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Chapter 4: Income Measurement and Accrual Accounting

238. Agle Company purchased a dump truck at a cost of $48,000 on January 1, 2015. The truck has an estimated useful

life of 6 years and a $6,000 estimated residual value. Show how the truck and any related amounts would appear on the

December 31, 2016, balance sheet immediately after the adjustments are recorded and posted.

ANSWER:

Accumulated depreciation = ($48,000 – $6,000)/6 = $7,000 × 2 years = $14,000

Long-term Assets:

Dump truck

$ 48,000

Less Accumulated depreciation

(14,000)

$ 34,000

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-05 – LO: 04-05

KEYWORDS:

Bloom’s: Analyzing

239. Union Company purchased a delivery van at a cost of $30,000 cash on January 1, 2015. The van has an estimated

useful life of 6 years and a $6,000 estimated residual value.

A.

What is the effect on the accounting equation of the purchase of the van?

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net Income

B.

How much depreciation expense should be reported for 2016?

C.

What is the total amount of accumulated depreciation at December 31, 2016?

ANSWER:

A.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net Income

Van

30,000

Cash

(30,000)

B. $30,000 – $6,000)/6 = $4,000

C. $4,000 × 2 = $8,000

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.04-05 – LO: 04-05

KEYWORDS:

Bloom’s: Analyzing

240. Marcus Roberts operates a small retail establishment. The following unadjusted amounts were taken from Roberts’

accounting records at December 31, 2016:

Accumulated Depreciation

$ 5,000

Machinery

50,000

Prepaid Advertising

1,200

Determine the effect on the accounting equation of the adjusting entries at December 31, 2016, for each of the transactions

that follow:

A.

The advertising costs are for television commercials to be aired equally throughout

December, 2016, and January and February, 2017.

B.

The machinery had an original cost of $50,000 and was purchased during 2011. The

estimated useful life is 6 years with an estimated salvage value equal to $8,000. Roberts

uses the straight-line method of depreciation.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net Income

ANSWER:

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

A. Prepaid

Advertising

(400)

Advertising

Expense

400

(400)

B. Accum.

Deprec.

(7,000)

Deprec.

Expense

7,000

(7,000)

($50,000 – $8,000)/6)

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-05 – LO: 04-05

KEYWORDS:

Bloom’s: Analyzing

241. Quirin Corp. purchases office supplies once a month and prepares monthly financial statements. The asset account

Office Supplies on hand has a balance of $1,850 on March 1. Purchases of supplies during March amount to $1,500.

Supplies on hand at March 31 amount to $1,020. Prepare the necessary adjusting entry on Quirin’s books on March 31.

What will be the effect on net income for March if this entry is not recorded?

ANSWER:

March 31.

Office Supplies Expense

2,330

Office Supplies on Hand

2,330

To record office supplies used:

$1,850 + $1,500 – $1,020.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Off.Supp

on

Hand

(2,330)

Office

Supplies

Expense

2,330*

(2,330)

Net income for the month of March would be overstated by $2,330 if this adjusting entry

were not recognized because expenses would be understated.

March 1 Beg. Bal. 1,850

March 31 End. Bal. 1,020

FACC.PONO.13.04-05 – LO: 04-05

242. On May 1, 2016, Meehan Inc. lends $125,000 to Solar Power Inc. The loan will be repaid in 90 days with interest at

12%.

Required:

1. Prepare the journal entry on Meehan’s books on May 1, 2016.

2. Assume that Meehan prepares quarterly statements on May 30, 2016. Prepare the adjusting entry on Meehan’s books on

May 30, 2016 regarding the loan.

3. Prepare the entry on Meehan’s books on July 29, 2016, when Solar Power repays the principal and interest.

ANSWER:

1.

May 1

Notes Receivable

125,000

Cash

125,000

To record 12%, 90-day loan to Solar Power Inc.

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Notes

Receivable

125,000

Cash

(125,000)

2.

