Chapter 3Operating Decisions and the Accounting SystemANSWERS TO QUESTIONS1. A typical business operating cycle for a manufacturer would be as follows: inventory ispurchased, 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 andperformance of a business can be reported periodically, usually everymonth, 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 fromongoing operations.Gains -- increases in assets or settlements of liabilities fromperipheral transactions.Expenses -- decreases in assets or increases in liabilities from ongoing operations.Losses -- decreases in assets or increases in liabilities fromperipheral transactions.4. Both revenues and gains are inflows of net assets. However, revenues occur in thenormal 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 expenseswhen incurred, regardless of the timing of cash receipts payments. Cash basis accounting is recording revenues when cash received and expenses when cash is paid.or is12.6.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 evidenee of an arran geme nt for customer payme nt, (3) the price is fixed or determ in able, and (4) collecti on is reas on ably assured.7.The expe nse match ing prin ciple requires that expe nses be recorded whe n incurred in earning revenue. For example, the cost of inventory sold duri ng a period is recorded in the same period as the sale, not whe n the goods are produced and held for sale.8.Net in come equals reve nues minus expe nses. Thus reve nues in crease net in come and expe nses decrease net in come. Because net in come in creases stockholders ' equity, reve nues in crease stockholders ' equity and expe nses decrease it.9.Reve nues in crease stockholders ' equity and expe nses decreasestockholders ' equity. To in crease stockholders ' equity, an acco unt must be credited; to decrease stockholders ' equity, an account must be debited. Thus reve nues are recorded as credits and expe nses as debits.13. Total net profit margin ratio is calculated as Net In comeNet Sales (or Operat ing Reve nu es). The net profit margin ratio measures how much of every sales dollar is profit. An in creas ing ratio suggests that the compa ny is managing its sales and expe nses effectively.ANSWERS TO MULTIPLE CHOICE1. c2. a3. b4. b5. c6. c7. d8. b9. a10. bAuthors' Recomme nded Soluti on Time(Time in min utes)* Due to the nature of this project, it is very difficult to estimate the amount of time students willneed to complete the assignment. As with anyopen-ended project, it is possible for students to devote a large amount of time to these assig nmen ts. While stude nts ofte n ben efit 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, whe n our goal is to sharpe n research skills, we devoteclass time discuss ing research strategies. When we want the stude nts to focus on a real acco un ti ng issue, we offer suggesti ons about possible compa nies or in dustries.MINI-EXERCISESM3- 1._________________ TERM G (1)L ossesC (2)Expe nse matchi ng _____ prin ciple F (3)Reve nuesE (4)Time periodassumpti on B (5)Operat ing cycleM3- 2.Cash BasisAccrual Basis In come Stateme ntIn come Stateme ntReve nu es:Reve nu es: Cash sales$8,000 Sales to $18,000Customer deposits5,000customersExpe nses:Expe nses: Inven tory purchases 1,000 Cost of sales 9,000 Wages paid900Wages expe nse 900Utilities 300expenseNet In come$11,100Net In come$7,800M3- 4.Reve nue Acco unt AffectedAmount of Reve nue Earned in Julya. Cash (+A) ......................................................................................... 15,000Games Reve nue (+R, +SE) ........................................................................ 15,000b. Cash (+A) ........................................................................................... 3,000Acco unts Receivable (+A) ................................................................ 5,000 Sales Reve nue (+R, +SE) ............................................................................. 8,000c. Cash (+A) ........................................................................................... 4,000Acco unts Receivable ( A) .............................................................................. 