CHAPTER 3
Measuring Revenues and Expenses
THINKING BEYOND THE QUESTION
How do we know how much profit our business has earned?
Revenues earned over several fiscal periods usually are allocated to each
QUESTIONS
Q3-1 The flow of cash often predates or follows the economic event to which it
is related. If financial reports are supposed to measure the economic ac-
tivities that occurred during a period, the amount of cash that flowed will
Q3-2 Agree. While the accrual measurement of revenue and expense is traced
to the accounting period in which the economic event occurred, the cash
52 Chapter 3
Q3-3 Profitability is reported on the income statement using an accrual meas-
ure. It is the difference between revenues earned and expenses con-
sumed. Profit is the amount of cash that is ultimately expected to result af-
Q3-4 Accounts Receivable links Revenue and Cash by recording the amount
Q3-5 Unearned Revenue is a liability that is reported on a company’s balance
Q3-7 At the moment the rent is paid, the company has acquired an asset. It has
purchased the exclusive right to use the landlord’s property for one
Q3-9 Subsidiary accounts are used to record the detail associated with an indi-
vidual item of importance to a company. For example, a separate subsidi-
ary account (Accounts Receivable—Sally Jobers) is maintained for each
Measuring Revenues and Expenses 53
Q3–10 Control accounts summarize the detailed information contained in subsid-
iary accounts. When decision makers outside the firm make decisions
concerning the organization, these summaries are sufficient and appropri-
Q3–11 Other common examples of period costs are interest, property taxes, rent
on office facilities, and management salaries. All of these costs generally
occur with the passage of time. In many cases, the company does not ever
Q3–12 This statement is not true. The numbers reported on a balance sheet are
related to the cost of the asset, not its current value. When an asset such
as a building or land is acquired, it is entered into the accounting records
at its cost (which is probably a good measure of its current value at that
Q3–13 The purpose of preparing a summary of general ledger account balances
Q3–14 The closing entries zero out the revenue and expense account balances at
54 Chapter 3
Q3–16 Proper accounting procedures make unethical behavior difficult. The pro-
Q3–17 Good accounting controls protect owners, creditors, and other stakehold-
EXERCISES
E3-1 Definitions of all terms are listed in the glossary.
E3-2 Net Income Net Cash Flow
Sale of wheat (all cash) $ 650,000 $650,000
Operating costs ($532,500 in cash) (585,000) (532,500)
Measuring Revenues and Expenses 55
E3-3 Received for miles traveled ($4.50 × 2,400 miles) $10,800
Expenses:
Gas 500
E3-4
Cash Flow
for September
Cash Flow
in Future
Sales Revenue
for September
E3-5
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
1
Interest Expense
–3,600
Interest Payable
3,600*
Unearned Rent
4,000
Prepaid Insurance
Accumulated Depreciation
56 Chapter 3
E3-6
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Oct. 1
Merchandise
3,600
Accounts Payable
3,600
Oct. 3
Cash
900
E3-7
Company
A
Company
B
Company
C
Cash received from customers during 2007
$300,000
$625,000
$242,000
Sales revenue for 2007
$352,500
$580,000
$260,000
Accounts receivable at beginning of 2007
$130,000
Accounts receivable at end of 2007
Company
A Revenue was $52,500 more than cash collected. Therefore, accounts
Sales Revenue
Cost of Goods Sold
Merchandise
Oct. 6
Accounts Receivable
Sales Revenue
1,800
Cost of Goods Sold
Merchandise
Oct. 9
Spoilage Expense
Merchandise
Oct. 10
Accounts Payable
Cash
Oct. 16
Cash
1,200
Accounts Receivable
Measuring Revenues and Expenses 57
Alternative presentations include:
Company A
Cash received in 2007 $300,000 Revenue for 2007 $352,500
E3-8 a.
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
1
Wages Expense
–7,600
Wages Payable
7,600
2
Office Supplies Inventory
Office Supplies Expense
3
Rent Receivable
Rent Revenue
4
Depreciation Expense
Accumulated Depreciation
5
Interest Expense
Interest Payable
E3-9 a.
Past
September
Future
Total
Revenues
Expenses
$1,500
$2,500
$1,000
Cash received
Cash paid
$5,000
$5,000
58 Chapter 3
b.
Past
September
Future
Total
c.
Past
September
Future
Total
Revenues
Expenses
$7,500
$7,500
Cash received
Cash paid
$5,000
$2,500
$7,500
d.
Past
September
Future
Total
Revenues
Expenses
Cash received
Cash paid
$2,500
e.
Past
September
Future
Total
Revenues
Expenses
Cash received
Cash paid
E3–10
Cash Flow
for June
Cash Flow
in July
Wages
Expense
for June
Cash paid for prior wages
$5,800
Cash paid for June wages
$4,200
$48,400
Total cash paid in June for wages
E3–11
January
February
March
Total for
Quarter
Cash paid for interest
Interest expense
Revenues
Expenses
Cash received
$6,000
Cash paid
Measuring Revenues and Expenses 59
E3–12
2007
2008
2009
Total for
3 Years
Cash paid for equipment
$600,000
$0
$0
$600,000
E3–13
April
May
June
Total for
3 Months
Cash paid for utilities
$850
$1,025
$1,150
$3,025
Utilities expense
$850
$1,025
$1,150
$3,025
E3–14
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
a.
Interest Expense
–1,200
Interest Payable
Rent Revenue
c.
Insurance Expense
–2,000
Prepaid Insurance
–2,000
Depreciation Expense
Accumulated Depreciation
E3–15 a. Merchandise—Canvas Material +$20,000
Accounts Payable—Ramirez, Inc. +$20,000
Depreciation expense
$200,000
$200,000
$200,000
$600,000
60 Chapter 3
E3–16 Assets Liabilities Equity Net Income
Year-end amounts
before correction $7,625 $2,820 $4,805 $1,200
E3–17 a. The purpose of closing the books is to empty out all of the revenue and
b.
