Class Practice Questions # 1

Question#1
Selected transactions for Fabulous Flora Company are listed below.
1. Made cash investment to start business.
2. Purchased equipment on account.
3. Paid salaries.
4. Billed customers for services performed.
5. Received cash from customers billed in (4).
6. Withdrew cash for owner’s personal use.
7. Incurred advertising expense on account.
8. Purchased additional equipment for cash.
9. Received cash from customers when service was performed.
Describe the effect of each transaction on assets, liabilities, and owner’s equity.
Solution #1
1. Increase in assets and increase in owner’s equity.
2. Increase in assets and increase in liabilities.
3. Decrease in assets and decrease in owner’s equity.
4. Increase in assets and increase in owner’s equity.
5. Increase in assets and decrease in assets.
6. Decrease in assets and decrease in owner’s equity.
7. Increase in liabilities and decrease in owner’s equity.
8. Increase in assets and decrease in assets.
9. Increase in assets and increase in owner’s equity.
Question#2
Joan Robinson opens her own law office on July 1, 2017. During the first month of operations, the following
transactions occurred.
a. Joan invested $11,000 in cash in the law practice.
b. Paid $800 for July rent on office space
c. Purchased equipment on account $3,000.
d. Performed legal services to clients for cash $1,500.
e. Borrowed $700 cash from a bank on a note payable.
f. Performed legal services for client on account $2,000.
g. Paid monthly expenses: salaries and wages $500, utilities $300, and advertising $100.
h. Joan withdrew $1,000 cash for personal use.
(a) Prepare a tabular summary of the transactions. (b) Prepare the income statement, owner’s equity statement,
and balance sheet at July 31, 2017, for Joan Robinson, Attorney.
Solution #2
Assets 5 Liabilities Owner’s Equity
Trans- Accounts Notes Accounts Owner’s Owner’s
Cash + Receivable +Equipment Payable + Payable Capital - Drawings + Revenues - Exp
(1) 1 + $11,000 +$11,000
(2) 2 -800 -$800
(3) $3,000 +$3,000
(4) +1,500 +$1,500
(5) +700 +$700
(6) +$2,000 +2,000
(7) -500 -500
-300 -300
-100 -100
(8) -1,000 -$1,000
 $10,500 + $2,000 + $3,000 $700 + $3,000 + $11,000 - $1,000 + $3,500 - $1,700
$15,500 $15,500

JOAN ROBINSON, ATTORNEY

Income Statement
For the Month Ended July 31, 2017
Revenues
Service revenue $3,500
Expenses
Rent expense $800
Salaries and wages expense 500
Utilities expense 300
Advertising expense 100
Total expenses 1,700
Net income $1,800

JOAN ROBINSON, ATTORNEY

Balance Sheet
July 31, 2017
Assets
Cash $10,500
Accounts receivable 2,000
Equipment 3,000
Total assets $15,500

Liabilities and Owner’s Equity

Liabilities
Notes payable $ 700
Accounts payable 3,000
Total liabilities 3,700
Owner’s equity
Owner’s capital 11,800
Total liabilities and owner’s equity $15,500

Question#3
At the beginning of the year, Gilles Company had total assets of $800,000 and total liabilities of $500,000.
Answer the following questions.
(a) If total assets increased $150,000 during the year and total liabilities decreased $80,000, what is the
amount of owner’s equity at the end of the year?
(b) During the year, total liabilities increased $100,000 and owner’s equity decreased $70,000. What is the
amount of total assets at the end of the year?
(c) If total assets decreased $80,000 and owner’s equity increased $120,000 during the year, what is the
amount of total liabilities at the end of the year?
Solution #3
(a) ($800,000 + $150,000) – ($500,000 – $80,000) = $530,000 (Owner’s equity).
(b) ($500,000 + $100,000) + ($800,000 – $500,000 – $70,000) = $830,000 (Assets).
(c) ($800,000 – $80,000) – ($800,000 – $500,000 + $120,000) = $300,000(Liabilities).
Question#4

Genesis Company performs the following accounting tasks during the year.
________Analyzing and interpreting information.
________Classifying economic events.
________Explaining uses, meaning, and limitations of data.
________Keeping a systematic chronological diary of events.
________Measuring events in dollars and cents.
________Preparing accounting reports.
________Reporting information in a standard format.
________Selecting economic activities relevant to the company.
________Summarizing economic events.
Accounting is “an information system that identifies, records, and communicates the economic events of an
organization to interested users.” Instructions Categorize the accounting tasks performed by Genesis as relating
to either the identification (I), recording (R), or communication (C) aspects of accounting.
Solution #4
C Analyzing and interpreting information.
R Classifying economic events.
C Explaining uses, meaning, and limitations of data.
R Keeping a systematic chronological diary of events.
R Measuring events in dollars and cents.
C Preparing accounting reports.
C Reporting information in a standard format.
I Selecting economic activities relevant to the company.
R Summarizing economic events.

