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CHAPTER 1
Accounting in Action
ASSIGNMENT CLASSIFICATION TABLE
Study Objectives Questions
Brief Exercises Exercises
A Problems
B Problems
- Explain what accounting is.
1, 2, 5 1
- Identify the users and uses of accounting.
3, 4 2
- Understand why ethics is a fundamental business concept.
3
- Explain generally accepted accounting principles and the cost principle.
6 4
- Explain the monetary unit assumption and the economic entity assumption.
7, 8, 9, 10 4
- State the accounting equation, and define assets, liabilities, and owner’s equity.
11, 12, 13 1, 2, 3, 4 5, 6, 7, 11 1A, 2A 4A
1B, 2B 4B
- Analyze the effects of business transactions on the accounting equation.
14, 15, 16, 18
5, 6, 7, 8 6, 7, 8, 10, 11
1A, 2A, 4A, 5A
1B, 2B, 4B, 5B
- Understand the four financial statements and how they are prepared.
17, 19, 20, 21
9, 10 9, 12, 13, 14, 15, 16
2A, 3A, 4A, 5A
2B, 3B, 4B, 5B
ASSIGNMENT CHARACTERISTICS TABLE
Problem Number Description
Difficulty Level
Time Allotted (min.)
1A Analyze transactions and compute net income. Moderate 40–
2A Analyze transactions and prepare income statement, owner’s equity statement, and balance sheet.
Moderate 50–
3A Prepare income statement, owner’s equity statement, and balance sheet.
Moderate 50–
4A Analyze transactions and prepare financial statements. Moderate 40–
5A Determine financial statement amounts and prepare owner’s equity statement.
Moderate 40–
1B Analyze transactions and compute net income. Moderate 40–
2B Analyze transactions and prepare income statement, owner’s equity statement, and balance sheet.
Moderate 50–
3B Prepare income statement, owner’s equity statement, and balance sheet.
Moderate 50–
4B Analyze transactions and prepare financial statements. Moderate 40–
5B Determine financial statement amounts and prepare owner’s equity statement.
Moderate 40–
ANSWERS TO QUESTIONS
1. Yes, this is correct. Virtually every organization and person in our society uses accounting information. Businesses, investors, creditors, government agencies, and not-for-profit organizations must use accounting information to operate effectively. 2. Accounting is the process of identifying, recording, and communicating the economic events of an organization to interested users of the information. The first step of the accounting process is therefore to identify economic events that are relevant to a particular business. Once identified and measured, the events are recorded to provide a history of the financial activities of the organization. Recording consists of keeping a chronological diary of these measured events in an orderly and systematic manner. The information is communicated through the preparation and distribution of accounting reports, the most common of which are called financial statements. A vital element in the communication process is the accountant’s ability and responsibility to analyze and interpret the reported information. 3. (a) Internal users are those who plan, organize, and run the business and therefore are officers and other decision makers. (b) To assist management, accounting provides internal reports. Examples include financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year. 4. (a) Investors (owners) use accounting information to make decisions to buy, hold, or sell stock. (b) Creditors use accounting information to evaluate the risks of granting credit or lending money. 5. Bookkeeping usually involves only the recording of economic events and therefore is just one part of the entire accounting process. Accounting, on the other hand, involves the entire process of identifying, recording, and communicating economic events. 6. Karen Sommers Travel Agency should report the land at $90,000 on its December 31, 2008 balance sheet. An important concept that accountants follow is the cost principle. The cost principle states that assets should be recorded at their cost. Cost has an important advantage over other valuations: it is reliable. Cost can be objectively measured and can be verified. 7. The monetary unit assumption requires that only transaction data capable of being expressed in terms of money be included in the accounting records. This assumption enables accounting to quantify (measure) economic events. 8. The economic entity assumption requires that the activities of the entity be kept separate and distinct from the activities of its owners and all other economic entities. 9. The three basic forms of business organizations are: (1) proprietorship, (2) partnership, and (3) corporation.
Questions Chapter 1 (Continued)
- One of the advantages Maria Gonzalez would enjoy is that ownership of a corporation is repre- sented by transferable shares of stock. This would allow Maria to raise money easily by selling a part of her ownership in the company. Another advantage is that because holders of the shares (stockholders) enjoy limited liability, they are not personally liable for the debts of the corporate entity. Also, because ownership can be transferred without dissolving the corporation, the corporation enjoys an unlimited life.
- The basic accounting equation is Assets = Liabilities + Owner’s Equity.
- (a) Assets are resources owned by a business. Liabilities are claims against assets. Put more simply, liabilities are existing debts and obligations. Owner’s equity is the ownership claim on total assets. (b) Owner’s equity is affected by owner’s investments, drawings, revenues, and expenses.
