roblem - (atch the &escriptions in Colu$n B 'ith the proper ter$s in Colu$n A0
1: 2: 3: 4: 5: 6: 7: 8: : 10: 11: 12: 13: 14: Colu,n A >inancial re'ortin/ ob8ecti+es. Fualitati+e characteristics. @ele+ance. Predicti+e +alue. >eedback +alue. .imeliness. @eliability. @e'resentational faithfulness. Gerifiability. Neutrality. Com'arability. Consistency. Cost<benefit. Hateriality. a: b: c: d: e: <: *: h: i: 7: %: l: ,: n: Colu,n 3 Information is free of measurement method bias. .he benefits e1ceed the costs. @elati+ely lar/e items must be accounted for in a theoretically correct ay. .he information can be substantially du'licated by inde'endent measurers usin/ the same measurement methods. =hen information im'ro+es users' ability to 'redict outcomes of e+ents. 0road o+erridin/ /oals sou/ht by accountants en/a/in/ in financial re'ortin/. =hen information is 'ertinent or bears on a decision. .he characteristics that accountin/ information should 'ossess to be useful in decision makin/. Information that re+eals the relati+e success of users in 'redictin/ outcomes. =hen accountin/ statements on economic acti+ity corres'ond to the actual underlyin/ acti+ity. =hen information is 'ro+ided soon enou/h that it may be considered in decision makin/. =hen information faithfully de'icts for users hat it 'ur'orts to re'resent. @equires a com'any to use the same accountin/ 'rinci'les and re'ortin/ 'ractices throu/h time. =hen re'orted differences and similarities in information are real and not the result of differin/ accountin/ treatments.

$.1$.%
A set o)

Alternate problems
asic concepts an& assu$ptions an& relate& principles that explain an& gui&e the

#lternate problem # ,elect the est ans'er to each o) the )ollo'ing 4uestions: accountantJs actions in i&enti)"ing, $easuring, an& co$$unicating econo$ic in)or$ation is calle&: a0 Accounting theor"0 0 Accounting rules0 c0 Accrual asis0 &0 (atching concept0 =hich o) the )ollo'ing state$ents is )alseQ a0 ,everal separate legal entities properl" $a" e consi&ere& to e one accounting entit"0 0 The sta le &ollar assu$ption is use& onl" 'hen the &ollar is a solutel" sta le0 c0 Pu licl" hel& corporations generall" prepare $onthl" )inancial state$ents )or internal $anage$ent an& pu lish 4uarterl" an& annual )inancial state$ents )or users outsi&e the co$pan"0 &0 =ithout the perio&icit" assu$ption, a usiness 'oul& have onl" one ti$e perio& running )ro$ the inception o) the usiness to its ter$ination0 p. I>* o) *++

=hich o) the )ollo'ing state$ents is trueQ a0 =hen the su stance o) a transaction con)licts 'ith the legal )or$ o) the transaction, the accountant shoul& e gui&e& " the legal )or$ in recor&ing the transaction0 0 The consistenc" concept prohi its a change in accounting principle even 'hen such a change 'oul& etter $eet the in)or$ation nee&s o) )inancial state$ent users0 c0 Mn&er the &ou le-entr" approach, each transaction $ust e recor&e& 'ith one &e it an& one cre&it o) e4ual &ollar a$ounts0 &0 ,pecial-purpose )inancial in)or$ation )or a speci)ic &ecision, such as 'hether or not to purchase a ne' $achine, is est o taine& )ro$ the &etaile& accounting recor&s rather than )ro$ the )inancial state$ents0 =hich o) the )ollo'ing state$ents is trueQ a0 All assets are carrie& in&e)initel" at their original costs in the )inancial state$ents0 0 Aia ilities are $easure& in the cash to e pai& or the value o) services to e per)or$e& to satis)" the lia ilities0 c0 Accounting principles are &erive& " $erel" su$$ari5ing accounting practices use& to &ate0 &0 Accountants can easil" $easure all changes in assets an& lia ilities since the" never involve esti$ates or calculations0 =hich o) the )ollo'ing state$ents is )alseQ a0 The exchange-price principle is also calle& the cost principle0 0 The $atching principle is closel" relate& to the revenue recognition principle0 c0 The install$ent sales $etho& recogni5es revenue sooner than it 'oul& nor$all" e recogni5e&0 &0 The percentage-o)-co$pletion $etho& recogni5es revenue sooner than the co$plete&- contract $etho&0 #lternate problem B /eva&a :eal %state ,ales Co$pan" sells lots in its &evelop$ent in <r" Cree! Can"on un&er ter$s calling )or s$all cash &o'n pa"$ents 'ith $onthl" install$ent pa"$ents sprea& over a )e' "ears0 Follo'ing are &ata on the co$pan"Js operations )or its )irst three "ears:
;ross mar/in rate ...................... Cash collected in #$5$ from sales of lots made in................ 2008 ..... %2D 200 %6D 2010 2$D ..... E4%$"$$$ E6$$"$$$ E)$$"$$$

The total selling price o) the lots sol& in IB1B 'as M,< +,BBB,BBB, 'hile general an& a&$inistrative expenses ('hich are not inclu&e& in the costs use& to &eter$ine gross $argin) 'ere M,< 8BB,BBB0 a0 Co$pute net inco$e )or IB1B assu$ing revenue is recogni5e& on the sale o) a lot0 0 Co$pute net inco$e )or IB1B assu$ing use o) the install$ent asis o) accounting )or sales an& gross $argin0 p. I>C o) *++

#lternate problem C The )ollo'ing contract prices an& costs relate to all o) Orlan&o Construction Co$pan"Js long-ter$ construction pro3ects (in $illions o) &ollars):
Costs #ncu""ed Cont"act !"ice E%4 5%% !"io" to 2010 E% #% #n 2010 E(4 %6 Cost to 3e #ncu""ed in (utu"e =ea"s E$ %6

9n 'ro8ects com'leted in #$5$ 9n incom'lete 'ro8ects

2eneral an& a&$inistrative expenses )or IB1B a$ounte& to M,< 1,IBB,BBB0 Assu$e that the general an& a&$inistrative expenses are not to e treate& as a part o) the construction cost0 a0 Co$pute net inco$e )or IB1B using the co$plete&-contract $etho&0 0 Co$pute net inco$e )or IB1B using the percentage-o)-co$pletion $etho&0 #lternate problem < 6n each o) these circu$stances, the accounting practices $a" the assu$ptions, concepts, or principles that 3usti)" "our position0 The salaries pai& to the top o))icers o) the co$pan" 'ere charge& to expense in the perio& in 'hich the" 'ere incurre& even though the o))icers spent over hal) o) their ti$e planning next "earJs activities0 /o entr" 'as $a&e to recor& the elie) that the $ar!et value o) the lan& o'ne& (carrie& in the accounts at M,< 8BB,BBB) ha& increase&0 The ac4uisition o) a tract o) lan& 'as recor&e& at the price pai& )or it o) M,< *BB,BBB, even though the co$pan" 'oul& have een 'illing to pa" M,< DBB,BBB0 A truc! ac4uire& at the price0 #lternate problem - ,elect the est ans'er to each o) the )ollo'ing 4uestions: 6n the conceptual )ra$e'or! pro3ect, ho' $an" )inancial reporting o 3ectives 'ere i&enti)ie& " the FA,BQ a0 One0 0 T'o0 c0 Three0 &0 Four0 The t'o pri$ar" 4ualitative characteristics are: a0 Pre&ictive value an& )ee& ac! value0 0 Ti$eliness an& veri)ia ilit"0 c0 Co$para ilit" an& neutralit"0 p. I>D o) *++ eginning o) the "ear 'as reporte& at "ear-en& at 8B per cent o) its ac4uisition price even though its $ar!et value then 'as onl" DC per cent o) its original ac4uisition e 4uestione&0 6n&icate 'hether "ou agree or &isagree 'ith the accounting practice e$plo"e& an& state

&0 :elevance an& relia ilit"0 A pervasive constraint o) accounting in)or$ation is that: a0 Bene)its $ust excee& costs0 0 The in)or$ation $ust e ti$el"0 c0 The in)or$ation $ust e neutral0 &0 The in)or$ation $ust e veri)ia le0 To e relia le, in)or$ation $ust (i&enti)" the incorrect 4ualit"): a0 Be veri)ia le0 0 Be ti$el"0 c0 #ave representational )aith)ulness0 &0 Be neutral0 The asic ele$ents o) )inancial state$ents consist o): a0 Ter$s an& their &e)initions0 0 The o 3ectives o) )inancial reporting0 c0 The 4ualitative characteristics0 &0 The ne' inco$e state$ent )or$at0

$.1$.'

0e ond the numbers9Critical thin&ing

Business .ecision case # ;i$ Case" recentl" receive& his accounting &egree )ro$ ,tate Mniversit" an& 'ent to 'or! )or a Big-Four CPA )ir$0 A)ter he ha& een 'ith the )ir$ )or a out six $onths, he 'as sent to the Aing Clothing Co$pan" to 'or! on the au&it0 #e 'as not ver" con)i&ent o) his !no'le&ge at this earl" point in his career0 #e notice&, ho'ever, that so$e o) the co$pan"Js transactions an& events 'ere recor&e& in a 'a" that $ight e in violation o) accounting theor" an& generall" accepte& accounting principles0 ,tu&" each o) the )ollo'ing )acts to see i) the au&itors shoul& challenge the )inancial accounting practices use& or the intentions o) $anage$ent0 =rite "our &ecisions an& the reasoning ehin& "our conclusions0 This pro le$ can serve as an opportunit" to appl" accounting theor" to situations 'ith 'hich "ou are not "et )a$iliar an& as a previe' o) )uture chapters0 ,o$e o) the )ollo'ing situations relate to $aterial "ou have alrea&" covere&, an& so$e situations relate to $aterial to e covere& in )uture chapters0 A)ter each ite$, 'e have given an in&ication o) the chapter in 'hich that ite$ is &iscusse&0 .ou $a" research )uture chapters to )in& the correct ans'er0 Alternativel", "ou coul& use "our present !no'le&ge o) accounting theor" to &eter$ine 'hether or not Case" shoul& challenge each o) the p. I>@ o) *++

)inancial accounting practices use&0 :eali5e, ho'ever, that so$e generall" accepte& accounting practices 'ere ase& on co$pro$ise an& see$ to &i))er 'ith accounting theor" as &escri e& in this chapter0 One o) the senior $e$ ers o) $anage$ent state& the co$pan" planne& to replace all o) the )urniture next "ear0 #e sai& that the cash in the Accu$ulate& <epreciation account 'oul& e use& to pa" )or the )urniture0 (Ch0 +) The co$pan" hel& the oo!s open at the en& o) IB1B so the" coul& recor& so$e earl" IB11 sales as IB1B revenue0 The 3usti)ication )or this practice 'as that IB1B 'as not a goo& "ear )or pro)its0 (Ch0 +, C, D) The co$pan"Js uil&ings 'ere appraise& )or insurance purposes0 The appraise& values 'ere M,< 1B,BBB,BBB higher than the oo! value0 The accountant &e ite& Buil&ings an& cre&ite& Pai&-in Capital )ro$ Appreciation )or the &i))erence0 (Ch0 C) The co$pan" recor&e& purchases o) $erchan&ise at the list price rather than the gross selling (invoice) price0 (Ch0 D) 2oo&s shippe& to the co$pan" )ro$ a supplier, FOB &estination, 'ere &e ite& to Purchases0 The goo&s 'ere not inclu&e& in en&ing inventor" ecause the goo&s ha& not "et arrive&0 (Ch0 C, D) The co$pan" counte& so$e ite$s t'ice in ta!ing the ph"sical inventor" at the en& o) the "ear0 The person ta!ing the inventor" sai& he ha& )orgotten to inclu&e so$e ite$s in last "earJs ph"sical inventor", an& counting so$e ite$s t'ice 'oul& $a!e up )or the ite$s $isse& last "ear so that net inco$e this "ear 'oul& e a out correct0 (Ch0 @) The co$pan" s'itche& )ro$ F6FO to A6FO in accounting )or inventories0 The prece&ing "ear it ha& s'itche& )ro$ the 'eighte&-average $etho& to F6FO0 The reason given )or the $ost recent change 'as that )e&eral inco$e taxes 'oul& e lo'er0 /o in&ication o) this s'itch 'as to appear in the )inancial state$ents0 (Ch0 C, @) ,ince things 'ere prett" hectic at "ear-en&, the accountant $a&e no e))ort to reconcile the an! account0 #is reason 'as that the an! pro a l" ha& not $a&e an" errors0 The an! alance 'as lo'er than the oo! alance, so the accountant &e ite& (iscellaneous %xpense an& cre&ite& Cash )or the &i))erence0 (Ch0 8) =hen a custo$er )aile& to pa" the a$ount &ue, the accountant &e ite& Allo'ance )or Mncollecti le Accounts an& cre&ite& Accounts :eceiva le0 The a$ount o) accounts 'ritten o)) in this $anner 'as huge0 (Ch0 >)

p. I>8 o) *++

A co$pletel" &epreciate& $achine 'as still eing use&0 The accountant le)t the asset an& its relate& accu$ulate& &epreciation on the oo!s, stoppe& recor&ing &epreciation on the $achine, an& &i& not go ac! an& correct earlier "earsJ net inco$e an& re&uce accu$ulate& &epreciation0 (Ch0 1B) The accountant state& that even though research an& &evelop$ent costs incurre& to &evelop a ne' pro&uct 'oul& ene)it )uture perio&s, these costs $ust e expense& as incurre&0 This "ear M,< IBB,BBB o) these costs 'ere charge& to expense0 (Ch0 11) An ol& truc! 'as tra&e& )or a ne' truc!0 ,ince the tra&e-in value o) the ol& truc! 'as higher than its oo! value, a gain 'as recor&e& on the transaction0 (Ch0 11) The co$pan" pai& )or a )ranchise giving it the exclusive right to operate in a given geographical area )or DB "ears0 The accountant is a$orti5ing the asset over DB "ears0 (Ch0 11) The co$pan" leases a uil&ing an& has a nonrene'a le lease that expires in 1C "ears0 The co$pan" $a&e so$e i$prove$ents to the uil&ing0 ,ince the i$prove$ents 'ill last +B "ears, the" are eing 'ritten o)) over +B "ears0 (Ch0 11) #nnual report analysis B :e)er to the K,u$$ar" o) signi)icant accounting policiesK in the annual report o) The Ai$ite&, 6nc0 Aist the policies &iscusse&0 For each o) the policies, explain in 'riting 'hat the co$pan" is tr"ing to co$$unicate0 -t%ics D # writing experience C :e)er to the ite$ KAn ethical perspective: (aplehurst co$pan"K0 =rite out the ans'ers to the )ollo'ing 4uestions: 6s $anage$ent eing ethical in this situationQ %xplain0 6s the accountant correct in &e)en&e&Q %xplain0 =hat 'oul& "ou &o i) "ou 'ere the accountantQ <escri e in &etail0 9roup pro2ect < 6n tea$s o) t'o or three stu&ents, go to the li rar" to locate one co$pan"Js annual report )or the $ost recent "ear0 (As an alternative, annual reports can e &o'nloa&e& )ro$ the ,%CJs %<2A: site at '''0sec0gov7e&gar0sht$l) %xa$ine the K,u$$ar" o) accounting policiesK, 'hich is part o) the F/otes to )inancial state$entsK section i$$e&iatel" )ollo'ing the )inancial state$ents0 As a tea$, 'rite a $e$oran&u$ to the instructor &etailing the signi)icant accounting policies o) the co$pan"0 The hea&ing o) the $e$oran&u$ shoul& contain the &ate, to 'ho$ it is 'ritten, )ro$ 'ho$, an& the su 3ect $atter0 9roup pro2ect - =ith one or t'o other stu&ents an& using li rar" sources, 'rite a paper on the histor" an& achieve$ents o) the Financial Accounting ,tan&ar&s Boar&0 This oar& is responsi le )or esta lishing the accounting stan&ar&s an& principles )or )inancial accounting in the private sector0 6t 'as )or$e& in 1>@+ an& too! over the rule setting )unction )ro$ the Accounting Principles Boar& o) the p. I>> o) *++ elieving that $anage$entJs position coul& not e success)ull"

A$erican 6nstitute o) Certi)ie& Pu lic Accountants at that ti$e0 Be sure to cite sources use& an& to treat &irect 4uotes properl"0 9roup pro2ect F .our tea$ o) stu&ents shoul& o tain a cop" o) the report, K6$proving Business :eportingLA Custo$er FocusK " the A6CPA ,pecial Co$$ittee on Financial :eporting (1>>*)0 .our li rar" $ight have a cop"0 6) not, it can e o taine& )ro$ the A6CPA 8Pro&uct /o0 B1>+B+, Or&er <epart$ent, A6CPA, #ar orsi&e Financial Center, IB1 Pla5a Three, ;erse" Cit", /; B@+11- +8819 8Toll )ree nu$ er 1-8BB-8DI-*I@I? FAZ 1-8BB-+DI-CBDD90 =rite a report giving a &escription o) the reco$$en&ations o) the co$$ittee0 Be sure to cite sources use& an& treat &irect 4uotes properl"0

$.1$.)

.sing the (nternet9A vie+ of the real +orld

Gisit the )ollo'ing 6nternet site )or 2eneral %lectric: http:77'''0ge0co$ Fin& the annual report liste& un&er Financial :eporting, an& then /otes to Financial ,tate$ents0 Print a cop" o) the su$$ar" o) ,igni)icant Accounting Policies0 =rite a short report to "our instructor su$$ari5ing "our )in&ings0 Gisit the )ollo'ing 6nternet site )or Oracle0: http:77'''0oracle0co$ Clic! on Fa outH, then un&er K6nvestor :elationsK clic! on F<etaile& FinancialsH0 %xa$ine the notes on the )inancial state$ents )or the latest 4uarter0 =rite a short report )or "our instructor on "our )in&ings0

$.1$.18 Ans+ers to self<test
$rue-0alse False. The usiness entit" concept assu$es that each usiness has an existence separate )ro$ its o'ners, cre&itors, e$plo"ees, custo$ers, other intereste& parties, an& other usinesses0 $rue. Accountants shoul& e gui&e& " the econo$ic su stance o) a transaction rather than its legal )or$0 $rue. The accrual asis o) accounting see!s to $atch e))ort an& acco$plish$ent " $atching expenses against the revenues the" create&0 False. %xceptions inclu&e the install$ent False. 6$$aterial ite$s &o have to asis o) revenue recognition )or sales an& the ut the" can e recor&e& in a theoreticall" percentage-o)- co$pletion $etho& )or long-ter$ construction pro3ects0 e recor&e&, incorrect 'a" (e0g0 expensing a 'aste as!et that 'ill last $an" "ears)0

p. +BB o) *++

$rue. :elevance an& relia ilit" are the t'o pri$ar" characteristics0 8ultiple-c%oice c. The $atching concept is one o) the $a3or principles o) accounting rather than an assu$ption0 b. The consistenc" concept re4uires that a co$pan" use the sa$e accounting principles an& reporting practices through ti$e0 b. Msuall", the accountant &oes not recogni5e revenue until the seller ac4uires the right to receive pa"$ent )ro$ the u"er0 ,S- ("$$$"$$$ I ,S-52"$$$"$$$ = ,S- %"2$$"$$$ 0 b. ,S-5$"$$$"$$$ a. Perio&icit" is an un&erl"ing assu$ption rather than a $o&i)"ing convention0

b. The categor", 4uantitative characteristics, is not part o) the conceptual )ra$e'or! pro3ect0 (erchan&ising transactions

p. +B1 o) *++

% (ntroduction to inventories and the classified income statement
%.1 Learning objective
A)ter stu&"ing this chapter, "ou shoul& e a le to:
 

:ecor& 3ournal entries )or sales transactions involving $erchan&ise0 <escri e rie)l" cost o) goo&s sol& an& the &istinction et'een perpetual an& perio&ic :ecor& 3ournal entries )or purchase transactions involving $erchan&ise0 <escri e the )reight ter$s an& recor& transportation costs0 <eter$ine cost o) goo&s sol&0 Prepare a classi)ie& inco$e state$ent0 Anal"5e an& use the )inancial resultsLgross $argin percentage0 Prepare a 'or! sheet an& closing entries )or a $erchan&ising co$pan" (Appen&ix)0

inventor" proce&ures0
     

%.2 A career as a CE/
Are "ou a lea&erQ =oul& "ou en3o" so$e&a" eco$ing the presi&ent or chie) executive o))icer (C%O) o) the co$pan" "ou 'or! )orQ Then "ou shoul& consi&er a &egree in accounting0 The accounting )iel& greatl" values in&ivi&uals 'ith lea&ership potential0 Accounting stu&ents 'ith the $ost 3o o))ers an& the highest starting salaries are also li!el" to e the ones 'ho est &e$onstrate an a ilit" to lea& others0 :ecruiters in pu lic accounting (i0e0 au&iting, tax, consulting) an& private accounting (i0e0 )inancial reporting, cost accounting, )inancial anal"sis, internal au&iting) ali!e &e$onstrate a strong pre)erence )or stu&ents 'ith lea&ership potential0 Fortunatel", "ou &o not have to run a co$pan" to &e$onstrate lea&ership a ilities to college recruiters0 ,o$e exa$ples o) lea&ership potential that 'oul& loo! goo& on a resu$e inclu&e organi5ing a success)ul )un&-raiser, participating e))ectivel" as an o))icer in a stu&ent clu , or ta!ing the lea& in a group pro3ect0 6) "ou &o not have a resu$e "et, stop " the career place$ent center at "our college an& as! the$ to assist "ou in preparing one0 (an" stu&ents at "our level alrea&" have a resu$e, an& it ta!es ti$e to re)ine an& &evelop an e))ective one0 A 'ell-prepare& resu$e 'ill )irst 3o upon gra&uation0 e i$portant )or securing internship opportunities an& part-ti$e 'or! in the usiness )iel&, as 'ell as )or lan&ing that

p. +BI o) *++

<i& "ou !no' that the chie) executive o))icers (C%O) o) $an" o) the largest $anu)acturing, $erchan&ising, an& service organi5ations in the Mnite& ,tates have &egrees in accountingQ ;a$es <i$on o) ;P(organ Chase, 2ar" C0 Nell" o) ,outh'est Airlines, Phil Nnight o) /i!e, ;a$es ;0 (ulva o) ConocoPhillips, an& 6n&ra N0 /oo"i o) PepsiCo all have &egrees in accounting0 6t is reall" not that surprising that accounting $a3ors are so success)ul, as accounting provi&es an excellent )oun&ation in usiness0 =ith a strong accounting )oun&ation an& the continue& &evelop$ent o) lea&ership a ilities over "our career, "ou $ight eco$e a C%O "oursel) so$e&a"0 .our stu&" o) accounting egan 'ith service co$panies as exa$ples ecause the" are the least co$plicate& t"pe o) usiness0 .ou are no' rea&" to appl" the accounting process to a $ore co$plex usinessLa $erchan&ising co$pan"0 Although the )un&a$ental accounting concepts )or service usinesses appl" to $erchan&ising usinesses, $erchan&ise accounting re4uires so$e a&&itional accounts an& techni4ues to recor& sales an& purchases0 The nor$al )lo' o) goo&s )ro$ $anu)acturer to )inal custo$er is as )ollo's:

8anu0acturers pro&uce goo&s )ro$ ra' $aterials an& nor$all" sell the$ to 'holesalers0 A)ter per)or$ing certain )unctions, such as pac!aging or la eling, w%olesalers sell the goo&s to retailers0 :etailers sell the goo&s to )inal custo$ers0 The t'o $i&&le This chapter egins oxes in the &iagra$ represent $erchan&ising co$panies0 These co$panies u" goo&s in )inishe& )or$ )or resale0 " co$paring the inco$e state$ent o) a service co$pan" 'ith that o) a $erchan&ising co$pan"0 Then, 'e &escri e (1) ho' to recor& $erchan&ise-relate& transactions (I) a classi)ie& inco$e state$ent an& (+) the gross $argin percentage0 Finall", in the appen&ix 'e explain the 'or! sheet an& the closing process )or a $erchan&ising co$pan"0

p. +B+ o) *++

SERVICE COMPANY Income Statement For the Year Ended 2010 December 1

MERCHANDISING COMPANY Income Statement For the Year Ended 2010 December 1

Service revenues

$"3,200

Sales revenues ,ost o( )oods sold Gross *ar)in

$262,000 "5@,000 $"03,000 74,@00 $ 29,"00

Expenses et inco!e

6,5"0 $ 6,6@0

Expenses et inco!e

%xhi it +I: Con&ense& inco$e state$ents o) a service co$pan" an& a $erchan&ising co$pan" co$pare&

%.3 T+o income statements compared9 6ervice compan and merchandising compan
6n %xhi it +I 'e co$pare the $ain &ivisions o) an inco$e state$ent )or a service co$pan" 'ith those )or a $erchan&ising co$pan"0 To &eter$ine pro)ita ilit" or net inco$e, a service co$pan" &e&ucts total expenses incurre& )ro$ revenues earne&0 A $erchan&ising co$pan" is a $ore co$plex usiness an&, there)ore, has a $ore co$plex inco$e state$ent0 As sho'n in %xhi it +I, $erchan&ising co$panies $ust &e&uct )ro$ revenues the cost o) the goo&s the" sell to custo$ers to arrive at gross $argin0 Then, the" &e&uct other expenses0 The inco$e state$ent o) a $erchan&ising co$pan" has three $ain &ivisions: (1) sales revenues, 'hich result )ro$ the sale o) goo&s " the co$pan"? (I) cost o) goo&s sol&, 'hich is an expense that in&icates ho' $uch the co$pan" pai& )or the goo&s sol&? an& (+) expenses, 'hich are the co$pan"Js other expenses in running the usiness0 6n the next t'o sections 'e &iscuss the )irst t'o $ain &ivisions o) the inco$e state$ent o) a $erchan&ising co$pan"0 The thir& &ivision (expenses) is si$ilar to expenses )or a service co$pan", 'hich 'e illustrate& in prece&ing chapters0 As "ou stu&" these sections, !eep in $in& ho' the &ivisions o) the $erchan&ising inco$e state$ent are relate& to each other an& pro&uce the )inal )igureLnet inco$e or net lossL'hich in&icates the pro)ita ilit" o) the co$pan"0

%.! 6ales revenues
The sale o) goo&s occurs et'een t'o parties0 The seller o) the goo&s trans)ers the$ to the u"er in exchange )or cash or a pro$ise to pa" at a later &ate0 This exchange is a relativel" si$ple usiness

p. +B* o) *++

transaction0 ,ellers $a!e sales to create revenues? this in)lo' o) assets in the )or$ o) cash or accounts receiva le results )ro$ selling goo&s to custo$ers0 6n %xhi it +I, 'e sho' a con&ense& inco$e state$ent to e$phasi5e its $a3or &ivisions0 /ext, 'e &escri e the $ore co$plete inco$e state$ent actuall" prepare& " accountants0 The $erchan&ising co$pan" that 'e use to illustrate the inco$e state$ent is #anlon :etail Foo& ,tore0 This section explains ho' to recor& sales revenues, inclu&ing the e))ect o) tra&e &iscounts0 Then, 'e explain ho' to recor& t'o &e&uctions )ro$ sales revenuesLsales &iscounts an& sales returns an& allo'ances (%xhi it ++)0 The a$ount that re$ains is net sales0 The )or$ula )or &eter$ining net sales is: /et sales S 2ross sales - (,ales &iscounts T ,ales returns an& allo'ances)
HAN!ON RE"AI! FOOD S"ORE Part#a$ #ncome Statement For the Year Ended 2010 December 1

+peratin) revenues: Gross sales 4ess: Sales discounts Sales returns and allo;ances "5,000 et sales $292,000 $ 5,000 20,000 $262,000

%xhi it ++: Partial inco$e state$ent o) $erchan&ising co$pan"
%RYAN &HO!ESA!E CO' ()* Ma+on Street Detro#t, M#ch#-an (..2 C1+tomer2+ Order No'0 2"9 So$d to0 Addre++0 In/o#ce No'0 "259 Date0 2$%$ :ec' "@,

&aier ,o!pan2 2255 Aannon Street
Date Sh#33ed0 2$%$ :ec' "@, Sh#33ed b40

&i) Rapids, *ic0i)an 49"06
"erm+0

et 30, /+& :estination
Item Number

a)el Truc6in) ,o'
Price 'er ,nit .otal Amount

-escri'tion

Fuantity

True3tone stereo radio

*odel o' 59693243@3

200 Total

$"00

$20,000 $20,000

%xhi it +*: 6nvoice 6n a sales transaction, the seller trans)ers the legal o'nership (title) o) the goo&s to the u"er0 Msuall", the ph"sical &eliver" o) the goo&s occurs at the sa$e ti$e as the sale o) the goo&s0 A usiness &ocu$ent calle& an invoice (a sales invoice )or the seller an& a purchase invoice )or the u"er) eco$es the asis )or recor&ing the sale0 p. +BC o) *++

An in'oice is a &ocu$ent prepare& " the seller o) $erchan&ise an& sent to the u"er0 The invoice contains the &etails o) a sale, such as the nu$ er o) units sol&, unit price, total price ille&, ter$s o) sale, an& $anner o) ship$ent0 A retail co$pan" prepares the invoice at the point o) sale0 A 'holesale co$pan", 'hich supplies goo&s to retailers, prepares the invoice a)ter the shipping &epart$ent noti)ies the accounting &epart$ent that it has shippe& the goo&s to the retailer0 %xhi it +* is an exa$ple o) an invoice prepare& " a 'holesale co$pan" )or goo&s sol& to a retail co$pan"0 Msing the invoice as the source &ocu$ent, a 'holesale co$pan" recor&s the revenue )ro$ the sale at the ti$e o) the sale )or the )ollo'ing reasons:
 The seller has passe& legal title o) the goo&s to the

u"er, an& the goo&s are no' the

responsi ilit" an& propert" o) the u"er0
 The seller has esta lishe& the selling price o) the goo&s0  The seller has co$plete& its o ligation0  The seller has exchange& the goo&s )or another asset, such as cash or accounts receiva le0  The seller can &eter$ine the costs incurre& in selling the goo&s0

%ach ti$e a co$pan" $a!es a sale, the co$pan" earns revenue0 This revenue increases a revenue account calle& ,ales0 :ecall )ro$ Chapter I that cre&its increase revenues0 There)ore, the )ir$ cre&its the ,ales account )or the a$ount o) the sale0 Msuall" sales are )or cash or on account0 =hen a sale is )or cash, the co$pan" cre&its the ,ales account an& &e its Cash0 For exa$ple, it recor&s a M,< IB,BBB sale )or cash as )ollo's:
,as0 #>$% Sales #>SE% To record t0e sales o( !erc0andise (or cas0' 20,000 20,000

=hen a sale is on account, it cre&its the ,ales account an& &e its Accounts :eceiva le0 The )ollo'ing entr" recor&s a M,< IB,BBB sale on account:
$ccounts Receiva5le #>$% Sales #>SE% To record t0e sales o( !erc0andise on account' 20,000 20,000

Msuall", a seller 4uotes the gross selling price, also calle& the invoice price, o) goo&s to the u"er0 #o'ever, so$eti$es a seller 4uotes a list price o) goo&s along 'ith availa le tra&e &iscounts0 6n this latter situation, the u"er $ust calculate the gross selling price0 The list price less all tra&e &iscounts is the gross selling price0 (erchan&ising co$panies that sell goo&s use the gross selling price as the cre&it to sales0

p. +BD o) *++

#n accounting perspecti'e: 6ses o0 tec%nology
A &ata ase $anage$ent s"ste$ stores relate& &ataLsuch as $onthl" sales &ata (salespersons, custo$ers, pro&ucts, an& sales a$ounts)Lin&epen&ent o) the application0 Once "ou have &e)ine& this in)or$ation to the &ata ase $anage$ent s"ste$, "ou can use co$$an&s to ans'er such 4uestions as: =hich pro&ucts have een sol& to 'hich custo$ersQ =hat are the a$ounts o) sales salesperson0 " in&ivi&ual salespersonsQ .ou coul& also print a custo$er list sorte& " X6P co&e, the alpha et, or

A tra.e .iscount is a percentage &e&uction, or &iscount, )ro$ the speci)ie& list price or catalog price o) $erchan&ise0 Co$panies use tra&e &iscounts to:
 :e&uce the cost o) catalog pu lication0 A seller can use a catalog )or a longer ti$e " printing list

prices in the catalog an& giving separate &iscount sheets to salespersons 'henever prices change0
 2rant 4uantit" &iscounts0  Allo' 4uotation o) &i))erent prices to various custo$ers, such as retailers an& 'holesalers0

The sellerJs invoice $a" sho' tra&e &iscounts0 #o'ever, sellers &o not recor& tra&e &iscounts in their accounting recor&s ecause the &iscounts are use& onl" to calculate the gross selling price0 /or &o tra&e &iscounts appear on the oo!s o) the purchaser0 To illustrate, assu$e an invoice contains the )ollo'ing &ata:
4ist price, 200 s;i!suits at $24 4ess: Trade discount, 30D Gross sellin) price #invoice price% $4,900 ",440 $3,360

The seller recor&s a sale o) M,< +,+DB0 The purchaser recor&s a purchase o) M,< +,+DB0 Thus, neither the seller nor the purchaser enters list prices an& tra&e &iscounts on their oo!s0 ,o$eti$es the list price o) a pro&uct is su 3ect to several tra&e &iscounts? this series o) &iscounts is a c%ain .iscount0 Chain &iscounts exist, )or exa$ple, 'hen a 'holesaler receives t'o tra&e &iscounts )or services per)or$e&, such as pac!aging an& &istri uting0 =hen $ore than one &iscount is given, the u"er applies each &iscount to the &eclining alance successivel"0 6) a pro&uct has a list price o) M,< 1BB an& is su 3ect to tra&e &iscounts o) IB per cent an& 1B per cent, the gross selling price (invoice price) 'oul& e M,< 1BB - B0I(M,< 1BB) S M,< 8B? M,< 8B - B01(M,< 8B) S M,< @I, co$pute& as )ollo's:
4ist price $"00

p. +B@ o) *++

4ess 20D 4ess "0D Gross sellin) price #invoice price%

3 $

20 90 ■ 9 72

$

.ou coul& o tain the sa$e results " $ultipl"ing the list price " the co$ple$ents o) the tra&e &iscounts allo'e&0 The co$ple$ent o) IB per cent is 8B per cent ecause IB per cent T 8B per cent S 1BB per cent0 The co$ple$ent o) 1B per cent is >B per cent ecause 1B per cent T >B per cent S 1BB per cent0 Thus, the gross selling price is M,< 1BB Z B08 Z B0> S M,< @I0 T'o co$$on &e&uctions )ro$ gross sales are (1) sales &iscounts an& (I) sales returns an& allo'ances0 ,ellers recor& these &e&uctions in contra revenue accounts to the ,ales account0 Contra accounts have nor$al alances that are opposite to the alance o) the account the" re&uce0 For exa$ple, since the ,ales account nor$all" has a cre&it alance, the ,ales <iscounts account an& ,ales :eturns an& Allo'ances account have &e it contra revenue accounts next0 "ales .iscounts =henever a co$pan" sells goo&s on account, it clearl" speci)ies ter$s o) pa"$ent on the invoice0 For exa$ple, the invoice in %xhi it +* states the ter$s o) pa"$ent as Knet +BK0 /et +B is so$eti$es 'ritten as Kn7+BK0 %ither 'a", this ter$ $eans that the u"er $a" not ta!e a &iscount an& $ust pa" the entire a$ount o) the invoice (M,< IB,BBB) on or e)ore +B &a"s a)ter IB1B <ece$ er 1> (invoice &ate)Lor IB11 ;anuar" 180 6n %xhi it +*, i) the ter$s ha& rea& Kn71B7%O(K (%O( $eans en& o) $onth), the u"er coul& not ta!e a &iscount, an& the invoice 'oul& e &ue on the 1Bth &a" o) the $onth )ollo'ing the $onth o) saleLor IB11 ;anuar" 1B0 Cre&it ter$s var" )ro$ in&ustr" to in&ustr"0 6n so$e in&ustries, cre&it ter$s inclu&e a cash &iscount o) 1 per cent to + per cent to in&uce earl" pa"$ent o) an a$ount &ue0 A cas% .iscount is a &e&uction )ro$ the invoice price that can e ta!en onl" i) the invoice is pai& 'ithin a speci)ie& ti$e0 A cash &iscount &i))ers )ro$ a tra&e &iscount in that a cash &iscount is a &e&uction )ro$ the gross selling price )or the pro$pt pa"$ent o) an invoice0 6n contrast, a tra&e &iscount is a &e&uction )ro$ the list price to &eter$ine the gross selling price (or invoice price)0 ,ellers call a cash &iscount a sales .iscount an& u"ers call it a purc%ase .iscount0 Co$panies o)ten state cash &iscount ter$s as )ollo's:
 +/(,, n/@,L$eans a u"er 'ho pa"s 'ithin 1B &a"s )ollo'ing the invoice &ate $a" &e&uct a

alances0 =e explain the $etho&s o) recor&ing these

&iscount o) I per cent o) the invoice price0 6) pa"$ent is not $a&e 'ithin the &iscount perio&, the entire invoice price is &ue +B &a"s )ro$ the invoice &ate0

p. +B8 o) *++

 +/-38, n/I,L$eans a u"er 'ho pa"s " the en& o) the $onth o) purchase $a" &e&uct a I

per cent &iscount )ro$ the invoice price0 6) pa"$ent is not $a&e 'ithin the &iscount perio&, the entire invoice price is &ue DB &a"s )ro$ the invoice &ate0
 +/(,/-38, n/I,L$eans a u"er 'ho pa"s " the 1Bth o) the $onth )ollo'ing the $onth o)

purchase $a" &e&uct a I per cent &iscount )ro$ the invoice price0 6) pa"$ent is not $a&e 'ithin the &iscount perio&, the entire invoice price is &ue DB &a"s )ro$ the invoice &ate0 ,ellers cannot recor& the sales &iscount e)ore the" receive the pa"$ent since the" &o not !no' 'hen the u"er 'ill pa" the invoice0 A cash &iscount ta!en " the u"er re&uces the cash that the seller actuall" collects )ro$ the sale o) the goo&s, so the seller $ust in&icate this )act in its accounting recor&s0 The )ollo'ing entries sho' ho' to recor& a sale an& a su se4uent sales &iscount0 Assu$e that on ;ul" 1I, a usiness sol& $erchan&ise )or M,< I,BBB on account? ter$s are I71B, n7+B0 On ;ul" I1 (nine &a"s a)ter invoice &ate), the usiness receive& a M,< 1,>DB chec! in pa"$ent o) the account0 The re4uire& 3ournal entries )or the seller are:
1ul2 "2 $ccounts Receiva5le #>$% Sales #>SE% To record sale on accountQ ter!s 2G"0, nG30 2" ,as0 #>$% Sales :iscounts #3SEQ ,ontra3Revenue $ccount% $ccounts Receiva5le #3$% To record collection on account, less a discount' ",@60 40 2,000 2,000 2,000

The "ales <iscounts account is a contra revenue account to the ,ales account0 6n the inco$e state$ent, the seller &e&ucts this contra revenue account )ro$ gross sales0 ,ellers use the ,ales <iscounts account (rather than &irectl" re&ucing the ,ales account) so $anage$ent can exa$ine the sales &iscounts )igure to evaluate the co$pan"Js sales &iscount polic"0 /ote that the ,ales <iscounts account is not an expense incurre& in generating revenue0 :ather, the purpose o) the account is to re&uce recor&e& revenue to the a$ount actuall" reali5e& )ro$ the sale0 "ales returns an. allowances (erchan&ising co$panies usuall" allo' custo$ers to return goo&s that are &e)ective or unsatis)actor" )or a variet" o) reasons, such as 'rong color, 'rong si5e, 'rong st"le, 'rong a$ounts, or in)erior 4ualit"0 6n )act, 'hen their polic" is satis)action guarantee&, so$e co$panies allo' custo$ers to return goo&s si$pl" ecause the" &o not li!e the $erchan&ise0 A sales return is $erchan&ise returne& " a u"er0 ,ellers an& u"ers regar& a sales return as a cancellation o) a sale0 Alternativel", so$e custo$ers !eep unsatis)actor" goo&s, an& the seller gives

p. +B> o) *++

the$ an allo'ance o)) the original price0 A sales allowance is a &e&uction )ro$ the original invoice& sales price grante& 'hen the custo$er !eeps the $erchan&ise ut is &issatis)ie& )or an" o) a nu$ er o) reasons, inclu&ing in)erior 4ualit", &a$age, or &eterioration in transit0 =hen a seller agrees to the sales return or sales allo'ance, the seller sen&s the u"er a cre&it $e$oran&u$ in&icating a re&uction (cre&iting) o) the u"erJs account receiva le0 A cre&it $e$oran&u$ is a &ocu$ent that provi&es space )or the na$e an& a&&ress o) the concerne& parties, )ollo'e& " a space )or the reason )or the cre&it an& the a$ount to e cre&ite&0 A cre&it $e$oran&u$ eco$es the asis )or recor&ing a sales return or a sales allo'ance0 6n theor", sellers coul& recor& oth sales returns an& sales allo'ances as &e its to the ,ales account ecause the" cancel part o) the recor&e& selling price0 #o'ever, ecause the a$ount o) sales returns an& sales allo'ances is use)ul in)or$ation to e sho'n separatel"0 The a$ount o) returns an& allo'ances in relation to $anage$ent, it shoul&

goo&s sol& can in&icate the 4ualit" o) the goo&s (high-return percentage, e4uals lo' 4ualit") or o) pressure applie& " salespersons (high-return percentage, e4uals high-pressure sales)0 Thus, sellers recor& sales returns an& sales allo'ances in a separate ,ales :eturns an& Allo'ances account0 The "ales :eturns an. #llowances account is a contra revenue account (to ,ales) that recor&s the selling price o) $erchan&ise returne& " u"ers or re&uctions in selling prices grante&0 (,o$e co$panies use separate accounts )or sales returns an& )or sales allo'ances, ut this text &oes not0) Follo'ing are t'o exa$ples illustrating the recor&ing o) sales returns in the ,ales :eturns an& Allo'ances account:
 Assu$e that a custo$er returns M,< +BB o) goo&s sol& on account0 6) pa"$ent has not "et een

receive&, the re4uire& entr" is:

Sales Returns and $llo;ances #3SE% $ccounts Receiva5le #3$% To record a sales return (ro! a custo!er' 300 300

 Assu$e that the custo$er has alrea&" pai& the account an& the seller gives the custo$er a cash

re)un&0 /o', the cre&it is to Cash rather than to Accounts :eceiva le0 6) the custo$er has ta!en a I per cent &iscount 'hen pa"ing the account, the co$pan" 'oul& return to the custo$er the sales price less the sales &iscount a$ount0 For exa$ple, i) a custo$er returns goo&s that sol& )or M,< +BB, on 'hich a I per cent &iscount 'as ta!en, the )ollo'ing entr" 'oul& e $a&e:

p. +1B o) *++

Sales Returns and $llo;ances #3SE% ,as0 #3$% Sales :iscount #>SE% To record a sales return (ro! a custo!er ;0o 0ad ta6en a discount and ;as sent a cas0 re(und'

300 2@4 6

The &e it to the ,ales :eturns an& Allo'ances account is )or the )ull selling price o) the purchase0 The cre&it o) M,< D re&uces the alance o) the ,ales <iscounts account0 /ext, 'e illustrate the recor&ing o) a sales allo'ance in the ,ales :eturns an& Allo'ances account0 Assu$e that a co$pan" grants a M,< *BB allo'ance to a custo$er )or &a$age resulting )ro$ i$properl" pac!e& $erchan&ise0 6) the custo$er has not "et pai& the account, the re4uire& entr" 'oul& e:
Sales Returns and $llo;ances #3SE% $ccounts Receiva5le #3$% To record a sales allo;ance )ranted (or da!a)ed !erc0andise' 400 400

6) the custo$er has alrea&" pai& the account, the cre&it is to Cash instea& o) Accounts :eceiva le0 6) the custo$er too! a I per cent &iscount 'hen pa"ing the account, the co$pan" 'oul& re)un& onl" the net a$ount (M,< +>I)0 ,ales <iscounts 'oul& e cre&ite& )or M,< 80 The entr" 'oul& e:
Sales Returns and $llo;ances #3SE% ,as0 #3$% Sales :iscount #>SE% To record a sales allo;ance ;0en a custo!er 0as paid and ta6en a 2D discount' 400 3@2 9

HAN!ON RE"AI! FOOD S"ORE Part#a$ #ncome Statement For the Year Ended 2010 December 1,

+peratin) revenues: Gross sales 4ess: Sales discounts Sales returns and allo;ances "5,000 et sales $292,000 $ 5,000 20,000 $262,000

[This illustration is the sa$e as %xhi it ++, repeate& here )or "our convenience0 %xhi it +C: Partial inco$e state$ent[

p. +11 o) *++

%xhi it +C sho's ho' a co$pan" coul& report sales, sales &iscounts, an& sales returns an& allo'ances in the inco$e state$ent0 (ore o)ten, the inco$e state$ent in a co$pan"Js annual report egins 'ith K/et salesK ecause sales &etails are not i$portant to external )inancial state$ent users0

#n accounting perspecti'e: Business insig%t
=hen exa$ining a co$pan"Js sales c"cle, $anage$ent an& users o) )inancial &ata shoul& e a'are o) an" seasonal changes that $a" a))ect its reporte& sales0 A national retailer o) personal co$puters an& relate& pro&ucts an& services, )or exa$ple, shoul& inclu&e 'or&ing si$ilar to that in the )ollo'ing paragraph in its Annual :eport &escri ing seasonalit"0 "easonality Base upon its operating %istory, t%e co"pany believes t%at its business is seasonal. Exclu ing t%e e&&ects o& ne' store openings, net sales an earnings are generally lo'er uring t%e &irst an &ourt% &iscal quarters t%an in t%e secon an t%ir &iscal quarters.