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Dec. 31
Retained Earnings
2,200
Sales Revenue
Retained Earnings
Cost of Goods Sold
Wages Expense
Utilities Expense
Depreciation Expense
Insurance Expense
Supplies Expense
Interest Expense
E3–18 a.
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Dec. 31
Retained Earnings
3,315
Service Revenue
Retained Earnings
Measuring Revenues and Expenses 61
Internet Service Expense
35
b. Assets:
Cash 20,600
Accounts Receivable 2,250
E3–19 a.
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Dec. 31
Retained Earnings
290,000
Sales Revenue
Retained Earnings
Insurance Expense
Wages Expense
Utilities Expense
Depreciation Expense
62 Chapter 3
b. Post-closing summary
Assets:
Cash 10,500
Liabilities:
Accounts Payable 31,000
Owners’ Equity:
Contributed Capital 84,500
E3–20 a. The purpose of closing the books is to empty out all of the revenue
b.
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Dec. 31
Retained Earnings
7,600
Sales Revenue
Retained Earnings
Cost of Goods Sold
2,840
Wages Expense
1,015
Utilities Expense
Depreciation Expense
Insurance Expense
Supplies Expense
Interest Expense
Measuring Revenues and Expenses 63
PROBLEMS
P3-1 M E M O R A N D U M
DATE: (today’s date)
TO: Robin Garrison
FROM: (student’s name)
RE: Klinger Realty operating results
Managers (and other parties) are interested in measuring the results of
transformation processes that occur during a fiscal period. As with many
that from a cash basis measurement.
Cash payments are measured and recorded when cash is paid out
to suppliers of goods or services to be sold to customers. The difference
between cash receipts and cash payments is net cash flow.
Under the accrual basis system of measurement, revenues are
measured and recorded when they have been earned, that is, at the point
64 Chapter 3
performed for customers during a period, but all work was on credit to be
collected during the subsequent period. None of the $200,000 would show
up on the current cash basis report, though all the work was completed.
P3-2 Hardy’s reasoning about the revenues is correct. Revenues should be
recorded on the accrual basis during the period the sales occur. A com-
plete reporting of the transaction would include Accounts Receivable on a
balance sheet noting that $50,000 of the amount was still owed by cus-
tomers. Hardy’s reasoning about the cost of goods sold is incorrect. Ex-
P3-3 The key to each event is a clear definition of revenue. Revenue is an in-
crease in assets as a result of goods sold or services rendered. Applying
this definition to each event yields the following results:
Measuring Revenues and Expenses 65
P3-4
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
March 15
Cash
4,500
Unearned Revenue
4,500
April 30
Unearned Revenue
–4,500
Sales Revenue
Cost of Goods Sold
Merchandise Inventory
P3-5
ASSETS
=
LIABILITIES
+
OWNERS’ EQUITY
Date
Accounts
Cash
Other
Assets
Contributed
Capital
Retained
Earnings
Jan. 1
Prepaid Insurance
3,600
Cash
–3,600
Dec. 31
Insurance Expense
Prepaid Insurance
P3-6 The key to each event is a clear definition of expense. An expense is the
consumption of resources in producing or providing goods or services
during a period. Applying this definition to the events yields the following:
66 Chapter 3
month of May.
P3-7 a. Because accounts receivable increased during the month, the cash col-
lections were less than the amount of sales. Further, this difference is
equal to the increase in accounts receivable. Therefore, cash collec-
tions from customers are as follows:
P3-8 Carlyle Company
Income Statement
For the First Year
Revenues ($235,000 + $80,000) $315,000
P3-9 A. Tinker’s financial report relied improperly on cash basis numbers. Prof-
its should be measured on the accrual basis. Sales should be included
Measuring Revenues and Expenses 67
B. The other partners would be foolish to sell out based on Tinker’s in-
A proper income statement and distribution of profits would show the
following:
Tinker, Evers, and Chance
Income Statement
For Fiscal 2007
Revenues $7,600,000
Expenses:
P3–10 A. The Water Fun Store
Net Cash Flow from Operating Activities
For August
Cash receipts:
Collected from customers ($5,350 + $3,700) $ 9,050
68 Chapter 3
B. The Water Fun Store
Accrual Basis Income Statement
For August
Sales ($7,350 + $6,350) $13,700
Expenses:
Cost of goods sold ($3,600 + $2,400) $6,000
P3–11 A. Based on the income statement and changes in the balance sheet, the
following transactions must have occurred:
1. Revenue from services rendered totaled $840,000. It was billed and
B. Explanation of the changes in cash:
Beginning cash balance $ 43,725
Measuring Revenues and Expenses 69
P3–12 A. Caldwell Furniture Repair
Income Statement
For March
Revenues $ 7,600
Expenses:
B. Explanation of the cash account:
Beginning balance $ 0
Owner investment 2,000
C. At the end of March there is an incomplete transformation cycle. A
70 Chapter 3
P3–13 A.
Event
Revenue,
Expense, or
Cash Flow?
Month of
February
Month of
March
Month of
April
Month of
May
Month
of June
1.
Expense
Cash Flow
0
0
$1,200
0
$1,200
$3,600
$1,200
0
0
0
B. In this problem, the patterns of accrual-based measures (revenues and
P3–14 A. Desert Harbor Inn
Income Statement
For the Year Ended December 31, 2007
Revenue from room rentals $165,000
2.
Revenue
Cash Flow
0
0
0
0
$7,500
0
$7,500
$7,500
0
4.
Expense
Cash Flow
0
$6,000
0
$4,000
0
$8,400
0