- The liabilities are: (b) Accounts payable and (g) Salaries payable.
- Yes, a business can enter into a transaction in which only the left side of the accounting equation is affected. An example would be a transaction where an increase in one asset is offset by a decrease in another asset. An increase in the Equipment account which is offset by a decrease in the Cash account is a specific example.
- Business transactions are the economic events of the enterprise recorded by accountants because they affect the basic equation. (a) The death of the owner of the company is not a business transaction as it does not affect the basic equation. (b) Supplies purchased on account is a business transaction as it affects the basic equation. (c) An employee being fired is not a business transaction as it does not affect the basic equation. (d) A withdrawal of cash from the business is a business transaction as it affects the basic equation.
- (a) Decrease assets and decrease owner’s equity. (b) Increase assets and decrease assets. (c) Increase assets and increase owner’s equity. (d) Decrease assets and decrease liabilities.
- (a) Income statement. (d) Balance sheet. (b) Balance sheet. (e) Balance sheet and owner’s equity statement. (c) Income statement. (f) Balance sheet.
- No, this treatment is not proper. While the transaction does involve a receipt of cash, it does not represent revenues. Revenues are the gross increase in owner’s equity resulting from business activities entered into for the purpose of earning income. This transaction is simply an additional investment made by the owner in the business.
- Yes. Net income does appear on the income statement—it is the result of subtracting expenses from revenues. In addition, net income appears in the statement of owner’s equity—it is shown as an addition to the beginning-of-period capital. Indirectly, the net income of a company is also included in the balance sheet. It is included in the capital account which appears in the owner’s equity section of the balance sheet.
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 1-
(a) $90,000 – $50,000 = $40,000 (Owner’s Equity). (b) $40,000 + $70,000 = $110,000 (Assets). (c) $94,000 – $60,000 = $34,000 (Liabilities).
BRIEF EXERCISE 1-
(a) $120,000 + $232,000 = $352,000 (Total assets). (b) $190,000 – $80,000 = $110,000 (Total liabilities). (c) $800,000 – 0.5($800,000) = $400,000 (Owner’s equity).
BRIEF EXERCISE 1-
(a) ($800,000 + $150,000) – ($500,000 – $80,000) = $530, (Owner’s equity). (b) ($500,000 + $100,000) + ($800,000 – $500,000 – $70,000) = $830, (Assets). (c) ($800,000 – $80,000) – ($800,000 – $500,000 + $120,000) = $300, (Liabilities).
BRIEF EXERCISE 1-
A (a) Accounts receivable A (d) Office supplies L (b) Salaries payable OE (e) Owner’s investment A (c) Equipment L (f) Notes payable
BRIEF EXERCISE 1-
Assets Liabilities Owner’s Equity (a) + + NE (b) + NE + (c) – NE –
BRIEF EXERCISE 1-
Assets Liabilities Owner’s Equity (a) + NE + (b) – NE – (c) NE NE NE
BRIEF EXERCISE 1-
E (a) Advertising expense D (e) Bergman, Drawing R (b) Commission revenue R (f) Rent revenue E (c) Insurance expense E (g) Utilities expense E (d) Salaries expense
BRIEF EXERCISE 1-
R (a) Received cash for services performed NOE (b) Paid cash to purchase equipment E (c) Paid employee salaries
BRIEF EXERCISE 1-
LOPEZ COMPANY
Balance Sheet December 31, 2008
Assets Cash ................................................................................................................ $ 49, Accounts receivable .................................................................................. 72, Total assets.......................................................................................... $121,
Liabilities and Owner’s Equity Liabilities Accounts payable .............................................................................. $ 90, Owner’s equity Kim Lopez, Capital............................................................................. 31, Total liabilities and owner’s equity ..................................... $121,
SOLUTIONS TO EXERCISES
EXERCISE 1-
C Analyzing and interpreting information. R Classifying economic events. C Explaining uses, meaning, and limitations of data. R Keeping a systematic chronological diary of events. R Measuring events in dollars and cents. C Preparing accounting reports. C Reporting information in a standard format. I Selecting economic activities relevant to the company. R Summarizing economic events.
EXERCISE 1-
(a) Internal users Marketing manager Production supervisor Store manager Vice-president of finance
External users Customers Internal Revenue Service Labor unions Securities and Exchange Commission Suppliers
(b) I Can we afford to give our employees a pay raise? E Did the company earn a satisfactory income? I Do we need to borrow in the near future? E How does the company’s profitability compare to other companies? I What does it cost us to manufacture each unit produced? I Which product should we emphasize? E Will the company be able to pay its short-term debts?