#n accounting perspecti'e: Business insig%t
For $an" retailers a large percentage o) their annual sales occurs &uring the perio& )ro$ Than!sgiving to Christ$as0 The" atte$pt to stoc! 3ust the right a$ount o) goo&s to $eet &e$an&0 ,ince this is a &i))icult esti$ate to $a!e accuratel", $an" retailers en& up 'ith a large a$ount o) unsol& goo&s at the en& o) this season0 The onl" 'a" the" can unloa& these goo&s is to o))er huge &iscounts &uring the )ollo'ing perio&0

%.# Cost of goods sold
The secon& $ain &ivision o) an inco$e state$ent )or a $erchan&ising usiness is cost o) goo&s sol&0 Cost o0 goo.s sol. is the cost to the seller o) the goo&s sol& to custo$ers0 For a $erchan&ising co$pan", the cost o) goo&s sol& can e relativel" large0 All $erchan&ising co$panies have a 4uantit" o) goo&s on han& calle& $erchan&ise inventor" to sell to custo$ers0 8erc%an.ise in'entory (or inventor") is the 4uantit" o) goo&s availa le )or sale at an" given ti$e0 Cost o) goo&s sol& is &eter$ine& " co$puting the cost o) (1) the eginning inventor", (I) the net cost o) goo&s purchase&, an& (+) the en&ing inventor"0 Aoo! at the cost o) goo&s sol& section o) #anlon :etail Foo& ,toreJs inco$e state$ent in %xhi it +D0 The $erchan&ise inventor" on IB1B ;anuar" 1, 'as M,< I*,BBB0 The net cost o) purchases )or the "ear p. +1I o) *++

'as M,< 1DD,BBB0 Thus, #anlon ha& M,< 1>B,BBB o) $erchan&ise availa le )or sale &uring IB1B0 On IB1B <ece$ er +1, the $erchan&ise inventor" 'as M,< +1,BBB, $eaning that this a$ount 'as le)t unsol&0 ,u tracting the unsol& inventor" (the en&ing inventor"), M,< +1,BBB, )ro$ the a$ount #anlon ha& availa le )or sale &uring the "ear, M,< 1>B,BBB, gives the cost o) goo&s sol& )or the "ear o) M,< 1C>,BBB0 Mn&erstan&ing this relationship sho'n on #anlon :etail Foo& ,toreJs partial inco$e state$ent gives "ou the necessar" ac!groun& to &eter$ine the cost o) goo&s sol& as presente& in this section0
,ost o( )oods sold: *erc0andise inventor2, 20"0 1anuar2 " =urc0ases 4ess: =urc0ase discounts =urc0ase returns and allo;ances et =urc0ases $dd: Transportation3in et cost o( purc0ases ,ost o( )oods availa5le (or sale 4ess: *erc0andise inventor2, 20"0 :ece!5er 3" ,ost o( )oods sold $"67,00 0 $ 24,000

$3,00 0 9,000 "",000

$"56,00 0 "0,000 "66,000 $"@0,00 0 3",000 $"5@,00 0

%xhi it +D: <eter$ination o) cost o) goo&s sol& )or #anlon :etail Foo& ,tore To &eter$ine the cost o) goo&s sol&, accountants $ust have accurate $erchan&ise inventor" )igures0 Accountants use t'o asic $etho&s )or &eter$ining the a$ount o) $erchan&ise inventor"L perpetual inventor" proce&ure an& perio&ic inventor" proce&ure0 =e $ention perpetual inventor" proce&ure onl" rie)l" here0 6n the next chapter, 'e e$phasi5e perpetual inventor" proce&ure an& )urther co$pare it 'ith perio&ic inventor" proce&ure0 =hen &iscussing inventor", 'e nee& to clari)" 'hether 'e are re)erring to the ph"sical goo&s on han& or the (erchan&ise 6nventor" account, 'hich is the )inancial representation o) the ph"sical goo&s on han&0 The &i))erence et'een perpetual an& perio&ic inventor" proce&ures is the )re4uenc" 'ith 'hich the (erchan&ise 6nventor" account is up&ate& to re)lect 'hat is ph"sicall" on han&0 Mn&er perpetual in'entory proce.ure, the (erchan&ise 6nventor" account is continuousl" up&ate& to re)lect ite$s on han&0 For exa$ple, "our super$ar!et uses a scanner to ring up "our purchases0 =hen "our ox o) :ice Nrispies crosses the scanner, the (erchan&ise 6nventor" account sho's that one less ox o) :ice Nrispies is on han&0

p. +1+ o) *++

Mn&er perio.ic in'entory proce.ure , the (erchan&ise 6nventor" account is up&ate& perio&icall" a)ter a ph"sical count has een $a&e0 Msuall", the ph"sical count ta!es place i$$e&iatel" e)ore the preparation o) )inancial state$ents0 &erpetual in'entory proce.ure Co$panies use perpetual inventor" proce&ure in a variet" o) usiness settings0 #istoricall", co$panies that sol& $erchan&ise 'ith a high in&ivi&ual unit value, such as auto$o iles, )urniture, an& appliances, use& perpetual inventor" proce&ure0 To&a", co$puteri5e& cash registers, scanners, an& accounting so)t'are progra$s auto$aticall" !eep trac! o) in)lo's an& out)lo's o) each inventor" ite$0 Co$puteri5ation $a!es it econo$ical )or $an" retail stores to use perpetual inventor" proce&ure even )or goo&s o) lo' unit value, such as groceries0 Mn&er perpetual inventor" proce&ure, the (erchan&ise 6nventor" account provi&es close control " sho'ing the cost o) the goo&s that are suppose& to e on han& at an" particular ti$e0 Co$panies &e it the (erchan&ise 6nventor" account )or each purchase an& cre&it it )or each sale so that the current alance is sho'n in the account at all ti$es0 Msuall", )ir$s also $aintain &etaile& unit recor&s sho'ing the 4uantities o) each t"pe o) goo&s that shoul& e on han&0 Co$pan" personnel also ta!e a ph"sical inventor" " actuall" counting the units o) inventor" on han&0 Then the" co$pare this ph"sical count 'ith the recor&s sho'ing the units that shoul& e on han&0 Chapter @ &escri es perpetual inventor" proce&ure in $ore &etail0 &erio.ic in'entory proce.ure (erchan&ising co$panies selling lo' unit value $erchan&ise (such as nuts an& olts, nails, Christ$as car&s, or pencils) that have not co$puteri5e& their inventor" s"ste$s o)ten )in& that the extra costs o) recor&-!eeping un&er perpetual inventor" proce&ure $ore than out'eigh the ene)its0 These $erchan&ising co$panies o)ten use perio&ic inventor" proce&ure0 Mn&er perio&ic inventor" proce&ure, co$panies &o not use the (erchan&ise 6nventor" account to recor& each purchase an& sale o) $erchan&ise0 6nstea&, a co$pan" corrects the alance in the (erchan&ise 6nventor" account as the result o) a ph"sical inventor" count at the en& o) the accounting perio&0 Also, the co$pan" usuall" &oes not $aintain other recor&s sho'ing the exact nu$ er o) units that shoul& e on han&0 Although perio&ic inventor" proce&ure re&uces recor&-!eeping, it also re&uces control over inventor" ite$s0 Co$panies using perio&ic inventor" proce&ure $a!e no entries to the (erchan&ise 6nventor" account nor &o the" $aintain unit recor&s &uring the accounting perio&0 Thus, these co$panies have no up-to-&ate alance against 'hich to co$pare the ph"sical inventor" count at the en& o) the perio&0 Also, these co$panies $a!e no atte$pt to &eter$ine the cost o) goo&s sol& at the ti$e o) each sale0 6nstea&, the" calculate the cost o) all the goo&s sol& &uring the accounting perio& at the en& o) the perio&0 To &eter$ine the cost o) goo&s sol&, a co$pan" $ust !no': p. +1* o) *++

 Beginning inventor" (cost o) goo&s on han& at the eginning o) the perio&)0  /et cost o) purchases &uring the perio&0  %n&ing inventor" (cost o) unsol& goo&s at the en& o) the perio&)0

The co$pan" 'oul& sho' this in)or$ation as )ollo's:
&e)innin) inventor2 $dd: et cost o( purc0ases durin) t0e period ,ost o( )oods availa5le (or sale durin) t0e period :educt: Endin) inventor2 ,ost o( )oods sold durin) t0e period $ 34,000 "40,000 $"74,000 20,000 $"54,000

6n this sche&ule, notice that the co$pan"

egan the accounting perio& 'ith M,< +*,BBB o)

$erchan&ise an& purchase& an a&&itional M,< 1*B,BBB, $a!ing a total o) M,< 1@*,BBB o) goo&s that coul& have een sol& &uring the perio&0 Then, a ph"sical inventor" sho'e& that M,< IB,BBB re$aine& unsol&, 'hich i$plies that M,< 1C*,BBB 'as the cost o) goo&s sol& &uring the perio&0 O) course, the M,< 1C*,BBB is not necessaril" the precise a$ount o) goo&s sol& ecause no actual recor& 'as $a&e o) the &ollar cost o) the goo&s sol&0 Perio&ic inventor" proce&ure asicall" assu$es that ever"thing not on han& at the en& o) the perio& has een sol&0 This $etho& &isregar&s pro le$s such as the)t or rea!age ecause the (erchan&ise 6nventor" account contains no up-to-&ate accounting perio& against 'hich to co$pare the ph"sical count0 Mn&er perio&ic inventor" proce&ure, a $erchan&ising co$pan" uses the &urc%ases account to recor& the cost o) $erchan&ise ought )or resale &uring the current accounting perio&0 The Purchases account, 'hich is increase& " &e its, appears 'ith the inco$e state$ent accounts in the chart o) accounts0 To illustrate entries a))ecting the Purchases account, assu$e that #anlon :etail Foo& ,tore $a&e t'o purchases o) $erchan&ise )ro$ ,$ith =holesale Co$pan"0 #anlon purchase& M,< +B,BBB o) $erchan&ise on cre&it (on account) on (a" *, an& on (a" I1 purchase& M,< IB,BBB o) $erchan&ise )or cash0 The re4uire& 3ournal entries )or #anlon are:
*a2 4 =urc0ases #>$% $ccounts =a2a5le #>4% To record purc0ases o( !erc0andise on account' 2" =urc0ases #>$% ,as0 #3$% To record purc0ase o( !erc0andise (or cas0' 30,000 30,000 20,000 20,000

alance at the en& o) the

p. +1C o) *++

The u"er &e&ucts purchase &iscounts an& purchase returns an& allo'ances )ro$ purchases to arrive at net purchases0 The accountant recor&s these ite$s in contra accounts to the Purchases account0 &urc%ase .iscounts O)ten co$panies purchase $erchan&ise un&er cre&it ter$s that per$it the$ to &e&uct a state& cash &iscount i) the" pa" invoices 'ithin a speci)ie& ti$e0 Assu$e that cre&it ter$s )or #anlonJs (a" * purchase are I71B, n7+B0 6) #anlon pa"s )or the $erchan&ise " (a" 1*, the store $a" ta!e a I per cent &iscount0 Thus, #anlon $ust pa" onl" M,< I>,*BB to settle the M,< +B,BBB account pa"a le0 The entr" to recor& the pa"$ent o) the invoice on (a" 1* is:
*a2 "4 $ccounts =a2a5le #34% ,as0 #3$% =urc0ase :iscount #>SE% To record pa2!ent on account ;it0in t0e discount period' 30,000 2@,400 600

The u"er recor&s the purchase &iscount onl" 'hen the invoice is pai& 'ithin the &iscount perio& an& the &iscount is ta!en0 The &urc%ase <iscounts account is a contra account to Purchases that re&uces the recor&e& invoice price o) the goo&s purchase& to the price actuall" pai&0 #anlon reports purchase &iscounts in the inco$e state$ent as a &e&uction )ro$ purchases0 Co$panies ase purchase &iscounts on the invoice price o) goo&s0 6) an invoice sho's purchase returns or allo'ances, the" $ust e &e&ucte& )ro$ the invoice price e)ore calculating purchase &iscounts0 For exa$ple, in the previous transaction, the invoice price o) goo&s purchase& 'as M,< +B,BBB0 6) #anlon returne& M,< I,BBB o) the goo&s, the seller calculates the I per cent purchase &iscount on M,< I8,BBB0 1nterest rate implie. in cas% .iscounts To &eci&e 'hether "ou shoul& ta!e a&vantage o) &iscounts " using "our cash or orro'ing, $a!e this si$ple anal"sis0 Assu$e that "ou $ust pa" M,< 1B,BBB 'ithin +B &a"s or M,< >,8BB 'ithin 1B &a"s to settle a M,< 1B,BBB invoice 'ith ter$s o) I71B, n7+B0 B" a&vancing pa"$ent IB &a"s )ro$ the )inal &ue &ate, "ou can secure a &iscount o) M,< IBB0 The interest expense incurre& to orro' M,< >,8BB at 1I per cent per "ear )or IB &a"s is M,< DC0++, calculate& as (M,< >,8BB x 01I x IB7+DB)0 .ou 'oul& save M,< 1+*0D@ (M,< IBB - M,< DC0++) " orro'ing the $one" an& pa"ing the invoice 'ithin the &iscount perio&0 6n ter$s o) an annual rate o) interest, the I per cent rate o) &iscount )or IB &a"s is e4uivalent to a +D per cent annual rate: (+DB7IB) Z I per cent0 The )or$ula is:

p. +1D o) *++

.ou can convert all cash &iscount ter$s to their approxi$ate annual interest rate e4uivalents " use o) this )or$ula0 Thus, a co$pan" coul& a))or& to pa" up to +D per cent 8(+DB7IB) Z I per cent9 on orro'e& )un&s to ta!e a&vantage o) &iscount ter$s o) I71B, n7 +B0 The co$pan" coul& pa" 18 per cent on ter$s o) 171B, n7+B0 &urc%ase returns an. allowances A purchase return occurs 'hen a u"er returns $erchan&ise to a seller0 =hen a u"er receives a re&uction in the price o) goo&s shippe&, a purchase allo'ance results0 Then, the u"er co$$onl" uses a &e it $e$oran&u$ to noti)" the seller that the account pa"a le 'ith the seller is eing re&uce& (Accounts Pa"a le is &e ite&)0 The u"er $a" use a cop" o) a &e it $e$oran&u$ to recor& the returns or allo'ances or $a" 'ait )or con)ir$ation, usuall" a cre&it $e$oran&u$, )ro$ the seller0 Both returns an& allo'ances re&uce the u"erJs &e t to the seller an& &ecrease the cost o) the goo&s purchase&0 The u"er $a" 'ant to !no' the a$ount o) returns an& allo'ances as the )irst step in controlling the costs incurre& in returning unsatis)actor" $erchan&ise or negotiating purchase allo'ances0 For this reason, u"ers recor& purchase returns an& allo'ances in a separate &urc%ase :eturns an. #llowances account0 6) #anlon returne& M,< +CB o) $erchan&ise to ,$ith =holesale e)ore pa"ing )or the goo&s, it 'oul& $a!e this 3ournal entr":
$ccounts =a2a5le #34% =urc0ase Returns and $llo;ances #>SE% To record return o( da!a)ed !erc0andise to supplier 350 350

The entr" 'oul& have een the sa$e to recor& a M,< +CB allo'ance0 Onl" the explanation 'oul& change0 6) #anlon ha& alrea&" pai& the account, the &e it 'oul& e to Cash instea& o) Accounts Pa"a le, since #anlon 'oul& receive a re)un& o) cash0 6) the co$pan" too! a &iscount at the ti$e it pai& the account, onl" the net a$ount 'oul& e re)un&e&0 For instance, i) a I per cent &iscount ha& een ta!en, #anlonJs 3ournal entr" )or the return 'oul& e:

p. +1@ o) *++

,as0 #>$% =urc0ase :iscounts #3SE% =urc0ase Returns and $llo;ances #>SE% To record return o( da!a)ed !erc0andise to supplier and record receipt o( cas0'

343 7 350

Purchase returns an& allo'ances is a contra account to the Purchases account, an& the inco$e state$ent sho's it as a &e&uction )ro$ purchases0 =hen oth purchase &iscounts an& purchase returns an& allo'ances are &e&ucte& )ro$ purchases, the result is net purc%ases0 Transportation costs are an i$portant part o) cost o) goo&s sol&0 To un&erstan& ho' to account )or transportation costs, "ou $ust !no' the $eaning o) the )ollo'ing ter$s:
 F3B s%ipping point $eans K)ree on

oar& at shipping pointK0 The

u"er incurs all

transportation costs a)ter the $erchan&ise has een loa&e& on a railroa& car or truc! at the point o) ship$ent0 Thus, the u"er is responsi le )or ulti$atel" pa"ing the )reight charges0
 F3B .estination $eans K)ree on

oar& at &estinationK0 The seller ships the goo&s to their

&estination 'ithout charge to the u"er0 Thus, the seller is ulti$atel" responsi le )or pa"ing the )reight charges0
 &assage o0 title is a ter$ that in&icates the trans)er o) the legal o'nership o) goo&s0 Title to the

goo&s nor$all" passes )ro$ seller to u"er at the FOB point0 Thus, 'hen goo&s are shippe& FOB shipping point, title usuall" passes to the u"er at the shipping point0 =hen goo&s are shippe& FOB &estination, title usuall" passes at the &estination0
 Freig%t prepai. $eans the seller $ust initiall" pa" the )reight at the ti$e o) ship$ent0  Freig%t collect in&icates the u"er $ust initiall" pa" the )reight ill on the arrival o) the goo&s0

To illustrate the use o) these ter$s, assu$e that a co$pan" ships goo&s FOB shipping point, )reight collect0 Title passes at the shipping point0 The u"er is responsi le )or pa"ing the M,< 1BB )reight costs an& &oes so0 The seller $a!es no entr" )or )reight charges? the entr" on the u"erJs oo!s is:
Transportation3.n #or /rei)0t3.n% #>SE% ,as0 #3$% To record pa2!ent o( (rei)0t 5ill on )oods purc0ased' "00 "00

The $ransportation-1n account recor&s the in'ar& )reight costs o) ac4uiring $erchan&ise0 Transportation-6n is an a&3unct account in that it is a&&e& to net purchases to arrive at net cost o0 p. +18 o) *++

purc%ases0 An a.2unct account is closel" relate& to another account (Purchases, in this instance), an& its alance is a&&e& to the alance o) the relate& account in the )inancial state$ents0 :ecall that a contra account is 3ust the opposite o) an a&3unct account0 Bu"ers &e&uct a contra account, such as accu$ulate& &epreciation, )ro$ the relate& )ixe& asset account in the )inancial state$ents0 =hen shipping goo&s FOB &estination, )reight prepai&, the seller is responsi le )or an& pa"s the )reight ill0 Because the seller cannot ill a separate )reight cost to the u"er, the u"er sho's no entr" )or )reight on its oo!s0 The seller, ho'ever, has un&ou te&l" consi&ere& the )reight cost in setting selling prices0 The )ollo'ing entr" is re4uire& on the sellerJs oo!s:
:eliver2 Expense #or Transportation3+ut Expense% #3SE% ,as0 #3$% To record (rei)0t cost on )oods sold' "00 "00

=hen the ter$s are FOB &estination, the seller recor&s the )reight costs as .eli'ery expense? this selling expense appears on the inco$e state$ent 'ith other selling expenses0 FOB ter$s are especiall" i$portant at the en& o) an accounting perio&0 2oo&s in transit then elong to either the seller or the u"er, an& one o) these parties $ust inclu&e these goo&s in its en&ing inventor"0 2oo&s shippe& FOB &estination elong to the seller 'hile in transit, an& the seller inclu&es these goo&s in its en&ing inventor"0 2oo&s shippe& FOB shipping point elong to the u"er 'hile in transit, an& the u"er recor&s these goo&s as a purchase an& inclu&es the$ in its en&ing inventor"0 For exa$ple, assu$e that a seller ships goo&s on IBB> <ece$ er +B, an& the" arrive at their &estination on IB1B ;anuar" C0 6) ter$s are FOB &estination, the seller inclu&es the goo&s in its IBB> <ece$ er +1, inventor", an& neither seller nor u"er recor&s the exchange transaction until IB1B ;anuar" C0 6) ter$s are FOB shipping point, the u"er inclu&es the goo&s in its IBB> <ece$ er +1, inventor", an& oth parties recor& the exchange transaction as o) IBB> <ece$ er +B0 ,o$eti$es the seller prepa"s the )reight as a convenience to the u"er, even though the u"er is ulti$atel" responsi le )or it0 The u"er $erel" rei$ urses the seller )or the )reight pai&0 For exa$ple, assu$e that =oo& Co$pan" sol& $erchan&ise to Aou& Co$pan" 'ith ter$s o) FOB shipping point, )reight prepai&0 The )reight charges 'ere M,< 1BB0 The )ollo'ing entries are necessar" on the oo!s o) the u"er an& the seller:
%14er5!o1d Com3an4 Transportation3.n #3SE% $ccounts =a2a5le #>4% "00 "00 Se$$er5&ood Com3an4

$ccounts Receiva5le #>$% ,as0 #3$%

"00

"00

p. +1> o) *++

,uch entries are necessar" ecause =oo& initiall" pai& the )reight charges 'hen not re4uire& to &o so0 There)ore, Aou& Co$pan" $ust rei$ urse =oo& )or the charges0 6) the u"er pa"s )reight )or the seller (e0g0 FOB &estination, )reight collect), the u"er $erel" &e&ucts the )reight pai& )ro$ the a$ount o'e& to the seller0 The )ollo'ing entries are necessar" on the oo!s o) the u"er an& the seller:
%14er5!o1d Com3an4 Se$$er5&ood Com3an4

$ccounts =a2a5le #34% ,as0 #3$%

"00 "00

:eliver2 Expense #3SE% $ccounts Receiva5le #3$%

"00 "00

Purchase &iscounts $a" e ta!en onl" on the purchase price o) goo&s0 There)ore, a u"er 'ho o'es the seller )or )reight charges cannot ta!e a &iscount on the )reight charges o'e&, even i) the u"er $a!es pa"$ent 'ithin the &iscount perio&0 =e su$$ari5e our &iscussion o) )reight ter$s an& the resulting 3ournal entries to recor& the )reight charges in %xhi it +@0 8erc%an.ise in'entory is the cost o) goo&s on han& an& availa le )or sale at an" given ti$e0 To &eter$ine the cost o) goo&s sol& in an" accounting perio&, $anage$ent nee&s inventor" in)or$ation0 (anage$ent $ust !no' its cost o) goo&s on han& at the start o) the perio& ( eginning inventor"), the net cost o) purchases &uring the perio&, an& the cost o) goo&s on han& at the close o) the perio& (en&ing inventor")0 ,ince the en&ing inventor" o) the prece&ing perio& is the eginning inventor" )or the current perio&, $anage$ent alrea&" !no's the cost o) the eginning inventor"0 Co$panies recor& purchases, purchase &iscounts, purchase returns an& allo'ances, an& transportation-in throughout the perio&0 There)ore, $anage$ent nee&s to &eter$ine onl" the cost o) the en&ing inventor" at the en& o) the perio& in or&er to calculate cost o) goo&s sol&0 $aking a p%ysical in'entory Mn&er perio&ic inventor" proce&ure, co$pan" personnel &eter$ine en&ing inventor" cost " ta!ing a p%ysical in'entory0 Ta!ing a ph"sical inventor" consists o) counting ph"sical units o) each t"pe o) $erchan&ise on han&0 To calculate inventor" cost, the" $ultipl" the nu$ er o) each !in& o) $erchan&ise " its unit cost0 Then, the" co$ ine the total costs o) the various !in&s o) $erchan&ise to provi&e the total en&ing inventor" cost0 6n ta!ing a ph"sical inventor", co$pan" personnel $ust e care)ul to count all goo&s o'ne&, regar&less o) 'here the" are locate&, an& inclu&e the$ in the inventor"0
S0ippin) point: :etroit3
Good+ tra/e$ 6rom +h#33#n- 3o#nt to de+t#nat#on I6 +h#33#n- term+ are0
>90 shi''in/ 'ointB0uyer incurs

:estination: San :ie)o

t0e (rei)0t

>90 destinationBSeller incurs

t0e (rei)0t

p. +IB o) *++

c0ar)es
>rei/ht 're'aidBSeller initiall2

c0ar)e pa2s t0e (rei)0t
>rei/ht collectB0uyer initiall2

c0ar)es

c0ar)es

pa2s t0e (rei)0t

I6 the 6re#-ht term+ are comb#ned a+ 6o$$o7+0 Part4 that Part4 that "erm+ In#t#a$$4 Pa4+ 8$t#mate$4 %ear+ E93en+e

#"% #2% #3% #4%

/+& /+& /+& /+&

s0ippin) point, (rei)0t collect destination, (rei)0t prepaid s0ippin) point, (rei)0t prepaid destination, (rei)0t collect

&u2er Seller Seller &u2er

&u2er Seller &u2er Seller

%xhi it +@: ,u$$ar" o) shipping ter$s
E01lanat%on#? /+& s0ippin) point, (rei)0t collect N &u2er 5ot0 incurs and initiall2 pa2s t0e (rei)0t c0ar)ers' T0e proper part2 #5u2er% paid t0e (rei)0t' T0e 5u2er de5its Transportation3.n and credits ,as0' /+& destination, (rei)0t prepaid N Seller 5ot0 incurs and initiall2 pa2s t0e (rei)0t c0ar)es' T0e proper part2 #seller% paid t0e (rei)0t' T0e seller de5its :eliver2 Expense and credits ,as0' /+& s0ippin) point, (rei)0t prepaid N &u2er incurs t0e (rei)0t c0ar)ers, and seller initiall2 pa2s t0e (rei)0t c0ar)es' &u2er !ust rei!5urse seller (or (rei)0t c0ar)es' T0e seller de5its $ccounts Receiva5le and credits ,as0 upon pa2in) t0e (rei)0t' T0e 5u2er de5its Transportation3.n and credits $ccounts =a2a5le ;0en in(or!ed o( t0e (rei)0t c0ar)es' /+& destination, (rei)0t collect N Seller incurs (rei)0t c0ar)es, and 5u2er initiall2 pa2s (rei)0t c0ar)es' &u2er deducts (rei)0t c0ar)es (ro! a!ount o;ed to seller' T0e 5u2er de5its $ccounts =a2a5le and credits ,as0 ;0en pa2in) t0e (rei)0t' T0e seller de5its :eliver2 Expense and credits $ccounts Receiva5le ;0en in(or!ed o( t0e (rei)0t c0ar)es'

Thus, co$panies shoul& inclu&e goo&s shippe& to potential custo$ers on approval in their inventories0 ,i$ilarl", co$panies shoul& not recor& consigne. goo.s (goo&s &elivere& to another part" 'ho atte$pts to sell the$ )or a co$$ission) as sol& goo&s0 These goo&s re$ain the propert" o) the o'ner (consignor) until sol& " the consignee an& $ust e inclu&e& in the o'nerJs inventor"0 8erc%an.ise in transit is $erchan&ise in the han&s o) a )reight co$pan" on the &ate o) a ph"sical inventor"0 As state& a ove, u"ers $ust recor& $erchan&ise in transit at the en& o) the elong to the part" 'ho ulti$atel" ears the accounting perio& as a purchase i) the goo&s 'ere shippe& FOB shipping point an& the" have receive& title to the $erchan&ise0 6n general, the goo&s transportation charges0 =hen accounting personnel !no' the eginning an& en&ing inventories an& the various ite$s $a!ing up the net cost o) purchases, the" can &eter$ine the cost o) goo&s sol&0 To illustrate, assu$e the )ollo'ing account alances )or #anlon :etail Foo& ,tore as o) IB1B <ece$ er +1:
*erc0andise .nventor2, 20"0 1anuar2 " =urc0ases =urc0ase :iscounts =urc0ase Returns and $llo;ances Transportation3.n $ 24,000 "67,000 3,000 9,000 "0,000 :r' :r' ,r' ,r' :r'

B" ta!ing a ph"sical inventor", #anlon &eter$ine& the IB1B <ece$ er +1, $erchan&ise inventor" to e M,< +1,BBB0 #anlon then calculate& its cost o) goo&s sol& as sho'n in %xhi it +80 This co$putation appears in a section o) the inco$e state$ent &irectl" elo' the calculation o) net sales0

p. +I1 o) *++

,ost o( )oods sold: *erc0andise inventor2, 20"0 1anuar2 " =urc0ases 4ess: =urc0ase discounts =urc0ase returns and allo;ances et =urc0ases $dd: Transportation3in et cost o( purc0ases ,ost o( )oods availa5le (or sale 4ess: *erc0andise inventor2, 20"0 :ece!5er 3" ,ost o( )oods sold T0is illustration is t0e sa!e as Ex0i5it 36, repeated 0ere (or 2our convenience' $3,000 9,000 "",000 $"56,000 "0,000 "66,000 $"@0,000 3",000 $"5@,000 $"67,000 $ 24,000

%xhi it +8: <eter$ination o) cost o) goo&s sol& )or #anlon :etain Foo& ,tore[ 6n %xhi it +8, #anlonJs eginning inventor" (M,< I*,BBB) plus net cost o) purchases (M,< 1DD,BBB) is e4ual to cost o0 goo.s a'ailable 0or sale (M,< 1>B,BBB)0 The )ir$ &e&ucts the en&ing inventor" cost (M,< +1,BBB) )ro$ cost o) goo&s availa le )or sale to arrive at cost o) goo&s sol& (M,< 1C>,BBB)0 Another 'a" o) loo!ing at this relationship is the )ollo'ing &iagra$:

Beginning inventor" an& net cost o) purchases co$ ine to )or$ cost o) goo&s availa le )or sale0 #anlon &ivi&es the cost o) goo&s availa le )or sale into en&ing inventor" ('hich is the cost o) goo&s not sol&) an& cost o) goo&s sol&0 To continue the calculation appearing in %xhi it +8, net cost o) purchases (M,< 1DD,BBB) is e4ual to purchases (M,< 1D@,BBB), less purchase &iscounts (M,< +,BBB) an& purchase returns an& allo'ances (M,< 8,BBB), plus transportation-in (M,< 1B,BBB)0

p. +II o) *++

As sho'n in %xhi it +8, en&ing inventor" cost ($erchan&ise inventor") appears in the inco$e state$ent as a &e&uction )ro$ cost o) goo&s availa le )or sale to co$pute cost o) goo&s sol&0 %n&ing inventor" cost ($erchan&ise inventor") is also a current asset in the en&-o)-perio& alance sheet0 Co$panies use perio&ic inventor" proce&ure ecause o) its si$plicit" an& relativel" lo' cost0 #o'ever, perio&ic inventor" proce&ure provi&es little control over inventor"0 Fir$s assu$e an" ite$s not inclu&e& in the ph"sical count o) inventor" at the en& o) the perio& have een sol&0 Thus, the" $ista!enl" assu$e ite$s that have een stolen have een sol& an& inclu&e their cost in cost o) goo&s sol&0 To illustrate, suppose that the cost o) goo&s availa le )or sale 'as M,< IBB,BBB an& en&ing inventor" 'as M,< DB,BBB0 These )igures suggest that the cost o) goo&s sol& 'as M,< 1*B,BBB0 /o' suppose that M,< I,BBB o) goo&s 'ere actuall" shopli)te& &uring the "ear0 6) such goo&s ha& not een stolen, the en&ing inventor" 'oul& have een M,< DI,BBB an& the cost o) goo&s sol& onl" M,< 1+8,BBB0 Thus, the M,< 1*B,BBB cost o) goo&s sol& calculate& un&er perio&ic inventor" proce&ure inclu&es oth the cost o) the $erchan&ise &elivere& to custo$ers an& the cost o) $erchan&ise stolen0

#n accounting perspecti'e: 6ses o0 tec%nology
(an" co$panies are uil&ing private net'or!s to lin! their e$plo"ees, custo$ers, an& suppliers together0 These net'or!s 'ithin the 6nternet are re)erre& to as co$paniesJ intranets0 The 6nternet can e li!ene& to the entire universe, 'hile an intranet can e li!ene& to a solar s"ste$ 'ithin the universe0 A co$pan"Js intranet is uilt to e secure )ro$ outsi&e users0 For instance, these net'or!s are &esigne& to e secure against Khac!ersK an& other unauthori5e& persons0 The intranet so)t'are t"picall" encr"pts &ata sent over the 6nternet to sa)eguar& )inancial transactions0

%.$ Classified income statement
6n prece&ing chapters, 'e illustrate& the unclassi)ie& (or single-step) inco$e state$ent0 An unclassi0ie. income statement has onl" t'o categoriesLrevenues an& expenses0 6n contrast, a classi0ie. income statement &ivi&es oth revenues an& expenses into operating an& nonoperating ite$s0 The state$ent also separates operating expenses into selling an& a&$inistrative expenses0 A classi)ie& inco$e state$ent is also calle& a $ultiple-step inco$e state$ent0 6n %xhi it +>, 'e present a classi)ie& inco$e state$ent )or #anlon :etail Foo& ,tore0 This state$ent uses the previousl" presente& &ata on sales (%xhi it +C) an& cost o) goo&s sol& (%xhi it +8), p. +I+ o) *++

together 'ith a&&itional assu$e& &ata on operating expenses an& other expenses an& revenues0 /ote in %xhi it +> that a classi)ie& inco$e state$ent has the )ollo'ing )our $a3or sections:
 Operating revenues0  Cost o) goo&s sol&0  Operating expenses0  /onoperating revenues an& expenses (other revenues an& other expenses)0

The classi)ie& inco$e state$ent sho's i$portant relationships that help in anal"5ing ho' 'ell the co$pan" is per)or$ing0 For exa$ple, " &e&ucting cost o) goo&s sol& )ro$ operating revenues, "ou can &eter$ine " 'hat a$ount sales revenues excee& the cost o) ite$s eing sol&0 6) this $argin, calle& gross $argin, is lo'er than &esire&, a co$pan" $a" nee& to increase its selling prices an&7or &ecrease its cost o) goo&s sol&0 The classi)ie& inco$e state$ent su &ivi&es operating expenses into selling an& a&$inistrative expenses0 Thus, state$ent users can see ho' $uch expense is incurre& in selling the pro&uct an& ho' $uch in a&$inistering the usiness0 ,tate$ent users can also $a!e co$parisons 'ith other "earsJ &ata )or the sa$e usiness an& 'ith other usinesses0 /onoperating revenues an& expenses appear at the otto$ o) the inco$e state$ent ecause the" are less signi)icant in assessing the pro)ita ilit" o) the usiness0

#n accounting perspecti'e: Business insig%t
(anage$ent chooses 'hether to use a classi)ie& or unclassi)ie& inco$e state$ent to present a co$pan"Js )inancial &ata0 This choice $a" e ase& either on ho' their co$petitors present their &ata or on the costs associate& 'ith asse$ ling the &ata0
HAN!ON RE"AI! FOOD S"ORE Income Statement For the Year Ended 2010 December 1

+peratin) revenues: Gross sales 4ess: Sales discounts Sales return and allo;ances et sales ,ost o( )oods sold: *erc0andise inventor2, 20"0 1anuar2 " =urc0ases 4ess: =urc0ase discount =urc0ase returns and allo;ances et purc0ases $"67,00 0 $24,000 $ 5,000 "5,000 20,000 $262,000 $292,000

$3,00 0 9,000 "",000

$"56,00 0

p. +I* o) *++

$dd: Transportation3in et cost o( purc0ases ,ost o( )oods availa5le (or sale 4ess: *erc0andise inventor2, 20"0 :ece!5er 3" ,ost o( )oods sold Gross *ar)in +peratin) expenses: Sellin) expenses: Salaries and co!!issions expense Salespersons8 travel expense :eliver2 expense $dvertisin) expense Rent expenseMstore 5uildin) Supplies expense -tilities expense :epreciation expenseMstore e7uip!ent +t0er sellin) expense $d!inistrative expenses: Salaries expense, executive Rent expenseMad!inistrative 5uildin) .nsurance expense Supplies expense :epreciation expenseMo((ice e7uip!ent +t0er ad!inistrative expenses Total operatin) expenses .nco!e (ro! operations onoperatin) revenues and expenses: onoperatin) revenues: .nterest revenue onoperatin) expenses: .nterest expense et inco!e

"0,000 "66,000 $"@0,00 0 3",000 "5@,000 $"03,000

$ 26,000 3,000 2,000 4,000 2,500 ",000 ",900 700 400 $2@,000 ",600 ",500 900 ","00 300 34,300 75,700 $ 27,300 $4",400

",400 $ 29,700 600 $ 29,"00

%xhi it +>: Classi)ie& inco$e state$ent )or a $erchan&ising co$pan" /ext, 'e explain the $a3or hea&ings o) the classi)ie& inco$e state$ent in %xhi it +>0 The ter$s in so$e o) these hea&ings are alrea&" )a$iliar to "ou0 Although )uture illustrations o) classi)ie& inco$e state$ents $a" var" so$e'hat in )or$, 'e retain the asic organi5ation0
 3perating re'enues are the revenues generate&

" the $a3or activities o) the

usinessL

usuall" the sale o) pro&ucts or services or oth0

p. +IC o) *++

 Cost o0 goo.s sol. is the $a3or expense in $erchan&ising co$panies0 /ote the cost o) goo&s

sol& section o) the classi)ie& inco$e state$ent in %xhi it +>0 This chapter has alrea&" &iscusse& the ite$s use& in calculating cost o) goo&s sol&0 (erchan&isers usuall" highlight the a$ount " 'hich sales revenues excee& the cost o) goo&s sol& in the top part o) the inco$e state$ent0 The excess o) net sales over cost o) goo&s sol& is the gross margin or gross pro0it0 To express gross $argin as a percentage rate, 'e &ivi&e gross $argin " net sales0 6n %xhi it +>, the gross $argin rate is approxi$atel" +>0+ per cent (M,< 1B+,BBB7M,< IDI,BBB)0 The gross $argin rate in&icates that out o) each sales &ollar, approxi$atel" +> cents is availa le to cover other expenses an& pro&uce inco$e0 Business o'ners 'atch the gross $argin rate closel" since a s$all percentage )luctuation can cause a large &ollar change in net inco$e0 Also, a &o'n'ar& tren& in the gross $argin rate $a" in&icate a pro le$, such as the)t o) $erchan&ise0 For instance, one ,outheastern sporting goo&s co$pan", ,portsTo'n, 6nc0, su))ere& signi)icant gross $argin &eterioration )ro$ increase& shopli)ting an& e$plo"ee the)t0
 3perating expenses )or a $erchan&ising co$pan" are those expenses, other than cost o)

goo&s sol&, incurre& in the nor$al usiness )unctions o) a co$pan"0 Msuall", operating expenses are either selling expenses or a&$inistrative expenses0 "elling expenses are expenses a co$pan" incurs in selling an& $ar!eting e))orts0 %xa$ples inclu&e salaries an& co$$issions o) salespersons, expenses )or salespersonsJ travel, &eliver", a&vertising, rent (or &epreciation, i) o'ne&) an& utilities on a sales uil&ing, sales supplies use&, an& &epreciation on &eliver" truc!s use& in sales0 #.ministrati'e expenses are expenses a co$pan" incurs in the overall $anage$ent o) a usiness0 %xa$ples inclu&e a&$inistrative salaries, rent (or &epreciation, i) o'ne&) an& utilities on an a&$inistrative uil&ing, insurance expense, a&$inistrative supplies use&, an& &epreciation on o))ice e4uip$ent0 Certain operating expenses $a" e share& " the selling an& a&$inistrative )unctions0 For exa$ple, a co$pan" $ight incur rent, taxes, an& insurance on a uil&ing )or oth sales an& a&$inistrative purposes0 %xpenses covering prorate& oth the selling an& a&$inistrative )unctions $ust e anal"5e& an& et'een the t'o )unctions on the inco$e state$ent0 For instance, i) M,< 1,BBB o)

&epreciation expense relates DB per cent to selling an& *B per cent to a&$inistrative ase& on the s4uare )ootage or nu$ er o) e$plo"ees, the inco$e state$ent 'oul& sho' M,< DBB as a selling expense an& M,< *BB as an a&$inistrative expense0
 !onoperating re'enues (other revenues) an& nonoperating expenses (other expenses)

are revenues an& expenses not relate& to the sale o) pro&ucts or services regularl" o))ere& )or sale " a usiness0 An exa$ple o) a nonoperating revenue is interest that a usiness earns on notes p. +ID o) *++

receiva le0 An exa$ple o) a nonoperating expense is interest incurre& on $one" orro'e& " the co$pan"0 To su$$ari5e the $ore i$portant relationships in the inco$e state$ent o) a $erchan&ising )ir$ in e4uation )or$:
 !et sales S 2ross sales - (,ales &iscounts T ,ales returns an& allo'ances)0  !et purc%ases S Purchases - (Purchase &iscounts T Purchase returns an& allo'ances)0  !et cost o0 purc%ases S /et purchases T Transportation-in0  Cost o0 goo.s sol. S Beginning inventor" T /et cost o) purchases - %n&ing inventor"0  9ross margin S /et sales - Cost o) goo&s sol&0  1ncome 0rom operations S 2ross $argin - Operating (selling an& a&$inistrative) expenses0  !et income S 6nco$e )ro$ operations T /onoperating revenues - /onoperating expenses0

%ach o) these relationships is i$portant

ecause o) the 'a" it relates to an overall $easure o)

usiness pro)ita ilit"0 For exa$ple, a co$pan" $a" pro&uce a high gross $argin on sales0 #o'ever, ecause o) large sales co$$issions an& &eliver" expenses, the o'ner $a" reali5e onl" a ver" s$all percentage o) the gross $argin as pro)it0 The classi)ications in the inco$e state$ent allo' a user to )ocus on the 'hole picture as 'ell as on ho' net inco$e 'as &erive& (state$ent relationships)0

#n et%ical perspecti'e: Eorl. auto parts corporation
;ohn Bentle" is the chie) )inancial o))icer )or =orl& Auto Parts Corporation0 The co$pan" u"s approxi$atel" M,< CBB $illion o) auto parts each "ear )ro$ s$all suppliers all over the 'orl& an& resells the$ to auto repair shops in the Mnite& ,tates0 (ost o) the suppliers have cash &iscount ter$s o) I71B, n7+B0 ;ohn has instructe& his personnel to pa" invoices on the +Bth &a" a)ter the invoice &ate ut to ta!e the I per cent &iscount even though the" are not entitle& to &o so0 =henever a supplier co$plains, ;ohn instructs his purchasing agent to )in& another supplier 'ho 'ill go along 'ith this practice0 =hen so$e o) his o'n e$plo"ees 4uestione& the practice, ;ohn respon&e& as )ollo's: T%is practice really oes no %ar". T%ese s"all suppliers are "uc% better o&& to go along an %ave our business t%an to not go along an lose it. For "ost o& t%e", 'e are t%eir largest custo"er. Besi es, i& t%ey are 'illing to sell to ot%ers at a : per cent iscount, '%y s%oul t%ey not be 'illing to sell to us at t%at sa"e iscount even t%oug% 'e pay a little laterC T%e bene&it to our co"pany is very signi&icant. Dast year

p. +I@ o) *++

our pro&its 'ere E,F #77 "illion. A total o& E,F #7 "illion o& t%e pro&its 'as attributable to t%is practice. Fo you really 'ant "e to c%ange t%is practice an give up E,F #7 "illion o& our pro&itsC

%.% Anal -ing and using the financial results9Bross margin percentage
As &iscusse& earlier, "ou can calculate the gross margin percentage )or$ula: ;ross mar/in 'ercenta/e = ;ross mar/in Net sales " using the )ollo'ing

To &e$onstrate the use o) this ratio, consi&er the )ollo'ing in)or$ation )ro$ the IBBB Annual :eport o) A ercro$ ie P Fitch0
#$ !illions% Revenues Gross pro(it Gross pro(it #!ar)in% percenta)e
2000 1::: 1::.

