67
CHAPTER 3
BASIC ACCOUNTING SYSTEMS: ACCRUAL BASIS
CLASS DISCUSSION QUESTIONS
1. AT&T and Microsoft use the accrual ba-
sis of accounting. Generally accepted
accounting principles (GAAP) require all
but very small businesses to use the ac-
2. a. Under the cash basis of accounting,
revenues are reported in the period
in which cash is received, and ex-
penses are reported in the period in
5. Accrual basis only: c, f
Cash or accrual basis: a, b, d, e
6. Yes. Land needs no adjustment at the
end of the period.
7. No. Supplies before adjustments nor-
mally represents the cost of the supplies
at the beginning of the period plus the
cost of the supplies purchased during
the period. Some of the supplies have
been used; therefore, an adjustment is
necessary for the supplies used before
the amount for the balance sheet is de–
revenues), accrued expenses (accrued liabili-
ties), and accrued revenues (accrued assets).
10. Statement (b): Increases the balance of an ex-
pense account (accrued expense).
preciation expense is the expired cost for the
period. The reduction in the fixed asset ac-
count is recorded by increasing Accumulated
Depreciation rather than decreasing the
fixed asset account. The use of the contra
statement; Accumulated Depreciation ap-
pears in the balance sheet. Note: Deprecia-
tion may also appear on the statement of
cash flows when the indirect method is used.
The indirect method of preparing the state-
ment of cash flows is discussed in Chapter 4.
14. a. Current assets are cash and other assets
that are expected to be converted to cash or
sold or used up within one year or less,
through normal operations.
b. Property, plant, and equipment are com-
posed of assets used in the business that
68
E3–1
Financial Statement Effects
Balance Sheet
Assets = Liabilities + Stockholders’ Equity
Prepaid Accounts Common Retained
Cash + Supplies + Ins. = Payable + Stock + Earnings
a. Investment 30,000 30,000
e. Paid expenses (34,000) (34,000) e.
Balances 47,600 1,800 5,400 1,800 30,000 23,000
f. Paid dividends (8,000) (8,000)
Balances 39,600 1,800 5,400 1,800 30,000 15,000
Statement of Cash Flows
Income Statement
a. Financing 30,000 d. Fees earned 57,000
b. Operating (5,400) e. Wages exp. (21,600)
69
E3–2
Financial Statement Effects
Balance Sheet
Assets = Liabilities + Stockholders’ Equity
Prepaid Accounts Common Retained
Cash + Supplies + Ins. = Payable + Stock + Earnings
Balances (balances
from E3-1, refer to
solution for E3-1 for
Statement of Cash Flows Income Statement
a. Financing 30,000 d. Fees earned 57,000
70
E3–3
SUCCULENT EXPRESS
Income Statement
For the Month Ended February 28, 20Y4
Fees earned ………………………………………………………………… $ 57,000
Operating expenses:
Wages expense ……………………………………………………… $21,600
Rent expense …………………………………………………………. 6,400
Net income …………………………………………………………………. $ 21,050
SUCCULENT EXPRESS
Statement of Stockholders’ Equity
For the Month Ended February 28, 20Y4
Common Stock Retained Earnings Total
Balances, Feb. 1, 20Y4 ………………. — — —
Issued common stock ……………….. $30,000 $30,000
71
E3–3, Concluded
SUCCULENT EXPRESS
Balance Sheet
February 28, 20Y4
Assets
Cash …………………………………………………………………………… $39,600
Supplies ……………………………………………………………………… 300
Prepaid insurance ……………………………………………………….. 4,950
Total assets ………………………………………………………………… $44,850
Liabilities
Accounts payable ……………………………………………………….. $ 1,800
SUCCULENT EXPRESS
Statement of Cash Flows
For the Month Ended February 28, 20Y4
Cash flows from (used for) operating activities:
Cash received from customers ……………………………….. $ 57,000
