4-accrual accounting concepts

Introduction

chapter 4

Accrual Accounting ConceptsAccounting Matters!

Swapping QuartersA financial reporting system's accuracy depends on answers to some fundamental questions. When was revenue earned or the earnings process complete? And when were expenses really incurred?

Consider this example. One morning a brother and sister opened a lemonade stand in their front yard. As their neighbour left for work, she bought a glass of lemonade for a quarter. Unfortunately, it was a cool day and the kids lived on a quiet cul-de-sac. In short, business was slow.

After an hour with no more customers, the brother decided to buy some lemonade. He passed the neighbour's quarter to his sister and enjoyed a glass. A little later, the sister decided to buy some so she passed the quarter back to her brother. Within an hour, after passing the quarter back and forth, they had finished off the lemonade. They went inside and told their parents they had sold the whole pitcher. Only, they were unable to figure out why, after so many sales, they had only one quarter.

Before being too critical of these siblings, consider this. During the 1990s' boom in dotcom companies' share prices, many were earning revenue by swapping advertising space on their websites. Company A would put an ad on company B's website, and company B would put an ad on company A’s. No money changed hands, but each company recorded revenues and expenses (for the value of the ad space). This didn’t change net earnings or add to cash flow—but it did increase reported revenue.

Recording revenue or expenses in the wrong year is another common transgression. WorldCom stunned financial markets with its admission that it had boosted its 2001 net earnings by billions of dollars by delaying expense recognition until later years. Since then, similar stories have surfaced in both Canada and the United States.

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Introduction

Toronto-based refrigerated-warehouse operator Atlas Cold Storage got into hot water when it had to restate its financial statements for 2001 and 2002. A significant number of expenses were incorrectly recorded as additions to property, plant, and equipment. The result: 2001 net earnings were reduced by $5.2 million, from $11.4 million to $6.2 million, while 2002 net earnings shrunk by $37.4 million, from $19 million to a net loss of $18.4 million.

Why do so many companies violate basic financial reporting rules? Many observers speculate that, as share prices climb, executives feel greater pressure to meet higher earnings expectations. In response, regulators and standard-setters have now made improving revenue recognition and disclosure practices a priority.

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Copyright © 2008 John Wiley & Sons Canada, Ltd. All rights reserved.


Study Objectives and Preview

Study Objectives

After studying this chapter, you should be able to:

1. Explain the revenue recognition principle and the matching principle. 2. Prepare adjusting entries for prepayments. 3. Prepare adjusting entries for accruals. 4. Describe the nature and purpose of the adjusted trial balance. 5. Explain the purposes of closing entries.

Preview of Chapter 4

Recording revenues and expenses properly is essential, as indicated in the feature story, because doing otherwise leads to a misstatement of net earnings and related accounts. In this chapter, we introduce you to the accrual accounting concepts that guide the recognition of revenue and the matching of expenses in the appropriate time period.

The chapter is organized as follows:

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Study Objectives and Preview



Timing Issues

Timing IssuesConsider the following story:

study objective 1Explain the revenue recognition principle and the matching principle.

A grocery store owner from the old country kept his accounts payable on a spindle, accounts receivable on a notepad, and cash in a shoebox. His daughter, a CA, chided him: “I don’t understand how you can run your business this way. How do you know what you’ve earned?”

“Well,” the father replied, “when I arrived in Canada 40 years ago, I had nothing but the pants I was wearing. Today your sister is a doctor, your brother is a teacher, and you are a chartered accountant. Your mother and I have a nice car, a well-furnished house, and a cottage at the lake. We have a good business and everything is paid for. So, you add all that together, subtract the pants, and there's your net earnings.”

Although the old grocer may be correct in his evaluation of how to calculate earnings over his lifetime, most companies need more immediate feedback about how well they are doing. For example, management needs monthly reports on financial results, large corporations present quarterly and annual financial statements to shareholders, and the Canada Revenue Agency requires all businesses to file annual tax returns.

Consequently, accounting divides the economic life of a business into artificial time periods. As indicated in Chapter 2, this is the time period assumption. Accounting time periods are generally one month, one quarter, or one year.

Many accounting transactions affect more than one of these arbitrary time periods. For example, a new building purchased by Loblaw or a new airplane purchased by Air Canada will be used for many years. It does not make sense to expense the full cost of the building or the airplane at the time of purchase, because each will be used for many subsequent periods. Instead, we must determine the impact of each transaction on specific accounting periods.

Determining the amount of revenue and expenses to report in a particular accounting period can be difficult. Generally accepted accounting principles include two principles for recognizing revenue and expenses: the revenue recognition principle and the matching principle.

Revenue Recognition PrincipleThe revenue recognition principle states that revenue must be recognized in the accounting period in which it is earned. In a merchandising company, revenue is considered to be earned when the merchandise is sold (normally


Timing Issues

at the point of sale). In a service company, revenue is considered earned at the time the service is performed.

Revenue recognition is governed by general guidelines and there are a wide variety of interpretations. In general, though, revenue is recognized when the sales effort is substantially complete and collection reasonably assured.

To illustrate, assume a dry-cleaning business cleans clothing on June 30, but customers do not claim and pay for their clothes until the first week of July. Under the revenue recognition principle, revenue is earned in June when the service is performed, not in July when the cash is received. At June 30, the dry-cleaning service would report a receivable on its balance sheet and revenue in its statement of earnings for the service performed.

Improper use of the revenue recognition principle can have devastating consequences for investors. For example, as mentioned in the feature story for Chapter 2, Nortel Network's shares lost a significant portion of their value after investors learned about accounting irregularities related to reported revenue.

Decision ToolkitDecision

CheckpointsInfo Needed for

DecisionTools to Use for

DecisionHow to Evaluate

Results

At what point should the company record revenue?

Need to understand the nature of the company’s business

Revenue should be recorded when earned. For a service company, revenue is earned when a service is performed.

Recognizing revenue too early overstates current period revenue; recognizing it too late understates current period revenue.

Matching PrincipleIn recognizing expenses, a simple rule is followed: “Let the expenses follow the revenues.” Thus, expense recognition is tied to revenue recognition. Consider again the dry-cleaning business mentioned in the last section. Matching expenses with revenues means that the salary expense of performing the cleaning service on June 30 should be reported in the same period in which the service revenue is recognized. The critical issue in expense recognition is determining when the expense contributes to revenue. This may or may not be the same period in which the expense is paid. If the salary incurred on June 30 is not paid until July, the dry cleaner would still report salaries payable on its June 30 balance sheet.

The practice of expense recognition is referred to as the matching principle because it states that efforts


Timing Issues

(expenses) must be matched with accomplishments (revenues). Some expenses are easy to match with revenues. For example, the cost of goods sold can be directly matched to sales revenue in the period in which the sale occurs.

Other costs are more difficult to directly associate with revenue. For example, it is difficult to match administrative salary expense or interest expense with the revenue these help earn. Such costs are normally expensed in the period in which they are incurred. Other examples include costs that help generate revenue over multiple periods of time, such as the amortization of equipment. The association of these types of expense with revenue is less direct than that of cost of goods sold, and we therefore have to make assumptions about how to best allocate these costs to each period. We will learn more about allocating expenses later in this chapter.

Accounting Matters! Management Perspective

Suppose you work for a movie studio. Over what period should the cost of producing a movie be expensed? It should be expensed over the economic life of the movie. But what is its economic life? The filmmaker must estimate how much revenue will be earned from box office sales, DVD sales, television, and games and toys—a period that could be less than a year or many years.

Take, for example, Harry Potter and the Prisoner of Azkaban, released by Warner Bros. in 2004. It cost U.S. $130 million to produce this film, and the film more than recovered this cost in the first two weekends it was released. In fact, all of the Harry Potter movies have broken box office and product sales records. Compare this to The Cat in the Hat, released by Universal Studios in 2003. It cost U.S. $109 million to produce this movie but it has only recovered U.S. $100.4 million to date. These situations illustrate how difficult it can be in real life for companies to properly match expenses to revenues.


Timing Issues

Decision ToolkitDecision

CheckpointsInfo Needed for

DecisionTools to Use for Decision

How to Evaluate Results

At what point should the company record expenses?


Expenses should “follow” revenues—that is, the effort (expense) should be matched with the result (revenue).

Recognizing expenses too early overstates current period expenses; recognizing them too late understates current period expenses.

Accrual Versus Cash Basis of AccountingThe combined application of the revenue recognition principle and the matching principle results in accrual basis accounting. Accrual basis accounting means that transactions that affect a company's financial statements are recorded in the periods in which the events occur, rather than when the company actually receives or pays cash. This means recognizing revenues when they are earned rather than when cash is received. Likewise, expenses are recognized in the period in which services or goods are used or consumed to produce these revenues, rather than when cash is paid. This results in matching revenues that have been earned with the expenses incurred to earn these same revenues.

International Note Although different accounting principles are often used in other countries, the accrual basis of accounting is central to all these principles.

An alternative to the accrual basis is the cash basis. Under cash basis accounting, revenue is recorded only when cash is received, and an expense is recorded only when cash is paid. A statement of earnings presented under the cash basis of accounting does not satisfy generally accepted accounting principles. Why not? Because it fails to record revenue that has been earned but for which cash has not yet been received, thus violating the revenue recognition principle. Similarly, a cash basis statement of earnings fails to match expenses with earned revenues, which violates the matching principle.

Illustration 4-1 compares accrual-based numbers and cash-based numbers, using a simple example. Suppose that


Timing Issues

you own a painting company and you paint a large building during year 1. In year 1, you incur and pay total expenses of $50,000, which includes the cost of the paint and your employees' salaries. You bill your customer $80,000 at the end of year 1, but you are not paid until year 2. On an accrual basis, you would report the revenue during the period earned—year 1—and the expenses would be matched to the period in which the revenues were earned. Thus, your net earnings for year 1 would be $30,000, and no revenue or expense from this project would be reported in year 2. The $30,000 of earnings reported for year 1 provides a useful indication of the profitability of your efforts during that period.

Illustration 4-1

Accrual versus cash basis accounting

If, instead, you were reporting on a cash basis, you would report expenses of $50,000 in year 1 and revenues of $80,000 in year 2. Net earnings for year 1 would be a loss of $50,000, while net earnings for year 2 would be $80,000. While total earnings are the same over the two-year period ($30,000), cash basis measures are not very informative about the results of your efforts during year 1 or year 2.



Before You Go On #1

Before You Go On . . .

Review It

1. What are the revenue recognition and matching principles?

2. What are the differences between the cash and accrual bases of accounting?


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The Basics of Adjusting Entries

The Basics of Adjusting EntriesFor revenues to be recorded in the period in which they are earned, and for expenses to be matched with the revenue they generate, adjusting entries are made to adjust accounts at the end of the accounting period. Adjusting entries make it possible to produce relevant financial information at the end of the accounting period. Thus, the balance sheet reports appropriate assets, liabilities, and shareholders' equity at the statement date, and the statement of earnings shows the proper revenues, expenses, and net earnings (or loss) for the period.

Adjusting entries are necessary because the trial balance—the first pulling together of the transaction data—may not contain complete and up-to-date data. This is true for several reasons:

1. Some events are not journalized daily, because it would not be useful or efficient to do so. Examples are the use of supplies and the earning of wages by employees.

2. Some costs are not journalized during the accounting period, because these costs expire with the passage of time rather than as a result of recurring daily transactions. Examples include insurance and amortization.

3. Some items may be unrecorded. An example is a utility service bill that will not be received until the next accounting period. The bill, however, covers services delivered in the current accounting period.

Adjusting entries are required every time financial statements are prepared. We first analyze each account in the trial balance to see if it is complete and up to date. The analysis requires an understanding of the company's operations and the interrelationship of accounts. Preparing adjusting entries is often a long process. For example, to accumulate the adjustment data, a company may need to count its remaining supplies. It may also need to prepare supporting schedules of insurance policies, rental agreements, and other commitments.

Types of Adjusting EntriesAdjusting entries can be classified as either prepayments or accruals. Each of these classes has two subcategories as shown below:

Prepayments



1. Prepaid expenses: Expenses paid in cash and recorded as assets before they are used or consumed

2. Unearned revenues: Cash received and recorded as liabilities before revenue is earned

Accruals

1. Accrued expenses: Expenses incurred but not yet paid in cash or recorded

2. Accrued revenues: Revenues earned but not yet received in cash or recorded



Specific examples and explanations of each type of adjustment are provided in the following pages. Each example is based on the October 31 trial balance of Sierra Corporation, from Chapter 3, shown again here in Illustration 4-2.

Illustration 4-2

Trial balance

We assume that Sierra Corporation uses an accounting period of one month. Thus, monthly adjusting entries need to be made.



Adjusting Entries for Prepayments

Adjusting Entries for PrepaymentsPrepayments are either prepaid expenses or unearned revenues. Adjusting entries for prepayments record the portion of the payment that applies to the current accounting period. This means that for prepaid expenses, the adjusting entry records the expenses which apply to the period. For unearned revenues, the adjusting entry records the revenues earned in the period.

study objective 2Prepare adjusting entries for prepayments.

Prepaid Expenses

Costs that are paid for in cash before they are used are recorded as prepaid expenses. When such a cost is incurred, a prepaid account should be increased (debited)—to show the service or benefit that will be received in the future—and cash should be decreased (credited). Examples of common prepayments are insurance, supplies, and rent. In addition, long-term prepayments are made when long-lived assets, such as buildings and equipment, are purchased.

Helpful Hint A cost can be an asset or an expense. If the cost has future benefits (i.e., the benefits have not yet expired), it is an asset. If the cost has no future benefits (i.e., the benefits have expired), it is an expense.

Prepaid expenses are costs that expire either with the passage of time (e.g., rent and insurance) or through use (e.g., supplies). The expiration of these costs does not require daily entries, which would be impractical and unnecessary. Accordingly, we postpone recognizing these expired costs until financial statements are prepared. At each statement date, adjusting entries are made for two purposes: (1) to record the expenses (expired costs) applicable to the current accounting period, and (2) to show the remaining amounts (unexpired costs) in the asset accounts.

Until prepaid expenses are adjusted, assets are overstated and expenses are understated. If expenses are understated, then net earnings and shareholders' equity will be overstated. As shown below, an adjusting entry for prepaid expenses results in an increase (a debit) to an expense account and a decrease (a credit) to an asset account.



Let's look in more detail at some specific types of prepaid expenses, beginning with supplies.

