Demonstration Problem 2-2 Solution, part A. Horizontal Financial Statements Model for 2014
A spreadsheet is embedded to reflect the solution to this question. This spreadsheet covers both 2014
Demonstration Problem 2-2 Solution, parts A & B. Financial Statements
Income Statements for the Years Ended 12/31
2015
Consulting revenue
$ 5,100
Total revenue
5,100
Salary expense
(1,500)
Insurance Expense
(410)
Net income
$ 3,190
Statements of Changes in Stockholders’ Equity
Beginning common stock
$ 2,000
Plus: Common stock issued
3,000
Ending common stock
5,000
Beginning retained earnings
680
Plus: Net income
3,190
Less: Dividends
(300)
Ending retained earnings
2,890
Total stockholders’ equity
$ 8,570
Balance Sheets as of December 31
Cash
$ 8,650
Accounts receivable
200
Prepaid Insurance
70
Total assets
$ 8,920
Salaries payable
$ 350
Unearned Revenue
0
Total liabilities
350
Common stock
5,000
Retained earnings
3,570
Total stockholders’ equity
8,570
Total liabilities and stockholders’ equity
$ 8,920
Statements of Cash Flows
Cash flows from operating activities
Cash receipts from consulting revenue
$ 2,800
Cash payments for salaries
(1,350)
Cash payments for insurance
(420)
Net cash inflow from operating activities
1,030
Cash flows from investing activities
Net cash outflow for investing activities
0
Cash flows from financing activities
Cash receipt from common stock issue
3,000
Cash payment for dividends
(300)
Net cash inflow from financing activities
2,700
Net change in cash
3,730
Beginning cash balance
4,920
Ending cash balance
$ 8,650
Demonstration Problem 2-1 Workpaper, part 1.
Assets
=
Liabilities
+
Equity
Part A, 2014
Cash
+
Accounts
Receivable
=
Liabilities
+
Common
Stock
+
Retained
Earnings
Beginning balances
$ 0
$ 0
$ 0
$ 0
$ 0
Effect of recognizing
revenue
Part B, 2015
Effect of collecting cash
─────
─────
─────
─────
─────
Ending balances
$5,000
+
$ 0
=
$ 0
+
$ 0
+
$5,000
═════
════
═════
═════
═════
Demonstration Problem 2-1 Workpaper, part 2. Financial Statements
Packard Consultants
Income Statements
For the Years Ended December 31,
2014
2015
Consulting revenue
$
$
Expenses
Net income
$ 5,000
$ 0
Statements of Retained Earnings
Beginning retained earnings
$ 0
$
Plus: Net income
Less: Dividends
Ending retained earnings
$5,000
$5,000
Balance Sheets at December 31
Assets
Cash
$
$
Accounts receivable
Total assets
$
$
Equity
Retained earnings
$5,000
$5,000
Statements of Cash Flows
Cash flows from operating activities
$
$
Cash flows from investing activities
0
0
Cash flows from financing activities
0
0
Net change in cash
Beginning cash balance
Ending cash balance
$ 0
$5,000
Demonstration Problem 2-1B Workpaper, part 2
Jackson Legal Services
Financial Statements
Income Statements
For the Years Ended December 31,
2014
2015
Fees revenue
Expenses
Net income
$ 3,000
$ 9,000
Statements of Retained Earnings
Beginning retained earnings
$ 0
$ 3,000
Plus: Net income
Less: Dividends
Ending retained earnings
$ 3,000
$12,000
Balance Sheets as of December 31
Assets
Cash
Liabilities
Unearned revenue
Equity
Retained earnings
3,000
12,000
Total liabilities and equity
Statements of Cash Flows
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Net change in cash
Beginning cash balance
0
Ending cash balance
$12,000
$12,000
Demonstration Problem 2-2 Workpaper, parts A & B. Financial Statements
Income Statements for the Years Ended 12/31
2015
Consulting revenue
$
Total revenue
Salary expense
Insurance Expense
Net income
$ 3,190
Statements of Changes in Stockholders’ Equity
Beginning common stock
$
Plus: Common stock issued
Ending common stock
5,000
Beginning retained earnings
Plus: Net income
Less: Dividends
Ending retained earnings
2,890
Total stockholders’ equity
$
Balance Sheets as of December 31
Cash
$
Accounts receivable
Prepaid Insurance
Total assets
Salaries payable
$
Unearned Income
Total liabilities
2,425
Common stock
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
$10,980
Statements of Cash Flows
Cash flows from operating activities
Cash receipts from consulting revenue
$
Cash payments for salaries
Cash payments for insurance
Net cash inflow from operating activities
1,030
Cash flows from investing activities
Net cash outflow for investing activities
0
Cash flows from financing activities
Cash receipt from common stock issue
Cash payment for dividends
Net cash inflow from financing activities
2,700
Net change in cash
Beginning cash balance
Ending cash balance
$ 8,650
2-6
Quiz Questions for Chapter 2
1. X Company recognized $500 of revenue on account and realized $400 of cash collections. The company had
accrued salary expense of $300 and invested $200 in a certificate of deposit. Based on this information alone,
the amount of cash flow from operating activities would be
a. $100.
