Chapter 03 - Operating Decisions and the Income Statement

Chapter 03
Operating Decisions and the Income
Statement

ANSWERS TO QUESTIONS
1.

A typical business operating cycle for a manufacturer would be as follows:

inventory is purchased, cash is paid to suppliers, the product is manufactured
and sold on credit, and the cash is collected from the customer.

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.

Each element is defined as follows:
Revenues -- increases in assets or settlements of liabilities from ongoing
operations.
Gains -increases in assets or settlements of liabilities from peripheral
transactions.
Expenses -- decreases in assets or increases in liabilities from ongoing
operations.
Losses -decreases in assets or increases in liabilities from peripheral
transactions.

4.

Both revenues and gains are inflows of net assets. However, revenues occur in
the normal course of operations, whereas gains occur from transactions
peripheral to the central activities of the company. An example is selling land at
a price above cost (at a gain) for companies not in the business of selling land.
Both expenses and losses are outflows of net assets. However, expenses occur
in the normal course of operations, whereas losses occur from transactions
peripheral to the central activities of the company. An example is a loss suffered
from fire damage.

5.

Accrual accounting requires recording revenues when earned and recording

expenses when incurred, regardless of the timing of cash receipts or payments.
Cash basis accounting is recording revenues when cash is received and
expenses when cash is paid.

3-1

Chapter 03 - Operating Decisions and the Income Statement

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
rendered, (2) there is persuasive evidence of an arrangement for customer
payment, (3) the price is fixed or determinable, and (4) collection is reasonably
assured.

7.

The matching principle requires that expenses be recorded when incurred in

earning revenue. For example, the cost of inventory sold during a period is
recorded in the same period as the sale, not when the goods are produced and
held for sale.

8.

Net income equals revenues minus expenses. Thus revenues increase net
income and expenses decrease net income. Because net income increases
stockholders equity, revenues increase stockholders equity and expenses
decrease it.

9.

Revenues increase stockholders equity and expenses decrease stockholders

equity. To increase stockholders equity, an account must be credited; to
decrease stockholders equity, an account must be debited. Thus revenues are
recorded as credits and expenses as debits.

10.

Item

Increase

Decrease

Credit
Debit
Credit
Debit

Debit
Credit
Debit
Credit

Debit

Credit

Decrease
Increase
Decrease
Increase

Increase
Decrease
Increase
Decrease

Operating,
Investing, or
Financing

Direction
of the Effect
on Cash

Operating
None
Operating
Investing
Operating
Financing

None
+

Revenues
Losses
Gains
Expenses
11.

Item
Revenues
Losses
Gains
Expenses

12.

Transaction

Cash paid to suppliers

Sale of goods on account
Cash received from customers
Purchase of investments
Cash paid for interest
Issuance of stock for cash

3-2

Chapter 03 - Operating Decisions and the Income Statement

13.

Total asset turnover is calculated as Sales (or Operating revenues) Average

total assets. The total asset turnover ratio measures the sales generated per
dollar of assets. A high ratio suggests that the company is managing its assets
(resources used to generate revenues) efficiently.

ANSWERS TO MULTIPLE CHOICE

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

c
a
b
b
b
c
d
b
a
b

3-3

Chapter 03 - Operating Decisions and the Income Statement

Authors' Recommended Solution Time

(Time in minutes)

Mini-exercises
No.
Time
1
5
2
6
3
6
4
5
5
5
6
5
7
5
8
6
9
6
10
6
11
6

Exercises
No.
Time
1
10
2
15
3
20
4
20
5
20
6
20
7
18
8
20
9
20
10
20
11
20
12
15
13
20
14
20
15
20
16
20
17
20
18
10
19
10

Problems
No.
Time
1
20
2
20
3
25
4
40
5
20
6
40
7
30

Alternate
Problems
No.
Time
1
30
2
30
3
35
4
40
5
20
6
40

Cases and
Projects
No.
Time
1
20
2
30
3
30
4
20
5
30
6
30
7
60
8
30
9
*

* 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
possible for students to devote a large amount of time to these assignments. While
students often benefit from the extra effort, we find that some become frustrated by the
perceived difficulty of the task. You can reduce student frustration and anxiety by
making your expectations clear. For example, when our goal is to sharpen research
skills, we devote class time discussing research strategies. When we want the students
to focus on a real accounting issue, we offer suggestions about possible companies or
industries.

3-4

Chapter 03 - Operating Decisions and the Income Statement

MINI-EXERCISES
M31.
TERM
G
C
F
E
B

(1) Losses
(2) Matching principle
(3) Revenues
(4) Time period assumption
(5) Operating cycle

M32.
Cash Basis
Income Statement
Revenues:
Cash sales
Customer deposits
Expenses:
Inventory purchases
Wages paid

Net Income

$10,000
3,000
1,000
750

$11,250

3-5

Accrual Basis
Income Statement
Revenues:
Sales to customers
$15,000
Expenses:
Cost of sales
Wages expense
Utilities expense
Net Income

9,000
750
200
$5,050

Chapter 03 - Operating Decisions and the Income Statement

M33.
Revenue Account Affected
a. Games Revenue
b. Sales Revenue

Amount of Revenue Earned in July

$13,000
$7,000

c. None

No revenue earned in July; cash collections in

July related to earnings in June.

d. None

No revenue earned in July; earnings process is

not yet complete Unearned Revenue is
recorded upon receipt of cash.

M34.
Expense Account Affected
e. Cost of Goods Sold
f. None
g. Wages Expense
h. Insurance Expense

i. Repairs Expense
j. Utilities Expense

Amount of Expense Incurred in July

$3,890
No expense is incurred in July; payment related
to June electricity usage.
$4,700
$600 incurred and expensed in July and
$1,200 not incurred until future months
(recorded as Prepaid Expense (A)).
$1,400
$2,600 incurred in July

3-6

Chapter 03 - Operating Decisions and the Income Statement

M35.
a.
b.

c.

d.

Cash (+A) ............................................................................

Games Revenue (+R, +SE) ...........................................

13,000

Cash (+A) ............................................................................

Accounts Receivable (+A) ...................................................
Sales Revenue (+R, +SE) ..............................................

3,000
4,000

Cash (+A) ............................................................................

Accounts Receivable (A) ..............................................

2,500

Cash (+A) ............................................................................

Unearned Revenue (+L).................................................

2,600

Cost of Goods Sold (+E, SE) .............................................

Inventory (A).................................................................

3,890

Accounts Payable (L) ........................................................

Cash (A) .......................................................................

1,900

Wages Expense (+E, SE) ..................................................

Cash (A) .......................................................................

4,700

Insurance Expense (+E, SE) .............................................

Prepaid Expenses (+A)........................................................
Cash (A) .......................................................................

600
1,200

Repairs Expense (+E, SE).................................................

Cash (A) .......................................................................

1,400

Utilities Expense (+E, SE) .................................................

Accounts Payable (+L) ...................................................

2,600

13,000

7,000
2,500

2,600

M36.
e.

f.

g.

h.

i.

j.

3-7

3,890

1,900

4,700

1,800

1,400

2,600

Chapter 03 - Operating Decisions and the Income Statement

M37.

Assets

Balance Sheet
Income Statement
Stockholders
Net
Liabilities
Equity
Revenues Expenses
Income

a.

+13,000

NE

+13,000

+13,000

NE

+13,000

b.

+7,000

NE

+7,000

+7,000

NE

+7,000

c.

+2,500
2,500

NE

NE

NE

NE

NE

d.

+2,600

+2,600

NE

NE

NE

NE

Transaction (c) results in an increase in an asset (cash) and a decrease in an asset

(accounts receivable). Therefore, there is no net effect on assets.

M38.

Assets

Balance Sheet
Income Statement
Stockholders
Net
Liabilities
Equity
Revenues Expenses
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

h.

1,800/
+1,200

NE

600

NE

+600

600

i.

1,400

NE

1,400

NE

+1,400

1,400

j.

NE

+2,600

2,600

NE

+2,600

2,600

Transaction (h) results in an increase in an asset (prepaid expenses) and a decrease in

an asset (cash). Therefore, the net effect on assets is 600.

3-8

Chapter 03 - Operating Decisions and the Income Statement

M39.
Craigs Bowling, Inc.
Income Statement
For the Month of July 2011
Revenues:
Games revenue
Sales revenue
Total revenues

$13,000
7,000
20,000

Expenses:
Cost of goods sold
Utilities expense
Wages expense
Insurance expense
Repairs expense
Total expenses

3,890
2,600
4,700
600
1,400
13,190

Net income

$ 6,810

M310.
Craigs Bowling, Inc.
Partial Statement of Cash Flows
For the Month of July 2011
Cash Flows from Operating Activities:
Cash received from customers
(=$13,000+$3,000+$2,500+$2,600)

$21,100

Cash paid to suppliers

(=$1,900+$1,800+$1,400)

(5,100)

Cash paid to employees

(4,700)

Cash from operating activities

$11,300

M311.
2012
Total Asset =
Sales
Turnover
Average Total Assets

$163,000
$56,500*

2011
= 2.89

$151,000
$47,000**

= 3.21

* ($53,000 + $60,000) 2
** ($41,000 + $53,000) 2
The decrease in the asset turnover ratio suggests that the company is managing its
assets less efficiently, generating fewer sales per dollar of assets in 2012 than in 2011.

3-9

Chapter 03 - Operating Decisions and the Income Statement

EXERCISES
E31.
TERM
K
E
G
I
M
C
D
F
J
L

(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)

Expenses
Gains
Revenue principle
Cash basis accounting
Unearned revenue
Operating cycle
Accrual basis accounting
Prepaid expenses

(9) Revenues Expenses = Net Income

(10) Ending Retained Earnings =
Beginning Retained Earnings + Net Income Dividends Declared

E32.
Req. 1
Cash Basis
Income Statement
Revenues:
Cash sales
Customer deposits
Expenses:
Inventory purchases
Wages paid
Utilities paid
Net Income

$520,000
35,000
90,000
164,200
17,200
$283,600

Accrual Basis
Income Statement
Revenues:
Sales to customers $630,000
Expenses:
Cost of sales
Wages expense
Utilities expense

387,000
169,000
18,940

Net Income

$55,060

Req. 2
Accrual basis financial statements provide more useful information to external users.
Financial statements created under cash basis accounting normally postpone (e.g.,
$110,000 credit sales) or accelerate (e.g., $35,000 customer deposits) recognition of
revenues and expenses long before or after goods and services are produced and
delivered (until cash is received or paid). They also do not necessarily reflect all assets
or liabilities of a company on a particular date.