Question#5
Selected transactions for Green Valley Lawn Care Company are listed below.
1. Made cash investment to start business.
2. Paid monthly rent.
3. Purchased equipment on account.
4. Billed customers for services performed.
5. Withdrew cash for owner’s personal use.
6. Received cash from customers billed in (4).
7. Incurred advertising expense on account.
8. Purchased additional equipment for cash.
9. Received cash from customers when service was performed.

Describe the effect of each transaction on assets, liabilities, and owner’s equity. For example, the first
answer is: (1) Increase in assets and increase in owner’s equity.
Solution #5
1. Increase in assets and increase in owner’s equity.
2. Decrease in assets and decrease in owner’s equity.
3. Increase in assets and increase in liabilities.
4. Increase in assets and increase in owner’s equity.
5. Decrease in assets and decrease in owner’s equity.
6. Increase in assets and decrease in assets.
7. Increase in liabilities and decrease in owner’s equity.
8. Increase in assets and decrease in assets.
9. Increase in assets and increase in owner’s equity.
Question#6
Finch Company had the following assets and liabilities on the dates indicated.
December 31 Total Assets Total Liabilities
2016 $400,000 $250,000
2017 $460,000 $300,000
2018 $590,000 $400,000
Finch began business on January 1, 2016, with an investment of $100,000.

From an analysis of the change in owner’s equity during the year, compute the net income (or loss) for:
(a) 2016, assuming Finch’s drawings were $15,000 for the year.
(b)2017, assuming Finch made an additional investment of $50,000 and had no drawings in 2017.
(c) 2018, assuming Finch made an additional investment of $15,000 and had drawings of $30,000 in 2018.

Solution #6

(a) Owner’s equity—12/31/16 ($400,000 – $250,000)..................... $150,000

Owner’s equity—1/1/16 .................................................................... 100,000
Increase in owner’s equity.............................................................. 50,000
Add: Drawings .................................................................................. 15,000
Net income for 2016 ................................................................. $ 65,000

(b) Owner’s equity—12/31/17 ($460,000 – $300,000) .................. $160,000

Owner’s equity—1/1/17—see (a)................................................. 150,000
Increase in owner’s equity ........................................................... 10,000
Less: Additional investment....................................................... 50,000
Net loss for 2017.............................................................................. $ 40,000

(c) Owner’s equity—12/31/18 ($590,000 – $400,000) .................. $190,000

Owner’s equity—1/1/18—see (b) ................................................ 160,000
Increase in owner’s equity ........................................................... 30,000
Less: Additional investment....................................................... 15,000
15,000
Add: Drawings ............................................................................... 30,000
Net income for 2018.............................................................. $ 45,000

Question#7
Abby Roland is the bookkeeper for Cheng Company. Abby has been trying to determine the correct balance
sheet for Cheng Company. Cheng’s balance sheet is shown below.

CHENG COMPANY
Balance Sheet December 31, 2017
Assets Liabilities
Cash $15,000 Accounts payable $20,000
Supplies 8,000 Accounts receivable (8,500)
Equipment 46,000 Owner’s capital 67,500
Owner’s drawings 10,000
Total assets $79,000 Total liabilities & owner’s equity $79,000

Prepare a correct balance sheet.

Solution #7
Cheng COMPANY
Balance Sheet
December 31, 2017
Assets
Cash................................................................................................................ $15,000
Accounts receivable.................................................................................. 8,500
Supplies......................................................................................................... 8,000
Equipment..................................................................................................... 46,000
Total assets ......................................................................................... $77,500

Liabilities and Owner’s Equity

Liabilities
Accounts payable.............................................................................. $20,000
Owner’s equity
Abby, Capital ($67,500 – $10,000) ........................................... 57,500
Total liabilities and owner’s equity..................................... $77,500

Question#8
On June 1, Cindy Godfrey started Divine Designs Co., a company that provides craft opportunities, by
investing $ 45,000 cash in the business. Following are the assets and liabilities of the company at June 30, 2018
and the revenues and expenses for the month of June.

