ACCT 210 Homework Chapter 5, Fall 2012

© The McGraw-Hill Companies, Inc., 2010 Overview CHAPTER 5 THE ACCOUNTING CYCLE: REPORTING FINANCIAL RESULTS Brief Learning Exercises Topic Objectives Skills B. Ex. 5.1 Balancing the accounting equation 1, 2 Analysis B. Ex. 5.2 Financial statement relationships 1, 2 Analysis B. Ex. 5.3 Classifying balance sheet accounts 1, 2 Analysis B. Ex. 5.4 Closing temporary accounts 4 Analysis B. Ex. 5.5 Closing entries of profitable firms 4 Analysis B. Ex. 5.6 Closing entries of unprofitable firms 4 Analysis B. Ex. 5.7 After-closing trial balance 5 Analysis B. Ex. 5.8 Profitability and liquidity measures 6 Analysis B. Ex. 5.9 Measuring interim revenue 7 Analysis B. Ex. *5.10 The worksheet 8 Learning Exercises Topic Objectives Skills 5.1 Accounting terminology 1-7 Analysis 5.2 Financial statement preparation 1, 2, 6 Analysis 5.3 Financial statement preparation 1, 2, 6 Analysis 5.4 2, 4, 5 Analysis, communication 5.5 2, 4, 5 Analysis, communication 5.6 3 Analysis, communication 5.7 Closing entries of profitable firms 2, 4 Analysis 5.8 Closing entries of unprofitable firms 2, 4 Analysis 5.9 Adjusting versus closing entries 2, 4 Analysis, communication 5.10 6 Analysis 5.11 6 Analysis 5.12 Interim results 1, 2, 7 Analysis 5.13 Interim results 1, 2, 7 Analysis 5.14 Effects of accounting errors 2, 3 Analysis 5.15 3, 6 Communication, analysis OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS AND CRITICAL THINKING CASES Judgment, communication, analysis Closing and after-closing trial balance Closing and after-closing trial balance Real World: Cathay Pacific Adequate Disclosure Profitability and liquidity measures Profitability and liquidity measures Real World: adidas AG Using an annual report © The McGraw-Hill Companies, Inc., 2010 Overview Real World: adidas AG Using an annual report *Supplemental Topic, "The Worksheet." © The McGraw-Hill Companies, Inc., 2010 Overview (p.2) Problems Learning Sets A, B Topic Objectives Skills 5.1 A,B Correcting classification errors 1, 2, 4, 6 Analysis, communication 5.2 A,B 1, 2, 4-6 Analysis, communication 5.3 A,B 1-4, 6 Analysis, communication 5.4 A,B Interim financial statements 1, 2, 7 Analysis, communication 5.5 A,B 1–4, 6 Analysis, communication 5.6 A,B 1–4, 6 Analysis, communication *5.7 A,B 8 Analysis, communication 5.8 A,B 6 Analysis, communication Critical Thinking Cases 5.1 Adequate disclosure 3 Analysis, communication 5.2 Conflicts of interest 1 (Ethics, fraud & corporate governance) 5.3 3 5.4 Real World: Ford Motor Company 3 Annual report disclosures (Internet) Statement preparation and closing process of a profitable firm Statement preparation and closing process of an unprofitable firm Comprehensive problem combining Chapter 4 and Chapter 5 Comprehensive problem combining Chapter 4 and Chapter 5 Comprehensive problem combining Chapter 4 and Chapter 5 Real World: Capcom/Carrefour Evaluating profitability and liquidity Communication, judgment, analysis, research Sarbanes-Oxley Act: CEO and CFO personal certifications Analysis, judgment, communication *Supplemental Topic, "The Worksheet." © The McGraw-Hill Companies, Inc., 2010 Overview Desc. DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES Problems (Sets A and B) 5.1 A,B Party Wagon Limited/Strong Knot Limited 20 Easy 5.2 A,B Lawn Pride Limited/Garden Wizards 30 Medium 5.3 A,B Mystic Masters Limited/Debit Doctors Limited 45 Strong 5.4 A,B Guardian Insurance Agency/Silver Real Estate 25 Easy 5.5 A,B Silver Lining Limited/Next Job Limited 70 Strong 5.6 A,B Brushstroke Art Studio/Touchtone Talent Agency 70 Strong *5.7 A,B Internet Consulting Service Limited/Campus Theater 50 Strong 5.8 A,B Capcom Co., Ltd/Carrefour 15 Medium Below are brief descriptions of each problem and case. These descriptions are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially filled-in working papers. Students are required to correct errors in a set of financial statements. Upon completion of the corrected financial statements, closing entries and a brief financial analysis are required. Students are required to prepare a set of financial statements for a profitable company from an adjusted trial balance. Closing entries, an after-closing trial balance, and a brief financial