3-10

Chapter 03 - Operating Decisions and the Income Statement

E33.
Activity

Amount of Revenue Earned in

September

Revenue Account Affected

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.

e.

Sales revenue

$15,000 (= 1,000 shirts x $15 per shirt);

revenue earned when goods are delivered.

f.

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.

i.

None

No revenue earned in September;

earnings process is not yet complete.

j.

Ticket sales revenue

$3,660,000 (= $18,300,000 5 games)

k.

None

No revenue earned in September;

earnings process is not yet complete.

l.

Sales revenue

$18,400

m.

Sales revenue

$100

3-11

Chapter 03 - Operating Decisions and the Income Statement

E34.
Activity

Amount of Expense Incurred in

January

Expense Account Affected

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.

c.

Salary expense

$189,750 incurred in January.

The remaining half was incurred in
December.

d.

None

Expense will be recorded when the related

revenue has been earned.

e.

None

Expense will be recorded in the future when

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

i.

None

Expense will be recorded as depreciation

over the equipments useful life.

j.

Supplies expense

$5,190 (= $4,000 + $2,600 - $1,410)

k.

Wages expense

$104 (= 8 hours x $13 per hour)

l.

Insurance expense

$300 (= $3,600 12 months)

m.

Repairs expense

$300

n.

Utilities Expense

$202

o.

Consulting Expense

$1,285

p.

None

December expense paid in January.

q.

Cost of goods sold

$5,000 (= 500 shirts x $10 per shirt)

3-12

Chapter 03 - Operating Decisions and the Income Statement

E35.

Assets

Balance Sheet
Income Statement
Stockholders
Net
Liabilities
Equity
Revenues Expenses
Income

a.

NE

NE

NE

NE

b.

NE

NE

NE

NE

c.

NE

NE

NE

NE

d.

NE

NE

e.

NE

NE

f.

NE

NE

g.

NE

NE

NE

NE

h.

NE

NE

i.

NE

NE

j.

NE

NE

NE

NE

k.

+/

NE

NE

NE

NE

NE

l.

NE

NE

+*

m.

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.

3-13

Chapter 03 - Operating Decisions and the Income Statement

E36.

Assets

Balance Sheet
Income Statement
Stockholders
Net
Liabilities
Equity
Revenues Expenses
Income

a.

+7,047

NE

+7,047

NE

NE

NE

b.

+765,472

+765,472

NE

NE

NE

NE

c.

+59,500

+59,500

NE

NE

NE

NE

NE
NE

+1,220,568
734,547

+1,220,568
NE

NE
+734,547

+1,220,568
734,547

NE

20,758

NE

NE

NE

NE

NE

NE

NE

NE

d. +1,220,568
734,547
20,758

e.

f. +/24,126
g.

258,887

+86,296

345,183

NE

+345,183

345,183

h.

+1,757

NE

+1,757

+1,757

NE

+1,757

i.

NE

+2,850

2,850

NE

+2,850

2,850

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.
E37.
(in thousands)
a.

b.

c.

Plant and equipment (+A) ...................................................

515
Cash (A) .......................................................................
Debits equal credits. Assets increase and decrease by the same amount.

515

Cash (+A) ...........................................................................

758
Short-term notes payable (+L) .......................................
Debits equal credits. Assets and liabilities increase by the same amount.

758

Cash (+A) ...........................................................................

10,272
Accounts receivable (+A) ....................................................
27,250
Service revenue (+R, +SE) .............................................
37,522
Debits equal credits. Revenue increases retained earnings (part of
stockholders' equity). Stockholders' equity and assets increase by the same
amount.

3-14

Chapter 03 - Operating Decisions and the Income Statement

E37. (continued)
d.

4,300
Accounts payable (L) ........................................................
4,300
Cash (A) .......................................................................
Debits equal credits. Assets and liabilities decrease by the same amount.

e.

Inventory (+A) .....................................................................

30,449
Accounts payable (+L) ....................................................
30,449
Debits equal credits. Assets and liabilities increase by the same amount.

f.

3,500
Wages expense (+E, SE) .................................................
3,500
Cash (A) .......................................................................
Debits equal credits. Expenses decrease retained earnings (part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.

g.

Cash (+A) ...........................................................................

37,410
37,410
Accounts receivable (A) ...............................................
Debits equal credits. Assets increase and decrease by the same amount.

h.

750
Fuel expense (+E, SE) .....................................................
750
Cash (A) .......................................................................
Debits equal credits. Expenses decrease retained earnings (part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.

i.

497
Retained earnings (SE) ....................................................
497
Cash (A) .......................................................................
Debits equal credits. Assets and stockholders equity decrease by the same
amount.

j.

68
Utilities expense (+E, SE) .................................................
55
Cash (A) .......................................................................
13
Accounts payable (+L) ....................................................
Debits equal credits. Expenses decrease retained earnings (part of
stockholders' equity). Together, stockholders' equity and liabilities decrease by
the same amount as assets.

3-15

Chapter 03 - Operating Decisions and the Income Statement

E38.
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.

b.

Equipment (+A) .......................................................... 95,000

Cash (A).........................................................
95,000
Debits equal credits. Assets increase and decrease by the same amount.

c.

Merchandise inventory (+A)........................................

40,000
Accounts payable (+L) .....................................
40,000
Debits equal credits. Assets and liabilities increase by the same amount.

d.

Repair and maintenance expense (+E, SE) ............. 62,000

Cash (A).........................................................
62,000
Debits equal credits. Expenses decrease retained earnings (part of stockholders'
equity). Stockholders' equity and assets decrease 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.
(2) Cost of goods sold (+E, SE) ................................
450
Merchandise inventory (A) .............................
450
Debits equal credits. Expenses decrease retained earnings (a part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.

3-16

Chapter 03 - Operating Decisions and the Income Statement

E38. (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.

h.

Cash (+A) ................................................................... 3,200

Unearned rent revenue (+L) ............................
3,200
Debits equal credits. Since the rent is received before the townhouse is used,
revenue is deferred until it is earned. Assets and liabilities 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.

j.

Cash (+A) ...................................................................

400
Accounts receivable (A) .................................
400
Debits equal credits. Assets increase and decrease by the same amount.

k.

Wages expense (+E, SE) ......................................... 258,000

Cash (A).........................................................
258,000
Debits equal credits. Expenses decrease retained earnings (a part of
stockholders' equity). Stockholders' equity and assets decrease by the same
amount.

Req. 2
Accounts Receivable
(j)
Beg. bal. 1,200 400
(f)
750
End. bal. 1,550

3-17

Chapter 03 - Operating Decisions and the Income Statement

E39.
2/1 Rent expense (+E, SE) .....................................................
Cash (A) .................................................................

275

2/2 Fuel expense (+E, SE) .....................................................

Accounts payable (+L) ..............................................

490

2/4 Cash (+A) ...........................................................................

Unearned revenue (+L) ............................................

820

2/7 Cash (+A) ...........................................................................

Transport revenue (+R, +SE) ...................................

910

2/10 Advertising expense (+E, SE) ...........................................

Cash (A) .................................................................

175

2/14 Wages payable (L) ...........................................................

Cash (A) .................................................................

2,300

2/18 Cash (+A) ...........................................................................

Accounts receivable (+A) ....................................................
Transport revenue (+R, +SE) ...................................

1,600
2,200

2/25 Parts supplies (+A) .............................................................

Accounts payable (+L) ..............................................

2,550

2/27 Retained earnings (SE) ....................................................

Dividends payable (+L) .............................................

200

3-18

275

490

820

910

175

2,300

3,800

2,550

200

Chapter 03 - Operating Decisions and the Income Statement

E310.
Req. 1 and 2
Cash
Beg. 6,200
(a) 18,400 2,140
(b)
600 15,000
(c)
820 2,600
(d) 7,200
960
12,520

(g)
(i)
(j)
(k)

Equipment
Beg. 9,600
(h) 920
10,520
Accounts
Payable
9,600 Beg.
(g) 2,140
520 (e)
7,980
Contributed Capital
8,600 Beg.
920 (h)
9,520
Rent Revenue
0 Beg.
820
(c)
820

Accounts Receivable
Beg.30,000
7,200 (d)

22,800
Land
Beg. 7,200
7,200
Unearned Fee
Revenue
3,840 Beg.
600 (b)
4,440
Retained Earnings
10,800 Beg.
(j) 2,600
8,200
Wages Expense
Beg.
0
(i) 15,000
15,000

Item (f) is not a transaction; there has been no exchange.

3-19

Supplies
Beg. 1,440
(k)
960

2,400
Building
Beg. 26,400
26,400
Note
Payable
48,000 Beg.
48,000
Rebuilding Fees
Revenue
0 Beg.
18,400 (a)
18,400
Utilities Expense
Beg.
0
(e) 520
520

Chapter 03 - Operating Decisions and the Income Statement

E310. (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
$ 3,700
(accrual basis)
Assets
$12,520
22,800
2,400
10,520
7,200
26,400
$81,840

Liabilities
$ 7,980
4,440
48,000

$60,420

Stockholders Equity
$ 9,520
8,200
3,700 net income

$21,420

Req. 4
Net income using the cash basis of accounting:
Cash receipts
$27,020 (transactions a through d)
18,100 (transactions g, i, and k)
Cash disbursements
$ 8,920
Net Income
(cash basis)
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
expenses versus disbursements between the two methods. The $7,800 higher amount
in cash receipts over revenues includes cash received prior to being earned (from (b),
$600) and cash received after being earned (in (d), $7,200). The $2,580 higher amount
in cash disbursements over expenses includes cash paid after being incurred in the
prior period (in (g), $2,140), plus cash paid for supplies to be used and expensed in the
future (in (k), $960), less an expense incurred in January to be paid in February (in (e),
$520).