4,000d. Cash (+A) ........................................................................................... 2,500Unearned Reve nue (+L) ............................................................................... 2,500 M3- 6.e. Cost of Goods Sold (+E, SE) ............................................................. 6,800Inven tory ( A) ............................................................................................ 6,800f. Accounts Payable ( - L) (800)Cash ( A) (800)g. Wages Expe nse (+E, SE) ................................................................. 3,500Cash ( A) ........................................................................................................ 3,500h. In sura nee Expe nse (+E, SE) (500)Prepaid Expe nses (+A) ....................................................................... 1,00 Cash ( A) ........................................................................................................ 1,500i. Repairs Expe nse (+E, SE) (700)Cash ( A) (700)j. Utilities Expe nse (+E, SE) (900)Acco unts Payable (+L) (900)Tran sact ion (c) results in an in crease in an asset (cash) and a decrease in an asset (acco unts receivable). Therefore, there is no net effect on assets.M3- 8.Tran sact ion (h) results in an in crease in an asset (prepaid expe nses) and adecrease in an asset (cash). Therefore, the net effect on assets is 500.Craig ' s Bowling, Inc. In come Stateme nt For the Month of July 2014Reve nu es:Games reve nue Sales reve nue Total reve nues Expe nses:Cost of goods soldUtilities expe nse Wages expe nseIn sura nee expe nse Repairs expe nse Total expe nses Net in comeM3- 10.$15,000 8,000 23,000 6,800 900 3,500 500 700 12,400 $ 10,600These results suggest that Jen ' s Jewelry Company earned approximately $ for every dollar of revenue in 2015, and over time, the ratio has improved.Jen' s has become more effective at managing sales and expe nses.Betwee n 2013 to 2014 and 2014 to 2015, sales have in creased at a lower perce ntage tha n net in come. This suggests that the compa ny has bee n more effective at con trolli ng expe nses tha n gen erat ing reve nu es.EXERCISESE3 - 1.TERM K (1) Expe nses E (2) Gai nsG (3) Reve nue realizati on prin ciple I (4) Cash basisacco unting M (5) Unearned reve nue C (6) Operati ng cycleD (7) Accrual basis acco unting F(8) Prepaid expe nsesJ (9) Reve nuesExpe nses = Net In comeL (10) Ending Reta ined Earnings =Beg inning Reta ined Earnings + Net In come DeclaredE3 - 2. Req. 1Cash BasisAccrual Basis In come Stateme ntIn come Stateme ntReve nu es:Reve nu es:Cash sales$500,000 Sales to $750,000 Customer deposits 70,000 customersNet In come$282,500 Net In come$61,870Req. 2Accrual basis financial statements provide more useful information to external users.Divide ndsExpe nses:Inven tory purchases 90,000 Wages paid 180,300 Utilities paid17,200 Expe nses:Cost of sales 485,000 Wages expe nse 184,000 Utilities19,130 expense ________Financial statements created under cash basis accounting normally postpone ., $250,000 credit sales) or accelerate ., $70,000 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.Activity Reve nue Acco unt Amount of Reve nueActivity Expe nse Acco unt Affected Amount of Expe nseE3 - 5.Bala nee In come StatemeTran sact ion (k) results in an in crease in an asset (cash) and a decrease in an asset (acco unts receivable). Therefore, there is no net effect on assets.A loss affects net in come n egatively, as do expe nses.E3 - 6.Tran sact ion (f) results in an in crease in an asset (property, pla nt, and equipme nt) and a decrease in an asset (cash). Therefore, there is no net effect on assets.E3 - 7.(in thousa nds)a. Pla nt and equipme nt (+A) (636)Cash ( A) (636)Debits equal credits. Assets in crease and decrease by the same amount.b. Cash (+A) (181)Short-term no tes payable (+L) (181)Debits equal credits. Assets and liabilities in crease by the same amount.c. Cash (+A) .......................................................................................... 10,765Acco unts receivable (+A) .................................................................. 