Cash paid for expenses ………………………………………….. (39,400)*
Net cash flows from operating activities ………………….. $17,600
Cash flows from (used for) financing activities:
72
E3–4 (Appendix)
Net income ………………………………………………………………………… $ 21,050
Changes in noncash current operating assets and liabilities:
E3–5
a. Transaction:
(a) Issued common stock in exchange for cash, $35,000
(b) Purchased supplies on account, $1,800
(c) Paid cash to creditors for amounts owed, $800
(d) Earned fees from cash customers, $31,300
E3–6
1. (b) Deferred revenue (unearned revenue)
2. (a) Deferred expense (prepaid expense)
3. (b) Deferred revenue (unearned revenue)
73
E3–7
Account Answer
a. Accounts Receivable …………………… Normally requires adjustment (AR)
b. Accumulated Depreciation ………….. Normally requires adjustment (DE)
c. Common Stock …………………………… Does not normally require adjustment
d. Dividends …………………………………… Does not normally require adjustment
e. Interest Payable ………………………….. Normally requires adjustment (AE)
E3–8
a. $4,800 = $7,000 – $2,200
E3–9
a. Insurance Expense, increase, $52,800 = $19,200 + $57,600 – $24,000
Prepaid Insurance, decrease, $52,800
E3–10
Unearned Fees, decrease, $275,000 = $1,375,000 – $1,100,000
Fees Earned, increase, $275,000
E3–11
74
E3–12
a. Rent revenue (or revenues) will be understated by $36,750. Net income will be
understated by $36,750.
E3–13
a. Salary Expense, increase, $1,600 [($8,000 ÷ 5 days) × 1 day]
Salaries Payable, increase, $1,600
E3–14
$813,100 = $825,000 – $11,900
E3–15
a. Salary expense (or expenses) will be understated by $6,750. Net income will
be overstated by $6,750.
E3–16
a. Salary expense (or expenses) will be overstated by $6,750. Net income will be
understated by $6,750.
75
E3–17
a. $561 million
b. 43.4% = $561 ÷ $1,293
E3–18
Error (a) Error (b)
Over- Under- Over- Under-
stated stated stated stated
1. Revenue for the year would be …………… $ 0 $175,000 $ 0 $ 0
2. Expenses for the year would be …………. 0 0 0 12,300
3. Net income for the year would be ………. 0 175,000 12,300 0
E3–19
$2,387,300 = $2,224,600 + $175,000 – $12,300
E3–20
a. Accounts Receivable, increase, $47,700
Fees Earned, increase, $47,700
E3–21
a. Unearned Fees, decrease, $775,000
Fees Earned, increase, $775,000
76
E3–22
a. Fees earned (or revenues) will be understated by $13,400. Net income will be
understated by $13,400.
E3–23
a. Depreciation Expense, increase, $133,000
Accumulated Depreciation, increase, $133,000
b. (1) Depreciation expense would be understated by $133,000. Net income
would be overstated by $133,000.
E3–24
Adjustment Account Increase or Decrease Amount
1. Accounts Receivable Increase $11,250
Fees Earned Increase 11,250
2. Supplies Expense Increase 1,350
Supplies Decrease 1,350
3. Insurance Expense Increase 1,800
Prepaid Insurance Decrease 1,800
77
E3–25
a. $276,122 = $2,682,981 – $2,406,859
b. No. Depreciation is an allocation method not a valuation method. That is, de-
preciation allocates the cost of a fixed asset over its useful life. Depreciation
does not attempt to measure market values, which may vary significantly
from year to year.
78
E3–28
ELEVEN-ELEVEN, INC.
Balance Sheet
November 30, 20Y9
Assets
Current assets:
Cash ………………………………………………………….. $ 43,800
Accounts receivable …………………………………… 64,500
Supplies …………………………………………………….. 24,000
Prepaid insurance ………………………………………. 14,400
Liabilities
Current liabilities:
Accounts payable……………………………………….. $ 67,800
Stockholders’ Equity
Common stock ………………………………………………… $ 75,000
Retained earnings …………………………………………… 427,500
79
E3–29
LA-Z-BOY INC.