$ ",239'6 50@'4

$ ",030'@ 450'4

$ 905'2 33"'4 $33"'4G$905'2 ? 4"'"6D

$ 50@'5G$",239'6 ? 4"'"3D $450'4G$",030'@ ? 43'6@D

A ercro$ ieJs gross $argin hel& at a rather high *1-*+ per cent over those three "ears0 .ou shoul& no' un&erstan& the &istinction " $erchan&ising co$panies0 et'een accounting )or a service co$pan" an& a $erchan&ising co$pan"0 The next chapter continues the &iscussion o) $erchan&ise inventor" carrie&

%.' .nderstanding the learning objectives
 6n a sales transaction, the seller trans)ers the legal o'nership (title) o) the goo&s to the u"er0  An invoice is a &ocu$ent, prepare&

" the seller o) $erchan&ise an& sent to the u"er, that

contains the &etails o) a sale, such as the nu$ er o) units sol&, unit price, total price, ter$s o) sale, an& $anner o) ship$ent0
 Msuall" sales are )or cash or on account0 =hen a sale is )or cash, the &e it is to Cash an& the

cre&it is to ,ales0 =hen a sale is on account, the &e it is to Accounts :eceiva le an& the cre&it is to ,ales0
 =hen co$panies o))er tra&e &iscounts, the gross selling price (gross invoice price) at 'hich the

sale is recor&e& is e4ual to the list price $inus an" tra&e &iscounts0

p. +I8 o) *++

 T'o co$$on &e&uctions )ro$ gross sales are (1) sales &iscounts an& (I) sales returns an&

allo'ances0 These &e&uctions are recor&e& in contra revenue accounts to the ,ales account0 Both the ,ales <iscounts account an& the ,ales :eturns an& Allo'ances account nor$all" have &e it alances0 /et sales S ,ales - (,ales &iscounts T ,ales returns an& allo'ances)0
 ,ales &iscounts arise 'hen the seller o))ers the u"er a cash &iscount o) 1 per cent to + per cent to

in&uce earl" pa"$ent o) an a$ount &ue0
 ,ales returns result )ro$ $erchan&ise

eing returne&

" a

u"er

ecause the goo&s are

consi&ere& unsatis)actor" or have is &issatis)ie&0

een &a$age&0 A sales allo'ance is a &e&uction )ro$ the

original invoice& sales price grante& to a custo$er 'hen the custo$er !eeps the $erchan&ise ut
 Cost of /oods sold = 0e/innin/ in+entory + Net cost of 'urchases− Endin/ in+entory 0

Net cost of 'urchases = Purchases−( Purchase discounts + Purchase returns )+ .rans'ortation −¿
 T'o $etho&s o) accounting )or inventor" are perpetual inventor" proce&ure an& perio&ic

inventor" proce&ure0 Mn&er perpetual inventor" proce&ure, the inventor" account is continuousl" up&ate& &uring the accounting perio&0 Mn&er perio&ic inventor" proce&ure, the inventor" account is up&ate& onl" perio&icall"La)ter a ph"sical count has een $a&e0
 Purchases o) $erchan&ise are recor&e&

" &e iting Purchases an& cre&iting Cash ()or cash

purchases) or cre&iting Accounts Pa"a le ()or purchases on account)0
 T'o co$$on &e&uctions )ro$ purchases are (1) purchase &iscounts an& (I) purchase returns

an& allo'ances0 6n the general le&ger, oth o) these ite$s nor$all" carr" cre&it alances0 Fro$ the u"erJs si&e o) the transactions, cash &iscounts are purchase &iscounts, an& $erchan&ise returns an& allo'ances are purchase returns an& allo'ances0
 FOB shipping point $eans )ree on oar& at shipping pointLthe u"er incurs the )reight0  FOB &estination $eans )ree on oar& at &estinationLthe seller incurs the )reight0  Passage o) title is a ter$ in&icating the trans)er o) the legal o'nership o) goo&s0  Freight prepai& is 'hen the seller $ust initiall" pa" the )reight at the ti$e o) ship$ent0  Freight collect is 'hen the u"er $ust initiall" pa" the )reight on the arrival o) the goo&s0  %xpansion an& application o) the relationship intro&uce& in Aearning o 3ective I0 Beginning

inventor" T /et cost o) purchases S Cost o) goo&s availa le )or sale0 Cost o) goo&s availa le )or sale - %n&ing inventor" S Cost o) goo&s sol&0
 A classi)ie& inco$e state$ent has )our $a3or sectionsLoperating revenues, cost o) goo&s sol&,

operating expenses, an& nonoperating revenues an& expenses0

p. +I> o) *++

 Operating revenues are the revenues generate& " the $a3or activities o) the usinessLusuall"

the sale o) pro&ucts or services or oth0
 Cost o) goo&s sol& is the $a3or expense in $erchan&ising co$panies0  Operating expenses )or a $erchan&ising co$pan" are those expenses other than cost o) goo&s

sol& incurre& in the nor$al usiness )unctions o) a co$pan"0 Msuall", operating expenses are classi)ie& as either selling expenses or a&$inistrative expenses0
 /onoperating revenues an& expenses are revenues an& expenses not relate& to the sale o)

pro&ucts or services regularl" o))ere& )or sale " a usiness0 ;ross mar/in  ;ross mar/in 'ercenta/e = Net sales
 The gross $argin rate in&icates the a$ount o) sales &ollars availa le to cover expenses an&

pro&uce inco$e0
 %xcept )or the $erchan&ise-relate& accounts, the 'or! sheet )or a $erchan&ising co$pan" is the

sa$e as )or a service co$pan"0
 An" revenue accounts an& contra purchases accounts in the A&3uste& Trial Balance cre&it

colu$n o) the 'or! sheet are carrie& to the 6nco$e ,tate$ent cre&it colu$n0
 Beginning inventor", contra revenue accounts0 Purchases, Transportation-6n, an& expense

accounts in the A&3uste& Trial Balance &e it colu$n are carrie& to the 6nco$e ,tate$ent &e it colu$n0
 %n&ing $erchan&ise inventor" is entere& in the 6nco$e ,tate$ent cre&it colu$n an& in the

Balance ,heet &e it colu$n0
 Closing entries $a" e prepare& &irectl" )ro$ the 'or! sheet0 The )irst 3ournal entr" &e its all

ite$s appearing in the 6nco$e ,tate$ent cre&it colu$n an& cre&its 6nco$e ,u$$ar"0 The secon& entr" cre&its all ite$s appearing in the 6nco$e ,tate$ent &e it colu$n an& &e its 6nco$e ,u$$ar"0 The thir& entr" &e its 6nco$e ,u$$ar" an& cre&its the :etaine& %arnings account (assu$ing positive net inco$e)0 The )ourth entr" &e its the :etaine& %arnings account an& cre&its the <ivi&en&s account0

%.) Appendi,: The +or& sheet for a merchandising compan
%xhi it *B sho's a 'or! sheet )or a $erchan&ising co$pan"0 A"ons Co$pan" is a s$all sporting goo&s )ir$0 The illustration )or A"ons Co$pan" )ocuses on $erchan&ise-relate& accounts0 Thus, 'e &o not sho' the )ixe& assets (lan&, uil&ing, an& e4uip$ent)0 %xcept )or the $erchan&ise-relate& accounts, the 'or! sheet )or a $erchan&ising co$pan" is the sa$e as )or a service co$pan"0 :ecall

p. ++B o) *++

that use o) a 'or! sheet assists in the preparation o) the a&3usting an& closing entries0 The 'or! sheet also contains all the in)or$ation nee&e& )or the preparation o) the )inancial state$ents0 To )urther si$pli)" this illustration, assu$e A"ons nee&s no a&3usting entries at $onth-en&0 The trial alance is )ro$ the le&ger accounts at IB1B <ece$ er +10 The M,< @,BBB $erchan&ise inventor" in the trial alance is the eginning inventor"0 The sales an& sales-relate& accounts an& the purchases an& purchases-relate& accounts su$$ari5e the $erchan&ising activit" )or <ece$ er IB1B0 A"ons carries an" revenue accounts (,ales) an& contra purchases accounts (Purchase <iscounts, Purchase :eturns an& Allo'ances) in the A&3uste& Trial Balance cre&it colu$ns o) the 'or! sheet to the 6nco$e ,tate$ent cre&it colu$n0 6t carries eginning inventor", contra revenue accounts (,ales <iscounts, ,ales :eturns an& Allo'ances), Purchases, Transportation-6n, an& expense accounts (,elling %xpenses, A&$inistrative %xpenses) in the A&3uste& Trial Balance &e it colu$n to the 6nco$e ,tate$ent &e it colu$n0 Assu$e that en&ing inventor" is M,< 8,BBB0 A"ons enters this a$ount in the 6nco$e ,tate$ent cre&it colu$n ecause it is &e&ucte& )ro$ cost o) goo&s availa le )or sale ( eginning inventor" plus net cost o) purchases) in &eter$ining cost o) goo&s sol&0 6t also enters the en&ing inventor" in the Balance ,heet &e it colu$n to esta lish the proper alance in the (erchan&ise 6nventor" account0 The eginning an& en&ing inventories are on the 6nco$e ,tate$ent ecause A"ons uses oth to calculate cost o) goo&s sol& in the inco$e state$ent0 /et inco$e o) M,< C,8*+ )or the perio& alances the 6nco$e ,tate$ent colu$ns0 The )ir$ carries the net inco$e to the ,tate$ent o) :etaine& %arnings cre&it colu$n0 :etaine& earnings o) M,< 18,8*+ alances the ,tate$ent o) :etaine& %arnings colu$ns0 A"ons Co$pan" carries the retaine& earnings to the Balance ,heet cre&it colu$n0 A"ons carries all other asset account alances (Cash, Accounts :eceiva le, an& en&ing (erchan&ise 6nventor") to the Balance ,heet &e it colu$n0 6t also carries the lia ilit" (Accounts Pa"a le) an& Capital ,toc! account alances to the Balance ,heet cre&it colu$n0 The alance sheet colu$ns total to M,< I>,C*+0 Once the 'or! sheet has een co$plete&, A"ons prepares the )inancial state$ents0 A)ter entering an" a&3usting an& closing entries in the 3ournal, the )ir$ posts the$ to the le&ger0 This process clears the recor&s )or the next accounting perio&0 Finall", it prepares a post-closing trial alance0 1ncome statement %xhi it *1 sho's the inco$e state$ent A"ons prepare& )ro$ its 'or! sheet in %xhi it *B0 The )ocus in this inco$e state$ent is on &eter$ining the cost o) goo&s sol&0 "tatement o0 retaine. earnings The state$ent o) retaine& earnings, as "ou recall, is a )inancial state$ent that su$$ari5es the transactions a))ecting the :etaine& %arnings account alance0 6n

p. ++1 o) *++

%xhi it *I, the state$ent o) retaine& earnings sho's an increase in e4uit" resulting )ro$ net inco$e an& a &ecrease in e4uit" resulting )ro$ &ivi&en&s0

Acct. no'

$ccount Titles

!YONS COMPANY &or;+heet For the Month Ended 2010 December 1 Trial &alance :e5it ,redit $d<ust!ents :e5it ,redit $d<usted Tr%al &alance :e5it 1C"== 1"AA0 B00 10"00 0 1<"00 0 1;"=0 0 B"000 B00 10"00 0 1<"00 0 1;"=0 0 B"000 A"000 ,redit .nco!e State!ent :e5it ,redit

State!ent o( Retained Earnin)s :e5it ,redit

&alance S0eet :e5it 1C"=< 1"AA0 A"000

100 10 10< 200 00 310 320 ;10 ;11 ;12 <00 SOI <02 <0 <<B <=B

Ca#h Account# Rece%2a&le Merchand%#e In2entory" :ecem&er 1 Account# .aya&le Ca1%tal Stoc' Reta%ned Earn%n+#" :ecernl<er 1 :%2%dend# Sale# Sale# :%#count# Sale# Return# and Allo,ance# .urcha#e# .urcha#e# :%#count# .urcha#e Return# and Allo,ance# Tran#1ortat%on-In M%#cellaneou# Sell%n+ E01en#e# M%#cellaneou# Adm%n%#trat%2e E01en#e# Net Income Reta%ned Earn%n+#" :ecem&er 1

1C"== 1" A0 B"000

1<"000 1;"=00 ;; 20 ="000 2 100 2"000

2"000 ;; 20 ="000

2"000 ;; 20 ="000

A2 100

A2 100

B< 2"=<0

B< 2"=<0

B< 2"=<0

1"1<0 ;0";A2 ;0";A 2

1"1<0 ;0"; 2

1"1<0 ;0";A 1="C C 22"BA2 2 <"A; 22"B 2 22"BA2 2"000 1A"S; 20"A;

<" ; 20" ; 20"A;

2C"<; 2C"<;

%xhi it *B: =or! sheet )or a $erchan&ising co$pan"

p. ++I o) *++

!YONS COMPANY Income Statement For the Month Ended 2010 December 1

+peratin) revenues: Gross sales 4ess: Sales discounts Sales return and allo;ances et sales ,ost o( )oods sold: *erc0andise inventor2, 20"0 1anuar2 " =urc0ases 4ess: =urc0ase discount =urc0ase returns and allo;ances et purc0ases $dd: Transportation3in et cost o( purc0ases ,ost o( )oods availa5le (or sale 4ess: *erc0andise inventor2, 20"0 :ece!5er 3" ,ost o( )oods sold Gross *ar)in +peratin) expenses: *iscellaneous sellin) expense *iscellaneous ad!inistrative expense Total operatin) expenses et inco!e $2,650 ","50 3,900 $ 5,943 $ 92 "00 "92 $5,9"9 75 5,9@3 $"2,9@ 3 9,000 4,9@3 $ @,643 $ 6,000 $ 7,000 $ 44 20 64 $"4,536 $"4,600

%xhi it *1: 6nco$e state$ent )or a $erchan&ising co$pan"
!YONS COMPANY Statement o6 Reta#ned Earn#n-+ For the Month Ended 2010 December 1

Retained earnin)s, 20"0 :ece!5er " $dd: et inco!e (or t0e !ont0 Total :educt: :ividends Retained earnin)s, 20"0 :ece!5er 3"

$"5,000 5,943 $20,943 2,000 $"9,943

%xhi it *I: ,tate$ent o) retaine& earnings

p. +++ o) *++

!YONS COMPANY %a$ance Sheet 2010 December 1 A++et+

,as0 $ccounts receiva5le *erc0andise inventor2 Total assets
!#ab#$#t#e+ and Stoc;ho$der+2 E<1#t4

$"@,663 ",990 9,000 $2@,543

4ia5ilities: $ccounts pa2a5le Stoc60olders8 e7uit2: ,apital stoc6 Retained earnin)s Total stoc60olders8 e7uit2 Total lia5ilities and stoc60olders8 e7uit2 $ "0,000 "9,943 $ 700

29,943 $2@,543

%xhi it *+: Balance sheet )or a $erchan&ising co$pan" Balance s%eet The alance sheet, %xhi it *+, contains the assets, lia ilities, an& stoc!hol&ersJ e4uit" ite$s ta!en )ro$ the 'or! sheet0 /ote the M,< 8,BBB en&ing inventor" is a current asset0 The :etaine& %arnings account alance co$es )ro$ the state$ent o) retaine& earnings0 :ecall )ro$ Chapter * that the closing process nor$all" ta!es place a)ter the accountant has prepare& the )inancial state$ents )or the perio&0 The closing process closes revenue an& expense accounts " trans)erring their alances to a clearing account calle& 6nco$e ,u$$ar" an& then to :etaine& %arnings0 The closing process re&uces the revenue an& expense account alances to 5ero so that in)or$ation )or each accounting perio& $a" e accu$ulate& separatel"0 A"onsJs accountant 'oul& prepare closing entries &irectl" )ro$ the 'or! sheet in %xhi it *B using the sa$e proce&ure presente& in Chapter *0 The closing entries )or A"ons Co$pan" )ollo'0 The )irst 3ournal entr" &e its all ite$s appearing in the 6nco$e ,tate$ent cre&it colu$n o) the 'or! sheet an& cre&its 6nco$e ,u$$ar" )or the total o) the colu$n, M,< II,@8I0
20"0 :ec' R "st entr2 3" *erc0andise .nventor2 #endin)% Sales =urc0ase :iscounts =urc0ase Returns and $llo;ances .nco!e Su!!ar2 To close accounts ;it0 a credit 5alance in t0e .nco!e State!ent colu!ns and to esta5lis0 endin) !erc0andise inventor2' 9,000 "4,600 92 "00 22,792

The secon& entr" cre&its all ite$s appearing in the 6nco$e ,tate$ent &e it colu$n an& &e its 6nco$e ,u$$ar" )or the total o) that colu$n, M,< 1D,>+>0

p. ++* o) *++

20"0 :ec' 3" .nco!e Su!!ar2 *erc0andise .nventor2 #5e)innin)% Sales :iscounts Sales Returns and $llo;ance =urc0ases Transportation3.n *iscellaneous Sellin) Expenses *iscellaneous $d!inistrative Expenses To close accounts ;it0 a de5it 5alance in t0e .nco!e State!ent colu!ns'
"6,@3@

7,000 44 20 6,000 75 2,650 ","50

R 2nd entr2

The thir& entr" closes the cre&it alance in the 6nco$e ,u$$ar" account o) M,< C,8*+ to the :etaine& %arnings account0
20"0 :ec' 3" .nco!e Su!!ar2 Retained Earnin)s To close t0e .nco!e Su!!ar2 account to t0e Retained Earnin)s account' 5,943 5,943

The )ourth entr" closes the <ivi&en&s account alance o) EI,BBB to the :etaine& %arnings account " &e iting :etaine& %arnings an& cre&iting <ivi&en&s0
20"0 :ec' 3" Retained Earnin)s :ividends To close t0e :ividends account to t0e Retained Earnin)s account' 2,000 2,000

/ote ho' the )irst three closing entries tie into the totals in the 6nco$e ,tate$ent colu$ns o) the 'or! sheet in %xhi it *B0 6n the )irst closing 3ournal entr", the cre&it to the 6nco$e ,u$$ar" account is e4ual to the total o) the 6nco$e ,tate$ent cre&it colu$n0 6n the secon& entr", the &e it to the 6nco$e ,u$$ar" account is e4ual to the su total o) the 6nco$e ,tate$ent &e it colu$n0 The &i))erence et'een the totals o) the t'o 6nco$e ,tate$ent colu$ns (M,< C,8*+) represents net inco$e an& is the a$ount o) the thir& closing entr"0

%.).1 Demonstration problem
The )ollo'ing transactions occurre& et'een Co$panies C an& < in ;une IB1B: ;une 1B Co$pan" C purchase& $erchan&ise )ro$ Co$pan" < )or M,< 8B,BBB? ter$s I71B7%O(, n7DB, FOB &estination, )reight prepai&0 11 Co$pan" < pai& )reight o) M,< 1,IBB0

p. ++C o) *++

1* Co$pan" C receive& an allo'ance o) M,< *,BBB )ro$ the gross selling price ecause o) &a$age& goo&s0 I+ Co$pan" C returne& M,< 8,BBB o) goo&s purchase& ecause the" 'ere not the 4ualit" or&ere&0 +B Co$pan" < receive& pa"$ent in )ull )ro$ Co$pan" C0 a0 ;ournali5e the transactions )or Co$pan" C0 0 ;ournali5e the transactions )or Co$pan" <0

%.).2 6olution to demonstration problem
a0
Genera$ =o1rna$

:ate 20"0 1une " 0

$ccount Titles and Explanation
Com3an4 C

=ost' Re('

:e5it 9 0 0 0 0

,redit

=urc0ases $ccounts =a2a5le =urc0ased !erc0andise (ro! ,o!pan2 :Q ter!s 2G"0GE+*, nG60

9 0 0 0 0

" 4

$ccounts =a2a5le =urc0ase Return and $llo;ances Received an allo;ance (ro! ,o!pan2 : (or da!a)ed )oods'

4 0 0 0 4 0 0 0

2 3

$ccounts =a2a5le =urc0ase Returns and $llo;ances Returned !erc0andise to ,o!pan2 : 5ecause o( i!proper 7ualit2

9 0 0 0 9 0 0 0

3 0

$ccounts =a2a5le #$90,000 3 $4,000 3 $9,000% =urc0ase :iscounts #$69,000 x 0'02% ,as0 #$69,000 3 $",360% =aid t0e a!ount due to ,o!pan2 :'

6 9 0 0 0 " 3 6 0 6 6 6 4 0

0

p. ++D o) *++

Genera$ =o1rna$

:ate 20"0 1une " 0

$ccount Titles and Explanation
Com3an4 D

=ost' Re('

:e5it 9 0 0 0 0

,redit

$ccounts Receiva5le Sales Sold !erc0andise to ,o!pan2 ,Q ter!s 2G"0GE+*, nG60

9 0 0 0 0

" "

:eliver2 Expense ,as0 =aid (rei)0t on sale o( !erc0andise s0ipped /+& destination, (rei)0t prepaid'

" 2 0 0 " 2 0 0

" 4

Sales Returns and $llo;ances $ccounts Receiva5le Granted an allo;ance to ,o!pan2 , (or da!a)ed )oods'

4 0 0 0 4 0 0 0

2 3

Sales Returns and $llo;ances $ccounts Receiva5le *erc0andise returned (ro! ,o!pan2 , due to i!proper 7ualit2'

9 0 0 0 9 0 0 0

3 0

,as0 #$69,000 3 $",360% Sales :iscounts #$69,000 x 0'02% $ccounts Receiva5le #$90,000 3 $4,000 3 $9,000% Received t0e a!ount due (ro! ,o!pan2 ,'

6 6 6 4 0 " 3 6 0 6 9 0 0 0

%.18 ;e terms
#.2unct account Closel" relate& to another account? its alance is a&&e& to the alance o) the relate& account in the )inancial state$ents0 #.ministrati'e expenses %xpenses a co$pan" incurs in the overall $anage$ent o) a usiness0 Cas% .iscount A &e&uction )ro$ the invoice price that can e ta!en onl" i) the invoice is pai& 'ithin a speci)ie& ti$e0 To the seller, it is a sales &iscount? to the u"er, it is a purchase &iscount0 C%ain .iscount Occurs 'hen the list price o) a pro&uct is su 3ect to a series o) tra&e &iscounts0 Classi0ie. income statement <ivi&es oth revenues an& expenses into operating an& nonoperating ite$s0 The state$ent also separates operating expenses into selling an& a&$inistrative expenses0 Also calle& the $ultiple-step inco$e state$ent0 Consigne. goo.s 2oo&s &elivere& to another part" 'ho atte$pts to sell the goo&s )or the o'ner at a co$$ission0 Cost o0 goo.s a'ailable 0or sale %4ual to eginning inventor" plus net cost o) purchases0

p. ++@ o) *++

Cost o0 goo.s sol. ,ho's the cost to the seller o) the goo&s sol& to custo$ers? un&er perio&ic inventor" proce&ure, cost o) goo&s sol& is co$pute& as Beginning inventor" T /et cost o) purchases - %n&ing inventor"0 <eli'ery expense A selling expense recor&e& " the seller )or )reight costs incurre& 'hen ter$s are FOB &estination0 F3B .estination (eans )ree on oar& at &estination? goo&s are shippe& to their &estination 'ithout charge to the u"er? the seller is responsi le )or pa"ing the )reight charges0 F3B s%ipping point (eans )ree on oar& at shipping point? u"er incurs all transportation costs a)ter the $erchan&ise is loa&e& on a railroa& car or truc! at the point o) ship$ent0 Freig%t collect Ter$s that re4uire the u"er to pa" the )reight ill on arrival o) the goo&s0 Freig%t prepai. Ter$s that in&icate the seller has pai& the )reight ill at the ti$e o) ship$ent0 9ross margin or gross pro0it /et sales - Cost o) goo&s sol&? i&enti)ies the nu$ er o) &ollars availa le to cover expenses other than cost o) goo&s sol&0 9ross margin percentage 2ross $argin &ivi&e& " net sales0 9ross selling price (also calle& the invoice price) The list price less all tra&e &iscounts0 1ncome 0rom operations 2ross $argin - Operating (selling an& a&$inistrative) expenses0 1n'oice A &ocu$ent prepare& " the seller o) $erchan&ise an& sent to the u"er0 6t contains the &etails o) a sale, such as the nu$ er o) units sol&, unit price, total price ille&, ter$s o) sale, an& $anner o) ship$ent0 6t is a purchase invoice )ro$ the u"erJs point o) vie' an& a sales invoice )ro$ the sellerJs point o) vie'0 8anu0acturers Co$panies that pro&uce goo&s )ro$ ra' $aterials an& nor$all" sell the$ to 'holesalers0 8erc%an.ise in transit (erchan&ise in the han&s o) a )reight co$pan" on the &ate o) a ph"sical inventor"0 8erc%an.ise in'entory The 4uantit" o) goo&s availa le )or sale at an" given ti$e0 !et cost o0 purc%ases /et purchases T Transportation-in0 !et income 6nco$e )ro$ operations T /onoperating revenues - /onoperating expenses0 !et purc%ases Purchases - (Purchase &iscounts TPurchase returns an& allo'ances)0 !et sales 2ross sales - (,ales &iscounts T ,ales returns an& allo'ances)0 !onoperating expenses (other expenses) %xpenses incurre& " a usiness that are not relate& to the ac4uisition an& sale o) the pro&ucts or services regularl" o))ere& )or sale0 !onoperating re'enues (other revenues) :evenues not relate& to the sale o) pro&ucts or services regularl" o))ere& )or sale " a usiness0 3perating expenses Those expenses other than cost o) goo&s sol& incurre& in the nor$al usiness )unctions o) a co$pan"0 3perating re'enues Those revenues generate& " the $a3or activities o) a usiness0 &assage o0 title A legal ter$ use& to in&icate trans)er o) legal o'nership o) goo&s0 &erio.ic in'entory proce.ure A $etho& o) accounting )or $erchan&ise ac4uire& )or sale to custo$ers 'herein the cost o) $erchan&ise sol& an& the cost o) $erchan&ise on han& are &eter$ine& onl" at the en& o) the accounting perio& " ta!ing a ph"sical inventor"0 &erpetual in'entory proce.ure A $etho& o) accounting )or $erchan&ise ac4uire& )or sale to custo$ers 'herein the (erchan&ise 6nventor" account is continuousl" up&ate& to re)lect

p. ++8 o) *++

ite$s on han&? this account is &e ite& )or each purchase an& cre&ite& )or each sale so that the current alance is sho'n in the account at all ti$es0 &%ysical in'entory Consists o) counting ph"sical units o) each t"pe o) $erchan&ise on han&0 &urc%ase .iscount ,ee Cash &iscount0 &urc%ase <iscounts account A contra account to Purchases that re&uces the recor&e& gross invoice cost o) the purchase to the price actuall" pai&0 &urc%ase :eturns an. #llowances account An account use& un&er perio&ic inventor" proce&ure to recor& the cost o) $erchan&ise returne& to a seller an& to recor& re&uctions in selling prices grante& " a seller ecause $erchan&ise 'as not satis)actor" to a u"er? vie'e& as a re&uction in the recor&e& cost o) purchases0 &urc%ases account An account use& un&er perio&ic inventor" proce&ure to recor& the cost o) goo&s or $erchan&ise ought )or resale &uring the current accounting perio&0 :etailers Co$panies that sell goo&s to )inal consu$ers0 "ales allowance A &e&uction )ro$ original invoice& sales price grante& to a custo$er 'hen the custo$er !eeps the $erchan&ise ut is &issatis)ie& )or an" o) a nu$ er o) reasons, inclu&ing in)erior 4ualit", &a$age, or &eterioration in transit0 "ales .iscount ,ee Cash &iscount0 "ales <iscounts account A contra revenue account to ,ales? it is sho'n as a &e&uction )ro$ gross sales in the inco$e state$ent0 "ales return Fro$ the sellerJs point o) vie', $erchan&ise returne& " a u"er )or an" o) a variet" o) reasons? to the u"er, a purchase return0 "ales :eturns an. #llowances account A contra revenue account to ,ales use& to recor& the selling price o) $erchan&ise returne& " u"ers or re&uctions in selling prices grante&0 "elling expenses %xpenses a co$pan" incurs in selling an& $ar!eting e))orts0 $ra.e .iscount A percentage &e&uction, or &iscount, )ro$ the speci)ie& list price or catalog price o) $erchan&ise to arrive at the gross invoice price? grante& to particular categories o) custo$ers (e0g0 retailers an& 'holesalers)0 Also see Chain &iscount0 $ransportation-1n account An account use& un&er perio&ic inventor" proce&ure to recor& in'ar& )reight costs incurre& in the ac4uisition o) $erchan&ise? a part o) cost o) goo&s sol&0 6nclassi0ie. income statement ,ho's onl" $a3or categories )or revenues an& expenses0 Also calle& the single-step inco$e state$ent0 E%olesalers Co$panies that nor$all" sell goo&s to other co$panies (retailers) )or resale0

%.11 6elf<test
%.11.1
o o

True<false

6n&icate 'hether each o) the )ollo'ing state$ents is true or )alse0 To co$pute net sales, sales &iscounts are a&&e& to, an& sales returns an& allo'ances are &e&ucte& )ro$, gross sales0 Mn&er perpetual inventor" proce&ure, the (erchan&ise 6nventor" account is &e ite& )or each purchase an& cre&ite& )or each sale0

p. ++> o) *++

o o o

Purchase &iscounts an& purchase returns an& allo'ances are recor&e& in contra accounts to the Purchases account0 6n ta!ing a ph"sical inventor", consigne& goo&s &elivere& to another part" 'ho atte$pts to sell the goo&s are not inclu&e& in the en&ing inventor" o) the co$pan" that sent the goo&s0 A classi)ie& inco$e state$ent consists o) onl" t'o categories o) ite$s, revenues an& expenses0

%.11.2

=ultiple<choice

,elect the est ans'er )or each o) the )ollo'ing 4uestions0 A seller sol& $erchan&ise 'hich has a list price o) M,< *,BBB on account, giving a tra&e &iscount o) IB per cent0 The entr" on the oo!s o) the seller is:
a' $ccounts Receiva5le Trade :iscounts Sales 5' $ccounts Receiva5le Sales c' $ccounts Receiva5le Trade :iscounts Sales d' $ccounts Receiva5le Sales 3,200 3,200 3,200 900 4,000 4,000 4,000 3,200 900 4,000

Z Co$pan"

egan the accounting perio& 'ith M,< DB,BBB o) $erchan&ise, an& net cost o)

purchases 'as M,< I*B,BBB0 A ph"sical inventor" sho'e& M,< @I,BBB o) $erchan&ise unsol& at the en& o) the perio&0 The cost o) goo&s sol& o) . Co$pan" )or the perio& is: a0 M,< +BB,BBB0 0 M,< II8,BBB0 c0 M,< ICI,BBB0 &0 M,< 1D8,BBB0 e0 /one o) the a ove0 A usiness purchase& $erchan&ise )or M,< 1I,BBB on account? ter$s are I71B, n7+B0 6) M,< I,BBB o) the $erchan&ise 'as returne& an& the re$aining a$ount &ue 'as pai& 'ithin the &iscount perio&, the purchase &iscount 'oul& e: a0 M,< I*B0 0 M,< IBB0 p. +*B o) *++

c0 M,< 1,IBB0 &0 M,< 1,BBB0 e0 M,< +,DBB0 A classi)ie& inco$e state$ent consists o) all o) the )ollo'ing $a3or sections except )or: a0 Operating revenues0 0 Cost o) goo&s sol&0 c0 Operating expenses0 &0 /onoperating revenues an& expenses0 e0 Current assets0 (Appen&ix) Closing entries )or $erchan&ise-relate& accounts inclu&e all o) the )ollo'ing except )or: a0 A cre&it to ,ales <iscounts0 0 A cre&it to (erchan&ise 6nventor" )or the cost o) en&ing inventor"0 c0 A &e it to Purchase <iscounts0 &0 A cre&it to Transportation-6n0 e0 A &e it to ,ales0 /o' turn to FAns'ers to sel)-testH at the en& o) the chapter to chec! "our ans'ers0

%.11.3


>uestions
=hich account titles are li!el" to appear in a $erchan&ising co$pan"Js le&ger that &o not appear in the le&ger o) a service enterpriseQ =hat entr" is $a&e to recor& a sale o) $erchan&ise on account un&er perio&ic inventor" proce&ureQ <escri e tra&e &iscounts an& chain &iscounts0 ,ales &iscounts an& sales returns an& allo'ances are &e&ucte& )ro$ sales on the inco$e state$ent to arrive at net sales0 =h" not &e&uct these &irectl" )ro$ the ,ales account " &e iting ,ales each ti$e a sales &iscount, return, or allo'ance occursQ



 



=hat are the t'o asic proce&ures )or accounting )or inventor"Q #o' &o these t'o proce&ures &i))erQ =hat use)ul purpose &oes the Purchases account serveQ



p. +*1 o) *++



=hat &o the letters FOB stan& )orQ =hen ter$s are FOB &estination, 'ho incurs the cost o) )reightQ =hat t"pe o) an expense is &eliver" expenseQ =here is this expense reporte& in the inco$e state$entQ Perio&ic inventor" proce&ure is sai& to a))or& little control over inventor"0 %xplain 'h"0 #o' &oes the accountant arrive at the total &ollar a$ount o) the inventor" a)ter ta!ing a ph"sical inventor"Q #o' is cost o) goo&s sol& &eter$ine& un&er perio&ic inventor" proce&ureQ 6) the cost o) goo&s availa le )or sale an& the cost o) the en&ing inventor" are !no'n, 'hat other a$ount appearing on the inco$e state$ent can e calculate&Q =hat are the $a3or sections in a classi)ie& inco$e state$ent )or a $erchan&ising co$pan", an& in 'hat or&er &o these sections appearQ =hat is gross $arginQ =h" $ight $anage$ent e intereste& in the percentage o) gross $argin to net salesQ (Appen&ix) A)ter closing entries are poste& to the le&ger, 'hich t"pes o) accounts have alancesQ =h"Q $%e Limite., 1nc. Base& on the )inancial state$ents o) The Ai$ite& in the Annual :eport Appen&ix, 'hat 'ere the IBBB operating expensesQ For each o) the three "ears sho'n, 'hat percentage o) net sales 'ere these expensesQ 6s the tren& )avora le or un)avora leQ



 

 











$%e Limite., 1nc. Base& on the )inancial state$ents o) The Ai$ite&, 6nc0, in the Annual :eport Appen&ix, 'hat 'ere the IBBB cost o) goo&s sol&, occupanc", an& u"ing costsQ For each o) the three "ears sho'n, 'hat percentage o) net sales 'ere these expensesQ 6s the tren& )avora le or un)avora leQ

%.11.!

E,ercises

-xercise # 6n the )ollo'ing ta le, in&icate ho' to increase or &ecrease (&e it or cre&it) each account, an& in&icate its nor$al alance (&e it or cre&it)0
Increa+ed b4 >deb#t "#t$e o6 Acco1nt or cred#t? Decrea+ed b4 >deb#t or cred#t? Norma$ %a$ance >deb#t or cred#t?

*erc0andise .nventor2 Sales

p. +*I o) *++

Sales Returns and $llo;ances Sales :iscounts $ccounts Receiva5le =urc0ases =urc0ase Returns and $llo;ances =urc0ase :iscounts $ccounts =a2a5le
Transportation3.n

-xercise B a0 ,ilver Co$pan" purchase& M,< CD,BBB o) $erchan&ise )ro$ (ilton Co$pan" on account0 Be)ore pa"ing its account, ,ilver Co$pan" returne& &a$age& $erchan&ise 'ith an invoice price o) M,< 11,D8B0 Assu$ing use o) perio&ic inventor" proce&ure, prepare entries on co$paniesJ oo!s to recor& oth the purchase7sale an& the return0 0 ,ho' ho' an" o) the re4uire& entries 'oul& change assu$ing that (ilton Co$pan" grante& an allo'ance o) M,< +,+DB on the &a$age& goo&s instea& o) giving per$ission to return the $erchan&ise0 -xercise C =hat is the last pa"$ent &ate on 'hich the cash &iscount can e ta!en on goo&s sol& on (arch C )or M,< C1,IBB? ter$s +71B7%O(, n7DBQ Assu$e that the ill is pai& on this &ate an& prepare the correct entries on oth the u"erJs an& sellerJs oo!s to recor& the pa"$ent0 -xercise < .ou have purchase& $erchan&ise 'ith a list price o) M,< +D,BBB0 Because "ou are a 'holesaler, "ou are grante& a tra&e &iscount o) *>0D per cent0 The cash &iscount ter$s are I7%O(, n7DB0 #o' $uch 'ill "ou re$it i) "ou pa" the invoice " the en& o) the $onth o) purchaseQ #o' $uch 'ill &iscounts on pa"$ent "ou re$it i) "ou &o not pa" the invoice until the )ollo'ing $onthQ -xercise - Aas!" Co$pan" sol& $erchan&ise 'ith a list price o) M,< DB,BBB on ;ul" 10 For each o) the )ollo'ing in&epen&ent assu$ptions, calculate (1) the gross selling price use& to recor& the sale an& (I) the a$ount that the u"er 'oul& have to re$it 'hen pa"ing the invoice0
"rade D#+co1nt Granted a' 30D, 20D b' 40D, "0D c' 30D, "0D, 5D d' 40D Cred#t "erm+ Date Pa#d

oth

2G"0, nG30 2GE+*, nG60 3G"0GE+*, nG60 "G"0, nG30

1ul2 "0 $u)ust "0 $u)ust "0 1ul2 "2

-xercise F :aiser Co$pan" purchase& goo&s at a gross selling price o) M,< I,*BB on August 10 <iscount ter$s o) I71B, n7+B 'ere availa le0 For each o) the )ollo'ing in&epen&ent situations, p. +*+ o) *++

&eter$ine (1) the cash &iscount availa le on the )inal pa"$ent an& (I) the a$ount pai& i) pa"$ent is $a&e 'ithin the &iscount perio&0
P1rcha+e "ran+3ortat#on "erm+ a' /+& s0ippin) point b' /+& destination c' /+& s0ippin) point d' /+& destination Fre#-ht Pa#d >b4? A$$o7ance Granted

$240 #5u2er% "20 #seller% "90 #seller% "@2 #5u2er%

$490 240 720 "20

-xercise 9 ,tuart Co$pan" purchase& goo&s )or M,< 8*,BBB on ;une 1*, un&er the )ollo'ing ter$s: +71B, n7 +B? FOB shipping point, )reight collect0 The ill )or the )reight 'as pai& on ;une 1C, M,< 1,IBB0 a0 Assu$e that the invoice 'as pai& on ;une I*, an& prepare all entries re4uire& on ,tuart Co$pan"Js oo!s0 0 Assu$e that the invoice 'as pai& on ;ul" 110 Prepare the entr" to recor& the pa"$ent $a&e on that &ate0 -xercise = Cra$er Co$pan" uses perio&ic inventor" proce&ure0 <eter$ine the cost o) goo&s sol& )or the co$pan" assu$ing purchases &uring the perio& 'ere M,< *B,BBB, transportation-in 'as M,< +BB, purchase returns an& allo'ances 'ere M,< 1,BBB, eginning inventor" 'as M,< IC,BBB, purchase &iscounts 'ere M,< I,BBB, an& en&ing inventor" 'as M,< 1+,BBB0 -xercise 1 6n each case, use the )ollo'ing in)or$ation to calculate the $issing in)or$ation:
Ca+e 1 Ca+e 2 Ca+e

Gross sales Sales discounts Sales returns and allo;ances et sales *erc0andise inventor2, 1anuar2 " =urc0ases =urc0ase discounts =urc0ase returns and allo;ances et purc0ases Transportation3in et cost o( purc0ases ,ost o( )oods availa5le (or sale *erc0andise inventor2, :ece!5er 3" ,ost o( )oods sold Gross !ar)in

$ 640,000 F "@,200 609,000 256,000 394,000 7,690 24,320 352,000 25,600 377,600 F F 320,000

$F 25,600 44,900 ",20@,600 769,000 "3,440 3",360 39,400 76",600 ",09",600 394,000 F 5"2,000

$F "@,200 32,000 394,000 "2,900 32,000 672,000 32,000 F ",099,000 449,000 640,000 320,000

p. +** o) *++

-xercise > 6n each o) the )ollo'ing e4uations suppl" the $issing ter$(s): a0 /et sales S 2ross sales - (RRRRRRRRRRRRRRRRRRRRRR T ,ales returns an& allo'ances)0 0 Cost o) goo&s sol& S Beginning inventor" T /et cost o) purchases - RRRRRRRR RRRRRRRR0 c0 2ross $argin S RRRRRRRR RRRRRRRR - Cost o) goo&s sol&0 &0 6nco$e )ro$ operations S RRRRRRRRRR RRRRRRRRR - Operating expenses0 e0 /et inco$e S 6nco$e )ro$ operations T RRRRRRRRR RRRRRRRR - RRRRRRRR RRRRRRRR0 -xercise ? 2iven the alances in this partial trial alance, in&icate ho' the alances 'oul& e treate& in the 'or! sheet0 The en&ing inventor" is M,< >D0 (The a$ounts are unusuall" s$all )or ease in re'riting the nu$ ers0 =e purposel" le)t out the ,tate$ent o) :etaine& %arnings colu$ns since the" are not use&0)
Acco1nt+ "#t$e+ "r#a$ %a$ance Deb#t Cred#t Ad@1+tment+ Deb#t Cred#t Ad@1+ted "r#a$ %a$ance Deb#t Cred#t Income Statement Deb#t Cred#t %a$ance Sheet Deb#t Cred#t

*erc0andise .nventor2 Sales Sales :iscounts Sales Returns and $llo;ances =urc0ases =urc0ase :iscounts =urc0ase Returns and $llo;ances Transportation3.n 36 24 "2 45 600 "9 "20 S40

-xercise L Msing the &ata in the previous exercise prepare closing entries )or the prece&ing accounts0 <o not close the 6nco$e ,u$$ar" account0

%.11.#
&roblem # IB1B:

1roblems
a0 ,pencer ,porting 2oo&s Co$pan" engage& in the )ollo'ing transactions in April

