Chapter -3 Operating Decisions and the Income Statement
Chapter 3
Operating Decisions and the Income Statement
ANSWERS TO QUESTIONS
1. A typical business operating cycle for a manufacturer would be as follows:
2. The time period assumption means that the financial condition and performance
of a business can be reported periodically, usually every month, quarter, or year,
even though the life of the business is much longer.
3. Net Income = Revenues + Gains – Expenses – Losses.
4. Both revenues and gains are inflows of net assets. However, revenues occur in
the normal course of operations, whereas gains occur from transactions
5. Accrual accounting requires recording revenues when earned and recording
Chapter 3 -Operating – Decisions – and -the – Income – Statement
3-2
6. The four criteria that must be met for revenue to be recognized under the accrual
basis of accounting are (1) delivery has occurred or services have been
7. The matching principle requires that expenses be recorded when incurred in
8. Net income equals revenues minus expenses. Thus revenues increase net
9. Revenues increase stockholders’ equity and expenses decrease stockholders’
10.
Item
Increase
Decrease
Revenues
Credit
Debit
Losses
Debit
Credit
Expenses
Debit
Credit
11.
Item
Debit
Credit
Revenues
Decrease
Increase
Gains
Decrease
Increase
Expenses
12.
Transaction
Operating,
Investing, or
Financing
Direction
of the Effect
on Cash
Cash paid to suppliers
Operating
–
Sale of goods on account
None
None
Cash received from customers
Operating
+
Purchase of investments
–
Cash paid for interest
Operating
–
Chapter -3 Operating Decisions and the Income Statement
3-3
13. Total asset turnover is calculated as Sales (or Operating revenues) Average
ANSWERS TO MULTIPLE CHOICE
Authors’ Recommended Solution Time
(Time in minutes)
Mini-exercises
Exercises
Problems
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Problems
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Chapter 3 -Operating – Decisions – and -the – Income – Statement
3-4
* Due to the nature of this project, it is very difficult to estimate the amount of time
students will need to complete the assignment. As with any open-ended project, it is
MINI-EXERCISES
M3–1.
M3–2.
Cash Basis
Income Statement
Accrual Basis
Income Statement
Expenses:
Inventory purchases
Wages paid
Expenses:
Cost of sales
Wages expense
Revenues:
Cash sales
Customer deposits
$10,000
3,000
Revenues:
Sales to customers
$15,000
Chapter -3 Operating Decisions and the Income Statement
M3–3.
Revenue Account Affected
Amount of Revenue Earned in July
a.
Games Revenue
$13,000
b.
Sales Revenue
July related to earnings in June.
recorded upon receipt of cash.
M3–4.
Expense Account Affected
Amount of Expense Incurred in July
e.
Cost of Goods Sold
$3,890
f.
None
g.
Wages Expense
$4,700
(recorded as Prepaid Expense (A)).
Utilities Expense
No expense is incurred in July; payment related
M3–5.
a.
Cash (+A) ………………………………………………………………….
13,000
Games Revenue (+R, +SE) …………………………………….
13,000
b.
Cash (+A) ………………………………………………………………….
3,000
Accounts Receivable (+A) ……………………………………………
4,000
Sales Revenue (+R, +SE) ……………………………………….
c.
Cash (+A) ………………………………………………………………….
d.
Cash (+A) ………………………………………………………………….
Unearned Revenue (+L) ………………………………………….
Chapter 3 -Operating – Decisions – and -the – Income – Statement
3-6
M3–6.
e.
Cost of Goods Sold (+E, −SE) ………………………………………
3,890
Inventory (−A) ………………………………………………………..
3,890
f.
Accounts Payable (–L) ………………………………………………..
1,900
M3–7.
Balance Sheet
Income Statement
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
a.
+13,000
NE
+13,000
+13,000
NE
+13,000
b.
NE
NE
d.
NE
NE
NE
Prepaid Expenses (+A) ………………………………………………..