28,558Service revenue (+R, +SE) .....................39,323 Debits equal credits. Revenue increases retained earnings (part of stockholders' equity). Stockholders' equity and assets increase by the same amount.E3 - 7. (continued)d. Acco unts payable ( L) ....................................................................... 32,074Cash ( A) ......................................................................................................... 32,074 Debits equal credits. Assets and liabilities decrease by the same amount.e. Inven tory (+A) ................................................................................... 32,305Acco unts payable (+L) ................................................................................... 32,305 Debits equal credits. Assets and liabilities in crease by the same amount.f. Wages expe nse (+E, SE) .................................................................... 3,500Cash ( A) ........................................................................................................... 3,500 Debits equal credits. Expe nses decrease reta ined earnings (part of stockholders'equity). Stockholders' equity and assets decrease by the same amount.g. Cash (+A) ........................................................................................... 39,043Acco unts receivable ( A) ................................................................... 39,043 Debits equal credits. Assets in crease and decrease by the same amount.h. Fuel expe nse (+E, SE) (750)Cash ( A) (750)Debits equal credits. Expe nses decrease reta ined earnings (part of stockholders'equity). Stockholders' equity and assets decrease by the same amount.i. Reta ined earnings ( SE) (597)Cash ( A) (597)Debits equal credits. Assets and stock holders ' equity decrease by thesame amount.j. Utilities expe nse (+E, SE) (68)Cash ( A) (55)Acco unts payable (+L) (13)Debits equal credits. Expe nses decrease reta ined earnings (part of stockholders'equity). Together, stockholders' equity and liabilities decrease by the same amount as assets.E3 - 8.Req. 1a. Cash (+A) ....................................................................... 2,300,000Short-term note payable (+L) ................................................. 2,300,000 Debits equal credits. Assets and liabilities in crease by the same amount.b. Equipme nt (+A)............................... 98,000Cash ( A) ..................................................................................... 98,000 Debits equal credits. Assets in crease and decrease by the same amount.c. Mercha ndise inven tory (+A) ................. 35,000Acco unts payable (+L) ............................................................. 35,000 Debits equal credits. Assets and liabilities in crease by the same amount.d. Repairs (or maintenan ce) expe nse (+E, SE).... 62,000Cash ( A) .................................................................................. 62,000 Debits equal credits. Expe nses decrease reta ined earnings (part of stockholders'equity). Stockholders' equity and assets decrease by the same amount.e. Cash (+A) .......................................................................... 390,000Unearned pass reve nue (+L) .................................................... 390,000 Debits equal credits. Since the seas on passes are sold before Vail Resorts provides service, reve nue is deferred un til it is earn ed. Assets and liabilities in crease by the same amount.f. Two tran sacti ons occur:(1) Acco unts receivable (+A) (800)Ski shop sales reve nue (+R, +SE) (800)Debits equal credits. Reve nue in creases reta ined earnings (a part of stockholders' equity). Stockholders' equity and assets in crease by the same amount.⑵ Cost of goods sold (+E, SE) (500)Mercha ndise inven tory ( A) (500)Debits equal credits. Expe nses decrease reta ined earnings (a part of stockholders' equity). Stockholders' equity and assets decrease by the same amount.E3 - 8. (continued)g. Cash (+A) ........................................................................... 320,000Lift reve nue (+R, +SE) ........................................................... 