Apr0 1 ,ol& $erchan&ise on account )or M,< I88,BBB? ter$s I71B, n7+B, FOB shipping point, )reight collect0 C M,< *+,IBB o) the goo&s sol& on account on April 1 'ere returne& )or a )ull cre&it0 Pa"$ent )or these goo&s ha& not "et een receive&0

p. +*C o) *++

8 A sales allo'ance o) M,< C,@DB 'as grante& on the $erchan&ise sol& on April 1 ecause the $erchan&ise 'as &a$age& in ship$ent0 1B Pa"$ent 'as receive& )or the net a$ount &ue )ro$ the sale o) April 10 0 #igh ,tereo Co$pan" engage& in the )ollo'ing transactions in ;ul" IB1B0 ;ul" I Purchase& stereo $erchan&ise on account at a cost o) M,< *+,IBB? ter$s I71B, n7+B, FOB &estination, )reight prepai&0 1C ,ol& $erchan&ise )or M,< D*,8BB, ter$s I71B, n7+B, FOB &estination, )reight prepai&0 1D Pai& )reight costs on the $erchan&ise sol&, M,< I,1DB0 IB #igh ,tereo Co$pan" 'as grante& an allo'ance o) M,< I,88B on the purchase o) ;ul" I ecause o) &a$age& $erchan&ise0 +1 Pai& the a$ount &ue on the purchase o) ;ul" I0 Prepare 3ournal entries to recor& the transactions0 &roblem B (ars (usical 6nstru$ent Co$pan" an& Tiger Co$pan" engage& in the )ollo'ing transactions 'ith each other &uring ;ul" IB1B: ;ul" I (ars (usical 6nstru$ent Co$pan" purchase& $erchan&ise on account 'ith a list price o) M,< *8,BBB )ro$ Tiger Co$pan"0 The ter$s 'ere +7%O(, n7DB, FOB shipping point, )reight collect0 Tra&e &iscounts o) 1C per cent, 1B per cent, an& C per cent 'ere grante& " Tiger Co$pan"0 C The u"er pai& the )reight ill on the purchase o) ;ul" I, M,< 1,1B*0 D The u"er returne& &a$age& $erchan&ise 'ith an invoice price o) M,< I,@>B to the seller an& receive& )ull cre&it0 On the last &a" o) the &iscount perio&, the u"er pai& the seller )or the $erchan&ise0 Prepare all the necessar" 3ournal entries )or the u"er an& the seller0 &roblem C The )ollo'ing &ata )or ;une IB1B are )or :us! Co$pan"Js )irst $onth o) operations: ;une 1 :us! Co$pan" 'as organi5e&, an& the stoc!hol&ers investe& M,< 1,BB8,BBB cash, M,< ++D,BBB o) $erchan&ise inventor", an& a M,< I88,BBB plot o) lan& in exchange )or capital stoc!0 * (erchan&ise 'as purchase& )or cash, M,< *+I,BBB? FOB shipping point, )reight collect0 > Cash o) M,< 1B,B8B 'as pai& to a truc!ing co$pan" )or &eliver" o) the $erchan&ise purchase& ;une *0 1+ The co$pan" sol& $erchan&ise on account, M,< I88,BBB? ter$s I71B, n7 +B0 1C The co$pan" sol& $erchan&ise on account, M,< I+B,*BB? ter$s I71B, n7+B0 p. +*D o) *++

1D O) the $erchan&ise sol& ;une 1+, M,< +1,D8B 'as returne& )or cre&it0 IB ,alaries )or services receive& 'ere pai& as )ollo's: to o))ice e$plo"ees, M,< +1,D8B? to salespersons, M,< 8+,CIB0 II The co$pan" collecte& the a$ount &ue on the re$aining M,< ICD,+IB o) accounts receiva le arising )ro$ the sale o) ;une 1+0 I* The co$pan" purchase& $erchan&ise on account at a cost o) M,< +*C,DBB? ter$s I71B, n7+B, FOB shipping point, )reight collect0 ID The co$pan" returne& M,< C@,DBB o) the $erchan&ise purchase& ;une I* to the ven&or )or cre&it0 I@ A truc!ing co$pan" 'as pai& M,< @,IBB )or &eliver" to :us! Co$pan" o) the goo&s purchase& ;une I*0 I> The co$pan" sol& $erchan&ise on account, M,< +8*,BBB? ter$s I71B, n7+B0 +B ,ol& $erchan&ise )or cash, M,< 1@I,8BB0 +B Pa"$ent 'as receive& )or the sale o) ;une 1C0 +B Pai& store rent )or ;une, M,< *+,IBB0 +B Pai& the a$ount &ue on the purchase o) ;une I*0 The inventor" on han& at the close o) usiness ;une +B 'as M,< D@I,BBB at cost0 a0 Prepare 3ournal entries )or the transactions0 0 Post the 3ournal entries to the proper le&ger accounts0 Mse the account nu$ ers in the chart o) accounts sho'n in a separate )ile at the en& o) the text0 Assu$e that all postings are )ro$ page IB o) the general 3ournal0 c0 Prepare a trial alance as o) IB1B ;une +B0 &0 Prepare a classi)ie& inco$e state$ent )or the $onth en&e& IB1B ;une +B0 /o a&3usting entries are nee&e&0 &roblem < The =estern =ear Co$pan", a 'holesaler o) 'estern 'ear clothing, sells to retailers0 The co$pan" entere& into the )ollo'ing transactions in (a" IB1B: (a" 1 The =estern =ear Co$pan" 'as organi5e& as a corporation0 The stoc!hol&ers purchase& stoc! at par )or the )ollo'ing assets in the usiness: M,< *DI,BBB cash, M,< 1D8,BBB $erchan&ise, an& M,< 1BC,BBB lan&0 1 Pai& rent on a&$inistrative o))ices )or (a", M,< IC,IBB0 p. +*@ o) *++

C The co$pan" purchase& $erchan&ise )ro$ Carl Co$pan" on account, M,< 18>,BBB? ter$s I71B, n7+B0 Freight ter$s 'ere FOB shipping point, )reight collect0 8 Cash o) M,< 8,*BB 'as pai& to a truc!ing co$pan" )or &eliver" o) the $erchan&ise purchase& (a" C0 1* The co$pan" sol& $erchan&ise on account, M,< +1C,BBB? ter$s I71B, n7+B0 1C Pai& Carl Co$pan" the a$ount &ue on the purchase o) (a" C0 1D O) the $erchan&ise sol& (a" 1*, M,< 1+,8DB 'as returne& )or cre&it0 1> ,alaries )or services receive& 'ere pai& )or (a" as )ollo's: o))ice e$plo"ees, M,< 1D,8BB? salespersons, M,< ++,DBB0 I* The co$pan" collecte& the a$ount &ue on M,< 1ID,BBB o) the accounts receiva le arising )ro$ the sale o) (a" 1*0 IC The co$pan" purchase& $erchan&ise on account )ro$ Bon& Co$pan", M,< 1C1,IBB? ter$s I71B, n7+B0 Freight ter$s 'ere FOB shipping point, )reight collect0 I@ O) the $erchan&ise purchase& (a" IC, M,< IC,IBB 'as returne& to the ven&or0 I8 A truc!ing co$pan" 'as pai& M,< I,1BB )or &eliver" to The =estern =ear Co$pan" o) the goo&s purchase& (a" IC0 I> The co$pan" sol& $erchan&ise on open account, M,< 1C,1IB? ter$s I71B, n7+B0 +B Cash sales 'ere M,< @*,B880 +B Cash o) M,< 1BB,8BB 'as receive& )ro$ the sale o) (a" 1*0 +1 Pai& Bon& Co$pan" )or the $erchan&ise purchase& on (a" IC, ta!ing into consi&eration the $erchan&ise returne& on (a" I@0 The inventor" on han& at the close o) usiness on (a" +1 is M,< I>>,B*B0 Fro$ the &ata given )or The =estern =ear Co$pan": a0 Prepare 3ournal entries )or the transactions0 0 Post the 3ournal entries to the proper le&ger accounts0 Mse the account nu$ ers in the chart o) accounts sho'n in a separate )ile at the en& o) the text0 Assu$e that all postings are )ro$ page 1C o) the general 3ournal0 (There 'ere no a&3usting 3ournal entries0) c0 Prepare a trial alance0 &0 Prepare a classi)ie& inco$e state$ent )or the $onth en&e& IB1B (a" +10 e0 Prepare a classi)ie& alance sheet as o) IB1B (a" +10

p. +*8 o) *++

&roblem - The )ollo'ing &ata are )or Aeone Au$ er Co$pan":
!EONE !8M%ER COMPANY "r#a$ %a$ance 2010 December 1 Acct' No' Acco1nt "#t$e Deb#t+ Cred#t+

"00 "03 "05 "07 "09 ""2 "70 "7" 200 300 3"0 4"0 4"2 4"9 500 502 503 505 509 50@ 5"0 5"" 536 540 567

,as0 $ccounts Receiva5le *erc0andise .nventor2, 20"0 1anuar2 " Supplies on Aand =repaid .nsurance =repaid Rent E7uip!ent $ccu!ulated :epreciationME7uip!ent $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " Sales Sales Returns and $llo;ances .nterest Revenue =urc0ases =urc0ases Returns and $llo;ances Transportation3.n $dvertisin) Expense Sales Salaries Expense +((ice Salaries Expense +((icers8 Salaries Expense -tilities Expense 4e)al and $ccountin) Expense .nterest Expense *iscellaneous $d!inistrative Expense

$ 70,640 "5@,520 295,200 5,360 4,900 57,600 99,000

$ "7,600 "02,900 200,000 2"@,640 ","22,360 $ ",000 $4,040

5,"60 $ 500,940 $7,940 79,000 "39,400 90,900 "60,000 4,900 "0,000 600 @,990 $",667,440

$",667,440

 A total o) M,< +,*BB o) the prepai& insurance has expire&0  An inventor" o) supplies sho'e& that M,< 1,@BB are still on han&0  Prepai& rent expire& &uring the "ear is M,< CB,DBB0  <epreciation expense on store e4uip$ent is M,< 8,8BB0  Accrue& sales salaries are M,< *,BBB0  Accrue& o))ice salaries are M,< +,BBB0  (erchan&ise inventor" on han& is M,< +CB,BBB0

Prepare the )ollo'ing: a0 A 'or! sheet )or the "ear en&e& IB1B <ece$ er +10 :e)er to the chart o) accounts sho'n in a separate )ile at the en& o) the text )or an" other account nu$ ers "ou nee&0 0 A classi)ie& inco$e state$ent0 The onl" selling expenses are sales salaries, a&vertising, supplies, an& &epreciation expenseLe4uip$ent0 c0 A state$ent o) retaine& earnings0 &0 A classi)ie& alance sheet0

p. +*> o) *++

e0 :e4uire& closing entries0

%.11.$

Alternate problems

Alternate pro le$ A a. Can.le Carpet Company engage. in t%e 0ollowing transactions in #ugust +,(,: Aug0 I ,ol& $erchan&ise on account )or M,< +BB,BBB? ter$s I71B, n7+B, FOB shipping point, )reight collect0 18 :eceive& pa"$ent )or the sale o) August I0 IB A total o) M,< 1B,BBB o) the $erchan&ise sol& on August I 'as returne&, an& a )ull re)un& 'as $a&e ecause it 'as the 'rong $erchan&ise0 I8 An allo'ance o) M,< 1D,BBB 'as grante& on the sale o) August I ecause so$e $erchan&ise 'as )oun& to e &a$age&? M,< 1D,BBB cash 'as returne& to the custo$er0 b. Lee Furniture Company engage. in t%e 0ollowing transactions in #ugust +,(,: Aug0 * Purchase& $erchan&ise on account at a cost o) M,< 1*B,BBB? ter$s I71B, n7+B, FOB shipping point, )reight collect0 D Pai& )reight o) M,< I,BBB on the purchase o) August *0 1B ,ol& goo&s )or M,< 1BB,BBB? ter$s I71B, n7+B0 1I :eturne& M,< I*,BBB o) the $erchan&ise purchase& on August *0 1* Pai& the a$ount &ue on the purchase o) August *0 Prepare 3ournal entries )or the transactions0 #lternate problem B %&'ar&o Auto Parts Co$pan" an& ,poon Co$pan" engage& in the )ollo'ing transactions 'ith each other &uring August IB1B: Aug01C %&'ar&o Auto Parts Co$pan" purchase& $erchan&ise on account 'ith a list price o) M,< 1>I,BBB )ro$ ,poon Co$pan"0 Tra&e &iscounts o) IB per cent an& 1B per cent 'ere allo'e&0 Ter$s 'ere I71B, n7+B, FOB &estination, )reight prepai&0 1D The seller pai& the )reight charges, M,< I,*BB0 1@ The u"er re4ueste& an allo'ance o) M,< *,C1I against the a$ount &ue ecause the goo&s 'ere &a$age& in transit0 IB The seller grante& the allo'ance re4ueste& on August 1@0 The u"er pai& the a$ount &ue on the last &a" o) the &iscount perio&0 :ecor& all o) the entries re4uire& on the oo!s o) oth the u"er an& the seller0 p. +CB o) *++

#lternate problem C 2ar&ner Co$pan" engage& in the )ollo'ing transactions in ;une IB1B, the co$pan"Js )irst $onth o) operations: ;une 1 ,toc!hol&ers investe& M,< +8*,BBB cash an& M,< 1**,BBB o) $erchan&ise inventor" in the usiness in exchange )or capital stoc!0 + (erchan&ise 'as purchase& on account, M,< 1>I,BBB? ter$s I71B, n7+B, FOB shipping point, )reight collect0 * Pai& height on the ;une + purchase, M,< C,I8B0 @ (erchan&ise 'as purchase& on account, M,< >D,BBB? ter$s I71B, n7+B, FOB &estination, )reight prepai&0 1B ,ol& $erchan&ise on account, M,< I+B,*BB? ter$s I71B, n7+B, FOB shipping point, )reight collect0 11 :eturne& M,< I8,8BB o) the $erchan&ise purchase& on ;une +0 1I Pai& the a$ount &ue on the purchase o) ;une +0 1+ ,ol& $erchan&ise on account, M,< I*B,BBB? ter$s I71B, n7+B, FOB &estination, height prepai&0 1* Pai& height on sale o) ;une 1+, M,< 1*,*BB0 IB Pai& the a$ount &ue on the purchase o) ;une @0 I1 M,< *8,BBB o) the goo&s sol& on ;une 1+ 'ere returne& )or cre&it0 II :eceive& the a$ount &ue on sale o) ;une 1+0 IC :eceive& the a$ount &ue on sale o) ;une 1B0 I> Pai& rent )or the a&$inistration uil&ing )or ;une, M,< 1>,IBB0 +B Pai& sales salaries o) M,< C@,DBB )or ;une0 +B Purchase& $erchan&ise on account, M,< *8,BBB? ter$s I71B, n7+B, FOB &estination, )reight prepai&0 The inventor" on han& on ;une +B 'as M,< I88,BBB0 a0 Prepare 3ournal entries )or the transactions0 0 Post the 3ournal entries to the proper le&ger accounts0 Mse the account nu$ ers in the chart o) accounts sho'n in a separate )ile at the en& o) the text0 Assu$e that all postings are )ro$ page 1B o) the general 3ournal0 c0 Prepare a trial alance as o) IB1B ;une +B0 &0 Prepare a classi)ie& inco$e state$ent )or the $onth en&e& IB1B ;une +B0 /o a&3usting entries are nee&e&0 p. +C1 o) *++

#lternate problem < Organi5e& on IB1B (a" 1, /oah Ca inet Co$pan" engage& in the )ollo'ing transactions: (a" 1 The stoc!hol&ers investe& M,< >BB,BBB in this ne' usiness " purchasing capital stoc!0 1 Purchase& $erchan&ise on account )ro$ ,tring Co$pan", M,< *D,8BB? ter$s n7DB, FOB shipping point, )reight collect0 + ,ol& $erchan&ise )or cash, M,< I8,8BB0 D Pai& transportation charges on (a" 1 purchase, M,< 1,**B cash0 @ :eturne& M,< +,DBB o) $erchan&ise to ,tring Co$pan" &ue to i$proper si5e0 1B :e4ueste& an& receive& an allo'ance o) M,< 1,8BB )ro$ ,tring Co$pan" )or i$proper 4ualit" o) certain ite$s0 1* ,ol& $erchan&ise on account to Texas Co$pan", M,< 18,BBB? ter$s I7IB, n7+B, FOB shipping point, )reight collect0 1D 6ssue& cash re)un& )or return o) $erchan&ise relating to sale $a&e on (a" +, M,< 18B0 18 Purchase& $erchan&ise on account )ro$ Tan Co$pan" invoice& at M,< I8,8BB? ter$s I71C, n7+B, FOB shipping point, )reight collect0 18 :eceive& a ill )or )reight charges o) M,< >BB )ro$ Ball Truc!ing Co$pan" on the purchase )ro$ Tan Co$pan"0 1> Texas Co$pan" returne& M,< +DB o) $erchan&ise purchase& on (a" 1*0 I* :eturne& M,< I,88B o) &e)ective $erchan&ise to Tan Co$pan"0 :eceive& )ull cre&it0 I8 Texas Co$pan" re$itte& alance &ue on sale o) (a" 1*0 +1 Pai& Tan Co$pan" )or the purchase o) (a" 18 a)ter a&3usting )or transaction o) (a" I*0 +1 Pai& $iscellaneous selling expenses o) M,< @,IBB0 +1 Pai& $iscellaneous a&$inistrative expenses o) M,< 1B,8BB0 The (a" +1st inventor" is M,< C@,DBB0 Fro$ the &ata )or /oah Ca inet Co$pan": a0 ;ournali5e the transactions0 :oun& all a$ounts to the nearest &ollar0 0 Post the entries to the proper le&ger accounts0 Mse the account nu$ ers appearing in the chart o) account sho'n in a separate )ile at the en& o) the text0 Assu$e all postings are )ro$ page C o) the general 3ournal0 (There 'ere no a&3usting 3ournal entries0) p. +CI o) *++

c0 Prepare a trial alance0 &0 Prepare a classi)ie& inco$e state$ent )or the $onth en&e& IB1B (a" +10 #lternate problem The )ollo'ing &ata are )or Ba"er Aa$p Co$pan":
!ayer $am1 Com1any Tr%al !alance 2010 :ecem&er 1
Acct. No. "00 "03 "05 "09 "30 "40 "4" "74 "75 200 300 3"0 4"0 4"" 4"2 4"9 500 50" 502 503 505 509 50@ 5"@ 540 ,as0 $ccounts Receiva5le *erc0andise .nventor2, 20"0 1anuar2 " =repaid .nsurance 4and &uildin) $ccu!ulated :epreciation N &uildin) Store /ixtures $ccu!ulated :epreciation N Store /ixtures $ccounts =a2a5le ,apital Stoc6 Retained Earnin)s, 20"0 1anuar2 " Sales Sales :iscounts Sales Returns and $llo;ances .nterest Revenue =urc0ases =urc0ases :iscounts =urc0ases Returns and $llo;ances Transportation3.n $dvertisin) Expense Sales Salaries Expense +((ice Salaries Expense :eliver2 Expense .nterest Expense 2@,200 49,000 256,000 2@6,000 "9,400 9,000 $ 3,432,400 $ 3,432,400 ",25",600 "0,400 5,600 "4,900 9,000 ",600 222,400 44,490 "5",600 400,000 490,720 2,206,000 $ 229,900 "@3,200 "66,400 "",600 240,000 440,000 $ "32,000 Account T%tle :e&%t# Cred%t#

<epreciation expense on the store uil&ing is M,< 8,8BB0
 <epreciation expense on the store )ixtures is M,< II,I*B0  Accrue& sales salaries are M,< C,DBB0  6nsurance expire& in IB1B is M,< 1B,BBB0  Cost o) $erchan&ise inventor" on han& IB1B <ece$ er +1, is M,< III,BBB0

p. +C+ o) *++

Prepare the )ollo'ing: a0 A 'or! sheet )or the "ear en&e& IB1B <ece$ er +10 :e)er to the chart o) accounts sho'n in a separate )ile at the en& o) the text )or an" other account nu$ ers "ou nee&0 0 A classi)ie& inco$e state$ent0 The onl" a&$inistrative expenses are o))ice salaries an& insurance0 The uil&ing &epreciation is on the store uil&ing0 c0 A state$ent o) retaine& earnings0 &0 A classi)ie& alance sheet0 e0 The re4uire& closing entries0

%.11.%

0e ond the numbers9Critical thin&ing
usiness, is

Business .ecision case # Can&"Js ,hirts, 6nc0, has an opportunit" to purchase *B,BBB shirts 'ith the logo o) her )avorite school in ;anuar" IBB>0 Can&", 'ho is not currentl" in consi&ering u"ing these shirts an& then renting a &ispla" cart )ro$ 'hich to sell these shirts (calle& a !ios!) in a shopping $all0 Base& on the )ollo'ing in)or$ation an& esti$ates, Can&" nee&s to &eci&e i) the usiness 'oul& e pro)ita le:
 Cost o) the *B,BBB shirts, all o) 'hich $ust e purchase& in ;anuar" IBB>, is M,< **B,BBB0  Can&" thin!s it 'oul& ta!e t'o "ears to sell all o) the shirts0 ,he esti$ates her sales at IC,BBB

shirts in IBB> an& 1C,BBB shirts in IB1B0
 :ent o) the !ios! 'oul& e M,< 1,CBB per $onth in IBB> an& M,< 1,DBB per $onth in IB1B0  Can&" can

u" so$e counters on 'hich to &ispla" the $erchan&ise )or M,< *,BBB0 ,he coul&

sell the counters )or M,< CBB at the en& o) the secon& "ear0
 Can&" esti$ates the cost to &ecorate her !ios! 'oul& e M,< I,CBB0  Can&" 'oul& hire e$plo"ees an& pa" the$ M,< 1 per shirt sol&0  Can&" plans to sell the shirts )or M,< 1@ each0  Can&" an& her hus an& purchase& M,< 1BB,BBB o) capital stoc! in the usiness0 There)ore, she

plans to orro' M,< *BB,BBB )ro$ their )a$il" an!er0 6nterest expense on this loan 'ill e M,< CI,BBB in IBB> an& M,< D,CBB in IB1B0 Can&" plans to repa" M,< +BB,BBB on IB1B ;anuar" I, an& the re$aining M,< 1BB,BBB on IB1B ;ul" 1
 Can&" nee&s to rent so$e storage space ecause all *B,BBB shirts cannot e store& at the !ios!0

,torage space costs M,< I,CBB per "ear0 a0 Prepare esti$ate& inco$e state$ents )or IBB> an& IB1B )or Can&"Js usiness0 <oes it appear that the usiness 'ill e pro)ita leQ p. +C* o) *++

0 =ill Can&" have the cash availa le to pa" the an! loan as she planne&Q Business .ecision case B 6n the Annual report appen&ix, re)er to the consoli&ate& state$ents o) earnings )or The Ai$ite&Js $ost recent three "ears0 Calculate the gross $argin percentage an& 'rite an explanation o) 'hat the results $ean )or each o) the three "ears0 #nnual report analysis C :e)er to the consoli&ate& state$ents o) inco$e o) The Ai$ite& in the Annual report appen&ix0 6&enti)" the IBBB, 1>>>, an& 1>>8 net sales? cost o) goo&s sol&? gross pro)it? selling, a&$inistrative, an& general expenses? an& operating inco$e0 <o the results present a )avora le tren&Q Co$$ent on the results0 -t%ics case D Eriting experience < Base& on the ethics case relate& to =orl& Auto Parts Corporation, respon& in 'riting to the )ollo'ing 4uestions: a0 <o "ou agree that the total i$pact o) this practice coul& e as $uch as M,< 1B $illionQ 0 Are the s$all suppliers pro a l" etter o)) going along 'ith the practiceQ c0 6s this practice ethicalQ 9roup pro2ect - 6n tea$s o) t'o or three stu&ents, go to the li rar" (or )in& an annual report at '''0sec0gov7e&gar0sht$l) to locate one $erchan&ising co$pan"Js annual report )or the $ost recent "ear0 Calculate the co$pan"Js gross $argin percentage )or each o) the $ost recent three "ears0 As a tea$, 'rite a $e$oran&u$ to the instructor sho'ing "our calculations an& co$$enting on the results0 The hea&ing o) the $e$oran&u$ shoul& contain the &ate, to 'ho$ it is 'ritten, )ro$ 'ho$, an& the su 3ect $atter0 9roup pro2ect F 6n a tea$ o) t'o or three stu&ents, contact a variet" o) usinesses in "our area an& in4uire as to the t"pes o) sales &iscount ter$s the" o))er to cre&it custo$ers an& the t"pes o) purchase &iscount ter$s the" are o))ere& " their suppliers0 Calculate the approxi$ate annual rate o) interest i$plie& in several o) the $ore co$$on &iscount ter$s0 For instance, the oo! states that the i$plie& annual rate o) interest on ter$s o) I71B, n7+B is +D per cent, assu$ing 'e use a +DB-&a" "ear0 Present "our )in&ings in a 'ritten report to "our instructor0 9roup pro2ect 9 6n a tea$ o) t'o or three stu&ents, o tain access to several annual reports o) co$panies in &i))erent in&ustries (see '''0sec0gov7e&gar0sht$l0) %xa$ine their inco$e state$ents

p. +CC o) *++

an& i&enti)" &i))erences in their )or$ats0 <iscuss these &i))erences 'ithin "our group an& then present "our )in&ings in a report to "our instructor0

%.11.'

.sing the (nternet9A vie+ of the real +orld

Gisit the Fat Brains To"s 'e site at: http:77)at rainto"s0co$ 'e site Bro'se aroun& the site )or interesting in)or$ation0 =hat pro&ucts &o the" sellQ =hat 3ournal entries 'oul& the" $a!e to recor& sales o) these pro&uctsQ =rite a report to "our instructor su$$ari5ing "our experience at this site0

%.11.)
$rue-0alse

Ans+ers to self<test

False. ,ales &iscounts, as 'ell as sales returns an& allo'ances, are &e&ucte& )ro$ gross sales0 $rue. Mn&er perpetual inventor" proce&ure, the (erchan&ise 6nventor" account is &e ite& )or each purchase an& cre&ite& )or each sale0 $rue0 Purchase <iscounts an& Purchase :eturns an& Allo'ances are contra accounts to the Purchases account0 The purchases0 False0 Consigne& goo&s &elivere& to another part" )or atte$pte& sale are inclu&e& in the en&ing inventor" o) the co$pan" that sent the goo&s0 False0 An unclassi)ie& inco$e state$ent, not a classi)ie& inco$e state$ent, has onl" t'o categories o) ite$s0 8ultiple-c%oice .. Tra&e &iscounts are not recor&e& on the oo!s o) either a u"er or a seller0 6n other 'or&s, the invoice price o) sales (purchases) is recor&e&: ,S-%"$$$ I$.6 = ,S-("#$$ b. The cost o) goo&s sol& is co$pute& as )ollo's:
&e)innin) inventor2 et cost o( purc0ases ,ost o( )oods availa5le (or sale Endin) inventor2 ,ost o( )oods sold $60,000 240,000 $ 300,000 72,000 $229,000

alances o) those accounts are &e&ucte& )ro$ purchases to arrive at net

b. Purchase &iscounts are ase& on invoice prices less purchase returns an& allo'ances, i) an"0

p. +CD o) *++

e. All o) the sections $entione& in (a-&) appear in a classi)ie& inco$e state$ent0 Current assets appear on a classi)ie& alance sheet0 b. (erchan&ise 6nventor" is &e ite& )or the cost o) en&ing inventor"0

.ou $a" close &e it alance& accounts (in the inco$e state$ent) e)ore cre&it alance& accounts0 This practice &oes not a))ect the alance o) the 6nco$e ,u$$ar" account or the a$ount o) net inco$e0

p. +C@ o) *++

' =easuring and reporting inventories
'.1 Learning objectives
A)ter stu&"ing this chapter, "ou shoul& e a le to:
  

%xplain an& calculate the e))ects o) inventor" errors on certain )inancial state$ent ite$s0 6n&icate 'hich costs are properl" inclu&e& in inventor"0 Calculate cost o) en&ing inventor" an& cost o) goo&s sol& un&er the )our $a3or inventor" %xplain the a&vantages an& &isa&vantages o) the )our $a3or inventor" costing $etho&s0 :ecor& $erchan&ise transactions un&er perpetual inventor" proce&ure0 Appl" net reali5a le value an& the lo'er-o)-cost-or-$ar!et $etho& o) inventor"0 %sti$ate cost o) en&ing inventor" using the gross $argin an& retail inventor" $etho&s0 Anal"5e an& use the )inancial results- inventor" turnover ratio0

costing $etho&s using perio&ic an& perpetual inventor" proce&ures0
    

'.2 Choosing an accounting career
Chapter @ &iscusses ho' co$panies have a choice in inventor" cost $etho&s et'een speci)ic i&enti)ication, F6FO, A6FO, an& 'eighte&-average0 ,i$ilarl", one o) the greatest ene)its o) o taining an accounting &egree is the roa& range o) career choices availa le0 There are over *B &i))erent t"pes o) accounting 3o s availa le in pu lic accounting, private in&ustr", an& govern$ental accounting0 For exa$ple, chec! out the list o) accounting 3o s at: http:77'''0unc'il0e&u7stua))7career7(a3ors7accounting0ht$\relate& careertitles0 One o) the pri$ar" reasons $an" stu&ents go into accounting is success)ul 3o place$ent0 Accounting $a3ors have een etter a le to )in& positions than $a3ors in an" o) the other usiness options, 'ith the possi le exception o) $anage$ent in)or$ation s"ste$s ((6,)0 %ven the relative &e$an& )or (6, $a3ors has &i$inishe& recentl", 'hile the &e$an& )or accounting $a3ors re$ains strong0 =e are currentl" experiencing a shortage o) accounting $a3ors across the nation0 Another i$portant )actor to !eep in $in& regar&ing 3o place$ent is 'here "ou 'oul& li!e to e three to )ive "ears )ro$ no'0 Accounting o))ers an excellent )oun&ation 'ith opportunities )or a&vance$ent, 'here " $an" accounting gra&uates $a!e &ou le their entr"-level salar" in onl" )ive "ears0 (an" stu&ents pursue an accounting &egree ecause it &oes not restrict their career opportunities as $uch as having a &i))erent usiness &egree0 For exa$ple, 'ith an accounting &egree, a stu&ent can p. +C8 o) *++

appl" )or positions in $anage$ent, $ar!eting, an& )inance, as 'ell as accounting0 6n )act, $an" recruiters in usiness )avor accounting gra&uates ecause the" recogni5e an accounting &egree as a $ore &i))icult usiness &egree to o tain0 #o'ever, $anage$ent, $ar!eting, an& )inance stu&ents cannot appl" )or accounting positions ecause the" lac! necessar" accounting course'or!0 6n )act, 'ith so$e a&&itional courses in s"ste$s, an accounting $a3or is 'ell e4uippe& to pursue a career in an" usiness )iel& inclu&ing in)or$ation s"ste$s0 #ave "ou ever ta!en a&vantage o) a pre-inventor" sale at "our )avorite retail storeQ (an" stores o))er argain prices to re&uce the $erchan&ise on han& an& to $ini$i5e the ti$e an& expense o) ta!ing the inventor"0 A s$aller inventor" also enhances the pro a ilit" o) ta!ing an accurate inventor" since the store has less $erchan&ise to count0 Fro$ Chapter D "ou !no' that co$panies use inventor" a$ounts to &eter$ine the cost o) goo&s sol&? this $a3or expense a))ects a $erchan&ising co$pan"Js net inco$e0 6n this chapter, "ou learn ho' i$portant inventories are in preparing an accurate inco$e state$ent, state$ent o) retaine& earnings, an& alance sheet0 This chapter &iscusses $erchan&ise inventor" carrie& " $erchan&ising retailers an& 'holesalers0 8erc%an.ise in'entory is the 4uantit" o) goo&s hel& " a $erchan&ising co$pan" )or resale to custo$ers0 (erchan&ising co$panies &eter$ine the 4uantit" o) inventor" ite$s " a ph"sical count0 The $erchan&ise inventor" )igure use& " accountants &epen&s on the 4uantit" o) inventor" ite$s an& the cost o) the ite$s0 This chapter &iscusses )our accepte& $etho&s o) costing the ite$s: (1) speci)ic i&enti)ication? (I) )irst-in, )irst-out (F6FO)? (+) last-in, )irst-out (A6FO)? an& (*) 'eighte&average0 %ach $etho& has a&vantages an& &isa&vantages0 This chapter stresses the i$portance o) having accurate inventor" )igures an& the serious conse4uences o) using inaccurate inventor" )igures0 =hen "ou )inish this chapter, "ou shoul& un&erstan& ho' ta!ing inventor" connects 'ith the cost o) goo&s sol& )igure on the storeJs inco$e state$ent, the retaine& earnings a$ount on the state$ent o) retaine& earnings, an& oth the inventor" )igure an& the retaine& earnings a$ount on the storeJs alance sheet0

'.3 (nventories and cost of goods sold
6nventor" is o)ten the largest an& $ost i$portant asset o'ne& " a $erchan&ising usiness0 The inventor" o) so$e co$panies, li!e car &ealerships or 3e'elr" stores, $a" cost several ti$es $ore than an" other asset the co$pan" o'ns0 As an asset, the inventor" )igure has a &irect i$pact on reporting the solvenc" o) the co$pan" in the alance sheet0 As a )actor in &eter$ining cost o) goo&s sol&, the inventor" )igure has a &irect i$pact on the pro)ita ilit" o) the co$pan"Js operations as reporte& in the inco$e state$ent0 Thus, the i$portance o) the inventor" )igure shoul& not e un&eresti$ate&0 p. +C> o) *++

'.! (mportance of proper inventor valuation
A $erchan&ising co$pan" can prepare accurate inco$e state$ents, state$ents o) retaine& earnings, an& alance sheets onl" i) its inventor" is correctl" value&0 On the inco$e state$ent, a co$pan" using perio&ic inventor" proce&ure ta!es a ph"sical inventor" to &eter$ine the cost o) goo&s sol&0 ,ince the cost o) goo&s sol& )igure a))ects the co$pan"Js net inco$e, it also a))ects the alance o) retaine& earnings on the state$ent o) retaine& earnings0 On the alance sheet, incorrect inventor" a$ounts a))ect oth the reporte& en&ing inventor" an& retaine& earnings0 6nventories appear on the alance sheet un&er the hea&ing KCurrent AssetsK, 'hich reports current assets in a &escen&ing or&er o) li4ui&it"0 Because inventories are consu$e& or converte& into cash 'ithin a "ear or one operating c"cle, 'hichever is longer, inventories usuall" )ollo' cash an& receiva les on the alance sheet0 :ecall that un&er perio&ic inventor" proce&ure 'e &eter$ine the cost o) goo&s sol& )igure " a&&ing the eginning inventor" to the net cost o) purchases an& &e&ucting the en&ing inventor"0 6n each accounting perio&, the appropriate expenses $ust e $atche& 'ith the revenues o) that perio& to &eter$ine the net inco$e0 Applie& to inventor", $atching involves &eter$ining (1) ho' $uch o) the cost o) goo&s availa le )or sale &uring the perio& shoul& e &e&ucte& )ro$ current revenues an& (I) ho' $uch shoul& e allocate& to goo&s on han& an& thus carrie& )or'ar& as an asset ( $erchan&ise inventor") in the alance sheet to e $atche& against )uture revenues0 Because 'e &eter$ine the cost o) goo&s sol& " &e&ucting the en&ing inventor" )ro$ the cost o) goo&s availa le )or sale, a highl" signi)icant relationship exists: /et inco$e )or an accounting perio& &epen&s &irectl" on the valuation o) en&ing inventor"0 This relationship involves three ite$s: First, a $erchan&ising co$pan" $ust e sure that it has properl" value& its en&ing inventor"0 6) the en&ing inventor" is overstate&, cost o) goo&s sol& is un&erstate&, resulting in an overstate$ent o) gross $argin an& net inco$e0 Also, overstate$ent o) en&ing inventor" causes current assets, total assets, an& retaine& earnings to e overstate&0 Thus, an" change in the calculation o) en&ing inventor" is re)lecte&, &ollar )or &ollar (ignoring an" inco$e tax e))ects), in net inco$e, current assets, total assets, an& retaine& earnings0 ,econ&, 'hen a co$pan" $isstates its en&ing inventor" in the current "ear, the co$pan" carries )or'ar& that $isstate$ent into the next "ear0 This $isstate$ent occurs ecause the en&ing inventor" a$ount o) the current "ear is the eginning inventor" a$ount )or the next "ear0 Thir&, an error in one perio&Js en&ing inventor" auto$aticall" causes an error in net inco$e in the opposite &irection in the next perio&0 A)ter t'o "ears, ho'ever, the error 'ashes out, an& assets an& retaine& earnings are properl" state&0

p. +DB o) *++

%xhi it ** an& %xhi it *C prove that net inco$e )or an accounting perio& &epen&s &irectl" on the valuation o) the inventor"0 Allen Co$pan"Js inco$e state$ents an& the state$ents o) retaine& earnings )or "ears IBB> an& IB1B sho' this relationship0
A$$EN COM.AN@ For @ear Ended 200C :ecem&er 1 End%n+ In2entory End%n+ In2entory O2er#tated Correctly Stated !y 7<"000 $400,000 $400,000 $300,000 $300,000 35,000 40,000 265,000 260,000 $"35,000 $"40,000 $95,000 95,000 $ 50,000 $55,000 $"20,000 50,000 $"70,000 $"20,000 55,000 $"75,000

Income Statement Sales ,ost o( )oods availa5le (or sale Endin) inventor2 ,ost o( )oods sold Gross !ar)in +t0er expenses et inco!e Statement o* Reta%ned Earn%n+# &e)innin) retained earnin)s et inco!e Endin) retained earnin)s

%xhi it **: %))ects o) an overstate& en&ing inventor"
A$$EN COM.AN@ For @ear Ended 2010 :ecem&er 1 !e+%nn%n+ !e+%nn%n+ In2entory In2entory O2er#tated Correctly Stated !y 7<"000 $425,000 $425,000 $ 35,000 $40,000 2@0,000 2@0,000 $325,000 $330,000 45,000 45,000 290,000 295,000 $"45,000 $"40,000 53,500 53,500 $ @",500 $ 96,500 $"70,000 @",500 $26",500 $"75,000 96,500 $26",500

Income Statement Sales &e)innin) inventor2 =urc0ases ,ost o( )oods availa5le (or sale Endin) inventor2 ,ost o( )oods sold Gross !ar)in +t0er expenses et inco!e Statement o* Reta%ned Earn%n+# &e)innin) retained earnin)s et inco!e Endin) retained earnin)s

%xhi it *C: %))ects o) an overstate& eginning inventor" 6n %xhi it ** the correctl" state& en&ing inventor" )or the "ear IBB> is M,< +C,BBB0 As a result, Allen has a gross $argin o) M,< 1+C,BBB an& net inco$e o) M,< CB,BBB0 The state$ent o) retaine& earnings sho's a eginning retaine& earnings o) M,< 1IB,BBB an& an en&ing retaine& earnings o) M,< 1@B,BBB0 =hen the en&ing inventor" is overstate& " M,< C,BBB, as sho'n on the right in %xhi it **, the gross $argin is M,< 1*B,BBB, an& net inco$e is M,< CC,BBB0 The state$ent o) retaine& earnings p. +D1 o) *++

then has an en&ing retaine& earnings o) M,< 1@C,BBB0 The en&ing inventor" overstate$ent o) M,< C,BBB causes a M,< C,BBB overstate$ent o) net inco$e an& a M,< C,BBB overstate$ent o) retaine& earnings0 The alance sheet 'oul& sho' oth an overstate& inventor" an& an overstate& retaine& earnings0 <ue to the error in en&ing inventor", oth the stoc!hol&ers an& cre&itors $a" overesti$ate the pro)ita ilit" o) the usiness0 %xhi it *C is a continuation o) %xhi it ** an& contains AllenJs operating results )or the "ear en&e& IB1B <ece$ er +10 /ote that the en&ing inventor" in %xhi it ** no' eco$es the eginning inventor" o) %xhi it *C0 #o'ever, AllenJs inventor" at IB1B <ece$ er +1, is no' an accurate inventor" o) M,< *C,BBB0 As a result, the gross $argin in the inco$e state$ent 'ith the eginning inventor" correctl" state& is M,< 1*C,BBB, an& Allen Co$pan" has net inco$e o) M,< >1,CBB an& an en&ing retaine& earnings o) M,< ID1,CBB0 6n the inco$e state$ent colu$ns at the right, in 'hich the inventor" is overstate& 8D,CBB, 'ith the en&ing retaine& earnings also at M,< ID1,CBB0 Thus, in contrast to an overstate& en&ing inventor", resulting in an overstate$ent o) net inco$e, an overstate& eginning inventor" results in an un&erstate$ent o) net inco$e0 6) the eginning inventor" is overstate&, then cost o) goo&s availa le )or sale an& cost o) goo&s sol& also are overstate&0 Conse4uentl", gross $argin an& net inco$e are un&erstate&0 /ote, ho'ever, that 'hen net inco$e in the secon& "ear is close& to retaine& earnings, the retaine& earnings account is state& at its proper a$ount0 The overstate$ent o) net inco$e in the )irst "ear is o))set " the un&erstate$ent o) net inco$e in the secon& "ear0 For the t'o "ears co$ ine& the net inco$e is correct0 At the en& o) the secon& "ear, the alance sheet contains the correct a$ounts )or oth inventor" an& retaine& earnings0 %xhi it *D su$$ari5es the e))ects o) errors o) inventor" valuation:
End%n+ In2entory Under#tated ,ost o( )ood sold et inco!e +verstated -nderstated O2er#tated -nderstated +verstated !e+%nn%n+ In2entory Under#tated -nderstated +verstated O2er#tated +verstated -nderstated

eginning

" M,< C,BBB, the gross $argin is M,< 1*B,BBB an& net inco$e is M,<

%xhi it *D: 6nventor" errors

'.# Determining inventor cost
To place the proper valuation on inventor", a usiness $ust ans'er the 4uestion: =hich costs shoul& e inclu&e& in inventor" costQ Then, 'hen the usiness purchases i&entical goo&s at &i))erent

p. +DI o) *++

costs, it $ust ans'er the 4uestion: =hich cost shoul& e assigne& to the ite$s sol&Q 6n this section, "ou learn ho' accountants ans'er these 4uestions0 The costs inclu&e& in inventor" &epen& on t'o varia les: 4uantit" an& price0 To arrive at a current inventor" )igure, co$panies $ust egin 'ith an accurate ph"sical count o) inventor" ite$s0 The" $ultipl" the 4uantit" o) inventor" " the unit cost to co$pute the cost o) en&ing inventor"0 This section &iscusses the ta!ing o) a ph"sical inventor" an& the $etho&s o) costing the ph"sical inventor" un&er oth perpetual an& perio&ic inventor" proce&ures0 The re$ain&er o) the chapter &iscusses &epartures )ro$ the cost asis o) inventor" $easure$ent0 As rie)l" &escri e& in Chapter D, to ta!e a ph"sical inventor", a co$pan" $ust count, 'eigh, $easure, or esti$ate the ph"sical 4uantities o) the goo&s on han&0 For exa$ple, a clothing store $a" count its suits? a har&'are store $a" 'eigh olts, 'ashers, an& nails? a gasoline co$pan" $a" $easure gasoline in storage tan!s? an& a lu$ er"ar& $a" esti$ate 4uantities o) lu$ er, coal, or other ul!" $aterials0 Throughout the ta!ing o) a ph"sical inventor", the goal shoul& e accurac"0 Ta!ing a ph"sical inventor" $a" &isrupt the nor$al operations o) a usiness0 Thus, the count shoul& e a&$inistere& as 4uic!l" an& as e))icientl" as possi le0 The actual ta!ing o) the inventor" is not an accounting )unction? ho'ever, accountants o)ten plan an& coor&inate the count0 Proper )or$s are re4uire& to recor& accurate counts an& &eter$ine totals0 6&enti)ication na$es or s"$ ols $ust e chosen, an& those persons 'ho count, 'eigh, or $easure the inventor" ite$s $ust !no' these s"$ ols0
In2entory Ta+ JMA Cor1. .nventor2 Ta) o' 2A1 :escription 4ocation Suantit2 ,ounted ,ounted 52 ,0ec6ed 52 :u1l%cate In2entory Ta+ .nventor2 Ta) o' 2A1 :escription 4ocation Suantit2 ,ounted ,ounted 52 ,0ec6ed 52 :ate :ate

p. +D+ o) *++

%xhi it *@: 6nventor" tag Ta!ing a ph"sical inventor" o)ten involves using inventor" tags, such as that in %xhi it *@0 These tags are consecutivel" nu$ ere& )or control purposes0 A tag usuall" consists o) a stu an& a &etacha le &uplicate section0 The &uplicate section )acilitates chec!ing &iscrepancies0 The )or$at o) the tags can var"0 #o'ever, the tag usuall" provi&es space )or (1) a &etaile& &escription an& i&enti)ication o) inventor" ite$s " pro&uct, class, an& $o&el? (I) location o) ite$s? (+) 4uantit" o) ite$s on han&? an& (*) initials o) the counters an& chec!ers0 The &escriptive in)or$ation an& count $a" e entere& on one cop" o) the tag " one tea$ o) counters0 Another tea$ o) counters $a" recor& its count on the &uplicate cop" o) the tag0 <iscrepancies et'een counts o) the sa$e ite$s " &i))erent tea$s are reconcile& " supervisors, an& the correct counts are asse$ le& on inter$e&iate inventor" sheets0 Onl" 'hen the inventor" counts are co$plete& an& chec!e& &oes $anage$ent sen& the )inal sheets to the accounting &epart$ent )or pricing an& extensions (4uantit" Z price)0 The ta ulate& result is the &ollar a$ount o) the ph"sical inventor"0 Aater in the chapter 'e explain the &i))erent $etho&s accountants use to cost inventor"0 Msuall", inventor" cost inclu&es all the necessar" outla"s to o tain the goo&s, get the goo&s rea&" to sell, an& have the goo&s in the &esire& location )or sale to custo$ers0 Thus, inventor" cost inclu&es:
 ,ellerJs invoice price less an" purchase &iscount0  Cost o) the u"erJs insurance to cover the goo&s 'hile in transit0  Transportation charges 'hen orne " the u"er0  #an&ling costs, such as the cost o) pressing clothes 'rin!le& &uring ship$ent0

6n theor", the cost o) each unit o) inventor" shoul& inclu&e its net invoice price plus its share o) other costs incurre& in ship$ent0 The 1>8D Tax :e)or$ Act re4uires co$panies to assign these costs to inventor" )or tax purposes0 For accounting purposes, these cost assign$ents are reco$$en&e& ut not re4uire&0 Practical &i))iculties arise in allocating so$e o) these costs to inventor" ite$s0 Assu$e, )or exa$ple, that the )reight ill on a ship$ent o) clothes &oes not separate out the cost o) shipping one shirt0 Also, assu$e that the co$pan" 'ants to inclu&e the )reight cost as part o) the inventor" cost o) the shirt0 Then, the )reight cost 'oul& have to e allocate& to each unit ecause it cannot e $easure& &irectl"0 6n practice, allocations o) )reight, insurance, an& han&ling costs to the in&ivi&ual units o) inventor" purchase& are o)ten not 'orth the a&&itional cost0 Conse4uentl", in the past $an" co$panies have not assigne& the costs o) )reight, insurance, an& han&ling to inventor"0 6nstea&, the" have expense& these costs as incurre&0 =hen co$panies o$it these costs )ro$ oth eginning an& en&ing inventories, the" p. +D* o) *++

$ini$i5e the e))ect o) expensing these costs on net inco$e0 The re4uire& allocation )or tax purposes has pro a l" resulte& in $an" co$panies using the sa$e inventor" a$ounts in their )inancial state$ents0 %ven i) a co$pan" &erives a cost )or each unit in inventor", the inventor" valuation pro le$ is not solve&0 (anage$ent $ust consi&er t'o other aspects o) the pro le$:
 6) goo&s 'ere purchase& at var"ing unit costs, ho' shoul& the cost o) goo&s availa le )or sale

e allocate& et'een the units sol& an& those that re$ain in inventor"Q For exa$ple, assu$e #i-Fi Bu"s, 6nc0, purchase& t'o i&entical <G< pla"ers )or resale0 One cost M,< ICB an& the other, M,< IBB0 6) one 'as sol& &uring the perio&, shoul& #i-Fi Bu"s assign it a cost o) M,< ICB, M,< IBB, or an average cost o) M,< IICQ
 <oes the )act that current replace$ent costs are less than the costs o) so$e units in inventor"

have an" earing on the a$ount at 'hich inventor" shoul& e carrie&Q Msing the sa$e exa$ple, i) #i-Fi Bu"s can currentl" u" all <G< pla"ers )or M,< IBB, is it reasona le to carr" so$e units in inventor" at M,< ICB rather than M,< IBBQ =e ans'er these 4uestions in the next section0 2enerall" co$panies shoul& account )or inventories at historical cost? that is, the cost at 'hich the ite$s 'ere purchase&0 #o'ever, this rule &oes not in&icate ho' to assign costs to en&ing inventor" an& to cost o) goo&s sol& 'hen the goo&s have een purchase& at &i))erent unit costs0 For exa$ple, suppose a retailer has three shirts on han&0 One costs M,< IB? another, M,< II? an& a thir&, M,< I*0 6) the retailer sells t'o shirts )or M,< +B each, 'hat is the cost o) the t'o shirts sol&Q Accountants &evelope& these )our inventor" costing $etho&s to solve costing pro le$s: (1) speci)ic i&enti)ication? (I) )irst-in, )irst-out (F6FO)? (+) last-in, )irst-out (A6FO)? an& (*) 'eighte&-average0 Be)ore explaining the inventor" costing $etho&s, 'e rie)l" intro&uce perpetual inventor" proce&ure an& co$pare perio&ic an& perpetual inventor" proce&ures0 6n Chapter D, the e$phasis 'as on perio&ic inventor" proce&ure0 Mn&er perio&ic inventor" proce&ure, )ir$s &e it the Purchases account 'hen goo&s are ac4uire&? the" use other accounts, such as Purchase <iscounts, Purchase :eturns an& Allo'ances, an& Transportation-6n, )or purchase-relate& transactions0 Co$panies &eter$ine cost o) goo&s sol& onl" at the en& o) the perio& as the &i))erence et'een cost o) goo&s availa le )or sale an& en&ing inventor"0 The" !eep no recor&s o) the cost o) ite$s as the" are sol&, an& have no in)or$ation on possi le inventor" shortages0 The" assu$e an" goo&s not in en&ing inventor" have een sol&0

p. +DC o) *++

.te! 4ocation

TH3@6974

*axi!u! *ini!u!