Balance Sheet
April 28
(in thousands)
Assets
Current assets:
Cash ………………………………………………………………………. $ 136,871
Accounts receivable ……………………………………………….. 154,055
Inventories …………………………………………………………….. 184,841
Other current assets ………………………………………………. 42,451
Total current assets …………………………………………… $518,218
Fixed Assets:
Liabilities
Current liabilities:
Accounts payable …………………………………………………… $ 62,403
Accrued expenses payable……………………………………… 118,721
Debt due within one year ………………………………………… 223
Total current liabilities ……………………………………….. $181,347
Stockholders’ Equity
Common stock ……………………………………………………………. $ 46,788
80
E3–30
a. 1. The date of the statement should be “May 31, 20Y5” and not “For the Year
Ended May 31, 20Y5.”
2. Accounts payable should be a current liability.
3. Land should be classified as property, plant, and equipment.
4. “Accumulated depreciation” should be deducted from the related fixed
asset.
81
E3–30, Concluded
b. A corrected balance sheet would be as follows:
ATLAS SERVICES CO.
Balance Sheet
May 31, 20Y5
Assets
Current assets:
Cash …………………………………………………….. $ 12,000
Accounts receivable ……………………………… 40,800
Supplies ……………………………………………….. 4,800
Prepaid insurance …………………………………. 17,400
Liabilities
Current liabilities:
Accounts payable …………………………………. $ 47,900
Wages payable ……………………………………… 8,100
Total liabilities ……………………………………………. $ 56,000
82
P3–1
Financial Statement Effects
Balance
Assets
Accts. Prepaid Acc.
Cash + Rec. + Insurance + Supplies + Buildin
g
–
Dep
. +
Balances, Jan. 1 10,000 22,250 350 600 75,000
(
5,600
)
Jan. 1. Received rent rev. 13,500
Balances 23,500 22,250 350 600 75,000
(
5,600
)
1. Paid ins.
(
3,000
)
3,000
(
)
(
)
(
)
(
)
(
)
(
)
18. Issued common stock 5,000
Balances 39,000 6,250 3,350 1,500 75,000
(
5,600
)
20. Billed patients 26,000
Balances 39,000 32,250 3,350 1,500 75,000
(
5,600
)
25. Cash fees 7,500
(
)
(
)
(
)
(
)
(
)
Statement of Cash Flows
Jan. 1. Operating 13,500
1. Operatin
g
(
3,000
)
9. Operatin
g
16,000
g
(
)
g
g
g
(
)
g
(
)
83
P3–1, Concluded
Sheet
= Liabilities + Stockholders’ Equit
y
Accts. Unearned Wa
g
es Notes Common Retained
+ Land = Pa
y
able + Revenue + Pa
y
able + Pa
y
able + Stock + Earnin
g
s
60,000 3,850 0 0 15,000 25,000 118,750
(
2,500
)
60,000 2,250 13,500 0 15,000 25,000 118,750
5,000
60,000 2,250 13,500 0 15,000 30,000 118,750
26,000 Jan. 20.
60,000 2,250 13,500 0 15,000 30,000 144,750
7,500 Jan. 25.
60,000 2,250 13,500 0 15,000 30,000 152,250
(
24,000
)
Jan. 30.
60,000 2,250 13,500 0 15,000 30,000 128,250
(
4,000
)
60,000 2,250 13,500 0 15,000 30,000 124,250
Income Statement
Jan. 20. Fees earned 26,000
(
)
(
)
(
)
(
)
(
)
84
P3–2
Financial Statement Effects
Balance
Assets
Accts. Prepaid Acc.
Cash + Rec. + Insurance + Supplies + Buildin
g
–
Dep
. +
Balances 18,500 32,250 3,350 1,500 75,000
(
5,600
)
Ad
j
ustments
Jan. 31. Insurance exp.
(
450
)
(
)
(
)
(
)
(
)
(
)
(
)
Balances 18,500 32,250 2,900 600 75,000
(
6,750
)
31. Fees earned 2,500
Balances, Jan. 31 18,500 34,750 2,900 600 75,000
(
6,750
)
Statement of Cash Flows
Jan. 1. Operatin
g
13,500
1. Operatin
g
(
3,000
)
9. Operatin
g
16,000
11. Operatin
g
(
2,500
)
g
g
g
(
)
g
(
)
g