Cash $5,600 Service Revenue $7,500

Accounts Receivable 7,200 Advertising Expense 500
Repair Expense 400 Rent Expense 1,200
Equipment 64,000 Gasoline Expense 2,500
Notes Payable 30,000 Insurance Expense 400
Accounts Payable 800
Cindy made no additional investment in June but withdrew $1,500 in cash for personal use during the month.
a) Prepare an income statement and owner’s equity statement for the month of June and a balance sheet
at June 30, 2018.
b) Prepare an income statement and owner’s equity statement for June assuming the following data are
not included above: (1) $900 of services were performed and billed but not collected at June 30, and
(2) $1,500 of gasoline expense was incurred but not paid.

Solution #8
(a) CINDY GODFREY STARTED DIVINE DESIGNS CO
Income Statement
For the Month Ended June 30, 2018
Revenues ................................................... $7,500
Expenses
Fuel expense............................................ $2,500
Rent expense ........................................... 1,200
Advertising expense................................. 500
Insurance expense..................................... 400
Repair expense......................................... 400
Total expenses ............................................ 5,000
Net income..................................................... $2,500
CINDY GODFREY STARTED DIVINE DESIGNS CO
Owner’s Equity Statement
For the Month Ended June 30, 2018
Capital, June 1 ....................................... $0
Add: Investments....................................................... $45,000
Net income......................................................... 2,500 47,500
47,500
Less: Drawings ............................................................ 1,500
Capital, June 30..................................... $46,000

CINDY GODFREY STARTED DIVINE DESIGNS CO

Balance Sheet
June 30,2018
Assets
Cash......................................................................................................... $ 5,600
Accounts receivable........................................................................... 7,200
Equipment.............................................................................................. 64,000
Total assets .................................................................................. $ 76,800

CINDY GODFREY STARTED DIVINE DESIGNS CO

Balance Sheet (Continued)
June 30,2018
Liabilities and Owner’s Equity
Liabilities
Notes payable............................................................................... $30,000
Accounts payable ....................................................................... 800
Total liabilities ..................................................................... 30,800
Owner’s equity
Capital.................................................................... 46,000
Total liabilities and owner’s equity .............................. $76,800

(b) CINDY GODFREY STARTED DIVINE DESIGNS CO

Income Statement
For the Month Ended June 30, 2018
Revenues ($7,500 + $900)..................... $8,400
Expenses
Fuel expense ($2,500 + $1,500) ...................... $4,000
Rent expense..................................................... 1,200
Advertising expense .......................................... 500
Insurance expense ............................................. 400
Repair expense.................................................... 400
Total expenses............................................ 6,500
Net income ..................................................................... $1,900

CINDY GODFREY STARTED DIVINE DESIGNS CO

Owner’s Equity Statement
For the Month Ended June 30,2018
Capital, June 1....................................... $0
Add: Investments ...................................................... $45,000
Net income ....................................................... 1,900 46,900
46,900
Less: Drawings ........................................................... 1,500
Capital, June 30.................................... $45,400
Question#9
Several timing concepts are discussed. A list of concepts is provided below, with a description of the concept
given underneath. There are more descriptions provided than concepts. Match the description of the concept to
the concept.
1. ____Accrual-basis accounting.
2. ____Calendar year.
3. ____Time period assumption.
4. ____Expense recognition principle.

(a) Monthly and quarterly time periods.

(b) Efforts (expenses) should be matched with results (revenues).
(c) Accountants divide the economic life of a business into artificial time periods.
(d) Companies record revenues when they receive cash and record expenses when they pay out cash.
(e) An accounting time period that starts on January 1 and ends on December 31.
(f) Companies record transactions in the period in which the events occur.

Solution #9

1. f 2. e 3. c 4. B

Questions # 10
a. What are the three distinct types of business activity in which companies engage? Assume that you start
your own company to rent bicycles in the summer and skis in the winter. Give an example of at least one of
each of the three types of business activities in which you would engage.

The types of activities in which companies engage are financing, investing, and operating. To start a new
business, such as renting bicycles and skis, requires initial financing, such as initial contributions by the
owners and loans by a bank. Next, the business would need to invest in the assets it will rent—that is,
bicycles and skis. Once investments in assets are made, the business would earn revenue by renting out
bicycles and skis. The business would also incur various operating expenses, such as wages, advertising, and
taxes.

b. Rogers Corporation starts the year with a Retained Earnings balance of $55,000. Net income for the year is
$27,000. The ending balance in Retained Earnings is $70,000. What was the amount of dividends for the
year?
If Rogers has $55,000 in Retained Earnings to begin the year and net income for the year of $27,000, the
ending balance in Retained Earnings would be $82,000 if no dividends were paid during the year. Because
the ending balance in Retained Earnings is $70,000, the company must have paid $12,000 in dividends.
c. Evaluate the following statement: The auditors are in the best position to evaluate a company because they
have prepared the financial statements.