analysis are also required. Students are required to prepare a set of financial statements for an unprofitable company from an adjusted trial balance. Closing entries, an after-closing trial balance, and a brief financial analysis are also required. Interim financial statements are required for a company that adjusts monthly, but closes at year-end. This problem generates good class discussion. This is a comprehensive problem that requires students to combine Chapter 4 material with that of Chapter 5. An unadjusted trial balance is presented. Students are required to prepare adjusting entries and an adjusted trial balance. From their adjusted trial balance they are asked to prepare a set of financial statements, closing entries, an after-closing trial balance, and a brief financial analysis. This is a comprehensive problem combining elements of Chapter 4 and Chapter 5. It is similar in format to Problem 5.5 A,B. This is a comprehensive problem that requires students to combine Chapter 4 material with that of Chapter 5. From an unadjusted trial balance, students are asked to complete a 10-column worksheet. Information from an actual annual report is used to evaluate profitability and solvency. © The McGraw-Hill Companies, Inc., 2010 Overview Desc. *Supplemental Topic, "The Worksheet." © The McGraw-Hill Companies, Inc., 2010 Desc. of Prob & Cases Critical Thinking Cases 5.1 Adequate Disclosure 25 Strong 5.2 Working for the Competition No time estimate Ethics, Fraud & Corporate Governance 5.3 Sarbanes-Oxley Act and CEO/CFO Certifications 5 Easy Students are asked to analyze five items that may (or may not) require disclosure in the notes accompanying the financial statements. Students must defend their position. This is a group assignment focusing on the following issues: "Is it ethical for a CPA to provide accounting services to companies that compete with each other?" Interviews are required. Working in groups, students are required to discuss the meaning, purpose, and impact of CEO/CFO personal certifications required under the Sarbanes-Oxley Act. © The McGraw-Hill Companies, Inc., 2010 Q1-6 SUGGESTED ANSWERS TO DISCUSSION QUESTIONS 1. 2. 3. 4. 5. 6. An annual report generally includes comparative financial statements, supporting information about the company’s financial position, its business operations, and a discussion by management concerning the company’s future prospects. Before the annual report is issued, the financial statements must be audited by a firm of Certified Public Accountants (CPAs). Publicly owned companies must file their financial statements and detailed supporting schedules with the Securities and Exchange Commission (SEC). The income statement’s measurement of profit is not absolutely accurate or precise due to various assumptions and estimates involved in the accounting process. For instance, the amounts shown for depreciation expense are based upon estimates of the useful lives of the company’s depreciable assets. Also, the income statement includes only those events that have been evidenced by actual business transactions. For instance, a strong customer base is an important step toward profitable operations; however the development of a customer base is not reflected in the income statement because its value cannot be measured objectively until actual sales transactions take place. Retained earnings is that portion of shareholders’ equity created by earning income and retaining all or part of the resources created in the business. Profit is a function of revenue less expenses. We have learned that cash is not always received at the exact time that revenue is earned, nor is cash necessarily disbursed at the exact time that an expense is incurred. Thus, the profit retained by a company is not in the form of cash. Even if a company’s profit did equal its net cash inflow, the amount retained would not be kept in the form of cash. As the company grew, the cash would be converted into property, plant, equipment, and other assets. Dividends are not part of income. As such, the dividends paid to shareholders are never reported in the income statement as an expense. Dividends represent a policy decision by a corporation’s directors to distribute a portion of income to