320,000 Debits equal credits. Reve nue in creases reta ined earnings (a part of stockholders'equity). Stockholders' equity and assets in crease by the same amount.h. Cash (+A) ............................................................................. 3,500Unearned rent reve nue (+L) .................................................... 3,500 Debits equal credits. Since the rent is received before the townhouse is used,revenue is deferred until it is earned. Assets and liabilities in crease by the sameamount.i. Acco unts payable ( L) ....................................................... 17,500Cash ( A) ................................................................................... 17,500 Debits equal credits. Assets and liabilities decrease by the same amount.j. Cash (+A) (400)Acco unts receivable ( A) (400)Debits equal credits. Assets in crease and decrease by the same amount.k. Wages expe nse (+E, SE) ................................................ 245,000Cash ( A) .................................................................................... 245,000 Debits equal credits. Expe nses decrease reta ined earnings (a part of stockholders' equity). Stockholders' equity and assets decrease by the same amount.Req. 22/1 Rent expe nse (+E, SE) (275)Cash ( A) (275)2/2 Fuel expe nse (+E, SE) (490)Acco unts payable (+L) (490)2/4 Cash (+A) (820)Unearned reve nue (+L) (820)2/7 Cash (+A) (910)Tran sport reve nue (+R, +SE) (910)2/10 Advertising expense (+E, SE) (175)Cash ( A) (175)2/14 Wages payable ( L) ........................................................................ 2,300Cash ( A) ........................................................................................ 2,3002/18 Cash (+A) .......................................................................................... 1,600 Acco unts receivable (+A) ................................................................... 2,200Tran sport revenue (+R, +SE) ..................................................................... 3,8002/25 Parts supplies (+A) ............................................................................ 2,550Acco unts payable (+L) ............................................................................... 2,5502/27 Retained earnings ( SE) (200)Divide nds payable (+L) (200)Req. 1 and 2Rebuild ing Fees Revenue Re ntRevenueWages Expe Utilities ExpeItem (f) is not a tran sact ion; there has bee n no excha nge.E3 - 10. (con ti nued) Req. 3Net in come using the accrual basis of acco un ti ng:Revenues $19,850 ($19,000 + $850)-Expenses16,900 ($16,500 + $400) Net In come $ 2,950(accrual basis)Assets=Liabilities+Stockholders 'Equity $12,090 $ 7,700$ 1,700 24,800 4,4407,820 2,460 48,5009,360 10,4202,950 netin come7,400 25,300$82,470 $60,640$21,830Req. 4Net in come using the cash basis of acco unting:Cash receipts $27,650 - Cash disburseme nts 19,760Net In come $ 7,890(cash basis)Cash basis net in come ($7,890) is higher tha n accrual basis net in come ($2,950) because ofthe differe nces in the timi ng of recordi ng reve nues versus receipts and expe nses versusdisburseme nts betwee n the two methods. The $7,800 higher amount in cash receipts over reve nues in cludes cash received prior to being earned (from (b), $600) and cash received after being earned (in (d), $7,200).The $2,860 higher amount in cash disburseme nts over expe nses in cludes cash paid after being in curred in the prior period (in (g), $2,300), plus cash paid for supplies to be used and expe nsed in the future (in (k), $960), less an expe nse in curred in January to be paid in February (in (e), $400).(tra nsactions (tra nsactio a through d) g, i, and k )E3 - 11.STACEY S PIANO REBUILDING COMPANYIn come Stateme nt (un adjusted)For the Mon th En ded Jan uary 31,2014Operati ng Reve nu es:Rebuild ing fees reve nue Total operati ng reve nuesOperati ng Expe nses:Wages expe nseUtilities expe nseTotal operati ng expe nses Operat ing In comeOther Item:Rent reve nueNet In come $ 19,000~~19,00016,50040016,9002,100850 $ 2,950Cateri ng Sales Food Sales Reve nue RevenueWages Expe nseBeg.(i)6,280 _______6,280Fuel ExpenseBeg.