Supplies. The purchase of supplies, such as paper, results in an increase (a debit) to an asset account. During the accounting period, supplies are used. Rather than record supplies expense as the supplies are used, supplies expense is recognized at the end of the accounting period. At that time, the company must count the remaining supplies. The difference between the balance in the supplies (asset) account and the actual cost of supplies on hand gives the supplies used (an expense) for that period.

Recall from the facts presented in Chapter 3 that Sierra Corporation purchased advertising supplies costing $2,500 on October 9. The payment was recorded by increasing (debiting) the asset account Advertising Supplies. This account shows a balance of $2,500 in the October 31 trial balance. A count at the close of business on October 31 reveals that $1,000 of supplies are still on hand. Thus, the cost of supplies used is $1,500 ($2,500 – $1,000).

This use of supplies decreases an asset, Advertising Supplies. It also decreases shareholders' equity by increasing an expense account, Advertising Supplies Expense. The use of supplies is recorded as follows:

After the adjusting entry is posted, the two supplies accounts are as follows in T account form:

The asset account Advertising Supplies now shows a balance of $1,000, which is equal to the cost of supplies on hand at the statement date. In addition, Advertising Supplies Expense shows a balance of $1,500, which equals the cost of supplies used in October. If the adjusting entry is not made, October expenses will be understated and net earnings overstated by $1,500. Moreover, as the accounting equation shows, both assets and shareholders' equity will be overstated by $1,500 on the October 31 balance sheet.

Insurance. Companies purchase insurance to protect themselves from losses caused by fire, theft, and



unforeseen accidents. Insurance must be paid in advance, often for one year. Insurance payments (premiums) made in advance are normally recorded in the asset account Prepaid Insurance. At the financial statement date, it is necessary to make an adjustment to increase (debit) Insurance Expense and decrease (credit) Prepaid Insurance for the cost of insurance that has expired during the period.

On October 6, Sierra Corporation paid $600 for a one-year insurance policy. Coverage began on October 1. The payment was recorded by increasing (debiting) Prepaid Insurance when it was paid. This account shows a balance of $600 in the October 31 trial balance. An analysis of the insurance policy reveals that $50 of insurance expires each month ($600 ÷ 12 mos.). The expiration of the prepaid insurance would be recorded as follows:

After the adjusting entry is posted, the accounts appear as follows:

The asset Prepaid Insurance shows a balance of $550, which represents the cost that applies to the remaining 11 months of insurance coverage (11 × $50). At the same time, the balance in Insurance Expense is equal to the insurance cost that was used in October. If this adjustment is not made, October expenses will be understated and net earnings overstated by $50. Moreover, both assets and shareholders' equity will be overstated by $50 on the October 31 balance sheet.

Amortization. A company typically owns a variety of assets that have long lives, such as buildings and equipment. Each is recorded as an asset, rather than as an expense, in the year it is acquired because these long-lived assets provide a service for many years. The period of service is referred to as the useful life.

From an accounting standpoint, the acquisition of long-lived assets is essentially a long-term prepayment for services. Similar to other prepaid expenses, there is a need to recognize the cost that has been used (an expense) during the period and to report the unused cost (an asset) at the end of the period. Amortization is the process of allocating the cost of a long-lived asset to expense over its useful life.

One point is very important to understand: Amortization is an allocation concept, not a valuation concept. That is, we amortize an asset to allocate its cost to the periods over which we use it. We are not trying to record a change in the value of the asset. We are only trying to match expenses with the revenues generated in each period.

Calculation of Amortization. A common practice for calculating amortization expense is to divide the cost of the asset by its useful life. This is known as the straight-line method of amortization. Of course, at the time an asset is acquired, its useful life is not known with any certainty. It must therefore be estimated.



Sierra Corporation purchased office equipment that cost $5,000 on October 3. If its useful life is expected to be five years, annual amortization is $1,000 ($5,000 ÷ 5). In its simplest form, the formula to calculate amortization expense is as follows:

Illustration 4-3

Formula for amortization

Of course, if you are calculating amortization for partial periods, the annual expense amount must be adjusted for the relevant portion of the year. For example, if we wish to determine the amortization for one month, we would multiply the annual result by one-twelth as there are twelve months in a year. Calculating amortization will be refined and examined in more detail in Chapter 9.

For Sierra Corporation, amortization on the office equipment is estimated to be $83 per month ($1,000 × 1/12). Accordingly, amortization for October is recognized by this adjusting entry:


The balance in the Accumulated Amortization account will increase by $83 each month until the asset is fully amortized in five years.

As in the case of other prepaid expenses, if this adjusting entry is not made, total assets, shareholders' equity, and net earnings will all be overstated by $83 and amortization expense will be understated by $83.

Statement Presentation. As we learned in Chapter 2, a contra account is an account that is offset against (deducted from) a related account on the statement of earnings or balance sheet. Accumulated Amortization—Office Equipment is a contra asset account. That means it is offset against an asset account (Office Equipment) on the balance sheet. Its normal balance is a credit—the opposite of the normal debit balance of its related account, Office Equipment.



Helpful Hint Every contra account has increases, decreases, and normal balances that are opposite to those of the account it relates to.

There is a simple reason for using a separate contra account instead of decreasing (crediting) Office Equipment: using this account discloses both the original cost of the equipment and the total estimated cost that has expired to date. In the balance sheet, Accumulated Amortization—Office Equipment is deducted from the related asset account as follows:

Office equipment $5,000 Less: Accumulated amortization—office equipment 83 Net book value 4,917

The difference between the cost of any amortizable asset and its related accumulated amortization is referred to as the net book value, or book value, of that asset. In the above illustration, the book value of the office equipment at the balance sheet date is $4,917. Be sure to understand that, except at acquisition, the book value of the asset and its market value (the price at which it could be sold) are two different values. As noted earlier, the purpose of amortization is not to state an asset's value, but to allocate its cost over time.

Alternative Terminology Book value is also referred to as carrying value.

Unearned Revenues

Cash received before revenue is earned is recorded by increasing (crediting) a liability account for unearned revenue. Items like rent, magazine subscriptions, and customer deposits for future service may result in unearned revenues. Airlines such as Air Canada, for instance, treat receipts from the sale of tickets as unearned revenue until the flight service is provided. Similarly, tuition fees received by universities and colleges before the academic session begins are considered unearned revenue.

Unearned revenues are the opposite of prepaid expenses. Indeed, unearned revenue on the books of one company is likely to be a prepayment on the books of the company that has made the advance payment. For example, if identical accounting periods are assumed, your landlord will have unearned rent revenue when you (the tenant) have prepaid rent.

When a payment is received for services that will be provided in a future accounting period, cash should be increased (debited) and unearned revenue (a liability) should be increased (credited) to recognize the obligation that exists. Unearned revenues are later earned when the service is provided to the customer.



It is not practical to make daily journal entries as the revenue is earned. Instead, recognition of earned revenue is delayed until the adjustment process. Then an adjusting entry is made to record the revenue that has been earned during the period and to show the liability that remains at the end of the accounting period. Typically, until the adjustment is made, liabilities are overstated and revenues are understated. If revenues are understated, then net earnings and shareholders' equity are also understated. As shown below, the adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.

Sierra Corporation received $1,200 on October 4 from R. Knox for advertising services expected to be completed before the end of next month, November 30. The payment was credited to Unearned Service Revenue, and this liability account shows a balance of $1,200 in the October 31 trial balance. From an evaluation of the work performed by Sierra for Knox during October, it is determined that $400 worth of work was earned in October.

The following adjusting entry is made:


The liability Unearned Service Revenue now shows a balance of $800, which represents the remaining advertising services expected to be performed in the future. At the same time, Service Revenue shows total revenue earned in October of $10,400. If this adjustment is not made, revenues and net earnings will be understated by $400 in the statement of earnings. Moreover, liabilities will be overstated by $400 and shareholders' equity will be understated by that amount on the October 31 balance sheet.


Before You Go On #2


Review It

1. What are the four types of adjusting entries?

2. What is the effect on assets, liabilities, shareholders' equity, revenues, expenses, and net earnings if an adjusting entry for a prepaid expense is not made?

3. What was the amount of Loblaw's 2003 depreciation expense? What were its accumulated depreciation and net book value as at January 3, 2004? (Hint: These amounts are reported in the notes to the financial statements.) The answers to these questions are provided at the end of this chapter.

4. What is the effect on assets, liabilities, shareholders' equity, revenues, expenses, and net earnings if an adjusting entry for unearned revenue is not made?

Do It

Hammond, Inc.'s general ledger includes these selected accounts on March 31, 2006, before adjusting entries are prepared:

Debit Credit Prepaid insurance $ 3,600 Office supplies 2,800 Office equipment 25,000 Accumulated amortization—office equipment $9,583 Unearned service revenue 9,200

An analysis of the accounts shows the following:

Depreciation expense, $393 million (see Consolidated Statement of Earnings); accumulated depreciation, $2,588 million and net book value, $6,422 million (see note 8 in Notes to the Consolidated Financial Statements).


Before You Go On #2

1. The insurance policy is a 12-month policy, effective March 1. 2. Office supplies on hand total $800. 3. The office equipment was purchased April 1, 2004, and is estimated to have a useful life of five

years. 4. Half of the unearned service revenue was earned in March.

Prepare the adjusting entries for the month of March.

Action Plan

Make sure you prepare adjustments for the appropriate time period. Adjusting entries for prepaid expenses require a debit to an expense account and a credit to an asset account. Adjusting entries for unearned revenues require a debit to a liability account and a credit to a revenue account.

Solution

1. Mar. 31 Insurance Expense 300 Prepaid Insurance 300 (To record insurance expired: $3,600 × 1/12) 2. 31 Office Supplies Expense 2,000 Office Supplies 2,000 (To record supplies used: $2,800 − $800)

3. 31 Amortization Expense 417 Accumulated Amortization—Office Equipment 417 (To record monthly amortization: $25,000 ÷ 5 × 1/12) 4. 31 Unearned Service Revenue 4,600 Service Revenue 4,600 (To record revenue earned: $9,200 × 1/2)



Adjusting Entries for Accruals

Adjusting Entries for AccrualsThe second category of adjusting entries is accruals. Adjusting entries for accruals are required in order to record revenues earned, or expenses incurred, in the current accounting period. Accruals have not been recognized through daily entries and thus are not yet reflected in the accounts. Until an accrual adjustment is made, the revenue account (and the related asset account), or the expense account (and the related liability account), is understated. Thus, adjusting entries for accruals will increase both a balance sheet account and a statement of earnings account.

study objective 3Prepare adjusting entries for accruals.

There are two types of adjusting entries for accruals—accrued revenues and accrued expenses. We now look at each type in more detail.

Accrued Revenues

Revenues earned but not yet received in cash or recorded at the statement date are accrued revenues. Accrued revenues may accumulate (accrue) with the passing of time, as in the case of interest revenue. Or they may result from services that have been performed but not yet billed or collected, as in the case of fees. The former are unrecorded because, as when interest is earned, they do not involve daily transactions. The latter may be unrecorded because only a portion of the total service has been provided and the clients will not be billed until the service has been completed.

Alternative Terminology Accrued revenues are also called accrued receivables.

An adjusting entry is required for two purposes: (1) to show the receivable that exists at the balance sheet date, and (2) to record the revenue that has been earned during the period. Until the adjustment is made, both assets and revenues are understated. Consequently, net earnings and shareholders' equity will also be understated. As shown below, an adjusting entry for accrued revenues results in an increase (a debit) to an asset account and an increase (a credit) to a revenue account.



In October, Sierra Corporation earned $200 for advertising services that were not billed to clients before October 31. Because these services have not been billed, they have not been recorded. The adjusting entry would be as follows:

After the adjusting entry is posted, the accounts appear as below:

The asset Accounts Receivable shows that $200 is owed by clients at the balance sheet date. The balance of $10,600 in Service Revenue represents the total revenue earned during the month. If the adjusting entry is not made, assets and shareholders' equity on the balance sheet, and revenues and net earnings on the statement of earnings, will be understated.

In the next accounting period, the clients will be billed. When this occurs, the entry to record the billing should recognize that $200 of revenue earned in October has already been recorded in the October 31 adjusting entry and should not be re-recorded. The subsequent collection of cash from clients will be recorded with an increase (a debit) to Cash and a decrease (a credit) to Accounts Receivable.

Accrued Expenses

Expenses incurred but not yet paid or recorded at the statement date are called accrued expenses. Interest, salaries, and income taxes are common examples of accrued expenses. Accrued expenses result from the same factors as accrued revenues. In fact, an accrued expense on the books of one company is an accrued revenue to another company. For example, the $200 accrual of service revenue for Sierra Corporation discussed above is an accrued



expense for the client that received the service.

Alternative Terminology Accrued expenses are also called accrued liabilities.

Adjustments for accrued expenses are necessary to (1) record the obligations that exist at the balance sheet date, and (2) recognize the expenses that apply to the current accounting period. Until the adjustment is made, both liabilities and expenses are understated. Consequently, net earnings and shareholders' equity are overstated. An adjusting entry for accrued expenses results in an increase (a debit) to an expense account and an increase (a credit) to a liability account, as shown below:

Helpful Hint To make the illustration easier to understand, a simplified method of interest calculation is used. In reality, interest is calculated using the exact number of days in the interest period and year (365).

Let's look in more detail at some specific types of accrued expenses, beginning with accrued interest.

Interest. Sierra Corporation signed a three-month note payable for $5,000 on October 2. The note requires interest at an annual rate of six percent. The amount of the interest accumulation is determined by three factors: (1) the face value, or principal amount, of the note, (2) the interest rate, which is always expressed as an annual rate, and (3) the length of time the note is outstanding.

In this instance, the total interest due on the $5,000 note at its due date, three months in the future, is $75 ($5,000 × 6% × 3/12), or $25 for one month. Note that the time period is expressed as a fraction of a year. The formula for calculating interest and how it applies to Sierra Corporation for the month of October are shown in Illustration 4-4.



Illustration 4-4

Formula for calculating interest

The accrual of interest at October 31 would be reflected in an adjusting entry as follows:


Interest Expense shows the interest charges for the month of October. The amount of interest owed at the statement date is shown in Interest Payable. It will not be paid until the note comes due at the end of three months. The Interest Payable account is used, instead of crediting Notes Payable, to disclose the two different types of obligations—interest and principal—in the accounts and statements. If this adjusting entry is not made, liabilities and interest expense will be understated and net earnings and shareholders' equity will be overstated.

