31
CHAPTER 2
BASIC ACCOUNTING CONCEPTS
CLASS DISCUSSION QUESTIONS
1. The basic elements of a financial accounting
system include (1) a set of rules for deter-
mining what, when, and the amount that
should be recorded; (2) a framework for
2. a. Purchase of land for cash affects only
assets.
b. Payment of a liability affects assets and
liabilities; receipt of cash for fees earned
affects assets and stockholders’ equity.
c. Incurring an expense that is partially
paid in cash decreases assets, increas-
es liabilities, and decreases stockhold-
ers’ equity (retained earnings). For ex-
($6,000), and decrease stockholders’ eq–
uity (retained earnings) $10,000. The ex-
pense is an organizational expense.
Likewise, a new business might hire a
new chief operating officer by agreeing
to pay a nonrefundable, noncancellable
signing bonus of $50,000, with $30,000
due at signing and the remainder due in
four installments. This transaction would
4. a. Out of balance. Assets are overstated
by $27,000 ($85,000 – $58,000), and
thus, total assets would exceed total lia-
bilities plus stockholders’ equity by
set each other, and the accounting
equation balances.
5. A primary control for determining the accu-
racy of record keeping is the equality of the
accounting equation. The accounting equa-
tion must balance.
6. Total assets are increased by $175,000: an
increase in cash of $375,000 and a de-
crease in land of $200,000. Stockholders’
ment of dividends. Dividends are a dis-
tribution of income to stockholders and
are not an expense.
8. a. The equality of the accounting equation
would not be affected. That is, the ac-
counting equation would still balance.
b. On the income statement, total operat-
ing expenses (salary expense) would be
overstated by $30,000, and net income
32
financing activities is overstated, since
cash paid for dividends is understated.
The understatement of net cash flows
from operating activities is offset by the
overstatement of net cash flows from
financing activities, and thus, the net
increase or decrease in cash for the
period is correct, as is the ending cash
balance.
9. a. The equality of the accounting equation
would not be affected. That is, the ac-
counting equation would still balance.
b. On the income statement, revenues
(fees earned) would be overstated by
$75,000, and net income would be
overstated by $75,000. On the retained
earnings statement, the beginning re-
ers’ equity is correct. On the statement
of cash flows, net cash flows from oper-
ating activities is overstated, since cash
received from fees earned is overstated.
In addition, net cash flows from financ-
ing activities is understated, since cash
received from borrowing (notes payable)
is understated. The overstatement of net
cash flows from operating activities is
offset by the understatement of net cash
flows from financing activities, and thus,
the net increase or decrease in cash for
the period is correct, as is the ending
cash balance.
10. a. $350,000 ($500,000 – $150,000)
b. Stockholders’ equity as of
EXERCISES
E2–1
a. $1,000,000 ($250,000 + $750,000)
E2–2
a. $37,385 ($72,124 – $34,739)
E2–3
a. $1,088 ($6,862 – $5,774)
b. $190 decrease ($332 – $142)
34
E2–4
(a) $11,610 ($14,429 – $2,819)
(b) $46,241 ($57,851 – $11,610)
E2–5
a. $550,000 ($750,000 – $200,000)
b. $635,000 ($550,000 + $125,000 – $40,000)
35
E2–6
a. (3) No effect
b. (3) No effect
f. (2) Decrease
g. (2) Decrease
E2–7
a. Increases assets and increases stockholders’ equity.
b. Decreases assets and decreases stockholders’ equity.
E2–8
(1) Total assets decreased $5,000.
(2) Total liabilities decreased $120,000.
(3) Stockholders’ equity increased $115,000.
E2–9
1. (a) increase
4. (b) decrease
36
E2–10
1. (c)
2. (e)
6. (c)
7. (d)
E2–11
a. (1) Sale of catering services for cash, $28,000.