shareholders. The income statement, statement of changes in equity, and balance sheet are prepared directly from the amounts shown in the adjusted trial balance. The income statement reports revenue earned during the period less expenses incurred in generating that revenue. When revenue exceeds expenses, profit is reported, and an increase in shareholders’ equity results. When expenses exceed revenue, a net loss is reported, and a decrease in shareholders’ equity results. The profit (or net loss) from the income statement is added to the beginning Retained Earnings balance in the statement of changes in equity. Any dividends declared during the period are subtracted in arriving at the ending Retained Earnings balance to be reported in the balance sheet at the end of the period. Items that may require disclosure include, but are not limited to: pending lawsuits, scheduled plant closings, certain governmental investigations, significant events occurring after the balance sheet date but before the statements are issued, specific customers that account for a large portion of the company’s business, names of shareholders that own large amounts of the company’s shares, any changes in accounting principles having a significant impact on the company’s financial position, and any unusual conflicts between the company and its officers. © The McGraw-Hill Companies, Inc., 2010 Q7-15 7. 8. 9. 10. 11. 12. 13. 14. 15. Temporary (or nominal) accounts include revenue, expenses, and dividend accounts. These are the accounts involved in the closing process at the end of the year. Generally speaking, all income statement accounts (and dividends reported in the statement of changes in equity) are considered temporary. Permanent (or real) accounts include assets, liability, and shareholders’ equity accounts. These accounts are not involved in the closing process at the end of the year. Generally speaking, all accounts reported in the balance sheet (and in the after-closing trial balance) are considered permanent. Dividends paid to shareholders are not considered an expense of the business and, therefore, are not taken into account in determining profit for the period. Since dividends are not an expense, the Dividends account is not closed to the Income Summary account. Instead, it is closed directly to the Retained Earnings account. After all revenue, expense, and dividend accounts have been closed, the only accounts that remain are the permanent (or real) accounts appearing in the balance sheet. In comparison to the adjusted trial balance, the after-closing trial balance contains only balance sheet accounts. Also, the Retained Earnings account is no longer reported at its beginning balance. A company can be both profitable and insolvent. For instance, the company’s sales might be made only on account. If customers delay in paying what they owe, the average number of days that accounts receivable remain outstanding could be very high (say, 120 days). At the same time, the company’s creditors may require payment at a much faster rate, say, 30 days. Thus even though this business might be profitable (i.e., its revenue exceed its expenses), it may not be able to remain solvent if its accounts receivable fail to convert to cash in time to settle its accounts payable. A company may close its accounts annually, but prepare financial reports monthly or quarterly. These monthly (or quarterly) statements are referred to as interim financial statements. General ledger accounts to be reported in the interim income statement require certain computations in order to determine their correct monthly or quarterly amounts. Computations are not required to ascertain interim balance sheet amounts because the balance is always based on the account balances at the balance sheet date. Adequate disclosure means that financial statements should include whatever supplemental information is necessary for an intelligent user to interpret the statements properly. The notes accompanying financial statements include whatever disclosures are necessary for users to interpret the statements properly. Among the facts disclosed in notes are the accounting methods in use, due dates of major liabilities, significant events occurring after the balance sheet date, and litigation pending against the company. The notes do not include disclosure of items that are immaterial, or which do not directly affect the financial position of the business. Unlike most other operating expenses, depreciation does not require regular periodic outlays of cash. Depreciation is merely an estimate of that portion of a depreciable asset’s cost which is to be matched against revenue earned during the current accounting period. © The McGraw-Hill Companies, Inc., 2010 Q16-20 16. 