May 30

Interest Receivable

1,250

Interest Income

1,250

To accrue interest due on note for one month:

$125,000 × 12% × 30/360.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Interest

Receivable

1,250

Interest

Income

1,250

3.

July 29

Cash

128,750

Notes Receivable

125,000

Interest Receivable

1,250

Interest Income

2,500

To record collection of note and interest at maturity date.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Cash

128,750

Notes Receivable

(125,000)

Interest Receivable

(1,250)

2,500

Interest

Income

2,500

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-05 – LO: 04-05

KEYWORDS:

Bloom’s: Analyzing

Stockholders’

Net

Payable (92,650)

Moderate

FACC.PONO.13.04-05 – LO: 04-05

Bloom’s: Analyzing

243. Exclusive Builders owns property in Camden County. Exclusive’s 2016 property taxes amounted to $85,000.

Camden County will send out the 2017 property tax bills to property owners during April 2017. Taxes must be paid by

June 1, 2017. Assume that Exclusive prepares adjusting entries only once a year, on December 31 for the entire year’s

taxes, and that property taxes for 2017 are expected to increase by 9% over those for 2016.

Required:

1. Prepare the adjusting entry required to record the 2016 property taxes payable on December 31, 2016.

2. Prepare the journal entry to record the payment of the 2017 property taxes on June 1, 2017.

ANSWER:

1. Dec 31. 2016

Dec. 31 Property Tax Expense 92,650

Property Taxes Payable 92,650

To accrue 2016 property taxes: 109% × $85,000.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Property Taxes

Payable 92,650

(92,650)

Property

Tax

Expense

(92,650)

2. June 1, 2017

June 1 Property Taxes Payable 92,650

Cash 92,650

To record payment of 2017 property taxes.

Balance Sheet

Income Statement

(2,500)

Moderate

FACC.PONO.13.04-05 – LO: 04-05

Bloom’s: Analyzing

244. Brooke Accounting Services collected $15,000 from a customer on June 1 and agreed to provide accounting services

during the next six months. Brooke expects to provide an equal amount of services each month.

Required:

1. Prepare the journal entry for the receipt of the customer deposit on June 1.

2. Prepare the adjusting entry on June 30.

3. What will be the effect on net income for June if the entry in (2) is not recorded?

ANSWER:

1.

June 1

Cash

15,000

Customer Deposits

15,000

To record receipt of customer deposit for

six months of accounting service.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Cash

15,000

Customer

Deposits

15,000

2.

June 30

Customer Deposits

2,500

Accounting Fees Earned

2,500

To record one month of accounting fees earned:

$15,000/6.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Customer

Deposits

Accounting

Fees

Earned

Purchase price

Less estimated salvage value

Depreciable cost

Monthly Depreciation

= Depreciable Cost/Estimated Life

= $240,000/60 months

= $4,000/month

245. On October 1, 2016, Winter Corp. buys a computer system for $270,000 in cash. Assume that the computer is

expected to have a five-year life and an estimated salvage value of $30,000 at the end of that time.

Required:

1. Prepare the journal entry to record the purchase of the computer on October 1, 2016.

2. Compute the depreciable cost of the computer.

3. Using the straight-line method, compute the monthly depreciation.

4. Prepare the adjusting entry to record depreciation at the end of October 2016.

5. Compute the computer’s carrying value that will be shown on Winter’s balance sheet prepared on December 31, 2016.

ANSWER:

1.

Oct. 1

Computer

270,000

Cash

270,000

To record purchase of computer.

4.

Oct. 31

Depreciation Expense

4,000

Accumulated Depreciation—Computer System

4,000

To record one month’s depreciation expense.

Balance Sheet

Income Statement

Assets

=

Liabilities

+

Stockholders’

Equity

Revenues

–

Expenses

=

Net

Income

Accumulated

Depreciation

—

Computer

System*

(4,000)

Depreciation

Expense

(4,000)

*The Accumulated Depreciation—Computer System account has increased. It is

shown as a decrease in the equation above because it is a contra account and causes

total assets to decrease.

