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Chapter 3

Accrual Accounting & Income


Short Exercises
(10 min.) S 3-1
Millions
850
(290)
(325)
$ 235

Sales revenue.
Cost of goods sold
All other expenses
Net income..

Beginning cash..
Collections ($850 $27)..
Payments for: inventory.
everything else.
Ending cash

$ 75
823
(380)
(255)
$ 263

(10 min.) S 3-2


Statement
Income statement

Reports (Amounts in millions)


Interest expense

$ .8

Balance sheet

Notes payable ($4.1 + $1.7 $1.6).

$4.2

Interest payable.

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Chapter 3

Accrual Accounting and Income

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(10 min.) S 3-3


At the end of each accounting period, the business reports its performance through
the preparation of financial statements. In order to be useful to the various users of
financial statements, they must be up-to-date. Accounts such as Cash, Equipment,
Accounts Payable, Common Stock, and Dividends are up to date and require no
adjustment at the end of the accounting period. Accounts such as Accounts
Receivable, Supplies, Salary Expense, and Salaries Payable may not be up to date as
of the last day of the accounting period. Why? Because certain transactions that
took place during the month may not have been recorded.
The accrued salaries, which are owed to the employees but have not been paid, are
an expense related to the current period but also represent a liability or debt that is
owed by the business. The business must make an adjusting entry to record the
accrued salary owed as both an increase in Salary Expense and an increase in
Salaries Payable. If the business does not make this adjustment, the expenses will
be understated, net income will be overstated, and liabilities will be understated.

(10 min.) S 3-4


The large auto manufacturer should record sales revenue when the revenue is
earned by delivering automobiles to Budget or Hertz. The large auto manufacturer
should not record any revenue prior to delivery of the vehicles, because the large
auto manufacturer hasnt earned the revenue yet. The revenue principle governs this
decision.
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Financial Accounting 9/e Solutions Manual

When the large auto manufacturer records the revenue from the sale, at that time
not before or afterthe large auto manufacturer should also record cost of goods
sold, the expense. The expense recognition principle tells when to record expenses.
(10 min.) S 3-5
Depreciation is the periodic allocation of the cost of a tangible long-lived asset, less
its estimated residual value, over its estimated useful life. All long-lived or plant
assets, except for land, decline in usefulness during their lives, and this decline is an
expense. Accountants must allocate the cost of each plant asset, except for land,
over the assets useful life. Depreciation is the process of allocating the cost of a
plant asset to expense. Depreciation also decreases the book value of the asset to
reflect its usage.

(10 min.) S 3-6


a. The Expense Recognition Principle

e.

b.

The Time Period Concept

c.

The Revenue Principle

d.

The Revenue Principle

The Expense Recognition Principle

(10 min.) S 3-7


a.

Chapter 3

Accrual Accounting and Income

3-3

Oct. 31

Rent Expense ($3,000 1/6)...


Prepaid Rent.
To record rent expense.

500
500

Prepaid Rent
Oct. 1

3,000 Oct. 31

Bal.

2,500

Rent Expense
500

Oct. 31

500

Bal.

500

b.
Oct. 31

Supplies Expense ($950 $400)


Supplies..
To record supplies expense.

Supplies
Oct. 1

950 Oct. 31

Bal.

400

550
550

Supplies Expense
550

Oct. 31

550

Bal.

550

(10 min.) S 3-8


Req. 1
(a)

(b)

3-4

Jan. 1

Dec. 31

Computer Equipment...
Cash.
Purchased computer equipment.
Depreciation Expense
Computer Equipment ($50,000 / 5).
Accumulated Depreciation
Computer Equipment.......
Record depreciation expense.

Financial Accounting 9/e Solutions Manual

50,000
50,000

10,000
10,000

Req. 2
Accumulated Depreciation
Computer Equipment
Computer Equipment
Jan. 1
Bal.

Depreciation
Expense
Computer Equipment

50,000

Dec. 31 10,000

Dec. 31

10,000

50,000

Bal.

Bal.

10,000

10,000

Req. 3
Computer equipment.

$50,000

Less: Accumulated depreciation

(10,000)

Book value

$40,000

Chapter 3

Accrual Accounting and Income

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(10 min.) S 3-9


(Amounts in millions)
Income statement:
Salary expense ($42.4 + $2.2)..

2012
$44.6

Balance sheet:
Salary payable.........

2012
$ 2.2

(10 min.) S 3-10


Req. 1
Oct. 31

Nov. 30

Dec. 31

Interest Expense..
Interest Payable..
To accrue interest expense for October.

250

Interest Expense..
Interest Payable..
To accrue interest expense for November.

250

Interest Expense...
Interest Payable
To accrue interest expense for December.

250

250

250

Req. 2
Interest Payable
Oct.

31

250

Nov. 30

250

Dec. 31

250

Bal.

750

Req. 3

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Financial Accounting 9/e Solutions Manual

250

Dec. 31

Interest Payable..........
Cash..
To pay interest.

750
750

(10 min.) S 3-11


Req. 1
Oct. 31

Nov. 30

Dec. 31

Interest Receivable
Interest Revenue..
To accrue interest revenue for October.