Salaries. Some types of expenses, such as employee salaries, are paid for after the services have been performed. At Sierra Corporation, salaries were last paid on October 20. The next payment of salaries will not occur until November 3. As shown on the calendar in Illustration 4-5, seven as yet unpaid working days remain in October (October 23–27 and October 30–31).



Illustration 4-5

Calendar showing Sierra Corporation's pay periods

At October 31, the salaries for these seven days represent an accrued expense and a related liability to Sierra. The four employees each receive a salary of $500 a week for a five-day work week, from Monday to Friday, or $100 a day. Thus, accrued salaries at October 31 are $2,800 (7 days × $100/day × 4 employees). This accrual increases a liability, Salaries Payable, and an expense account, Salaries Expense, in the following adjusting entry:

After this adjusting entry is posted, the accounts are as follows:

After this adjustment, the balance in Salaries Expense of $6,800 (17 days × $100/day × 4 employees) is the actual salary expense for October. The balance in Salaries Payable of $2,800 is the amount of the liability for salaries owed as at October 31. If the $2,800 adjustment for salaries is not recorded, Sierra's expenses and liabilities will be understated by $2,800. Net earnings and shareholders' equity will be overstated by $2,800.



At Sierra Corporation, salaries are payable every two weeks. Consequently, the next pay-day is November 3, when total salaries of $4,000 will again be paid. The payment consists of $2,800 of salaries payable at October 31 plus $1,200 of salaries expense for November (3 days × $100/day × 4 employees). Therefore, the following entry is made on November 3:

This entry eliminates the liability for salaries payable that was recorded in the October 31 adjusting entry and records the proper amount of salaries expense for the period between November 1 and November 3.

Income Taxes. For accounting purposes, corporate income taxes must be accrued based on the current period's earnings. Sierra's monthly income taxes payable are estimated to be $250. This accrual increases a liability, Income Tax Payable, and an expense account, Income Tax Expense. The adjusting entry is:

After this adjusting entry is posted, the accounts are as follows:

Corporations, such as Sierra, pay corporate income taxes in monthly instalments. The payment is based on the income tax that was actually payable in the prior year. If there was no prior year, as is the case with Sierra, or if there was no tax payable in the prior year, then no income tax instalment payments are required. However, the liability must still be accrued.

If the adjustment for income taxes is not recorded, Sierra's expenses and liabilities will be understated by $250 and net earnings and shareholders' equity will be overstated by $250.

Summary of Basic RelationshipsThe two basic types of adjusting entries—prepayments and accruals—are summarized below. Take some time to study and analyze the adjusting entries. Be sure to note that each adjusting entry affects one balance sheet account and one statement of earnings account.



Type of Adjustment Reason for Adjustment Accounts before Adjustment Adjusting Entry Prepayments Prepaid expenses Prepaid expenses,

originally recorded in asset accounts, have been used.

Assets overstated; expenses understated

Dr. ExpenseCr. Asset

Unearned revenues Unearned revenues, initially recorded in liability accounts, have been earned.

Liabilities overstated; revenues understated

Dr. LiabilityCr. Revenue

Accruals Accrued revenues Revenues have been earned but not yet received in cash or recorded.

Assets understated; revenues understated

Dr. AssetCr. Revenue

Accrued expenses Expenses have been incurred but not yet paid.

Expenses understated; liabilities understated

Dr. ExpenseCr. Liability

It is important to understand that adjusting entries never involve the Cash account (except for bank reconciliations, which we will study in Chapter 7). In the case of prepayments, cash has already been received or paid and recorded in the original journal entry. The adjusting entry simply reallocates or adjusts amounts between a balance sheet account (e.g., prepaid expenses or unearned revenues) and a statement of earnings account (e.g., expenses or revenues). In the case of accruals, cash will be received or paid in the future and recorded then. The adjusting entry simply records the receivable or payable and the related revenue or expense.

Accounting Matters! Ethics Perspective

In the wake of financial scandals that are still making an impression, the Canadian Securities Administrators introduced requirements in 2005 for management to evaluate the reliability of a company's accounting system and controls. This includes a review of year-end procedures, including the procedures that are used to record recurring and nonrecurring adjusting entries.

This review will include asking such questions as the following: How are the transactions developed, authorized, and checked? What principles does the accounting department use to make adjusting entries? Do the accounting estimates and judgements reflect any biases that would consistently overstate or understate key amounts? Are the proper people involved in the year-end decision-making? All of these, and other similar questions are designed to improve the quality and reliability of financial statements.

Sierra Corporation Illustration



The journalizing and posting of the adjusting entries described in this chapter for Sierra Corporation on October 31 are shown below and on the following two pages. As you review the general ledger, notice that the adjustments are highlighted in colour.

Note also that an account for retained earnings has been added in the general ledger. Because this is Sierra's first month of operations, there is no balance in the Retained Earnings account. Although accounts with a zero balance are not normally included in the trial balance, we have added it here to make it easier to prepare the statement of retained earnings in the next section. In addition, we will again need to use this account in the section on closing entries later in this chapter.


Before You Go On #3


Review It

1. What is the effect on assets, liabilities, shareholders' equity, revenues, expenses, and net earnings if an adjusting entry for accrued revenue is not made?

2. What is the effect on assets, liabilities, shareholders' equity, revenues, expenses, and net earnings if an adjusting entry for an accrued expense is not made?

Do It

Micro Computer Services Inc. began operations on August 1, 2006. Management prepares monthly financial statements. This information is for August:

1. Revenue earned but unrecorded for August totalled $1,100. 2. On August 1, the company borrowed $30,000 from a local bank on a one-year note payable. The

annual interest rate is 5% and interest is payable at maturity. 3. At August 31, the company owed its employees $800 in salaries that will be paid on September 1. 4. Estimated income tax payable for August totalled $275.

Prepare the adjusting entries needed at August 31.

Action Plan

Remember that accruals are entries that were not previously recorded; therefore the adjustment pattern is different from that for prepayments. Adjusting entries for accrued revenues require a debit to a receivable account and a credit to a revenue account. Adjusting entries for accrued expenses require a debit to an expense account and a credit to a liability account.

Solution


Before You Go On #3

1. Aug. 31 Accounts Receivable 1,100 Service Revenue 1,100 (To accrue revenue earned but not billed or collected) 2. Aug. 31 Interest Expense 125 Interest Payable 125 (To record accrued interest: $30,000 × 5% × 1/12) 3. Salaries Expense 800 Salaries Payable 800 (To record accrued salaries) 4. Income Tax Expense 275 Income Tax Payable 275 (To record accrued income taxes)



The Adjusted Trial Balance and Financial Statements

The Adjusted Trial Balance and Financial StatementsAfter all adjusting entries have been journalized and posted, another trial balance is prepared from the ledger accounts. This trial balance is called an adjusted trial balance. It shows the balances of all accounts at the end of the accounting period, including those that have been adjusted. The purpose of an adjusted trial balance is to prove the equality of the total debit balances and the total credit balances in the ledger after all adjustments have been made. Because the accounts contain all the data that are needed for financial statements, the adjusted trial balance is the main source for the preparation of financial statements.

study objective 4Describe the nature and purpose of the adjusted trial balance.

Preparing the Adjusted Trial BalanceThe adjusted trial balance for Sierra Corporation presented in Illustration 4-6 has been prepared from the ledger accounts shown in the previous section. Compare the adjusted trial balance to the unadjusted trial balance presented earlier in the chapter in Illustration 4-2. The amounts affected by the adjusting entries are highlighted in colour.



Illustration 4-6

Adjusted trial balance

Preparing Financial StatementsFinancial statements can be prepared directly from an adjusted trial balance. The interrelationships of data in the adjusted trial balance of Sierra Corporation is presented in Illustration 4-7 on the following page.



Illustration 4-7

Preparation of the financial statements from the adjusted trial balance

As Illustration 4-7 shows, the statement of earnings is prepared from the revenue and expense accounts. The statement of retained earnings is prepared from the Retained Earnings account, Dividends account, and the net earnings (or net loss) shown in the statement of earnings. The balance sheet is then prepared from the asset, liability, and shareholders' equity accounts. Shareholders' equity includes the ending retained earnings as reported in the statement of retained earnings.



Before You Go On #4


Review It

1. What is the purpose of an adjusted trial balance?

2. When is an adjusted trial balance prepared?



Closing the Books

Closing the BooksIn previous chapters, you learned that revenue and expense accounts and the dividends account are subdivisions of retained earnings, which is reported in the shareholders' equity section of the balance sheet. Because revenues, expenses, and dividends are only for a particular accounting period, they are considered temporary accounts. In contrast, all balance sheet accounts are considered permanent accounts because their balances are carried forward into future accounting periods. Illustration 4-8 identifies the accounts in each category.

Illustration 4-8

Temporary and permanent accounts

study objective 5Explain the purposes of closing entries.

Preparing Closing EntriesAt the end of the accounting period, the temporary account balances are transferred to the permanent shareholders' equity account Retained Earnings through the preparation of closing entries. Closing entries formally record in the general ledger the transfer of the balances in the revenue, expense, and dividends accounts to the Retained Earnings account. In Illustration 4-6, you will note that Retained Earnings has an adjusted balance of zero. Until the closing entries are made, the balance in Retained Earnings will be its balance at the beginning of the period. For Sierra, this is zero because it is Sierra's first year of operations. After closing entries are recorded and posted, the balance in Retained Earnings will reflect its balance at the end of the period. This ending account balance will now be the same as the balance reported in the statement of retained earnings and the balance sheet.

In addition to updating retained earnings to its ending balance, closing entries produce a zero balance in each temporary account. As a result, these accounts are ready to accumulate data about revenues, expenses, and dividends in the next accounting period separately from the data in the prior periods. Permanent accounts are not closed.


Closing the Books

When closing entries are prepared, each revenue and expense account could be closed directly to Retained Earnings. This is common in computerized accounting systems where the closing process occurs automatically when it is time to start a new accounting period. However, in manual accounting systems, this practice can result in too much detail in the Retained Earnings account. Accordingly, the revenue and expense accounts are first closed to another temporary account, Income Summary. Only the resulting total amount (net earnings or net loss) is transferred from this account to the Retained Earnings account. Illustration 4-9 shows the closing process.

Illustration 4-9

Closing process

To prepare closing entries, four steps are necessary:

1. To close revenue accounts: Debit each individual revenue account for its balance, and credit Income Summary for total revenues.

2. To close expense accounts: Debit Income Summary for total expenses, and credit each individual expense account for its balance.

3. To close Income Summary: Debit Income Summary for the balance in the account (or credit it if there is a net loss), and credit (debit) Retained Earnings.

4. To close dividends: Debit Retained Earnings, and credit Dividends for its balance.

Closing entries can be prepared directly from the general ledger or the adjusted trial balance. If we were to prepare closing entries for Sierra Corporation, we would likely start with the adjusted trial balance presented earlier in the chapter in Illustration 4-6. In Sierra's case, all temporary accounts (Dividends, Service Revenue, and its seven different expense accounts) must be closed.

Even though Retained Earnings is not a temporary account, it will also be involved in the closing process. Remember that the balance presented in the adjusted trial balance for Retained Earnings is the beginning, not ending, balance. This permanent account is not closed but the net earnings (loss) and dividends for the period must be recorded to update the account to its ending balance.

Sierra's general journal, showing its closing entries, and its general ledger, showing the posting of the closing entries, follow:


Closing the Books


Closing the Books

Stop and check your work after the closing entries are posted: (1) The balance in the Income Summary account, immediately before the final closing entry to transfer the balance to the Retained Earnings account, should equal the net earnings (or net loss) reported in the statement of earnings. (2) All temporary accounts (dividends, revenues, expenses, and income summary) should have zero balances. (3) The balance in the Retained Earnings account should equal the ending balance reported in the statement of retained earnings and balance sheet.

Accounting Matters! Management Perspective


Closing the Books

Garry Beattie, CMA and owner of HBM Integrated Technology Inc., believes that the closing process should be completed within five days of the end of the month. Accounting done in a timely, efficient manner through streamlined, computerized accounting systems can save a business time and money. “With good technology, you can provide better information faster,” he says. In fact, Beattie says that studies show that posting journal entries daily can save four hours of work per week. The five-day close is possible for anyone, since many multinational companies, such as Cisco Systems, do it in less than one day.

Source: Rosemary Godin, “Five-Day Close Saves Time on Balance Sheets, Says Halifax CMA,” Bottom Line, January 2003.

Preparing a Post-closing Trial BalanceAfter all closing entries are journalized and posted, another trial balance, called a post-closing trial balance, is prepared from the ledger. We have learned about the unadjusted and adjusted trial balances so far. The last trial balance is the post-closing trial balance, which lists all permanent accounts and their balances after closing entries are journalized and posted. The purpose of this trial balance is to prove the equality of the permanent account balances that are carried forward into the next accounting period. Since all temporary accounts will have zero balances, the post-closing trial balance will contain only permanent—balance sheet—accounts.

Illustration 4-10 shows Sierra Corporation's post-closing trial balance on the following page.


Closing the Books

Illustration 4-10

Post-closing trial balance

Summary of the Accounting CycleThe required steps in the accounting cycle are shown in Illustration 4-11. You can see that the cycle begins with the analysis of business transactions and ends with the preparation of a post-closing trial balance. The steps in the cycle are done in sequence and are repeated in each accounting period.


Closing the Books

Illustration 4-11

Required steps in the accounting cycle

Steps 1 to 3 may occur daily during the accounting period, as explained in Chapter 3. Steps 4 to 7 are done on a periodic basis, such as monthly, quarterly, or annually. Steps 8 and 9, closing entries and a post-closing trial balance, are usually prepared only at the end of a company's annual accounting period.



Before You Go On #5


Review It

1. How do permanent accounts differ from temporary accounts?

2. What four different types of entries are required in closing the books?

3. What financial statement amount will the balance in the Income Summary account equal immediately before it is closed into the Retained Earnings account?

4. What are the content and purpose of a post-closing trial balance?

5. What are the required steps in the accounting cycle?

Do It

The adjusted trial balance for the Nguyen Corporation shows the following: Dividends $5,000; Common Shares $30,000; Retained Earnings $12,000; Service Revenue $18,000; and Operating Expenses $10,000. Prepare the closing entries at December 31.