5.

Computer

$270,000

Less: Accumulated depreciation (3 months ×

$4,000/month)

(12,000)

Carrying value

$258,000

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-05 – LO: 04-05

KEYWORDS:

Bloom’s: Analyzing

246. Morgan Realty reported the following accounts on its income statement:

Commissions Earned

$83,000

Travel and Entertainment

4,500

Real Estate Board Fees Paid

8,000

Insurance Expired

780

Computer Line Charge

765

Advertising Expense

1,460

Depreciation on Computer

450

Office Supplies Used

940

Car Expenses

2,200

Required:

1. Prepare the necessary entries to close the temporary accounts.

2. Explain why the closing entries are necessary and when they should be recorded.

ANSWER:

1.

Closing entries:

Commissions Earned

83,000

Income Summary

83,000

To close revenue account.

Income Summary

19,095

Travel and Entertainment

4,500

Real Estate Board Fees Paid

8,000

Insurance Expired

780

Computer Line Charge

765

Advertising Expense

1,460

Depreciation on Computer

450

Office Supplies Used

940

Car Expenses

2,200

To close expense accounts.

Income Summary

63,905

Retained Earnings

63,905

To close Income Summary to Retained Earnings.

2. Closing entries serve two purposes. First, the balances in revenue, expense, and dividend

accounts are returned to zero to start the following period. Second, the net income and the

dividends of the period are transferred to Retained Earnings. Closing entries are recorded at

the end of the period.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-07 – LO: 04-07

KEYWORDS:

Bloom’s: Analyzing

247. The following accounts appear on Treetop Inc. 2016 financial statements. The accounts are listed in alphabetical

order, and the balance in each account is the normal balance for that account. All amounts are in millions of dollars.

Prepare closing entries for Treetop for 2016.

Cash Dividends Paid

$ 104

Cost of Sales and Related Buying and Occupancy Costs

4,317

Credit Card Revenues

325

Income Tax Expense

207

Interest Expense, net

126

Other Income and Expense, net

13

Net Sales

7,172

Selling, General and Administrative Expenses—Credit

Segment

275

Selling, General and Administrative Expenses—Retail Stores,

Direct and Other Segments

2,228

ANSWER:

Net Sales

7,172

Credit card Revenues

325

Other Income and Expense, net*

13

Income Summary

7,510

To close Net Sales and other income accounts.

*Assumes that the amount netted to income rather than expense.

Income Summary

7,153

Cost of Sales and Related Buying and Occupancy Costs

4,317

Selling, General and Administrative Expenses—Retail Stores,

Direct and Other Segment

2,228

Selling, General and Administrative Expenses—Credit Segment

275

Income Tax Expense

207

Interest Expense, net

126

To close expense accounts.

Income Summary

357

Retained Earnings

357

To close Net Income to Retained Earnings.

Retained Earnings

104

Cash Dividends Paid

104

To close Dividends to Retained Earnings.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-07 – LO: 04-07

KEYWORDS:

Bloom’s: Analyzing

Fees Earned

3)

Unearned Revenue

Fees Earned

4)

Wages Expense

530

Wages Payable

1)

Fees Earned

Income Summary

2)

Income Summary

Wages Expense

Rent Expense

Insurance Expense

Utilities Expense

Retained Earnings

248. Reconstruct the adjusting and closing entries from the following T-Accounts.

Prepaid Insurance

Accounts

Receivable.