The auditors may be in an excellent position to evaluate a company, but not because they have prepared the
financial statements. The preparation of the statements is the responsibility of management. The role of the
auditor is to perform various tests and procedures as a basis for rendering an opinion on the fairness of the
presentation of the statements.
d. What is the relationship between the cost principle and the going concern assumption?
We assume in the absence of evidence to the contrary that a business will continue indefinitely. This
assumption, known as the going concern assumption, helps to justify the use of historical costs in the
statements. For example, if we knew that a company was in the process of liquidation, it would not be
appropriate to use historical costs in assigning an amount to such assets as land and buildings. Instead, the
 current or market values of the assets would be more meaningful to a user of the balance sheet. Because the
normal assumption is that a business will continue indefinitely, the objectivity of historical cost makes it
more attractive as a basis for valuation.

e. Why does inflation present a challenge to the accountant? Relate your answer to the monetary unit
assumption.
Inflation, as evidenced by the changing value of the dollar, poses a problem for the accountant. Accountants
make the assumption in preparing a set of financial statements that the dollar is a stable measuring unit. This
assumption, called the monetary unit assumption, may or may not be accurate, depending on the level of
inflation in the economy. The higher the rate of inflation, the less reliable is the dollar as a measuring unit.

f. How would you evaluate the following statement: The cash flows to a company are irrelevant to an investor;
all the investor cares about is the potential for receiving dividends on the investment.
The primary concern to an investor is the future cash to be received from the investment. However, this
does not mean that the cash flows of the company that has been invested in are not relevant. A relationship
exists between the cash flows to the investor and those to the company. For example, a company that does
not consistently generate sufficient cash flows from its operations will not be able to pay cash dividends to
the investors over a sustained time.

g. A key characteristic of useful financial information is understandability. How does this qualitative
characteristic relate to the background of the user of the information?
The understandability characteristic does not imply that someone must have an extensive accounting
background to be able to use financial statements. However, accounting information should be
understandable to those who are willing to learn to use it properly. In other words, the information should
make sense to someone who spends the time required to have a basic understanding of accounting.

h. What does relevance mean with regard to the use of accounting information?
Relevance is the capacity of accounting information to make a difference in a financial decision. For
example, an income statement is relevant when the use of it has at least the potential to make a difference in
an investment decision.

i. What is the qualitative characteristic of comparability? Why is it important in preparing financial

statements?
Comparability is the quality of accounting information that allows comparisons to be made between or
among companies. Without it, financial statements would be very limited in their value. Financial
decisions require choices to be made about the investment of limited resources. Investors need assurance
that the financial statements of companies that they are considering as investments are comparable.

j. What is the difference between comparability and consistency as they relate to the use of accounting
information?
Comparability is the quality of information that allows for comparisons to be made between two or more
companies, whereas consistency is the quality that allows for comparisons to be made within a single entity
from one accounting period to the next.
k. How does the concept of materiality relate to the size of a company?

The concept of materiality is closely related to the size of a company. For example, assume that a company
must decide whether a $500 expenditure that will benefit future periods should be expensed immediately or
capitalized (i.e., recorded as an asset). The decision cannot be made without considering the amount in
relation to the size of the company. An amount that is immaterial for a large multinational corporation may
be material for a smaller business

l. How does the concept of the operating cycle relate to the definition of a current asset?

A current asset is an asset that a company expects to realize in cash, sell, or consume during its normal
operating cycle. Therefore, accounts receivable, inventory, and supplies all meet this definition and are
classified as current assets. By their nature, the benefits from each of these assets will be realized during the
normal operating cycle of the business.

m. How would you evaluate the following statement: A note payable with an original maturity of five years
will be classified on the balance sheet as a long-term liability until it matures.
The note payable will be classified on the balance sheet as long-term until one year from its maturity date.
At that time, it should be reclassified from long-term to current because it will be paid within the next year.
Any liability that will mature within one year of the date of the balance sheet should be classified as current,
regardless of the original term of the loan (five years in this case).

n. In auditing the financial statements of a company, does the auditor certify that the statements are totally
accurate without errors of any size or variety? Explain.

An audit of a set of financial statements does not ensure that the statements contain no errors. Because of
the sheer number of transactions entered into during a period of time, it would be impossible for an auditor
to check every single transaction to determine that it was correctly recorded. Instead, through various types
of tests, the auditor renders an opinion as to whether the statements are free of material misstatement.

o. What are four different forms of cash?