17. 18. 19. *20. A worksheet (or spreadsheet software): * * * Revenue, expense, and dividend accounts are called temporary accounts, or nominal accounts, because they accumulate the transactions of only one accounting period. At the end of the period, the changes in equity accumulated in these temporary accounts need to be transferred to the Retained Earnings account, and the temporary accounts need to have zero balances in order to be ready to measure the revenue, expenses, and dividends of the next accounting period. The closing process serves these purposes. Revenue and expense accounts are first closed to the Income Summary account which, in turn, is closed to the Retained Earnings account. Any dividends declared during the period are then closed directly to the Retained Earnings account. Virtually every accounting software package performs the year-end closing process automatically without having to perform manually the series of journal entries illustrated in the text. When a business first purchases a software package accountants prepare a chart of accounts specifically tailored for the reporting needs of the company. During this process, revenue and expense accounts are identified as candidates for closing at year-end. The software is written such that those accounts identified as revenues are closed with debits, and those identified as expenses are closed with credits. Income statements report business activity for a period of time (e.g., a month, quarter, year, etc.). Balance sheets report financial position at a specific point in time. Thus, the balance sheet always is based on account balances at the balance sheet date. A March 31 balance sheet, for example, looks exactly the same regardless of the time period covered by the other financial statements (i.e., the income statement, statement of changes in equity, and statement of cash flows). Return on equity is a measure of profit relative to a company's average stockholders' equity throughout the year. Thus, it conveys the amount of income generated for every dollar of equity capital. A high return on equity indicates that management efficiently used resources provided through equity to generate income. A low return on equity indicates that management was not efficient in using resources provided through equity to generate income. Provides a “scratch pad” for working out adjusting entries prior to actually entering these items in the accounts. Enables accountants to prepare interim financial statements without formally adjusting and closing the accounts. Without affecting the account balances, provides both accountants and management with a “preview” of the effects of proposed entries upon the financial statements. *Supplemental Topic, "The Worksheet." © The McGraw-Hill Companies, Inc., 2010 BE5.1-4 SOLUTIONS TO BRIEF EXERCISES B. Ex. 5.1 Decrease in assets during the year………………….. $ (60,000) Decrease in liabilities during the year………………. (300,000) Increase in shareholders' equity during the year…… $ 240,000 Less: New shares issued during the year…………… (100,000) Profit for the year…………………………….. (250,000) Decrease to equity attributed to dividends…………. $ (110,000) B. Ex. 5.2 Share capital (January 1, 2009)……………………. $ 200,000 New shares issued during the year……………… 60,000 Share capital (December 31, 2009)……………….. $ 260,000 Add: Retained earnings (December 31, 2009)…… 90,000 Total shareholders' equity (December 31, 2009)…. $ 350,000 B. Ex. 5.3 a. CA b. CL c. CL d. NCA* e. SHE f. LTL g. CL h. CA i. NCA j. CA B. Ex. 5.4 a. C b. N c. D d. C e. C f. N g. D h. N i. C j. N Note: The depreciation of the truck is included in the profit which is included in the ending retained earnings given. Likewise, the dividend is also included in the ending retained earnings figure given. * Accumulated depreciation is a contra asset classified in the non current asset section of the balance sheet. © The McGraw-Hill Companies, Inc., 2010 BE5.1-4 k. D l. C © The McGraw-Hill Companies, Inc., 2010 BE5.5-6 B. Ex. 5.5 Service Revenue …………………………………………………… 19,800 Income Summary ………………………… 19,800 To close revenue to income summary. Income Summary……………………….