Action Plan

Debit each individual revenue account for its balance and credit the total to the Income Summary account. Credit each individual expense account for its balance and debit the total to the Income Summary account. Stop and check your work: Does the balance in the Income Summary account equal the reported net earnings (loss)? If there are net earnings, debit the balance in the Income Summary account and credit the amount to the Retained Earnings account (do the opposite if the result is a net loss). Credit the balance in the Dividends account and debit the amount to the Retained Earnings account. Do not close Dividends with the expenses. Stop and check your work: Do the temporary accounts have zero balances? Does the ending Retained Earnings balance equal the balance reported on the statement of retained earnings and balance sheet?

Solution


Before You Go On #5

Dec. 31 Service Revenue 18,000 Income Summary 18,000 (To close revenue account)

31 Income Summary 10,000 Operating Expenses 10,000 (To close expense account)

31 Income Summary 8,000 Retained Earnings 8,000 (To close income summary)

31 Retained Earnings 5,000 Dividends 5,000 (To close dividends)



Using the Decision Toolkit

Using the Decision ToolkitFPI (Fishery Products International) Limited is the world's largest seafood supplier. A simplified version of FPI's December 31, 2004, year-end adjusted trial balance is shown below.

Instructions

From the adjusted trial balance, prepare a statement of earnings, statement of retained earnings, and classified balance sheet.



Solution


Summary of Study Objectives

Summary of Study Objectives1. Explain the revenue recognition principle and the matching principle. The revenue recognition

principle states that revenue must be recognized in the accounting period in which it is earned. The matching principle states that expenses must be recognized when they make their contribution to revenues.

2. Prepare adjusting entries for prepayments. Adjusting entries for prepayments are required in order to record the portion of the prepayment that applies to the expense incurred or revenue earned in the current accounting period. Prepayments are either prepaid expenses or unearned revenues. The adjusting entry for prepaid expenses results in an increase (a debit) to an expense account and a decrease (a credit) to an asset account. The adjusting entry for unearned revenues results in a decrease (a debit) to a liability account and an increase (a credit) to a revenue account.

3. Prepare adjusting entries for accruals. Adjusting entries for accruals are required in order to record the revenues and expenses that apply to the current accounting period and that have not been recognized through daily entries. Accruals are either accrued revenues or accrued expenses. The adjusting entry for accrued revenues results in an increase (a debit) to an asset account and an increase (a credit) to a revenue account. The adjusting entry for accrued expenses results in an increase (a debit) to an expense account and an increase (a credit) to a liability account.

4. Describe the nature and purpose of the adjusted trial balance. An adjusted trial balance is a trial balance that shows the balances of all accounts at the end of an accounting period, including those that have been adjusted. The purpose of an adjusted trial balance is to show the effects of all financial events that have occurred during the accounting period.

5. Explain the purposes of closing entries. One purpose of closing entries is to update the Retained Earnings account to its end-of-period balance with the results of operations for the period. A second purpose is to enable all temporary accounts (dividends, revenue, and expense accounts) to begin a new period with a zero balance. To accomplish this, entries are made to close each individual revenue and expense account to Income Summary, then Income Summary to Retained Earnings, and finally Dividends to Retained Earnings. Only temporary accounts are closed.



Decision ToolkitA Summary

Decision Toolkit—A SummaryDecision

CheckpointsInfo Needed for Decision

Tools to Use for Decision

How to Evaluate Results

At what point should the company record revenue?


Revenue should be recorded when earned. For a service company, revenue is earned when a service is performed.

Recognizing revenue too early overstates current period revenue; recognizing it too late understates current period revenue.

At what point should the company record expenses?


Expenses should “follow” revenues—that is, the effort (expense) should be matched with the result (revenue).

Recognizing expenses too early overstates current period expenses; recognizing them too late understates current period expenses.



Demonstration Problem

Demonstration ProblemThe Green Thumb Lawn Care Corporation was incorporated on April 1. At April 30, the trial balance shows the following balances for selected accounts:

Prepaid insurance $3,600 Equipment 30,000 Note payable 20,000 Unearned service revenue 4,200 Service revenue 1,800

Analysis reveals the following additional data about these accounts:

1. Prepaid insurance is the cost of a one-year insurance policy, effective April 1. 2. The equipment is expected to have a useful life of four years. 3. The note payable is dated April 1. It is a six-month, 6% note. Interest is payable on the first of each month. 4. Seven customers paid for the company's six-month, $600 lawn service package beginning in April. These

customers were serviced in April. 5. Lawn services provided to other customers but not billed at April 30 totalled $1,500. 6. Income tax expense for April is estimated to be $100.

Instructions

Prepare the adjusting entries for the month of April.

Action Plan Note that adjustments are being made for only one month. Look at what amounts are currently recorded in the accounts before determining what adjustments are necessary. Show your calculations. Select account titles carefully. Use existing titles wherever possible. Use T accounts to help plan, or check, your adjustments.

Solution to Demonstration Problem


Demonstration Problem



Self-Study Questions

Self-Study QuestionsAnswers are at the end of the chapter.

(SO 1) 1. Which principle or assumption states that efforts (expenses) must be recorded with accomplishments (revenues)?

(a) Matching principle(b) Cost principle(c) Time period assumption(d) Revenue recognition principle

(SO 1) 2. Adjusting entries are made to ensure that:

(a) expenses are matched to revenues in the period in which the revenue is generated.(b) revenues are recorded in the period in which they are earned.(c) balance sheet and statement of earnings accounts have correct balances at the end of

an accounting period.(d) All of the above

(SO 2) 3. The trial balance shows Supplies $1,350 and Supplies Expense $0. If $600 of supplies are on hand at the end of the period, the adjusting entry is:

(a) Supplies 600 Supplies Expense 600 (b) Supplies Expense 600 Supplies 600 (c) Supplies 750 Supplies Expense 750 (d) Supplies Expense 750 Supplies 750



(SO 2) 4. Frontenac Corp. purchased equipment at the beginning of year 1 for $25,000, which was estimated to have a useful life of 5 years. How much is the equipment's net book value at the end of year 3?

(a) $5,000(b) $10,000(c) $15,000(d) $25,000

(SO 2) 5. On February 1, Magazine City received $600 in advance for ten 12-month subscriptions to Climbing Magazine. What adjusting journal entry should Magazine City make on February 28?

(a) Subscription Revenue 550 Unearned Subscription Revenue 550 (b) Unearned Subscription Revenue 50 Subscription Revenue 50 (c) Unearned Subscription Revenue 550 Subscription Revenue 550 (d) Cash 600 Subscription Revenue 600

(SO 3) 6. A bank has a three-month, $6,000 note receivable, issued on January 1 at an interest rate of 4%. Interest is due at maturity. What adjusting entry should the bank make at the end of January?

(a) Note Receivable 20 Interest Revenue 20 (b) Interest Receivable 60 Interest Revenue 60 (c) Cash 20 Interest Revenue 20 (d) Interest Receivable 20 Interest Revenue 20



(SO 3) 7. Kathy Kiska earned a salary of $400 for the last week of September. She will be paid on October 1. The adjusting entry for Kathy's employer at September 30 is:

(a) Salaries Expense 400 Salaries Payable 400 (b) Salaries Expense 400 Cash 400 (c) Salaries Payable 400 Cash 400 (d) No entry is required

(SO 4) 8. Which statement is incorrect concerning the adjusted trial balance?

(a) An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made.

(b) The adjusted trial balance is the main source for the preparation of financial statements.

(c) The adjusted trial balance is prepared after the closing entries have been journalized and posted.

(d) The adjusted trial balance is prepared after the adjusting entries have been journalized and posted.

(SO 4) 9. The Retained Earnings account in an unadjusted trial balance is $10,000. Net earnings for the period are $2,500 and dividends are $500. The Retained Earnings account balance in the adjusted trial balance will be:

(a) $9,500.(b) $10,000.(c) $12,000.(d) $12,500.



(SO 5) 10. Which account will have a zero balance after closing entries have been journalized and posted?

(a) Service Revenue(b) Advertising Supplies(c) Unearned Revenue(d) Accumulated Amortization

(SO 5) 11. Which types of accounts will appear in the post-closing trial balance?

(a) Permanent accounts(b) Temporary accounts(c) Statement of earnings accounts(d) Cash flow statement accounts

Answers to Self-Study Questions1.a 2.d 3.d 4.b 5.b 6.d 7.a 8.c 9.b 10.a 11.a



Questions

Questions(SO 1) 1. Why are adjusting entries needed? Include in your explanation a description of the

assumption and two generally accepted accounting principles that relate to adjusting the accounts.

(SO 1) 2. Tony Galego, a lawyer, accepts a legal engagement in March, does the work in April, bills the client $8,000 in May, and is paid in June. If Galego's law firm prepares monthly financial statements, when should it recognize revenue from this engagement? Why?

(SO 1) 3. In completing the engagement in question 2, Galego incurs $2,000 of expenses that are specifically related to this engagement in March, $2,500 in April, and none in May and June. How much expense should be deducted from revenues in the month(s) the revenue is recognized? Why?

(SO 1) 4. The Higher Education University collects tuition for the fall term from registered students in September. The fall term runs from September to December. In what month(s) should the university recognize the revenue earned from tuition fees? Explain your reasoning.

(SO 1) 5. How does the cash basis of accounting differ from the accrual basis of accounting? Which basis gives more useful information for decision-making? Why?

(SO 2) 6. The name “prepaid expense” implies that this type of account is an expense account and belongs on a statement of earnings. Instead the account appears on the balance sheet as an asset. Explain why this is appropriate and why prepaid expense items require adjustment at the end of each period.

(SO 2) 7. The name “unearned revenue” implies that this type of account is a revenue account and belongs on a statement of earnings. Instead the account appears on the balance sheet as a liability. Explain why this is appropriate and why unearned revenue items require adjustment at the end of each period.

(SO 2) 8. “Amortization is a process of valuation that results in the reporting of the fair market value of the asset.” Do you agree? Explain.

(SO 2) 9. Explain the difference between amortization expense, accumulated amortization, and net book value.

(SO 2, 3) 10. Distinguish between the two categories of adjusting entries and identify the types of adjustments for each category.


Questions

(SO 2, 3) 11. The trial balance of Hoi Inc. includes the balance sheet accounts listed below. Identify the accounts that might require adjustment. For each account that requires adjustment, indicate (1) the type of adjusting entry (prepaid expenses, unearned revenues, accrued revenues, and accrued expenses) and (2) the related account in the adjusting entry.

(a) Accounts Receivable (b) Prepaid Insurance (c) Equipment (d) Accumulated Amortization—Equipment (e) Notes Payable (f) Interest Payable (g) Unearned Service Revenue

(SO 2, 3) 12. “An adjusting entry may affect more than one balance sheet or statement of earnings account.” Do you agree? Why or why not?

(SO 2, 3) 13. Adjusting entries for prepayments always include the Cash account, and adjusting entries for accruals never include the Cash account. Do you agree? Explain why or why not.

(SO 3) 14. A company has revenue earned but not yet received or recorded. Explain why it is necessary to create an adjusting entry. Which accounts are debited and which ones are credited in the adjusting entry?

(SO 3) 15. A company has a utility expense that has been incurred but not yet paid or recorded. Explain why it is necessary to create an adjusting entry. Which accounts are debited and which ones are credited in the adjusting entry?

(SO 3) 16. A company makes an accrued revenue adjusting entry for $900 and an accrued expense adjusting entry for $600. Which financial statement items were overstated or understated before these entries? Explain.

(SO 4) 17. Why is it possible to prepare financial statements directly from an adjusted trial balance?

(SO 2, 3, 5)

18. How do adjusting journal entries differ from transaction journal entries? How do closing journal entries differ from adjusting journal entries?

(SO 4, 5) 19. Explain how an unadjusted trial balance, adjusted trial balance, and post-closing trial balance differ. How often should each one be prepared?

(SO 4, 5) 20. What items are disclosed on a post-closing trial balance? Why are the financial statements prepared using an adjusted trial balance instead of the postclosing trial balance?


Questions

(SO 5) 21. Why is the account Dividends not closed with the expense accounts? Why is a separate closing entry required for this account?

(SO 5) 22. Identify the summary account(s) that are debited and credited in each of the four closing entries, assuming the company has (a) net earnings for the year, and (b) a net loss for the year.



Brief Exercises

Brief ExercisesBE4-1 Transactions that affect earnings do not necessarily affect cash.

Identify the impact, if any, of each of the following transactions on cash and net earnings. The first transaction has been completed for you as an example.

Cash Net Earnings (a) Purchased

supplies for cash, $100.

(b) Made an adjusting entry to record use of $50 of the above supplies.

(c) Made sales of $1,000, all on account.

(d) Received $800 from customers in payment of their accounts.

(e) Purchased equipment for cash, $2,500. (f) Recorded amortization of equipment, $500.

$(100) $0

Indicate impact of transaction on cash and earnings.

(SO 1)


Brief Exercises

(f) Recorded amortization of equipment, $500.

(g) Borrowed $5,000 on a note payable.

(h) Made an adjusting entry to record $200 interest payable on the $5,000 note.

BE4-2 Sain Advertising Ltd.'s opening trial balance on January 1 shows Advertising Supplies $750. On April 1, the company purchased additional supplies for $3,500 on credit. On December 31, there are $1,000 of advertising supplies on hand.

(a) Prepare the journal entry to record the purchase of advertising supplies on April 1.

(b) Prepare the adjusting entry required at December 31. (c) Enter the opening balances in the affected advertising

accounts, post the adjusting entry, and indicate the adjusted balance in each account.

Prepare and post transaction and adjusting entry for supplies.

(SO 2)


Brief Exercises

BE4-3 On January 2, 2006, Cretien Corporation purchased a delivery truck for $45,000 cash. It estimates that the truck will have a five-year useful life. The company has a December 31 year end.

(a) Prepare the journal entry to record the purchase of the delivery truck.

(b) Prepare the adjusting entries required on December 31, 2006, 2007, and 2010.

(c) Indicate the balance sheet presentation of the delivery truck at December 31, 2006, 2007, and 2010.

Prepare transaction and adjusting entries for amortization; show statement presentation.

(SO 2)

BE4-4 On June 1, Bere Ltd. pays $10,000 to Marla Insurance Corp. for a one-year insurance contract. Both companies have fiscal years ending December 31.

(a) Record the June 1 transaction on the books of (1) Bere and (2) Marla.