250

Interest Receivable
Interest Revenue...
To accrue interest revenue for November.

250

Interest Receivable
Interest Revenue......
To accrue interest revenue for December.

250

250

250

250

Req. 2
Interest Receivable
Oct. 31

250

Nov. 30

250

Dec. 31

250

Bal.

750

Req. 3
Dec. 31

Cash.
Interest Receivable.
To collect interest.
Chapter 3

750
750

Accrual Accounting and Income

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Financial Accounting 9/e Solutions Manual

(5-10 min.) S 3-12


Unearned revenues are liabilities because The World Star has received cash from
subscribers in advance of providing them with newspapers. Receiving the cash in
advance creates an obligation (a liability) for The World Star. As The World Star
delivers newspapers to subscribers, The World Star earns the revenue, and the
dollar amount of the unearned revenue then goes into the revenue account.
a.

Cash.
Unearned Subscription Revenue.......
Received cash for revenue in advance.

60,000
60,000

b. Unearned Subscription Revenue..................


Subscription Revenue
To record the earning of subscription
revenue that was collected in advance.

40,000
40,000

(5-10 min.) S 3-13


Prepaid Rent at December 31:
a.

Unadjusted amount.

$18,000

b.

Adjusted amount ($18,000 $6,000)..

12,000

Rent Expense at December 31:


c.

Unadjusted amount

d.

Adjusted amount ($18,000 / 3).

-06,000

(10 min.) S 3-14


Chapter 3

Accrual Accounting and Income

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a.

b.

Accounts Receivable...
Service Revenue..

55,000

Cash.
Accounts Receivable.

35,000

Cash.
Unearned Service Revenue..

9,000

Unearned Service Revenue


Service Revenue..

7,000

55,000

35,000

9,000

7,000

(15-30 min.) S 3-15


Sparrow Sporting Goods Company
Income Statement
For the Year Ended March 31, 2012
Thousands
Net revenues.

$175,500

Cost of goods sold.

136,000

All other expenses..

29,000

Net income

$ 10,500

Sparrow Sporting Goods Company


Statement of Retained Earnings
For the Year Ended March 31, 2012
Thousands

3-10

Retained earnings, March 31, 2011...

$21,500

Add: Net income.

10,500

Retained earnings, March 31, 2012...

$32,000

Financial Accounting 9/e Solutions Manual

(continued) S 3-15
Sparrow Sporting Goods Company
Balance Sheet
March 31, 2012
Thousands
ASSETS
Current:
Cash....................................................................

$ 20,800

Accounts receivable..........................................

28,000

Inventories..........................................................

35,000

Other current assets..........................................

5,000

Total current assets.....................................

88,800

Property and equipment, net............................

6,300

Other assets.......................................................

22,000

Total assets...............................................................

$117,100

LIABILITIES
Total current liabilities.......................................

$ 55,100

Long-term liabilities...........................................

7,500

Total liabilities...........................................................

62,600

STOCKHOLDERS EQUITY
Common stock...................................................

22,500

Retained earnings..............................................

32,000

Total stockholders equity.......................................

54,500

Total liabilities and stockholders equity...............

$117,100

Chapter 3

Accrual Accounting and Income

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(5-10 min.) S 3-16


CLOSING ENTRIES
Thousands
Mar. 31

31

Net Revenues .
Retained Earnings.......

175,500

Retained Earnings.
Cost of Goods Sold.
All Other Expenses..

165,000

175,500

136,000
29,000

Retained Earnings
Mar. 31, 2012 Expenses

165,000 Mar. 31, 2011 Bal.

21,500

Mar. 31, 2012 Revenues

175,500

Mar. 31, 2012 Bal.

32,000

Retained Earnings ending balance agrees with the amount reported on the
statement of retained earnings and the balance sheet (in S 3-15).
(5 min.) S 3-17
(Dollars in thousands)
Req. 1
Net working capital
$33,700

Total current assets

$88,800

- Total current liabilities


-

$55,100

Req. 2
Current ratio

3-12

Total current assets


Total current liabilities

Financial Accounting 9/e Solutions Manual

$88,800
$55,100

1.61

Req. 3
Debt ratio

Total liabilities
Total assets

$62,600
$117,100

0.53

Req. 4
Net working capital of $33,700 means current assets exceed current liabilitiesa
positive sign. The current ratio and debt ratio values are strong.
(10 min.) S 3-18
1.

2.

Earned revenue of $10,000 on account:


a.

Net working capital = $43,700

[($88,800 + $10,000)- $55,100]

b.

Current ratio

$98,800
$55,100

1.79

c.

Debt ratio

$62,600
$127,100 ($117,100 +$10,000)

0.49

Paid accounts payable of $10,000:


a. Net working capital = $33,700 [($88,800 - $10,000) - ($55,100- $10,000)]
b.

Current ratio

$78,800
$45,100

1.74

c.

Debt ratio

$52,600 ($62,600 - $10,000)


$107,100 ($117,100 -$10,000)

0.49

Chapter 3

Accrual Accounting and Income

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