…………………….. 18,700 Supplies Expense…………………………… 525 Rent Expense……………………………… 3,660 Depreciation Expense: Equipment……… 1,200 Salaries Expense………………………….. 12,700 Income Taxes Expense………………….. 615 To close expense accounts to income summary. Income Summary……………………………………………. 1,100 Retained Earnings………………………… 1,100 To transfer profit to retained earnings. Retained Earnings…………………………………………… 600 Dividends………………………………….. 600 To close dividends to retained earnings. B. Ex. 5.6 Consulting Fees Earned……………………………………. 26,000 Interest Revenue…………………………………………… 300 Income Summary………………………….. 26,300 To close revenue to income summary. Income Summary…………………………………………….. 34,700 Insurance Expense……………………….. 1,900 Rent Expense…………………………….. 10,800 Depreciation Expense: Office Equip. ….. 5,600 Salaries Expense………………………….. 16,400 To close expense accounts to income summary. Retained Earnings……………………………………………. 8,400 Income Summary………………………….. 8,400 To transfert loss to income summary. Retained Earnings………………………………………….. 400 Dividends………………………………….. 400 To close dividends to retained earnings. © The McGraw-Hill Companies, Inc., 2010 BE5.7-10 B. Ex. 5.7 a. C b. C c. D d. N e. C f. N g. N h. C i. D j. N k. C l. C B. Ex. 5.8 a. Profit ($15,000) ÷ Total Revenue ($60,000)…. 25% b. Profit ($15,000) ÷ Average Equity ($37,500)…. 40% c. 4-to-1 Computations: Total revenue………………………………… 60,000 Total expenses………………………………. $ (45,000) Profit…………………………………… 15,000 Shareholders' equity (January 1, 2009)…………… $ 37,000 Shareholders' equity (December 31, 2009)………. 38,000 75,000 ÷ 2 Average shareholders' equity in 2009 37,500 B. Ex. 5.9 a. April through September ($450,000 - $140,000)…. $ 310,000 b. October through December ($680,000 - $450,000).. $ 230,000 c. April through December ($680,000 - $140,000)…… $ 540,000 *B. Ex.5.10a. Profit ($540,000 - $410,000)………………… $ 130,000 1 b. Income statement debits ($380,000 - $130,000)…. $ 250,000 2 1 2 Current Assets ($16,000) ÷ Current Liab. ($4,000) The amount needed to make the columns of the balance sheet equal is profit for the period. The credit column of the income statement represents total revenue whereas the debit column amount represents total expenses. Thus, total revenue ($380,000 credit column amount) minus profit ($130,000 computed in part a.), equals total expenses (i.e., the income statement debit column total). © The McGraw-Hill Companies, Inc., 2010 BE5.7-10 The credit column of the income statement represents total revenue whereas the debit column amount represents total expenses. Thus, total revenue ($380,000 credit column amount) minus profit ($130,000 computed in part a.), equals total expenses (i.e., the income statement debit column total). *Supplemental Topic, "The Worksheet." © The McGraw-Hill Companies, Inc., 2010 E5.1,2 SOLUTIONS TO EXERCISES Ex 5.1 a. Adequate disclosure b. Liquidity c. Nominal accounts d. Real accounts e. After-closing trial balance f. Dividends g. Closing entries h. None (This is an example of a "correcting entry.") Ex. 5.2 a. TUTORS FOR RENT LIMITED Income Statement For the Year Ended December 31, 2009 Revenues: Tutoring revenue earned $ 96,000 Expenses: Salary expense $ 52,000 Supply expense 1,200 Advertising expense 300 Depreciation expense: equipment 1,000 54,500 Profit before taxes $ 41,500 Income taxes expense 11,600 Profit $ 29,900 TUTORS FOR RENT LIMITED Statement of Changes in Equity For the Year Ended December 31, 2009 Retained earnings (1/1/09) $ 45,000 Add: Profit 29,900 Less: Dividends 2,000 Retained earnings (12/31/09) $ 72,900 © The McGraw-Hill Companies, Inc., 2010 E5.2 (p.2) Ex. 5.2 (concluded) TUTORS FOR RENT LIMITED Balance Sheet December 31, 2009 Assets Cash $ 91,100 Accounts receivable 4,500 Supplies 300 Equipment $ 12,000 Less: Accumulated depreciation: equipment 5,000 7,000 TOTAL ASSETS $ 102,900 Liabilities Accounts payable $ 1,500 Income taxes payable 3,500 TOTAL LIABILITIES $ 5,000 Shareholders' Equity Share capital $ 25,000 Retained earnings 72,900 TOTAL SHAREHOLDERS' EQUITY $ 97,900 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 102,900 b. c. The company appears to be extremely liquid. Cash and accounts receivable comprise 93% of total assets. Together, these highly liquid assets total $95,600, compared to only $5,000 in liabilities coming due. In other words, the combined total of cash and accounts receivable are 19 times the obligations coming due in the near future. The $45,000 credit Retained Earnings balance reported in the company’s adjusted trial balance is its beginning balance. In order to have retained $45,000 in earnings, the company must have been profitable in the past. © The McGraw-Hill Companies, Inc., 2010 E5.3 Ex. 5.3 a. WILDERNESS GUIDE SERVICES LIMITED Income Statement For the Year Ended December 31, 2009 Revenues: Guide revenue earned $ 102,000 Expenses: Salary expense $ 87,500 Camping supply expense 1,200 Insurance expense 9,600 Depreciation expense: equipment 5,000 Interest expense 1,700 105,000 Loss $ (3,000) WILDERNESS GUIDE SERVICES LIMITED Statement of Changes in Equity For the Year Ended December 31, 2009 Retained earnings (1/1/09) $ 15,000 Less: Loss 3,000 Less: Dividends 1,000 Retained earnings (12/31/09) $ 11,000 © The McGraw-Hill Companies, Inc., 2010 E5.3 (p.2) Ex. 5.3 (Concluded) WILDERNESS GUIDE SERVICES LIMITED Balance Sheet December 31, 2009 Assets Cash $ 12,200 Accounts receivable 31,000 Camping supplies 7,900 Unexpired insurance policies 2,400 Equipment $ 70,000 Less: Accumulated depreciation: equipment 60,000 10,000 TOTAL ASSETS $ 63,500 Liabilities Notes payable (due 4/1/10) $ 18,000 Accounts payable 9,500 TOTAL LIABILITIES $ 27,500 Shareholders' Equity Share capital $ 25,000 Retained earnings 11,000 TOTAL SHAREHOLDERS' EQUITY $ 36,000 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 63,500 b. c. The company appears to be liquid. Cash and accounts receivable comprise 68% of the company’s total assets. These highly liquid assets total $43,200, in comparison to $27,500 in liabilities coming due in the near future. However, given that its equipment is nearly fully depreciated, it may have to invest in new equipment shortly. The company was not profitable in the current period as evidenced by the $3,000 net loss reported in the income statement. However, the $15,000 credit Retained Earnings balance reported in the company’s adjusted trial balance is the balance carried forward from prior years. In order to have retained $15,000 in earnings, the company must have been profitable in the past. © The McGraw-Hill Companies, Inc., 2010 E5.4 Ex. 5.4 a. TUTORS FOR RENT General Journal December 31, 2009 (1) Dec. 31 Tutoring Revenue earned 96,000 Income Summary 96,000 To close Tutoring Revenue Earned (2) 31 Income Summary 66,100 Salary Expense 52,000 Supply Expense 1,200 Advertising Expense 300 Depreciation Expense: Equipment 1,000 Income Taxes Expense 11,600 To close all expense accounts. (3) 31 Income Summary 29,900 Retained Earnings 29,900 To transfer profit earned in 2009 to the Retained Earnings account ($96,000-$66,100 = $29,900). (4) 31 Retained Earnings 2,000 Dividends 2,000 To transfer dividends declared in 2009 to the Retained Earnings account. © The McGraw-Hill Companies, Inc., 2010 E5.4 (p.2) Ex. 5.4 (Concluded) b. TUTORS FOR RENT LIMITED After-Closing Trial Balance December 31, 2009 Cash $ 91,100 Accounts receivable 4,500 Supplies 300 Equipment 12,000 Less: Accumulated depreciation: equipment $ 5,000 Accounts payable 1,500 Income taxes payable 3,500 Share capital 25,000 Retained earnings $ 72,900 Totals $ 107,900 $ 107,900 c. The $72,900 Retained Earnings balance reported in the after-closing trial balance is $27,900 more than the $45,000 balance reported in the unadjusted trial balance. By adding profit to the Retained Earnings balance in the unadjusted trial balance, and subtracting dividends, one arrives at the $72,900 reported in the after-closing trial balance ($45,000 + $29,900 - $2,000 = $72,900). © The McGraw-Hill Companies, Inc., 2010 E5.5 Ex. 5.5 a. WILDERNESS GUIDE SERVICES LIMITED General Journal December 31, 2009 (1) Dec. 31 Guide Revenue