1,200
Chapter -3 Operating Decisions and the Income Statement
M3–8.
Balance Sheet
Income Statement
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
e.
–3,890
NE
–3,890
NE
+3,890
–3,890
f.
–1,900
–1,900
NE
NE
NE
NE
g.
–4,700
NE
–4,700
NE
+4,700
–4,700
+1,200
NE
+2,600
–2,600
NE
+2,600
–2,600
M3–9.
Craig’s Bowling, Inc.
Income Statement
For the Month of July 2011
Revenues:
Games revenue
$13,000
Sales revenue
7,000
Total revenues
20,000
Cost of goods sold
Utilities expense
Wages expense
Insurance expense
Repairs expense
Total expenses
Net income
Chapter 3 -Operating – Decisions – and -the – Income – Statement
3-8
M3–10.
Craig’s Bowling, Inc.
Partial Statement of Cash Flows
For the Month of July 2011
Cash Flows from Operating Activities:
M3–11.
2012
2011
Total Asset
=
Sales
$163,000
=
2.89
$151,000
=
3.21
Turnover
Average Total Assets
$56,500*
$47,000**
Chapter -3 Operating Decisions and the Income Statement
EXERCISES
E3–1.
TERM
K
(1) Expenses
E
(2) Gains
G
(3) Revenue principle
(4) Cash basis accounting
(5) Unearned revenue
C
(6) Operating cycle
(8) Prepaid expenses
(10) Ending Retained Earnings =
E3–2.
Req. 1
Cash Basis
Income Statement
Accrual Basis
Income Statement
Expenses:
Inventory purchases
Wages paid
Expenses:
Cost of sales
Wages expense
Net Income
Revenues:
Cash sales
Customer deposits
$520,000
35,000
Revenues:
Sales to customers
$630,000
Req. 2
Accrual basis financial statements provide more useful information to external users.
Financial statements created under cash basis accounting normally postpone (e.g.,
Chapter 3 -Operating – Decisions – and -the – Income – Statement
3-10
E3–3.
Activity
Revenue Account Affected
Amount of Revenue Earned in
September
a.
None
No revenue earned in September;
earnings process is not yet complete.
b.
Interest revenue
$12 (= $1,200 x 12% x 1month/12 months)
c.
Sales revenue
$18,050
d.
None
No transaction has occurred; exchange of
promises only.
None
Payment related to revenue recorded
previously in (e) above.
g.
None
No revenue earned in September;
earnings process is not yet complete.
h.
None
No revenue is earned; the issuance of
stock is a financing activity.
None
No revenue earned in September;
earnings process is not yet complete.
Ticket sales revenue
$3,660,000 (= $18,300,000 ÷ 5 games)
k.
None
No revenue earned in September;
earnings process is not yet complete.
Sales revenue
$18,400
Sales revenue
$100
Chapter -3 Operating Decisions and the Income Statement
E3–4.
Activity
Expense Account Affected
Amount of Expense Incurred in
January
a.
Utilities expense
$2,754
b.
Advertising expense
$282(= $846 x 1 month/3 months) incurred
in January. The remainder is a prepaid
expense (A) that is not incurred until
February and March.
Salary expense
December.
the related revenue has been earned.
f.
Cost of goods sold
$40,050 (= 450 books x $89 per book)
g.
None
December expense paid in January.
h.
Commission expense
$14,470
Supplies expense
$5,190 (= $4,000 + $2,600 – $1,410)
k.
Wages expense
$104 (= 8 hours x $13 per hour)
Insurance expense
$300 (= $3,600 ÷ 12 months)
Repairs expense
$300
n.
Utilities Expense
$202
o.
Consulting Expense
$1,285
p.
None
December expense paid in January.
q.
Cost of goods sold
3-12
E3–5.
Balance Sheet
Income Statement
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
a.
+
NE
+
NE
NE
NE
b.
+
+
NE
NE
NE
NE
NE
NE
NE
NE
d.