Unearned

Revenues

Wages Payable

1,200

6,000

1,350

530

300

1,500

435

530

900

7,500

915

Retained Earnings

Dividends

Income Summary

Fees Earned

12,280

2,100

9,935

8,000

2,100

5,180

2,100

4,655

1,500

15,360

0

5,280

435

0

9,935

0

Wages Expense

Rent Expense

Insurance Expense

Utilities Expense

2,600

1,145

300

180

530

1,145

300

180

3,130

0

ANSWER:

Adjusting Entries:

1)

Insurance Expense

300

Prepaid Insurance

300

2)

Accounts Receivable

1,500

Chapter 4: Income Measurement and Accrual Accounting

ANSWER:

Residential Enterprises

Work sheet

For the Year Ended December 31, 2016

Adjusted Trial

Balance

Income Statement

Balance Sheet

Account Title

Debit

Credit

Debit

Credit

Debit

Credit

Cash

14,500

Accounts Receivable

7,500

Supplies

500

Equipment

20,500

Accumulated Depr-

Equip

15,000

Accounts Payable

9,500

Wages Payable

3,060

Capital Stock

13,240

Retained Earnings,

1/1/16

5,000

Dividends

1,000

Fees Earned

34,000

Wages Expense

18,000

Rent Expense

9,300

Depreciation Expense

8,500

Totals

79,800

35,800

34,000

44,000

45,800

Net Loss

1,800

35,800

45,800

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-06 – LO: 04-06

FACC.PONO.13.04-08 – LO: 04-08

KEYWORDS:

Bloom’s: Analyzing

254. What is the revenue recognition principle? Are there any exceptions to this rule? If so, what are they? If not, explain

why

ANSWER:

The revenue recognition principle requires that revenues are recognized when they are

realized or realizable and earned. Normally, this is when a product or service is delivered to

the customer. An exception that may apply to this rule is a company that has a very high rate

of product returns. In this case, it would be prudent to recognize revenue only after the return

period expires.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-03 – LO: 04-03

KEYWORDS:

Bloom’s: Applying

255. What is the matching principle? How does it relate to the revenue recognition process?

ANSWER:

The matching principle is the association of costs in the accounting period with the related

revenue that was earned. The revenue recognition process determines when and how much

revenue should be recognized. Once revenue is determined, then the matching concept is

applied, i.e., the amount of expense to be allocated to that period is determined.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-04 – LO: 04-04

KEYWORDS:

Bloom’s: Applying

256. What role do accounting records play in the adjustment process?

ANSWER:

The adjustments are made by examining the balances of the accounts that need to be adjusted

that appear in the general ledger.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-05 – LO: 04-05

KEYWORDS:

Bloom’s: Applying

257. What is the significance of the timing in which cash is paid or received as it relates to the adjusting process?

ANSWER:

Cash paid before an expense is incurred results in a deferred expense, which is recognized as

an asset on the balance sheet. The adjusting entry reduces the asset and recognizes a

corresponding amount of expense. Cash received before revenue is earned requires the

recognition of a liability, a deferred revenue. The adjusting entry reduces the liability and

recognizes a corresponding amount of revenue. At the end of the period, if cash has not been

paid or received, amounts must be accrued for any assets expected to be received or any

liabilities owed.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-05 – LO: 04-05

KEYWORDS:

Bloom’s: Applying

258. Explain the differences between the cash and accrual basis of accounting and how the adjusting process fits in.

ANSWER:

The cash basis of accounting assumes revenues are recognized when cash is received and

expenses are recognized when cash is paid. The accrual basis assumes revenues are

recognized when earned and expenses are recognized when incurred. The two approaches

differ in the timing of when revenues and expenses are recognized on the income statement.

The adjusting process is used for the accrual basis, but is unnecessary for the cash basis of

accounting.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-02 – LO: 04-02

FACC.PONO.13.04-05 – LO: 04-05

KEYWORDS:

Bloom’s: Applying

259. Explain the purpose of a work sheet.

ANSWER:

A work sheet is not a financial statement, but is a useful device for organizing the

information needed to prepare the financial statements. It eliminates the immediate need to

record and post adjusting entries in the journal and ledger.