3-20

Chapter 03 - Operating Decisions and the Income Statement

E311.
Req. 1
STACEYS PIANO REBUILDING COMPANY
Income Statement (unadjusted)
For the Month Ended January 31, 2011
Operating Revenues:
Rebuilding fees revenue
Total operating revenues

$ 18,400
18,400

Operating Expenses:
Wages expense
Utilities expense
Total operating expenses
Operating Income

15,000
520
15,520
2,880

Other Item:
Rent revenue

820

Net Income

$ 3,700

Req. 2
STACEYS PIANO REBUILDING COMPANY
Statement of Stockholders Equity (unadjusted)
For the Month Ended January 31, 2011

Balance, December 31, 2010

Additional contributions
Net income
Dividends
Balance, January 31, 2011

Contributed
Capital
$ 8,600
920

$ 9,520

3-21

Retained
Earnings
$ 10,800
3,700
(2,600)
$11,900

Total
Stockholders
Equity
$19,400
920
3,700
(2,600)
$21,420

Chapter 03 - Operating Decisions and the Income Statement

E311. (continued)
Req. 3
STACEYS PIANO REBUILDING COMPANY
Balance Sheet (unadjusted)
At January 31, 2011
Assets
Current assets:
Cash
Accounts receivable
Supplies
Total current assets
Equipment
Land
Building
Total Assets
Liabilities and Stockholders Equity
Current liabilities:
Accounts payable
Unearned fee revenue
Total current liabilities
Note payable
Total Liabilities
Stockholders Equity:
Contributed Capital
Retained Earnings
Total Stockholders Equity
Total Liabilities and Stockholders Equity

3-22

$ 12,520
22,800
2,400
37,720
10,520
7,200
26,400
$ 81,840

7,980
4,440
12,420
48,000
60,420

9,520
11,900
21,420
$ 81,840

Chapter 03 - Operating Decisions and the Income Statement

E312.
STACEYS PIANO REBUILDING COMPANY
Statement of Cash Flows
For the Month Ended January 31, 2011
Operating Activities
Cash received from customers
(=$18,400+$600+$820+$7,200)
Cash paid to employees
Cash paid to suppliers (=$2,140+$960)
Total cash from operating activities
Investing Activities
None
Total cash provided by investing activities
Financing Activities
Dividends paid
Total cash used in financing activities

$27,020
(15,000)
(3,100)
8,920
0
0
(2,600)
(2,600)
6,320
6,200
$12,520

Increase in cash
Beginning cash balance
Ending cash balance

Transaction (h) is omitted from the statement of cash flows because the transaction did
not involve a cash payment. However, as discussed in future chapters, this type of
transaction is a noncash investing and financing activity that requires supplemental
disclosure.

3-23

Chapter 03 - Operating Decisions and the Income Statement

E313.
Req. 1 and 2
Cash
Beg.
0 72,000
(a)160,000 10,830
(c) 50,000
363
(e) 2,600
6,280
(f) 11,900
600
70,000
64,427

(b)
(d)
(h)
(i)
(j)
(k)

Equipment
Beg.
0
(a) 18,300
(k) 50,000
68,300

(j)

3,600

Beg.

Supplies Expense
Beg.
0
(d) 10,830
10,830

Supplies
Beg.
0
(a) 1,200

1,200

Building
Beg.
0
(b)360,000
(k) 20,000
380,000

Note Payable
0 Beg.
50,000 (c)
50,000
Retained
Earnings
0
600
600

Accounts Receivable
Beg.
0
(a) 2,000
(e) 1,600

Accounts Payable
0 Beg.
420
(g)
420

Mortgage Payable
0 Beg.
288,000(b)
288,000

Contributed Capital
0 Beg.
181,500 (a)
181,500

Food Sales Revenue

0 Beg.
11,900 (f)
11,900

Catering Sales
Revenue
0 Beg.
4,200 (e)
4,200

Utilities Expense
Beg.
0
(g)
420
420

Fuel Expense
Beg.
0
(h)
363
363

3-24

Wages Expense
Beg.
0
(i) 6,280
6,280

Chapter 03 - Operating Decisions and the Income Statement

E314.
Req. 1
TRAVELING GOURMET, INC.
Income Statement (unadjusted)
For the Month Ended March 31, 2011
Revenues:
Food sales revenue
Catering sales revenue
Total revenues
Expenses:
Supplies expense
Utilities expense
Wages expense
Fuel expense
Total costs and expenses
Net Loss

$ 11,900
4,200
16,100

10,830
420
6,280
363
17,893
(1,793)

Req. 2
TRAVELING GOURMET, INC.
Statement of Stockholders Equity (unadjusted)
For the Month Ended March 31, 2011

Beginning, March 1, 2011

Additional contributions
Net loss
Dividends
Ending, March 31, 2011

Contributed
Capital
$
0
181,500

$ 181,500

Retained
Earnings
$
0
(1,793)
(600)
$ (2,393)

Total
Stockholders
Equity
$
0
181,500
(1,793)
(600)
$179,107

Note: In many states, dividends could not have been declared legally due to the
insufficient amount in retained earnings.

3-25

Chapter 03 - Operating Decisions and the Income Statement

E314. (continued)
Req. 3
TRAVELING GOURMET, INC.
Balance Sheet (unadjusted)
At March 31, 2011
Assets
Current assets:
Cash
Accounts receivable
Supplies
Total current assets
Equipment
Building
Total Assets
Liabilities
Current liabilities:
Accounts payable
Note payable
Total current liabilities
Mortgage payable
Total Liabilities
Stockholders Equity
Contributed capital
Retained earnings
Total Stockholders Equity
Total Liabilities and Stockholders Equity

$ 64,427
3,600
1,200
69,227
68,300
380,000
$517,527

420
50,000
50,420
288,000
338,420

181,500
(2,393)
179,107
$517,527

Req. 4
The company generated a small loss during its first month of operations, before making
any adjusting entries. The adjusting entries for depreciation and interest expense will
increase the loss. So far the company does not appear to be successful, but it is only in
its first month of operating a retail store. If sales can be increased without inflating fixed
costs (particularly salaries expense), the company may soon turn a profit. It is not
unusual for small businesses to lose money as they start up operations.

3-26

Chapter 03 - Operating Decisions and the Income Statement

E315.
TRAVELING GOURMET, INC.
Statement of Cash Flows
For the Month Ended March 31, 2011
Operating Activities
Cash received from customers
(=$2,600+$11,900)
Cash paid to employees
Cash paid to suppliers (=$10,830+$363)
Total cash used in operating activities

$ 14,500
(6,280)
(11,193)
(2,973)

Investing Activities
Purchased building (=$72,000+$20,000)
Purchased equipment
Total cash used in investing activities

(92,000)
(50,000)
(142,000)

Financing Activities
Borrowed on a note payable
Issued stock
Paid dividends
Total cash from financing activities

50,000
160,000
(600)
209,400
64,427
0

Increase in cash
Beginning cash balance

$ 64,427

Ending cash balance

Note that portions of transactions (a) and (b) are omitted from the statement of cash
flows. However, as discussed in future chapters, these types of transactions are
noncash investing and financing activities that require supplemental disclosure.

3-27

Chapter 03 - Operating Decisions and the Income Statement

E316.
Req. 1
Transaction

Brief Explanation

Issued capital stock to shareholders for $63,300 cash.

Purchased store fixtures for $13,700 cash.

Purchased $24,800 of inventory, paying $6,200 cash and the balance

on account.

Sold $12,400 of goods or services to customers, receiving $8,680 cash

and the balance on account. The cost of the goods sold was $6,510.

Used $1,480 of utilities during the month, not yet paid.

Paid $1,240 in wages to employees.

Paid $2,480 in cash for rent, $620 related to the current month and
$1,860 related to future months.

Received $3,720 cash from customers, $1,240 related to current sales

and $2,480 related to goods or services to be provided in the future.

Req. 2
Kates Kite Company
Income Statement
For the Month Ended April 30, 2011
Sales Revenue
Expenses:
Cost of sales
Wages expense
Rent expense
Utilities expense
Total expenses
Net Income

3-28

$ 13,640

6,510
1,240
620
1,480
9,850
3,790

Chapter 03 - Operating Decisions and the Income Statement

E316. (continued)
Kates Kite Company
Balance Sheet
At April 30, 2010
Assets
Current Assets:
Cash
Accounts receivable
Inventory
Prepaid expenses
Total current assets
Store fixtures

$52,080
3,720
18,290
1,860
75,950
13,700

Total Assets

$89,650

Liabilities and Shareholders Equity

Current Liabilities:
Accounts payable
$20,080
Unearned revenue
2,480
Total current liabilities
22,560
Shareholders Equity:
Contributed capital
63,300
Retained earnings
3,790
Total shareholders equity
67,090
Total Liabilities &
Shareholders Equity
$89,650

E317.
Req. 1
Assets
$ 3,200
8,000
6,400
$17,600

Liabilities
$ 2,400
5,600
1,600
$9,600

3-29

Stockholders Equity
$ 4,800
3,200
$ 8,000

Chapter 03 - Operating Decisions and the Income Statement

E317. (continued)
Req. 2
Cash
Beg. 3,200 57,200 (d)
(a) 48,000
480 (g)
(b) 5,600
(c)
400
(e) 1,600
1,120

Accounts
Receivable
Beg. 8,000 5,600
(a) 10,000

(b)

12,400

6,400

Accounts
Payable
(d) 1,600 2,400 Beg.
800 (f)
1,600

Unearned
Revenue
5,600 Beg.
1,600 (e)
7,200

Contributed Capital
4,800 Beg.
4,800

Retained Earnings
(g)
480 3,200 Beg.
2,720

Consulting Fee
Revenue
0 Beg.
58,000 (a)
58,000

Investment
Income
0 Beg.
400 (c)
400

Wages Expense
Beg.
0
(d) 36,000
36,000

Long-Term
Investments
Beg. 6,400

Travel Expense
Beg.
0
(d) 12,000
12,000

Rent Expense
Beg.
0
(d) 7,600
7,600

3-30

Long-Term
Notes Payable
1,600 Beg.
1,600

Utilities Expense
Beg.
0
(f)
800
800

Chapter 03 - Operating Decisions and the Income Statement

E317. (continued)
Req. 3
$58,400 ($58,000 + $400)
56,400 ($36,000 + $12,000 + $800 + $7,600)
$ 2,000

Revenues
Expenses
Net Income
Assets
$ 1,120
12,400
6,400
$19,920

Liabilities
$ 1,600
7,200
1,600
$10,400

Stockholders Equity
$ 4,800
2,720
2,000 net income
$ 9,520

Req. 4
Total Asset Turnover =

Sales (Operating) Revenues

Average Total Assets

= $58,000* = 3.09
$18,760**

* The $400 of investment income is not an operating revenue and is not included in the
computation.
** ($17,600 beginning total assets + $19,920 ending total assets) 2
The increasing trend in the total asset turnover ratio from 1.80 in 2010 and 2.00 in 2011
to 3.09 in 2012 suggests that the company is managing its assets more efficiently over
time.