(b) Prepare the adjusting entry required on December 31 by (1) Bere and (2) Marla.

(c) Post the above entries and indicate the adjusted balance in each account.

Prepare and post transaction and adjusting entries for insurance.

(SO 2, 3)

BE4-5 The total payroll for Classic Autos Ltd. is $5,000 every Friday ($1,000 per day) for employee salaries earned during a five-day week (Monday through Friday, inclusive). Salaries were last paid on Friday, December 27. This year the company's year end, December 31, falls on a Tuesday. Salaries will be paid next on Friday, January 3, at which time employees will receive pay for the five-day work week (including the New Year's holiday). Prepare the journal entries required to record:

(a) the payment of the salaries on December 27. (b) the adjustment to accrue salaries at December 31. (c) the payment of salaries on January 3.

Prepare transaction and adjusting entries for salaries.

(SO 3)


Brief Exercises

BE4-6 On July 1, 2006, a company purchased a truck for $40,000, paying $12,000 cash and signing a 6% note payable for the remainder. The interest and principal of the note are due on January 1, 2007. Prepare the journal entry to record the (a) purchase of the truck on July 1, 2006, (b) accrual of the interest at year end, December 31, 2006, and (c) repayment of the interest and the note on January 1, 2007.

Prepare transaction and adjusting entries for interest.

(SO 3)

BE4-7 Fill in the missing amounts in the following schedule. Assume that 2005 was the company's first year of operations.

2005 2006 2007 Income tax expense $2,400 $3,500 (c) Income tax payable (a) 500 $ 700 Income tax paid 2,200 (b) 3,300

Determine missing amounts for income taxes.

(SO 3)

BE4-8 The unadjusted and adjusted trial balances for Miscou Island Corporation at February 28, 2006, are as follows:

Trial Balance Adjusted Trial Balance

Debit Credit Debit Credit Cash $ 6,000 $ 6,000 Accounts receivable 25,000 (d) Supplies (a) 1,000 Prepaid insurance 6,000 (e) Equipment 22,000 22,000 Accumulated amortization—equipment

$ 1,000 (f)

Accounts payable 13,000 $13,000 Salaries payable 0 2,000 Income tax payable 0 (g) Common shares 20,000 20,000 Retained earnings (b) 21,000 Dividends (c) 4,000 Fees earned 29,000 32,000

Determine missing amounts.

(SO 4)


Brief Exercises

Salaries expense 7,000 (h) Rent expense 6,000 6,000 Amortization expense

0 (i)

Insurance expense 0 4,000 Supplies expense 0 3,000 Utilities expense 2,400 (j) Miscellaneous expense

1,600 1,600

Income tax expense 0 0 400 0 Totals $84,000 $84,000 $93,800 $93,800

Selected data for the year-end adjustments are as follows:

1. Revenue earned but not yet billed, $3,000 2. Supplies on hand, $1,000 3. Insurance premiums expired, $4,000 4. Amortization expense, $4,400 5. Salaries earned, but not yet paid, $2,000 6. Estimated income tax expense, $400

Determine the missing amounts.

BE4-9 Refer to the data in BE4–8 for Miscou Island Corporation. Prepare a statement of earnings, statement of retained earnings, and balance sheet for the year.

Prepare financial statements.

(SO 4)

BE4-10 The statement of earnings for the Edgebrook Golf Club Ltd. for the month ended July 31 shows Green Fees Earned $16,000; Salaries Expense $8,400; Maintenance Expense $2,500; and Income Tax Expense $1,000. The statement of retained earnings shows an opening balance for Retained Earnings of $20,000 and Dividends $1,000.

(a) Prepare and post the closing journal entries. (b) What is the ending balance in Retained Earnings?

Prepare and post closing entries.

(SO 5)


Brief Exercises

BE4-11 The following selected accounts appear in the adjusted trial balance for Atomic Energy of Canada Limited (AECL). Identify which accounts would be included in AECL's post-closing trial balance.

(a) Accounts Receivable (b) Interest Expense (c) Interest Earned on Short-Term Investments (d) Inventory (e) Amortization Expense (f) Accounts Payable and Accrued Liabilities (g) Cost of Sales (h) Dividends (i) Accumulated Amortization

Identify post-closing trial balance accounts.

(SO 5)

BE4-12 The required steps in the accounting cycle are listed below in random order. List the steps in the proper sequence by writing the numbers 1 to 9 in the blank spaces.

(a) _________ Prepare a post-closing trial balance. (b) _________ Prepare an adjusted trial balance. (c) _________ Journalize the transactions. (d) _________ Journalize and post the closing entries. (e) _________ Prepare the financial statements. (f) _________ Analyze business transactions. (g) _________ Prepare a trial balance. (h) _________ Journalize and post the adjusting entries. (i) _________ Post to the ledger accounts.

List steps in accounting cycle.

(SO 5)



http://www.aecl.ca/

Exercises

ExercisesE4-1 The following independent situations require professional

judgement for determining when to recognize revenue from the transactions:

(a) WestJet Airlines sells you a non-refundable airline ticket in September for your flight home at Christmas at a special fare.

(b) Leon's Furniture sells you a home theatre on a “no money down, no interest, and no payments for one year” promotional deal.

(c) The Toronto Blue Jays sell season tickets to games in the Rogers Centre on-line. Fans can purchase the tickets at any time, although the season only begins officially in April and ends in October.

(d) The RBC Financial Group loans you money in August. The loan and the interest are repayable in full in November.

(e) In August, you order a sweater from Sears using its on-line catalogue. It arrives in September and you charge it to your Sears credit card. You receive and pay the Sears bill in October.

Instructions

Identify when revenue should be recognized in each of the above situations.

Identify point of revenue recognition.

(SO 1)


http://www.westjet.com/

http://www.leons.ca/

http://toronto.bluejays.mlb.com/

http://www.royalbank.com/

http://www.sears.com/

Exercises

E4-2 In its first year of operations, Brisson Corp. earned $26,000 in service revenue, of which $4,000 was on account. The remainder, $22,000, was collected in cash from customers.

The company incurred operating expenses of $15,000, of which $13,500 was paid in cash. Of this amount, $1,500 was still owing on account at year end. In addition, late in the year, Brisson prepaid $2,000 for insurance coverage that would not be used until its second year of operations. Brisson expects to owe $2,750 for income tax when it files its corporate income tax return after year end.

Instructions

(a) Calculate the first year's net earnings under the cash basis of accounting.

(b) Calculate the first year's net earnings under the accrual basis of accounting.

(c) Which basis of accounting (cash or accrual) gives the most useful information for decision-makers?

Calculate cash basis and accrual basis earnings.

(SO 1)

E4-3 The following information is available for Action Quest Games Inc. for the year ended December 31, 2006:

1. Purchased a one-year insurance policy on May 1, 2006, for $4,620 cash.

2. Paid $6,875 for five months' rent in advance on October 1, 2006. 3. Signed a contract for cleaning services starting December 1,

2006, for $1,050 per month. Paid for the first three months on December 1.

4. On September 15, 2006, received $3,600 cash from a corporation that sponsors a game each month for the most improved students. The $3,600 was for nine game sessions, once on the first Friday of each month starting in October. (Use the account Unearned Revenue.)

5. During the year, sold $1,500 of gift certificates. Determined that on December 31, 2006, $475 of these gift certificates had not yet been redeemed. (Use the account Unearned Gift Certificate Sales.)

Prepare and post transaction and adjusting entries for prepayments.

(SO 2)


Exercises

Instructions

(a) For each of the above, prepare and post the journal entry required to record the initial transaction.

(b) For each of the above, prepare and post the adjusting journal entry required on December 31, 2006.

(c) Calculate the final balance in each general ledger account.

E4-4 Action Quest Games Inc. owns the following long-lived assets:

Asset Date Purchased Estimated Useful Life

Cost

Furniture January 1, 2006 3 years $ 9,600 Lighting equipment

January 1, 2004 8 years 18,000

Instructions

(a) Prepare amortization adjusting entries for Action Quest Games for the years ended December 31, 2006 and 2007.

(b) For each asset, calculate its accumulated amortization and net book value at December 31, 2006 and 2007.

Prepare adjusting entries for amortization; calculate net book value.

(SO 2)

E4-5 Action Quest Games Inc. has the following information available for accruals that must be recorded for the year ended December 31, 2006:

1. The December utility bill for $420 was unrecorded on December 31. Action Quest paid the bill on January 17, 2007.

2. Action Quest is open seven days a week and employees are paid a total of $3,360 every Thursday for a seven-day work week. December 31, 2006, is a Sunday so employees will have worked three days since their last pay day. Employees will be paid next on January 4, 2007.

3. Action Quest has a 6% note payable to its bank for $45,000. Interest is payable on the first day of each month.

Prepare adjusting and subsequent entries for accruals.

(SO 3)


Exercises

4. Action Quest receives a 5% commission from its neighbour Pizza Shop for all pizzas sold to customers using Action Quest's facility. The amount owing for December is $920, which Pizza Shop will pay on January 4, 2007.

5. Action Quest sold some equipment on November 1, 2006, in exchange for an 8%, $6,000 note receivable. The principal and interest are due on February 1, 2007.

Instructions

(a) For each of the above, prepare the adjusting entry required at December 31, 2006.

(b) For each of the above, prepare the journal entry to record the subsequent cash transaction in 2007.

E4-6 On March 31, 2006, the trial balance of Easy Rental Agency Inc. is as follows:

Debits Credits Prepaid insurance $3,600 Supplies 2,800 Equipment 24,000 Accumulated amortization—equipment $6,000 Notes payable 20,000 Unearned rent revenue 9,300 Rent revenue 60,000 Wage expense 14,000

An analysis of the accounts shows the following:

1. The equipment, which was purchased January 1, 2005, is estimated to have a useful life of four years.

2. One-third of the unearned rent revenue was earned during the quarter.

3. Interest accrues at a rate of 5% on the notes payable. 4. Supplies on hand total $850.

Prepare adjusting entries.

(SO 2, 3)


Exercises

5. The insurance was purchased January 1, 2006, and expires December 31.

6. Income tax is estimated to be $5,000.

Instructions

Prepare the adjusting entries at March 31, assuming that adjusting entries are made quarterly.

E4-7 Selected accounts of Jasper Limited are shown here:

Accounts Receivable July 31 500

Supplies July 1 Bal. 1,100 July 31 500

10 200 Unearned Service Revenue

July 31 900 July 1 Bal. 1,500 20 700

Salaries Payable July 31 500

Income Tax Payable July 31 600

Service Revenue July 14 1,200 31 900 31 500

Salaries Expense July 15 1,200

31 500 Supplies Expense

July 31 500 Income Tax Expense

July 31 600

Recreate transactions and adjusting entries from adjusted data.

(SO 2, 3)


Exercises

Instructions

After analyzing the accounts, journalize (a) the July transaction entries (assume all were cash transactions) and (b) the adjusting entries that were made on July 31.

E4-8 Below are selected accounts from the adjusted trial balance of Nolet Ltd., whose fiscal year began January 1:

NOLET LTD.Adjusted Trial Balance (Partial)

January 31, 2006

Debit Credit Supplies $ 700 Prepaid insurance 4,400 Equipment 12,000 Accumulated amortization—equipment $6,000 Income tax payable 800 Unearned service revenue 750 Service revenue 2,500 Supplies expense 950 Insurance expense 400 Income tax expense 1,800

Instructions

(a) If the amount in Supplies Expense is the amount of the January 31 adjusting entry, and $850 of supplies were purchased in January, what was the balance in Supplies on January 1?

(b) If the amount in Insurance Expense is the amount of the January 31 adjusting entry, and the original insurance premium was for one year, what was the total premium and when was the policy purchased?

Analyze adjusted data.

(SO 2, 3, 4)


Exercises

(c) If the equipment had an estimated useful life of four years when it was originally purchased, and there have been no purchases or sales of equipment since then, how many years has it been amortized?

(d) If $2,500 of income tax was paid in January, what was the balance in Income Tax Payable on January 1?

(e) If $1,600 was received in January for services performed in January, what was the balance in Unearned Service Revenue on January 1?

E4-9 The unadjusted and adjusted trial balances for Inuit Inc. at the end of its fiscal year are shown below:

INUIT INC.Trial Balance

August 31, 2006

Unadjusted Adjusted Dr. Cr. Dr. Cr. Cash $10,400 $10,400 Accounts receivable 8,800 9,275 Office supplies 2,450 700 Prepaid insurance 3,775 2,355 Office equipment 14,100 14,100 Accumulated amortization—Office equipment

$ 3,525 $ 4,700

Accounts payable 5,800 5,800 Salaries payable 0 1,125 Income tax payable 0 1,000 Unearned service revenue

1,600 700

Common shares 10,000 10,000 Retained earnings 10,600 10,600 Dividends 800 800 Service revenue 40,800 42,175

Prepare adjusting entries from analysis of trial balances.

(SO 2, 3, 4)


Exercises

Salaries expense 17,000 18,125 Office supplies expense 0 1,750 Rent expense 15,000 15,000 Insurance expense 0 1,420 Amortization expense 0 1,175 Income tax expense 0 _______ 1,000 _______ $72,325 $72,325 $76,100 $76,100

Instructions

Prepare the adjusting entries that were made.

E4-10 The adjusted trial balance for Inuit Inc. is given in E4–9.

Instructions

Prepare the statement of earnings, statement of retained earnings, and balance sheet for the year.

Prepare financial statements.

(SO 4)

E4-11 The adjusted trial balance for Inuit Inc. is given in E4–9.

Instructions

(a) Prepare the closing entries at August 31. (b) Prepare a post-closing trial balance.

Prepare closing entries and post-closing trial balance.

(SO 5)



Problems: Set A

Problems: Set AP4-1A Ouellette Corporation began operations on January 2, 2006. Its

fiscal year end is December 31, and it prepares financial statements and adjusts its accounts annually. Selected transactions during 2006 follow:

1. On January 2, purchased office supplies for $4,100 cash. A physical count at December 31 revealed that $900 of supplies were still on hand.

2. Purchased a truck for $35,000 cash on March 1. The truck is estimated to have a useful life of five years.

3. Purchased a $3,780, one-year insurance policy for cash on August 1.

4. On November 15, Ouellette received a $1,200 advance cash payment from a client for services to be provided in the future. As at December 31, half of these services had been completed.

5. On December 15, the company rented out excess office space for a six-month period starting on this date and received a $540 cheque for two months of rent.