+
NE
+
+
NE
+
e.
NE
+
–
NE
+
–
+
NE
+
+
NE
+
g.
–
–
NE
NE
NE
NE
h.
–
NE
–
NE
+
–
i.
+
NE
+
+
NE
+
j.
+
+
NE
NE
NE
NE
l.
–
NE
–
NE
–
–
+
–
NE
+
–
n.
–
NE
–
NE
+
–
Transaction (k) results in an increase in an asset (cash) and a decrease in an asset
(accounts receivable). Therefore, there is no net effect on assets.
* A loss affects net income negatively, as do expenses.
Chapter -3 Operating Decisions and the Income Statement
E3–6.
Balance Sheet
Income Statement
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
a.
+7,047
NE
+7,047
NE
NE
NE
b.
+765,472
+765,472
NE
NE
NE
NE
NE
NE
NE
NE
NE
NE
+734,547
e.
NE
NE
NE
NE
NE
NE
NE
NE
NE
g.
NE
+345,183
h.
+1,757
NE
+1,757
+1,757
NE
+1,757
NE
+2,850
NE
Transaction (f) results in an increase in an asset (property, plant, and equipment) and a
decrease in an asset (cash). Therefore, there is no net effect on assets.
E3–7.
(in thousands)
a.
Plant and equipment (+A) ……………………………………………
515
Cash (−A) ……………………………………………………………..
515
Debits equal credits. Assets increase and decrease by the same amount.
Cash (+A) …………………………………………………………………
758
758
Debits equal credits. Assets and liabilities increase by the same amount.
Accounts receivable (+A) …………………………………………….
amount.
Chapter 3 -Operating – Decisions – and -the – Income – Statement
3-14
E3–7. (continued)
d.
Accounts payable (−L) ………………………………………………..
4,300
Cash (−A) ……………………………………………………………..
4,300
Debits equal credits. Assets and liabilities decrease by the same amount.
g.
Cash (+A) …………………………………………………………………
37,410
Accounts receivable (−A) ………………………………………..
37,410
Debits equal credits. Assets increase and decrease by the same amount.
h.
Fuel expense (+E, −SE) …………………………..…………………
750
Cash (−A) ……………………………………………………………..
750
Debits equal credits. Expenses decrease retained earnings (part of
stockholders’ equity). Stockholders’ equity and assets decrease by the same
amount.
Retained earnings (−SE) …………………………………………….
Cash (−A) ……………………………………………………………..
497
Debits equal credits. Assets and stockholders’ equity decrease by the same
amount.
Utilities expense (+E, −SE) ………………………………………….
Debits equal credits. Expenses decrease retained earnings (part of
stockholders’ equity). Together, stockholders’ equity and liabilities decrease by
the same amount as assets.
e.
Inventory (+A) ……………………………………………………………
30,449
30,449
Debits equal credits. Assets and liabilities increase by the same amount.
Wages expense (+E, −SE) ………………………………………….
3,500
Cash (−A) ……………………………………………………………..
3,500
Chapter -3 Operating Decisions and the Income Statement
E3–8.
Req. 1
a. Cash (+A) …………………………………………………………. 2,500,000
Short-term note payable (+L) ……………………… 2,500,000
Debits equal credits. Assets and liabilities increase by the same amount.
e. Cash (+A) …………………………………………………………. 372,000
Unearned pass revenue (+L) ……………………… 372,000
Debits equal credits. Since the season passes are sold before Vail Resorts
provides service, revenue is deferred until it is earned. Assets and liabilities
increase by the same amount.
f. Two transactions occur:
(1) Accounts receivable (+A) ……………………………….. 750
Ski shop sales revenue (+R, +SE) ………………. 750
Debits equal credits. Revenue increases retained earnings (a part of
stockholders’ equity). Stockholders’ equity and assets increase by the same
amount.