EXERCISE 1-
Larry Smith, president of Smith Company, instructed Ron Rivera, the head of the accounting department, to report the company’s land in their accounting reports at its market value of $170,000 instead of its cost of $100,000, in an effort to make the company appear to be a better investment. The cost principle requires that assets be recorded and reported at their cost, because cost is reliable and can be objectively measured and verified.
The stakeholders include stockholders and creditors of Smith Company, potential stockholders and creditors, other users of Smith’s accounting reports, Larry Smith, and Ron Rivera. All users of Smith’s accounting reports could be harmed by relying on information which violates accounting principles. Larry Smith could benefit if the company is able to attract more investors, but would be harmed if the fraudulent reporting is discovered. Similarly, Ron Rivera could benefit by pleasing his boss, but would be harmed if the fraudulent reporting is discovered.
Ron’s alternatives are to report the land at $100,000 or to report it at $170,000. Reporting the land at $170,000 is not appropriate since it would mislead many people who rely on Smith’s accounting reports to make finan- cial decisions. Ron should report the land at its cost of $100,000. He should try to convince Larry Smith that this is the appropriate course of action, but be prepared to resign his position if Smith insists.
EXERCISE 1-
- Incorrect. The cost principle^ requires that assets be recorded and reported at their cost.
- Correct. The monetary unit assumption^ requires that companies include in the accounting records only transaction data that can be expressed in terms of money.
- Incorrect. The economic entity assumption^ requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities.
EXERCISE 1-8 (Continued)
- Owner withdrew $2,000 cash for personal use.
- Paid $650 cash for rent.
- Collected $450 cash from customers on account.
- Paid salaries of $4,900.
- Incurred $500 of utilities expense on account.
(b) Investment ............................................................................................. $15, Service revenue ................................................................................... 8, Drawings................................................................................................. (2,000) Rent expense ........................................................................................ (650) Salaries expense.................................................................................. (4,900) Utilities expense................................................................................... (500) Increase in capital ............................................................................... $15,
(c) Service revenue ................................................................................... $8, Rent expense ........................................................................................ (650) Salaries expense.................................................................................. (4,900) Utilities expense................................................................................... (500) Net income............................................................................................. $2,
EXERCISE 1-
S. MOSES & CO.
Income Statement For the Month Ended August 31, 2008
Revenues Service revenue ................................................................... $8, Expenses Salaries expense.................................................................. $4, Rent expense ........................................................................ 650 Utilities expense................................................................... 500 Total expenses ............................................................ 6, Net income...................................................................................... $2,
EXERCISE 1-9 (Continued)
S. MOSES & CO. Owner’s Equity Statement For the Month Ended August 31, 2008
S. Moses, Capital, August 1 ................................................ $ 0 Add: Investments................................................................. $15, Net income................................................................... 2,250 17, 17, Less: Drawings ...................................................................... 2, S. Moses, Capital, August 31 .............................................. $15,
S. MOSES & CO.
Balance Sheet August 31, 2008
Assets Cash ................................................................................................................ $ 8, Accounts receivable .................................................................................. 3, Supplies ......................................................................................................... 750 Office equipment......................................................................................... 5, Total assets.......................................................................................... $17,
Liabilities and Owner’s Equity Liabilities Accounts payable .............................................................................. $ 2, Owner’s equity S. Moses, Capital................................................................................ 15, Total liabilities and owner’s equity ..................................... $17,
EXERCISE 1-
(a) Owner’s equity—12/31/07 ($400,000 – $250,000)..................... $150, Owner’s equity—1/1/07 .................................................................... 100, Increase in owner’s equity.............................................................. 50, Add: Drawings .................................................................................. 15, Net income for 2007 .......................................................................... $ 65,
EXERCISE 1-11 (Continued)
(d) Total owner’s equity (end of year).............................................. $130, Total owner’s equity (beginning of year) ................................. 80, Increase in owner’s equity............................................................ $ 50,
Total revenues .................................................................................. $100, Total expenses.................................................................................. 55, Net income ......................................................................................... $ 45,
Increase in owner’s equity................................... $50, Less: Net income ................................................... $(45,000) Additional investment .............................. (25,000) (70,000) Drawings .................................................................... $20,
EXERCISE 1-
LINDA STANLEY CO.
Income Statement For the Year Ended December 31, 2008
Revenues Service revenue.............................................................. $62, Expenses Salaries expense ............................................................ $30, Rent expense................................................................... 10, Utilities expense............................................................. 3, Advertising expense ..................................................... 1, Total expenses....................................................... 45, Net income ................................................................................ $17,
LINDA STANLEY CO.