Earned 102,000 Income Summary 102,000 To close Guide Revenue Earned. (2) 31 Income Summary 105,000 Salary Expense 87,500 Camping Supply Expense 1,200 Insurance Expense 9,600 Depreciation Expense: Equipment 5,000 Interest Expense 1,700 To close all expense accounts. (3) 31 Retained Earnings 3,000 Income Summary 3,000 To transfer loss incurred in 2009 to the Retained Earnings account ($102,000 - $105,000 = $3,000 loss). (4) 31 Retained Earnings 1,000 Dividends 1,000 To transfer dividends declared in 2009 to the Retained Earnings account. © The McGraw-Hill Companies, Inc., 2010 E5.5 (p.2) Ex. 5.5 (Concluded) b. WILDERNESS GUIDE SERVICES LIMITED After-Closing Trial Balance December 31, 2009 Cash $ 12,200 Accounts receivable 31,000 Camping supplies 7,900 Unexpired insurance policies 2,400 Equipment 70,000 Accumulated depreciation: equipment $ 60,000 Notes payable (due 4/1/10) 18,000 Accounts payable 9,500 Share capital 25,000 Retained earnings 11,000 Totals $ 123,500 $ 123,500 c. The $11,000 Retained Earnings balance reported in the after-closing trial balance is $4,000 less than the $15,000 balance reported in the unadjusted trial balance. By subtracting both the net loss and dividends from the Retained Earnings balance in the unadjusted trial balance, one arrives at the $11,000 reported in the after-closing trial balance ($15,000 - $3,000 - $1,000 = $11,000). © The McGraw-Hill Companies, Inc., 2010 E5.6 Ex. 5.6 a. 1. 2. 3. 4. b. 1. Cash……………………………………………… 500 Unearned Transportation Revenue…………………… 500 To record the sale of a $500 air ticket. 2. 500 Sales (Revenue)……………………… 500 To record the redemption of a $500 air ticket. c. Cathay Pacific recognizes revenue when the transportation service is provided to customers. This means that revenue is recorded at the time customers receive their service. The earnings process is not complete when the company first receives cash for gift cards. This is because no services have been delivered. Thus, as gift cards are sold, the company debits Cash and credits Unearned Transportation Revenue. As customers use their tickets, the company debits Unearned Transportation Revenue and credits Revenue (Sales). The company records replacement and maintenance cost in the period that it consumes and incurs. Thus, when it pays for maintenance it debits Maintenance Cost and credits Cash. The company matches the cost of fixed assets to the periods in which it contributes to generating revenue. It does so by dividing the cost of fixed assets by its anticipated life and charging the result to depreciation expense each period. Unearned Transportation Revenue………………………… Cathay Pacific matches labor cost to revenue in the period that it pays for wages and salary. The alternative would be to debit Other receivables and Prepayments when payment is made, and later debit labor cost and credit Other receivables and Prepayments when labor cost is incurred. Differences in these two alternatives are not considered material, so Cathay Pacific takes the simpler approach of expensing labor costs immediately. © The McGraw-Hill Companies, Inc., 2010 E5,7 Ex. 5.7 a. Counseling Revenue………………………………………… 225,000 Income Summary…………………………………… 225,000 To close counseling revenue earned. Close all expenses to the Income summary account: Income Summary……………………………………………… 170,400 Advertising Expense……………………………… 1,800 Salaries Expense……………………………………… 94,000 Office Supplies Expense………………………… 1,200 Utilities Expense……………………………………… 850 Malpractice Insurance Expense…………………… 6,000 Office Rent Expense…………………………………. 24,000 Continuing Education Expense………………… 2,650 Depreciation Expense: Fixtures…………………… 4,500 Miscellaneous Expense…………………………… 6,000 Income Taxes Expense…………………………… 29,400 To close all expense accounts. Income Summary………………………………………… 54,600 Retained Earnings………………………………… 54,600 Retained Earnings………………………………………… 6,000 Dividends…………………………………………….. 6,000 b. Retained Earnings, January 1, 2009 $ 92,000 Plus: Profit 54,600 $ 146,600 Less: Dividends Declared in 2009 (6,000) Retained Earnings, December 31, 2009 $ 140,600 To transfer profit earned in 2009 ($225,000 - $170,400) to Retained Earnings. To close dividends declared in 2009 to Retained Earnings. © The McGraw-Hill Companies, Inc., 2010 E5.8,9 Ex. 5