(h)363363E3 - 14.Req. 1 TRAVELING GOURMET, INC.In come Stateme nt (un adjusted)For the Month Ended March 31,2014Reve nu es:Food sales reve nue $ 11,900Cateri ng sales reve nue 4,200Total reve nues 16,100 Expe nses:Supplies expe nse 10,830Utilities expe nse 420Wages expe nse 6,280Fuel e xpense363Total costs and expe nses17,893 Net Loss $ (1,793)Req. 2O, I, or F ActivityTran sact ion (or No Effect) on Direction and AmountStateme nt of Cash of EffectFlowsReq. 3The compa ny gen erated a small loss of 1,793 duri ng its first monthoperations, before making any adjusting entries. The adjusting entriesuse of the buildi ng and equipme nt and in terest expe nse on the borrow ing will in crease the loss. Cash flows from operat ing activities were also n egative atof for$2,973 (= + 11,900 + 2,600 - 10,830 - 363 - 6,280) . 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 fixedcosts (particularly salaries expense), the company may soon turn a profit. Itis not unusual for small businesses to report a loss or have negative cash flows from operations as they start up operations.E3 - 15.Brief Expla nati onIssued 10,000 shares of com mon stock to shareholders for $82,000 cash. Purchased store fixtures for $15,400 cash.Purchased $24,800 of in ve ntory, payi ng $6,200 cash and the bala nee on acco unt.Sold $14,000 of goods or services to customers, recei ving $9,820 cash and the bala nee on acco unt. The cost of the goods sold was $7,000. Used $1,480 of utilities duri ng the mon th, not yet paid.Paid $1,300 in wages to employees.Paid $2,480 in cash for rent, $620 related to the curre nt month and $1,860 related to future mon ths.Received $3,960 cash from customers, $1,450 related to curre nt sales and $2,510 related to goods or services to be provided in the future.Kate ' s Kite CompanyIn come Stateme ntFor the Month Ended April 30, 2014Sales Reve nue Expe nses:Cost of sales Wages expe nse Rent expe nse Utilities expe nseTotal expe nsesNet In comeReq. 1 Tran sact ionab cde f ghReq. 2$ 15,450 7,000 1,300 620 1,480 10,400 $ 5,050E3 - 15. (con ti nued)Kate ' s Kite CompanyBala nee SheetAt April 30, 2014Assets Liabilities and Shareholders 'EquityCurre nt Assets: Curre nt Liabilities:Cash $70,400 Acco unts payable $20,080 Acco unts receivable 4,180 Unearned reve nue 2,510 Inven tory 17,800 Total curre nt 22,590liabilitiesPrepaid expe nses 1,860 Shareholders ' Equity :Total curre nt assets 94,240 Common stock 10,000 Store fixtures 15,400 Additi onal paid-i n capital 72,000Reta ined earnings 5,050Total shareholders '87,050equityTotal Liabilities &Total Assets $109,640 Shareholders ' Equity $109,640E3 - 16.Req. 1Assets = Liabilities +Stockholders ' Equity $ 3,200 $ 2,400 $ 8008,000 5,600 4,0006,400 1,600 3,200$17,600 $9,600 $ 8,000Wages Expe nseTravel Expe nseUtilities Expe nseE3 - 16. (con ti nued) Req. 2CashBeg. 3,200 (a) 48,000(b) 5.600 (c) 400 (e) 1.60057,200(d)480 (g) 1,120Acco unts Payable(d) 1,600 2,400 Beg.800 f)1,600Beg. 6,400Lon g-Term Inv estme nts 6,400Lon g-Term Notes Payable1,600 Beg.Common Stock800 Beg.800Additio nai Paid-in Cap itai4,000 Beg. 1,600Reta ined Earnings(g) | 3,200 Beg. 4802,720Con suit ing 4,000Rent Expe$58,400 ($58,000 from sales + $400 on in vestme nts) 56,400 ($36,000 + $12,000 + $800 + $7,600) $ 2,000 Assets =Liabilities +Stockholders ' Equity$ 1,120 $ 1,600$ 80012,400 7,2004,000 6,400 1,6002,7202,000 net in come $19,920$10,400$ 9,520Req. 4* The $400 of inv estme nt in come is not an operat ing reve nue and is not in cluded in thecomputatio n.The in creas ing trend in the net profit margin ratio (from % in 2013 to % in 2014 and the n to % in 2015) suggests that the compa ny is man agi ng its sales and expe nses more effectively over time. E3 - 16. (con ti nued) Req. 3Revenues -Expenses Net In come Net Profit Margin RatioNet In come Sales (Operat ing) Reve nues =$2,000$58,000*or %E3 - 17. Req. 1Acco unts receivable in creases with customer sales on acco unt and decreases with cash payme nts received from customers.Prepaid expe nses in crease with cash payme nts of expe nses related to future periods and decrease as these expe nses are in curred over time.Unearned subscripti ons in crease with cash payme nts received from customers for goods or services to be provided in the future and decreases whe n those goods or services are provided. Req. 2Computati ons:Beg inning+ Trade acco unts 717+ receivablePrepaid 95+expensesUnearned 224 +subscripti ons“. ____________________________________________________________________________________________________________ I™-I ■+_= Ending 5,240 ? = 693 ? = 5,264 203 ? =107 ? = 191 2,690? = 231 ?