3-31

Chapter 03 - Operating Decisions and the Income Statement

E318.
Req. 1
Accounts receivable increases with customer sales on account and decreases with
cash payments received from customers.
Prepaid expenses increase with cash payments of expenses related to future periods
and decrease as these expenses are incurred over time.
Unearned subscriptions increases with cash payments received from customers for
goods or services to be provided in the future and decreases when those goods and
services are provided.
Req. 2
Accounts
Receivable
1/1

438
2,949

12/31

Unearned
Subscriptions

Prepaid
Expenses
1/1

90
313

2,983

404

12/31

81 1/1
148 151

277

126

84 12/31

Computations:
Beginning

Ending

Accounts
receivable

438

2,949

?
?

=
=

404
2,983

Prepaid
expenses

90

313

?
?

=
=

126
277

Unearned
subscriptions

81

151

?
?

=
=

84
148

3-32

Chapter 03 - Operating Decisions and the Income Statement

E319.
ITEM

LOCATION

1. Description of a companys
primary business(es).

Letter to shareholders;
Managements Discussion and Analysis;
Summary of significant accounting policies
note

2. Income taxes paid.

Notes; Statement of cash flows

3. Accounts receivable.

Balance sheet

4. Cash flow from operating

activities.

Statement of cash flows

5. Description of a companys
revenue recognition policy.

Summary of significant accounting policies

note

6. The inventory sold during the

year.

Income statement (Cost of Goods Sold)

7. The data needed to compute the

total asset turnover ratio.

Balance sheet and income statement

3-33

Chapter 03 - Operating Decisions and the Income Statement

PROBLEMS
P3-1.
Transactions

Debit

Credit

1, 8

Paid cash for salaries and wages earned by employees this

period.

14

Paid cash on accounts payable for expenses

incurred last period.

d.

Purchased supplies to be used later; paid cash.

e.

Performed services this period on credit.

13

f.

Collected cash on accounts receivable for services

performed last period.

g.

Issued stock to new investors.

11

h.

Paid operating expenses incurred this period.

14

i.

Incurred operating expenses this period to be paid

next period.

14

j.

Purchased a patent (an intangible asset); paid cash.

k.

Collected cash for services performed this period.

13

l.

Used some of the supplies on hand for operations.

14

m.

Paid three-fourths of the income tax expense for the year;

the balance will be paid next year.

15

1, 10

8, 16

a.
b.
c.

n.
o.

Example: Purchased equipment for use in the business;

paid one-third cash and signed a note payable for the balance.

Made a payment on the equipment note in (a); the payment

was part principal and part interest expense.
On the last day of the current period, paid cash for an
insurance policy covering the next two years.

3-34

Chapter 03 - Operating Decisions and the Income Statement

P32.
a.
b.
c.

d.

e.

f.

g.

h.

i.

j.

Cash (+A) ............................................................................

Contributed capital (+SE) ...............................................

40,000

Cash (+A) ............................................................................

Note payable (long-term) (+L) ........................................

60,000

Rent expense (+E, SE)......................................................

Prepaid rent (+A) .................................................................
Cash (A) .......................................................................

1,500
1,500

Prepaid insurance (+A)........................................................

Cash (A) ......................................................................

2,400

Equipment (+A) ...................................................................

Accounts payable (+L) ..................................................
Cash (A) ......................................................................

15,000

Inventory (+A) ......................................................................

Cash (A) ......................................................................

2,800

Advertising expense (+E, SE)............................................

Cash (A) ......................................................................

350

Cash (+A) ............................................................................

Accounts receivable (+A) ....................................................
Sales revenue (+R, +SE) ..............................................

850
850

Cost of goods sold (+E, SE) ..............................................

Inventory (A) ...............................................................

900

Accounts payable (L) .........................................................

Cash (A) ......................................................................

12,000

Cash (+A) ............................................................................

Accounts receivable (A) ..............................................

210

3-35

40,000
60,000

3,000

2,400

12,000
3,000

2,800

350

1,700

900

12,000

210

Chapter 03 - Operating Decisions and the Income Statement

P33.
Req. 1

Req. 2

Assets

Balance Sheet
Income Statement
Stockholders
Net
Liabilities
Equity
Revenues Expenses Income

Stmt of
Cash
Flows

a.

+/

NE

NE

NE

NE

b.

+/

NE

NE

NE

NE

NE

c.

NE

d.

NE

NE

e.

NE

NE

NE*

f.

NE

NE

NE

NE

g.

NE

NE

h.

NE

NE

* Cash is not affected in this transaction.

3-36

Chapter 03 - Operating Decisions and the Income Statement

P34.
Req. 1 and 2
Cash
Beg.
0 5,640
(a) 27,600 1,430
(e) 11,000 11,000
(h) 2,675
500
(k)
155
550
(m) 2,400 1,500
130
23,080

(b)
(d)
(f)
(g)
(i)
(j)
(l)

Inventory
Beg.
0 1,200 (h)
(c) 5,500 1,210 (m)
3,090

Accounts Receivable
Beg.
0 155 (k)
(h)
325

170

1,430

Prepaid Expenses
Beg.
0
(b) 5,640
5,640

Furniture and Fixtures

Beg.
0
(f) 8,250
8,250

Accounts Payable
(i)
550
0 Beg.
5,500 (c)
4,950

Contributed Capital
0 Beg.
27,600 (a)

Sales Revenue
0 Beg.
3,000 (h)
2,400 (m)
5,400

27,600
Advertising Expense
Beg.
0
(g) 500
500

Supplies
Beg.
0
(d) 1,430

Wage Expense
Beg.
0
(j) 1,500
1,500

3-37

Equipment
Beg.
0
(f) 2,750
2,750
Notes Payable
0 Beg.
11,000 (e)
11,000
Cost of Goods Sold
Beg.
0
(h) 1,200
(m) 1,210
2,410
Repair Expense
Beg.
0
(l) 130
130

Chapter 03 - Operating Decisions and the Income Statement

P34. (continued)
Req. 3
BRIS SWEETS
Income Statement (unadjusted)
For the Month Ended February 28, 2011
Revenues:
Sales revenue

$ 5,400

Expenses:
Cost of goods sold
Advertising expense
Wage expense
Repair expense
Total costs and expenses
Net Income

2,410
500
1,500
130
4,540
$ 860

BRIS SWEETS
Statement of Stockholders Equity (unadjusted)
For the Month Ended February 28, 2011

Beginning, February 1, 2011

Additional contributions
Net income
Dividends
Ending, February 28, 2011

Contributed
Capital
$
0
27,600

$27,600

3-38

Retained
Earnings
$
0

860
(0)
860

Total
Stockholders
Equity
$
0
27,600
860
(0)
$28,460

Chapter 03 - Operating Decisions and the Income Statement

P34. (continued)
BRIS SWEETS
Balance Sheet (unadjusted)
At February 28, 2011
Assets
Current assets:
Cash
Accounts receivable
Inventory
Supplies
Prepaid expenses
Total current assets
Furniture and fixtures
Equipment
Total Assets
Liabilities and Stockholders Equity
Current liabilities:
Accounts payable
Total current liabilities
Notes payable
Total Liabilities
Stockholders Equity:
Contributed capital
Retained earnings
Total Stockholders Equity
Total Liabilities and Stockholders Equity

$ 23,080
170
3,090
1,430
5,640
33,410
8,250
2,750
$ 44,410

$ 4,950
4,950
11,000
15,950
27,600
860
28,460
$ 44,410

Req. 4
Date: (todays date)
To:
Brianna Webb
From: (your name)
After analyzing the effects of transactions for Bris Sweets for February, the
company has realized a profit of $860. This is 16% of sales revenue. However, this is
based on unadjusted amounts. There are several additional expenses that will
decrease the net income amount, perhaps resulting in a net loss. These include rent,
supplies, depreciation, interest, and wages. Therefore, the company does not appear to
be profitable, which is common for small businesses at the beginning of operations. A
focus on maintaining expenses while increasing revenues should result in profit in future
periods. It would also be useful to prepare a budget of cash flows each month for the
upcoming year to decide how potential cash shortages will be handled.

3-39

Chapter 03 - Operating Decisions and the Income Statement

P34. (continued)
Req. 5
Total Asset =
Turnover

Sales
Average
Total Assets

2012

2013

$82,500 =1.88
$44,000*

$93,500 = 1.36
$68,750**

* ($38,500 + $49,500) 2
** ($49,500 + $88,000) 2
The ratio for 2013 is lower than it otherwise would have been given Briannas decision
to open a second store. The loans and inventory purchases required have increased
the average total assets used and therefore decreased the turnover ratio. With future
sales expected to grow, the ratio should increase in coming years. Based on this
rationale, the manager should be promoted.
P35.
BRIS SWEETS
Statement of Cash Flows
For the Month Ended February 28, 2011
Operating Activities
Cash received from customers
(=$2,675+$155+$2,400)
Cash paid to employees
Cash paid to suppliers
(=$5,640+$1,430+$500+$550+$130)
Total cash used in operating activities
Investing Activities
Purchased equipment
Total cash used in investing activities

$ 5,230
(1,500)
(8,250)
(4,520)
(11,000)
(11,000)

Financing Activities
Issued stock
Borrowed from bank
Total cash from financing activities

27,600
11,000
38,600

Increase in cash
Beginning cash balance

23,080
0
$23,080

Ending cash balance

3-40

Chapter 03 - Operating Decisions and the Income Statement

P36.
Req. 1 and 2
Cash
4,598
Beg. 360
1,348
(a) 17,600
(e) 4,824
18
(g)
16 10,031
5,348
784
673

(c)
(d)
(f)
(h)
(i)
(j)

Prepaid Expenses
Beg.
82
(c) 1,531
1,613
Other Noncurrent
Assets
Beg. 1,850

Receivables
Beg. 1,162 4,824 (e)
(a) 4,567

905

294

Other Current Assets

Beg. 1,196
1,196

(j)

Accounts
Payable
784 835 Beg.