26 6

.urcha#ed 200A :ate &e)' inv' 1ul2 5 7 "2 22 "0 3"5 3,"50 6 2 24 9 320 2,560 "0 $300 $3,000 "2 Un%t Un%t# Co#t Total Co#t Un%t#

Sold Un%t Co#t Total Co#t Un%t# 9 "9 $300 $3,600 6 6 300 3"5 ",900 630 9 9 "0

!alance Un%t Co#t $300 300 300 300 3"5 Total Co#t $2,400 5,400 ",900 ",900 3,"50

3"5 3"5 320

2,520 2,520 2,560

%xhi it *8: Perpetual inventor" recor& (F6FO $etho&) The availa ilit" o) inventor" $anage$ent so)t'are pac!ages is causing $ore an& $ore usinesses to change )ro$ perio&ic to perpetual inventor" proce&ure0 Mn&er perpetual inventor" proce&ure, co$panies have no Purchases an& purchase-relate& accounts0 6nstea&, the" $a!e all entries involving $erchan&ise purchase& )or sale to custo$ers &irectl" in the (erchan&ise 6nventor" account0 Thus, the" &e it or cre&it (erchan&ise 6nventor" in place o) &e iting or cre&iting Purchases, Purchase <iscounts, Purchase :eturns an& Allo'ances, an& Transportation-6n0 At the ti$e o) each sale, )ir$s $a!e t'o entries: the )irst &e its Accounts :eceiva le or Cash an& cre&its ,ales at the retail selling price0 The secon& &e its Cost o) 2oo&s ,ol& an& cre&its (erchan&ise 6nventor" at cost0 There)ore, at the en& o) the perio& the (erchan&ise 6nventor" account sho's the cost o) the inventor" that shoul& e on han&0 Co$parison o) this a$ount 'ith the cost o taine& " ta!ing an& pricing a ph"sical inventor" $a" reveal inventor" shortages0 Thus, perpetual inventor" proce&ure is an i$portant ele$ent in provi&ing internal control over goo&s in inventor"0 &erpetual in'entory recor.s %ven though co$panies coul& appl" perpetual inventor" proce&ure $anuall", trac!ing units an& &ollars in an& out o) inventor" is $uch easier using a co$puter0 Both $anual an& co$puter processing $aintain a recor& )or each ite$ in inventor"0 Aoo! at %xhi it *8, an inventor" recor& )or %ntertain$ent =orl&, a )ir$ that sells $an" &i))erent ran&s o) television sets0 This inventor" recor& sho's the in)or$ation on one particular ran& an& $o&el o) television set carrie& in inventor"0 Other in)or$ation on the recor& inclu&es (1) the $axi$u$ an& p. +DD o) *++

$ini$u$ nu$ er o) units the co$pan" 'ishes to stoc! at an" ti$e, (I) 'hen an& ho' $an" units 'ere ac4uire& an& at 'hat cost, an& (+) 'hen an& ho' $an" units 'ere sol& an& 'hat cost 'as assigne& to cost o) goo&s sol&0 The nu$ er o) units on han& an& their cost are rea&il" availa le also0 %ntertain$ent =orl& assu$es that the )irst units ac4uire& are the )irst units sol&0 This assu$ption is the )irst-in, )irst-out (F6FO) $etho& o) inventor" costing? 'e 'ill &iscuss it later0

#n accounting perspecti'e: 6ses o0 tec%nology
Neeping trac! o) inventories un&er a perpetual inventor" s"ste$ is $uch $ore coste))ective 'ith co$puters0 Mn&er a $anual s"ste$, the cost o) an up-to-&ate inventor" )or stores 'ith high turnover 'oul& out'eigh the ene)it0 (ost retail stores use scanning &evices to rea& the inventor" nu$ ers o) pro&ucts purchase& at the cash register0 These ar co&es not onl" provi&e accurate sales prices ut also recor& the $erchan&ise sol& so that the total cost o) the storeJs inventor" is up to &ate0

The )ollo'ing co$parison reveals several &i))erences

et'een accounting )or inventories un&er

perio&ic an& perpetual proce&ures0 =e explain these &i))erences " using &ata )ro$ %xhi it *8 an& $a!ing a&&itional assu$ptions0 Aater, 'e &iscuss other 3ournal entries un&er perpetual inventor" proce&ure0 These entries recor& the purchase on ;ul" C un&er each o) the $etho&s:
.er%od%c .rocedure =urc0ases #>$% $ccounts =a2a5le #>4% .er1etual .rocedure *erc0andise .nventor2 #>$% 3,000 $ccounts =a2a5le #>4% 3,000

3,000 3,000

Assu$ing the $erchan&ise sol& on ;ul" @ 'as price& at M,< *,8BB, these entries recor& the sale:
.er%od%c .rocedure $ccounts Receiva5le #>$% Sales #>SE% .er1etual .rocedure $ccounts Receiva5le #>$% 4,900 Sales #>SE% 4,900 ,ost o( Goods Sold #3SE% 3,600 *erc0andise .nventor2#3$% 3,600

4,900

4,900

,everal other transactions not inclu&e& in %xhi it *8 coul& occur:
 Assu$e that t'o o) the units purchase& on ;ul" C 'ere returne& to the supplier ecause the"

'ere &e)ective0 The entries 'oul& e: p. +D@ o) *++

.er%od%c .rocedure $ccounts =a2a5le =urc0ase Returns and $llo;ances

600 600

.er1etual .rocedure $ccounts =a2a5le *erc0andise .nventor2

600 600

 Assu$e that the supplier instea& grante& an allo'ance o) M,< DBB to the co$pan" ecause

o) the &e)ective $erchan&ise0 The entries 'oul& e:
.er%od%c .rocedure $ccounts =a2a5le #34% =urc0ase Returns and $llo;ances #3$% .er1etual .rocedure $ccounts =a2a5le #34% *erc0andise .nventor2 #3$% 600

600

600 600

 Assu$e that the co$pan" incurre& an& pai& )reight charges o) M,< 1BB on the purchase o)

;ul" C0 The entries 'oul& e:
.er%od%c .rocedure Transportation3.n #>$% ,as0 #3$% .er1etual .rocedure *erc0andise .nventor2 #>$% ,as0 #3$%

"00 "00

"00 "00

6n these entries, notice that un&er perpetual inventor" proce&ure the (erchan&ise 6nventor" account recor&s purchases, purchase returns an& allo'ances, purchase &iscounts, an& transportationin0 Also, 'hen goo&s are sol&, the seller &e its (increases) Cost o) 2oo&s ,ol& an& cre&its or re&uces (erchan&ise 6nventor"0 At the en& o) the accounting perio&, un&er perpetual inventor" proce&ure, the onl" $erchan&iserelate& expense account to e close& is Cost o) 2oo&s ,ol&0 The Purchases, Purchase :eturns an& Allo'ances, Purchase <iscounts, an& Transportation-6n accounts &o not even exist0

p. +D8 o) *++

!e+%nn%n+ In2entory and .urcha#e# Un%t :ate &e)innin) inventor2 *arc0 2 *a2 29 $u)ust "2 +cto5er "2 :ece!5er 2" Un%t# "0 "0 20 "0 20 "0 90 Co#t $9'00 9'50 9'40 @'00 9'90 @'"0 Total Co#t $ 90 95 "69 @0 "76 @" $6@0 :ate *arc0 "0 1ul2 "4 Septe!5er 7 ove!5er 22

Sale#

Un%t# "0 20 "0 20

.r%ce $"2'00 "2'00 "4'00 "4'00

Total $"20 240 "40 290

60

$790

Endin) inventor2 ? 20 units, deter!ined &2 ta6in) a p02sical inventor2'

%xhi it *>: Beginning inventor", purchases an& sales

#n accounting perspecti'e: Business insig%t
=hen "ou u" a ox o) rea!)ast cereal at the super$ar!et, the cashier scans the ar co&e on the ox0 The na$e o) the ite$ an& the price appear on a vi&eo &ispla" that "ou can see0 The in)or$ation is also printe& on the sales slip so that "ou can later co$pare the ite$s pai& )or 'ith the ite$s receive&0 But this is not the en& o) the stor"0 The in)or$ation is also )e& to the storeJs co$puter to up&ate the inventor" recor&s0 The in)or$ation is inclu&e& 'ith other in)or$ation an& is use& to or&er $ore $erchan&ise )ro$ the 'arehouse so the ite$s can e replenishe& in the store0 At a certain point, the co$pan" also uses the re&uce& inventor" levels to or&er $ore $erchan&ise )ro$ suppliers, such as 'holesalers that suppl" the region 'ith rea!)ast cereals an& other goo&s0 The paper'or! )or the purchase an& pa"$ent are o)ten han&le& electronicall" through a process calle& electronic &ata interchange (%<6) an& electronic )un&s trans)er (%FT)0

Msing the &ata )or purchases, sales, an& eginning inventor" in %xhi it *>, next 'e explain the )our inventor" costing $etho&s0 %xcept )or the speci)ic i&enti)ication $etho&, 'e )irst present all o) the $etho&s using perio&ic inventor" proce&ure an& then present all o) the $etho&s using perpetual inventor" proce&ure0 Total goo&s availa le )or sale consist o) 8B units 'ith a total cost o) M,< D>B0 A ph"sical inventor" &eter$ine& that IB units are on han& at the en& o) the perio&0 ,ales revenue )or the

p. +D> o) *++

DB units sol& 'as M,< @8B0 The 4uestions to e ans'ere& are: =hat is the cost o) the IB units in inventor"Q =hat is the cost o) the DB units sol&Q "peci0ic i.enti0ication The speci0ic i.enti0ication met%o. o) inventor" costing attaches the actual cost to an i&enti)ia le unit o) pro&uct0 Fir$s )in& this $etho& eas" to appl" 'hen purchasing an& selling large inventor" ite$s such as autos0 Mn&er the speci)ic i&enti)ication $etho&, the )ir$ $ust i&enti)" each unit in inventor", unless it is uni4ue, 'ith a serial nu$ er or i&enti)ication tag0 To illustrate, assu$e that the co$pan" in %xhi it *> can i&enti)" the IB units on han& at "ear-en& as 1B units )ro$ the August 1I purchase an& 1B units )ro$ the <ece$ er I1 purchase0 The co$pan" co$putes the en&ing inventor" as sho'n in %xhi it CB? it su tracts the M,< 181 en&ing inventor" cost )ro$ the M,< D>B cost o) goo&s availa le )or sale to o tain the M,< CB> cost o) goo&s sol&0 /ote that "ou can also &eter$ine the cost o) goo&s sol& )or the "ear " recor&ing the cost o) each unit sol&0 The M,< CB> cost o) goo&s sol& is an expense on the inco$e state$ent, an& the M,< 181 en&ing inventor" is a current asset on the alance sheet0 The speci)ic i&enti)ication costing $etho& attaches cost to an i&enti)ia le unit o) inventor"0 The $etho& &oes not involve an" assu$ptions a out the )lo' o) the costs as in the other inventor" costing $etho&s0 Conceptuall", the $etho& $atches the cost to the ph"sical )lo' o) the inventor" an& eli$inates the e$phasis on the ti$ing o) the cost &eter$ination0 There)ore, perio&ic an& perpetual inventor" proce&ures pro&uce the sa$e results )or the speci)ic i&enti)ication $etho&0
Un%t# Endin) inventor2 co!posed o( purc0ases !ade on: $u)ust "2 :ece!5er 2" Endin) inventor2 ,ost o( )oods sold co!posed o(: &e)innin) inventor2 =urc0ases !ade on: *arc0 2 *a2 29 +cto5er "2 ,ost o( )oods availa5le (or sale Endin) inventor2 ,ost o( )oods sold "0 "0 20 "0 "0 20 20 Un%t Co#t $ @'00 @'"0 9'00 9'50 9'40 9'90 Total Co#t $ @0 @" $"9" $ 90 95 "69 "76 $50@ $6@0 "9" $50@

%xhi it CB: <eter$ining en&ing inventor" un&er speci)ic i&enti)ication F1F3 (0irst-in, 0irst-out) un.er perio.ic in'entory proce.ure The F1F3 (0irst-in, 0irstout) $etho& o) inventor" costing assu$es that the costs o) the )irst goo&s purchase& are those charge&

p. +@B o) *++

to cost o) goo&s sol& 'hen the co$pan" actuall" sells goo&s0 This $etho& assu$es the )irst goo&s purchase& are the )irst goo&s sol&0 6n so$e co$panies, the )irst units in ( ought) $ust e the )irst units out (sol&) to avoi& large losses )ro$ spoilage0 ,uch ite$s as )resh &air" pro&ucts, )ruits, an& vegeta les shoul& e sol& on a F6FO asis0 6n these cases, an assu$e& )irst-in, )irst-out )lo' correspon&s 'ith the actual ph"sical )lo' o) goo&s0 Because a co$pan" using F6FO assu$es the ol&er units are sol& )irst an& the ne'er units are still on han&, the en&ing inventor" consists o) the $ost recent purchases0 =hen using perio&ic inventor" proce&ure, to &eter$ine the cost o) the en&ing inventor" at the en& o) the perio& un&er F6FO, "ou 'oul& egin " listing the cost o) the $ost recent purchase0 6) the en&ing inventor" contains $ore units than ac4uire& in the $ost recent purchase, it also inclu&es units )ro$ the next-to-the-latest purchase at the unit cost incurre&, an& so on0 .ou 'oul& list these units )ro$ the latest purchases until that nu$ er agrees 'ith the units in the en&ing inventor"0 6n %xhi it C1, "ou can see ho' to &eter$ine the cost o) en&ing inventor" un&er F6FO using perio&ic inventor" proce&ure0 The co$pan" assu$es that the IB units in inventor" consist o) 1B units purchase& <ece$ er I1 an& 1B units purchase& Octo er 1I0 The total cost o) en&ing inventor" is M,< 1@>, an& the cost o) goo&s sol& is M,< C110 =e sho' the relationship et'een the cost o) goo&s sol& an& the cost o) en&ing inventor" un&er F6FO using perio&ic inventor" proce&ure in %xhi it CI0 The 8B units in cost o) goo&s availa le )or sale consists o) the eginning inventor" an& all o) the purchases &uring the perio&0 Mn&er F6FO, the en&ing inventor" o) IB units consists o) the $ost recent purchasesL1B units o) the <ece$ er I1 purchase an& 1B units o) the Octo er 1I purchaseLcosting M,< 1@>0 =e assu$e the eginning inventor" an& other earlier purchases have een sol& &uring the perio&, representing the cost o) goo&s sol& o) M,< C110

p. +@1 o) *++

Endin) inventor2 co!posed o( purc0ases !ade on: :ece!5er 2" +cto5er "2 Endin) inventor2 ,ost o( )oods sold co!posed o(: &e)innin) inventor2 =urc0ases !ade on: *arc0 2 *a2 29 $u)ust "2 +cto5er "2 ,ost o( )oods availa5le (or sale Endin) inventor2 ,ost o( )oods sold

Un%t# "0 "0 20 "0 "0 20 "0 "0

Un%t Co#t $@'"0 9'90 9'00 9'50 9'40 @'00 9'90

Total Co#t $ @" 99 $"7@ $ 90 95 "69 @0 99 $5""

$6@0 "7@ $5""

%xhi it C1: <eter$ining F6FO cost o) en&ing inventor" un&er perio&ic inventor" proce&ure

%xhi it CI: F6FO )lo' o) costs
L1F3 (last-in, 0irst-out) un.er perio.ic in'entory proce.ure The L1F3 (last-in, 0irstout) $etho& o) inventor" costing assu$es that the costs o) the $ost recent purchases are the )irst costs charge& to cost o) goo&s sol& 'hen the co$pan" actuall" sells the goo&s0 6n %xhi it C+, 'e sho' the use o) A6FO un&er perio&ic inventor" proce&ure0 ,ince the co$pan" charges the latest costs to cost o) goo&s sol& un&er perio&ic inventor" proce&ure, the en&ing inventor" al'a"s consists o) the ol&est costs0 There)ore, 'hen &eter$ining the cost o) inventor" un&er perio&ic

p. +@I o) *++

inventor" proce&ure, the co$pan" lists the ol&est units an& their costs0 The )irst units liste& are those in eginning inventor", then the )irst purchase, an& so on, until the nu$ er liste& agrees 'ith the units in en&ing inventor"0 Thus, en&ing inventor" in %xhi it C+ consists o) the 1B units )ro$ eginning inventor" an& the 1B units purchase& on (arch I0 The total cost o) these IB units, M,< 1DC, is the en&ing inventor" cost? the cost o) goo&s sol& is M,< CIC0 %xhi it C* is a graphic representation o) the A6FO )lo' o) costs un&er perio&ic inventor" proce&ure0
Un%t# Endin) inventor2 co!posed o(: &e)innin) inventor2 *arc0 2 purc0ase Endin) inventor2 ,ost o( )oods sold co!posed o( purc0ases !ade on: :ece!5er 2" +cto5er "2 $u)ust "2 *a2 29 ,ost o( )oods availa5le (or sale Endin) inventor2 ,ost o( )oods sold "0 "0 20 "0 20 "0 20 Un%t Co#t $9'00 9'50 @'"0 9'90 @'00 9'40 Total Co#t $ 90 95 $"65 $ @" "76 @0 "69 $525 $6@0 "65 $525

%xhi it C+: <eter$ining A6FO cost o) en&ing inventor" un&er perio&ic inventor" proce&ure

%xhi it C*: A6FO )lo' o) costs un&er perio&ic inventor" proce&ure

p. +@+ o) *++

Eeig%te.-a'erage un.er perio.ic in'entory proce.ure The weig%te.-a'erage met%o. o) inventor" costing is a $eans o) costing en&ing inventor" using a 'eighte&-average unit cost0 Co$panies $ost o)ten use the 'eighte&-average $etho& to &eter$ine a cost )or units that are asicall" the sa$e, such as i&entical ga$es in a to" store or i&entical electrical tools in a har&'are store0 ,ince the units are ali!e, )ir$s can assign the sa$e unit cost to the$0 Mn&er perio&ic inventor" proce&ure, a co$pan" &eter$ines the average cost at the en& o) the accounting perio& " &ivi&ing the total units purchase& plus those in eginning inventor" into total cost o) goo&s availa le )or sale0 The en&ing inventor" is carrie& at this per unit cost0 To see ho' a co$pan" uses the 'eighte&-average $etho& to &eter$ine inventor" costs using perio&ic inventor" proce&ure, loo! at %xhi it CC0 /ote that 'e co$pute 'eighte&-average cost per unit " &ivi&ing the cost o) units availa le )or sale, M,< D>B, " the total nu$ er o) units availa le )or sale, 8B0 Thus, the 'eighte&-average cost per unit is M,< 80DIC, $eaning that each unit sol& or re$aining in inventor" is value& at M,< 80DIC0
Un%t Co#t $9'00 9'50 9'40 @'00 9'90 @'"0 Total Co#t $ 90'00 95'00 "69'00 @0'00 "76'00 @"'00 $6@0'00 "72'50 $5"7'50

&e)innin) inventor2 .urcha#e# *arc0 2 *a2 29 $u)ust "2 +cto5er "2 :ece!5er 2" Total Lei)0ted3avera)e unit cost is $6@0 G 90, or $9'625 Endin) inventor2 t0en is $9'625 x 20 ,ost o( )oods sold: $9'625 x 60

Un%t# "0 "0 20 "0 20 "0 90

%xhi it CC: <eter$ining en&ing inventor" un&er 'eighte&-average $etho& using perio&ic inventor" proce&ure

p. +@* o) *++

.urcha#ed Un%t Total :ate &e)' inv' *ar' 2 "0 $9'50 $95 Un%t# Co#t Co#t Un%t#

Sold Un%t Co#t Total Co#t Un%t# "0 "0#$% "0

!alance Un%t Co#t $9'00 9'00 9'50 9'50 9'50 9'40 Total Co#t 90 90 95 95 95 "69 Sales are assu!ed to 5e (ro! t0e oldest units on 0and

*ar' "0 *a2 29 20 9'40 "69

"0

$9'00

#$%$90

"0 "0#&% 20#,%

1ul2 "4

"0 "0

9'50 9'40

#&%95 #,%95 "0 "0#:% "0 9'40 9'40 @'00 @'00 @'00 9'90 94 94 @0 @0 @0 "76

$u)' "2

"0

@'00 @0

Sept' 7 +ct' "2 20 9'90 "76

"0

9'40

#:%94

"0 "0#E% 20#/%

ov' 22

"0 "0

@'00 9'90

#E%@0 #/%99 "0 "0 "0 9'90 9'90 @'"0 99 99 @" $"7@ Total o( $"7@ ;ould a)ree ;it0 5alance alread2 existin) in *erc0andise .nventor2 account'

:ec 2"

"0

@'"0 @"

Total cost o( endin) inventor2 ?

%xhi it CD: <eter$ining F6FO cost o) en&ing inventor" un&er perpetual inventor" proce&ure F1F3 un.er perpetual in'entory proce.ure Mn&er perpetual inventor" proce&ure, the en&ing alance in the (erchan&ise 6nventor" account re)lects the $ost recent purchases as a result o) $a!ing the re4uire& entries &uring the perio&0 Also, the )ir$ has alrea&" recor&e& the cost o) goo&s sol& in the Cost o) 2oo&s ,ol& account0 %xhi it CD sho's ho' to &eter$ine the cost o) en&ing inventor" un&er F6FO using perpetual inventor" proce&ure0 This illustration uses the sa$e )or$at as the earlier perpetual inventor" recor& in %xhi it *80 The co$pan" !eeps a recor& o) the alance in the inventor" account as it $a!es purchases an& sells ite$s )ro$ inventor"0

p. +@C o) *++

.urcha#ed :ate &e)' inv' *ar' 2 *ar' "0 *a2 29 20 9'40 "69 Un%t# Un%t Co#t $9'50 Total Co#t $95 "0 Un%t#

Sold Un%t Co#t Total Co#t Un%t#

!alance Un%t Co#t $9'00 9'00 9'50 9'00 9'00 9'40 9'00 9'00 @'00 9'00 9'00 9'90 9'00 9'00 @'"0 Total Co#t 90 90 95 90 90 "69 90 90 @0 90 90 "76 90 90 @" Total o( $"7" ;ould a)ree ;it0 5alance alread2 existin) in *erc0andise .nventor2 account' Sales are assu!ed to 5e (ro! !ost recent purc0ases

"0

"0 "0 $9'50 95 "0 "0 20 20 9'40 "69 "0 "0 "0 "0 @'00 @0 "0 "0 20 20 9'90 "76 "0 "0 "0

1ul2 "4 $u)'"2 Sept' 7 +ct' "2 ov' 22 :ec' 2" "0 @'"0 @" 20 9'90 "76 "0 @'00 @0

Total cost o( endin) inventor2 ?

$"7"

%xhi it C@: <eter$ining A6FO cost o) en&ing inventor" un&er perpetual inventor" proce&ure /otice in %xhi it CD that each ti$e a sale occurs, the co$pan" assu$es the ite$s sol& are the ol&est on han&0 Thus, a)ter each transaction, it can rea&il" &eter$ine the alance in the (erchan&ise 6nventor" account )ro$ the perpetual inventor" recor&0 The alance a)ter the <ece$ er I1 purchase represents the IB units )ro$ the $ost recent purchases0 The total cost o) en&ing inventor" is M,< 1@>, 'hich the co$pan" reports as a current asset on the alance sheet0 <uring the accounting perio&, as sales occurre& the )ir$ 'oul& have &e ite& a total o) M,< C11 to Cost o) 2oo&s ,ol&0 A&&ing this M,< C11 to the en&ing inventor" o) M,< 1@> accounts )or the M,< D>B cost o) goo&s availa le )or sale0 Mn&er F6FO, using either perpetual or perio&ic inventor" proce&ures results in the sa$e total a$ounts )or en&ing inventor" an& )or cost o) goo&s sol&0 L1F3 un.er perpetual in'entory proce.ure Aoo! at %xhi it C@ to see the A6FO $etho& using perpetual inventor" proce&ure0 Mn&er this proce&ure, the inventor" co$position an& alance are up&ate& 'ith each purchase an& sale0 /otice in %xhi it C@ that each ti$e a sale occurs, the ite$s sol& are assu$e& to e the $ost recent ones ac4uire&0 <espite nu$erous purchases an& sales &uring the

p. +@D o) *++

"ear, the en&ing inventor" still inclu&es the 1B units )ro$ eginning inventor" in our exa$ple0 The re$ain&er o) the en&ing inventor" consists o) the last purchase ecause no sale occurre& a)ter the <ece$ er I1 purchase0 The total cost o) the IB units in en&ing inventor" is M,< 1@1? the cost o) goo&s sol& is M,< C1>0 %xhi it C8 sho's graphicall" the A6FO )lo' o) costs un&er perpetual inventor" proce&ure0 Appl"ing A6FO on a perpetual asis &uring the accounting perio&, as sho'n in %xhi it C@, results in &i))erent en&ing inventor" an& cost o) goo&s sol& )igures than appl"ing A6FO onl" at "ear-en& using perio&ic inventor" proce&ure0 (Co$pare %xhi it C@ an& %xhi it C+ to veri)" that en&ing inventor" an& cost o) goo&s sol& are &i))erent un&er the t'o proce&ures0) For this reason, i) A6FO is applie& on a perpetual asis &uring the perio&, special a&3ust$ents are so$eti$es necessar" at "ear-en& to ta!e )ull a&vantage o) using A6FO )or tax purposes0 Co$plicate& applications o) A6FO perpetual inventor" proce&ures that re4uire such a&3ust$ents are e"on& the scope o) this text0

T

%xhi it C8: A6FO )lo' o) costs un&er perpetual inventor" proce&ure

p. +@@ o) *++

.urcha#ed :ate &e)' inv' *ar' 2 *ar' "0 *a2 29 1ul2 "4 $u)' "2 Sept' 7 +ct' "2 ov' 22 :ec 2" "0 @'"0 @" 20 9'90 "76 "0 @'00 @0 "0 20 9'40 "69 20 Un%t# Un%t Co#t $9'50 Total Co#t $95 "0 Un%t#

Sold Un%t Co#t Total Co#t Un%t# "0 20 $9'25
&

!alance Un%t Co#t $9'00 9'25a$ 9'25 9'355 9'35 9'675c 9'675 9'759 c 9'759 $9'@2@e Total Co#t 90'00 "65'00 92'90 250'50 93'50 "73'50 96'75 262'75 97'59 $"79'59,

"0

$92'50

"0 30

9'35

"67'00

"0 20

9'675

96'75

"0 30

9'759

"75'"7

"0 20

a71=<.00M2 / 7A.2<. &72<0.<0M 0 / 7A. <. c71B .<0M20 / 7A.=B<. d72=2.B<M 0 / 7A.B<A. 0 / 7A.C2C J round%n+ d%**erence. e71B<.<AM2 0
$

$ ne; unit cost is calculated a(ter eac0 purc0ase' &T0e unit cost o( sales is t0e !ost recentl2 calculated cost' , &alance o( $"79'59 ;ould a)ree ;it0 5alance alread2 existin) in t0e *erc0andise .nventor2 account'

%xhi it C>: <eter$ining en&ing inventor" un&er 'eighte&-average $etho& using perpetual inventor" proce&ure Aoo! at %xhi it C8 an& %xhi it C*, the )lo' o) inventor" costs un&er A6FO using oth the perpetual an& perio&ic inventor" proce&ures0 /ote that en&ing inventor" an& cost o) goo&s sol& are &i))erent un&er the t'o proce&ures0 Eeig%te.-a'erage un.er perpetual in'entory proce.ure Mn&er perpetual inventor" proce&ure, )ir$s co$pute a ne' 'eighte&-average unit cost a)ter each purchase " &ivi&ing total cost o) goo&s availa le )or sale " total units availa le )or sale0 The unit cost is a $oving 'eighte&-average ecause it changes a)ter each purchase0 6n %xhi it C>, "ou can see ho' to co$pute the $oving 'eighte&-average using perpetual inventor" proce&ure0 The ne' 'eighte&-average unit cost co$pute& a)ter each purchase is the unit cost )or inventor" ite$s sol& until a ne' purchase is $a&e0 The unit cost o) the IB units in en&ing inventor" is M,< 80>I> )or a total inventor" cost o) M,< 1@80C80 Cost o) goo&s sol& un&er this proce&ure is M,< D>B $inus the M,< 1@80C8, or M,< C110*I0

p. +@8 o) *++

#.'antages an. .isa.'antages o0 speci0ic i.enti0ication Co$panies that use the speci)ic i&enti)ication $etho& o) inventor" costing state their cost o) goo&s sol& an& en&ing inventor" at the actual cost o) speci)ic units sol& an& on han&0 ,o$e accountants argue that this $etho& provi&es the $ost precise $atching o) costs an& revenues an& is, there)ore, the $ost theoreticall" soun& $etho&0 This state$ent is true )or so$e one-o)-a-!in& ite$s, such as autos or real estate0 For these ite$s, use o) an" other $etho& 'oul& see$ illogical0 One &isa&vantage o) the speci)ic i&enti)ication $etho& is that it per$its the $anipulation o) inco$e0 For exa$ple, assu$e that a co$pan" ought three i&entical units o) a given pro&uct at &i))erent prices0 One unit cost M,< I,BBB, the secon& cost M,< I,1BB, an& the thir& cost M,< I,IBB0 The co$pan" sol& one unit )or M,< I,8BB0 The units are ali!e, so the custo$er &oes not care 'hich o) the i&entical units the co$pan" ships0 #o'ever, the gross $argin on the sale coul& e either M,< 8BB, M,< @BB, or M,< DBB, &epen&ing on 'hich unit the co$pan" ships0 #.'antages an. .isa.'antages o0 F1F3 The F6FO $etho& has )our $a3or a&vantages: (1) it is eas" to appl", (I) the assu$e& )lo' o) costs correspon&s 'ith the nor$al ph"sical )lo' o) goo&s, (+) no $anipulation o) inco$e is possi le, an& (*) the alance sheet a$ount )or inventor" is li!el" to approxi$ate the current $ar!et value0 All the a&vantages o) F6FO occur ecause 'hen a co$pan" sells goo&s, the )irst costs it re$oves )ro$ inventor" are the ol&est unit costs0 A co$pan" cannot $anipulate inco$e " choosing 'hich unit to ship ecause the cost o) a unit sol& is not &eter$ine& " a serial nu$ er0 6nstea&, the cost attache& to the unit sol& is al'a"s the ol&est cost0 Mn&er F6FO, purchases at the en& o) the perio& have no e))ect on cost o) goo&s sol& or net inco$e0 The &isa&vantages o) F6FO inclu&e (1) the recognition o) paper pro)its an& (I) a heavier tax ur&en i) use& )or tax purposes in perio&s o) in)lation0 =e &iscuss these &isa&vantages later as a&vantages o) A6FO0 #.'antages an. .isa.'antages o0 L1F3 The a&vantages o) the A6FO $etho& are ase& on the )act that prices have risen al$ost constantl" )or &eca&es0 A6FO supporters clai$ this up'ar& tren& in prices lea&s to inventor", or paper, pro)its i) the F6FO $etho& is use&0 1n'entory, or paper, pro0its are e4ual to the current replace$ent cost o) a unit o) inventor" at the ti$e o) sale $inus the unitJs historical cost0 For exa$ple, assu$e a co$pan" has three units o) a pro&uct on han&, each purchase& at a &i))erent cost: M,< 1I, M,< 1C, an& M,< IB (the $ost recent cost)0 The sales price o) the unit nor$all" rises ecause the unitJs replace$ent cost is rising0 Assu$e that the co$pan" sells one unit )or M,< +B0 F6FO gross $argin 'oul& e M,< 18 (M,< +B – M,< 1I), 'hile A6FO 'oul& sho' a gross $argin o) M,< 1B (M,< +B – M,< IB)0 A6FO supporters 'oul& sa" that the extra M,< 8 gross $argin sho'n un&er F6FO p. +@> o) *++

represents inventor" (paper) pro)it? it is $erel" the a&&itional a$ount that the co$pan" $ust spen& over cost o) goo&s sol& to purchase another unit o) inventor" (M,< 8 T M,< 1I S M,< IB)0 Thus, the pro)it is not real? it exists onl" on paper0 The co$pan" cannot &istri ute the M,< 8 to o'ners, ut $ust retain it to continue han&ling that particular pro&uct0 A6FO sho's the actual pro)its that the co$pan" can &istri ute to the o'ners 'hile still replenishing inventor"0 <uring perio&s o) in)lation, A6FO sho's the largest cost o) goo&s sol& o) an" o) the costing $etho&s ecause the ne'est costs charge& to cost o) goo&s sol& are also the highest costs0 The larger the cost o) goo&s sol&, the s$aller the net inco$e0 Those 'ho )avor A6FO argue that its use lea&s to a etter $atching o) costs an& revenues than the other $etho&s0 =hen a co$pan" uses A6FO, the inco$e state$ent reports oth sales revenue an& cost o) goo&s sol& in current &ollars0 The resulting gross $argin is a etter in&icator o) $anage$entJs a ilit" to generate inco$e than gross $argin co$pute& using F6FO, 'hich $a" inclu&e su stantial inventor" (paper) pro)its0 ,upporters o) F6FO argue that A6FO (1) $atches the cost o) goo&s not sol& against revenues, (I) grossl" un&erstates inventor", an& (+) per$its inco$e $anipulation0 The )irst criticis$Lthat A6FO $atches the cost o) goo&s not sol& against revenuesLis an extension o) the &e ate over 'hether the assu$e& )lo' o) costs shoul& agree 'ith the ph"sical )lo' o) goo&s0 A6FO supporters conten& that it $a!es $ore sense to $atch current costs against current revenues than to 'orr" a out $atching costs )or the ph"sical )lo' o) goo&s0 The secon& criticis$Lthat A6FO grossl" un&erstates inventor"Lis vali&0 A co$pan" $a" report A6FO inventor" at a )raction o) its current replace$ent cost, especiall" i) the historical costs are )ro$ several &eca&es ago0 A6FO supporters conten& that the increase& use)ulness o) the inco$e state$ent $ore than o))sets the negative e))ect o) this un&ervaluation o) inventor" on the alance sheet0 The thir& criticis$Lthat A6FO per$its inco$e $anipulationLis also vali&0 6nco$e $anipulation is possi le un&er A6FO0 For exa$ple, assu$e that $anage$ent 'ishes to re&uce inco$e0 The co$pan" coul& purchase an a nor$al a$ount o) goo&s at current high prices near the en& o) the current perio&, 'ith the purpose o) selling the goo&s in the next perio&0 Mn&er A6FO, these higher costs are charge& to cost o) goo&s sol& in the current perio&, resulting in a su stantial &ecline in reporte& net inco$e0 To o tain higher inco$e, $anage$ent coul& &ela" $a!ing the nor$al a$ount o) purchases until the next perio& an& thus inclu&e so$e o) the ol&er, lo'er costs in cost o) goo&s sol&0 $ax bene0it o0 L1F3 The A6FO $etho& results in the lo'est taxa le inco$e, an& thus the lo'est inco$e taxes, 'hen prices are rising0 The 6nternal :evenue ,ervice allo's co$panies to use A6FO )or tax purposes onl" i) the" use A6FO )or )inancial reporting purposes0 Co$panies $a" also report an p. +8B o) *++

alternative inventor" a$ount in the notes to their )inancial state$ents )or co$parison purposes0 Because o) high in)lation &uring the 1>@Bs, $an" co$panies s'itche& )ro$ F6FO to A6FO )or tax a&vantages0 #.'antages an. .isa.'antages o0 weig%te.-a'erage =hen a co$pan" uses the 'eighte&average $etho& an& prices are rising, its cost o) goo&s sol& is less than that o taine& un&er A6FO, ut $ore than that o taine& un&er F6FO0 6nventor" is not as a&l" un&erstate& as un&er A6FO, ut it is not as up-to-&ate as un&er F6FO0 =eighte&-average costing ta!es a $i&&le-o)-the-roa& approach0 A co$pan" can $anipulate inco$e un&er the 'eighte&-average costing $etho& " u"ing or )ailing to u" goo&s near "ear-en&0 #o'ever, the averaging process re&uces the e))ects o) u"ing or not u"ing0 The )our inventor" costing $etho&s, speci)ic i&enti)ication, F6FO, A6FO, an& 'eighte&-average, involve assu$ptions a out ho' costs )lo' through a usiness0 6n so$e instances, assu$e& cost )lo's $a" correspon& 'ith the actual ph"sical )lo' o) goo&s0 For exa$ple, )resh $eats an& &air" pro&ucts $ust )lo' in a F6FO $anner to avoi& spoilage losses0 6n contrast, )ir$s use coal stac!e& in a pile in a A6FO $anner ecause the ne'est units purchase& are unloa&e& on top o) the pile an& sol& )irst0 2asoline hel& in a tan! is a goo& exa$ple o) an inventor" that has an average ph"sical )lo'0 As the tan! is re)ille&, the ne' gasoline $ixes 'ith the ol&0 Thus, an" a$ount use& is a len& o) the ol& gas 'ith the ne'0 Although ph"sical )lo's are so$eti$es cite& as support )or an inventor" $etho&, accountants no' recogni5e that an inventor" $etho&Js assu$e& cost )lo's nee& not necessaril" correspon& 'ith the actual ph"sical )lo' o) the goo&s0 6n )act, goo& reasons exist )or si$pl" ignoring ph"sical )lo's an& choosing an inventor" $etho& ase& on other criteria0 6n %xhi it DB an& %xhi it D1, 'e use &ata )ro$ %xhi it *> to sho' the cost o) goo&s sol&, inventor" cost, an& gross $argin )or each o) the )our asic costing $etho&s using perpetual an& perio&ic inventor" proce&ures0 The &i))erences )or the )our $etho&s occur ecause the co$pan" pai& &i))erent prices )or goo&s purchase&0 /o &i))erences 'oul& occur i) purchase prices 'ere constant0 ,ince a co$pan"Js purchase prices are sel&o$ constant, inventor" costing $etho& a))ects cost o) goo&s sol&, inventor" cost, gross $argin, an& net inco$e0 There)ore, co$panies $ust &isclose on their )inancial state$ents 'hich inventor" costing $etho&s 'ere use&0 E%ic% is t%e correct met%o.J All )our $etho&s o) inventor" costing are accepta le? no single $etho& is the onl" correct $etho&0 <i))erent $etho&s are attractive un&er &i))erent con&itions0 6) a co$pan" 'ants to $atch sales revenue 'ith current cost o) goo&s sol&, it 'oul& use A6FO0 6) a co$pan" see!s to re&uce its inco$e taxes in a perio& o) rising prices, it 'oul& also use A6FO0 On the

p. +81 o) *++

other han&, A6FO o)ten charges against revenues the cost o) goo&s not actuall" sol&0 Also, A6FO $a" allo' the co$pan" to $anipulate net inco$e " changing the ti$ing o) a&&itional purchases0 The F6FO an& speci)ic i&enti)ication $etho&s result in a $ore precise $atching o) historical cost 'ith revenue0 #o'ever, F6FO can give rise to paper pro)its, 'hile speci)ic i&enti)ication can give rise to inco$e $anipulation0 The 'eighte&-average $etho& also allo's $anipulation o) inco$e0 Onl" un&er F6FO is the $anipulation o) net inco$e not possi le0

#n accounting perspecti'e: Business insig%t
(anage$ent &eci&es 'hich inventor" costing $etho& or $etho&s (A6FO, F6FO, etc0) to use0 Also, $anage$ent $ust &eter$ine 'hich $etho& is the $ost $eaning)ul an& use)ul in representing econo$ic results0 Then, it $ust use the selecte& $etho& consistentl"0 The principal usiness o) Nell'oo& Co$pan" is the $ar!eting, $erchan&ising, an& $anu)acturing o) apparel, pri$aril" )or 'o$en0 /ote in the )ollo'ing )ootnote )ro$ Nell'oo&Js )inancial state$ents that it, li!e other co$panies, uses several costing $etho&s 'ithin the sa$e enterprise: “,u""ary o& signi&icant accounting policies 3. Inventories and revenue recognition 1nventories are state at t%e lo'er o& cost or "arket. T%e &irst)in, &irst)out 3F1F.4 "et%o is use to eter"ine t%e value o& B8 per cent o& t%e o"estic inventories, an t%e last)in, &irst)out 3D1F.4 "et%o is use to value t%e re"aining o"estic inventories. 1nventories o& &oreign subsi iaries are value using t%e speci&ic

i enti&ication "et%o . ,ales are recogni(e '%en goo s are s%ippe 0H

2enerall", co$panies use the inventor" $etho& that

est )its their in&ivi&ual circu$stances0

#o'ever, this )ree&o$ o) choice &oes not inclu&e changing inventor" $etho&s ever" "ear or so, especiall" i) the goal is to report higher inco$e0 Continuous s'itching o) $etho&s violates the accounting principle o) consistenc", 'hich re4uires using the sa$e accounting $etho&s )ro$ perio& to perio& in preparing )inancial state$ents0 Consistenc" o) $etho&s in preparing )inancial state$ents ena les )inancial state$ent users to co$pare state$ents o) a co$pan" )ro$ perio& to perio& an& &eter$ine tren&s0

p. +8I o) *++

Sales ,ost o( )oods sold: &e)innin) inventor2 $ 90'00 =urc0ases 6"0'00 ,ost o( )oods availa5le (or sale $6@0'00 Endin) inventor2 "9"'00 ,ost o( )oods sold $50@'00 Gross *ar)in $27"'00

S1ec%*%c Ident%*%cat%on $790'00

FIFO $790'00 $ 90'00 6"0'00 $6@0'00 "7@'00 $5""'00 $26@'00

$IFO $790'00 $ 90'00 6"0'00 $6@0'00 "7"'00 $5"@'00 $26"'00

De%+htedA2era+e $790'00 $ 90'00 6"0'00 $6@0'00 "79'59 $5""'42 $269'59

%xhi it DB: %))ects o) &i))erent inventor" costing $etho&s using perpetual inventor" proce&ure
S1ec%*%c Ident%*%cat%on $790'00 De%+htedA2era+e $790'00 $ 90'00 6"0'00 $6@0'00 "72'50 $5"7'50 $262'50

Sales ,ost o( )oods sold: &e)innin) inventor2 $ 90'00 =urc0ases 6"0'00 ,ost o( )oods availa5le (or sale $6@0'00 Endin) inventor2 "9"'00 ,ost o( )oods sold $50@'00 Gross *ar)in $27"'00

FIFO $790'00 $ 90'00 6"0'00 $6@0'00 "7@'00 $5""'00 $26@'00

$IFO $790'00 $ 90'00 6"0'00 $6@0'00 "65'00 $525'00 $255'00

%xhi it D1: %))ects o) &i))erent inventor" costing $etho&s using perio&ic inventor" proce&ure

p. +8+ o) *++

#n accounting perspecti'e: Business insig%t
,o$eti$es, co$panies change inventor" $etho&s in spite o) the principle o) consistenc"0 6$prove& )inancial reporting is the onl" 3usti)ication )or a change in inventor" $etho&0 A co$pan" that changes its inventor" $etho& $ust $a!e a )ull &isclosure o) the change0 Msuall", the co$pan" $a!es a )ull &isclosure in a )ootnote to the )inancial state$ents0 The )ootnote consists o) a co$plete &escription o) the change, the reasons 'h" the change 'as $a&e, an&, i) possi le, the e))ect o) the change on net inco$e0 ;0 (0 Tull 6n&ustries, 6nc0, sells a &iverse range o) $etals (alu$inu$, rass, copper, steel, stainless steel, an& nic!el allo"s) )or severe corrosion con&itions an& highte$perature applications0 For exa$ple, 'hen ;0 (0 Tull change& )ro$ lo'er o) average cost or $ar!et to A6FO, the )ollo'ing )ootnote appeare& in its annual report: !ote B. C%ange in accounting met%o. 0or in'entory T%e co"pany c%ange its "et%o o& eter"ining inventory cost &ro" t%e lo'er o& average cost or "arket "et%o to t%e last)in, &irst)out 3D1F.4 "et%o &or substantially all inventory. T%is c%ange 'as "a e because "anage"ent believes D1F. "ore clearly re&lects inco"e by provi ing a closer "atc%ing o& current cost against current revenue.