DIFFICULTY:

Easy

LEARNING OBJECTIVES:

FACC.PONO.13.04-06 – LO: 04-06

KEYWORDS:

Bloom’s: Applying

260. Does the Retained Earnings account that appears in the balance sheet credit column of a work sheet reflect the

beginning or the ending balance in the account? Explain.

ANSWER:

The beginning balance in the Retained Earnings account is entered initially on the work sheet

on the unadjusted trial balance and is spread to the balance sheet credit column of the work

sheet. The reason the unadjusted or beginning balance is entered in the balance sheet credit

column is that the net income of the period and any dividends declared are entered in the

balance sheet columns also. Thus, the balance sheet columns contain all three amounts: the

beginning retained earnings balance, the net income, and any dividends.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-06 – LO: 04-06

FACC.PONO.13.04-08 – LO: 04-08

KEYWORDS:

Bloom’s: Applying

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-08 – LO: 04-08

KEYWORDS:

Bloom’s: Applying

261. Answer each of the following questions (a–c) with a separate short paragraph per question.

(a) What is the difference between a real account and a nominal account? Give an example of each type of account. Why

is this distinction important for the closing process?

(b) What two purposes are served in making closing entries?

(c) Why is the Dividends account closed directly to Retained Earnings rather than to the Income Summary account?

ANSWER:

(a) Balance sheet accounts are called real accounts because they are permanent and are not

closed at the end of a period. Conversely, income statement accounts are called nominal or

temporary accounts because they are closed at the end of the period. For example, it would

not make sense to close the Equipment account at the end of the period. The account should

stay on the books as long as the company keeps the asset. On the other hand, Depreciation

Expense on the equipment is a temporary account that indicates the expense associated with

using the asset during the period and is therefore closed along with all other income

statement accounts at the end of the period.

(b) Closing entries are made at the end of an accounting period. They have two important

purposes: (1) to return the balance in all temporary or nominal accounts (revenues, expenses,

and dividends) to zero to start the next accounting period and (2) to transfer the net income

(or net loss) and the dividends of the period to Retained Earnings.

(c) The Dividends account is closed directly to Retained Earnings because it is not an

expense and therefore is not an income statement account. Because it does not appear on an

income statement, it is not closed through the Income Summary account, but instead directly

to Retained Earnings.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-07 – LO: 04-07

KEYWORDS:

Bloom’s: Applying

262. Assuming the use of a work sheet, are the formal adjusting entries recorded and posted to the accounts before or after

the financial statements are prepared? Explain your answer. Would your answer change if a work sheet was not prepared?

Explain.

ANSWER:

When a work sheet is used, the formal adjusting entries are recorded after the financial

statements have been prepared. Instead of taking the time to formally journalize adjusting

entries and post them to the accounts, the accountant enters the adjusting entries directly on a

work sheet as a basis for preparing the financial statements. The actual recording and posting

of the adjusting entries can be done after the statements are released. Of course, if a work

sheet is not prepared, adjusting entries must be recorded before the statements can be

263. The balance sheet columns of the work sheet for Barrows Corporation show total debits and total credits of $245,000

each. Dividends for the period are $5,000. Accumulated depreciation is $15,000 at the end of the period. Compute the

amount that should appear on the formal balance sheet for total assets. How do you explain the difference between this

amount and the amount that appears as the total debits and total credits on the work sheet?

ANSWER:

Total debits on the work sheet: $245,000

Less: Dividends (5,000)

Accumulated depreciation (15,000)

Total assets $225,000

Not all debits on the work sheet are assets. For example, Dividends are listed as a debit on the

work sheet, but they reduce retained earnings rather than increase assets. Also, some items in

the Asset section such as Accumulated Depreciation are not debits.

DIFFICULTY:

Moderate

LEARNING OBJECTIVES:

FACC.PONO.13.04-08 – LO: 04-08

KEYWORDS:

Bloom’s: Applying