1,850

51

Other Current
Liabilities
297 Beg.
297
Contributed Capital
492 Beg.
16 (g)
508
Delivery Service
Revenue
0 Beg.
22,167 (a)
22,167
Wage Expense
Beg.
0
(h) 10,031
10,031

Spare Parts, Supplies,

and Fuel
Beg. 294

Long-Term
Notes Payable
18
(f)
667 Beg.
1,345 (b)
1,994

Property and
Equipment (net)
Beg. 8,362
(b) 1,345
9,707
Accrued Expenses
Payable
1,675 Beg.
1,675
Other Noncurrent
Liabilities
3,513
Beg.
3,513

Retained Earnings
5,827 Beg.
5,827
Rental
Expense
Beg.
0
(c) 3,067
3,067
Fuel Expense
Beg.
0
(i) 5,348
5,348

3-41

Repair
Expense
Beg.
0
(d) 1,348
1,348
Item k does not
constitute a transaction.

Chapter 03 - Operating Decisions and the Income Statement

P36. (continued)
Req. 3

FedEx
Income Statement (unadjusted)
For the Year Ended May 31, 2012
(in millions)
Revenues:
Delivery service revenue
Expenses:
Rental expense
Wage expense
Fuel expense
Repair expense
Total expenses
Net Income

$ 22,167
3,067
10,031
5,348
1,348
19,794
$ 2,373

FedEx
Statement of Stockholders Equity (unadjusted)
For the Year Ended May 31, 2012
(in millions)

Beginning, May 31, 2011

Additional contributions
Net income
Dividends
Ending, May 31, 2012

Contributed
Capital
$ 492
16

508

3-42

Retained
Earnings
$5,827
2,373
(0)
$8,200

Total
Stockholders
Equity
$6,319
16
2,373
(0)
$8,708

Chapter 03 - Operating Decisions and the Income Statement

P36. Req. 3 (continued)

FedEx
Balance Sheet (unadjusted)
At May 31, 2012
(in millions)
Assets
Current assets:
Cash
Receivables
Prepaid expenses
Spare parts, supplies, and fuel
Other current assets
Total current assets
Property and equipment (net)
Other noncurrent assets
Total assets
Liabilities and Stockholders Equity
Current liabilities:
Accounts payable
Accrued expenses payable
Other current liabilities
Total current liabilities
Long-term notes payable
Other noncurrent liabilities
Total liabilities
Stockholders' Equity:
Contributed capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity

3-43

673
905
1,613
294
1,196
4,681
9,707
1,850
$ 16,238

51
1,675
297
2,023
1,994
3,513
7,530

508
8,200
8,708
$ 16,238

Chapter 03 - Operating Decisions and the Income Statement

P36. Req. 3 (continued)

FedEx
Statement of Cash Flows
For the Year Ended May 31, 2012
(in millions)
Cash Flows from Operating Activities
Cash received from customers
(=$17,600+$4,824)
Cash paid to employees
Cash paid to suppliers
(=$4,598+$1,348+$5,348+$784)
Total cash provided by operating activities
Cash Flows from Investing Activities
None

$ 22,424
(10,031)
(12,078)
315
0
0

Cash Flows from Financing Activities

Repayment of long-term debt
Proceeds from share issuance
Total cash used in financing activities

(18)
16
(2)

Increase in cash
Beginning cash balance

313
360
$ 673

Ending cash balance

Note that transaction (b) is omitted from the statement of cash flows. However, as
discussed in future chapters, this type of transaction is a noncash investing and
financing activity that requires supplemental disclosure.

3-44

Chapter 03 - Operating Decisions and the Income Statement

P36. (continued)
Req. 4
Total Asset Turnover

Sales (or Operating

Revenues)
Average Total Assets

* (Beginning $13,306

$22,167 = 1.50
$14,772*

Ending $16,238) 2

($360 + $1,162 + $294 + $82 + $1,196 + $8,362 + $1,850)

(computed in Req. 3)

The asset turnover ratio suggests that the company obtained $1.50 in sales for the year
for every $1 in assets. To analyze this result, we would need to calculate the ratio for
the company over time to observe the trend in how efficiently assets are being utilized.
We would also need the industry ratio for the current period to determine how the
company is doing in comparison to others in the industry.
P37.
Req. 1
(in thousands)
a. Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Admissions revenue (+R, +SE). . . . . . . . . . . . . . . .

566,266

b.

Operating expenses (+E, SE). . . . . . . . . . . . . . . . . . .

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable (+L). . . . . . . . . . . . . . . . . . . . . . . .

450,967

Notes payable (L). . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

58,962

Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Food, merchandise, and games revenue (+R, + SE)

335,917

Cost of goods sold (+E, SE). . . . . . . . . . . . . . . . . .

Food and merchandise inventory (A). . . . . . . . . . . .

90,626

Property and equipment (+A). . . . . . . . . . . . . . . . . . . . .

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

83,841

Cash (+A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts receivable (+A). . . . . . . . . . . . . . . . . . . . . . . .
Accommodations revenue (+R, +SE). . . . . . . . . . . . .

72,910
1,139

c.

d.

e.

f.

3-45

566,266

412,200
38,767

58,962

335,917

90,626

83,841

74,049

Chapter 03 - Operating Decisions and the Income Statement

P37. (continued)
g.

h.

i.

j.

Interest expense (+E, SE). . . . . . . . . . . . . . . . . . .

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

125,838

Food and merchandise inventory (+A). . . . . . . . . . .

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable (+L). . . . . . . . . . . . . . . . . . . . .

146,100

Selling, general and admin. expenses (+E, SE)

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Accounts payable (+L). . . . . . . . . . . . . . . . . . . . .

131,882

Accounts payable (L). . . . . . . . . . . . . . . . . . . . . . .

Cash (A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

9,600

125,838

118,000
28,100

125,500
6,382

9,600

Req. 2
Transaction

Operating, Investing, or
Financing Effect

Direction and Amount

of the Effect (in thousands)

(a)

+566,266

(b)

412,200

(c)

58,962

(d)

+335,917

(e)

83,841

(f)

+72,910

(g)

125,838

(h)

118,000

(i)

125,500

(j)

9,600

3-46

Chapter 03 - Operating Decisions and the Income Statement

ALTERNATE PROBLEMS
AP3-1.

c.

Transactions
Example: Issued stock to new investors.
Incurred and recorded operating expenses on credit to
be paid next period.
Purchased on credit but did not use supplies this period.

d.

Performed services for customers this period on credit.

e.

Prepaid a fire insurance policy this period to cover the

next 12 months.
Purchased a building this period by making a 20 percent
cash down payment and signing a mortgage loan for the
balance.
Collected cash this year for services rendered and
recorded in the prior year.
Collected cash for services rendered this period.
Paid cash this period for wages earned and recorded
last period.
Paid cash for operating expenses charged on accounts
payable in the prior period.
Paid cash for operating expenses incurred in the current
period.
Made a payment on the mortgage loan, which was part
principal repayment and part interest.
This period a shareholder sold some shares of her stock
to another person for an amount above the original
issuance price.
Used supplies on hand to clean the offices.
Recorded income taxes for this period to be paid at the
beginning of the next period.
Declared and paid a cash dividend this period.

a.
b.

f.

g.
h.
i.
j.
k.
l.
m.

n.
o.
p.

3-47

Debit
1

Credit
11

14

13

1, 8

1
1

2
13

14

8, 14

None
14

None
3

15
12

10
1

Chapter 03 - Operating Decisions and the Income Statement

AP32.
a.
b.

c.
d.

e.

f.

g.
h.

i.
j.

k.

Accounts receivable (+A) ....................................................

Service revenue (+R, +SE) ........................................

23,500

Accounts payable (L) .........................................................

Cash (A) ..................................................................

3,005

Office supplies (+A) .............................................................

Accounts payable (+L) ...............................................

2,600

Equipment (+A) ...................................................................

Cash (A) ..................................................................

3,800

Advertising expense (+E, SE) ............................................

Cash (A) ..................................................................

1,400

Wages expense (+E, SE) ..................................................

Wages payable (L) ............................................................
Cash (A) ..................................................................

8,100
3,800

Cash (+A) ............................................................................

Contributed capital (+SE) ..........................................

135,000

Cash (+A) ............................................................................

Accounts receivable (A) ...........................................

12,500

Accounts receivable (+A) ....................................................

Service revenue (+R, +SE) ........................................

14,500

Land (+A) ............................................................................

Cash (A) ..................................................................
Note payable (+L) ......................................................

10,000

Utilities expense (+E, SE) ..................................................

Accounts payable (+L) ...............................................

1,950

3-48

23,500

3,005

2,600
3,800

1,400

11,900

135,000
12,500

14,500
3,000
7,000

1,950

Chapter 03 - Operating Decisions and the Income Statement

AP33.
Req. 1

Req. 2

Assets

Balance Sheet
Income Statement
Stmt of
Cash Flows
Stockholders
Net
Liabilities
Equity
Revenues Expenses Income

a.

NE

b.

NE

NE

c.

NE

NE

NE

NE

NE

NE

NE

NE

(Net +)
d.

+/
(Net +)

e.

+/

NE

NE

NE

NE

NE

f.

NE

NE

NE

g.

NE

NE

NE

NE

h.

NE

NE

i.

+/

NE

NE

NE

NE

(Net +)
j.

NE

NE

NE

NE

k.

NE

NE

NE

NE

l.