Cash can take many different forms. One of the most common forms is a checking account. Other forms
include coin and currency on hand, savings accounts, money orders, certified checks, and cashier’s checks.

p. What is the meaning of the following statement? The choice between historical cost and current value is a
good example of the trade-off in accounting between relevance and reliability.
Accountants strive to present financial statements that are both relevant to the decisions made by users of
the statements and also reliable or verifiable. Sometimes, however, there are trade-offs. For example, in
deciding whether an asset that a company pledges as collateral for a loan is sufficient, a banker may be most
interested in the current value of the asset. That is, this amount may be the most relevant attribute or
characteristic of the asset for the banker's needs. The accountant, however, may be reluctant to present the
current value of the asset on the balance sheet because of the difficulty in measuring the value of the asset
with any degree of reliability. The amount paid for the asset—that is, its historical cost—may be more
reliable, although not as relevant to the banker's decision.

q. What does the following statement mean? If I want to assess the cash flow prospects for a company “down
the road,” I look at the company’s most recent statement of cash flows. An income statement prepared under
the accrual basis of accounting is useless for this purpose.
 This statement is not entirely accurate. Because it is based on historical cash flows, a statement of cash
flows is not necessarily the most accurate source of information on the future cash flow prospects for a
company. An income statement may in fact provide more important information about future cash flows.
For example, an income statement includes not only sales on a cash basis this period but also sales on credit
that will generate cash flows in future periods. Similarly, a statement of cash flows reports only expenses
that required a cash outlay in the current period. An accrual-based income statement provides information
on accrued expenses that will result in a cash outlay in future periods.

r. What is the relationship between the time period assumption and accrual accounting?
The time period assumption is important in accounting because financial statement users want information
about a company as of a particular point in time and for distinct periods of time. For example, a potential
stockholder wants to know the financial position at the end of the most recent year and the profit of a
business for the most recent year. Under an accrual accounting system, revenues are recognized when they
are earned regardless of when cash is received, and expenses are recognized when they are incurred
regardless of when cash is paid. The accountant does not wait until all of the cash from a sale has been
collected to report the sale on the income statement. In this way, the user of the statement receives
information on a timely basis.

s. Is it necessary for an asset to be acquired when revenue is recognized? Explain your answer.
No, the recognition of revenue is not always the result of the acquisition of an asset. Assume that a
publisher sells a magazine subscription and collects cash from the customer in advance. At the time cash is
collected, the publisher incurs a liability. As each month's magazine is mailed to the customer, a portion of
the liability is satisfied and revenue is recognized. Thus, in some instances revenue results from the
settlement of a liability.

Questions # 11
Three methods of matching costs with revenue were described in the chapter: (a) directly match a specific form
of revenue with a cost incurred in generating that revenue, (b) indirectly match a cost with the periods during
which it will provide benefits or revenue, and (c) immediately recognize a cost incurred as an expense because
no future benefits are expected. For each of the following costs, indicate how it is normally recognized as
expense by indicating either (a), (b), or (c). If you think that more than one answer is possible for any of the
situations, explain why.
1. New office copier
2. Monthly bill from the utility company for electricity
3. Office supplies
4. Biweekly payroll for office employees
5. Commissions earned by salespeople
6. Interest incurred on a six-month loan from the bank
7. Cost of inventory sold during the current period
8. Taxes owed on income earned during current period
9. Cost of three-year insurance policy

Solution #11

1. b
2. c
3. b or c (would recognize immediately if supplies are normally used up within the period)
4. c
5. a
6. c
7. a
8. c
9. b

Questions # 12
For the following situations, indicate whether each involves a deferred expense (DE), a deferred revenue (DR),
an accrued liability (AL), or an accrued asset (AA).
Example: DE Office supplies purchased in advance of their use
___________ 1. Wages earned by employees but not yet paid
___________ 2. Cash collected from subscriptions in advance of publishing a magazine
___________ 3. Interest earned on a customer loan for which principal and interest have not yet been collected
___________ 4. One year’s premium on life insurance policy paid in advance
___________ 5. Office building purchased for cash
___________ 6. Rent collected in advance from a tenant
___________ 7. State income taxes owed at the end of the year
___________ 8. Rent owed by a tenant but not yet collected

Solution #12

1. AL 5. DE
2. DR 6. DR
3. AA 7. AL
4. DE 8. AA

Questions # 13
Two years ago, Sue Stern opened an audio book rental shop. Sue reports the following accounts on her income
statement:

Sales $84,000
Advertising Expense 10,500
Salaries Expense 12,000
Depreciation on CDs 5,000
Rent Expense 18,000

These amounts represent two years of revenue and expenses. Sue asks you how she can tell how much of the
income is from the first year and how much is from the second year of business. She provides the following
additional data:
a. Sales in the second year are triple those of the fi rst year.
b. Advertising expense is for a $1,500 opening promotion and weekly ads in the newspaper.
c. Salaries represent one employee who was hired eight months ago. No raises have been granted.
d. Rent has not changed since the shop opened.