(2) Purchase of land for cash, $20,000.
b. $11,000 ($40,000 – $29,000)
c. $9,000 ($109,000 – $100,000)
E2–12
It would be incorrect to say that the business had incurred a net loss of $8,000.
The excess of the dividends over the net income for the period is a decrease in
the amount of retained earnings in the corporation.
37
E2–13
Company Sierra
Stockholders’ equity at end of year ($770,000 – $294,000) ………………… $476,000
Stockholders’ equity at beginning of year ($490,000 – $175,000) ………. 315,000
Net income (increase in stockholders’ equity) …………………………….. $161,000
Company Tango
Increase in stockholders’ equity (as determined for Sierra) ……………… $161,000
Add dividends ……………………………………………………………………………….. 55,000
Net income ……………………………………………………………………………….. $216,000
Company Yankee
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E2–14
In each case, solve for a single unknown, using the following equation:
Stockholders’ equity (beginning) + Issuance of Capital Stock – Dividends +
Revenues – Expenses = Stockholders’ equity (ending)
Carbon Stockholders’ equity at end of year ($495,000 – $160,000) … $335,000
Stockholders’ equity at beginning of year ($333,000 – $118,000) . 215,000
Krypton Stockholders’ equity at end of year ($350,000 – $110,000) … $240,000
Stockholders’ equity at beginning of year ($250,000 – $130,000) . 120,000
Increase in stockholders’ equity …………………………..…………. $120,000
Add dividends ………………………………………………………………… 16,000
$136,000
Deduct additional issuance of capital stock …………………….. 50,000
Increase due to net income …………………………………………….. $ 86,000
Add expenses ………………………………………………………………… 64,000
Revenue …………………………………………………………………….. (b) $150,000
Add dividends ………………………………………………………………… 60,000
Stockholders’ equity at beginning of year ……………………….. $188,000
Deduct additional issuance of capital stock …………………….. 40,000
$148,000
Add liabilities at beginning of year ………………………………….. 120,000
Assets at beginning of year …………………………………………. (d) $268,000
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E2–15
a. $3,492 ($28,236 – $24,744)
b. The net cash flows used for investing activities is determined by solving the
following equation:
E2–16
a. ABBY’S INTERIORS
Balance Sheet
October 31, 20Y6
Assets
Cash ……………………………………………………………………… $ 50,000
Land ……………………………………………………………………… 500,000
Total assets …………………………………………………………… $550,000
40
E2–16, Concluded
ABBY’S INTERIORS
Balance Sheet
November 30, 20Y6
Assets
Cash ……………………………………………………………………… $175,000
Land ……………………………………………………………………… 575,000
Total assets …………………………………………………………… $750,000
b. Retained earnings, November 30, 20Y6 …………………………..………….. $410,000
Retained earnings, October 31, 20Y6 ………………………………………….. 275,000
Increase in retained earnings …………………………………………………….. $135,000
Add dividends …………………………..………………………………………………. 12,000
Net income ……………………………………………………………………………….. $147,000
c. Net cash flows from operating activities = $147,000 = $125,000 + $75,000 – $53,000
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E2–17
BENJAMIN REALTY INC.
Income Statement
For the Month Ending April 30, 20Y9
Revenues:
Sales commissions ………………………………………………… $145,000
E2–18
BENJAMIN REALTY INC.
Retained Earnings Statement
For the Month Ending April 30, 20Y9
Net income …………………………………………………………………………………….. $ 45,000
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E2–19
BENJAMIN REALTY INC.
Balance Sheet
April 30, 20Y9
Assets
Cash ………………………………………………………………………….. $ 53,000
Land …………………………………………………………………………… 42,000
Total assets ……………………………………………………………….. $ 95,000
E2–20
BENJAMIN REALTY INC.