NE

NE

3-49

Chapter 03 - Operating Decisions and the Income Statement

AP34.
Req. 1 and 2
Cash
Beg.
0 31,000 (b)
(a) 60,000 1,240 (g)
(d) 13,200 2,700 (h)
(e) 2,400 6,000 (j)
(i) 10,000 3,600 (k)
500 (m)
40,560

Accounts Receivable
Beg.
0 10,000 (i)
(c) 35,260

25,260

15,810

Prepaid Insurance
Beg.
0
(k) 3,600

Land
Beg.
0
(a) 90,000

Barns
Beg.
0
(a)100,000
(b) 62,000
162,000

3,600

90,000

Accounts Payable
(h) 2,700
0 Beg.
3,810 (f)
1,800 (l)
2,910

Unearned Revenue
0 Beg.
2,400 (e)

Contributed Capital
0 Beg.
262,000(a)
262,000

Retained Earnings
(m) 500
0 Beg.

Animal Care
Service Revenue
0 Beg.
35,260 (c)
35,260
Utilities Expense
Beg.
0
(g) 1,240
(l) 1,800
3,040

2,400

500
Rental
Revenue
0 Beg.
13,200 (d)
13,200
Wages Expense
Beg.
0
(j) 6,000
6,000

3-50

Supplies
Beg.
0
(a) 12,000
(f) 3,810

Long-term
Note Payable
0 Beg.
31,000 (b)
31,000

Chapter 03 - Operating Decisions and the Income Statement

AP34. (continued)
Req. 3
ALPINE STABLES, INC.
Income Statement (unadjusted)
For the Month Ended April 30, 2011
Revenues:
Animal care service revenue
Rental revenue
Total revenues

$ 35,260
13,200
48,460

Expenses:
Wages expense
Utilities expense
Total costs and expenses
Net Income

6,000
3,040
9,040
$ 39,420

ALPINE STABLES, INC.

Statement of Stockholders Equity (unadjusted)
For the Month Ended April 30, 2011
Contributed
Capital
Beginning, April 1, 2011
$
0
Additional contributions
262,000
Net income
Dividends
Ending, April 30, 2011
$262,000

3-51

Retained
Earnings
$
0
39,420
(500)
$ 38,920

Total
Stockholders
Equity
$
0
262,000
39,420
(500)
$300,920

Chapter 03 - Operating Decisions and the Income Statement

AP34. (continued)
ALPINE STABLES, INC.
Balance Sheet (unadjusted)
At April 30, 2011
Assets
Current assets:
Cash
Accounts receivable
Supplies
Prepaid insurance
Total current assets

$ 40,560
25,260
15,810
3,600
85,230

Barns
Land
Total Assets

162,000
90,000
$337,230

Liabilities
Current liabilities:
Accounts payable
Unearned revenue
Total current liabilities
Note payable
Total Liabilities
Stockholders Equity
Contributed Capital
Retained Earnings
Total Stockholders Equity
Total Liabilities and Stockholders Equity

2,910
2,400
5,310
31,000
36,310

262,000
38,920
300,920
$337,230

Req. 4
Date: (todays date)
To:
Shareholders of Alpine Stables, Inc.
From: (your name)
After analyzing the effects of transactions for Alpine Stables, Inc., for April, the
company has realized a profit of $39,420. This is 81% of total revenues. However, this
is based on unadjusted amounts. There are several additional expenses that will
decrease the net income amount. These include depreciation of the barns, supplies,
insurance, interest, and wages. Therefore, the company appears to have earned a
small profit in its first month. It would be useful to prepare a budget of income and of
cash flows each month for the upcoming year to decide whether the positive income
and cash flows are likely to continue in the future.

3-52

Chapter 03 - Operating Decisions and the Income Statement

AP34. (continued)
Req. 5
2012:
Total =
Asset
Turnover
2013:

Sales (Operating)
Revenue
=
$400,000
= $400,000 = 1.29
Average
($300,000+$320,000)2
$310,000
Total Assets

Sales (Operating)
Revenue
Total =
=
$450,000
($320,000+$480,000)2
Asset
Average
Turnover
Total Assets

= $450,000 = 1.13
$400,000

Under your management, the asset turnover ratio appears to be decreasing over time.
The ratio for 2013 is lower than it otherwise would have been given the shareholders
decision to build a riding arena. The loans and building have increased the average
total assets used and therefore decreased the turnover ratio. In addition, with the new
facilities, revenues should increase in the future. Based on this rationale, you should be
promoted.
AP35.
ALPINE STABLES, INC.
Statement of Cash Flows
For the Month Ended April 30, 2011
Operating Activities
Cash received from customers ($13,200 +$2,400 +$10,000)
Cash paid to employees
Cash paid to suppliers ($1,240+$2,700+$3,600)
Total cash provided by operating activities

$25,600
(6,000)
(7,540)
12,060

Investing Activities
Purchase of barns
Total cash used in investing activities

(31,000)
(31,000)

Financing Activities
Proceeds from share issuance
Dividends paid
Total cash provided by financing activities

60,000
(500)
59,500

Increase in cash
Beginning cash balance

40,560
0
$40,560

Ending cash balance

3-53

Chapter 03 - Operating Decisions and the Income Statement

AP36.
Req. 1 and 2 (in millions)
Cash
3 (c)
Beg. 31,437
(b) 3,100
1,238 (e)
7,545 (f)
82 (h)
11 (i)
6 (j)
25,652
Inventories
Beg. 9,331 5,984 (d)
(g)
23
3,370
Investments
Beg. 28,556
28,556
Accounts Payable
36,640 Beg.
1,610 (a)
23 (g)
38,273
Notes Payable (LT)
7,025 Beg.

Marketable Securities
Beg. 570

570

Retained Earnings
107,651 Beg.
107,651
Utilities Expense
Beg.
0
(c)
3
3

61,382

Prepaid Expenses
Beg. 2,315
(h)
82
2,397
Property &
Equipment (net)
Beg.121,346
(a)
1,610
122,956
Income Tax Payable
(f)
7,545 10,060 Beg.

2,515
Other Long-Term Debt
(i)
10 58,962 Beg.

7,025

58,952
Sales Revenue
0 Beg.
39,780 (d)
39,780
Interest Expense
Beg.
0
(i)
1
1

3-54

Accounts Receivable
3,100 (b)
Beg. 24,702
(d) 39,780

Other Current Assets

Beg. 3,911
3,911
Other Assets and
Intangibles (net)
Beg. 5,884
(j)
6
5,890
Notes Payable (ST)
2,400 Beg.

2,400
Contributed Capital
5,314 Beg.
5,314
Cost of Sales
Beg.
0
(d) 5,984
5,984
Wages Expense
Beg.
0
(e) 1,238
1,238

Chapter 03 - Operating Decisions and the Income Statement

AP36. (continued)
Req. 3

Exxon Mobil Corporation

Income Statement (unadjusted)
For the Month Ended January 31, 2011
(in millions)
Revenues:
Sales revenue

$39,780

Costs and expenses:

Cost of sales
Wage expense
Utilities expense
Total costs and expenses
Operating income

5,984
1,238
3
7,225
32,555

Other revenues (expenses):

Interest expense
Net Income (pretax)

1
$32,554

Exxon Mobil Corporation

Statement of Stockholders Equity (unadjusted)
For the Month Ended January 31, 2011
(in millions)

Beginning, December 31, 2010

Stock issuance
Net income
Dividends
Ending, January 31, 2011

Contributed
Capital
$ 5,314
0

$ 5,314

3-55

Retained
Earnings
$107,651
32,554
(0)
$140,205

Total
Stockholders
Equity
$112,965
0
32,554
(0)
$145,519

Chapter 03 - Operating Decisions and the Income Statement

AP36. (continued)

Exxon Mobil Corporation

Balance Sheet (unadjusted)
At January 31, 2011
(in millions)
Assets
Current assets:
Cash
Marketable securities
Accounts receivable
Inventories
Prepaid expenses
Other current assets
Total current assets
Investments
Property & equipment (net)
Other assets and intangibles (net)

$ 25,652
570
61,382
3,370
2,397
3,911
97,282
28,556
122,956
5,890

Total assets

$254,684

Liabilities and Stockholders Equity

Current liabilities:
Accounts payable
Income tax payable
Notes payable
Total current liabilities
Notes payable
Other long-term debt
Total liabilities
Shareholders' Equity:
Contributed capital
Retained earnings
Total stockholders equity
Total liabilities and shareholders' equity

3-56

$38,273
2,515
2,400
43,188
7,025
58,952
109,165

5,314
140,205
145,519
$254,684

Chapter 03 - Operating Decisions and the Income Statement

AP36. (continued)

Exxon Mobil Corporation

Statement of Cash Flows
For the Month Ended January 31, 2011
(in millions)
Cash Flows from Operating Activities
Cash received from customers
Cash paid to employees
Cash paid to suppliers (= $3 + $82)
Cash paid to government for taxes
Interest paid
Total cash used in operating activities

$ 3,100
(1,238)
(85)
(7,545)
(1)
(5,769)

Cash Flows from Investing Activities

Purchase of intangible assets
Total cash used in investing activities

(6)
(6)

Cash Flows from Financing Activities

Repayment of debt
Total cash used in financing activities

(10)
(10)
(5,785)
31,437

Decrease in cash
Beginning cash balance

$ 25,652

Ending cash balance

Req. 4
Total Asset
Turnover

Sales
=
Average Total Assets

$39,780
$241,368

= 0.165

* ($228,052 + $254,684) 2
The asset turnover ratio suggests that the company obtained $0.165 in sales for the
month for every $1 in assets. Assuming that sales are spread equally throughout the
year, the annual asset turnover would be 1.98 (0.165 x 12 months). Compared to other
examples in the text, this suggests that Exxon Mobil is a higher capital intensive
industry (requiring extremely high levels of assets). Exxon Mobils actual asset turnover
for a recent year was 2.03.