=2,683Trade Acco untsReceivable1/1 7175,240 12/31 6935,264Prepaid ExpensesUnearned Subscriptio nsE3 - 18.ITEM LOCATION1. Description of a company ' sprimary business(es).2. Income taxes paid.3. Accounts receivable.4. Cash flow from operatingactivities.5. Description of a company 'srevenue recognition policy.6. The inventory sold during theyear.7. The data needed to compute thenet profit margin ratio.Letter to shareholders; Managemen't s Discussion and Analysis Summary of significant accounting policies noteNotes; Statement of cash flowsBalance sheetStatement of cash flowsSummary of significant accounting policies noteIncome statement (Cost of Goods Sold) Income statementPROBLEMSP3-1.Tran sact ions Debit Credita.5 1,8Example: Purchased equipme nt for use in the bus in ess; paid one-third cash and sig ned a note payable for the bala nee.b.Paid cash for salaries and wages earned by employees this period. 15 1c. Paid cash on acco unts payable for expe nses in curred last period.7 1d. Purchased supplies to be used later; paid cash. 3 1e. Performed services this period on credit. 2 14f. Collected cash on acco unts receivable for services performed lastperiod. 1 2g. Issued stock to new inv estors. 1 11,12h. Paid operati ng expe nses in curred this period. 15 1i.In curred operati ng expe nses this period to be paid n ext period. 15 7 j. Purchased a pate nt (an intan gible asset); paid cash. 6 1 k. Collected cash for services performed this period. 1 14 l. Used some of the supplies on hand for operati ons. 15 3 m.16 1, 10Paid three-fourths of the in come tax expe nse for the year;the bala nee will be paid n ext year.n. Made a payme nt on the equipme nt note in ( a); the payme ntwas part prin cipal and part in terest expe nse. 8, 17 1o. On the last day of the curre nt period, paid cash for an in sura neepolicy coveri ng the n ext two years. 4 1a. Cash (+A) ......................................................................................... 40,000Common stock (+SE) (20)Additio nal paid-in capital (+SE) ................................................................. 39,980b. Cash (+A) ......................................................................................... 60,000Note payable (Ion g-term) (+L) .................................................................... 60,000c. Rent expe nse (+E, SE) ...................................................................... 1,500Prepaid rent (+A) ................................................................................ 1,500 Cash ( A) ..................................................................................................... 3,000d. Prepaid in sura nee (+A) .................................................................... 2,400Cash ( A) .................................................................................................... 2,400e. Furn iture and fixtures (or Equipme nt) .................................................. (+A) 15,000Acco unts payable (+L) ............................................................................... 12,000Cash ( A) .................................................................................................... 3,000f. Inven tory (+A) ................................... 2,800Cash ( A) .................................................................................................... 2,800g. Advertis ing expe nse (+E, SE) (350)Cash ( A) (350)h. Cash (+A) (850)Acco unts receivable (+A) (850)Sales reve nue (+R, +SE) ............................................................................. 1,700Cost of goods sold (+E, SE) (900)Inven tory ( A) (900)i. Acco unts payable ( L) ...................................................................... 12,000Cash ( A) .................................................................................................... 12,000j. Cash (+A) (210)Acco unts receivable ( A) (210)。