b. $500.
c. $200.
d. $400.
2. On January 1, 2012, West Company had accounts receivable of $500. During 2014 West earned $2,500 of
service revenue on account. If the accounts receivable balance as of December 31, 2014, was $400, what was
the amount of cash flow from operating activities?
a. $2,000.
b. $3,000.
c. $2,400.
d. $2,600.
3. The entry to record revenue on account
a. increases liabilities.
b. decreases equity.
c. decreases assets.
d. none of the above.
4. K Company collected $500 cash on an account receivable that was due from L Company. Based on this
information, which of the following statements is true?
a. K Company’s total assets would increase.
b. L Company’s total assets would not change.
c. K Company’s equity would decrease.
d. None of the above.
5. On April 1, Flavin Co. paid $12,000 cash for an insurance policy that provides coverage for one year
beginning immediately. On December 31, Flavin adjusted the books to recognize the amount of the insurance
policy used during the year. The amount of the adjustment would be:
a. $8,000
b. $9,000
c. $12,000
d. $0
6. Which of the following illustrates the recognition of revenue earned on account?
Balance Sheet
Income Statement
Statement of
Assets
=
Liab.
+
Equity
Rev.
─
Exp.
=
Net Inc.
Cash Flow
a.
+
NA
+
NA
NA
NA
NA
b.
+
NA
+
+
NA
+
NA
c.
─
NA
─
NA
+
─
─ OA
d.
+
NA
+
+
NA
+
+ OA
Use the following information to answer the next two questions. BBC Company received $9,900 cash on
February 1, 2014, from XYZ Company as advance payment for services BBC promised to perform for XYZ over
the next three years on a continuous basis. Assume that BBC Company’s year-end is December 31.
2-7
7. On its 2014 income statement, BBC would report revenue of
a. $3,300
b. $9,900
c. $3,025
d. $2,750
8. On its December 31, 2015 balance sheet BBC would report liabilities of
a. $3,575
b. $3,300
c. $9,900
d. $6,875
9. Which of the following illustrates purchasing supplies on account?
Balance Sheet
Income Statement
Statement of
Assets
=
Liab.
+
Equity
Rev.
─
Exp.
=
Net Inc.
Cash Flow
a.
+
NA
+
NA
NA
NA
NA
b.
+
+
NA
NA
NA
NA
NA
c.
+
+
NA
NA
NA
NA
+ OA
d.
+
NA
+
+
NA
+
+ OA
10. Which of the following illustrates receiving cash as an advance payment for future services?
Balance Sheet
Income Statement
Statement of
Assets
=
Liab.
+
Equity
Rev.
─
Exp.
=
Net Inc.
Cash Flow
a.
+
NA
+
NA
NA
NA
NA
b.
+
+
NA
+
NA
+
NA
c.
+
+
NA
NA
NA
NA
+ OA
d.
+
NA
+
+
NA
+
+ OA
Quiz Answers
Question
Answer
1
D
2
D
3
D
4
B
5
B
6
B
7
C
8
A
9
B
10
C
Summary Outline of a Lesson Plan for Chapter 2
I. Use Demonstration Problem 2-1 to define and illustrate the concept of accrual
accounting. This problem includes both an accrual (part A) and a deferral (part B) example.
2-8
assignment. Have slower students finish the problem as homework. Use parallel problem 2-38 in
the textbook as a homework assignment.
IV. Time considerations and homework assignments. Demonstration Problems 2-1 and 2-
2 require approximately one hour of class time. Consider assigning exercises 2-11, 2-15, 2-18, 2-
21, and Problem 2-28 from the textbook as homework.
V. Use a financial statements model to highlight the differences between accrual
and cash basis accounting.
VI. Hand out official answers to the Demonstration Problems worked in class.