Statement of Cash Flows
For the Month Ending April 30, 20Y9
Cash flows from operating activities:
Cash receipts from operating activities …………………… $ 145,000
Deduct cash payments for operating activities ………… (100,000)
Net cash flows from operating activities ………………………. $ 45,000
Cash flows used for investing activities:
Cash payments for land …………………………………………. (42,000)
E2–21
a. Decrease in assets and decrease in stockholders’ equity.
b. Increase in assets and decrease in assets.
c. Increase in assets and increase in stockholders’ equity.
E2–22
a. operating section
b. investing section
g. operating section
h. investing section
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PROBLEMS
P2–1
1.
Statement of
Balance Sheet
Cash Flows
Assets
=
Liabilities
+
Stockholders’ Equity
Notes
Capital
Retained
Cash
+
Land
=
Payable
+
Stock
+
Earnings
a.
Investment
50,000
50,000
b.
Issued note payable
25,000
25,000
Balances
75,000
25,000
50,000
c.
Fees earned
28,000
Balances
103,000
25,000
50,000
Rent expense
–3,000
–3,000
Balances
100,000
25,000
50,000
25,000
e.
Paid expenses
Balances
25,000
50,000
22,300
Paid salary expense
Balances
93,100
25,000
50,000
18,100
g.
Paid interest expense
–100
–100
Balances
93,000
25,000
50,000
18,000
h.
Purchased land
–55,000
55,000
Balances
38,000
55,000
25,000
50,000
18,000
i.
Paid dividends
–4,000
–4,000
Balances, March 31
34,000
55,000
25,000
50,000
14,000
Statement of Cash Flows
Income Statement
a.
Financing
50,000
c. Fees earned
28,000
b.
Financing
25,000
d. Rent expense
–3,000
c.
Operating
e. Auto expense
Operating
e. Misc. expense
e.
Operating
f. Salary expense
f.
Operating
g. Interest expense
Investing
Financing
Increase in cash
2. Stockholders’ equity is the right of stockholders to the assets of the busi-
ness. These rights are increased by stockholders’ investments and revenues
and decreased by dividends and expenses.
45
P2–1, Continued
3. JORDAN INSURANCE INC.
Income Statement
For the Month Ending March 31, 20Y5
Revenues:
Fees earned………………………………………………………. $ 28,000
Expenses:
Salary expense …………………………………………………. $4,200
Rent expense ……………………………………………………. 3,000
JORDAN INSURANCE INC.
Retained Earnings Statement
For the Month Ending March 31, 20Y5
Net income ……………………………………………………………. $ 18,000
Less dividends ………………………………………………………. 4,000
Retained earnings, March 31, 20Y5 …………………………. $ 14,000
4. JORDAN INSURANCE INC.
Balance Sheet
March 31, 20Y5
Assets
Cash ……………………………………………………………………… $ 34,000
Land ……………………………………………………………………… 55,000
Total assets …………………………………………………………… $ 89,000
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P2–1, Concluded
5. JORDAN INSURANCE INC.
Statement of Cash Flows
For the Month Ending March 31, 20Y5
Cash flows from operating activities:
Cash receipts from operating activities ……………… $ 28,000
Deduct cash payments for operating activities …… (10,000)
Net cash flows from operating activities …………………. $ 18,000
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P2–2
1. UP-DATE COMPUTER SERVICES
Income Statement
For the Month Ended August 31, 20Y4
Fees earned …………………………………………………………… $27,000
Operating expenses:
Salaries expense ………………………………………………. $4,600
2. UP-DATE COMPUTER SERVICES
Retained Earnings Statement
For the Month Ended August 31, 20Y4
Net income for August ………………………………………………………………. $18,000
Less dividends ………………………………………………………………………….. 3,000
Retained earnings, August 31, 20Y4 …………………………………………… $15,000
3. UP-DATE COMPUTER SERVICES
Balance Sheet
August 31, 20Y4
Assets
Cash ……………………………………………………………………… $10,000
Land ……………………………………………………………………… 40,000
Total assets …………………………………………………………… $50,000