/o' 'e illustrate in $ore &etail the 3ournal entries $a&e 'hen using perpetual inventor" proce&ure0 <ata )ro$ %xhi it CD serves as the asis )or so$e o) the entries0 .ou 'oul& &e it the (erchan&ise 6nventor" account to recor& the increases in the asset &ue to purchase costs an& transportation-in costs0 .ou 'oul& cre&it (erchan&ise 6nventor" to recor& the &ecreases in the asset rought a out " purchase returns an& allo'ances, purchase &iscounts, an& cost o) goo&s sol& to custo$ers0 The alance in the account is the cost o) the inventor" that shoul& e on han& at an" &ate0 This entr" recor&s the purchase o) 1B units on (arch I in %xhi it CD ?
*ar' 2 *erc0andise .nventor2 #>$% $ccounts =a2a5le #>4% To record purc0ases o( "0 units at $9'50 on account' 95 95

p. +8* o) *++

.ou 'oul& also recor& the 1B units sol& on the perpetual inventor" recor& in %xhi it CD0 Perpetual inventor" proce&ure re4uires t'o 3ournal entries )or each sale0 One entr" is at selling priceLa &e it to Accounts :eceiva le (or Cash) an& a cre&it to ,ales0 The other entr" is at costLa &e it to Cost o) 2oo&s ,ol& an& a cre&it to (erchan&ise 6nventor"0 Assu$ing that the 1B units sol& on (arch 1B in %xhi it CD ha& a retail price o) M,< 1+ each, "ou 'oul& recor& the )ollo'ing entries:
*ar' "0 $ccounts Receiva5le #>$% Sales #>SE% To record "0 units sold at $"3 eac0 on account' "0 ,ost o( Goods Sold #3SE% *erc0andise .nventor2 #3$% To record cost o( $9 on eac0 o( t0e "0 units sold' "30 "30 90 90

=hen a co$pan" sells $erchan&ise to custo$ers, it trans)ers the cost o) the $erchan&ise )ro$ an asset account ((erchan&ise 6nventor") to an expense account (Cost o) 2oo&s ,ol&)0 The co$pan" $a!es this trans)er ecause the sale re&uces the asset, an& the cost o) the goo&s sol& is one o) the expenses o) $a!ing the sale0 Thus, the Cost o) 2oo&s ,ol& account accu$ulates the cost o) all the $erchan&ise that the co$pan" sells &uring a perio&0 A sales return also re4uires t'o entries, one at selling price an& one at cost0 Assu$e that a custo$er returne& $erchan&ise that cost M,< IB an& originall" sol& )or M,< +I0 The entr" to re&uce the accounts receiva le an& to recor& the sales return o) M,< +I is:
*ar' "7 Sales Return and $llo;ances #3SE% $ccounts Receiva5le #3$% To record t0e reduction in a!ount o;ed 52 a custo!er upon return o( )oods' 32 32

The entr" that increases the (erchan&ise 6nventor" account an& &ecreases the Cost o) 2oo&s ,ol& account " M,< IB is as )ollo's:
*ar' "7 *erc0andise .nventor2 #>$% ,ost o( Goods Sold #>SE% To record replace!ent o( )oods returned to inventor2' 20 20

,ales returns a))ect oth revenues an& cost o) goo&s sol& ecause the goo&s charge& to cost o) goo&s sol& are actuall" returne& to the seller0 6n contrast, sales allo'ances grante& to custo$ers a))ect onl" revenues ecause the custo$ers &o not have to return goo&s0 Thus, i) the co$pan" ha& grante& a sales allo'ance o) M,< +I on (arch 1@, onl" the )irst entr" 'oul& e re4uire&0 p. +8C o) *++

The alance o) the (erchan&ise 6nventor" account is the cost o) the inventor" that shoul& e on han&0 This )act is a $a3or reason so$e co$panies choose to use perpetual inventor" proce&ure0 The cost o) inventor" that shoul& e on han& is rea&il" availa le0 A ph"sical inventor" &eter$ines the accurac" o) the account alance0 (anage$ent $a" investigate an" $a3or &iscrepancies et'een the alance in the account an& the cost ase& on the ph"sical count0 6t there " achieves greater control over inventor"0 =hen a shortage is &iscovere&, an a&3usting entr" is re4uire&0 Assu$ing a M,< 1C shortage (at cost) is &iscovere&, the entr" is:
:ec' 3" 4oss (ro! .nventor2 S0orta)e #3SE% *erc0andise .nventor2 #3$% To record inventor2 s0orta)e "5 "5

Assu$e that the Cost o) 2oo&s ,ol& account ha& a alance o) M,< IBB,BBB " "ear-en& 'hen it is close& to 6nco$e ,u$$ar"0 There are no other purchase-relate& accounts to e close&0 The entr" to close the Cost o) 2oo&s ,ol& account is:
:ec' 3" .nco!e Su!!ar2 ,ost o( Goods Sold To close ,ost o( Goods Sold account to .nco!e Su!!ar2 at t0e end o( t0e 2ear' 200,000

200,000

'.$ Departures from cost basis of inventor measurement
2enerall", co$panies shoul& use historical cost to value inventories an& cost o) goo&s sol&0 #o'ever, so$e circu$stances 3usti)" &epartures )ro$ historical cost0 One o) these circu$stances is 'hen the utilit" or value o) inventor" ite$s is less than their cost0 A &ecline in the selling price o) the goo&s or their replace$ent cost $a" in&icate such a loss o) utilit"0 This section explains ho' accountants han&le so$e o) these &epartures )ro$ the cost asis o) inventor" $easure$ent0 Co$panies shoul& not carr" goo&s in inventor" at $ore than their net reali5a le value0 !et reali4able 'alue is the esti$ate& selling price o) an ite$ less the esti$ate& costs that the co$pan" incurs in preparing the ite$ )or sale an& selling it0 <a$age&, o solete, or shop'orn goo&s o)ten have a net reali5a le value lo'er than their historical cost an& $ust e 'ritten &o'n to their net reali5a le value0 #o'ever, goo&s &o not have to e &a$age&, o solete, or shop'orn )or this situation to occur0 Technological changes an& increase& co$petition have cause& signi)icant re&uctions in selling prices )or such pro&ucts as co$puters, TGs, <G< pla"ers, an& &igital ca$eras0

p. +8D o) *++

To illustrate a necessar" 'rite-&o'n in the cost o) inventor", assu$e that an auto$o ile &ealer has a &e$onstrator on han&0 The &ealer ac4uire& the auto at a cost o) M,< 18,BBB0 The auto ha& an original selling price o) M,< 1>,DBB0 ,ince the &ealer use& the auto as a &e$onstrator an& the ne' $o&els are co$ing in, the auto no' has an esti$ate& selling price o) onl" M,< 18,1BB0 #o'ever, the &ealer can get the M,< 18,1BB onl" i) the &e$onstrator receives so$e sche&ule& $aintenance, inclu&ing a tune-up an& so$e paint &a$age repairs0 This 'or! an& the sales co$$ission cost M,< +BB0 The net reali5a le value o) the &e$onstrator, then, is M,< 1@,8BB (selling price o) M,< 18,1BB less costs o) M,< +BB)0 For inventor" purposes, the re4uire& 3ournal entr" is:
4oss :ue to t0e :ecline in *ar6et Halue o( .nventor2 #3SE% *erc0andise .nventor2 #3$% To ;rite do;n inventor2 to net realiEa5le value #$"9,000 3 $"7,900% 200 200

This entr" treats the M,< IBB inventor" &ecline as a loss in the perio& in 'hich the &ecline in utilit" occurre&0 ,uch an entr" is necessar" onl" 'hen the net reali5a le value is less than cost0 6) net reali5a le value &eclines ut still excee&s cost, the &ealer 'oul& continue to carr" the ite$ at cost0 The lower-o0-cost-or-market (LC8) met%o. is an inventor" costing $etho& that values inventor" at the lo'er o) its historical cost or its current $ar!et (replace$ent) cost0 The ter$ cost re)ers to historical cost o) inventor" as &eter$ine& un&er the speci)ic i&enti)ication, F6FO, A6FO, or 'eighte&-average inventor" $etho&0 (ar!et generall" re)ers to a $erchan&ise ite$Js replace$ent cost in the 4uantit" usuall" purchase&0 The asic assu$ption o) the AC( $etho& is that i) the purchase price o) an ite$ has )allen, its selling price also has )allen or 'ill )all0 The AC( $etho& has long een accepte& in accounting0 Mn&er AC(, inventor" ite$s are 'ritten &o'n to $ar!et value 'hen the $ar!et value is less than the cost o) the ite$s0 For exa$ple, assu$e that the $ar!et value o) the inventor" is M,< +>,DBB an& its cost is M,< *B,BBB0 Then, the co$pan" 'oul& recor& a M,< *BB loss ecause the inventor" has lost so$e o) its revenue-generating a ilit"0 The co$pan" $ust recogni5e the loss in the perio& the loss occurre&0 On the other han&, i) en&ing inventor" has a $ar!et value o) M,< *C,BBB an& a cost o) M,< *B,BBB, the co$pan" 'oul& not recogni5e this increase in value0 To &o so 'oul& recogni5e revenue e)ore the ti$e o) sale0 LC8 applie. A co$pan" $a" appl" AC( to each inventor" ite$ (such as (onopol"), each inventor" class (such as ga$es), or total inventor"0 To see ho' the co$pan" 'oul& appl" the $etho& to in&ivi&ual ite$s an& total inventor", loo! at %xhi it DI0

p. +8@ o) *++

6) AC( is applie& on an ite$- "-ite$ asis, en&ing inventor" 'oul& e M,< C,BBB0 The co$pan" 'oul& &e&uct the M,< C,BBB en&ing inventor" )ro$ cost o) goo&s availa le )or sale on the inco$e state$ent an& report this inventor" in the current assets section o) the alance sheet0 Mn&er the class $etho&, a co$pan" applies AC( to the total cost an& total $ar!et )or each class o) ite$s co$pare&0 One class $ight e ga$es? another $ight e to"s0 Then, the co$pan" values each class at the lo'er o) its cost or $ar!et a$ount0 6) AC( is applie& on a total inventor" asis, en&ing inventor" 'oul& e M,< C,1BB, since total cost o) M,< C,1BB is lo'er than total $ar!et o) M,< C,1CB0 An annual report o) <u Pont contains an actual exa$ple o) appl"ing AC(0 The report states that Ksu stantiall" all inventories are value& at cost as &eter$ine& " the last-in, )irst-out (A6FO) $etho&? in the aggregate, such valuations are not in excess o) $ar!etK0 The ter$ in the aggregate $eans that <u Pont applie& AC( to total inventor"0

#n accounting perspecti'e: Business insig%t
Procter P 2a$ le $ar!ets a roa& range o) laun&r", cleaning, paper, eaut" care, health care, )oo&, an& everage pro&ucts aroun& the 'orl&0 Procter P 2a$ leJs )ootnote in its /otes to Consoli&ate& Financial ,tate$ents in its annual report illustrates that co$panies o)ten &isclose AC( in their notes to )inancial state$ents0 1nventories are value at cost, '%ic% is not in excess o& current "arket price. 9ost is pri"arily eter"ine by eit%er t%e average cost or t%e &irst)in, &irst)out "et%o . T%e replace"ent cost o& last)in, &irst)out inventories excee s carrying value by approxi"ately E,F #8G <"illion=.
$CM on Item-&y-Item !a#%# $ @00 ",600 2,500 $5,000

Item " 2 3

Euant%ty "00 units 200 units 500 units

Un%t Co#t $"0 9 5

Un%t Mar'et $@'00 9 '7 5 5'00

Total Co#t $",000 ",600 2,500 $5,"00

Total Mar'et $ @00 " ,7 5 0 2,500 $5,"50

%xhi it DI: Application o) lo'er-o)-cost-or-$ar!et $etho&

p. +88 o) *++

* e r c 0 a n d i s e i n v e n t o r 2, 2 0 " 0 1anuar2 et cost o( purc0ases , o s t o ( ) o o d s a va i l a 5 l e ( o r s a l e 4ess esti!ated cost o( )oods sold: et sales Gross !ar)in #30D o( $700,000% Esti!ated cost o( )oods sold E s t i ! a t e d i n v e n t o r 2, 2 0 " 0 :ece!5er 3"

$ 40,000 490,000 $520,000 $700,000 2"0,000

4@0,000 $ 30,000

%xhi it D+: 6nventor" esti$ation using gross $argin $etho& A co$pan" using perio&ic inventor" proce&ure $a" esti$ate its inventor" )or an" o) the )ollo'ing reasons:
 To o tain an inventor" cost )or use in $onthl" or 4uarterl" )inancial state$ents 'ithout

ta!ing a ph"sical inventor"0 The e))ort o) ta!ing a ph"sical inventor" can e ver" expensive an& &isrupts nor$al usiness operations? once a "ear is o)ten enough0
 To co$pare 'ith ph"sical inventories to &eter$ine 'hether shortages exist0  To &eter$ine the a$ount recovera le )ro$ an insurance co$pan" 'hen )ire has &estro"e&

inventor" or the inventor" has een stolen0 /ext, 'e intro&uce t'o recogni5e& $etho&s o) esti$ating the cost o) en&ing inventor" 'hen a co$pan" has not ta!en a ph"sical inventor"Lthe gross $argin $etho& an& the retail inventor" $etho&0 9ross margin met%o. The steps in calculating en&ing inventor" un&er the gross $argin $etho& are:
 %sti$ate gross $argin ( ase& on net sales) using the sa$e gross $argin rate experience& in

prior accounting perio&s0
 <eter$ine esti$ate& cost o) goo&s sol& " &e&ucting esti$ate& gross $argin )ro$ net sales0  <eter$ine esti$ate& en&ing inventor" " &e&ucting esti$ate& cost o) goo&s sol& )ro$ cost o)

goo&s availa le )or sale0 Thus, the gross margin met%o. esti$ates en&ing inventor" " &e&ucting esti$ate& cost o) goo&s sol& )ro$ cost o) goo&s availa le )or sale0 The gross $argin $etho& assu$es that a )airl" sta le relationship exists et'een gross $argin an& net sales0 6n other 'or&s, gross $argin has een a )airl" constant percentage o) net sales, an& this relationship has continue& into the current perio&0 6) this percentage relationship has change&, the gross $argin $etho& &oes not "iel& satis)actor" results0

p. +8> o) *++

To illustrate the gross $argin $etho& o) co$puting inventor", assu$e that )or several "ears Fiel& Co$pan" has $aintaine& a +B per cent gross $argin on net sales0 The )ollo'ing &ata )or IB1B are availa le: The ;anuar" 1 inventor" 'as M,< *B,BBB? net cost o) purchases o) $erchan&ise 'as M,< *8B,BBB? an& net sales o) $erchan&ise 'ere M,< @BB,BBB0 As sho'n in %xhi it D+, Fiel& can esti$ate the inventor" )or IB1B <ece$ er +1, " &e&ucting the esti$ate& cost o) goo&s sol& )ro$ the actual cost o) goo&s availa le )or sale0 An alternative )or$at )or calculating esti$ate& en&ing inventor" uses the stan&ar& inco$e state$ent )or$at an& solves )or the one un!no'n (en&ing inventor"):
et sales 4ess cost o( )oods sold: *erc0andise inventor2, 20"0 1anuar2 " et cost o( purc0ases ,ost o( )oods availa5le (or sale 4ess esti!ated inventor2, 20"0 :ece!5er 3" Esti!ated cost o( )oods sold Esti!ated )ross !ar)in $700,000 $ 40,000 490,000 $520,000 #70D o( net sales #30D o( net sales%

4@0,000 $2"0,000

=e !no' that: Costs o) goo&s availa le )or sale− %n&ing inventor" = Cost o) goo&s sol& There)ore (let Z S %n&ing inventor"): M,< CIB,BBB - Z S M,< *>B,BBB Z S M,< +B,BBB The gross $argin $etho& is not precise enough to e use& )or "ear-en& )inancial state$ents0 At "ear-en&, a ph"sical inventor" $ust e ta!en an& value& " either the speci)ic i&enti)ication, F6FO, A6FO, or 'eighte&-average $etho&s0 :etail in'entory met%o. :etail stores )re4uentl" use the retail inventor" $etho& to esti$ate en&ing inventor" at ti$es other than "ear-en&0 Ta!ing a ph"sical inventor" &uring an accounting perio& (such as $onthl" or 4uarterl") is too ti$e consu$ing an& signi)icantl" inter)eres 'ith usiness operations0 The retail in'entory met%o. esti$ates the cost o) the en&ing inventor" " appl"ing a cost7retail price ratio to en&ing inventor" state& at retail prices0 The a&vantage o) this $etho& is that co$panies can esti$ate en&ing inventor" (at cost) 'ithout ta!ing a ph"sical inventor"0 Thus, the use o) this esti$ate per$its the preparation o) interi$ )inancial state$ents ($onthl" or 4uarterl") 'ithout

p. +>B o) *++

ta!ing a ph"sical inventor"0 The steps )or )in&ing the en&ing inventor" " the retail inventor" $etho& are:
 Total the eginning inventor" an& the net a$ount o) goo&s purchase& &uring the perio& at

oth cost an& retail prices0
 <ivi&e the cost o) goo&s availa le )or sale " the retail price o) the goo&s availa le )or sale to

)in& the cost7retail price ratio0
 <e&uct the retail sales )ro$ the retail price o) the goo&s availa le )or sale to &eter$ine en&ing

inventor" at retail0
 (ultipl" the cost7retail price ratio or percentage " the en&ing inventor" at retail prices to

re&uce it to the en&ing inventor" at cost0
*erc0andise inventor2, 20"0 1anuar2 " =urc0ases =urc0ase returns =urc0ase allo;ances Transportation3in Goods availa5le (or sale ,ostGretail price ratio: $204,000G$340,000?60D Sales Endin) inventor2 at retail prices Ti!es costGretail price ratio Endin) inventor2 at cost, 20"0 *arc0 3" Co#t $ 22,000 "92,000 #2,000% #3,000% 5,000 $204,000 Reta%l $ 40,000 303,000 #3,000% $340,000 290,000 $ 60,000 x 60D

$ 36,000

%xhi it D*: 6nventor" esti$ation 6n %xhi it D*, 'e sho' the retail inventor" $etho&0 6n the exhi it, the cost (M,< II,BBB) an& retail (M,< *B,BBB) a$ounts )or eginning inventor" are availa le )ro$ the prece&ing perio&Js co$putation0 The a$ounts )or the )irst 4uarter purchases, purchase returns, purchase allo'ances, an& transportation-in ca$e )ro$ the accounting recor&s0 The a$ounts )or purchase allo'ances an& transportation-in appear onl" in the cost colu$n0 The )irst 4uarter sales a$ount (M,< I8B,BBB) is )ro$ the ,ales account an& state& at retail (sales) prices0 The &i))erence et'een 'hat 'as availa le )or sale at retail prices an& 'hat 'as sol& at retail prices ('hich is sales) e4uals 'hat shoul& e on han& ((arch +1 inventor" o) M,< DB,BBB) expresse& in retail prices0 The retail price o) the (arch +1 inventor" nee&s to e converte& into cost )or use in the )inancial state$ents0 =e &o this " $ultipl"ing it ti$es the cost7retail price ratio0 6n the exa$ple, the cost7retail price ratio is DB per cent, 'hich $eans that on the average, DB cents o) each sales &ollar is cost o) goo&s sol&0 To )in& the IB1B (arch +1, inventor" at cost (M,< +D,BBB), 'e $ultiplie& the en&ing inventor" at retail (M,< DB,BBB) " DB per cent0

p. +>1 o) *++

Once the (arch +1 inventor" has een esti$ate& at cost (M,< +D,BBB), 'e &e&uct the cost o) the inventor" )ro$ cost o) goo&s availa le )or sale (M,< IB*,BBB) to &eter$ine cost o) goo&s sol& (M,< 1D8,BBB)0 =e can also )in& the cost o) goo&s sol& " $ultipl"ing the cost7retail price ratio o) DB per cent " sales o) M,< I8B,BBB0 For the next 4uarterl" perio&, the M,< +D,BBB an& M,< DB,BBB a$ounts 'oul& appear on the sche&ule as eginning inventor" at cost an& retail, respectivel"0 =e 'oul& inclu&e other 4uarterl" &ata regar&ing purchases, purchase returns, purchase allo'ances, an& transportation-in to &eter$ine goo&s availa le )or sale at cost an& at retail0 Fro$ these a$ounts, 'e coul& co$pute a ne' cost7retail price ratio )or the secon& 4uarter0 At the en& o) each "ear, $erchan&isers usuall" ta!e a ph"sical inventor" at retail prices0 ,ince the retail prices are on the in&ivi&ual ite$s ('hile the cost is not), ta!ing an inventor" at retail prices is $ore convenient than ta!ing an inventor" at cost0 Accountants can then co$pare the results o) the ph"sical inventor" to the calculation o) inventor" at retail un&er the retail inventor" $etho& )or the )ourth 4uarter to &eter$ine 'hether a shortage exists0 Both the gross $argin an& the retail inventor" $etho&s can help "ou &etect inventor" shortages0 To illustrate ho' "ou can &eter$ine inventor" shortages using the retail $etho&, assu$e that a ph"sical inventor" ta!en at "ear en&, sho'e& onl" M,< DI,BBB o) retail-price& goo&s in the store0 Assu$e that use o) the retail $etho& )or the )ourth 4uarter sho'e& that M,< DD,BBB o) goo&s shoul& e on han&, thus in&icating a M,< *,BBB inventor" shortage at retail0 A)ter converting the M,< *,BBB to M,< I,*BB o) cost (M,< *,BBB Z B0DB) "ou 'oul& report this as a KAoss )ro$ inventor" shortageK in the inco$e state$ent0 Nno'le&ge o) such shortages $a" lea& $anage$ent to re&uce or prevent the$, " increasing securit" or i$proving the training o) e$plo"ees0

p. +>I o) *++

#n et%ical perspecti'e: <orsey %ar.ware
Terr" <orse" starte& <orse" #ar&'are, a s$all har&'are store, t'o "ears ago an& has struggle& to $a!e it success)ul0 The )irst "ear o) operations resulte& in a su stantial loss? in the secon& "ear, there 'as a s$all net inco$e0 #is initial cash invest$ent 'as al$ost &eplete& ecause he ha& to 'ith&ra' $one" )or living expenses0 The current "ear o) operations loo!e& $uch etter0 #is custo$er ase 'as gro'ing an& see$e& to e lo"al0 To increase sales, ho'ever, Terr" ha& to invest his re$aining )un&s an& the procee&s o) a M,< *B,BBB an! loan into &ou ling the si5e o) his inventor" an& purchasing so$e ne' &ispla" shelves an& a ne' truc!0 At the en& o) the thir& "ear, Terr"Js accountant as!e& hi$ )or his en&ing inventor" )igure an& later tol& hi$ that initial esti$ates in&icate& that net inco$e (an& taxa le inco$e) )or the "ear 'oul& e approxi$atel" M,< 8B,BBB0 Terr" 'as &elighte& until he learne& that the )e&eral inco$e taxes on that inco$e 'oul& e a out M,< 1@,ICB0 #e tol& the accountant that he &i& not have enough cash to pa" the taxes an& coul& not even orro' it, since he alrea&" ha& an outstan&ing loan at the an!0 Terr" as!e& the accountant )or a cop" o) the inco$e state$ent )igures so he coul& see i) an" ite$s ha& een overloo!e& that $ight re&uce his net inco$e0 #e notice& that en&ing inventor" o) M,< 1DB,BBB ha& een &e&ucte& )ro$ cost o) goo&s availa le )or sale o) M,< D*B,BBB to arrive at cost o) goo&s sol& o) M,< *8B,BBB0 /et sales o) M,< @IB,BBB an& expenses o) M,< 1DB,BBB coul& not e change&0 But Terr" hit on a sche$e to re&uce his net inco$e0 The next &a" he tol& his accountant that he ha& $a&e an error in &eter$ining en&ing inventor" an& that its correct a$ount 'as M,< 1IB,BBB0 This lo'er inventor" a$ount 'oul& increase cost o) goo&s sol& " M,< *B,BBB an& re&uce net inco$e " that sa$e a$ount0 The resulting inco$e taxes 'oul& e a out M,< D,BBB, 'hich 'as 3ust a out 'hat Terr" ha& pai& in esti$ate& taxes0 To 3usti)" his action in his o'n $in&, Terr" use& the )ollo'ing argu$ents: (1) )e&eral taxes are too high, an& the )e&eral govern$ent see$s to e taxing the little gu" out o) existence? (I) no har$ is reall" &one ecause, 'hen the usiness eco$es $ore pro)ita le, 6 'ill use correct inventor" a$ounts, an& this loan )ro$ the govern$ent 'ill e pai& ac!? (+) since 6 a$ the onl" one 'ho !no's the correct en&ing inventor" 6 'ill not get caught? an& (*) 6 et a lot o) other people &o the sa$e thing0

p. +>+ o) *++

'.% Anal -ing and using financial results9inventor turnover ratio
An i$portant ratio )or $anagers, investors, an& cre&itors to consi&er 'hen anal"5ing a co$pan"Js inventor" is the inventor" turnover ratio0 This ratio tests 'hether a co$pan" is generating a su))icient volu$e o) usiness ase& on its inventor"0 To calculate the in'entory turno'er ratio: In+entory turno+er ratio = Cost of /oods sold A+era/e in+entory

6nventor" turnover $easures the e))icienc" o) the )ir$ in $anaging an& selling inventor": thus, it gauges the li4ui&it" o) the )ir$Js inventor"0 A high inventor" turnover is generall" a sign o) e))icient inventor" $anage$ent an& pro)it )or the )ir$? the )aster inventor" sells, the less ti$e )un&s are tie& up in inventor"0 A relativel" lo' turnover coul& e the result o) a co$pan" carr"ing too $uch inventor" or stoc!ing inventor" that is o solete, slo'-$oving, or in)erior0 6n assessing inventor" turnover, anal"sts also consi&er the t"pe o) in&ustr"0 =hen $a!ing co$parisons a$ong )ir$s, the" chec! the cost-)lo' assu$ption use& to value inventor" an& cost o) pro&ucts sol&0 A ercro$ ie P Fitch reporte& the )ollo'ing )inancial &ata )or IBBB (in thousan&s):
,ost o( )oods sold''''''' &e)innin) inventor2'''''' Endin) inventor2'''''''' $729,22@ 75,262 "20,@@7

Their inventor" turnover is: M,< @I8,II>78(M,< @C,IDI T M,< 1IB,>>@)7I9 S @0* ti$es .ou shoul& no' un&erstan& the i$portance o) ta!ing an accurate ph"sical inventor" an& !no'ing ho' to value this inventor"0 6n the next chapter, "ou 'ill learn the general principles o) internal control an& ho' to control cash0 Cash is one o) a co$pan"Js $ost i$portant an& $o ile assets0

'.' .nderstanding the learning objectives
 /et inco$e )or an accounting perio& &epen&s &irectl" on the valuation o) en&ing inventor"0  6) en&ing inventor" is overstate&, cost o) goo&s sol& is un&erstate&, resulting in an overstate$ent

o) gross $argin, net inco$e, an& retaine& earnings0

p. +>* o) *++

 =hen en&ing inventor" is $isstate& in the current "ear, co$panies carr" that $isstate$ent

)or'ar& into the next "ear0
 An error in the net inco$e o) one "ear cause&

" $isstate& en&ing inventor" auto$aticall"

causes an error in net inco$e in the opposite &irection in the next perio& ecause o) the $isstate& eginning inventor"0
 6nventor" cost inclu&es all necessar" outla"s to o tain the goo&s, get the goo&s rea&" to sell, an&

have the goo&s in the &esire& location )or sale to custo$ers0
 6nventor" cost inclu&es:

a0 ,ellerJs gross selling price less purchase &iscount0 0 Cost o) insurance on the goo&s 'hile in transit0 c0 Transportation charges 'hen orne " the u"er0 &0 #an&ling costs, such as the cost o) pressing clothes 'rin!le& &uring ship$ent0
 "peci0ic i.enti0ication: Attaches actual cost o) each unit o) pro&uct to units in en&ing

inventor" an& cost o) goo&s sol&0 ,peci)ic i&enti)ication creates precise $atching in &eter$ining net inco$e0
 F1F3 (0irst-in, 0irst-out): %n&ing inventor" consists o) the $ost recent purchases0 F6FO

assu$es that the costs o) the )irst goo&s purchase& are those charge& to cost o) goo&s sol& 'hen goo&s are sol&0 <uring perio&s o) rising prices, F6FO creates higher net inco$e since the costs charge& to cost o) goo&s sol& are lo'er0
 L1F3 (last-in, 0irst-out) : %n&ing inventor" consists o) the ol&est costs0 A6FO assu$es that the

costs o) the $ost recent purchases are the )irst costs charge& to cost o) goo&s sol&0 /et inco$e is usuall" lo'er un&er A6FO since the costs charge& to cost o) goo&s sol& are higher &ue to in)lation0 The en&ing inventor" $a" &i))er et'een perpetual an& perio&ic inventor" proce&ures0
 Eeig%te.-a'erage: %n&ing inventor" is price& using a 'eighte&-average unit cost0 Mn&er

perpetual inventor" proce&ure, a ne' 'eighte&-average is &eter$ine& a)ter each purchase0 Mn&er perio&ic proce&ure, the average is &eter$ine& at the en& o) the accounting perio& " &ivi&ing the total nu$ er o) units purchase& plus those in eginning inventor" into total cost o) goo&s availa le )or sale0 6n &eter$ining cost o) goo&s sol&, this average unit cost is applie& to each ite$0 Mn&er the 'eighte&-average $etho&, in a perio& o) rising prices net inco$e is usuall" higher than inco$e un&er A6FO an& lo'er than inco$e un&er F6FO0
 "peci0ic i.enti0ication: A&vantages: (1) ,tates cost o) goo&s sol& an& en&ing inventor" at the

actual cost o) speci)ic units sol& an& on han&, an& (I) provi&es the $ost precise $atching o) costs an& revenues0 <isa&vantage: 6nco$e $anipulation is possi le0 p. +>C o) *++

 F1F3: A&vantages: (1) F6FO is eas" to appl", (I) the assu$e& )lo' o) costs o)ten correspon&s

'ith the nor$al ph"sical )lo' o) goo&s, (+) no $anipulation o) inco$e is possi le, an& (*) the alance sheet a$ount )or inventor" is li!el" to approxi$ate the current $ar!et value0 <isa&vantages: (1) :ecogni5es paper pro)its, an& (I) tax ur&en is heavier i) use& )or tax purposes 'hen prices are rising0
 L1F3: A&vantages: (1) A6FO reports oth sales revenue an& cost o) goo&s sol& in current &ollars,

an& (I) lo'er inco$e taxes result i) use& )or tax purposes 'hen prices are rising0 <isa&vantages: (1) O)ten $atches the cost o) goo&s not sol& against revenues, (I) grossl" un&erstates inventor", an& (+) per$its inco$e $anipulation0
 Eeig%te.-a'erage: A&vantages: <ue to the averaging process, the e))ects o) "ear-en& u"ing

or not u"ing are lessene&0 <isa&vantage: (anipulation o) inco$e is possi le0
 Perpetual inventor" proce&ure re4uires an entr" to (erchan&ise 6nventor" 'henever goo&s are

purchase&, returne&, sol&, or other'ise a&3uste&, so that inventor" recor&s re)lect actual units on han& at all ti$es0 Thus, an entr" is re4uire& to recor& cost o) goo&s sol& )or each sale0
 Co$panies shoul& not carr" goo&s in inventor" at $ore than their net reali5a le value0 /et

reali5a le value is the esti$ate& selling price o) an ite$ less the esti$ate& costs incurre& in preparing the ite$ )or sale an& selling it0 6nventor" ite$s are 'ritten &o'n to $ar!et value 'hen the $ar!et value is less than the cost o) the ite$s0 6) $ar!et value is greater than cost, the increase in value is not recogni5e&0 AC( $a" e applie& to each inventor" ite$, each inventor" class, or total inventor"0
 The steps in calculating en&ing inventor" un&er the gross $argin $etho& are:

a0 %sti$ate gross $argin ( ase& on net sales) using the sa$e gross $argin rate experience& in prior accounting perio&s0 0 <eter$ine esti$ate& cost o) goo&s sol& " &e&ucting esti$ate& gross $argin )ro$ net sales0 c0 <eter$ine esti$ate& en&ing inventor" " &e&ucting esti$ate& cost o) goo&s sol& )ro$ cost o) goo&s availa le )or sale0
 The retail inventor" $etho& esti$ates the cost o) the en&ing inventor" " appl"ing a cost7retail

price ratio to en&ing inventor" state& at retail prices0 To )in& the cost7retail price ratio, &ivi&e the cost o) goo&s availa le )or sale " the retail price o) the goo&s availa le )or sale0 ( Cost o) goo&s sol&)  6nventor" turnover ration= ( Average inventor" )

p. +>D o) *++

 6nventor" turnover $easures the e))icienc" o) the )ir$ in $anaging an& selling inventor"0 6t

gauges the li4ui&it" o) the )ir$Js inventor"0

'.'.1 Demonstration problem
<emonstration problem # Follo'ing are &ata relate& to A&ler Co$pan"Js eginning inventor", purchases, an& sales:
!e+%nn%n+ In2entory and .urcha#e# Un%t# &e)innin) inventor2 6,250 *arc0 "5 5,000 *a2 "0 9,750 $u)ust "2 6,250 ove!5er 20 3,750 30,000 U U U U U Un%t Co#t $3'00 3'"2 3'30 3'49 3'72

Sale# /e5ruar2 3 *a2 4 Septe!5er "6 +cto5er @ Un%t# 5,250 4,500 9,000 7,250 25,000

a0 Co$pute the en&ing inventor" un&er each o) the )ollo'ing $etho&s: ,peci)ic i&enti)ication (assu$e en&ing inventor" is ta!en e4uall" )ro$ the August 1I an& /ove$ er IB purchases)0 F6FO: (a) Assu$e use o) perpetual inventor" proce&ure0 ( ) Assu$e use o) perio&ic inventor" proce&ure0 A6FO: (a) Assu$e use o) perpetual inventor" proce&ure0 ( ) Assu$e use o) perio&ic inventor" proce&ure0 =eighte&-average: (a) Assu$e use o) perpetual inventor" proce&ure0 ( ) Assu$e use o) perio&ic inventor" proce&ure0 (Carr" unit cost to )our &eci$al places an& roun& total cost to nearest &ollar0) 0 2ive the 3ournal entries to recor& the in&ivi&ual purchases an& sales (Cost o) 2oo&s ,ol& entr" onl") un&er the A6FO $etho& an& perpetual proce&ure0 <emonstration problem B a0 ;oel Co$pan" reporte& annual net inco$e as )ollo's: IBB@0000 M,< I@,IBB IBB80000 M,< I8,*BB IBB>0000 M,< I*,BBB Anal"sis o) the inventories sho's that certain clerical errors 'ere $a&e 'ith the )ollo'ing results:

p. +>@ o) *++

1ncorrect in'entory amount IBB@ <ece$ er +1 IBB8 <ece$ er +1 E*,8BB C,DBB

Correct in'entory amount EC,D8B *,D8B

=hat is the correcte& net inco$e )or IBB@, IBB8, an& IBB>Q 0 The recor&s o) Aittle Corporation sho' the )ollo'ing account alances on the &a" a )ire &estro"e& the co$pan"Js inventor": (erchan&ise inventor", ;anuar" 1 M,< *B,BBB /et cost o) purchases (to &ate) M,< IBB,BBB ,ales (to &ate) M,< +BB,BBB Average rate o) gross $argin )or the past )ive "ears +B per cent o) net sales0 Co$pute an esti$ate& value o) the en&ing inventor" using the gross $argin $etho&0 c0 The recor&s o) <raper Co$pan" sho' the )ollo'ing account alances at "ear-en&: Co#t Reta%l *erc0andise inventor2, 1anuar2 " '$"7,600 $25,000 =urc0ases 69,000 "00,000 Transportation3in ",@00 Sales "0",000 Co$pute the esti$ate& en&ing inventor" at cost using the retail inventor" $etho&0

'.'.2 6olution to demonstration problem
"olution to .emonstration problem # a0 The en&ing inventor" is C,BBB units, calculate& as )ollo's:
&e)innin) inventor2 =urc0ases Goods availa5le Sales Endin) inventor2 Un%t# 6,250 23,750 30,000 25,000 5,000

%n&ing inventor" un&er speci)ic i&enti)ication:
.urcha#ed ove!5er 20 $u)ust "2 Un%t# 2,500 2,500 Un%t Co#t $3'72 3'49 Total Co#t $ @,300 9,700 $ "9,000

p. +>8 o) *++

I0 %n&ing inventor" un&er F6FO: (a) Perpetual:
:ate .urcha#ed Un%t Total Un%t# Co#t Co#t $3'"2 $"5,600 ",000 3,500 9,750 6,250 3'30 29,975 3'49 2",750 ",500 6,500 2,250 5,000 3'"2 3'30 3'30 3'49 3'00 3'"2 Un%t# 5,250 Sold Un%t Co#t $3'00 Total Co#t Un%t# !alance Un%t $3'00 3'00 3'00 3'"2 3'"2 3'"2 3'30 3'"2 3'30 3'49 3'30 3'49 3'49 3'49 3'72 $"9,300 $"9,750 3,000 3,000 "5,600 4,690 4,690 29,975 4,690 29,975 2",750 7,425 2",750 4,350 4,350 "3,@50

&e)' inv' /e5' 3 *ar' "5 5,000 *a2 4 *a2 "0 $u)' "2 Sept' "6 +ct' @ ov' 20 3,750

3'72

"3,@50

Endin) inventor2 ? #",250 I $3'49%

6,250 $"5,750 ",000 ",000 5,000 3,000 ",500 "0,@20 ",500 9,750 ",500 9,750 6,250 4,690 2,250 2",450 6,250 7,425 ",250 "7,400 ",250 3,750 > #3,750 I $3'72% ?