Instructions

For each of the above situations, prepare the journal entry for the original transaction and any adjusting journal entry required at December 31.

Prepare transaction and adjusting entries for prepayments.

(SO 2)


Problems: Set A

P4-2A Zheng Corporation had the following selected transactions in the month of February:

1. Zheng has five employees who each earn $100 a day. Salaries are normally paid on Fridays for work completed Monday through Friday of the same week. Salaries were last paid Friday, February 24, and will be paid next on Friday, March 3.

2. The company has a 6%, $12,000 note payable due in one year. Interest is payable the first of each month. It was last paid on February 1, and will be paid next on March 1.

3. At the end of February, Zheng has earned $2,500 that it has not yet billed. It bills its clients on March 3, and collects $1,500 of the amount due on March 30.

4. At the end of February, the company earned $200 interest on its investments. The bank deposited this amount in Zheng's bank account on March 1.

5. At the end of February, the company owed the utility company $550 and the telephone company $200 for services received during the month. These bills were paid on March 10.

Instructions

(a) For each of the above situations, prepare the monthly adjusting journal entry required at February 28.

(b) Prepare any subsequent transaction entries that occur in the month of March.


(SO 3)

P4-3A The New Age Theatre Ltd. had the following selected transactions during the year ended November 30, 2006:

1. On June 1, the theatre borrowed $5,000 from the Bank of Montreal at an interest rate of 6%. The principal is to be repaid in two years' time. The interest is payable the first of each month.

2. The theatre has eight plays each season. This year's season started October 2006 and ends in May 2007 (one play per month). Season tickets sell for $160 each. On September 1, 150 tickets were sold for the 2006–07 season.

Prepare transaction and adjusting entries.

(SO 2, 3)


Problems: Set A

3. Office supplies on hand amounted to $500 at the beginning of the year. During the year, additional office supplies were purchased for cash at a cost of $1,550. At the end of the year, a physical count showed that supplies on hand amounted to $300.

4. On December 1, 2005, the theatre purchased a truck for $39,000 cash. The estimated useful life of the truck is four years.

5. Upon reviewing its books on November 30, the theatre noted that the utility bill for the month of November had not yet been received. A call to Hydro-Québec determined that the amount owed was $1,350. The bill was paid on December 10.

6. The total payroll is $3,000 every Monday for employee wages earned during a six-day week (Tuesday to Sunday). This year, November 30 falls on a Thursday.

Instructions

(a) Prepare the journal entries to record the original transactions for items 1, 2, 3, and 4.

(b) Prepare the year-end adjusting entries required for each of the above.

(c) Journalize the subsequent cash transaction for the (1) interest paid on December 1 (item 1); (2) payment of the utility bill on December 10 (item 5); and (3) payment of the payroll on December 4 (item 6).

P4-4A A review of the ledger of Come-By-Chance Corporation at December 31, 2006, produces the following account and other data for the preparation of annual adjusting entries:

1. Note Receivable $8,000: The note was issued on September 1, 2006, at an annual interest rate of 7.75%, and matures on June 1, 2007. Interest and principal are to be paid at maturity.

2. Prepaid Insurance $13,100: The company has separate insurance policies on its building and its motor vehicles. Policy B4564 on the building was purchased on September 1, 2005, for $10,320. The policy has a term of two years. Policy A2958 on the vehicles was purchased on January 1, 2006, for $4,500. This policy has a term of 18 months.


(SO 2, 3)


Problems: Set A

3. Buildings $190,250: The company owns two buildings. The first was purchased on September 1, 1995, for $125,250 and has an estimated 30-year useful life. The second was purchased on May 1, 2003, for $165,000 and has an estimated 40-year useful life.

4. Unearned Subscription Revenue $61,200: Come-by-Chance produces a monthly magazine. The selling price of a magazine subscription is $60 for 12 issues. A review of subscription contracts reveals the following:

Subscription Date Number of Subscriptions October 1 220

November 1 310 December 1 490

1,020

5. Salaries Payable $0: There are nine salaried employees.

Salaries are paid every Monday for the previous five-day work week (Monday to Friday). Six employees receive a salary of $625 each per week, and three employees earn $750 each per week. December 31 is a Sunday.

Instructions

(a) Prepare a calculation to show why the balance (before adjustment) in the Prepaid Insurance account is $13,100 and why the balance (before adjustment) in the Unearned Subscription Revenue account is $61,200.

(b) Prepare the adjusting journal entries required at December 31, 2006.


Problems: Set A

P4-5A During the first week of January 2006, Creative Designs Ltd. began operations. Although the company kept no formal accounting records, it did maintain a record of cash receipts and disbursements and had a cash balance of $7,580 at the end of December 2006. Creative Designs approached the local bank for a $10,000 loan and was asked to submit financial statements prepared on an accrual basis.

The following information is available for the year ended December 31, 2006:

Cash Receipts Cash Payments Issue of common shares $18,500 Equipment $17,700 Supplies 8,400 Rent 9,900 Income tax 4,000 Insurance 1,920 Advertising 3,400 Wages 29,900 Telephone 1,000 Dividends 5,000 Design revenue 70,300 ______ $88,800 81,220

Additional information:

1. The equipment has an estimated five-year life. 2. Supplies on hand on December 31 were $1,630. 3. Rent payments included a $750 per month rental fee and a

$900 deposit that is refundable at the end of the two-year lease. 4. The insurance was paid for a one-year period expiring on

March 31, 2007. 5. Wages earned for the last week in December and to be paid in

January 2007 amounted to $525. 6. Design revenue earned but not yet collected amounted to

$3,950.

Convert earnings from cash to accrual basis; prepare financial statements.

(SO 1, 2, 3, 4)


Problems: Set A

7. The company manager used her personal automobile for business purposes: 10,000 km at 35 cents per kilometre. She was not paid for the use of her car but would like to be.

Instructions

Prepare an accrual basis statement of earnings, statement of retained earnings, and balance sheet for the year.

P4-6A Scenic Tours Limited's unadjusted trial balance is presented below.

SCENIC TOURS LIMITEDTrial BalanceJune 30, 2006

Debit Credit Cash $ 3,000 Accounts receivable 2,640 Prepaid insurance 7,320 Supplies 965 Equipment 13,440 Accumulated amortization—equipment $ 3,300 Buses 140,400 Accumulated amortization—buses 46,800 Accounts payable 1,985 Notes payable 54,000 Unearned revenue 14,000 Common shares 30,000 Retained earnings 15,000 Tour revenue 17,110 Salaries expense 9,560 Advertising expense 825 Rent expense 2,175 Gas and oil expense 1,170 Income tax expense 700 ________

Prepare and post adjusting entries; prepare adjusted trial balance.

(SO 2, 3, 4)


Problems: Set A

$182,195 $182,195


1. The insurance policy has a one-year term beginning June 1, 2006.

2. The equipment has an estimated useful life of eight years. The buses have an estimated useful life of six years.

3. A physical count shows $240 of supplies on hand at June 30. 4. The note payable has a 7% interest rate. Interest is paid at the

beginning of each month. 5. Deposits of $1,400 each were received for advanced tour

reservations from 10 school groups. At June 30, three of these deposits have been earned.

6. Bus drivers are paid a combined total of $425 per day. At June 30, three days' salaries are unpaid.

7. A senior citizens' organization that had not made an advance deposit took a scenic tour on June 30 for $1,150. This group was not billed for the services provided until July.

8. Additional advertising costs of $620 have been incurred, but the bills have not been received by June 30.

9. Income taxes payable are estimated to be $65.

Instructions

(a) Prepare a general ledger and enter the trial balance amounts. (b) Prepare and post the adjusting journal entries for the month of

June. (c) Prepare an adjusted trial balance at June 30, 2006.


Problems: Set A

P4-7A On October 31, 2006, the Alou Equipment Repair Corp.'s post-closing trial balance was as follows:

ALOU EQUIPMENT REPAIR CORP.Post-Closing Trial Balance

October 31, 2006

Debit Credit Cash $ 2,790 Accounts receivable 2,910 Supplies 2,000 Equipment 9,000 Accumulated amortization—equipment $ 1,800 Accounts payable 2,300 Unearned service revenue 500 Salaries payable 400 Common shares 10,000 Retained earnings _______ 1,700 $16,700 $16,700

During November, the following transactions were completed:

Nov. 11 Paid $1,100 for salaries due employees, of which $700 is for November and $400 is for

12 Received $1,200 cash from customers in payment of accounts receivable.

14 Received $5,700 cash for services performed in November.

17 Purchased supplies on account, $1,300. 20 Paid creditors $2,500 of accounts payable due. 22 Paid November rent, $300. 25 Paid salaries, $1,100. 27 Performed services on account, $1,900. 29 Received $550 from customers for services to be

provided in future.

Complete accounting cycle through to preparation of financial statements.

(SO 2, 3, 4)


Problems: Set A

Adjustment data:

1. Supplies on hand are valued at $1,000. 2. Accrued salaries payable are $500. 3. The equipment has an estimated useful life of five years. 4. Unearned service revenue of $400 was earned during the

month. 5. Income taxes payable are estimated to be $200.

Instructions

(a) Prepare a general ledger and enter the opening balances. (b) Prepare and post the November transaction entries. (c) Prepare a trial balance at November 30. (d) Prepare and post the adjusting journal entries for the month of

November. (e) Prepare an adjusted trial balance. (f) Prepare a statement of earnings, statement of retained

earnings, and balance sheet for the month.

P4-8A The unadjusted and adjusted trial balances of Ozaki Corp. at the end of its first quarter of operations are shown below:

OZAKI CORP.Trial Balance

September 30, 2006

Unadjusted Adjusted Debit Credit Debit Credit Cash $ 3,250 $ 3,250 Accounts receivable 6,335 7,435 Prepaid rent 1,500 0 Supplies 1,750 1,265 Equipment 15,040 15,040

Prepare adjusting entries and financial statements; assess financial performance.

(SO 2, 3, 4)


Problems: Set A

Accumulated amortization—equipment

$ 0 $ 750

Note payable 6,000 6,000 Accounts payable 4,250 4,460 Salaries payable 0 840 Interest payable 0 90 Income tax payable 0 1,000 Unearned commission revenue

775 550

Common shares 11,000 11,000 Dividends 700 700 Commission revenue 20,160 21,485 Salaries expense 13,000 13,840 Rent expense 0 1,500 Amortization expense 0 750 Supplies expense 0 485 Utilities expense 610 820 Interest expense 0 90 Income tax expense 0 _______ 1,000 _______ $42,185 $42,185 $46,175 $46,175

Instructions

(a) Prepare the quarterly adjusting journal entries that were made. (b) Prepare a statement of earnings, statement of retained

earnings, and balance sheet for the quarter. (c) A friend of yours is considering investing in the company and

asks you to comment on the results of operations and financial position. Is the company performing well or not? Does the financial position look healthy or weak? Use specific information from the financial statements to support your answer.


Problems: Set A

P4-9A The adjusted trial balance for Ozaki Corp. is presented in P4–8A. The company closes its books quarterly.

Instructions

(a) Prepare a general ledger and enter the adjusted trial balance amounts.

(b) Prepare and post the closing entries. (c) Prepare a post-closing trial balance at September 30.

Prepare and post closing entries; prepare post-closing trial balance.

(SO 5)

P4-10A The unadjusted trial balance for River Run Motel Ltd. is presented below:

RIVER RUN MOTEL LTD.Trial BalanceMay 31, 2006

Debit Credit Cash $ 3,200 Accounts receivable 5,900 Prepaid insurance 5,460 Supplies 2,440 Land 50,000 Lodge 84,000 Accumulated amortization—lodge $ 29,400 Furniture 16,800 Accumulated amortization—furniture 6,880 Accounts payable 4,700 Unearned rent revenue 8,750 Mortgage payable 53,000 Common shares 30,000 Retained earnings 10,500 Dividends 1,000 Rent revenue 100,160 Salaries expense 49,350

Prepare and post adjusting entries; prepare adjusted trial balance and financial statements; prepare and post closing entries; prepare post-closing trial balance.

(SO 2, 3, 4, 5)


Problems: Set A

Interest expense 4,620 Insurance expense 1,820 Utilities expense 13,300 Advertising expense 500 Income tax expense 5,000 ________ $243,390 $243,390


1. The annual insurance policy was purchased on May 1 for $5,460.

2. A count of supplies shows $670 of supplies on hand on May 31.

3. The lodge has an estimated useful life of 20 years. The furniture has an estimated useful life of 5 years.

4. Customers must pay a $50 deposit if they want to book a room in advance during the peak period. An analysis of these bookings indicates that 175 deposits were received and credited to Unearned Rent Revenue. By May 31, 65 of the deposits were earned.

5. The mortgage interest rate is 8%. Interest has been paid to May 1; the next payment is due June 1.

6. The May utility bill of $1,210 has not yet been recorded or paid.

7. Salaries of $975 are unpaid at May 31. 8. On May 28, a local business contracted with the River Run

Motel to rent one of its rooms for four months, starting June 1, at a rate of $1,400 per month. An advance payment equal to one month's rent was paid on May 28 and credited to Rent Revenue.

9. On May 31, the River Run Motel has earned $980 of rent revenue from customers who are currently staying in the motel. The customers will only pay the amount owing when they check out in early June.

10. Additional income taxes are estimated to be $500.

Instructions


Problems: Set A

(a) Prepare a general ledger and enter the trial balance amounts. (b) Prepare and post the adjusting journal entries for the month

of May. (c) Prepare an adjusted trial balance at May 31. (d) Prepare a statement of earnings, statement of retained

earnings, and balance sheet for the month. (e) Prepare and post the closing journal entries. (f) Prepare a post-closing trial balance.

P4-11A Corellian Window Washing Inc. opened on July 1, 2006. During July, the following transactions occurred:

July 1 Issued $24,000 of common shares for cash. 1 Purchased a used truck for $36,000, paying $16,000 cash

and the balance with a oneyear, 8% note payable. Interest is due the first of each month.

3 Purchased cleaning supplies for $800 on account. 5 Paid $1,200 cash for a one-year insurance policy

effective July 1. 12 Billed customers $4,500 for cleaning services. 18 Paid $500 on amount owed on cleaning supplies. 20 Paid $1,600 cash for employee salaries. 21 Collected $2,500 cash from customers billed on July 12. 25 Billed customers $2,000 for cleaning services. 31 Paid $250 for gas and oil used in the truck during the

month. 31 Declared and paid a $600 cash dividend.