Owner’s Equity Statement For the Year Ended December 31, 2008
Linda Stanley, Capital, January 1............................................................ $48, Add: Net income ......................................................................................... 17, 65, Less: Drawings............................................................................................. 6, Linda Stanley, Capital, December 31 ..................................................... $59,
EXERCISE 1-
MENDEZ COMPANY
Balance Sheet December 31, 2008
Assets Cash ................................................................................................................ $15, Accounts receivable.................................................................................. 8, Supplies......................................................................................................... 8, Equipment..................................................................................................... 46, Total assets ......................................................................................... $77,
Liabilities and Owner’s Equity Liabilities Accounts payable.............................................................................. $20, Owner’s equity Mendez, Capital ($67,500 – $10,000) ........................................... 57, Total liabilities and owner’s equity..................................... $77,
EXERCISE 1-
(a) Camping fee revenues ..................................................................... $140, General store revenues ................................................................... 50, Total revenue ............................................................................. 190, Expenses.............................................................................................. 150, Net income........................................................................................... $ 40,
(b) DEER PARK Balance Sheet December 31, 2008
Assets Cash ....................................................................................................... $ 23, Supplies................................................................................................ 2, Equipment............................................................................................ 105, Total assets ................................................................................ $131,
EXERCISE 1-16 (Continued)
- (a) Ending capital balance $198,
- Beginning capital balance................................................................................................ 168,
- Net income.......................................................................................................................... $ 30,
- (b) Ending capital balance $198,
- Beginning capital balance................................................................................................ 168,
- Deduct: Investment 13,
- Net income.......................................................................................................................... $ 17,
- (a) Total revenues ($20,000 + $70,000) $90,
- (b) Total expenses ($26,000 + $40,000)............................................................................. $66,
- (c) Total revenues $90,
- Total expenses................................................................................................................... 66,
- Net income.......................................................................................................................... $24,
- (b) Owner’s equity—12/31/08 ($460,000 – $300,000) $160,
- Owner’s equity—1/1/08—see (a)................................................. 150,
- Increase in owner’s equity 10,
- Less: Additional investment....................................................... 50,
- Net loss for 2008 $ 40,
- (c) Owner’s equity—12/31/09 ($590,000 – $400,000) $190,
- Owner’s equity—1/1/09—see (b) 160,
- Increase in owner’s equity 30,
- Less: Additional investment....................................................... 15,
- Add: Drawings 30,
- Net income for 2009........................................................................ $ 45,
- EXERCISE 1-
- (a) Total assets (beginning of year)................................................. $95,
- Total liabilities (beginning of year) 85,
- Total owner’s equity (beginning of year)................................. $10,
- (b) Total owner’s equity (end of year) $40,
- Total owner’s equity (beginning of year)................................. 10,
- Increase in owner’s equity $30,
- Total revenues.................................................................................. $215,
- Total expenses 175,
- Net income......................................................................................... $ 40,
- Increase in owner’s equity $30,
- Additional investment........................................... $14, Add: Drawings 24,000) (16,000)
- (c) Total assets (beginning of year)................................................. $129,
- Total owner’s equity (beginning of year)................................. 80,
- Total liabilities (beginning of year) $ 49,
- (a) Assets, January 1, 2008 $85, Supporting Computations
- Liabilities, January 1, 2008............................................................. 62,
- Capital, January 1, 2008 $23,
- (b) Legal service revenue...................................................................... $350,
- Total expenses 211,
- Net income........................................................................................... $139,
- (c) Assets, December 31, 2008 $168,
- Liabilities, December 31, 2008 85,
- Capital, December 31, 2008............................................................ $ 83,
1-
(a)
BARONE REPAIR SHOP
Cash
ReceivableAccounts
Supplies
Equipment
= PayableAccounts
N. Barone, Capital
- 1.
4,
4,
8,
6,
+$ 6,
+$630+–120+ 750+$
+$500+ 500+0000+ 500+0000+ 500+0000+ 500+0000+ 500+0000+ 500+0000+ 500+$
+$5,000+ 5,000+00,000+ 5,000+00,000+ 5,000+00,000+ 5,000+00,000+ 5,000+00,000+ 5,000+00,000+ 5,000+00,000+ 5,000+00,000+ 5,000+$5,
= = = = = = = = = = =
+$250+0250+0000+0250+0000+ 250+0000+ 250+0000+ 250+0000+ 250+$
- 10,000+000,000+ 10,000+$10,
9,
9,
+$12,060+ 12,
Service RevenueUtilities ExpenseSalaries ExpenseDrawingsService RevenueAdv. ExpenseRent ExpenseInvestment
$12,
$12,
PROBLEM 1-1A
SOLUTIONS TO PROBLEMS