( ) Perio&ic:
.urcha#ed ove!5er 20 $u)ust "2 J ote t0at t0e cost o( endin) inventor2 is t0e sa!e as under perpetual' Un%t# 3,750 ",250 5,000 Un%t Co#t $3'72 3'49 Total Co#t $ "3,@50 4,350 $ "9,300 J

p. +>> o) *++

+0 %n&ing inventor" un&er A6FO: (a) Perpetual:
:ate &e)' inv' /e5' 3 *ar' "5 *a2 4 *a2 "0 $u)' "2 9,750 6,250 3'30 3'49 29,975 2",750 5,000 $3'"2 $"5,600 4,500 3'"2 "4,040 5,250 $3'00 .urcha#ed Un%t# Un%t Co#t Total Co#t Un%t# Sold Un%t Co#t Total Co#t Un%t# 6,250 $"5,750 ",000 ",000 5,000 ",000 500 ",000 500 9,750 ",000 500 9,750 6,250 ",000 500 7,000 ",000 250 ",000 250 3,750 $3'72% ? !alance Un%t $3'00 3'00 3'00 3'"2 3'00 3'"2 3'00 3'"2 3'30 3'00 3'"2 3'30 3'49 3'00 3'"2 3'30 3'00 3'"2 3'00 3'"2 3'72 $"7,730 $"9,750 3,000 3,000 "5,600 3,000 ",560 3,000 ",560 29,975 3,000 ",560 29,975 2",750 3,000 ",560 23,"00 3,000 790 3,000 790 "3,@50

Sept' "6 +ct' @ ov' 20 3,750 3'72 #",00 0 "3,@50

6,250 ",750 7,000 250

3'49 3'30 3'30 3'"2

2",750 5,775 23,"00 790

Endin) inventor2 ?

I $3'00% > #250 I $3'"2% > #3,750 I

( ) Perio&ic:
Un%t *erc0andise .nventor2, 1anuar2 " Un%t# 5,000 Co#t $3'00 Total Co#t $ "5,000

p. *BB o) *++

*0 %n&ing inventor" un&er 'eighte&-average: (a) Perpetual:
:ate &e)' inv' /e5' 3 *ar' "5 *a2 4 *a2 "0 $u)' "2 Sept' "6 +ct' @ ov' 20 .urcha#ed Un%t Total Un%t# Co#t Co#t 5,000 $3'"2 $"5,600 4,500 9,750 6,250 3'30 29,975 3'49 2",750 9,000 7,250 3,750 3'72 "3,@50 3'35 3'35 26,900 24,299 3'"0 Un%t# 5,250 Sold Un%t Co#t $3'00 !alance Un%t Un%t# Co#t Total Co#t 6,250 $3'0000 $"9,750 $"5,750 ",000 3'0000 3,000 6,000 3'"000 "9,600 a Total Co#t "3,@50 ",500 "0,250 "6,500 9,500 ",250 5'000 3'"000 3'2707 5 3'3500 c 3'3500 3'3500 3'6274 d 4,650 33,525 55,275 29,475 J 4,"97 J "9,"37

Endin) inventor2 ? #5,000 I $3'6274% ? $"9,"37 a $"9,600 ? $3'"00 5 $33,525 ? $3'2707 c $55,275 ? $3'3500 d $"9,"37 ? $3'6274 6,000 "0,250 "6,500 5,000 J Roundin) di((erence'

( ) Perio&ic
=urc0ased * e r c 0 a n d i s e . n v e n t o r 2, 1 a n u a r 2 " *arc0 "5 -nits 6,250

-nit ,ost $3'00

Total

$

5,000 9 ,7 5 0 6,250 3 ,7 5 0 30,000

3'"2 3'30 3'49 3 '7 2 $

*a2 "0 $u)ust "2 ove!5er 20

Lei)0ted3avera)e unit cost ? $@9,@25G30,000 ? $3'2@75 Endin) inventor2 cost ? $3'2@75 x 5,000 ? $"6,499J JRoundin) di((erence

,ost " 9 ,7 5 0 "5,60 0 29,97 5 2 " ,7 5 0 "3,@5 0 @9,@2 5

p. *B1 o) *++

0 ;ournal entries un&er A6FO perpetual:
/e5' *ar' 3 "5 ,ost o( Goods Sold #3SE% *erc0andise .nventor2 #3$% To record cost o( $3 on 5,200 units sold *erc0andise .nventor2 #>$% $ccounts =a2a5le #>4% To record purc0ase o( 5,000 units at $3'"2 on $ccount' ,ost o( Goods Sold #3SE% *erc0andise .nventor2 #3$% To record cost o( $3'"2 on 4,500 units sold' *erc0andise .nventor2 #>$% $ccounts =a2a5le #>4% To record purc0ase o( 9,750 units at $3'30 on account' *erc0andise .nventor2 #>$% $ccounts =a2a5le #>4% To record purc0ase o( 6,250 units at $3'49 on account ,ost o( Goods Sold #3SE% *erc0andise .nventor2 #3$% To record costs o( $3'49 and $3'30 on 6,250 units at ",750 units sold, respectivel2' ,ost o( Goods Sold #3SE% *erc0andise .nventor2 #3$% To record costs o( $3'30 and $3'"2 on 7,000 units and 250 units sold, respectivel2' *erc0andise .nventor2 #>$% $ccounts =a2a5le #>4% To record purc0ase o( 3,750 units at $3'72 on account' 200A 29,400 #990% #@20% "5,750 "5,600 "5,750 "5,600

*a2

4 "0

"4,040 29,975

"4,040 29,975

$u)'

"2

2",750

2",750

Sept' "6

27,525

27,525

+ct'

@

23,990

23,990

ov'

20

"3,@50

"3,@50

"olution to .emonstration problem B a0 Correcte& net inco$e:
et inco!e as reported $d<ust!ents #"% #2% 200B $ 27,200 990 200C 24,000 Total $ 7@,600

#3% ,orrected net inco!e $ 29,090 26,600 (1) %n&ing inventor" un&erstate& (E C,D8B - E *,8BB S E 88B) (I) Beginning inventor" un&erstate& (C,D8B – *,8BB S 88B) %n&ing inventor" overstate& (C,DBB – *,D8B S >IB) (+) Beginning inventor" overstate& (C,DBB – *,D8B S >IB)

@20 24,@20

$ 7@,600

p. *BI o) *++

0 Co$putation o) inventor":
*erc0andise .nventor2, 1anuar2 " et cost o( purc0ases ,ost o( )oods availa5le (or sale 4ess esti!ated cost o( )oods sold: et Sales Gross !ar)in #$300,000 I 0'30% Esti!ated cost o( )oods sold .nventor2 at cost, esti!ated 52 )ross !ar)in !et0od' $ 300,000 @0,000 $ 40,000 200,000 $ 240,000

2"0,000 $ 30,000

c0 Co$putation o) inventor":
*erc0andise .nventor2, 1anuar2 " =urc0ases Transportation3in Goods availa5le (or sale $ ,ostGretail price ratio: $97,500G$"25,000 ? 70D Sales Endin) inventor2 at retail price Ti!es costGretail price ratio Endin) inventor2 at cost, :ece!5er 3"' Co#t $ "7,600 69,000 ",@00 $ 97,500 Reta%l $ 25,000 "00,000 M $ "25,000

"0",000 $24,000 I 70D $ "6,900

'.'.3 ;e terms
F1F3 (0irst-in, 0irst-out) A $etho& o) costing inventor" that assu$es the costs o) the )irst goo&s purchase& are those charge& to cost o) goo&s sol& 'hen the co$pan" actuall" sells goo&s0 9ross margin met%o. A proce&ure )or esti$ating inventor" cost in 'hich esti$ate& cost o) goo&s sol& (&eter$ine& using an esti$ate& gross $argin) is &e&ucte& )ro$ the cost o) goo&s availa le )or sale to &eter$ine esti$ate& en&ing inventor"0 The esti$ate& gross $argin is calculate& using gross $argin rates (in relation to net sales) o) prior perio&s0 1n'entory, or paper, pro0its %4ual to the current replace$ent cost to purchase a unit o) inventor" at ti$e o) sale $inus the unitJs historical cost0 1n'entory turno'er ratio Cost o) goo&s sol&7Average inventor"0 L1F3 (last-in, 0irst-out) A $etho& o) costing inventor" that assu$es the costs o) the $ost recent purchases are the )irst costs charge& to cost o) goo&s sol& 'hen the co$pan" actuall" sells the goo&s0 Lower-o0-cost-or-market (LC8) met%o. An inventor" costing $etho& that values inventor" at the lo'er o) its historical cost or its current $ar!et (replace$ent) cost0 8erc%an.ise in'entory The 4uantit" o) goo&s hel& " a $erchan&ising co$pan" )or resale to custo$ers0 !et reali4able 'alue %sti$ate& selling price o) an ite$ less the esti$ate& costs incurre& in preparing the ite$ )or sale an& selling it0 :etail in'entory met%o. A proce&ure )or esti$ating the cost o) the en&ing inventor" " appl"ing a cost7 retail price ratio to en&ing inventor" state& at retail prices0 p. *B+ o) *++

"peci0ic i.enti0ication met%o. An inventor" costing $etho& that attaches the actual cost to an i&enti)ia le unit o) pro&uct0 Eeig%te.-a'erage met%o. A $etho& o) costing en&ing inventor" using a 'eighte&-average unit cost0 Mn&er perpetual inventor" proce&ure, a ne' 'eighte&-average is calculate& a)ter each purchase0 Mn&er perio&ic proce&ure, the 'eighte&-average is &eter$ine& " &ivi&ing the total nu$ er o) units purchase& plus those in eginning inventor" into total cost o) goo&s availa le )or sale0 Mnits in the en&ing inventor" are carrie& at this per unit cost0

'.'.! 6elf<test '.'.!.1 True<false
6n&icate 'hether each o) the )ollo'ing state$ents is true or )alse0 (1) Overstate& en&ing inventor" results in an overstate$ent o) cost o) goo&s sol& an& an un&erstate$ent o) gross $argin an& net inco$e0 (I) 6n a perio& o) rising prices, F6FO results in the lo'est cost o) goo&s sol&0 (+) Mn&er AC(, inventor" is 'ritten &o'n to $ar!et value 'hen the $ar!et value is less than the cost, an& inventor" is 'ritten up to $ar!et value 'hen the $ar!et value is greater than the cost0 (*) Mn&er the gross $argin $etho&, an esti$ate $ust e $a&e o) gross $argin to &eter$ine esti$ate& cost o) goo&s sol& an& esti$ate& en&ing inventor"0 (C) To use the retail inventor" $etho&, oth cost an& retail prices $ust e !no'n )or the goo&s availa le )or sale0 (D) Mn&er perpetual proce&ure, cost o) goo&s sol& is &eter$ine& as a result o) the closing entries $a&e at the en& o) the perio&0

'.'.!.2 =ultiple<choice
,elect the est ans'er )or each o) the )ollo'ing 4uestions0 ;ac! Co$pan" egan the accounting perio& 'ith inventor" o) +,BBB units at M,< +B each0 <uring the perio&, the co$pan" purchase& an a&&itional C,BBB units at M,< +D each an& sol& *,DBB units0 Assu$e the use o) perio&ic inventor" proce&ure )or the )ollo'ing six 4uestions0 Cost o) en&ing inventor" using F6FO is: a0 M,< 1B*,*BB0 0 M,< 1II,*BB0 c0 M,< 1IB,BBB0 p. *B* o) *++

&0 M,< 1*@,DBB0 e0 /one o) the a ove0 Cost o) goo&s sol& using F6FO is: a0 M,< 1DC,DBB0 0 M,< 1CB,BBB0 c0 M,< 1*@,DBB0 &0 M,< 1II,*BB0 e0 /one o) the a ove0 Cost o) en&ing inventor" using A6FO is: a0 M,< 1B*,*BB0 0 M,< 11*,@CB0 c0 M,< 1CD,BBB0 &0 M,< 1II,*BB0 e0 /one o) the a ove0 Cost o) goo&s sol& using A6FO is: a0 M,< 1CC,ICB0 0 M,< 11*,BBB0 c0 M,< 1*@,DBB0 &0 M,< 1DC,DBB0 e0 /one o) the a ove0 Cost o) en&ing inventor" using 'eighte&-average is: a0 M,< 11*,@CB0 0 M,< 1C@,DBB0 c0 M,< 1II,*BB0 &0 M,< 1B>,DCB0 e0 /one o) the a ove0

p. *BC o) *++

Cost o) goo&s sol& using 'eighte&-average is: a0 M,< 1*@,IBB0 0 M,< 1DB,+CB0 c0 M,< 1CC,ICB0 &0 M,< 11*,BBB0 e0 /one o) the a ove0 <uring a perio& o) rising prices, 'hich inventor" $etho& $ight e expecte& to give the highest net inco$eQ a0 =eighte&-average0 0 F6FO0 c0 A6FO0 &0 ,peci)ic i&enti)ication0 e0 Cannot &eter$ine0 /o' turn to FAns'ers to sel)-testH at the en& o) the chapter to chec! "our ans'ers0

'.'.!.3 >uestions
 

=h" is proper inventor" valuation so i$portantQ =h" &oes an un&erstate& en&ing inventor" un&erstate net inco$e )or the perio& " the sa$e a$ountQ =h" &oes an error in en&ing inventor" a))ect t'o accounting perio&sQ =hat is the $eaning o) ta!ing a ph"sical inventor"Q =hat is the accountantJs responsi ilit" regar&ing ta!ing a ph"sical inventor"Q =hich cost ele$ents are inclu&e& in inventor"Q =hat practical pro le$s arise " inclu&ing the costs o) such ele$entsQ =hich accounts that are use& un&er perio&ic inventor" proce&ure are not use& un&er perpetual inventor" proce&ureQ =hat entries are necessar" un&er perpetual inventor" proce&ure 'hen goo&s are sol&Q =h" is there closer control over inventor" un&er perpetual inventor" proce&ure than un&er perio&ic inventor" proce&ureQ =h" is perpetual inventor" proce&ure eing use& increasingl" in usinessQ p. *BD o) *++

   



 





=hat is the cost )lo' assu$ptionQ =hat is $eant " the ph"sical )lo' o) goo&sQ <oes a relationship et'een cost )lo's an& the ph"sical )lo' o) goo&s exist, or shoul& such a relationship existQ



6n&icate ho' a co$pan" can $anipulate its net inco$e i) it uses A6FO0 6s the sa$e opportunit" availa le un&er F6FOQ =h" or 'h" notQ =hat are the $ain a&vantages o) using F6FO an& A6FOQ =hich inventor" $etho& is the correct oneQ Can a co$pan" change inventor" $etho&sQ =h" are en&ing inventor" an& cost o) goo&s sol& the sa$e un&er F6FO perpetual an& F6FO perio&icQ =oul& "ou agree 'ith the )ollo'ing state$entQ :e&ucing the a$ount o) taxes pa"a le currentl" is a vali& o 3ective o) usiness $anage$ent an&, since A6FO results in such a re&uction, all usinesses shoul& use A6FO0

  



 

=hat is net reali5a le value, an& ho' is it use&Q =h" is it accepta le accounting practice to recogni5e a loss " 'riting &o'n an ite$ in inventor" to $ar!et, ut unaccepta le to recogni5e a gain " 'riting up an inventor" ite$Q



Mn&er 'hat con&itions 'oul& the gross $argin $etho& o) co$puting an esti$ate& inventor" "iel& approxi$atel" correct a$ountsQ =hat are the $ain reasons )or esti$ating en&ing inventor"Q ,houl& a co$pan" rel" exclusivel" on the gross $argin $etho& to &eter$ine the en&ing inventor" an& cost o) goo&s sol& )or the en&-o)-"ear )inancial state$entsQ #o' can the retail $etho& e use& to esti$ate inventor"Q $%e Limite. Base& on the notes to the )inancial state$ents o) The Ai$ite& containe& in the Annual :eport Appen&ix, 'hat inventor" $etho&s 'ere use&Q

 

 

'.'.!.! E,ercises
-xercise # Croc!er Co$pan" reporte& annual net inco$e as )ollo's:
2009 200@ 20"0 $494,490 497,690 40@,@94

p. *B@ o) *++

Anal"sis o) its inventories reveale& the )ollo'ing incorrect inventor" a$ounts an& these correct a$ounts:
Incorrect In2entory Amount 2009 :ece!5er 3" 200@ :ece!5er 3" $ 76,900 96,400 Correct %n2entory amount $9@,600 77,600

Co$pute the annual net inco$e )or each o) the three "ears assu$ing the correct inventories ha& een use&0 -xercise B ,late Truc! Co$pan" $anu)actures truc!s an& i&enti)ies each truc! 'ith a uni4ue serial plate0 On <ece$ er +1, a custo$er or&ere& C truc!s )ro$ the co$pan", 'hich currentl" has IB truc!s in its inventor"0 Ten o) these truc!s cost M,< IB,BBB each, an& the other 1B cost M,< IC,BBB each0 6) ,late 'ishe& to $ini$i5e its net inco$e, 'hich truc!s 'oul& it shipQ B" ho' $uch coul& ,late re&uce net inco$e " selecting units )ro$ one group versus the other groupQ -xercise C (ia$i <iscount Co$pan" inventor" recor&s sho':
Un%t Co#t $39'00 3@'00 40'00 40'30 40'60 4"'00 Total Co#t $""4,000 35,"00 @6,000 72,540 73,090 24,600

&e)innin) inventor2 =urc0ases: /e5ruar2 "4 *arc0 "9 1ul2 2" Septe!5er 27 ove!5er 27 Sales: $pril "5 $u)ust 20 +cto5er 3

Un%t# 3,000 @00 2,400 ",900 ",900 600 2,900 2,000 ",500

The <ece$ er +1 inventor" 'as *,IBB units0 (ia$i <iscount Co$pan" uses perpetual inventor" proce&ure0 Present a sche&ule sho'ing the $easure$ent o) the en&ing inventor" using F6FO perpetual inventor" proce&ure0 -xercise < Msing the &ata in the previous exercise )or (ia$i <iscount Co$pan", present a sche&ule sho'ing the $easure$ent o) the en&ing inventor" using A6FO perpetual inventor" proce&ure0

p. *B8 o) *++

-xercise - Aon&on Co$pan" ha& a eginning inventor" o) 1DB units at M,< I* (total S M,< +,8*B) an& the )ollo'ing inventor" transactions &uring the "ear: ;anuar" 8, sol& *B units0 ;anuar" 11, purchase& 8B units at M,< +B0BB0 ;anuar" 1C, purchase& 8B units at M,< +I0BB0 ;anuar" II, sol& 8B units0 Msing the prece&ing in)or$ation, price the en&ing inventor" at its 'eighte&-average cost, assu$ing perpetual inventor" proce&ure0 -xercise F Nettle Co$pan" $a&e the )ollo'ing purchases o) Pro&uct A in its )irst "ear o) operations:
Un%t# 1anuar2 2 *arc0 3" 1ul2 5 ove!5er " ",400 ",200 2,400 ",900 U U U U Un%t Co#t $7'40 7'00 7'60 9'00

The en&ing inventor" that "ear consiste& o) I,*BB units0 Nettle uses perio&ic inventor" proce&ure0 a0 Co$pute the cost o) the en&ing inventor" using each o) the )ollo'ing $etho&s: (1) F6FO, (I) A6FO, an& (+) 'eighte&-average0 0 =hich $etho& 'oul& "iel& the highest a$ount o) gross $arginQ %xplain 'h" it &oes0 -xercise 9 The )ollo'ing are selecte& transactions an& other &ata o) the Custer Co$pan": Purchase& IB units at M,< +DB per unit on account on IB1B ,epte$ er 180 ,ol& D units on account )or M,< C@D per unit on IB1B ,epte$ er IB0 <iscovere& a shortage o) M,< I,D*B at "ear-en& a)ter a ph"sical inventor"0 Prepare 3ournal entries )or these transactions using F6FO perpetual inventor" proce&ure0 Assu$e the eginning inventor" consists o) IB units at M,< ++D per unit0 -xercise = Follo'ing are selecte& transactions o) 2a$ le Co$pan": Purchase& 1BB units o) $erchan&ise at M,< I*B each? ter$s I71B, n7+B0 Pai& the invoice in transaction 1 'ithin the &iscount perio&0 ,ol& 8B units at M,< +8* each )or cash0 Purchase& 1BB units at M,< +DB? ter$s I71B, n7+B0

p. *B> o) *++

Pai& the invoice in transaction * 'ithin the &iscount perio&0 ,ol& DB units at M,< CCI each )or cash0 Prepare 3ournal entries )or the six prece&ing ite$s0 Assu$e 2a$ le uses F6FO perpetual inventor" proce&ure0 -xercise 1 =ells Co$pan" ha& the )ollo'ing transactions &uring Fe ruar": Purchase& 1+C units at M,< DC on account0 ,ol& 1B8 units at M,< >B on account0 Purchase& 1@B units at M,< @C on account0 ,ol& 1II units at M,< >C on account0 ,ol& D@ units at M,< 1BB on account0 The eginning inventor" consiste& o) D@ units purchase& at a cost o) M,< CC0 Prepare the 3ournal entries relating to inventor" )or these )ive transactions, assu$ing =ells accounts )or inventor" using perpetual inventor" proce&ure an& the A6FO inventor" $etho&0 <o not recor& the entries )or sales0 -xercise > Follo'ing are inventor" &ata )or Nintech Co$pan": ;anuar" 1 inventor" on han&, *BB units at M,< I808B0 ;anuar" sales 'ere 8B units0 Fe ruar" sales totale& 1IB units0 (arch 1, purchase& IBB units at M,< +B0I*0 ,ales )or (arch through August 'ere 1DB units0 ,epte$ er 1, purchase& *B units at M,< ++01I0 ,epte$ er through <ece$ er sales 'ere 18B units0 -xercise ? A co$pan" purchase& 1,BBB units o) a pro&uct at M,< 1I0BB an& I,BBB units at M,< 1+0IB0 6t sol& all o) these units at M,< 180BB each at a ti$e 'hen the current cost to replace the units sol& 'as M,< 1+08B0 Co$pute the a$ount o) gross $argin un&er F6FO that A6FO supporters 'oul& call inventor", or paper, pro)its0 -xercise L Cla"ton Co$pan"Js inventor" 'as 1I,BBB units 'ith a cost o) M,< 1DB each on IB1B ;anuar" 10 <uring IB1B, nu$erous units 'ere purchase& an& sol&0 Also &uring IB1B, the purchase price o) this pro&uct )ell stea&il" until at "ear-en& it 'as M,< 1IB0 The inventor" at "ear-en& 'as

p. *1B o) *++

18,BBB units0 ,tate 'hich $etho& o) inventor" $easure$ent, A6FO or F6FO, 'oul& have resulte& in higher reporte& net inco$e, an& explain rie)l"0 -xercise 8 Aevi (otor Co$pan" o'ns a luxur" auto$o ile that it has use& as a &e$onstrator )or eight $onths0 The auto has a list or stic!er price o) M,< 8C,BBB an& cost Aevi M,< @C,BBB0 At the en& o) the )iscal "ear, the auto is on han& an& has an expecte& selling price o) M,< 8B,BBB0 Costs expecte& to e incurre& to sell the auto inclu&e tune-up an& $aintenance costs o) M,< +,BBB, a&vertising o) M,< 1,BBB, an& a co$$ission o) C per cent o) the selling price to the e$plo"ee selling the auto0 Co$pute the a$ount at 'hich the auto shoul& e carrie& in inventor"0 -xercise ! Pure ,oun& ,"ste$s use& one soun& s"ste$ as a )loor $o&el0 6t cost M,< +,DBB an& ha& an original selling price o) M,< *,8BB0 A)ter six $onths, the soun& s"ste$ 'as &a$age& an& replace& " a ne'er $o&el0 The soun& s"ste$ ha& an esti$ate& selling price o) M,< I,88B, ut 'hen the co$pan" per)or$e& M,< *8B in repairs, it coul& e sol& )or M,< +,8*B0 Prepare the 3ournal entr", i) an", that $ust e $a&e on Pure ,oun&Js oo!s to recor& the &ecline in $ar!et value0 -xercise 3 .our assistant has co$pile& the )ollo'ing &ata:
Euant%ty 4un%t#5 300 300 @00 500 Un%t Co#t $ 57'60 29'90 2"'60 "2'00 Un%t Mar'et $ 55'20 33'60 2"'60 "3'20 Total Co#t $"7,290 9,640 "@,440 6,000 Total Mar'et $"6,560 "0,090 "@,440 6,600

Item $ & , :

Calculate the &ollar a$ount o) the en&ing inventor" using the AC( $etho&, applie& on an ite$- "ite$ asis, an& the a$ount o) the &ecline )ro$ cost to lo'er-o)-cost-or-$ar!et0 -xercise & Mse the &ata in the previous exercise to co$pute the cost o) the en&ing inventor" using the AC( $etho& applie& to the total inventor"0 -xercise H Tille"-(ill Co$pan" ta!es a ph"sical inventor" at the en& o) each calen&ar-"ear accounting perio& to esta lish the en&ing inventor" a$ount )or )inancial state$ent purposes0 6ts )inancial state$ents )or the past )e' "ears in&icate an average gross $argin on net sales o) IC per cent0 On ;ul" 18, a )ire &estro"e& the entire store uil&ing an& its contents0 The recor&s in a )ireproo) vault 'ere intact0 Through ;ul" 1@, these recor&s sho':

p. *11 o) *++

(erchan&ise inventor", ;anuar" 1 M,< D@I,BBB (erchan&ise purchases M,< >,*B8,BBB Purchase returns M,< 1+*,*BB Transportation-in M,< CB*,BBB ,ales M,< 1*,++D,BBB ,ales returns M,< D@I,BBB The co$pan" 'as )ull" covere& " insurance an& as!s "ou to &eter$ine the a$ount o) its clai$ )or loss o) $erchan&ise0 -xercise : :"an Co$pan" ta!es a ph"sical inventor" at the en& o) each calen&ar-"ear accounting perio&0 6ts )inancial state$ents )or the past )e' "ears in&icate an average gross $argin on net sales o) +B per cent0 On ;une 1I, a )ire &estro"e& the entire store uil&ing an& the inventor"0 The recor&s in a )ireproo) vault 'ere intact0 Through ;une 11, these recor&s sho':
*erc0andise inventor2, 1anuar2 " *erc0andise purc0ases =urc0ase returns Transportation 3in Sales $"20,000 $3,000,000 $36,000 $204,000 $3,720,000

The co$pan" 'as )ull" covere& " insurance an& as!s "ou to &eter$ine the a$ount o) its clai$ )or loss o) $erchan&ise0 -xercise " Gictoria Falls Co$pan", 6nc0, recor&s sho' the )ollo'ing account alances )or the "ear en&ing IB1B <ece$ er +1:
Co#t &e)innin) inventor2 =urc0ases Transportation3in Sales -S: 42,000 25000 500 52500 Reta%l -S: 57,500 37500

Msing these &ata, co$pute the esti$ate& cost o) en&ing inventor" using the retail $etho& o) inventor" valuation0

p. *1I o) *++

'.'.!.# 1roblems
&roblem # Nelle" Co$pan" reporte& net inco$e o) M,< +C8,BCB )or IBB>, M,< +@1,*BB )or IB1B, an& M,< +IC,8BB )or IB11, using the incorrect inventor" a$ounts sho'n )or IBB> <ece$ er +1, an& IB1B0 :ecentl", Nelle" correcte& the inventor" a$ounts )or those &ates0 Nelle" use& the correct IB11 <ece$ er +1, inventor" a$ount in calculating IB11 net inco$e0
Incorrect 200@ :ece!5er 3" 20"0 :ece!5er 3" -S: 72,600 94000 Correct -S: 96,200 70200

Prepare a sche&ule that sho's: (a) the reporte& net inco$e )or each "ear, ( ) the a$ount o) correction nee&e& )or each "ear, an& (c) the correct net inco$e )or each "ear0 &roblem B An exa$ination o) the )inancial recor&s o) Aanal Co$pan" on IBB> <ece$ er +1, &isclose& the )ollo'ing 'ith regar& to $erchan&ise inventor" )or IBB> an& prior "ears: IBBC <ece$ er +1, inventor" 'as correct0 IBBD <ece$ er +1, inventor" 'as overstate& M,< IBB,BBB0 IBB@ <ece$ er +1, inventor" 'as overstate& M,< 1BB,BBB0 IB81 <ece$ er +1, inventor" 'as un&erstate& M,< IIB,BBB0 IBB> <ece$ er +1, inventor" 'as correct0 The reporte& net inco$e )or each "ear 'as:
2006 2007 2009 200@ $394,000 544,000 670,000 946,000

a0 Prepare a sche&ule o) correcte& net inco$e )or each o) the )our "ears, IBBD-IBB>0 0 =hat error(s) 'oul& have een inclu&e& in each <ece$ er +1 alance sheetQ Assu$e each "earJs error is in&epen&ent o) the other "earsJ errors0 c0 Co$$ent on the i$plications o) "our correcte& net inco$e as contraste& 'ith reporte& net inco$e0 &roblem C Brett Co$pan" sells personal co$puters an& uses the speci)ic i&enti)ication $etho& to account )or its inventor"0 On IB1B /ove$ er +B, the co$pan" ha& *D Orange 666 personal co$puters on han& that 'ere ac4uire& on the )ollo'ing &ates an& at these state& costs:

p. *1+ o) *++

1ul2 3 Septe!5er "0 ove!5er 2@

Un%t# "0 U 20 U "6 U

Un%t co#t $"0,090 $ @,600 $"0,700

Brett sol& +D Orange 666 co$puters at M,< 1I,@IB each in <ece$ er0 There 'ere no purchases o) this $o&el in <ece$ er0 a0 Co$pute the gross $argin on <ece$ er sales o) Orange 666 co$puters assu$ing the co$pan" shippe& those units that 'oul& $axi$i5e reporte& gross $argin0 0 :epeat part (a) assu$ing the co$pan" shippe& those units that 'oul& $ini$i5e reporte& gross $argin )or <ece$ er0 c0 6n vie' o) "our ans'ers to parts (a) an& ( ), 'hat 'oul& e "our reaction to an assertion that the speci)ic i&enti)ication $etho& shoul& not e consi&ere& an accepta le $etho& )or costing inventor"Q &roblem < The inventor" recor&s o) Thi$ le Co$pan" sho' the )ollo'ing: (arch 1 Beginning inventor" consists o) 1B units costing M,< *B per unit0 + ,ol& C units at M,< >* per unit0 1B Purchase& 1D units at M,< *8 per unit0 1I ,ol& 8 units at M,< >D per unit0 IB ,ol& @ units at M,< >D per unit0 IC Purchase& 1D units at M,< CB per unit0 +1 ,ol& 8 units at M,< >D per unit0 Assu$e all purchases an& sales are $a&e on cre&it0 Msing F6FO perpetual inventor" proce&ure, prepare the appropriate 3ournal entries )or (arch0 &roblem - The )ollo'ing purchases an& sales )or :ipple Co$pan" are )or April IB1B0 There 'as no inventor" on April 10
.urcha#e# $pril $pril $pril $pril 3 "0 22 29 Un%t# 3,200 ",600 2,000 ",900 U U U U Un%t Co#t $33'00 34'00 35'00 36'00 Sale# $pril 6 $pril "2 $pril 25 Un%t# ",500 ",400 2,300

p. *1* o) *++

a0 Co$pute the en&ing inventor" as o) IB1B April +B, using perpetual inventor" proce&ure, un&er each o) the )ollo'ing $etho&s: (1) F6FO, (I) A6FO, an& (+) 'eighte&-average (carr" unit cost to )our &eci$al places an& roun& total cost to nearest &ollar)0 0 :epeat a using perio&ic inventor" proce&ure0 &roblem F :e)er to the &ata in pro le$ % a0 Msing A6FO perpetual inventor" proce&ure, prepare the 3ournal entries )or the purchases an& sales (Cost o) 2oo&s ,ol& entr" onl")0 0 :epeat (a) using A6FO perio&ic inventor" proce&ure, inclu&ing closing entries0 (/ote: .ou $a" 'ant to re)er to the Appen&ix in Chapter D )or this part0) &roblem 9 The )ollo'ing &ata relate to the eginning inventor", purchases, an& sales o) Braxton Co$pan" )or the "ear IB1B:
*erc0andise .nventor2, 1anuar2 " =urc0ases: /e5ruar2 2 $pril 5 1une "5 Septe!5er 30 ove!5er 29 Sales: *arc0 "0 *a2 "5 1ul2 6 $u)ust 23 :ece!5er 22 Un%t# ",400 ",000 2,000 ",200 ",400 ",900 @00 ",900 900 600 2,500 Un%t Co#t U $5'04 U U U U U 4'90 3'60 3'00 2'99 4'20

a0 Assu$ing use o) perpetual inventor" proce&ure, co$pute the en&ing inventor" an& cost o) goo&s sol& un&er each o) the )ollo'ing $etho&s: (1) F6FO, (I) A6FO, an& (+) 'eighte&-average (carr" unit cost to )our &eci$al places an& roun& total cost to nearest &ollar)0 0 :epeat (a) assu$ing use o) perio&ic inventor" proce&ure0 &roblem = =elch Co$pan" accounts )or a pro&uct it sells using A6FO perio&ic inventor" proce&ure0 Pro&uct &ata )or the "ear en&e& IBB> <ece$ er +1, are sho'n inventor" on ;anuar" 1 'as +,BBB units at M,< 1*0*B each0 elo'0 (erchan&ise

p. *1C o) *++

.urcha#e# 1anuar2 5 *arc0 3" $u)ust "2 :ece!5er 26 Un%t# 6,000 "9,000 "2,000 6,000 U U U U Un%t Co#t $"9'00 2"'60 27'00 29'90 1anuar2 "0 $pril 2 $u)ust 22 :ece!5er 24

Sale# Un%t# 4,000 "5,000 "6,000 3,000 U U U U Un%t Co #t $29'90 32'40 36'00 3@'60

a0 Co$pute the gross $argin earne& on sales o) this pro&uct )or IBB>0 0 :epeat part (a) assu$ing that the <ece$ er ID purchase 'as $a&e in ;anuar" IB1B0 c0 :eco$pute the gross $argin assu$ing that 1B,BBB rather than D,BBB units 'ere purchase& on <ece$ er ID at the sa$e cost per unit0 &0 ,olve parts (a), ( ), an& (c) using the F6FO $etho&0 &roblem 1 The accountant )or 2entr" Co$pan" prepare& the )ollo'ing sche&ule o) the co$pan"Js inventor" at IBB> <ece$ er +1, an& use& the AC( $etho& applie& to total inventor" in &eter$ining cost o) goo&s sol&:
Item S R S T Euant%ty 4,200 2,400 5,400 4,900 Un%t Co#t $7'20 6'00 4'90 4'20 Un%t Mar'et $7'20 5'76 4'56 4'32

a0 ,tate 'hether this approach is an accepta le $etho& o) inventor" $easure$ent an& sho' the calculations use& to &eter$ine the a$ounts0 0 Co$pute the a$ount o) the en&ing inventor" using the AC( $etho& on an ite$- "-ite$ asis0 c0 ,tate the e))ect on net inco$e in IBB> i) the $etho& in ( ) 'as use& rather than the $etho& re)erre& to in (a)0 &roblem > As part o) a loan agree$ent 'ith a local an!, Bra5os Co$pan" $ust present 4uarterl" an& cu$ulative inco$e state$ents )or the "ear IBB>0 The co$pan" uses perio&ic inventor" proce&ure an& $ar!s its $erchan&ise to sell at a price "iel&ing a gross $argin o) +B per cent0 ,electe& &ata )or the )irst six $onths o) IBB> are as )ollo's:
F%r#t Euarter $249,000 "60,000 @,600 3,200 9,000 9,000 25,600 @,600 Second Euarter $256,000 "94,000 "",200 3,520 4,900 9,320 24,000 9,000

Sales =urc0ases =urc0ase returns and allo;ances =urc0ase discounts Sales returns and allo;ances Transportation3in *iscellaneous sellin) expenses *iscellaneous ad!inistrative expenses

p. *1D o) *++

The cost o) the ph"sical inventor" ta!en IBB8 <ece$ er +1, 'as M,< +B,*BB0 a0 6n&icate ho' inco$e state$ents can e prepare& 'ithout ta!ing a ph"sical inventor" at the en& o) each o) the )irst t'o 4uarters o) IBB>0 0 Prepare inco$e state$ents )or the )irst 4uarter, the secon& 4uarter, an& the )irst six $onths o) IBB>0 Co Co$pan" recor&s sho' the )ollo'ing in)or$ation )or IB1B:
Co#t Sales =urc0ases Transportation3in *erc0andise inventor2, 1anuar2 " =urc0ase returns $2G0,000 26,290 "2,000 "5,"20 Reta%l $350,400 420,000 M "G,400 "9,600

Co$pute the esti$ate& "ear-en& inventor" alance at cost using the retail $etho& o) esti$ating inventor"0

'.'.!.$ Alternate problems
#lternate problem # #arris Co$pan" reporte& net inco$e o) M,< +1I,BBB )or IBB>, M,< +I*,BBB )or IB1B, an& M,< +*8,BBB :ecentl" #arris correcte& these inventor" a$ounts0 #arris use& the correct IB11 <ece$ er +1, inventor" a$ount in calculating IB11 net inco$e0
200@ :ece!5er 3" 20"0 :ece!5er 3" $@6,000 @",200 $"09,000 94,000

Prepare a sche&ule that sho's: (a) the reporte& net inco$e )or each "ear, ( ) the a$ount o) correction nee&e& )or each "ear, an& (c) the correct net inco$e )or each "ear0 #lternate problem B An exa$ination o) the )inancial recor&s o) ;erse" Co$pan" on IBB> <ece$ er +1, &isclose& the )ollo'ing 'ith regar& to $erchan&ise inventor" )or IBB> an& prior "ears: IBB8 <ece$ er +1, inventor" 'as correct0 IBB> <ece$ er +1, inventor" 'as un&erstate& M,< CB,BBB0 IB1B <ece$ er +1, inventor" 'as overstate& M,< +C,BBB0 IB11 <ece$ er +1, inventor" 'as un&erstate& M,< +B,BBB0 IB1I <ece$ er +1, inventor" 'as correct0 The reporte& net inco$e )or each "ear 'as: p. *1@ o) *++

200@ 20"0 20"" 20"2

$2@2,500 $355,000 $392,500 $350,000

a0 Prepare a sche&ule o) correcte& net inco$e )or each o) the )our "ears, IBB>-IB1I0 0 =hat errors 'oul& have een inclu&e& in each <ece$ er +1 alance sheetQ Assu$e each "earJs error is in&epen&ent o) the other "earsJ errors0 c0 Co$$ent on the i$plications o) the correcte& net inco$e as contraste& 'ith reporte& net inco$e0 #lternate problem C #igh ,ur) Co$pan" sells the Mltra-Aight $o&el 'in& sur)er an& uses the speci)ic i&enti)ication $etho& to account )or its inventor"0 The Mltra-Aights are i&entical except )or i&enti)"ing serial nu$ ers0 On IBB> August 1, the co$pan" ha& three Mltra-Aights that cost M,< 1*,BBB each in its inventor"0 <uring the $onth, the co$pan" purchase& the )ollo'ing:
Un%t# 5 6 6 Un%t co#t $"3,000 $"4,500 "5,000

$u)ust 3 $u)ust "7 $u)ust 29

U U U

#igh ,ur) Co$pan" sol& 1+ Mltra-Aights in August at M,< IB,BBB each0 a0 Co$pute the gross $argin earne& " the co$pan" in August i) it shippe& the units that 'oul& $axi$i5e gross $argin0 0 :epeat part (a) assu$ing the co$pan" shippe& the units that 'oul& $ini$i5e gross $argin0 c0 <o "ou thin! #igh ,ur) Co$pan" shoul& e per$itte& to use the speci)ic i&enti)ication $etho& o) accounting )or Mltra-Aights in vie' o) the $anipulation possi le as sho'n " "our calculations in (a) an& ( )Q #lternate problem < The inventor" recor&s o) Coral Co$pan" sho' the )ollo'ing: ;an0 1 Beginning inventor" consists o) 1I units costing M,< *8 per unit0 C Purchase& 1C units ] M,< *>0>I per unit0 1B ,ol& > units ] M,< 1B8 per unit0 1I ,ol& @ units ] M,<1B8 per unit0 IB Purchase& IB units ] M,< CB01D per unit0 II Purchase& C units ] M,< *8 per unit0

p. *18 o) *++

+B ,ol& IB units ] M,< 11B0*B per unit0 Assu$e all purchases an& sales are $a&e on account0 a0 Msing F6FO perpetual inventor" proce&ure, co$pute cost o) goo&s sol& )or ;anuar"0 0 Msing F6FO perpetual inventor" proce&ure, prepare the 3ournal entries )or ;anuar"0 c0 Co$pute the cost o) goo&s sol& un&er F6FO perio&ic inventor" proce&ure0 6s there a &i))erence et'een the a$ount co$pute& using the t'o &i))erent proce&uresQ #lternate problem - Follo'ing are &ata )or <an&" Co$pan" )or the "ear IB1B:
Un%t# Un%t Co#t $20'4 0

* e r c 0 a n d i s e . n v e n t o r 2, 1anuar2 " =urc0ases: /e 5 r u a r 2 2 $pril 5 1une " 5 Septe!5er 30 ove!5er 29 Sales: *arc0 5 1ul2 "9 $u)ust "2 +cto5er "5

700 500 ",000 600 700 @00 4,400 400 ",200 900 @00 3,300

U U U U U U

2"'00 24'00 2G'00 30'00 3"'20

a0 Co$pute the en&ing inventor" as o) IB1B <ece$ er +1, assu$ing use o) perpetual inventor" proce&ure, un&er each o) the )ollo'ing $etho&s: (1) F6FO, (I) A6FO, an& (+) 'eighte&-average (carr" unit cost to )our &eci$al places an& roun& total cost to nearest &ollar)0 0 Co$pute the en&ing inventor" as o) IB1B <ece$ er +1, assu$ing use o) perio&ic inventor" proce&ure, un&er each o) the )ollo'ing $etho&s: (1) F6FO, (I) A6FO, an& (+) 'eighte&-average0 #lternate problem F :e)er to the &ata in alternate pro le$ % a0 2ive the 3ournal entries to recor& the purchases an& sales (Cost o) 2oo&s ,ol& entr" onl") )or the "ear un&er F6FO perpetual0 0 2ive the 3ournal entries to recor& the purchases )or the "ear an& necessar" "ear-en& entries to charge 6nco$e ,u$$ar" 'ith the cost o) goo&s sol& )or the "ear un&er F6FO perio&ic0 (/ote: .ou $a" 'ant to re)er to the Appen&ix in Chapter D )or this part0) #lternate problem 9 Follo'ing are &ata relate& to a pro&uct o) Coen Co$pan" )or the "ear IB1B:

p. *1> o) *++

*erc0andise .nventor2, 1anuar2 " =urc0ases: *arc0 "0 *a2 24 1ul2 "5 Septe!5er 20 :ece!5er " Sales: $pril 5 1une "3 +cto5er @ ove!5er 2"

Un%t# 2,"00 ",500 3,000 ",900 2,"00 2,700 ",400 2,@00 2,300 ",700

Un%t Co#t U $"2'60 U U U U U "2'00 ""'20 "0'50 @'00 "0'00

a0 Assu$ing use o) perpetual inventor" proce&ure, co$pute the en&ing inventor" an& cost o) goo&s sol& un&er each o) the )ollo'ing $etho&s: (1) F6FO, (I) A6FO, an& (+) 'eighte&-average (carr" unit cost to )our &eci$al places an& roun& total cost to nearest &ollar)0 0 Assu$ing use o) perio&ic inventor" proce&ure, co$pute the en&ing inventor" an& cost o) goo&s sol& un&er each o) the )ollo'ing $etho&s: (1) F6FO, (I), A6FO, an& (+) 'eighte&-average (carr" unit cost to )our &eci$al places an& roun& total cost to nearest &ollar)0 #lternate problem = ,tar Co$pan" accounts )or its inventor" using the A6FO $etho& un&er perio&ic inventor" proce&ure0 <ata on purchases, sales, an& inventor" )or the "ear en&e& IBB> <ece$ er +1, are:
Un%t# *erc0andise inventor2, 1anuar2 " =urc0ases: 1anuar2 G 1ul2 7 :ece!5er 2" 2,000 5,000 "0,000 6,000 U U U U Un%t Co#t $20 24 29 32