Instructions

(a) Open general ledger accounts as required. Prepare and post the July transaction entries.

(b) Prepare a trial balance at July 31.

Complete all steps in accounting cycle.

(SO 2, 3, 4, 5)


Problems: Set A

(c) Prepare and post the following adjustments:

1. Services provided but unbilled and uncollected at July 31 were $1,400.

2. An inventory count shows $600 of cleaning supplies on hand at July 31.

3. Expired insurance needs to be recorded. 4. The truck is expected to have an estimated useful life

of five years. 5. Accrued but unpaid employee salaries were $400. 6. Interest on the note payable needs to be accrued. 7. Income taxes payable is estimated to be $1,500.

(d) Prepare an adjusted trial balance at July 31. (e) Prepare a statement of earnings, statement of retained

earnings, and a balance sheet for the month. (f) Prepare and post the closing journal entries. (g) Prepare a post-closing trial balance at July 31.



Problems: Set B

Problems: Set BP4-1B Bourque Corporation began operations on January 1, 2006. Its

fiscal year end is December 31, and it prepares financial statements and adjusts its accounts annually. Selected transactions during 2006 follow:

1. On January 2, purchased office supplies for $3,100 cash. A physical count at December 31 revealed that $670 of supplies were still on hand.

2. Purchased office equipment for $12,000 cash on March 1. The office equipment is estimated to have a useful life of three years.

3. Purchased a one-year, $5,040 insurance policy for cash on June 1.

4. On November 15, Bourque received a $1,275 advance cash payment from three clients for services to be provided in the future. As at December 31, services had been performed for two of the clients ($425 each).

5. On December 15, the company paid $4,500 rent in advance for the month of January 2007.

Instructions

For each of the above events, prepare the journal entry for the original transaction and any adjusting journal entry required at December 31.

Prepare transaction and adjusting entries for prepayments.

(SO 2)


Problems: Set B

P4-2B Hangzhou Corporation had the following selected transactions in the month of November:

1. Hangzhou has a biweekly payroll of $6,000. Salaries are normally paid every second Monday for work completed for the two preceding weeks. Employees work a five-day week, Monday through Friday. Salaries were last paid Monday, November 28 for the ten days worked during the weeks of November 14 and 21. They will be paid next on Monday, December 12.

2. The company has a 6%, $120,000 mortgage payable due in five years. Interest is payable the first of each month. It was last paid on November 1, and will be paid next on December 1.

3. At the end of November, Hangzhou has $500 of invoices that have not yet been sent to customers. It mails these invoices on December 1, and collects the amounts due on December 20.

4. At the end of November, the company earned $20 interest on the cash in its bank account. The bank deposited this amount in the company's bank account on November 30, but the company did not learn of the interest until it received its bank statement on December 5.

5. At the end of November, it was estimated that the company owed $1,000 of income tax. This amount was paid on December 18.

Instructions

(a) For each of the above situations, prepare the monthly adjusting journal entry required at November 30.

(b) Prepare any subsequent transaction entries that occur in the month of December.


(SO 3)


Problems: Set B

P4-3B The Repertory Theatre Ltd. had the following selected transactions during the year ended December 31, 2006:

1. Supplies on hand amounted to $460 at the beginning of the year. During the year, additional supplies were purchased for $1,720 cash. At the end of the year, a physical count showed that supplies on hand amounted to $990.

2. On January 2, 2006, the theatre purchased a used truck for $23,500 cash. The estimated useful life of the truck is five years.

3. On March 1, the theatre borrowed $10,000 from La Caisse Populaire Desjardins at an interest rate of 6.5%. The principal is to be repaid in one year. The interest is paid at the beginning of each month.

4. Repertory Theatre Ltd. has nine plays each season, which starts in September 2006 and ends in May 2007 (one play per month). Season tickets sell for $135 each. On August 1, 200 tickets were sold for the upcoming 2006–07 season.

5. Every Monday, the total payroll for the theatre is $3,000 for wages earned during a six-day work week (Tuesday–Sunday). This year, December 31 falls on a Sunday. Wages were last paid (and recorded) on Monday, December 25.

6. Upon reviewing its books on December 31, the theatre noted that a telephone bill for the month of December had not yet been received. A call to Aliant determined that the telephone bill was $375. The bill was paid on January 12.

Instructions

(a) Prepare the journal entries to record the original transactions for items 1, 2, 3, and 4.

(b) Prepare the year-end adjusting entries required for each of the above.

(c) Journalize the subsequent cash transaction for the (1) interest paid on January 1 (item 3); (2) payment of the payroll on January 1 (item 5); and (3) payment of the telephone bill on January 12 (item 6).

Prepare transaction and adjusting entries.

(SO 2, 3)


Problems: Set B

P4-4B A review of the ledger of Greenberg Corporation at January 31, 2006, produces the following data for the preparation of annual adjusting entries:

1. Prepaid Advertising $14,160: This balance consists of payments on two advertising contracts. The contracts provide for monthly advertising in two trade magazines and the first advertisement runs in the month in which the contract is signed. The terms of the contracts are as follows:

Contract Date Amount Number of Magazine Issues A650 May 1 $6,240 12 B974 Sept. 1 7,920 24

$14,160

2. Salaries Payable $0: There are eight salaried employees.

Salaries are paid every Saturday for a six-day work week (Monday–Saturday). Six employees receive a salary of $750 each per week, and two employees earn $550 each per week. January 31 is a Tuesday.

3. Unearned Rent Revenue $351,000: The company began subleasing office space in its new building on December 1. At January 31, the company had the following rental contracts that are paid in full for the entire term of the lease:

Date Term (in months)

Monthly Rent

Number of Leases

Rent Paid

Dec. 1 6 $4,500 5 $135,000 Jan. 1 6 9,000 4 216,000 $351,000

4. Note Payable $85,000: This balance consists of a one-year, 8%

note issued on June 1. Interest is payable at maturity.

Instructions

Prepare the adjusting journal entries at January 31, 2006.


(SO 2, 3)


Problems: Set B

P4-5B The Radical Edge Ltd., a ski tuning and repair shop, opened November 1, 2005. The company carefully kept track of all its cash receipts and cash payments and had a cash balance of $5,145 at the end of its first ski season, April 30. The following information is available at April 30, 2006:

Cash Receipts Cash Payments Issue of common shares $20,000 Repair equipment $34,520 Rent 1,575 Advertising 460 Utility bills 950 Wages 3,600 Income tax 7,000 Ski and snowboard repair services

33,250 _______

$53,250 $48,105


1. The repair equipment has an estimated useful life of eight years.

2. The company rents space at a cost of $225 per month on a one-year lease. The lease contract requires payment of the first and last months' rent in advance, which was done.

3. At April 30, $120 is owed for unpaid wages. 4. At the end of April, customers also owe The Radical Edge

$720 for services they have received but have not yet paid for.

Instructions

Prepare an accrual basis statement of earnings, statement of retained earnings, and balance sheet for the six months ended April 30, 2006.

Convert earnings from cash to accrual basis; prepare financial statements.

(SO 1, 2, 3, 4)


Problems: Set B

P4-6B Ortega Limo Service Ltd.'s unadjusted trial balance is presented below:

ORTEGA LIMO SERVICE LTD.Trial Balance

December 31, 2006

Debit Credit Cash $ 12,400 Accounts receivable 3,200 Prepaid insurance 3,600 Prepaid rent 1,225 Supplies 2,500 Automobiles 58,000 Accumulated amortization—automobiles

$ 14,500

Office furniture 16,000 Accumulated amortization—office furniture

4,000

Note payable 46,000 Unearned service revenue 3,600 Common shares 10,000 Retained earnings 7,600 Dividends 8,820 Service revenue 110,600 Salaries expense 57,000 Interest expense 3,105 Rent expense 14,700 Repairs expense 6,000 Gas and oil expense 9,300 Income tax expense 450 ________ $196,300 $196,300


Prepare and post adjusting entries, prepare adjusted trial balance.

(SO 2, 3, 4)


Problems: Set B

1. Service revenue earned but unbilled is $3,000 at December 31. 2. The insurance policy has a one-year term beginning April 1. 3. The automobiles were purchased on January 2, 2005, and have

an estimated useful life of four years. The office furniture was purchased on July 2, 2003, and has an estimated useful life of 10 years.

4. Interest on the 9% note payable is paid on the first day of each quarter (January 1, April 1, July 1, and October 1).

5. One of Ortega's customers paid in advance for a six-month contract at the rate of $600 per month. The contract began on November 1.

6. Drivers' salaries total $225 per day. At December 31, three days of salaries are unpaid.

7. Repairs of $650 have been incurred for automobiles, but bills have not been received prior to December 31. (Use Accounts Payable.)

8. On December 28, Ortega paid $1,225 for January 2007 rent. 9. Income taxes payable are estimated to be $50.

Instructions

(a) Prepare a general ledger and enter the trial balance amounts. (b) Prepare and post the adjusting journal entries for the year. (c) Prepare an adjusted trial balance at December 31, 2006.

P4-7B On August 31, 2006, the Rijo Equipment Repair Corp.'s post-closing trial balance was as follows:

Complete accounting cycle through to preparation of financial statements.

(SO 2, 3, 4)


Problems: Set B

RIJO EQUIPMENT REPAIR CORP.Post-Closing Trial Balance

August 31, 2006

Debit Credit Cash $ 4,880 Accounts receivable 3,720 Supplies 800 Equipment 15,000 Accumulated amortization—equipment $ 1,500 Accounts payable 3,100 Unearned service revenue 400 Salaries payable 700 Common shares 10,000 Retained earnings _______ 8,700 $24,400 $24,400

During September, the following transactions were completed:

Sept. 8 Paid $1,100 for salaries due to employees, of which $400 is for September and $700 is for August salaries payable.

10 Received $1,200 cash from customers in payment of accounts.

12 Received $4,400 cash for services performed in September.

17 Purchased supplies on account, $1,000. 20 Paid creditors $3,500 of accounts payable due. 22 Paid September and October rent, $1,000 ($500 per

month). 22 Paid salaries, $1,100. 27 Performed services on account, $800. 29 Received $650 from customers for services to be

provided in the future. 30 Paid income tax for month, $600.


Problems: Set B

Adjustment data:

1. Supplies on hand total $500. 2. Accrued salaries payable are $600. 3. The equipment has a useful life of five years. 4. Unearned service revenue of $350 has been earned.

Instructions

(a) Prepare a general ledger and enter the opening balances. (b) Prepare and post the September transaction entries. (c) Prepare a trial balance at September 30. (d) Prepare and post the adjusting journal entries for the month of

September. (e) Prepare an adjusted trial balance. (f) Prepare a statement of earnings, statement of retained

earnings, and balance sheet for the month.

P4-8B The unadjusted and adjusted trial balances for Grant Advertising Agency Limited as at December 31, 2006, follow:

GRANT ADVERTISING AGENCY LIMITEDTrial Balance

December 31, 2006

Unadjusted Adjusted Debit Credit Debit Credit Cash $ 11,000 $ 11,000 Short-term investments

10,850 10,850

Accounts receivable

18,650 19,750

Art supplies 7,200 1,265 Prepaid insurance

2,400 800

Prepare adjusting entries and financial statements; assess financial performance.

(SO 2, 3, 4)


Problems: Set B

Printing equipment

66,000 66,000

Printing equipment—accumulated amortization

$ 26,400 $ 39,600

Accounts payable

4,200 4,800

Interest payable 0 700 Note payable 10,000 10,000 Unearned advertising revenue

7,100 6,200

Salaries payable 0 1,625 Income tax payable

0 7,000

Common shares 20,000 20,000 Retained earnings

10,400 10,400

Dividends 2,000 2,000 Advertising revenue

58,600 60,600

Salaries expense 12,000 13,625 Insurance expense

0 1,600

Interest expense 0 700 Amortization expense

0 13,200

Art supplies expense

0 5,935

Rent expense 6,600 7,200 Income tax expense

0 ________ 7,000 ________

$136,700 $136,700 $160,925 $160,925

Instructions


Problems: Set B

(a) Prepare the annual adjusting journal entries that were made. (b) Prepare a statement of earnings, statement of retained

earnings, and balance sheet for the year. (c) A friend of yours is considering investing in the company and

asks you to comment on the results of operations and financial position. Is the company performing well or not? Does the financial position look healthy or weak? Use specific information from the financial statements to support your answer.

P4-9B The adjusted trial balance for Grant Advertising Agency Limited is presented in P4–8B.

Instructions

(a) Prepare a general ledger and enter the adjusted trial balance amounts.

(b) Prepare and post the closing entries. (c) Prepare a post-closing trial balance at December 31.

Prepare and post closing entries; prepare post-closing trial balance.

(SO 5)

P4-10B The unadjusted trial balance for Highland Cove Resort Inc. is presented below, immediately before annual adjusting entries are made:

HIGHLAND COVE RESORT INC.Trial Balance

August 31, 2006

Debit Credit Cash $ 18,870 Prepaid insurance 6,360 Supplies 3,495 Land 25,000 Cottages 145,000 Accumulated amortization—cottages $ 34,800 Furniture 28,600

Prepare and post adjusting entries; prepare adjusted trial balance and financial statements; prepare and post closing entries; prepare post-closing trial balance.

(SO 2, 3, 4, 5)


Problems: Set B

Accumulated amortization—furniture 10,725 Accounts payable 6,500 Unearned rent revenue 36,200 Mortgage payable 60,000 Common shares 35,000 Retained earnings 23,500 Dividends 5,000 Rent revenue 247,500 Salaries expense 153,000 Utilities expense 37,600 Interest expense 4,400 Repair expense 14,400 Income tax expense 12,500 ________ $454,225 $454,225


1. The annual insurance policy was purchased on May 31 for $6,360.

2. A count of supplies on August 31 shows $760 of supplies on hand.

3. The cottages have an estimated useful life of 25 years. The furniture has an estimated useful life of 8 years.

4. Customers must pay a $100 deposit if they want to book a cottage during the peak period. An analysis of these bookings indicates 362 deposits were received and credited to Un-earned Rent Revenue. All but 45 of these deposits have been earned by August 31.

5. Salaries of $1,100 were unpaid at August 31. 6. The August utility bill of $1,840 has not yet been recorded

or paid. 7. On August 25, a local business contracted with Highland

Cove to rent one of the cottages for six months, starting October 1, at a rate of $1,500 per month. An advance payment equal to two months' rent was received on August 31 and credited to Rent Revenue.