Required
Prepare income statements for Years 1 and 2.
Solution #13
Income statements for the first two years:

SUE'S AUDIO BOOK RENTALS

INCOME STATEMENTS
Year 1 Year 2
Sales revenue (a) $ 21,000 $ 63,000
Expenses:
Advertising (b) $ 6,000 $ 4,500
Salaries 0 12,000
Depreciation (c) 2,500 2,500
Rent (d) 9,000 9,000
Total expenses $ 17,500 $ 28,000
Net income $ 3,500 $ 35,000

Explanations:
a. Let X = Year 1 sales:
Year 1 sales + 3(Year 1 sales) = $84,000
4X = $84,000
X = $21,000 = Year 1 sales
3X = $63,000 = Year 2 sales
b. Total advertising expense $ 10,500
Less promotional portion 1,500
Total ad expense $ 9,000 or $4,500/year
Year 1 advertising = $4,500 + $1,500 = $6,000
Year 2 advertising = $4,500
c. Depreciation per year = $5,000/2 = $2,500/year

d. Rent per year = $18,000/2 = $9,000/year

Questions # 14
Jane Erving, a newly hired accountant wanting to impress her boss, stayed late one night to analyze the long-
distance calls by area code and time of day placed. She determined the monthly cost for the previous 12 months
by hour and area code called.

Required
a. What did Jane think her boss would learn from this information? What action might be taken as a result of
knowing it?
b.Would this information be more relevant if Jane worked for a hardware store or for a real estate company?
Discuss.
Solution #14

a. The pattern of long distance calls might point to alternative long-distance plans with one of the many
carriers now in this business. For example, some companies might give a discount for calls made in off-
peak hours. The analysis might point to misuse by certain employees (overuse, personal use, etc.), a
situation that could be corrected by talking to the employees who are misusing the long distance service.

b. This question deals with the concept of materiality. It would be difficult to decide which of the two
types of companies, a realtor or a hardware store, would make more long distance calls. A realtor might
make a large number of long distance calls if it deals with out-of-state clients. The hardware store
might regularly order inventory from vendors outside of its area code.

Questions # 15
You are controller for an architectural firm whose accounting year ends on December 31. As part of the
management team, you receive a year-end bonus directly related to the firm’s earnings for the year. One of your
duties is to review the transactions recorded by the bookkeepers. A new bookkeeper recorded the receipt of
$10,000 in cash as an increase in cash and an increase in service revenue. The $10,000 is a deposit, and the
bookkeeper explains to you that the firm plans to provide the services to the client in March of the following
year.

Required
a. Did the bookkeeper correctly record the client’s deposit? Explain your answer.
b.What would you do as controller for the firm? Do you have a responsibility to do anything to correct the
books? Explain your answer.

Solution #15
a. No, the bookkeeper did not account for the client's deposit correctly. Because the amount received from the
client is a deposit for work to be done next year, it represents a liability at the end of the year rather than
revenue.
b. As controller for the firm, you are responsible for the accuracy and fairness of the financial statements. You
do have a moral and ethical responsibility to correct the books, even though in so doing the income for the
year will be reduced. A reduction in the reported income will affect your year-end bonus, but you have a
responsibility on your part to the users of the financial statements that supersedes any concerns over your
personal financial situation.

Questions # 16
As assistant controller for a small consulting firm, you are responsible for recording and posting the daily cash
receipts and disbursements to the ledger accounts. After you have posted the entries, your boss, the controller,
prepares a trial balance and the financial statements. You make the following entries on June 30, 2010:

2010
June 30 Cash 1,430
Accounts Receivable 1,950
Service Revenue 3,380
To record daily cash receipts.
June 30 Advertising Expense 12,500
Utilities Expense 22,600
Rent Expense 24,000
Salary and Wage Expense 17,400
Cash 76,500
To record daily cash disbursements.
The daily cash disbursements are much larger on June 30 than on any other day because many of the company’s
major bills are paid on the last day of the month. After you have recorded these two transactions and before you
have posted them to the ledger accounts, your boss comes to you with the following request:

As you are aware, the first half of the year has been a tough one for the consulting industry and for our business
in particular. With first-half bonuses based on net income, I am wondering whether you or I will get a bonus this
time around. However, I have a suggestion that should allow us to receive something for our hard work and at
the same time not hurt anyone. Go ahead and post the June 30 cash receipts to the ledger, but don’t bother to
post that day’s cash disbursements. Even though the treasurer writes the checks on the last day of the month and
you normally journalize the transaction on the same day, it is silly to bother posting the entry to the ledger since
it takes at least a week for the checks to clear the bank.