3-57

Chapter 03 - Operating Decisions and the Income Statement

CASES AND PROJECTS

FINANCIAL REPORTING AND ANALYSIS CASES
CP31.
1. The largest expense on the income statement for the year ended January 31, 2009,
is the cost of sales for $1,814,765 (in thousands). As goods were sold throughout
the year, cost of goods sold would be recorded and inventory would be reduced.
2. This question is intended to focus students on accounts receivable and the typical
activities that increase and decrease the account.
Assuming all net sales are on credit, American Eagle Outfitters collected
$2,797,510,000 from customers. T-account numbers are in thousands.
Accounts and Notes
Receivable
Beginning
Sales
Ending

31,920
2,988,866

2,979,315 Collections

41,471

Most retailers settle sales in cash at the register and would not have accounts
receivable related to sales unless they had layaway or private credit. For American
Eagle, the accounts receivable on the balance sheet primarily relates to amounts
owed from landlords for their construction allowances for building new American
Eagle stores in malls.
3. Over the life of the business, total earnings will equal total net cash flow. However,
for any given year, the assumption that net earnings is equal to cash inflows is not
valid. Accrual accounting requires recording revenues when earned and expenses
when incurred, not necessarily when cash is received or paid. There may be
revenues recorded as earnings that are not yet received in cash. In the same way,
there may be cash outflows as prepayments of expenses that are not recorded as
expenses until incurred, such as inventories, insurance, and rent. Or, there may be
expenses that have been incurred for which payment will occur in the future.
4. An income statement reports the financial performance of a company over a period
of time in terms of revenues, gains, expenses, and losses. A balance sheet or
statement of financial position lists the economic resources owned by an entity and
the claims to those resources from creditors and investors at a point in time. They
are linked through retained earnings.

3-58

Chapter 03 - Operating Decisions and the Income Statement

CP31. (continued)
5.
Total Asset =
Turnover

(In thousands)
$2,988,866
($1,867,680 +
$1,963,676)2

Sales
=
Average
Total Assets

= $2,988,866
$1,915,678

1.56

The total asset turnover ratio measures the sales generated per dollar of assets.
American Eagle Outfitters generated $1.56 of sales per $1 of assets.
CP3-2.
1. Urban Outfitters revenue recognition policy for retail store sales is to record
revenues when customers purchase merchandise. Internet, catalog, and wholesale
sales are recognized when the goods are shipped. Revenue is recognized for
stored value cards and gift certificates when they are redeemed for merchandise.
(See pages F-10 and F-11 of the notes to the financial statements).
2. Assuming that $50 million of cost of sales is due to distribution and occupancy costs,
Urban Outfitters purchased $1,068,913 thousand worth of inventory.
Inventory (in thousands)
Beginning

171,925

Purchases

1,068,913

Ending

1,071,140 Cost of Sales*

169,698

* Total cost of sales reported $1,121,140 - an estimated $50,000 for noninventory

purchase costs = $1,071,140.
3.

Year ended 1/31/09

Year ended 1/31/08

Percentage
Genl., Admin. &
Selling Expenses
Net Sales

$414,043
$1,834,618

22.6%

Percentage
$351,827
$1,507,724

23.3%

General, Administration, & Selling Expenses increased by 17.7% over the amount for
the year ended 1/31/08.

3-59

Chapter 03 - Operating Decisions and the Income Statement

4.

Total Asset =
Turnover

Sales
=
$1,834,618
= $1,834,618 = 1.48
Average
($1,329,009+$1,142,791)2
$1,235,900
Total Assets

The total asset turnover ratio measures the sales generated per dollar of assets. Urban
Outfitters generated $1.48 of sales per $1 of assets.
CP33.
1. American Eagle Outfitters calls its income statement the Consolidated Statements
of Operations. Urban Outfitters calls its income statement the Consolidated
Statements of Income. Consolidated implies that the statements of two or more
companies (usually the company and its majority-owned subsidiaries) have been
combined into a single statement for presentation.
2. Urban Outfitters had the higher net income of $199,364 for the year ended January
31, 2009, compared to American Eagle Outfitters net income of $179,061 for the
same year (all dollars in thousands). American Eagle reported a $22,889
impairment charge in the most recent year that reduced net income. Urban
Outfitters did not report any impairment charge. If the charge were not included,
American Eagle would have reported $201,950 in net income, higher than Urban
Outfitters.
3.
(in thousands)
Total Asset =
Sales
Turnover
Average Total Assets

American Eagle
Outfitters

Urban
Outfitters

$2,988,866 =1.56
$1,915,678*

$1,834,618 = 1.48
$1,235,900**

* ($1,867,680 + $1,963,676)2

** ($1,329,009+$1,142,791)2

American Eagle Outfitters has the higher asset turnover ratio, 1.56 compared to Urban
Outfitters of 1.47, suggesting that Urban Outfitters is utilizing its assets less effectively
to generate sales than is American Eagle Outfitters. However, the difference is not
very large.
4.
Asset Turnover =

Industry
Average
1.90

American Eagle
Outfitters
1.56

3-60

Urban
Outfitters
1.48

Chapter 03 - Operating Decisions and the Income Statement

Both American Eagle Outfitters and Urban Outfitters are utilizing their assets to
generate sales less effectively than the average company in their industry. Companies
that are expanding will have higher asset values that may not as of yet have generated
sales.
5.

Operating
cash flows

2009

2008

$302,193

$464,270

2009
Operating
cash flows

2008

$251,570 $254,353

American Eagle Outfitters

Percentage
Change
2008
2007
(34.91%)

$464,270 $749,268

Urban Outfitters
Percentage
Change
2008
(1.09%)

3-61

2007

$254,353 $187,117

Percentage
Change
(38.04%)

Percentage
Change
35.93%

Chapter 03 - Operating Decisions and the Income Statement

CP34.
Req. 1
American Eagle Outfitters (dollars in thousands)
Fiscal year ended:
2006:

Total =
Sales
=
$2,321,962
= $2,321,962 = 1.58
($1,328,926+$1,605,649)2
Asset
Average
$1,467,287.5
Turnover
Total Assets

2007:

Total =
Sales
=
$2,794,409
= $2,794,409 = 1.56
($1,605,649+$1,979,558)2
Asset
Average
$1,792,603.5
Turnover
Total Assets

2008:

Total =
Sales
=
$3,055,419
= $3,055,419 = 1.59
Asset
Average
($1,979,558+$1,867,680) 2
$1,923,619
Turnover
Total Assets

2009:

Total =
Sales
=
$2,988,866
= $2,988,866 = 1.56
Asset
Average
($1,867,680+$1,963,676)2
$1,915,678
Turnover
Total Assets

Req. 2
Current Ratio =

Current Assets
Current Liabilities

Reported in American Eagle Outfitters 10-K report (Item 6):

2006
3.06
2007
2.56
2008
2.71
2009
2.30
Req. 3
American Eagle Outfitterstotal asset turnover ratio has remained relatively stable from
2006 to 2009.
On the other hand, the current ratio has steadily declined from 3.06 in 2006 to 2.30 in
2009, although American Eagle Outfitters continues to have sufficient liquidity.
Companies with strong cash management systems tend to have lower current ratios. In
addition, American Eagle Outfitters receives most of its sales in cash and should have
sufficient cash flows to pay current liabilities when they come due.

3-62

Chapter 03 - Operating Decisions and the Income Statement

CP35.
Req. 1
Accrual accounting is defined in the article as follows:
By accruing, or allotting, revenues to specific periods, they (accountants) aim to
allocate income to the quarter or year in which it was effectively earned, though
not necessarily received. Likewise, expenses are allocated to the period when
sales were made, not necessarily when the money was spent. (from Business
Week, October 4, 2004, p. 78)
Req. 2
The author of the article suggests that fuzzy numbers result from the judgments
companies make to come up with revenues and expenses on an accrual basis.
Companies are given wide discretion in determining estimates to use to compute net
income under current accounting rules, and users of the financial statements need to
read statements carefully to understand the impact of management judgments and
accounting rules. Even then, the author suggests that financial statements are often
unclear, incomplete, or too complex.
Req. 3
Congress and the SEC have adopted reforms to attempt to address the rising concerns
about financial reporting. The article suggests that many of the reforms will not help to
make financial statements clearer and more consistent. Instead, many of the reforms
are aimed at policing managers and auditors and not at clarifying estimates managers
make.

3-63

Chapter 03 - Operating Decisions and the Income Statement

CP36.
Req. 1
a. Given as an example in the textbook.
b. Cash decreased $5,000, Office Fixtures increased $22,000, and long-term Notes
Payable increased $17,000. Therefore, transaction (b) was the purchase of office
fixtures for $22,000, paid partly in cash of $5,000 and the rest by signing a long-term
notes payable for $17,000.
c. Cash increased $15,000, Accounts Receivable increased $12,000, and Paint
Revenue increased $27,000. Therefore, transaction (c) was delivery of painting
services for $27,000; $15,000 was received in cash and the rest was on account.
d. Cash decreased $14,000, Land increased $18,000, and Note Payable increased
$4,000. Therefore, transaction (d) was a purchase of land for $18,000; $14,000 was
paid in cash and an interest-bearing note was signed for the remainder.
e. Cash decreased $10,000, Accounts Payable increased $3,000, Supplies Expense
increased $5,000, and Wages Expense increased $8,000. Therefore, transaction (e)
was purchase and use of $5,000 of supplies and $8,000 of employee labor. $10,000
was paid in cash and $3,000 is owed.
f. Cash increased $3,000, Accounts Receivable increased $14,000, and Paint Revenue
increased $17,000. Therefore, transaction (f) was a sale of painting services made
on account for $14,000 while $3,000 was received in cash.
g. Cash decreased $4,000, and Retained Earnings decreased $4,000. Therefore,
transaction (g) was declaration and payment of a dividend of $4,000.
h. Cash decreased $11,000, Accounts Payable increased $7,000, Supplies Expense
increased $3,000, and Wages Expense increased $15,000. Therefore, transaction
(h) was purchase and use of supplies of $3,000 and employee labor of $15,000.
$11,000 was paid in cash, and $7,000 is owed.
i. Cash decreased by $5,000, and Accounts Payable decreased by $5,000. Therefore,
transaction (i) is a payment made on account.
j. Cash increased $16,000, Accounts Receivable decreased $16,000. Therefore,
transaction (j) was the receipt of payments from customers.