Problems: Set B

8. The mortgage interest rate is 8%. Interest has been paid to August 1; the next payment is due September 1.

9. On August 31, Highland Cove has earned but not yet received $1,360 of rent revenue from customers who are currently using the cottages. The customers will pay this amount when they check out in September.

10. Additional income taxes payable are estimated to be $1,000.

Instructions

(a) Prepare a general ledger and enter the trial balance amounts. (b) Prepare and post the adjusting journal entries for the year. (c) Prepare an adjusted trial balance at August 31. (d) Prepare a statement of earnings, statement of retained

earnings, and balance sheet for the year. (e) Prepare and post the closing entries. (f) Prepare a post-closing trial balance.

P4-11B Ewok's Carpet Cleaners Ltd. opened on March 1, 2006. During March, the following transactions were completed:

Mar. 1 Issued $10,000 of common shares for cash. 1 Purchased a used truck for $26,000, paying $6,000 cash

and signing a three-year, 8% note payable for the balance. Interest is due the first of each month.

2 Paid rent for the month, $500. 3 Purchased cleaning supplies for $1,200 on account. 5 Paid $1,800 cash for a one-year insurance policy

effective March 1. 14 Billed customers $4,800 for cleaning services. 18 Paid $700 on amount owed on cleaning supplies. 20 Paid $1,500 cash for employee salaries. 21 Collected $3,600 cash from customers billed on March

14. 28 Billed customers $4,500 for cleaning services. 31 Paid $400 for gas and oil for the truck during the month.

Complete all steps in accounting cycle.

(SO 2, 3, 4, 5)


Problems: Set B

31 Paid a $1,000 cash dividend.

Instructions

(a) Open general ledger accounts as required. Prepare and post the March transaction entries.

(b) Prepare a trial balance at March 31. (c) Prepare and post the following adjustments:

1. Services provided but unbilled and uncollected at March 31 were $1,600.

2. An inventory count shows $400 of cleaning supplies on hand at March 31.

3. Expired insurance needs to be recorded. 4. The truck is expected to have a useful life of five

years. 5. Interest on the note needs to be accrued. 6. Accrued but unpaid employee salaries were $700. 7. Income tax for the month is estimated to be $1,400.

(d) Prepare an adjusted trial balance at March 31. (e) Prepare a statement of earnings, statement of retained

earnings, and a balance sheet for the month. (f) Prepare and post the closing journal entries. (g) Prepare a post-closing trial balance at March 31.



Broadening Your Perspective


Financial Reporting and Analysis

Financial Reporting Problem: Loblaw

BYP4-1 The financial statements of Loblaw are presented in Appendix A at the end of this book.

Instructions

(a) Does Loblaw report any prepayments on its balance sheet? If so, identify each item that is a prepaid expense or unearned revenue. Using the statement of earnings, indicate the other account that is likely used in preparing adjusting entries for these items.

(b) Does Loblaw report any accruals on its balance sheet? If so, identify each item that is an accrued revenue or accrued expense. Using the statement of earnings, indicate the other account that is likely used in preparing adjusting entries for these items.

(c) Reconstruct the summary closing journal entries prepared by Loblaw at January 3, 2004.

Comparative Analysis Problem: Loblaw and Sobeys

BYP4-2 The financial statements of Sobeys are presented in Appendix B, following the financial statements for Loblaw in Appendix A.

Instructions

(a) Identify two accounts on Sobeys' balance sheet which show that Sobeys uses accrual accounting. In each case, identify the statement of earnings account that would be affected by the adjustment process.

(b) Identify two accounts on Loblaw's balance sheet which show that Loblaw uses accrual accounting. In each case, identify the statement of earnings account that would be affected by the adjustment process.

Research Case


http://www.sobeys.com/

http://www.loblaw.com/


BYP4-3 The article “PwC Identifies Best Practices for Monthly Close” appears in the February 1, 2005, issue of the Accounting Department Management Report, published by the Institute of Management and Administration. In this article, PricewaterhouseCoopers (PwC) reports findings from its global best practices survey. It finds that leading companies are able to close their books in a single day.

Instructions

Read the article and answer these questions:

(a) What industry sectors are generally able to close their books in only one day? What industry sectors can take as many as 10 days to close their books?

(b) PwC identifies 11 attributes of a fast close. Identify any five of these.

Interpreting Financial Statements

BYP4-4 Google Inc. is the most used site in the world for Internet searches. An excerpt from the notes to Google's 2004 financial statements follows:

Instructions


http://www.google.com/


(a) When does Google recognize the revenue from its advertising services? From its search services? (b) When would Google likely incur the expenses related to its advertising and search services? Explain how the

matching principle does, or does not, relate to Google's revenue recognition practices. (c) Google reports U.S. $36.5 million of deferred revenue in the current liabilities section of its balance sheet.

“Deferred revenue” is another name for unearned revenue. Under what circumstances should Google record unearned revenue from its advertising services? From its search services?

A Global Focus

BYP4-5 Internet Initiative Japan Inc. (IIJ) is one of Japan's leading Internet-access and comprehensive Internet solution providers. In its 2004 annual report, it reported the following selected information (in millions):

2004 2003 Cash and cash equivalents ¥12.3 ¥ 3.6 Accounts receivable 9.0 10.3 Total revenues 38.8 44.0 Net loss 0.1 16.5 Cash provided by operating activities 1.9 1.6

Instructions

(a) Explain how the company could have reported a net loss in both fiscal years and still have a positive cash flow from operating activities.

(b) Explain how the company's cash from operating activities could be ¥1.9 million in 2004, while its cash and cash equivalents balance increased by ¥8.7 million to ¥12.3 million in 2004.

(c) During 2004, the company's revenues were ¥38.8 million. At the beginning of the year, it had ¥10.3 million of accounts receivable. At the end of the year, it had ¥9 million of accounts receivable. Based on this data, determine the amount of cash collected from customers during the year.

Financial Analysis on the Web

BYP4-6 This case reviews the revenue recognition policies used by Rogers Communications Inc. and its subsidiary, the Toronto Blue Jays Baseball Club.

Instructions

Specific requirements of this Web case can be found on the Toolkit website.


http://www.iij.ad.jp/

http://www.rogers.com/

http://www.rogers.com/

http://toronto.bluejays.mlb.com/


Critical Thinking

Collaborative Learning Activity

BYP4-7 Air Canada sells tickets for airline flights that can vary a great deal in price and conditions. For example, at the low end of the pricing scheme, you can purchase a nonrefundable ticket from Fredericton to Toronto for a one-way “Tango” fare of $238. At the high end of the pricing scheme, you can purchase a fully refundable ticket from Fredericton to Toronto for a one-way “Latitude” fare of $426.

Assume that Air Canada's management team is brainstorming its options in terms of recognizing the revenue from the different categories of fares. One member of the management team says it should recognize the revenue as soon as the tickets are sold for the Tango-type fares because these tickets are nonrefundable. Another member of the management team states that revenue should be recognized when passengers pick up their tickets and pay for the flight. “What about when the boarding passes are collected at the gate?” a third asks. “Or when passengers arrive at their destinations?” a fourth adds.

Instructions

With the class divided into groups, do the following:

(a) Each group will be assigned, or should choose, one of the above fare types (Tango or Latitude). Evaluate the effect of each of the revenue recognition choices on recorded revenues, expenses, and net earnings for your assigned fare type.

(b) Determine the point at which you think Air Canada should recognize the revenue from flight ticket sales for your fare type. Explain why you believe your chosen point of revenue recognition is the best: refer to appropriate generally accepted accounting principles in your answer.

Communication Activity

BYP4-8 There are many people today who believe that cash is a better indicator of a company's future success than net earnings. This notion gained popularity after many reports of corporate financial scandals where management was apparently able to manipulate prepayments and accruals to influence net earnings.

Instructions

Write a memo discussing whether you believe cash is a more reliable performance measure than net earnings. Include in your memo the answers to the following questions:

(a) What is the difference between accrual-based net earnings and cash? (b) Do you believe that it is possible for management to manipulate net earnings? If so, identify one way that

management might be able to increase net earnings by manipulating prepayments or accruals. (c) Do you believe that it is possible for management to manipulate cash? If so, identify one way that management

might be able to increase cash flow.


http://www.aircanada.com/


Ethics Case

BYP4-9 Die Hard Corporation is a pesticide manufacturer. Its sales declined greatly this year because of new legislation that outlaws the sale of several Die Hard chemical pesticides. During the coming year, Die Hard will have environmentally safe and competitive chemicals to replace these discontinued products. Sales in the next year are expected to be much higher than those of any prior year. The decline in this year's sales and profits appears, therefore, to be a one-year aberration.

Even so, the company president believes that a large dip in the current year's profits could cause a significant drop in the market price of Die Hard's shares and make the company a takeover target. To avoid this possibility, he urges Carole Denton, the company's controller, to accrue every possible revenue and to defer as many expenses as possible when making this period's year-end adjusting entries. The president says to Carole, “We need the revenues this year, and next year can easily absorb expenses deferred from this year. We can’t let our share price be hammered down!” Carole did not get around to recording the adjusting journal entries until January 17, but she dated the entries December 31 as if they were recorded then. Carole also made every effort to comply with the president's request.

Instructions

(a) Who are the stakeholders in this situation? (b) What are the ethical considerations of the president's request and Carole's dating

the adjusting entries December 31? (c) Can Carole aggressively accrue revenues and defer expenses and still be ethical?

Serial Problem(Note: This serial problem started in Chapter 1 and continued in chapters 2 and 3. From the information gathered through Chapter 3, follow the instructions below using the general ledger accounts you have already prepared.)

BYP4-10 Cookie Creations is gearing up for the Christmas season. During the month of December 2005, the following transactions occur:

Dec. 1 An assistant is hired at an hourly wage of $8 to help Natalie with cookie making and some administrative duties.

5 Natalie teaches the class that was booked on November 25. The balance outstanding is received. 8 A cheque is received for the amount due from the neighbourhood school for the class given on November

30. 9 The local school board pays $625 in advance for five classes that are to be given during December and

January. 15 The cell phone invoice outstanding at November 30 is paid.



19 A deposit of $50 is received on a cookie class scheduled for early January. 23 Additional revenue earned during the month for cookie-making classes amounts to $3,500. (Natalie has

not had time to account for each class individually.) Cash of $3,000 has been collected and $500 is still outstanding. (This is in addition to the December 5 and December 9 transactions.)

23 Additional supplies purchased during the month for sugar, flour, and chocolate chips amount to $1,250 cash.

23 A cheque is issued to Natalie's assistant for $800. Her assistant worked approximately 100 hours from when she was hired until December 23.

23 Natalie is paid $500 cash for her salary earned to date. 28 A dividend of $100 is paid to the common shareholder (Natalie).

As at December 31, Cookie Creations' year end, the following adjusting entry data is available:

1. A count reveals that $50 of brochures and posters remains at the end of December. 2. Amortization is recorded on the baking equipment purchased in November. The baking equipment has a

useful life of five years. (Assume that only one month's worth of amortization is required.) 3. Interest on the note payable is accrued. (Assume that one and a half months of interest accrued during

November and December.) 4. One month's worth of insurance has expired. 5. Natalie is unexpectedly telephoned on December 28 to give a cookie class at the neighbourhood community

centre. The community centre is invoiced in early January for $375. 6. A count reveals that $1,000 of baking supplies were used. 7. A cell phone invoice is received for $75. The invoice is for services provided during the month of December

and is due on January 15. 8. Because the cookie-making class occurred unexpectedly on December 28 and is for such a large group of

children, Natalie's assistant helps out. Her assistant worked seven hours at a rate of $8 per hour. 9. An analysis of the Unearned Revenue account reveals that two of the five classes paid for by the local school

board on December 9 have still not been taught by the end of December. The $50 deposit received on December 19 for another class also remains unearned.

10. Cookie Creations Ltd. expects to pay income tax at a rate of 15% on earnings before income tax.

Instructions

(a) Journalize the above transactions. (b) Post the December transactions. (Use the general ledger accounts that you prepared in Chapter 3.) (c) Prepare a trial balance at December 31. (d) Prepare and post adjusting journal entries for the month of December. (e) Prepare an adjusted trial balance at December 31. (f) Prepare a statement of earnings and a statement of retained earnings for the two-month period ending

December 31, and a balance sheet at December 31. (g) Prepare and post the closing entries. (h) Prepare a post-closing trial balance at December 31.


Glossary

GlossaryAccrual basis accounting An accounting basis in which transactions that change a company’s financial statements are recorded in the periods in which the events occur, rather than in the periods in which the company receives or pays cash.

Accrued expenses Expenses incurred but not yet paid in cash or recorded.

Accrued revenues Revenues earned but not yet received in cash or recorded.

Adjusted trial balance A list of accounts and their balances after all adjustments have been made.

Adjusting entries Journal entries made at the end of an accounting period because of the time period assumption and to ensure that the revenue recognition and matching principles are followed.

Amortization The process of allocating the cost of a longlived asset to expense over its useful life.

Cash basis accounting An accounting basis in which revenue is recorded only when cash is received, and an expense is recorded only when cash is paid.

Closing entries Entries at the end of an accounting period to transfer the balances of temporary accounts (dividends, revenues, and expenses) to the permanent shareholders’ equity account Retained Earnings.

Contra asset account An account that is offset against (reduces) an asset account on the balance sheet.

Income Summary A temporary account used in closing revenue and expense accounts.

Matching principle The principle that states that efforts (expenses) must be matched with accomplishments (revenues).

Net book value The difference between the cost of an amortizable asset and its accumulated amortization.

Permanent accounts Balance sheet accounts whose balances are carried forward to the next accounting period.

Post-closing trial balance A list of permanent accounts and their balances after closing entries have been journalized and posted.


Glossary

Prepaid expenses Expenses paid in cash and recorded as assets before they are used or consumed.

Revenue recognition principle The principle that states that revenue must be recognized in the accounting period in which it is earned.

Straight-line method of amortization An amortization method in which amortization expense is calculated as the cost divided by the useful life.

Temporary accounts Revenue, expense, and dividend accounts whose balances are transferred to Retained Earnings at the end of an accounting period.

Unearned revenue Cash received before revenue is earned and recorded as a liability until it is earned.

Useful life The length of service of a productive facility.



4-accrual accounting concepts

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