Chapter 3 -Operating – Decisions – and -the – Income – Statement
3-16
E3–8. (continued)
g. Cash (+A) …………………………………………………………. 270,000
Lift revenue (+R, +SE) ………………………………. 270,000
Debits equal credits. Revenue increases retained earnings (a part of
stockholders’ equity). Stockholders’ equity and assets increase by the same
amount.
i. Accounts payable (−L) ………………………………………… 20,000
Cash (−A) ………………………………………………… 20,000
Debits equal credits. Assets and liabilities decrease by the same amount.
Req. 2
Accounts Receivable
Beg. bal. 1,200
(f) 750
400 (j)
End. bal. 1,550
Chapter -3 Operating Decisions and the Income Statement
E3–9.
2/1
Rent expense (+E, −SE) ……………………………………………..
275
Cash (−A) ………………………………………………………..
275
2/2
Fuel expense (+E, −SE) …………………………..…………………
Accounts payable (+L) ……………………………………….
Cash (+A) …………………………………………………………………
Unearned revenue (+L) ……………………………………..
820
2/7
Cash (+A) …………………………………………………………………
910
Transport revenue (+R, +SE) ……………………………..
910
2/10
Advertising expense (+E, −SE) …………………………………….
175
Cash (−A) ………………………………………………………..
175
2/14
Wages payable (−L) …………………………………………………..
2,300
Cash (−A) ………………………………………………………..
2,300
Transport revenue (+R, +SE) ……………………………..
Parts supplies (+A) …………………………………………………….
2/27
Retained earnings (−SE) …………………………………………….
Dividends payable (+L) ………………………………………
Chapter 3 -Operating – Decisions – and -the – Income – Statement
3-18
E3–10.
Req. 1 and 2
Cash
Accounts Receivable
Supplies
Beg. 6,200
(a) 18,400
2,140 (g)
Beg.30,000
7,200 (d)
Beg. 1,440
(k) 960
Equipment
Land
Building
Beg. 9,600
(h) 920
Beg. 7,200
Beg. 26,400
10,520
7,200
26,400
Accounts
Payable
Unearned Fee
Revenue
Note
Payable
7,980
4,440
Contributed Capital
Retained Earnings
Rebuilding Fees
Revenue
8,600 Beg.
10,800 Beg.
0 Beg.
Rent Revenue
Wages Expense
Utilities Expense
820 (c)
820
Chapter -3 Operating Decisions and the Income Statement
3-19
E3–10. (continued)
Req. 3
Net income using the accrual basis of accounting:
Revenues
$19,220
($18,400 + $820)
– Expenses
15,520
($15,000 + $520)
Net Income
(accrual basis)
$ 3,700
Assets
=
Liabilities
+
Stockholders’ Equity
$12,520
$ 7,980
$ 9,520
Req. 4
Net income using the cash basis of accounting:
Cash receipts
$27,020
(transactions a through d)
– Cash disbursements
18,100
(transactions g, i, and k)
Net Income
(cash basis)
$ 8,920
Cash basis net income ($8,920) is higher than accrual basis net income ($3,700)
because of the differences in the timing of recording revenues versus receipts and
3,700 net income
$81,840
$60,420
Chapter 3 -Operating – Decisions – and -the – Income – Statement
E3–11.
Req. 1
STACEY’S PIANO REBUILDING COMPANY
Income Statement (unadjusted)
For the Month Ended January 31, 2011
Operating Revenues:
Rebuilding fees revenue
$ 18,400
Total operating revenues
18,400
Operating Expenses:
Wages expense
15,000
Utilities expense
Total operating expenses
Operating Income
Other Item:
Rent revenue
Net Income
Req. 2
STACEY’S PIANO REBUILDING COMPANY
Statement of Stockholders’ Equity (unadjusted)
For the Month Ended January 31, 2011
Contributed
Capital
Retained
Earnings
Total
Stockholders’
Equity
Balance, December 31, 2010
$ 8,600
$ 10,800
$19,400
Balance, January 31, 2011
$11,900
$21,420