3-64

Chapter 03 - Operating Decisions and the Income Statement

CP36. (continued)
Req. 2

PETES PAINTING SERVICE

Income Statement
For the Month Ended January 31, 2011
Revenues:
Paint revenue

$44,000

Expenses:
Supplies expense
Wages expense
Total costs and expenses
Net Income

8,000
23,000
31,000
$13,000

PETES PAINTING SERVICE

Statement of Stockholders Equity
For the Month Ended January 31, 2011

Beginning, January 20, 2011

Additional contributions
Net income
Dividends
Ending, January 31, 2011

Contributed
Capital
$
0
75,000

$75,000

3-65

Retained
Earnings
$
0
13,000
(4,000)
$ 9,000

Total
Stockholders
Equity
$
0
75,000
13,000
(4,000)
$84,000

Chapter 03 - Operating Decisions and the Income Statement

CP36. (continued)

PETES PAINTING SERVICE

Balance Sheet
At January 31, 2011
Assets
Current assets:
Cash
Accounts receivable
Total current assets
Office fixtures
Land
Total assets

$ 60,000
10,000
70,000
22,000
18,000
$110,000

Liabilities and Shareholders Equity

Current liabilities:
Accounts payable
Total current liabilities
Notes payable
Total liabilities

$ 5,000
5,000
21,000
26,000

Shareholders' Equity:
Contributed capital
Retained earnings
Total shareholders equity
Total liabilities and shareholders' equity

75,000
9,000
84,000
$110,000

Req. 3
Transaction

Operating, Investing, or
Financing Effect

(a)

+75,000

(b)

5,000

(c)

+15,000

(d)

14,000

(e)

10,000

(f)

+3,000

(g)

4,000

(h)

11,000

(i)

5,000

(j)

+16,000

3-66

Direction and Amount

of the Effect

Chapter 03 - Operating Decisions and the Income Statement

CRITICAL THINKING CASES

CP37.
Req. 1
Estela used the cash basis of accounting. We can infer this from his references to
income collected rather than earned, expenses paid rather than incurred, and supplies
purchased rather than used. Accrual accounting should be used because it correctly
assigns revenues and expenses to the accounting period in which they are earned or
incurred.
Req. 2
(a)

(b)

Building (+A) ........................................................................

Tools and equipment (+A) ...................................................
Land (+A) ............................................................................
Cash (+A) ............................................................................
Contributed capital (+SE) .........................................

21,000
17,000
20,000
1,000

Cash (+A) .............................................................................

Accounts receivable (+A) .....................................................
Unearned revenue (+L) .............................................
Service fees revenue (+R, +SE) ................................

55,000
52,000

59,000

20,000
87,000

(c)

No entry

(d)

Operating expenses (+E, SE) ............................................

Accounts payable (+L) ...............................................
Cash (A) ..................................................................

61,000

Supplies expense (+E, SE)* ..............................................

Supplies (+A) .......................................................................
Cash (A) ..................................................................

2,500
700

(e)

Other
(1) Loss from theft (+E, SE) ....................................................
Cash (A) ..................................................................
(2)

Tools and equipment (+A) ...................................................

Cash (A) ..................................................................

39,000
22,000

3,200

500
500
1,000

* Supplies purchased, $3,200 Supplies on hand at end of 2012, $700 = $2,500

supplies used

3-67

1,000

Chapter 03 - Operating Decisions and the Income Statement

CP37. (continued)
ASSETS:
Cash
Beg.
0 22,000
3,200
(a) 1,000
(b) 55,000
500
1,000

(d)
(e)
(1)
(2)

29,300
Building
Beg.
0
(a) 21,000

21,000
LIABILITIES:
Accounts Payable
0 Beg.
39,000 (d)
39,000
SHAREHOLDERS EQUITY:
Contributed Capital
0 Beg.
59,000 (a)
59,000

Accounts Receivable
Beg.
0
(b) 52,000

52,000

Beg.
(e)

Supplies
0
700

700

Land
Beg.
0
(a) 20,000

Tools and Equipment

Beg.
0
(a) 17,000
(2) 1,000

20,000

18,000

Unearned Revenue
0 Beg.
20,000 (b)
20,000

Retained Earnings
0 Beg.
0

REVENUES AND EXPENSES:

Operating Expenses
Service Fees Revenue
0 Beg.
Beg.
0
87,000 (b)
(d) 61,000
61,000
87,000
Loss from Theft
Beg.
0
(1)
500
500

3-68

Supplies Expense
Beg.
0
(e)
2,500
2,500

Chapter 03 - Operating Decisions and the Income Statement

CP37. (continued)
Req. 3
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
(k)

ESTELA COMPANY
Income Statement
For the Year Ended December 31, 2012

Revenues:
Service fees revenue
[see note]
Costs and expenses:
Operating expenses
Supplies expense
Loss from theft
Total costs and expenses
Net Income

$ 87,000
61,000
2,500
500
64,000
$ 23,000

Use the standard title.

Date to indicate time period covered.
Use appropriate title.
Use accrual figure -- revenue earned, rather than cash collected.
Exclude the dividends because the stock is owned by Julio and not the company
-- apply the separate entity assumption.
Use appropriate title.
Use accrual figure -- expenses incurred, not cash paid.
Expense is supplies used, $2,500; the $700 is still an asset until used.
Stolen property should be recorded as a loss for the amount not covered by
insurance.
Use appropriate caption.
Use standard terminology.

3-69

Chapter 03 - Operating Decisions and the Income Statement

CP37. (continued)
ESTELA COMPANY
Balance Sheet
At December 31, 2012
Assets
Current assets:
Cash
Accounts receivable
Supplies
Total current assets
Building
Land
Tools and equipment
Total assets

$ 29,300
52,000
700
82,000
21,000
20,000
18,000
$141,000

Liabilities
Current liabilities:
Accounts payable
Unearned revenue
Total current liabilities

$ 39,000
20,000
59,000

Shareholders' Equity
Contributed capital
Retained earnings
Total shareholders equity
Total liabilities and shareholders' equity

59,000
23,000
82,000
$141,000

3-70

Chapter 03 - Operating Decisions and the Income Statement

CP37. (continued)
ESTELA COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2012
Cash from Operating Activities
Cash received from customers
Cash paid to suppliers ($22,000 + $3,200)
Cash stolen
Total cash provided by operating activities
Cash from Investing Activities
Purchase of tools and equipment
Total cash used in investing activities
Cash from Financing Activities
Proceeds from share issuance
Total cash provided by financing activities

$55,000
(25,200)
(500)
29,300
(1,000)
(1,000)
1,000
1,000
29,300
0

Increase in cash
Beginning cash balance

$29,300

Ending cash balance

Req. 4
The above statements do not yet take into account most year-end adjustments,
including depreciation and income taxes. The adjusting entry for income taxes is
especially important because of the implication for future cash flows.
The statements also record the building, land, and tools and equipment originally
contributed in exchange for shares in the new company at their market value at that
time. Their current market value at year-end is more relevant to a loan decision.
Current market values for the building and land are provided ($32,000 and $30,000,
respectively), but the current value of the tools and equipment is also needed.
The stock in ABC Industrial is owned by Julio and not the company. However, it may be
used as collateral if Julio is willing to sign an agreement pledging personal assets as
collateral for the loan. This is a common requirement for small start-up businesses.
Other of Julios personal assets could also be considered for collateral.
Lastly, pro forma financial statements (or budgets) outlining the expected revenues,
expenses, and cash flows from the expanded business would be helpful to gauge its
viability.

3-71

Chapter 03 - Operating Decisions and the Income Statement

CP37. (continued)
Req. 5
(todays date)
Dear Mr. Estela:
We regret to inform you that your request for a $100,000 loan has been denied.
Your current business appears profitable and appears to generate sufficient cash to
maintain operations, even once additional expenses, such as income taxes, are
considered. However, pro forma financial statements (or budgets) outlining the
expected revenues, expenses, and cash flows from the expanded business would be
needed to gauge its future viability.
We also require that there be sufficient collateral pledged against the loan before we
can consider it. A loan of this size would increase your companys size by over 70% of
its current asset base. The current market value of the building and land held by the
company are insufficient as collateral. The current value of the tools and equipment
may provide additional collateral, if you provide us with this information. Your personal
investments may also be considered viable collateral if you are willing to sign an
agreement pledging these assets as collateral for the loan. This is a common
requirement for small start-up businesses.
If you would like us to reconsider your application, please provide us with the pro forma
financial statements and with the current market values of any assets you would pledge
as collateral.
Regards,
(your name)
Loan Application Department,
Your Bank

3-72

Chapter 03 - Operating Decisions and the Income Statement

CP38.
Req. 1
This type of ethical dilemma occurs quite frequently. The situation is difficult personally
because of the possible repercussions to you by your boss, Mr. Lynch, if you do not
meet his request. At the same time, the ethical and professional response is to follow
the revenue recognition rule and account for the cash collection as deferred revenue (as
was done). To record the collection as revenue overstates income in the current period.
Req. 2
In the short run, Mr. Lynch would benefit by receiving a larger bonus. You also
benefit in the short run because you would not experience any negative repercussions
from your boss. However, there is the risk that sometime in the future, perhaps through
an audit, the error will be found. At that point, both you and Mr. Lynch could be
implicated in a fraud. In addition, this may be the first instance where you are being
asked to account for a transaction in violation of accepted principles or company
policies. There is a very strong possibility Mr. Lynch may ask you for additional favors
in the future if you demonstrate your willingness at this point.
Req. 3
In the larger picture, shareholders are harmed by the misleading income figures
by relying on them to purchase stock at inflated prices. In addition, creditors may lend
funds to the insurance company based on the misleading information. The negative
impact of the discovery of misleading financial information will cause stock prices to fall,
causing shareholders to lose on their investment. Creditors will be concerned about
future debt repayment. You will also experience diminished self-respect because of the
violation of your integrity.
Req. 4
Managers are agents for shareholders. To act in ways to the benefit of the
manager at the detriment of the shareholders is inappropriate. Therefore, the ethically
correct response is to fail to comply with Mr. Lynch's request. Explaining your position
to Mr. Lynch will not be easy. You may want to express that you understand the reason
for his request, but cannot ethically or professionally comply.

FINANCIAL REPORTING AND ANALYSIS TEAM PROJECT

CP39.
The solution to this project will depend on the companies and/or accounting periods
selected for analysis.

3-73