Required
a. Explain why the controller’s request will result in an increase in net income.
b.Do you agree with the controller that the omission of the entry on June 30 “will not hurt anyone”? Whom
could it hurt? Does omitting the entry provide information that is free from bias? Explain your answer.
c. What would you do if the controller told you to do this? To whom should you talk about this issue? Is this
situation an ethical issue? Why or why not?

Solution #16

a. Entries entered into the journal but not posted to the ledger accounts will not be reflected in the financial
statements. Failure to post the expense/cash disbursement entry will mean that cash will be higher on the
trial balance prepared by the controller, and expenses will be lower. By ignoring a total of $76,500 in
various expenses, net income will be increased by the same amount.

b. The controller is not correct in saying that the omission of the expense entry “will not hurt anyone.” First,
there is the basic issue: whether the company should rightfully be required to pay bonuses on a profit level
that was not attained. Second, there is the related issue: the effect of this deceptive practice on various
constituencies of the company. What about the stockholders? They have entrusted responsibility for
managing the business in a fair and ethical manner to the officers of the corporation. This particular practice
would be a serious violation of this trust. Finally, any number of outside users of the financial statements
could be misled by this practice. For example, a banker relies on the income statement of a company to
provide a clear and accurate picture of the results of operations. The failure to accurately reflect the
expenses of the period results in information that is not free from bias and is certainly misleading.

c. The assistant controller has a definite moral and ethical responsibility to confront the controller about the
suggestion. A direct confrontation in this particular case may be warranted. The assistant controller should
point out that this practice not only violates accounting principles but also is a very serious violation of the
trust shown in both individuals by the stockholders. The assistant controller should explain why this practice
is not acceptable. If the situation becomes confrontational, and the controller orders the assistant not to make
the entry, the assistant has a responsibility to talk to the controller's boss about the problem. This situation
does present the assistant controller with an ethical dilemma since that person understands that the request
by the controller would result in information that is not acceptable practice and is not free from bias.

Questions # 17
Fill in the blank with the qualitative characteristic for each of the following descriptions.
_________________ 1. Information that users can depend on to represent the events that it purports to represent
_________________ 2. Information that has the capacity to make a difference in a decision
_________________ 3. Information that is valid, that indicates an agreement between the underlying data and
the events represented
_________________ 4. Information that allows for comparisons to be made from one accounting period to the
next
_________________ 5. Information that is free from error
_________________ 6. Information that is meaningful to those who are willing to learn to use it properly
_________________ 7. Information that is not slanted to portray a company’s position any better or worse than
the circumstances warrant
_________________ 8. Information that allows for comparisons to be made between or among companies

Solution #17

1. reliability 5. verifiability
2. relevance 6. understandability
3. representational faithfulness 7. neutrality
4. consistency 8. comparability

Questions #18
For each of the following cases, fill in the blank with the appropriate dollar amount.

Sara’s Amy’s Jane’s

Coffee Shop Deli Bagels
Net sales 35,000 ________ 78,000
Cost of goods sold 45,000 ______0000 0_---_____
Gross profit 7,000 18,000 00 _________ __000 0
Selling expenses 3,000 ______ 9,000
General and administrative expenses 1,500 2,800 00000 0______
Total operating expenses ______ 8,800 13,600
Net income 2,500 9,200 25,400

Solution #18

Sara’s
Coffee Amy’s Jane’s
Shop Deli Bagels

Net sales $ 35,000 (3) $ 63,000

$ 78,000
Cost of goods sold (1) 28,000 45,000 (7) 39,000
Gross profit 7,000 18,000 (6) 39,000
Selling expenses 3,000 (4) 6,000 9,000
General and admini-
strative expenses 1,500 2,800 (5) 4,600
Total operating
expenses (2) 4,500 8,800 13,600
Net income $ 2,500 $ 9,200 $ 25,400

Solved as follows (in the order listed):

(1) 35,000 – 7,000 = 28,000

(2) 3,000 + 1,500 = 4,500
(3) 45,000 + 18,000 = 63,000
(4) 8,800 – 2,800 = 6,000
(5) 13,600 – 9,000 = 4,600
(6) 25,400 + 13,600 = 39,000
(7) 78,000 – 39,000 = 39,000
Questions # 19
Roberto is the plant superintendent of a small manufacturing company that is owned by a large corporation. The
corporation has a policy that any expenditure over $1,000 must be approved by the chief financial officer in the
corporate headquarters. The approval process takes a minimum of three weeks. Roberto would like to order a
new labeling machine that is expected to reduce costs and pay for itself in six months. The machine costs
$2,200, but Roberto can buy the sales rep’s demo for $1,800. Roberto has asked the sales rep to send two
separate bills for $900 each.