<uring IBB>, 1D,BBB units 'ere sol& )or M,< 1,I8B,BBB, leaving an inventor" on IBB> <ece$ er +1, o) @,BBB units0 a0 Co$pute the gross $argin earne& on sales &uring IBB>0 0 Co$pute the change in gross $argin that 'oul& have resulte& i) the purchase o) <ece$ er I1 ha& een &ela"e& until IB1B ;anuar" D0 c0 :eco$pute the gross $argin assu$ing that >,BBB units rather than D,BBB units 'ere purchase& on <ece$ er I1 at the sa$e cost per unit0 &0 ,olve parts (a), ( ), an& (c) using the F6FO $etho&0

p. *IB o) *++

#lternate problem 1 <ata on the en&ing inventor" o) ;annis Co$pan" on IBB> <ece$ er +1, are:
Item " 2 3 4 5 6 Euant%ty 9,400 "6,900 5,600 "4,000 "",200 2,900 Un%t Co#t $3'20 2'99 2'90 3'94 3'60 3'04 Un%t Mar'et $3'"2 3'04 2'99 3'60 3'69 2'99

a0 Co$pute the en&ing inventor" appl"ing the AC( $etho& to the total inventor"0 0 <eter$ine the en&ing inventor" " appl"ing the AC( $etho& on an ite$- "-ite$ asis0 #lternate problem > The sales an& cost o) goo&s sol& )or Aivel" Co$pan" )or the past )ive "ears 'ere as )ollo's:
@ear 2004 2005 2006 2007 2009 Sale# 4net5 $ @,@94,@60 "0,7@4,240 "2,346,560 "",@26,090 "2,747,940 Co#t o* 8ood# Sold $ 6,240,600 6,746,400 7,7"6,600 7,272,000 7,@20,000

The )ollo'ing in)or$ation is )or the seven $onths en&e& IBB> ;ul" +1:
Sales =urc0ases =urc0ase returns Sales returns *erc0andise inventor2, 200@ 1anuar2 " $7,749,000 4,599,900 29,900 "73,760 @49,000

To secure a loan, Aivel" Co$pan" has een as!e& to present current )inancial state$ents0 #o'ever, the co$pan" &oes not 'ish to ta!e a co$plete ph"sical inventor" as o) IBB> ;ul" +10 a0 6n&icate ho' )inancial state$ents can e prepare& 'ithout ta!ing a co$plete ph"sical inventor"0 0 Fro$ the &ata given, co$pute the esti$ate& inventor" as o) IBB> ;ul" +10 #lternate problem ? Apple Co$pan"Js recor&s containe& the )ollo'ing inventor" in)or$ation:
Co#t $3@6,000 A,400 "0,900 2",600 Reta%l $420,000 592,000 12"000 M 0,000

Sales =urc0ases .urcha#e return# Transportation3in *erc0andise inventor2 1anuar2 "

p. *I1 o) *++

'.'.# 0e ond the numbers9Critical thin&ing
Business .ecision case # ,usan 2reen an& Carol Ae'is, 'ere intereste& in starting part-ti$e usiness activities to supple$ent their )a$il" inco$es0 Both hear& a presentation " the $anu)acturer o) an exercise &evice an& &eci&e& to eco$e a &istri utor o) this exerciser0 2reenJs sales territor" is Co Count", an& Ae'isJs sales territor" is 2'innett Count"0 %ach o'ns her o'n usiness0 To in&uce 2reen an& Ae'is to eco$e &istri utors, the $anu)acturer $a&e price concessions on the )irst 1,BBB units purchase&0 The $anu)acturer sol& the )irst IBB units at M,< 1C each, the next +BB at M,< 18 per unit, an& the next CBB at M,< 1> per unit0 A)ter that, 2reen an& Ae'is ha& to pa" M,< IB per unit0 <uring the )irst "ear, each ought 1,IBB units? coinci&entall", oth sol& exactl" >CB units )or M,< I@ each0 2reen ha& M,< I,DBB o) selling expenses? Ae'is incurre& M,< 1,@BB o) selling expenses0 (2reenJs expenses 'ere consi&era l" higher ecause on <ece$ er I8 she &istri ute& *,BBB sales rochures to househol&s in her territor" at a cost o) M,< 8BB0 The rochures stresse& that people 'oul& 'ant to ta!e o)) the extra poun&s gaine& &uring the holi&a" season? also, these exercisers 'ere inexpensive an& coul& e use& at ho$e0) At the en& o) the "ear, oth ha& to &eter$ine their net inco$es0 2reen receive& a B in the accounting course she too! at ,tate Mniversit"0 ,he re$e$ ere& the F6FO inventor" $etho& an& plans to use it0 Ae'is !no's nothing a out inventor" costing $etho&s0 #o'ever, her hus an& is ac4uainte& 'ith the A6FO inventor" $etho& use& at the co$pan" 'here he 'or!s0 #e 'ill help her co$pute the cost o) the en&ing inventor" an& the cost o) goo&s using A6FO0 a0 Prepare inco$e state$ents )or 2reen an& Ae'is0 0 =hich usiness has per)or$e& etterQ %xplain 'h"0 c0 <eter$ine the inventor" turnovers )or 2reen an& Ae'is0

p. *II o) *++

Business .ecision case B Connie <alton o'ns an& operates a sporting goo&s store0 On Fe ruar" I the store su))ere& extensive )ire &a$age, an& all o) the inventor" 'as &estro"e&0 <alton uses perio&ic inventor" proce&ure an& has the )ollo'ing in)or$ation in her accounting recor&s, 'hich 'ere un&a$age&:
*erc0andise .nventor2, 1anuar2 " =urc0ases: 1anuar2 9 1anuar2 20 1anuar2 30 et Sales: :urin) 1anuar2 /e5ruar2 " and 2 $ 90,000 32,000 49,000 64,000 240,000 "6,000

<altonJs gross $argin rate on net sales has een *B per cent )or the past three "ears0 #er insurance co$pan" o))ere& to pa" M,< CD,BBB to settle this inventor" loss unless <alton can sho' that she su))ere& a greater loss0 ,he has as!e& "ou, her CPA, to help her in &eter$ining her loss0 Ans'er these 4uestions: Base& on "our anal"sis, shoul& <alton settle )or M,< CD,BBBQ 6) not, ho' can she sho' that she su))ere& a greater lossQ =hat is "our esti$ate o) her lossQ #nnual report analysis C :e)er to the )inancial state$ents o) The Ai$ite& in the Annual :eport Appen&ix0 <escri e ho' inventor" values are &eter$ine& (see Footnote 1)0 Also, &eter$ine the inventor" turnover ratio )or IBBB0 -t%ics case D Eriting experience < :espon& in 'riting to the )ollo'ing 4uestions ase& on the ethics case concerning Terr" <orse": a0 <o "ou elieve that Terr"Js sche$e 'ill 'or!Q 0 =hat 'oul& "ou &o i) "ou 'ere Terr"Js accountantQ c0 Co$$ent on each o) Terr"Js points o) 3usti)ication0 9roup pro2ect - 6n tea$s o) t'o or three stu&ents, intervie' the $anager o) a $erchan&ising co$pan"0 6n4uire a out inventor" control $etho&s, inventor" costing $etho&s, an& an" other in)or$ation a out the co$pan"Js inventor" proce&ures0 As a tea$, 'rite a $e$oran&u$ to "our instructor su$$ari5ing the results o) the intervie'0 The hea&ing o) the $e$oran&u$ shoul& inclu&e the &ate, to 'ho$ it is 'ritten, )ro$ 'ho$, an& the su 3ect $atter0

p. *I+ o) *++

9roup pro2ect F 6n a tea$ o) t'o or three stu&ents, locate an& visit a near " retail store that uses perpetual inventor" proce&ure an& a co$puteri5e& inventor" $anage$ent s"ste$0 6nvestigate ho' the s"ste$ 'or!s " intervie'ing a !no'le&gea le person in the co$pan"0 =rite a report to "our instructor an& $a!e a short presentation to the class on "our )in&ings0 9roup pro2ect 9 =ith a s$all group o) stu&ents, i&enti)" an& visit a retail store that uses perio&ic inventor" proce&ure an& uses the retail inventor" $etho& )or preparing interi$ ($onthl" or 4uarterl") )inancial reports0 <iscover ho' the retail inventor" $etho& is applie& an& ho' the en&-o)-"ear inventor" a$ount is calculate&0 =rite a report to "our instructor su$$ari5ing "our )in&ings0

'.'.$ .sing the (nternet9A vie+ of the real +orld
Gisit the /ational Association o) ,tate Boar&s o) Accountanc" 'e site at: http:77'''0nas a0org Fin& the a&&ress o) the state oar& o) accountanc" in "our state0 Also chec! out so$e o) the in)or$ation provi&e& at 'e sites o) other state oar&s " clic!ing on an" sites that appear at the en& o) a listing )or a particular state0 6n a report to "our instructor, su$$ari5e 'hat "ou learne& a out state oar&s at so$e o) these sites0 Gisit the Aexis-/exis 'e site at: http:77'''0lexis-nexis0co$ <eter$ine the !in&s o) in)or$ation that can e o taine& at this site0 ,peci)icall", 'hat !in&s o) pro&ucts an& services are availa leQ =hat is the ac!groun& o) Aexis-/exisQ =hat pricing in)or$ation is availa le )or using its servicesQ =rite a report to "our instructor su$$ari5ing "our )in&ings0

'.'.% Ans+ers to self<test '.'.%.1 True<false
False0 Overstate& en&ing inventor" results in an un&erstate$ent o) cost o) goo&s sol& an& an overstate$ent o) gross $argin an& net inco$e0 $rue0 The cost o) goo&s sol& consists o) the earliest purchases at the lo'est costs in a perio& o) rising prices0 False. Mn&er AC(, inventor" is a&3uste& to $ar!et value onl" 'hen the $ar!et (replace$ent) value is less than the cost0 $rue. The )irst step in the gross $argin $etho& is to esti$ate gross $argin using the gross $argin rate experience& in the past0 p. *I* o) *++

$rue. The cost7retail ratio is co$pute& " &ivi&ing the cost o) goo&s availa le )or sale " the retail price o) the goo&s availa le )or sale0 False0 Mn&er perpetual proce&ure, the Cost o) 2oo&s ,ol& account is up&ate& as sales occur0

'.'.%.2 =ultiple<choice
b0 The cost o) en&ing inventor" using F6FO consists o) the $ost recent purchase: Cost of endin/ in+entory =("%$$ × ,S-(4= ,S-5##"%$$ c0 The cost o) goo&s sol& using F6FO is: Cost of /oods a+ailable for sale =(("$$$ × ,S-($ )+(2"$$$ × ,S-(4 )= ,S- #3$"$$$ Cost of /oods sold = ,S- #3$"$$$ * ,S-5##"%$$ = ,S-5%3"4$$ a. The cost o) en&ing inventor" using A6FO is: (("$$$× ,S-($ )+( %$$× ,S-(4 )= ,S- 5$%"%$$ .. The cost o) goo&s sol& using A6FO is: ,S-#3$"$$$ * ,S-5$%"%$$ = ,S-542"4$$ a. The cost o) en&ing inventor" using 'eighte&-average cost is co$pute&: ,nit cost = ,S- #3$"$$$ −6"$$$ = ,S- ((.32 Cost of endin/ in+entory =("%$$ I ,S- ((.32= ,S-55%"32$ c. The cost o) goo&s sol& using 'eighte&-average cost is: ,S-#3$"$$$ * ,S-55%"32$ = ,S-522"#2$

b. <uring a perio& o) rising prices, F6FO results in the lo'est cost o) goo&s sol&, thus the highest net inco$e0

p. *IC o) *++

Alphabetical (nde,
academic accountants............................................................................................................................................21 accountin/ cycle..........................................31, 77, 86, 87, 123, 124, 126, 167, 190, 191, 214, 215, 229, 232, 234 Accountin/ Education Chan/e Commission....................................................................................................6, 26 accountin/ equation........................................30, 39-48, 53, 54, 56, 58, 60, 62-64, 66, 70, 75, 78, 81, 82, 86, 191 Accountin/ 'eriod...............................................................................................................................................169 Accountin/ Princi'les 0oard (AP0&.....................................................................................................................24 Accountin/ @e+ie ...............................................................................................................................................24 Accountin/ @e+ie " .he.......................................................................................................................................24 accountin/ system...........................................15, 40, 41, 78, 79, 87, 123, 209, 210, 214, 215, 229, 233, 256, 261 accountin/ theory........................................................................224, 254, 255, 270, 279, 283, 284, 295, 298, 299 Accountin/ year..................................................................................................................................................169 Accounts Payable 36-38, 42-44, 48, 51, 54, 56-59, 61, 65-69, 71, 72, 79, 84, 92, 96, 98-100, 103, 104, 108, 109, 111-113, 115, 118-122, 129, 131-134, 136, 138, 139, 150, 186, 195, 196, 200, 210-212, 216, 218, 222, 226, 227, 229, 232, 234, 235, 237, 239-248, 252, 253, 316-318, 320-322, 330, 332, 333, 335, 337, 344, 350, 354, 368, 369, 385, 403 Accounts @ecei+able.....37, 38, 42-44, 47, 48, 51, 54, 56-58, 61, 65, 66, 68-72, 75, 76, 79, 92, 99-101, 108-110, 112, 116, 118-122, 125, 129, 131-134, 136, 138, 139, 150, 162-164, 169, 170, 172, 186, 195, 200, 201, 210212, 216, 219, 220, 223, 226, 227, 229, 232, 234, 235, 237, 239-242, 244-248, 252, 253, 259, 261, 299, 306, 307, 310-312, 320-322, 329, 332, 333, 335, 338, 341, 344, 348-350, 354, 367, 368, 386 accrual basis. . .92, 123, 144-146, 163, 167, 169, 173-175, 181, 185, 187, 257, 272, 283, 286, 288, 293, 295, 301 Accrual basis of accountin/................................................................................................................................123 accrued assets and liabilities...............................................................................................................................170 Accrued re+enues and e1'enses..........................................................................................................................170 Accumulated amorti?ation..................................................................................................................218, 221, 229 Accumulated -e'reciation. .158-160, 168, 170, 171, 182, 183, 186, 188, 195, 211, 218, 221, 227-229, 235, 238248, 252, 259, 284, 299, 300, 320, 350, 354 Accumulated -e'reciation account.............................................................................158-160, 170, 171, 188, 299 Ad8unct account..................................................................................................................................319, 320, 338 ad8ustin/ entries......87, 118, 144-151, 155, 156, 162, 166-168, 170-173, 175, 180, 181, 184-187, 192, 194, 196, 200, 201, 224-226, 228, 229, 233, 253, 257, 259, 260, 332, 348, 352 administrati+e e1'enses.......................................266, 294, 296, 297, 324-327, 331, 332, 336, 338, 353, 355, 417 AECC..................................................................................................................................................................6, 9 AICPA.................................................................................................17, 23, 24, 28, 147, 210, 261, 262, 266, 301 Allo ances account.....................................................................................................309, 311, 312, 318, 330, 340 American Accountin/ Association.................................................................................................... 15, 23-25, 261 assets......4, 33, 35-49, 51, 52, 54, 57-63, 68, 69, 71, 72, 74-76, 78, 80-82, 84-86, 90-93, 113, 116-118, 124, 130, 141, 146-149, 156, 157, 159, 160, 162, 165, 167, 170, 171, 174, 178, 186-188, 190-192, 194, 197, 200, 209, 216-226, 229-232, 234, 235, 238, 251, 256, 258-263, 267, 269, 270, 273, 277-279, 281, 284, 285, 290, 293, 296, 306, 331, 335, 342, 348, 358, 361, 389, 395 balance sheet.......7, 16, 30, 34-39, 41, 44, 45, 47, 48, 51, 54-56, 58-62, 65, 67-73, 76, 78, 90, 93, 118, 124, 140, 141, 145, 147, 150, 151, 153, 155, 156, 158, 159, 161-166, 168, 170, 171, 178, 188, 190-192, 196-200, 208, 215-223, 225, 227, 229-235, 240, 244, 245, 248, 250-253, 256, 258-260, 273, 275, 293, 324, 331-333, 335, 346, 349, 350, 355, 358, 360, 361, 363, 371, 377, 380, 381, 389, 397, 414, 419

p. *ID o) *++

bias..............................................................................................................................260, 275, 276, 284, 285, 295 bonds 'ayable......................................................................................................................................223, 229, 230 book +alue............................................................................................158-160, 170, 261, 267, 284, 285, 299, 300 0uildin/s ............................................................................................................................................ 119, 121, 228 0usiness em'hasis...................................................................................................................................................6 business entity conce't..................................................................31, 32, 40, 58, 61, 256, 284, 286, 288, 293, 301 0usiness transactions.......................................................................................................................................... 123 calendar year.......................................................................................................................147, 169, 170, 188, 291 ca'ital stock......36, 38, 42, 44, 46-48, 51, 54-58, 62-72, 82, 84, 85, 89, 91-93, 105-108, 111, 112, 118, 119, 121, 122, 124, 125, 127-136, 138, 139, 143, 150, 181, 186, 192, 195, 197, 200, 202, 209, 211, 226, 227, 234, 235, 237, 239-248, 252, 332, 333, 335, 347, 350, 352-355 cash basis of accountin/...................................................... 145, 146, 167, 170, 173-175, 181, 185, 257, 264, 287 cash discount...............................................................................309, 310, 317, 318, 328, 330, 338, 340, 344, 345 cash equi+alents...................................................................................................................116, 218, 219, 229, 281 CC<0!<NC<.............................................................................................................................................................3 Certified Internal Auditor......................................................................................................................................20 Certified Hana/ement Accountants......................................................................................................................20 Certified Public Accountant........................................................................17, 23, 25, 75, 147, 210, 261, 266, 301 Chain discount.....................................................................................................................................308, 338, 340 Chart of accounts................................................................................................................................................ 123 CIA........................................................................................................................................................................20 classified balance sheet...7, 190, 191, 215-217, 219, 223, 225, 229, 232, 233, 240, 244, 245, 248, 250, 253, 349, 350, 355, 358 classified income statement..................303, 304, 324-327, 330, 338, 341-343, 348-350, 352, 354, 355, 357, 358 closin/ 'rocess..............................................................45, 201, 202, 208, 226, 229, 231, 232, 236, 251, 304, 335 Com'arability......................................................................................................276, 277, 283, 284, 292, 295, 297 com'leted<contract method.........................................................................................265, 284, 286, 293, 294, 297 Com'ound 8ournal entry.....................................................................................................................................123 Conser+atism.........................................................................................................267-270, 283-285, 288-290, 294 Consi/ned /oods.........................................................................................................................322, 338, 341, 357 consistency..........................................................258, 260, 276, 283, 284, 287, 290, 293, 295, 296, 302, 383, 385 Construction in 'ro/ress..................................................................................................................... 218, 221, 229 continuity............................................................................................ 41, 58, 59, 62, 256, 260, 283, 285, 290, 294 contra asset account............................................................................................................ 151, 159, 170, 188, 221 Co'yri/ht.................................................................................................................................................... 221, 229 Cor'oration...24, 33, 35, 38-40, 42, 45, 52, 53, 55, 58, 60, 63, 71, 76, 82, 91, 140, 212, 214, 222, 224, 230, 235, 238, 256, 289, 293, 328, 348, 356, 399 cost....2, 23, 32, 41, 52, 56, 58, 59, 62, 66, 68, 69, 71, 92, 100, 136, 148, 149, 151, 152, 156-159, 168, 170, 176, 180-183, 186, 214, 216-218, 221, 235, 259, 261, 264, 265, 267-270, 273, 274, 277, 279-281, 283-285, 288291, 294-297, 303, 305, 308, 313-316, 318-328, 330-332, 334, 338-343, 345-348, 351, 354-413, 415-423, 425, 426 cost of /oods a+ailable for sale. .314, 316, 323, 324, 326, 330, 332, 334, 338, 343, 345, 357, 361-363, 366, 371375, 377, 379, 384, 389-394, 396, 397, 404, 405, 426 cost of /oods sold. 267, 291, 303, 305, 313-316, 319, 321-328, 330-332, 334, 339-343, 345, 346, 356, 357, 359363, 366-369, 371-382, 384-387, 390-398, 403-408, 416, 417, 420-422, 425, 426 cost 'rinci'le...............................................................................................................................261, 284, 285, 296 Cost<benefit consideration..........................................................................................................................268, 285 CPA.................................17-20, 22-25, 28, 32, 50, 77, 78, 142, 147, 210, 233, 261, 262, 266, 268, 298, 301, 424

p. *I@ o) *++

Credit balance..................................................................................................................................................... 123 Creditors and lenders............................................................................................................................................ 22 Cross<inde1in/....................................................................................................................................................123 current assets.........................................................116, 217-220, 222-226, 229, 230, 232, 238, 342, 358, 361, 389 Current liabilities..................................................................................................217-219, 222-226, 229, 232, 238 current ratio.............................................................................................7, 190, 215, 223, 224, 226, 229, 250, 251 Curriculum concerns...............................................................................................................................................5 customers....22, 31, 34, 35, 37, 40, 45, 53, 54, 56, 58, 59, 63, 72, 79, 92, 105, 127, 128, 130-133, 135, 138, 141, 145, 160, 161, 163, 171, 184, 185, 210, 216, 219, 220, 222, 229, 231, 249, 250, 253, 256, 260, 263, 282, 284, 292, 301, 304-306, 308, 310, 313, 322, 324, 339, 340, 356, 360, 365, 367, 385, 386, 396, 404 -ebit balance ......................................................................................................................................................123 deferred items..............................................................................................149, 151, 162, 167, 168, 170, 173, 175 -eli+ery E1'ense.................................................................................................320-322, 326, 338, 339, 343, 354 -e'reciable amount....................................................................................................................................158, 170 -e'reciable asset.........................................................................................................................................157, 170 de'reciation accountin/......................................................................................................................157, 170, 257 -e'reciation e1'ense..150, 157, 158, 160, 169, 170, 188, 193, 195, 198, 201, 204, 206, 226-228, 237, 239, 240, 243-245, 248, 252, 253, 257, 267, 269, 275, 326, 327, 350, 354 de'reciation formula...................................................................................................................157, 158, 170, 174 -i+idend...................... 35, 49, 58, 59, 63, 64, 73, 79, 83, 84, 86, 91, 104, 120, 123-125, 131, 134, 135, 139, 202 -i+idends 'ayable.......................................................................................................................................222, 229 -ouble<entry 'rocedure......................................................................................................................................123 Earnin/ 'rinci'le.........................................................................................................................263, 285, 293, 294 Ed ards...................................................................................................................................................................2 Em'loyees and their unions..................................................................................................................................22 end<of<cha'ter materials................................................................................................................................... 9, 26 entity............31-33, 40, 41, 58, 59, 61, 147, 169, 191, 256, 257, 259, 260, 277, 278, 283-288, 290, 293-295, 301 entre'reneur.......................................................................................................................................................... 30 equities..................................................................................................................39, 42, 52-54, 58-60, 65, 74, 259 equity ratio....................................................................................................................................30, 52, 54, 59, 74 estimated useful life............................................................................................................157, 170, 176, 180, 184 ethical beha+ior...............................................................................................................................................25, 26 ethics................................................................................................................. 5, 9, 25, 26, 75, 141, 300, 356, 424 e1chan/e<'rice....................................................................41, 59, 61, 62, 261, 270, 283, 285, 288, 290, 294, 296 e1chan/e<'rice (or cost& 'rinci'le.......................................................................................................261, 285, 288 e1'enses....4, 23, 35-37, 45, 46, 49, 51, 52, 54, 56, 57, 59, 61, 63, 66, 68-70, 72, 73, 81-83, 85, 90-92, 113, 117, 120, 123, 126, 129, 140, 141, 145-151, 153, 157, 164, 167-170, 173-175, 187, 192, 194, 196-198, 202-204, 206, 218-220, 222, 229, 230, 241, 249, 253, 257-261, 263, 264, 266-268, 270, 278, 285, 291, 293, 294, 296, 297, 301, 305, 320, 324-328, 330-334, 336, 338-343, 346, 350, 353, 355, 356, 361, 362, 386, 394, 417, 423 E1'osure -rafts.....................................................................................................................................................25 >AS0.......................................................................................24, 25, 255, 261, 269, 271, 273, 277, 279, 283, 297 feedback +alue.....................................................................................................................273, 285, 292, 295, 297 >inancial Accountin/ 1, 2, 14, 20-25, 39, 41, 78, 224, 254, 255, 260, 261, 269-271, 273, 277, 279, 285, 298-300 >inancial Accountin/ Standards 0oard................................................... 23-25, 254, 255, 261, 269, 273, 277, 300 >inancial Analysts >ederation...............................................................................................................................25 >inancial E1ecuti+es Institute.................................................................................................................23, 25, 261 financial re'ortin/ ob8ecti+es......................................................................................................271, 283, 285, 297 financial statements4, 15-17, 19, 21, 22, 25, 28, 30, 31, 34, 39-41, 48, 49, 53, 62, 64, 74, 79, 80, 86, 87, 93,

p. *I8 o) *++

114, 115, 117, 123, 127, 130, 145, 147-151, 155, 156, 159, 160, 166, 170-174, 176, 177, 181, 191, 199-201, 213-216, 224, 225, 229, 231-233, 256-260, 262, 266, 268, 270, 271, 275-277, 279, 280, 283-285, 288-291, 295, 296, 298-301, 315, 320, 332, 335, 338, 343, 366, 382, 383, 385, 389-392, 408, 412, 413, 422, 424 fiscal year............................................................................................................137, 147, 170, 188, 239, 244, 412 >90 destination...........................................263, 299, 306, 319-322, 330, 336, 338, 339, 343, 345, 347, 351, 352 >90 shi''in/ 'oint...............................................................................263, 319-322, 330, 339, 345-349, 351-353 frei/ht collect .....................................................................................................................................................322 frei/ht 're'aid.............................................................................319, 320, 322, 330, 336, 338, 339, 347, 351, 352 full disclosure 'rinci'le...............................................................................................261, 268, 276, 284, 285, 289 ;AAP................................................................................................................................22, 23, 33, 260, 271, 277 ;ain and loss reco/nition 'rinci'le.................................................................................................... 261, 267, 285 ;ains........................................................................................................................... 267, 270, 278, 281, 282, 285 ;AS0....................................................................................................................................................................24 /eneral 'ublic................................................................................................................................................22, 254 /enerally acce'ted accountin/ 'rinci'les......................4, 22, 23, 33, 187, 260-262, 270, 277, 279, 288, 293, 298 ;lobal .e1t Pro8ect.................................................................................................................................................2 ;oin/<concern...............................................................................................41, 58, 59, 61, 62, 256, 285, 288, 293 /ood ill.............................................................................................................................................. 221, 229, 281 ;o+ernmental Accountin/ Standards 0oard...................................................................................................23, 24 ;o+ernmental units...............................................................................................................................................22 /ross mar/in.....4, 264-266, 285, 287, 291, 293, 294, 296, 303-305, 325-329, 331, 334, 339, 343, 345, 346, 356, 359, 361-363, 380-382, 384, 390, 391, 393, 395, 397, 399, 404, 405, 408, 410-413, 415, 417, 419, 421, 424, 425 /ross mar/in 'ercenta/e..........................................................................4, 264, 265, 287, 303, 304, 329, 339, 356 /ross 'rofit.......................................................................................................................... 264, 327, 329, 339, 356 /ross sellin/ 'rice................................................................................................307-309, 329, 337, 339, 344, 396 Jermanson..............................................................................................................................................................2 historical cost..............................................................................................261, 285, 366, 380, 383, 387, 388, 404 Jori?ontal analysis..............................................................................................................................................123 IAS0......................................................................................................................................................................28 IASC......................................................................................................................................................................28 I>@S................................................................................................................................................................28, 29 Income from o'erations..............................................................................................................326, 328, 339, 346 income statement16, 30, 34-39, 41, 45, 48, 51, 54, 56, 57, 59-61, 65, 67-69, 71, 72, 76, 78, 83, 84, 90, 145, 147, 148, 153, 155, 156, 158, 161, 163-165, 171, 184, 187, 188, 190, 192, 195-199, 202-204, 225, 227, 231-234, 236, 237, 240, 244, 245, 248, 250, 251, 253, 258-260, 275, 298, 303-306, 310, 312-314, 316, 317, 319, 320, 322, 324-328, 330-336, 338, 340-343, 346, 348-350, 352, 354, 355, 357, 358, 360-363, 371, 381, 389, 391, 393, 394 Income Summary account........................... 202-204, 206, 207, 225, 228, 229, 231, 232, 236, 252, 336, 346, 358 Income ta1es 'ayable..........................................................................................................................218, 222, 230 installment basis...................................................................................264, 265, 283, 285-287, 291, 293, 296, 301 Institute of Certified Hana/ement Accountants...................................................................................................20 Institute of Chartered Accountants of India.........................................................................................................29 Institute of Hana/ement Accountants.......................................................................................................20, 23, 25 intan/ible assets .................................................................................................................................................217 Interest Payable...........................................................................................................166, 174, 222, 230, 240, 245 Interest @ecei+able......................................150, 162, 163, 172, 189, 195, 200, 201, 211, 219, 220, 230, 240, 245 Internal Auditors................................................................................................................................................... 20

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International Accountin/ Standards......................................................................................................................28 International >inancial @e'ortin/ Standards.................................................................................................28, 262 in+oice.................................. 135, 267, 299, 306-310, 317, 328, 329, 338-340, 344, 345, 347, 357, 365, 410, 411 in+oice 'rice.................................................................................307-310, 317, 329, 338-340, 344, 347, 357, 365 Kournal entry........................................................................................................................................................123 Kournal of Accountancy.........................................................................................................................................24 Land 38, 41, 56-58, 64, 65, 67-69, 72, 118-122, 138, 186, 218, 220, 226, 227, 230, 231, 238, 240, 242, 245, 251, 273, 279, 294, 295, 297, 331, 347, 348, 354 Leasehold im'ro+ements....................................................................................................................218, 221, 230 Leaseholds...................................................................................................................................................221, 230 Led/er................................................................................................................................................................. 123 liabilities.......4, 36-40, 42-44, 46-48, 51, 52, 54, 57-61, 63, 68, 69, 71, 72, 74, 76, 78, 81, 82, 84-86, 90-93, 113, 116, 118, 124, 140, 147, 149, 161, 162, 164, 165, 168, 170, 174, 178, 191, 192, 194, 197, 200, 209, 216-219, 222-226, 229-232, 234, 238, 259, 261, 262, 277, 278, 296, 335 liquidation...........................................................................................................................................256, 285, 293 lon/<term assets.................................................................................................38, 41, 62, 220, 230, 232, 267, 285 Lon/<term in+estment.........................................................................................................................220, 221, 230 Lon/<term liabilities............................................................................................217, 218, 223, 226, 229, 230, 238 losses.........................................................................19, 32, 52, 197, 267, 270, 275, 278, 281, 282, 285, 372, 382 Haher......................................................................................................................................................................2 mana/ement ad+isory........................................................................................................................................... 19 Hanufacturers....................................................................................................................................... 34, 304, 339 manufacturin/ com'anies...........................................................................................................33, 34, 54, 59, 267 marketable securities...........................................................................................................219, 224, 230, 238, 281 matchin/ 'rinci'le.......................................................147, 148, 158, 170, 175, 261, 267, 270, 285, 286, 294, 296 Hateriality.............................................................................................268-270, 277, 283-285, 288-290, 292, 295 HcCubbrey..............................................................................................................................................................2 Herchandise in transit.................................................................................................................................322, 339 Herchandise In+entory 230, 313-316, 321-326, 329, 331-336, 339, 340, 342, 343, 345, 347, 350, 352, 354, 357, 358, 360, 361, 367-369, 376, 377, 379, 385-388, 390-392, 397, 399, 401-404, 413, 414, 416, 418, 420-422, 424 Herchandisin/ com'anies...........................33, 34, 53, 59, 282, 304, 305, 307, 310, 313, 315, 327, 329, 331, 360 Hodifyin/ con+entions........................................................................................254, 255, 268-270, 283, 285, 288 Honey measurement...........................................................................41, 59, 62, 76, 256, 257, 260, 283, 285, 287 Net cost of 'urchases. .313, 314, 316, 319, 321-323, 326, 328, 330, 332, 334, 338, 339, 341, 345, 346, 357, 361, 390, 391, 399, 404 net income. 35-38, 46-48, 52, 55, 57, 59, 60, 62, 63, 65, 69, 73, 148, 165-168, 177, 178, 180, 184, 195-199, 202, 206, 207, 221, 225, 227, 229, 232-237, 250, 252, 258-260, 263, 266, 269, 270, 274, 284, 290, 291, 293, 294, 296, 297, 299, 300, 305, 326-328, 331-334, 336, 339, 346, 358, 360-363, 366, 380-383, 385, 394-396, 398, 399, 403, 405, 407-409, 412, 414, 417-419, 425, 426 net 'urchases...............................................................................314, 317, 319, 323, 325, 328, 334, 339, 345, 357 net sales......166, 306, 312, 313, 322, 325, 327, 328, 330, 334, 339, 340, 342, 343, 345, 346, 356, 390, 391, 394, 397, 399, 404, 412, 413, 424 neutrality.....................................................................................................................275, 276, 285, 292, 295, 297 Nominal accounts................................................................................................................................................123 Nono'eratin/ e1'enses........................................................................................................................326-328, 339 Nono'eratin/ re+enues................................................................................................325-328, 330, 331, 339, 342 Note38, 41, 42, 44, 47, 48, 56, 59, 63-66, 70, 79, 82, 86, 92, 106, 109, 113, 114, 123, 129-132, 135, 136, 138,

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151, 166, 172, 183, 192, 196, 197, 203, 204, 217, 219, 220, 222, 230, 273, 280, 310, 325, 327, 335, 336, 363, 371, 375, 379, 383, 385, 400, 416, 420 notes 'ayable. .36-38, 42-44, 46-48, 51, 54, 56, 57, 59, 61, 65, 66, 70, 79, 82, 106, 107, 118, 119, 121, 122, 131, 132, 136, 138, 183, 222, 223, 226, 227, 230, 238-240, 242, 245, 247, 248 9b8ecti+es and o+erall a''roach of the ei/hth edition...........................................................................................6 office equi'ment................................36-38, 42-44, 51, 64, 132, 134-136, 186, 220, 230, 242-245, 248, 326, 327 office furniture.....................................................................................................................133-136, 220, 230, 248 o'eratin/ cycle....................................................................................................................219, 222, 229, 230, 361 9'eratin/ e1'enses..........................................................66, 68, 324-327, 330, 331, 334, 338, 339, 342, 343, 346 9'eratin/ re+enues............................................................................. 306, 312, 325, 326, 330, 331, 334, 339, 342 9 ners and 'ros'ecti+e o ners........................................................................................................................... 22 Pacioli......................................................................................................................................................14, 79, 142 Paid<in Ca'ital.....................................................................................................................219, 223, 230, 284, 299 'artnershi'....................................................................................................................... 32, 53-55, 59, 60, 63, 214 Passa/e of title.................................................................................................................................... 319, 330, 339 Patent...........................................................................................................................................................221, 230 Peda/o/y.................................................................................................................................................................8 'ercenta/e<of<com'letion...........................................................................265, 266, 283, 285, 291, 294, 296, 297 Period costs.................................................................................................................................................267, 285 'eriodic in+entory 'rocedure.......314-316, 321, 324, 330, 339, 340, 342-345, 361, 366, 370-375, 378, 384, 390, 398, 405, 407, 410, 416, 417, 420, 421, 424, 425 Periodicity.................................................................... 41, 59, 62, 76, 256-260, 283, 286-288, 290, 293, 295, 302 Permanent accounts.............................................................................................................................................124 'er'etual in+entory 'rocedure......314, 315, 330, 339, 340, 357, 359, 366-370, 376-379, 384-387, 396-398, 405, 407, 409-411, 415, 416, 420, 421, 425 Philoso'hy and 'ur'ose..........................................................................................................................................4 'hysical in+entory......155, 156, 180, 299, 315, 316, 321, 322, 339-341, 343, 361, 364, 365, 367, 370, 387, 390393, 395, 407, 410, 412, 413, 418, 422 'ost<closin/ trial balance................87, 118, 190, 208, 209, 224, 225, 229-231, 233, 237, 240, 246, 251-253, 332 Predicti+e +alue...........................................................................................................273, 274, 286, 292, 295, 297 Pre'aid e1'ense...........................................................................................................151, 153, 155-157, 165, 170 're'aid e1'enses.........................................................................................149, 151, 157, 170, 219, 220, 230, 259 'ri+ate sector...........................................................................................................................................24, 28, 300 Product costs...............................................................................................................................................267, 286 'rofitability..................................................34, 39, 40, 52-54, 59, 60, 86, 148, 191, 256, 305, 325, 328, 360, 363 Pro'erty" 'lant" and equi'ment....................................................................................174, 220, 225, 229, 230, 238 'urchase discount........................................................................309, 317, 325, 334, 338, 340, 341, 356, 365, 396 Purchase -iscounts account........................................................................................................................317, 340 Purchase returns....314, 317-319, 321-323, 325, 328, 330, 332-335, 337, 339-341, 344-346, 357, 366, 367, 369, 385, 392, 393, 413, 417, 418, 422 Purchases account................................................................................................316, 317, 319, 340-342, 357, 366 qualitati+e characteristics............................................................271, 273, 274, 277, 283, 286, 288, 289, 297, 298 @etained Earnin/s.................................................................................................................................................51 real accounts........................................................................................................................................................124 @eali?ation 'rinci'le...........................................................................................................263, 283, 286, 293, 294 @ele+ance....................................................................................215, 273, 275, 276, 283, 286, 292, 295, 298, 302 reliability.......................................................................................14, 262, 275, 276, 283, 286, 292, 295, 298, 302 re'resentational faithfulness....................................................................................................... 275, 286, 292, 298

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retailers........................................................................................................281, 304, 307, 308, 313, 340, 348, 360 retained earnin/s. .16, 30, 34-39, 45-49, 51, 54-72, 76, 78, 82-86, 91, 92, 118, 119, 121, 122, 124, 126, 132-134, 136-139, 145, 165, 186, 190, 192, 195-202, 207-209, 211, 219, 223, 225-229, 231-236, 238-248, 251-253, 259, 260, 275, 331-336, 346, 350, 354, 355, 360-363, 395 re+enue reco/nition 'rinci'le......................................................................................261, 263, 267, 286, 287, 296 re+enues....4, 20, 35-37, 42, 45-47, 49, 51, 54, 57, 59, 61, 63, 69, 72, 81-83, 85, 90-92, 113, 123, 124, 126, 145149, 151, 153, 160, 162, 165, 167-170, 173-175, 187, 192, 194, 196-198, 202, 206, 219, 222, 229-232, 257, 258, 260, 261, 263-268, 270, 275, 278, 280, 281, 285, 286, 288, 289, 293, 301, 305-307, 312, 324-331, 334, 338-342, 361, 380, 381, 383, 386, 396, 397 re+enues recei+ed in ad+ance......................................................................................................................222, 231 Salaries Payable...................150, 165, 169, 170, 189, 195, 200, 201, 211, 222, 227, 228, 231, 232, 240, 245, 252 sales allo ance............................................................................................................311, 312, 330, 340, 347, 386 sales discount...............................................................................................................309-312, 338, 340, 342, 356 Sales -iscounts account......................................................................................................309, 310, 312, 330, 340 Sales @eturn.................................................................................................................310-312, 325, 334, 340, 386 Sales returns. .306, 309-313, 328, 330, 332, 333, 336, 338-340, 342, 344-346, 350, 354, 357, 386, 413, 417, 422 scra' +alue...................................................................................................................................................157, 170 SEC................................................................................................................................................. 24, 28, 261, 300 Securities and E1chan/e Act of 5)(%................................................................................................................... 24 Securities and E1chan/e Commission.........................................................................................19, 23-25, 28, 261 sellin/ e1'enses...........................................................293, 320, 326, 327, 331-333, 336, 340, 350, 353, 417, 423 ser+ice com'anies...............................................................................................................33, 34, 53, 59, 282, 304 ser+ice 'otential .................................................................................................................................................152 shareholders.................................................................................................................................................... 33, 60 Sim'le 8ournal entry............................................................................................................................................124 Sin/le 'ro'rietorshi'...............................................................................................................32, 53, 55, 59, 60, 63 sol+ency...................................................................................................... 34, 37, 39, 53, 59, 62, 74, 86, 191, 360 stable dollar assum'tion..............................................................................................................257, 286, 294, 295 statement of cash flo s...................................................................16, 30, 34, 38, 39, 41, 54, 60, 61, 78, 145, 275 statement of retained earnin/s....16, 30, 34-37, 39, 54, 56, 57, 60, 61, 65, 67, 68, 72, 76, 78, 145, 190, 192, 195200, 225, 227, 231-235, 240, 244, 245, 248, 251, 253, 259, 275, 332-335, 346, 350, 355, 360-362 stockholders 16, 21, 23, 27, 33-40, 42-49, 51-55, 57-62, 64, 65, 68, 69, 71, 72, 74-76, 78-82, 85, 86, 89-93, 104, 106-109, 113, 117, 118, 120, 123-125, 127, 140, 143, 147, 167, 178, 186, 191, 192, 197, 200, 202, 216-219, 222, 223, 226, 229, 231, 232, 238, 252, 259, 261-263, 275, 276, 281, 335, 347, 348, 352, 353, 363 stockholders' equity.....36, 42-44, 46-48, 51, 52, 58, 65, 68, 69, 71, 72, 78-82, 85, 86, 90-93, 113, 117, 118, 123, 124, 127, 143, 191, 192, 197, 200, 216-219, 223, 226, 229, 231, 232, 238, 252, 259, 261, 275, 281, 335 stockholdersL equity........................................................................37-40, 42, 44-49, 52-55, 58-62, 64, 74-76, 147 strai/ht<line.................................................................................................................157, 158, 170, 174, 257, 281 Summa de Arithmetica..........................................................................................................................................14 summary of transactions......................................................................41, 44, 51, 57, 60, 65, 66, 68-70, 72, 75, 80 .<account.............................................................................................................................................................124 .a1 ser+ices.....................................................................................................................................................16, 19 .a1es ithheld from em'loyees..........................................................................................................222, 231, 238 .em'orary accounts............................................................................................................................................124 .e1tbook Equity..................................................................................................................................................2, 3 time 'eriods.......................................................................................41, 59, 62, 147, 170, 257, 259, 260, 286, 290 .imeliness...........................................................................................................................274, 286, 292, 295, 297 .rade -iscount....................................................................................................................308, 309, 340, 341, 344

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transaction...39-48, 53, 56, 59-64, 66, 68-70, 72, 75, 79-83, 86-104, 106, 107, 115, 118, 123-125, 128-130, 145, 149, 150, 153, 155, 181, 184, 185, 191, 258-261, 263, 286, 296, 300, 301, 306, 317, 320, 329, 353, 377, 410, 411 .rans'ortation<In account...........................................................................................................................319, 340 unclassified balance sheet...........................................................................................................216, 217, 231, 233 unclassified income statement....................................................................................................324, 325, 340, 357 unearned re+enue........................................................................................................................149, 160, 171, 173 ,nearned re+enues .....................................................................................................................................222, 231 +erifiability..................................................................................................................275, 276, 286, 292, 295, 297 holesalers..................................................................................................................304, 308, 339, 340, 360, 370 ork sheet 87, 117, 190-193, 195-197, 199, 200, 202-204, 224-227, 229, 231-237, 241, 243, 244, 246-248, 251, 253, 303, 304, 331-333, 335, 336, 346, 350, 355 ork sheet ....................................................................................................................................................87, 200

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