What would you do if you were the sales rep? Do you agree or disagree with Roberto’s actions? What do you
think about the corporate policy?

Solution #19
The sales rep should be skeptical about Roberto's request for two separate bills for $900 each. If the rep is
aware that the request was made to circumvent a corporate policy, it would be unethical of the rep to comply
with the request. This certainly puts the rep in a predicament: should he or she risk losing the sale by refusing to
write up two separate bills?

Roberto is not acting in an ethical manner by requesting two bills, given that it is a deliberate attempt on his part
to circumvent corporate policy. He may not agree with the policy, but it is not ethical to devise a scheme to
work around the policy. Instead, he should write a memo to the corporate chief financial officer to explain his
dissatisfaction with the policy and why it is not appropriate in this particular situation.

Whether or not the corporate policy is appropriate is difficult to answer without additional information. At the
very least, it seems unreasonable that it should take three weeks for the approval process.

Questions # 20
Millie Abrams opened a ceramic studio in leased retail space, paying the first month’s rent of $300 and a $1,000
security deposit with a check on her personal account. She took molds and paint, worth about $7,500, from her
home to the studio. She also bought a new fi ring kiln to start the business. The new kiln had a list price of
$5,000, but Millie was able to trade in her old kiln, worth $500 at the time of trade, on the new kiln. Therefore,
she paid only $4,500 cash. She wrote a check on her personal account. Millie’s fi rst customers paid a total of
$1,400 to attend classes for the next two months. Millie opened a checking account in the company’s name with
the $1,400. She has conducted classes for one month and has sold $3,000 of unfinished ceramic pieces called
greenware. All greenware sales are cash. Millie incurred $1,000 of personal cost in making the greenware. At
the end of the fi rst month, Millie prepared the following balance sheet and income statement:

Millie’s Ceramic Studio

Balance Sheet
July 31, 2010
Cash $1,400
Kiln 5,000 Equity $6,400
Total $6,400 Total $6,400

Millie’s Ceramic Studio

Income Statement
For the Month Ended July 31, 2010
Sales $4,400
Rent $300
Supplies 600 900
Net income $3,500
Millie needs to earn at least $3,000 each month for the business to be worth her time. She is pleased with the
results.

Required
Identify the assumptions that Millie has violated and explain how each event should have been handled. Prepare
a corrected balance sheet and income statement.

Solution #20

Assumptions violated:
1. Economic entity—Should have separated her personal affairs from those for the business.
2. Cost principle—Should have recorded the molds and paint for $7,500 by increasing assets and owner’s
equity.
3. Matching principle—Even though this principle has not yet been introduced in the first chapter, it can be
pointed out that a portion of the cost of the long-term assets should be recognized as depreciation expense.
Because no useful lives are given in the problem, depreciation is ignored in the solution that follows. It can
also be pointed out that the owner violated the revenue recognition principle by recognizing the entire
$1,400 of revenue when only one-half of the total received had been earned at the end of the first month.

MILLIE’S CERAMIC STUDIO

INCOME STATEMENT
FOR THE MONTH ENDED JULY 31, 2010
Revenues:
Classes........................................................................................... $ 700
Greenware sales............................................................................. 3,000
Total revenues......................................................................... $3,700
Expenses:
Rent............................................................................................... $ 300
Supplies......................................................................................... 600*
Cost of greenware.......................................................................... 1,000
Total expenses........................................................................ 1,900
Net income .......................................................................................... $1,800
*Assumes the owner brought $600 of supplies from home and used all of them
during the month of July.

MILLIE’S CERAMIC STUDIO

BALANCE SHEET
JULY 31, 2010
Assets Liabilities and Owner’s Equity
Cash........................................ $ 4,400
Unearned revenue................... $ 700
Deposit................................... 1,000
Owner’s equity....................... 16,600**
Molds and paint...................... 6,900*
Kiln......................................... 5,000
Total liabilities and
Total assets............................. $17,300
........................owner’s equity $17,300
 *Assumes that the $600 of supplies used during the month were part of the $7,500
of molds and paint brought from home.
**Owner’s contributions:
$300 + $1,000 + $7,500 + $5,000 + $1,000 $14,800
Add: Net income 1,800
Owner’s equity, end of first month $16,600